An Investment Strategy for Higher-risk Periods

July 15, 2011 - PRLog -- The current market bias is positive, but there’s some concern about the chart. The S&P 500 breached its 50-day moving average (MA) on Monday before rallying, but has failed to mount any sustainable rebound, currently stuck around its 50-day MA. My concern is that failure to edge higher could drive the index back lower and continue the sideways channel in existence since February.

The absence of any strong catalyst could leave the broader market comatose for the summer months.

On the S&P 500, there is key support around 1,250. A break below would be bearish and see a move below 1,200. I expect the support to hold. On the upper end, there is strict resistance around 1,362. A strong break above could drive additional gains towards 1,400.

This means that stocks may waver as we continue into the traditionally slower summer trading months. Without leadership, markets may stall. Should this happen, my investment advice would be to write some covered call options to generate some premium income and reduce the average cost base of your positions. But be careful, as a market surge could take out your position at the call strike price. Make sure you are comfortable with the upper strike price of your covered call. Make sure it is just above the key resistance of the stock.

I have long favored the use of covered call options on long positions should the market trade flat. This may be the case now.

Why let your positions sit idle? As I said, you can write some covered calls to generate some premium income and help reduce your average cost base. It is simple to initiate. Just make sure you do not write a naked call, otherwise you’d be exposed to unnecessary risk.

Let’s take a look at Cisco Systems, Inc. (NASDAQ/CSCO) and assume you own 100 shares at a cost base of $14.00 per share. You are already up $1.60 a share based on the current market price of $15.60 as of July 14.

Now, say you continue to be long-term positive on Cisco, but at the same time feel the stock may pause or move lower over the next quarter.

There are several strategies at your disposal. You can sit on the position and wait for the stock to rise. The problem is that this is an inefficient use of capital, in my view.

So, why not make your capital work for you?

It’s much easier than you think and represents a win-win situation. The process involves writing covered calls on your holding of 100 shares of Cisco. For every board lot (100 shares) of Cisco, for example, one call option may be written.

Covered call writing is a straightforward, low-risk generator of premium income that also guarantees a selling price for the stock. Don’t write a covered call if you do not wish to lose the stock due to a possible exercise from the call holder.

So, in case stocks stall, you can make some money by writing some covered calls.

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