The Only Safe Way to Generate Income in Today's Market
By Tom Dyson
November 26, 2008
So far, we've only experienced the problems that come from falling prices in one section of the economy: single-family housing. It's wrecked Wall Street, and destroyed stock markets around the world.
As I look around, I see more debt that needs marking down... What about the loans made to consumers to buy cars, go to college, or use credit cards? Or the loans made to corporations to finance the takeover spree of 2006 and 2007? International loans will be another big problem. And then there's commercial property. What will happen when all the loans made against office buildings and retail parks across the country start defaulting?
For a good example, look at Citigroup's balance sheet. Residential mortgages make up less than 10%. The rest of its capital is invested in consumer loans, corporate loans, and commercial real estate loans. How many of these loans were written in the bull market and priced for perfection? I dread to think.
It's like we've been hit by a tidal wave. We've capsized. Now, several more tidal waves are speeding toward us...
The situation is particularly acute for income investors. Not only will companies cut dividends, investors will demand higher dividend yields to make investments. What's the use in buying a stock for its 10% dividend when its price could fall 50%?
In light of the situation, today I'm going to show you the ONLY safe way to generate income in bear markets like we're in now. By following this system, you'll put America's strongest stocks in your portfolio and use them to generate 20% annual income yields.
Here's how it works:
Step one in our strategy is to buy the absolute safest stocks.
As I've said many times before, the safest stocks are the ones that generate strong cash flows and have long histories of paying rising dividends… These dividend growers hold huge power over their competition through strong brand names, access to capital, the best management, and sheer size. These are the best companies in the world. Over time, they'll retain their value better than any other stocks.
Step two is to sell call options against these stocks.
DailyWealth's editor in chief, Brian Hunt, calls this the golden age for selling options. Brian's referring to the volatility in the market these days...
Volatility increases the price of options. That's because volatility makes it more likely option buyers will have the chance to profit. So when volatility rises, option sellers increase their prices.
Due to the incredible volatility, options have never been more expensive than they are right now. Today, options sell for five or six times more than similar options did in the calm markets of 2005 and 2006.
The textbooks call this a "covered call" strategy. In a covered call strategy, you buy a stock and sell call options against it. Essentially, you sell most of your upside potential to another investor in return for guaranteed income now.
Take Chevron Corp (CVX) for example. It pays a 3.7% dividend and buys back $7.5 billion in stock each year. No matter where the oil price goes, Chevron will still make money. In 2001, with oil prices around $25 a barrel, Chevron was able to crank out $11.5 billion in annual cash flow. In the last 12 months, Chevron has generated $31 billion in cash flow.
On Monday, Chevron's stock closed at $74.30. You could sell the June 2009 $80 call for $9.50. By selling this option, you sell any upside in the stock above $80. No matter what happens, you cannot make more than $5.70 in stock price gains (that's $80 - $74.30) between now and June.
If Chevron's stock falls, you take all the losses. But by buying Chevron after a 30% decline in its stock price, at less than seven times earnings, you've limited most of your downside risk.
In return for selling seven months' worth of upside potential, you'll receive $9.50 per share. If Chevron sells for less than $80 in June, you can sell another call option. I can't say how much the market will pay you for that option, but let's assume you get at least another $5 per share. Here's what that'll look like:
June 2009 option premium: |
$9.50 per share |
December 2009 option premium: |
$5.00 per share (guess) |
12 months of dividend payments: |
$2.60 per share |
Total income: |
$17.10 per share |
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If Chevron trades for $74.30, that's a 21% income yield over the next 12 months, not counting any movement in Chevron's stock price.
I suggest you talk to your broker about the strategy, find four or five of your favorite blue-chip stocks, and sell options against them. You're buying the strongest, most profitable companies in the world at the best values in a generation.
Then you take advantage of the highest option premiums in history to generate safe 20% income streams. There's no better income strategy in bear markets...
Good investing,
Tom
Editor's note: Tom Dyson is a regular contributor to DailyWealth, a free investment newsletter focused on the world's best contrarian opportunities. We write with a simple belief in mind: You don't have to take big risks to make big money with your investments.
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GOLD IN TERMS OF WHAT YOU CAN BURN AND EAT
Today is part two in our "gold is soaring, you just don't realize it" series.
Most folks believe gold has performed terribly this year. Gold's "underperformance" is unexpected, considering it normally soars when a big pile of you-know-what hits the fan.
As we covered yesterday, most folks look at gold in terms of U.S. dollars. But that doesn't give you the whole picture. Today, let's look at gold in terms of how much gasoline, cereal, bread, heating oil, hamburger, coffee, and construction materials it will buy you. Let's look at gold versus the "CRB."
The CRB Index is like the "Dow Industrials" of commodity prices. It's the world's most widely followed gauge of raw materials like oil, copper, and corn. As you can see from today's chart, when you look at gold in terms of things you actually eat, burn as fuel, or live in, gold is soaring. We stand by our claim: The bull market in gold is alive and well!
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The whole world, it seems, is rushing into Treasurys, and with reason. As asset prices melt globally, managers steering pension funds, foundations, hedge funds – you name it – are running for shelter.
They can't just dump tens of millions of dollars or more into their local bank. They need the liquidity of the Treasury market. And that helps explain why yields on Treasurys, which move in the opposite direction to price, have been pushed down so sharply.
The three-month T-bill yields barely above 0%. The one-year note offers less than 1%.
But frazzled Main Street investors shouldn't blindly shadow the supposed "smart money." When the panic trade ends (Friday's markets offered a glimmer of hope), the pros will seek some degree of risk and will pull money out of Treasurys. Treasury prices will move lower, leaving potential capital losses for those who don't flee government paper as fast.
Michael Darda, chief economist at MKM Partners, sees a savvier option. He notes that the yield on 10-year Treasury inflation-protected securities, so-called TIPS bonds, are trading at nearly a zero spread to standard 10-year Treasurys.
That means investors can pick up the same yield-to-maturity with TIPS, and at the same time protect against future inflation. The pros generally aren't in TIPS because that market isn't nearly as liquid.
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Dr. Doom, as money manager Marc Faber is known, has turned into Dr. Boom. He expects global stock markets to mount strong recoveries soon.
"What you could see in the next three months is a very strong rebound in asset markets, in equities, followed by a selloff in bonds and eventually a selloff in the dollar," he told CNBC last week.
Most asset markets are "terribly oversold," while the dollar and U.S. Treasuries are overbought, Faber says.
And what's going to cause the bounce-back? Fiscal and monetary stimulus – the huge amount of money that governments and central banks are throwing at the economy and financial system, he says.
Once people go back into financial markets, the move will probably be "stronger than people expect," as financial institutions' coffers are now full of cash that they have been so far unwilling to invest, Faber maintains.
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