No new trades for today’s post.
music selection: “Sarah Smile” — Daryl Hall & John Oates
An old co-worker was asking me for advice the other. Not the kind of advice I want to give but, “how can I buy stocks on margin?” and “which stocks have the very highest dividend yield?” So today I’m giving a lecture on understanding and mitigating risk. You don’t want to make a dumbo T.Rex move and step in Bronto poo.
buying on margin: Don’t do it raptors! I get it. You can double your returns. But you do so by doubling your risk! You can’t actually end up losing everything plus still owing your broker a loan. That is just crazy-cakes.
chasing yield: Don’t do this either! A stock showing a current yield of 33 to 50% on ‘Yahoo! Finance’ looks mighty attractive. But the market is flashing a big red warning sign by bidding shares down that low. A distribution cut or elimination is eminent. Your yield is going to evaporate and you are going to suffer a capital loss to boot. Some sectors have naturally higher yields such as BDCs, MLPs, and REITs. You can get acceptable yield with acceptable risk there if you don’t go for anything that is clearly too good to be true.
diversification: Do it! You need to be in multiple sectors and not be too heavily in any one issue. This is a good time to talk about bonds. Since raptors use options, we have a higher than normal Beta. Loading up on bonds can bring your Beta back down. And the best place to hold bonds is in closed end funds that are bought at a discount to NAV.
chasing premium: This is even worse than chasing yield. If a written put option is yielding 200% annualized (I’ve seen it in Chinese solar manufacturers that later went bankrupt), the market is warning you. That is a danger sign! You want to make at least 12% to compensate you for having your capital locked up for the expiry period. And that should be plenty. You are absolutely smoking the S&P average at that rate. Don’t get greedy.
take your time: Don’t feel you have to jump on every trade idea right now. Sometimes, waiting a few weeks offers a better risk/reward setup. In the meantime, there are always options trades that will yield 12% or better on something safe. Keep looking. Patience while stalking prey is the raptor way.
Starting Monday, I’ll be introducing a new asset class. It won’t be for everyone but I think you’ll find it interesting.
Devour your prey raptors!