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Making Money Even When Markets Fall

And to you, my faithful subscribers and listeners, I issue an apology...

It's been almost five months since I've had the chance to wield my wicked digital pen of market domination to our mutual benefit, but my resolution is to fix this going forward, making sure you have plenty of laughs, learning, and luck in the future...

Things have been crazy. I started a new job at the beginning of the year, which has been fun and exciting (I am now somewhat removed now from the investment banking world—which, if you don’t know what that entanglement entails, this is actually a GREAT thing for me, my money, my investments, and by extension, yours too!)

So what’s new? What have you been doing with your money? What have I been doing with mine? What have the world markets been up to? Well, today’s headline on Yahoo Finance give us a good indication:

“The hell does that mean?!?!?” you’re probably asking yourself. Are we in the midst of some kind of meltdown?

And, the question you should be following this one up with is,"If the market is tanking, how do I save myself? Is there any way to turn bad trades into good ones?"

That's what we'll talk about today.

Why are the markets falling?

But first of all, the above market headline means basically nothing in the long run for your money. In a nutshell, something technical got seriously effed up somewhere, so the stock exchange cancelled any buy/sell orders that investors/speculators had put in to try to make some money or cash out on bad trades they made, and halted further trading until whatever it was that got effed up became “un-effed” up. It appears to be just a technical issue at this point.

This happens once in a while when the markets are doing things that are totally erratic, like plunging a few percentage points in a day. But the exchanges have a kill-switch which shuts down anything and everything if the markets drop 7% in one trading day, so things can’t get that out of control. That’s nothing like what happened today. Let me explain a little more about that.

For almost what seems like years now, the market has basically gone up. If you just parked your money in any decent stock, you made money. If you were good at playing the small whipsaws along the way (as we like to do in The Village), you made even more.

But over the past week, that’s changed.

Even our bell-weather stocks have taken a sound beating—those that are typically more immune to bad news. Analysts and pundits across the board have been trying to guess when this would happen for months now. Well, this might be it… the market could take a dip… or a correction…. or a crash… or, the Fed chair or one of its stooges could wake up tomorrow morning and say, “You know what, I think I’ll get off my arse today, say something significant, and save the stock market from falling any further.”

That’s how irrational the markets are today. Everything hinges on what the Fed is saying or doing. It didn’t used to matter, because the Fed didn’t overtly intervene in monetary policy as it has done in recent history, and the speculations in the financial world didn’t use to be whether or not the Fed was “finally going to raise rates for the first time in 6 years.”

When the Fed raises the prime interest rates, US government bonds become more attractive relative to other investments, so at a certain point where rates are raised enough, money starts to shift out of other investments and into the government bonds again, which represent the “safest” investment in the world.

And that money has to shift “out” of something else in order to shift “into” the g-bonds. That “somewhere” is the stock market. And when money is shifting out, people are selling. When people sell, prices drop.

So, since the biggest speculation is that interest rates will begin to rise soon, which if that news was announced, would likely cause a drop in stocks. Is that what’s happening right now? I don’t know for sure. Why?

Because there are other things influencing the US stock market. China’s economy sucks big-time, and anything going wrong in the world’s largest economy is going to cause waves

Also, the European debt crisis is sucking the life out of anything Europe once considered safe, good and holy, due to leeches like Greece, whose financial solvency teeters on the brink, and somehow threatens the solvency of the entire Eurozone and its currency.

These bombshells all combined with the fact that the government is overtly manipulating economic figures, blaming the weather for a bad economy (it’s been in the 100’s lately, and if there’s anything worse than cold weather that causes citizens to hoard there cash, certainly it’s unbearable heat!), and doing a number of other shenanigans, result in a situation where things don’t always go as planned for our investments and trading.

But we always have a Plan.

The plan to make money in a down market is always the same

Part A of my is to typically hold only high-quality stocks in my portfolios, collecting dividends and cash in the form of share buybacks, to grow my money. But Part B is to supplement those dividends by selling (usually) monthly options contracts against shares I own to earn an extra 1-2% per month.

I’ll now explain how in doing so, I (and you too!) can turn any losing trade into a winner. I’ll do it with an actual trade I placed a few weeks ago before the market turned.

On June 15, I told myself that I wanted to make some money by selling a put option on Cisco, Inc. When I sell a put option, I agree to buy 100 shares of the stock if the price of the stock is trading below a certain threshold, called the strike price, on a certain date. In this example, I agreed to buy 100 shares of CSCO if the stock was trading below $28 on July 17, 2015. I got paid $60 for agreeing to this, or 2.1% of my capital at risk ($28 x 100 shares = $2800).

Since I got paid $0.60 per share to do this trade, I was essentially offsetting the cost basis of the shares I might be required to buy, down to $27.40. If 29 days from now CSCO is still trading below $28, I’ll have to buy 100 shares at $28.00, even if the price is below that.

So, right now CSCO is trading at $27.00. I’m losing money right now. BUT…. like I said, this isn’t the end.

Next Friday, I’ll likely be forced by my broker to buy 100 shares of CSCO and take a loss. So you know what I’ll do to reverse that loss? Simply agree to sell my shares for more than I had to buy them for, by selling a Call option.

With market volatility the way it is, I can envision Call options on the 20^th of July (the Monday after I get assigned shares) trading at around $0.50 for the August $29 or $30 strikes. So, what I’ll do is simply sell a call option, agreeing to sell my shares at $29 to someone else if the price is above $29 in the third week of August.

If I do that, I’ll make the $.50 per share (gain of $50), plus the capital gains up to $29. That’s a gain of $1 per share ($100), for a total of $150 in potential capital gains. That will offset my $0.40 loss per shares, bringing my overall gain to $110 in two months, or 3.9%. What is that on an annualized basis?

Over 23%.

You can’t beat a strategy like this. It definitely beats sitting on your just your dividends. And mutual funds can’t touch gains as easy and safe as these.

My Friends—this is how we correctly use stock options to not only protect ourselves from risk of loss, but also magnify our gains by simply entering into financial agreements with our brokers. This is how we reverse losses and turn them into gains in relatively short periods of time.

I promise that if you follow these strategies, your understanding of these things will be magnified into something you never before dreamed of.

For related articles on how this all works, check out the links below.

Live long and invest,

Jeremiah