Hello and Happy Holidays to everyone. I hope you all enjoyed
Christmas as much as I did. I had a very rare chance to get
together with my entire family, and I enjoyed it greatly. It's
just too bad there was no snow on the ground in Denver, but
the snow capped mountain peaks did sure look nice. Any how,
back to business.
The Dow Jones Industrial Average closed Friday down 128.83
points at 8,303.78 This is the lowest close on the Dow since
mid November. The trend on the Dow is clearly to the downside
at this point. Granted there is a moderate amount of support
to be found at 8,283.70 but I do not expect it to hold, and
it looks like the Dow is going to move lower and test 7.997.12
If that level of support does not hold, then I expect the Dow
will test its mid July low level of 7,702.34 Please keep in
mind that as we get closer to these levels the risk of a trend
reversal increases, but until then the trend is clearly lowers.
While I was in Denver I had a chance to talk with my sister's
father-in-law. During the conversation he asked me what I thought
of the "market" and where it was going? I answered that I
thought it was going lower in the short term, but ultimately
higher. He said he had some cash he needed to roll into his
IRA, but did not know what to do and was worried about the
market moving lower. This more or less is a very common question
I hear all the time and felt my reply to him would also be
useful to a lot of other people.
I believe he should transfer the cash into the IRA to avoid
the tax consequences of not doing so. I then suggested he hold
the cash and purchase his investments on a dollar cost average
program over a period of time. This more or less produced a
blank look, followed by the statement that he wasn't sure what
to buy. My suggestion was to invest in the Dow Jones Industrial
Average ETF, otherwise known as the "Diamonds" ticker symbol
The "Diamonds" are an Exchange Traded Fund that hold
the component stocks of the Dow Jones Industrial Average in the
same ratio as they are within the index. This allows an investor
to essentially purchase a single stock that is the Dow Jones
Industrial Average. It is like owning a share of the Dow Jones.
The Diamonds very accurately track the movement and performance
of the Dow Jones Industrial Average. Additionally there is
a very liquid options market for the Diamonds.
The Diamonds closed Friday at 82.96 If I was worried about
about the Dow Jones Industrial Average retesting its July lows,
but wanted to have an investment strategy designed to enter
the market and earn better than the money market rates, here
is the strategy I would take.
The July low on the Diamonds was $77.17 set on July 23rd. I
would look to own the Diamonds at a cost of $77.00 or less.
The Diamonds February 77 Put is currently trading at $1.75
I would therefore sell the February 77 put for $1.75
If at the expiration of the February Put Contract the Diamonds
were priced above $77.00/share, then I would get to keep the
$1.75/share that I sold the Put contract for. If the Diamonds
closed below the $77.00/share price, then I would be forced
to buy the Diamonds at $77.00/share and get to keep the $1.75/share
from the put. This would give me a cost basis (the price I
paid) of $75.25/share on the Diamonds. Considering that the
Diamonds have only traded a handful of days below this price
during all of 2002, I would feel comfortable owning them at
that price level.
I would base my decision of how many Put contracts to sell
based upon over what period of time I would be comfortable
fully investing my funds into the market. For example if I
had $100,000 and wanted to invest it over a 10 month period
of time, then I would look to invest approximately $10,000
per month. Combined with the strategy of selling puts, I would
then sell 1 Put contract (each contract covers 100 shares)
earning $175 minus commission and if the shares were put to
me then I would invest a net $7,525 that month. If the shares
do not get put to me then I have earned $175 from my capital
commitment of $7,700. That is approximately 2.3% in a month.
This is a very often overlooked strategy that I feel many investors
could benefit from learning more about and employing. I do
believe that in order to successfully employ this strategy
you need to either understand how to read a stock chart or
have access to someone who does, and you need to have a good
understanding of the options market. In future editions of
the Sterling Weekly newsletter I will further explain options
contracts and strategies involving there use.
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