Still more bullish housing news... Big bank numbers are improving... Another way to generate safe income from options... Can you get an education in college?...
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Yesterday, we told you about the increase in homebuilder confidence and Steve Sjuggerud's bullish housing thesis. The good news keeps coming...
Housing starts in the U.S. jumped 15% in September to the highest level in four years... Starts hit an 872,000 annual rate last month – the highest since July 2008... Economists' median estimate was 770,000.
Yet another sign that the housing crisis has turned the corner...
Shares of the iShares Home Construction Fund (ITB), an exchange-traded fund comprised of the United States' biggest homebuilders, jumped nearly 4% on the news. Steve recommended ITB to True Wealth subscribers in February as a way to play the revival in U.S. housing. The fund is up 53% since his recommendation.
And the big U.S. banks are confirming the bullish housing sentiment in their latest earnings announcements...
Bank of America announced a $340 million quarterly profit. (That figure includes a $1.6 billion litigation charge in the quarter.) The bank reported an 18% increase in mortgage originations...
"This is the best housing has felt in a long time," Chief Finance Officer Bruce Thompson told investors.
Bank of America also set aside $1.8 billion to cover against bad loans – down from $3.4 billion a year ago. Remember... that $1.6 billion goes to the bank's bottom line.
And U.S. Bancorp, the nation's biggest regional lender, announced record earnings of $1.47 billion – up 16%. The bank set aside $488 million for bad loans, a 6% decrease from a year ago.
Average total loans increased 7.3% to $216.9 billion from a year ago. The increase was driven by a 22% rise in commercial loans and a 20% rise in residential mortgages.
Yesterday, we discussed Citi's numbers, and how we predicted banks' numbers would improve as central banks continued printing money. You can read it here.
We've written a lot in the Digest about our favorite safe options strategies...
If done properly, selling options is one of the safest and most reliable ways to generate extra income in the market. Loads of our readers have sent us feedback saying they're making thousands, sometimes tens of thousands, of extra dollars each month selling options.
Today, I wanted to focus on how our trading guru, Jeff Clark, uses one particular strategy to help subscribers generate steady income… month after month… It's the same strategy he used to generate income for his wealthy clients at his former money management firm.
He believes it's the safest and most consistent way to get extra income. That's why he's dedicated his monthly Advanced Income advisory to this strategy… It's called selling "covered calls."
Most investors think the only way to make money in stocks is to buy shares of a stock and wait for the share price to appreciate (and accumulate dividend payments).
By selling covered calls, you can immediately extract cash from your equity positions... And the payments you receive can be larger than typical dividend distributions. Plus, you can continue collecting these cash payments as long as you hold the stock.
So what is selling a covered call? Simply put, the strategy involves buying a stock and selling someone else the right to buy it from you at a higher price sometime in the future.
We'll walk through a specific trade in a moment. But first, I'd like to explain the strategy using a real estate example...
Let's say you buy a piece of property for $200,000. You then turn around and sell someone the right to buy it from you anytime in the next three months for $210,000. For that right, you charge a premium of 4%, or $8,000. You pocket the $8,000 immediately. It's your money now. You are also obligated to sell the property for $210,000 if the buyer chooses to exercise his right.
This scenario has three possible outcomes...
1) The property goes up in value, and the buyer exercises his right to buy. In this case, you've pocketed the $8,000 premium, and you'll be selling the property for $210,000. That's an $18,000 gain (9%) in three months. You'll have to buy another piece of property in order to continue the strategy.
2) The property keeps its $200,000 value. In this case, you keep the $8,000 premium. Since the buyer won't be willing to pay $210,000 for a property that's only worth $200,000, you'll keep the property, too. You've made 4% in three months, and you can sell the right to someone else for another three months, repeating the process.
3) The property falls in value. In this case, the $8,000 premium you received helps to offset the loss on the property. The property can fall $8,000 in value before you lose any money. The buyer walks away when the right expires, and you're free to sell another right for another time period.
If the investment goes up, we sell it for a gain. If the investment stays the same, we profit off the premium. And if the investment drops in value, the premium helps offset the loss.
Here's how it worked with an actual trade Jeff recommended to Advanced Income readers...
In his January issue, Jeff identified for subscribers how gold exploration company Paramount Gold (PZG) held more than $11 billion in precious metal resources… but had a market cap of just $320 million.
The huge discount set up an excellent opportunity to sell covered calls on the company. Jeff's subscribers were able to buy shares of Paramount Gold at $2.35, and sell his recommended PZG June calls with a strike price of $2.50 for $0.45 each… (Remember, with options, you trade in increments of 100 shares.)
This meant subscribers who followed Jeff's advice paid $235 for 100 shares of Paramount Gold… and immediately received $45 for the calls. Those calls obligated subscribers to sell their stock at $2.50 a share (that's the "strike price") if Paramount shares sold for more than that by June 15 (the day the option would expire). Otherwise, they'd keep the $45 and still hold the shares.
