Scared Of Buying Stocks Near Record Highs? This Could Be the Answer

New highs are often followed by sell-offs… but they can also be followed by yet more new highs.

In time, we will know which is the case with the current market. For now, we need to develop strategies that could be profitable no matter what the future holds.

Regardless of what the broad market averages are doing, investors should generally have some exposure to the stock market. This can be difficult to accept given the history of the past couple of decades. If the broad market declines, as it did in 2000 and 2007, the losses could be large, and it could take a while to recover them. On the other hand, as we saw last year with the Covid-selloff, a sweeping decline can sometimes be followed by a broad recovery.

There is nothing magical about new highs, however, that require the market to move lower. Arguments for higher prices are easy to find and even higher highs are possible. Still, it’s difficult not to feel like we’re due for a pullback.

So how should we respond?

A Simple Way To Hedge Your Risk (And Earn Income)

Some investors act as if they believe their opinion on this matter should be backed by a commitment of 100% of their capital. Nothing could be further from the truth. Whether you are long or short, it makes sense to hedge some of the risk that is always present in the stock market.

Hedge funds are often thought of as high-risk investments. But the very first hedge fund was designed to minimize the risks of the stock market by balancing long and short positions.

Now, there are a number of ways to hedge risks. But one of my favorites is the covered call strategy.

Covered calls can be a way to reduce the anxiety of owning stocks, reduce risk, and generate immediate income. To establish a covered call position, you need to own at least 100 shares of a stock. Then, you sell one call option contract against those shares. Each call option will be for 100 shares, so the strategy has to involve multiples of 100 shares. You could sell two calls if you own 200 shares, for example.

Call buyers have the right, but not the obligation, to buy the stock at a predetermined price (strike price) for a predetermined amount of time. Call sellers have the obligation to deliver the shares during the life of the options contract. Covered call sellers already own the stock they might have to deliver, so the risks are limited.

How It Works

Theories behind options strategies can be confusing, so let’s use a real-world example by taking a look at a trade I made within my Maximum Income service back in September 2019. (Note: Prices will be different today; this is not an actionable trade recommendation.)

Back then, Telecom giant AT&T (NYSE: T) was trading around $37.75. I recommended buying 100 shares of T and then selling one T Jan-17 $36 Call for every 100 shares of T you purchased. That’s a call option on T with a strike price of $36 that expired on January 17, 2020.

The initial cost to enter the position was $3,775 ($37.75 x 100).

At the time, those Jan-17 $36 Calls were trading around $2.25 per share. ($2.25 x 100 shares = $225 premium.)

In addition to the income we received from the premium, we also received a dividend payment of $0.51 per share. ($0.51 x 100 shares = $51.) Between the premium and dividend, this would give us a cost basis of $34.99 ($37.75 purchase price – $2.25 premium – $0.51 premium).

This call obligated you to sell T at $36 a share if the stock traded above that on January 17 (the last day these options could be traded).

Now, in this case, two scenarios could happen…

1) Assuming T traded for $36 or less on January 17, we’d keep the $276 we received from the premium and distribution on $3,775. That’s a 7.3% return in 57 days. If we can repeat a similar trade every 57 days, we’d earn a 46.8% return on our capital in 12 months.

2) If T traded above $36 by January 17, our stock would be called. In that case, we would sell the shares for $36. But we’d keep the income we received from selling the call and collecting the distribution.

In this case, we would realize a profit of $1.01 per share ($36 – $34.99 new cost basis), or $101 per 100 shares. This is a profit of 2.9% in 57 days. If we can repeat a similar trade every 57 days, we’d earn an 18.5% return on our cost basis in 12 months.

Bringing It All Together

This trade offers just one example of the covered call strategy. But we make trades like this in every single issue of Maximum Income, and I’m confident that covered call writing could work well with other stocks or ETFs that you own.

The point is, this strategy offers a way to reduce risk. The premiums you earn help offset losses (by lowering your cost basis), and also allow you to turn current holdings into current income.

I believe any investor who is interested in lowering their risk in this market should consider using covered calls. It’s simple, effective, and easy to learn. Yet for far too long, Wall Street insiders have made options seem too risky or complicated for the rest of us.

That’s why I released a report that explains more about how this strategy works — and how you can get started today. To learn more, go here now.