In April, the S&P 500 gained +13%. That was the best monthly advance since 1987. And in May, the bullish momentum continued.
Historically, May kicks off the weakest period for stocks. But not this time.
It turns out the +4.5% gain in May was the best returns for the month of May in more than a decade (May 2009).
From the March 23rd trough to yesterday's high of 3,130, the S&P 500 has gained +43%.
It also aligns perfectly with the March 4th close. That was the last day the S&P 500 was above the 200-day moving average (blue line) before the avalanche came sliding down the mountain.
It wasn't until the end of May that the S&P 500 managed to move back above the 200-day moving average.
Now that we're back to where the carnage began, we're likely to begin to see a lot of interest sellers come out of the woodwork.
We're also looking at a stock market that's short-term overbought.
If we look at the percentage of stocks trading above their respective ten week (50-day) moving average on the NYSE Composite, a broader index of U.S. stocks, we find that 87% of the stocks are above this key level.
Readings above 70% typically mean we're in overbought territory.
But now we find the reading above 80% -- the highest reading in more than two years -- which is excessively high.
Now just because stocks are overbought doesn't mean the rally is over. But it does tell us that there is a higher risk of a selloff in the days ahead.
A corrective action doesn't have to be a massive selloff like what recently occurred from the February record highs. In fact, as we stated, those kinds of selloffs are very rare.
But we can certainly see a more typical pullback in the 3% to 5% range. Even a 10% pullback wouldn't be all too surprising after the +43% rally off the March lows.
Now let's take a look at the NASDAQ Composite, which has been the strongest among the three major stock market averages.
It's in the COMP where you'll find a concentration of the large-cap Technology stocks that have been doing the bulk of the lifting during the recovery phase.
And after the -33% decline, we find the COMP rallying back +46% off of the March lows and now sitting less than 2% below the February record highs.
This is also a key level that will attract interested sellers…
…those that got swept up in the large wave of selling and are eager to be made whole again.
Also, savvy investors who bought on the pullback will look to lock-in profits.
In other words, we're now approaching a level where there's going to be an overhead of supply.
If you are one of those investors who owns a basket of stocks, now's a good time to wring some cash from your positions.
I'm talking about applying an options strategy that will instantly generate a cash payment and provide a limited form of a downside hedge.
It's known as the Covered Call strategy, and with it you sell Call options against a long stock position you already own.
This type of market environment is perfectly suited for this strategy. Market breadth is positive, stocks are rising, and short-term conditions are overbought.
In this strategy we're going to be a seller of options.
Selling Covered Calls instantly generates cash and the proceeds you collect by selling the options also provides a limited form of downside protection.
That money is yours to keep and to use in any way you want.
Since the cash is instantly available, you can pull the cash out of your broker account or use the debit card to make purchases (if you have this type of customer broker account).
We'll now run through a timely example…
Here's How This Strategy Gets You Paid Today
Let's say that we own 200 shares of Microsoft (MSFT), a widely held stock that has a large weighting in the NASDAQ Composite.
In this example, MSFT is trading around $185 per share and approaching prior highs.
To get paid and generate instant income, you could look to sell nearer-dated out-of-the-money Call options.
In the case of MSFT, you could sell the July 190 Call for a $4.35 credit, which means you'll instantly collect $435 for each contract sold. That option expires in 43 days.
Since each Call option could obligate you to deliver 100 shares of MSFT (in the case of an assignment), you'd not want to sell more than two option contracts – thus ensuring the position is completely "covered", hence the name of the strategy.
Since we own 200 shares of stock, we can collect $870 in cash by selling two Call option contracts.
If you happen to own, say, 300 shares of MSFT, then you could sell up to three option contracts.
Also, notice that in the example, the option that we are selling is five points out-of-the-money. So in the event that MSFT trades above $190 per share at expiration and our stock gets called away, we can make an additional $5 in capital appreciation.
The instant cash generated on the stock earns a hefty return.
The $4.35 credit equates to a +2.4% return -- or a +20.4% annualized return.
And this doesn't include the potential five points in capital appreciation should the stock be above $190 per share at expiration.
Now here is where it can get even better...
Let's say that the stock does run into a wall of supply and remains below $190 per share at July expiration.
In this case, the option would expire worthless, relieving you from any obligation to sell the stock.
That means you could look to sell another round of covered calls and collect even more cash.
How cool is that!
Selling Covered Calls in this type of market environment is a great strategy to generate instant cash while also creating a limited hedge on stocks you own.
Other widely held technology stocks in the NASDAQ Composite that can benefit from this strategy include Apple (AAPL), Facebook (FB), Adobe (ADBE) and NVIDIA (NVDA).
By the way, this is far from the only way to make extra income in the market.
Next Wednesday I'm putting on a special investor briefing that focuses on just that -- extra income.
In this case I'm talking about an extra $4,928 every WEEK over the summer.
The event is FREE so I hope to see you there!
Until next time, ca-ching!
Costas Bocelli
True Market Insiders
No comments:
Post a Comment