In fact… Paramount shares closed June 15 at $2.37 a share. So subscribers kept the upfront payment (known as the option "premium") and continued holding shares.
Jeff subsequently recommended subscribers sell another set of calls against the stock, generating another $0.45 a share in premium. The position remains open in the Advanced Income model portfolio… and is showing a 43% gain.
As you can see… selling covered calls is a great strategy... But there are two major pitfalls.
First, the underlying equity could plummet. If that happened, you'd still collect the premium, but it wouldn't be enough to offset the loss. If a stock drops 10% or 20%, you can make it up by selling a few sets of options for more premiums... But you cannot make up for a 50% loss selling covered calls.
That's why you only sell covered calls on stocks that are already great values. The best opportunities for covered calls are high-quality stocks (think Dan Ferris' World Dominators) that have experienced a fast, overdone selloff.
The other pitfall with covered calls is you cap your upside potential... You forego potentially large gains in return for an immediate premium and smaller upside.
Take our previous property investment, for example. We are obligated to sell the property for $210,000. That's a good gain, especially considering the extra $8,000 premium. But if the property jumps to $300,000, you miss out on that upside.
But you can't let that bother you... The purpose of covered-call writing is to generate income, not capital gains. And you should only sell calls against stocks you wouldn't mind selling at the agreed-upon price.
In that scenario, your trade worked as planned and you made a profit. In Advanced Income, Jeff looks to generate 15%-20% annual returns selling calls on safe, cheap stocks.
New 52-week highs (as of 10/16/12): iShares Dow Jones U.S. Insurance Fund (IAK), SPDR International Health Care Fund (IRY), ProShares Ultra Health Care Fund (RXL), Guggenheim China Real Estate Fund (TAO). V.F. Corp (VFC), Abbott Laboratories (ABT), Eli Lilly (LLY), IBM (IBM), Chubb (CB), and Travelers (TRV).
In today's mailbag... one subscriber offers his experience in public service... and another touts the benefits of "higher education." Send your email to feedback@stansberryresearch.com...
"I heard a line in a TV show referring to firefighters 'you wanna know if they are heroes... just ask them.' Man that summed FF up for me. Very few do ever fight fires these day. I joined the local Volunteer Fire Department in 1984. In my rural NH town of 2,500 residents every 60 days we had a full blown house fire... 'burn to the ground potential' outcome depended on many factors. We got busy working with the building inspector and the Town Selectmen. They willingly work with the FD to put in place the national fire building codes etc.
"The result nearly 30 years is that rarely do we ever have a real fire... Thank god, but that's a fact. The budget is enormous now and they have far less to do now verses 30 years ago. I know it is blasphemy to point out the racket Paid Firefighters and some Cops have but I speak from experience. I have worked as a firefighter, I have worked as a police officer, I have crawled into burning homes and I have arrested felons at gunpoint... Both jobs were wonderful experiences that I would not trade for anything. But 100K to do either job and lifelong pensions after 20 years is ridiculous.
"One time I was asked to compare Police work with Firefighting... I tried to explain them with an analogy... Comparing Firefighting to Police work is like comparing Elementary school to College... absolutely no comparison. There is so little to do in the FD these days it is almost silly and when things go bad... Toss your hands up and run outside... 'We did the best we could'... Please
"Look, all public sector pensions are out of control... some pay scales are out of line as well. People love to do these jobs. There has been a very deliberate effort to eliminated volunteer firefighters over the years... Full time firefighters dump on 'Volleys' all the time... They need to wake up. The public is not going to continue to fund these huge budgets when there is nothing to do... There is absolutely no reason Cities and Town can't cut fire budgets and staffing at least in half... simply filling the void with volunteers... no real reason. They'll all scream safety and first response time... all nonstarters. Don't want the job quit see how long it takes to fill the opening." – Paid-up subscriber Dan Duffy
"While I agree with your statement 'Do not borrow money,' I very STRONGLY DISAGREE with your statement 'College is a waste of time to start with...' One of the primary strengths of a strong democracy is a well-educated populace. In my humble opinion, the lack of education is a major part of what is wrong with the US today and most certainly is what allows politicians and Wall Street to "get away" with as much as they do. The 'Dumbing Down of America' MUST stop!
"Please, do NOT encourage today's young people to skip their education. Again, I agree that going into severe debt is NOT a good idea, but the young people of today absolutely need to find some way to get that education so that they can understand what you and your publications are trying to teach them. Without a good education, all of the teachings in your fine publications are wasted!
Without a good education, how do we expect anyone to make intelligent choices in our elections? Democracy depends on a well educated populace!" – Paid-up subscriber LT
Porter comment: What makes you think you can get an education in college?
Regards,
Sean Goldsmith
New York, New York
October 17, 2012