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This is one way to profit in the current markets. It actually works great.

By sleepin'dawg ·
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I received this email this morning and it pretty much explains my current investing strategy. I thought it important enough to pass it along. This is almost the exact same strategy I've been following since before this market fiasco started and while my per share prices are down, I've added so many more shares of value companies to my portfolio, plus made money on the options, that I'm actually ahead. There's an old expression, Anyone can make money in a bull market but it takes real skill to make money during a bear market. To further underline that point, try to remember the end fate of bulls; they get slaughtered for bear food.

The Best Investment Strategy For A Market Like This... The Truth About Covered Call Investing

Friday, November 14, 2008
by Karim Rahemtulla
With the stock market still crazier than a drunken leprechaun and this year's economic and financial woes leaving many consumers seriously strapped for cash - just as the holiday season rolls in - I want to make sure you know one thing...

Yes, this is a tough market. No doubt about that. But far from throwing in the towel or panicking about it, in every market, there are strategies that can help you recoup losses, make money and even protect investments from future shocks.

Panic At Your Peril

Believe me, there are times I'm sure the last thing you want to hear about is the stock market. Sometimes, that's true for me, too! And I understand that with each day that your portfolio losses grow, that's when panic and/or depression sets in. When I was a rookie investor, I felt that way, because I didn't think there was anything I could do.

But take it from me: At times like this, you must avoid panicking at all costs.

The thing is, markets are not one-way streets. And although it's tough to argue that fact when we're in a midst of an extreme correction that can only be compared to a 100-year flood, events like this can happen and we simply have to deal with it.

So this is not the time for a pity party or complaining. Here's why...

Picking Through The Rubble For Strength And Extreme Value

While the stock market looks like a tornado has whipped through it over the past few months, lurking in the rubble are companies trading at valuations we haven't seen for decades.

What's more, they're good, solid companies. True survivors that will allow you to recoup your losses as the market bounces back. And while it's important to note that this may take some time, if you don't have a horse in the race, you have no chance of winning, or even placing.

So where does that leave investors like you and me? What's the best way forward?

An Investor's Best Friend

Over the past few months, one investment strategy has risen to the top of the pack.

In fact, people whom I never thought would embrace it are now raving about its benefits. But understand that this is a strategy for those who can look beyond the hype and promise of home run, triple-digit return promises and instead towards something that many investors crave right now: Steady, consistent income.

And it's a strategy that has taught me that there are ways to benefit from volatile and even falling markets - perfect for the current climate.

I'm referring to covered call investing.

In a nutshell, the strategy has two parts...

You buy shares of a company.
You sell call options against your shares.
What does this accomplish? First, it allows you to reduce your basis in the share price by collecting a special "dividend" (known as a premium) from the proceeds of the options that you sold.

In a flat or range bound market, you can do this over and over again, consistently reducing your original cost and setting yourself up for big returns in the future. Here's how it works...

The Breakdown Of A Covered Call Trade

Let's say you like General Electric (NYSE: GE).

You buy shares of GE at the current price around $17.

Against this position you sell GE $20 call options that expire in January 2009.

What this means is that you're obligated to sell your GE in January at $20 if - and only if - the share price is over $20 at the time. If not, you keep your GE shares and any proceeds you received for selling the option.

If GE closes below $20 at expiration in January, you can sell another option and collect more money and continue to lower your cost. The caveat here is that if GE closes above $20, you still only get $20. The loss of the upside is the price you pay for the safety of lowering your downside.

The money you receive for selling the option(s) is called the premium. For example, if GE January $20 options are trading for $1, you will receive $1 for each share that you own and have sold an option against it.

Remember, options trade in contracts, with each contract equal to 100 shares. So if you own 100 shares of GE, you can sell one call option contracts. At $1 per contract, you will receive $100 - 1 contract x 100 shares per contract x $1.

So let's say you sell just one call option against your 100 shares. With the $1 premium, your cost in GE is now $16 and your upside is $4 - the difference between the strike price and your cost. The extra dollar you picked up is like an extra 6% dividend ($1 divided by $16 (your cost).

But I like to put my own twist on this. It's not exactly the conventional way of covered call investing - but it's a big reason why my Strategic Income service has managed to notch up a 70% win rate over the past 11 years. Here's what I do...

An Even Better Way To Trade Covered Calls

Instead of selling a call option above the price at which you buy the underlying shares, you sell it below that price.

My rationale is this: We're essentially saying to the market that we want to own GE shares... but we want to own them at a lower price. Our price. Here's how it works.

~ We buy GE at $17

~ We then sell the January 2009 $15 calls against the position.

