Options  |  MAY 2009

Downside Protection With Double-Digit Returns by John Manley

Downside Protection With Double-Digit Returns by John Manley This strategy has potential for double-digit returns with a large built-in hedge. Current market conditions have set up a unique opportunity to build a conservative portfolio that will profit even if the market falls by a certain percent, stays flat, or eventually rises over the remainder of the year. It goes without saying we have witnessed the most violent and dramatic market moves of the last 75 years of late. After falling a whopping 38.5% in 2008, the Standard & Poor’s 500 is already down another 21% in the first eight weeks of 2009. How does a traditional investor defend himself against this kind of market volatility and still have a chance of making money? THE PREMISE What if you could build a diversified portfolio of quality stocks or exchange traded funds (Etfs) with a large built-in hedge of anywhere from 20% to 40% below entry prices and still pull off double-digit gains at the end of the year, even if the markets go nowhere? You can. Welcome to the in-the-money covered-call portfolio! What makes this strategy particularly attractive right now is that we have two favorable conditions present — depressed stock prices (subjectively, prices could fall further, but I am about to show you that’s okay) and high premiums for options (elevated implied volatility priced into options). One of the other desirable attributes of this strategy is that it is relatively low maintenance. It is perfect for the busy trader or investor who doesn’t have time to check the markets all the time — and it keeps transaction costs down.

by John Manley