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Weekend EditionThe Best of The S&A DigestSaturday, October 18, 2008  What a horrible month... I never dreamed we'd stop out of "no risk" picks we've owned for years. Whatever happens, follow your stops. The selling has gone way beyond any rational explanation... so who knows how much farther it will go?Why is this happening? The market clearly doesn't have confidence in the government's efforts to prevent bankruptcies and liquidations. There aren't any pain-free ways to get out of a giant credit bubble.
The good news is that these situations create wonderful buying opportunities for more prudent and patient people.
So what should you do? We repeat our advice from last week: Don't blow it. This is probably the one chance in your life you'll have to buy world-class blue-chip companies for less than five times earnings. You should be buying. Dip your toe in, at least.
The best way to buy? Selling puts. This is the best market, ever, for selling puts against stocks you want to buy. Warren Buffett is doing it – he's selling puts on Burlington Northern, the railroad.
Selling a put allows you to get paid a hefty premium for agreeing to buy a stock at a lower price. For example, on Monday, my subscribers agreed to buy Bank of America at $15 – 34% lower than where it was trading – between now and January 16, 2009. For agreeing to that, they earned $1.85 per share. That's a 12.3% premium to the conversion price, for a 49% annualized yield. And the stock would have to fall 34% in three months to trigger the conversion. The chances are very good my readers will simply take their 12% for doing absolutely nothing.
On the other hand, if the stock does fall that far, since they've already been paid $1.85 for agreeing to buy it, their real capital cost will only be $13.15. That's a 47% discount from its current price. It's hard to see how you can lose money in this situation, no matter what happens.
You can think of selling puts in today's environment as selling hurricane insurance after the storm has already come and gone.
The fear lasts longer than the carnage. And right now, that means free money in your pocket. The opportunity to sell puts and make huge gains – without ever buying stocks – has never been greater.
Why should you sell puts instead of simply buying the stocks? If you're uncertain about how long this bear market might last, selling puts allows you to earn cash immediately, even if the stocks don't move at all. And the yields available now from selling puts are incredible.
You can make 48%, on an annualized basis, selling puts on incredibly cheap super-high-quality stocks. That's more money than you're likely to make owning stocks in a single year, ever.
The secret to selling puts successfully is to find situations where you'll make around 50% annualized on the premium and where the strike price (the amount you would buy the stock for if the put is exercised) is significantly below the company's intrinsic value.
For example, one of the stocks I told my subscribers about was offered $26 per share this year in a takeover bid. Our strike price on this put is $10 per share – that's a 61% discount to fair value on the stock. And about 80% of this company's assets are cash. There's no legitimate risk here for us. And our entire obligation will expire on January 16, 2009.
Unless the company practically goes bankrupt before then – which is impossible thanks to its top-selling products and huge cash cushion – we'll make a lot of money.
There are a few good primers on the Internet that go over the basics of writing (selling) puts. Yahoo's primer is here and Wikipedia's is here.
If you want to get involved (and you should), make sure to have a discussion with your broker. Yes, you'll actually have to pick up the phone and call someone. You must be approved for selling options. You're selling insurance. Your broker has to certify you're good for the obligation.
Also, if you've never traded options before, it's important for your broker to explain the wide spreads between what you'll get for selling an option and what it costs to buy an option. And he can discuss using limit orders to minimize the effect of the spreads. It's not hard once you've done it once or twice, but it's a lot different than simply buying a stock. Let someone help you do it the first time or two.
Don't allow your fear of what has already occurred to paralyze you. Don't mistake past volatility for risk. It's not the same thing. Because most people have these fears, the rest of us get this opportunity.
Regards,
Porter Stansberry
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Date Range:10/13/2008 to 10/18/2008
Date Range:10/13/2008 to 10/18/2008
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