For doing so, we'll automatically get $2 back - known as the "intrinsic value" ($17 minus $15.) But we'll get more.

For time and risk, we'll pick up an extra $1 to make the total premium $3 ($2 intrinsic plus $1 for time and risk). That lowers our original cost in GE to $14.

So we stand to make $1 profit on the trade, as long as GE closes above $15 in January. If this happens, our return is about 7% in a couple of months - a full $2 below the current price.

You see how this works? We're not betting that the shares are going higher... we're actually saying that if they go nowhere or even lower, we still stand to make money as long as the shares are above our cost of $14 ($17 purchase price minus $3 premium received).

Three Chances To Win In A Market Like This? I'll Take It!

The bottom line here is that we have three chances to win...

If GE shares rise, we win.
If GE remains flat, we win.
If GE shares fall - but not under $14 - we win.
I don't know about you, but I like those odds - especially in a market like this.

But what happens if GE slides under $14?

Well, since our cost was lower than the $17 we paid for the shares, there is an excellent chance that we'll be able to sell more options and reduce our cost even further, while increasing our upside potential.

Do You Want To Win On 70% Of The Trades You Make?

As I said, covered call investing is an excellent strategy to use in a market like this. Even the mainstream financial media have picked up on it recently. But beware that you don't get suckered in by one of the hyped-up, but very raw "Johnny-Come-Lately" products out there, which over-promise, but under-deliver. With the twist we put on it in my Strategic Income service, we've won over 70% of the time.

And even though we take the occasional defeat, the loss is usually limited since we've already reduced our cost so much. And in some cases - like one trade we have in our portfolio right now - we're in the position of owning one company for absolutely nothing because we've sold calls against it at opportune times.

And you'd better believe that there's nothing quite like a feeling of owning something of value for nothing - especially in this market!

So that's the theory behind arguably the most powerful, income-producing investment strategy on the market. As far as I'm concerned, it works quite nicely; thank-you very much. I hope it works for you too, and lets you keep your head above water.

Dawg ]:)

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A lot of what you say about cutting and pasting is true but..............

by sleepin'dawg In reply to Dawg - two observations

if you were as deficient as I am in keyboard skills, that's the route you would choose when you found a well written article that coincided with your own thoughts and opinions.

I hesitate to share my thoughts on investment strategies,directly because much of what I do is most definitely not for everyone and I don't want to feel responsible for anyone losing money. However, that being said, the current mortgage crisis reminds me a lot about the S&L scandal back in the late eighties. That was one of the things that really lifted me up. I was buying realestate in Florida, Texas and various other places for mere pennies on the dollar. There is or was a rule that banks are not permitted to own realestate and at one point I was bidding on a golf course in South Carolina. I didn't get it but only because I was outbid by someone else. Did get a strip mall in that area though. I haven't really had time to look into this yet but something tells me, that if similar conditions don't apply yet, they will and the opportunities for investment should be even greater this time around because of the size and breadth if this financial debacle. It's worldwide but then so will be the opportunities Stay tuned, when I get a chance I'll PM you what I decide. I don't know if you're still in CO but I may have to be in Boulder, on business, in the not too distant future and was thinking of tying that in with some skiing in Vail or Aspen. Maybe we could get together.

Dawg ]:)

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I only say that because. . . . .

by maxwell edison In reply to A lot of what you say abo ...

.....some of us are interested in your opinion.

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Further to the above.

by sleepin'dawg In reply to I only say that because. ...

As I said, I'm curious about the similarities between the current mortgage foreclosure situation as compared to the S&L foreclosure mess of the late eighties. This morning I received a couple of spams from some outfit called Zitabid offering to accept bids on foreclosures. My antennae for easy profits are starting to twitch. I wouldn't bid on anything sight unseen, never mind over the net, but I'm experiencing a sort of Pavlovian response regarding this, so I'll be starting to look into this asap, probably starting tomorrow.

I'll probably get more of this type of spam, but not to worry. I buy nothing without doing my research and due diligence, but my gut is telling me, that like the S&L fiasco, there's money to be made here, lots of it.

I did extremely well during the S&L business, and with that experience behind me, it should help with this situation. I expect there will be some differences but they should be minor in nature. The strategy during the S&L was based upon assumable mortgages but I suspect this time around, more cash will be required. We'll just have to see how all this is going to play out. I'll be checking out the situation in and around New England and perhaps out in Colorado and Nevada, near our other branches, although from what I hear, the foreclosure situation in Nevada at present, is insanely glutted at the moment. CO??? Who knows?? I haven't been there since July and when I was, I was working under time pressure and wasn't thinking anything about local realestate conditions.

Dawg ]:)

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