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Time to sell and take a break!

Markets have been on tear for first 3 weeks of 2012. I decided to create a mock portfolio based on recommendations from my first post of 2012 by mock buying these picks in first 2 weeks at or below the prices mentioned. This portfolio is up by nearly 11% assuming all picks have equal amount of investment. Highest returns are BAC with 25% and then STX with 23%. So with yearly target of above 10% returns achieved in 3 weeks what should one do?
All indexes are heading towards highs of 2011 which were reached in May and July before European mess pulled the indexes down for a flat year. European mess is no where near resolution (see debt negotiations between Greece and bondholders). These worries are again going to come to front lines in Feb/Mar. So at this time best course of action to take some gains off the table by selling some of the winners and keeping some dry powder. There would be quite a few buying opportunities when DOW would go below 12000 sometime in next 3-4 months.
If one is for long-haul and does not want to time to market, one could use following strategy to generate some income and provide some downside protection:

  • Enable your brokerage account with "call options" - this would need some paperwork and take 2-3 weeks to get it approved
  • Identify your long-term picks (say BAC)
  • Sell out-of-money "covered call" against your holdings for next month. e.g. BAC120218C00008000. Premium for this is around $9 for one contract representing 100 shares. So if you have 1000 shares, you can sell 10 contracts generating income of about $80 after commission.
  • If stock goes above $8 by 2/18, you are forced to sell your holdings at $8. But that is ok since you would have generated 14% return in one month from current price of about $7
  • If stock remains below $8, you keep your holdings as well as call premium you received
  • If stock goes below current price of $7, do nothing. Since you are in long-haul, you should not be worried about short term paper losses
  • One can repeat this strategy every month and generate income as well as downside protection
It is time to be careful and cautious about this stock market rally since we are not out of woods yet.
Now coming to politics, republican presidential nominee just became lot more interesting with Newt winning South Carolina. Would Gingrich become "Grinch" who stole nomination from Mitt? For that, we will have to wait for results from Florida and then Super Tuesday in March. Till then, enjoy the circus of debates and attacks on each other! I am sure President Obama's campaign is lot more excited with today's results since more it drags on, more fodder it would provide to President Obama for fall campaign.

/Shyam


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