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Editor's note: We're wrapping up our three-part options-selling series from Dr. David "Doc" Eifrig. Over the past couple of days, Doc has detailed the greatest income-producing tool for retirees... and showed how you can use it to earn safe income with "Digital Utilities." In today's final segment, he explains why today's volatile market is presenting us with a great opportunity...
How to Make Volatility Work in Your FavorBy
Wednesday, January 20, 2016
If you've been following my series this week, you know that selling options our way is inherently less risky than owning stocks outright.
You have to stick to proper position sizing. You should sell options, not buy them, and only on stocks that you truly want to own.
If you stick to those tenets, the income that option selling generates will build a cushion that lowers your risk. That cushion is also what helps us maintain a high win percentage.
But no method wins 100% of the time. And even if our strategy entails less risk than buying stocks outright, it still entails risk.
With the market correcting, we're taking some losses. We're optimistic about where the market will go from here, but we can't be certain what will happen in the short term.
In the meantime, it's presenting an opportunity to get in while the getting's good.
That's because not only are stocks a good deal cheaper than they were a couple of weeks ago, but we can earn more income from them thanks to the market volatility.
Let me explain...
Volatility is up. Big time. The Volatility Index ("VIX") – a measure of broad market volatility – has leaped more than 50% over the past two months.
 When volatility is high, options get more expensive. It's built into the way options are priced. In a simple sense, you can think of those who buy puts as people buying insurance contracts. Those people are willing to pay a lot more when they are scared of what's happening in the market. For options sellers like us, this is a good thing. We can earn more income on the exact same trade simply because volatility is higher. Let me show you some numbers on a quick example.
If we were to sell a set of at-the-money puts two months out on software giant Microsoft (MSFT) right now, we'd be able to collect $2.75. If MSFT stayed even, we'd earn 26.7% (on margin) in two months.
However, if we plug MSFT's volatility levels from three weeks ago into a valuation model, the same option would only fetch $1.80. Our return would be cut down to 17.6%.
That means we're earning 1.6 times the return from the jump in volatility. People are scared and willing to pay more for options.
When you combine higher option premiums with the attractive prices we're seeing on all sorts of assets, it makes for a great time to enter some new trades. I recommend using this opportunity to select a few super safe trades that often don't pay that much in option income. Right now, they pay more than ever thanks to high volatility.
It's the right approach for a market like this one...
Here's to our health, wealth, and a great retirement,
Dr. David Eifrig
Further Reading:
"Most people who call themselves 'investors' really aren't," Doc says. "People buy high and sell low... Ultimately, it's a lot of stress and research for an uncertain payoff." But there's an easier way... Learn more here: This Is Your Cure for Stock Market Volatility.
"Many individual investors tune out immediately when they hear 'options,'" Sean Goldsmith writes. "'It's too risky,' they say. 'It's too complicated... It's not for me.'" But in this success story, he shows how almost any investor can use options to invest with lower risk... and earn profits that are "far greater than what's possible by just owning the stock outright."
Market NotesTHE BIG BUST IN EMERGING-MARKET STOCKS Yesterday, we updated you on the troubling state of the market by looking at the big downtrend in transportation stocks. As we mentioned, the U.S. transportation sector tends to lead the market up or down. Today, we turn to another important indicator that's telling us to be cautious right now: emerging-market stocks.
Monitoring emerging markets tells us a lot about what's going on here in the U.S. They have a large influence on major U.S. companies because so much of the end-user demand for things like computer chips, soft drinks, and even Disney movies comes from the major emerging markets – Brazil, Russia, India, and China.
Over the past decade, a combination of rising commodities prices and a weakening U.S. dollar created a boom in emerging markets. But more recently, things have reversed course in a big way... commodities have gotten crushed, and the U.S. dollar has grown stronger. Emerging markets that were once "booming" are now "busting"...
For a clear picture of this, take a look at the past year's performance of the iShares MSCI Emerging Markets Index Fund (EEM). This giant fund holds a basket of the most important emerging-market stocks. It's stuck in a downtrend, dropping 30%-plus since May. This is another big trend we suggest keeping an eye on...
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