Wells Fargo Covered Call Strategy

Wells Fargo (WFC) is clearly one of the strongest, if not the strongest, of the major US banks. Amazingly, Wells stock is actually higher now than at the beginning of the year. Meanwhile virtually all of its peers have seen their market prices slashed considerably.

If you are considering being long WFC, let me suggest an alternative. Sell an April '08 36 call for $2.80. This represents a premium of 10% in 5 months (almost 25% on an annual basis). If WFC is flat, you keep the premium for a 10% gain. If Wells is down, you have a 10 % cushion. If Wells rises to the call price of $36, your gain will be almost 40% in 5 months.

Take advantage of the incredibly high volatility and sell call options on stocks you buy (or already own). This method works best when you are cautiously bullish and pick strong companies.

Financial Covered Call Strategy (XLF)

If you are considering speculating on the market/financial and think now is a good time to buy (I am not totally in agreement, but let's put that aside for a moment), here is a high yielding covered call strategy.

Buy XLF (iShares financial ETF) for $12.50 and sell a June 2008 Call for 1.56, a 12% call premium which is unheard of for an option that is 20% out-of-the-money (OTM)!



If in June, XLF is trading for $15 or less, the covered-call strategy will be 12% better off than being long-only. In fact, the covered call strategy for XLF performs better than being long-only at any price under about $16.50 (which would be a 30% increase in 7 months). The covered call strategy has a max retun of 32% so if XLF goes to $20, you will have been better off having just bought the stock. On the other hand, the covered call strategy gives a 12% cushion to the downside, and generates very nice returns (20% annualized) even if XLF is still trading at$12.50 in June. For all this extra premium, do you really mind capping your returns on this trade at over (50% on an annualized basis)??

Deflation Now, Inflation Tomorrow - Long TIPS?

Look at the image above of the US monetary base.

While we may experience a slight bout of deflation as the world markets slowly collapse, once the "pipes" of the financial system are Roto-Rootered, this engorged monetary base is going to materialize in the form of massive inflation.

TIP, the iShares ETF, is a portfolio of Treasury Inflation Protected Securities (TIPS). It is currently trading at $95 versus essentialy a $100 par value. TIPS are like treasuries except they pay a smaller interest payment in return for having the principal increased by the amount of increase in the CPI. They are not adjusted downward for deflation. But, deflation is built into the current price. But the TIPs have a long time frame and are currently pricing in only very moderate inflation if any in the future.

A good long term investor will start buying TIPs at these CHEAP prices and keep buying if they fall more in the next year (as they are likely to do). In a year or less, I predict the discussion will have shifted back to inflation from the current concerns about deflation.

Nikkei at Attractive Levels

The Nikkei 225 is now trading at just above 8,200. This represents a 55% discount to July '07 prices and almost 40% off of July '08 prices. The best way to play the Nikkei may be to buy a Japan ETF like iShare's (EWJ). Even if the Nikkei remains flat, you will make a profit if the yen continues to decline against the dollar, because you own actual Yen-valued assets, not just an index number. The real discount, of course, is compared with 1989 Nikkei prices. Almost 20 years ago the Nikkei traded at over 38,000 at the height of the Japanese bubble. Even if it took another 20 years to reach that lofty level, investors would make about 7% annually. Of course, Japan is better treated as a short to medium term play. With the Nikkei's fall steeper than the S&P 500 and the likelihood of further yen strength, the Nikkei may be in store for a quicker and more lofty rebound.

Dow Under 8300. Time to Buy?

With the down now approaching its 5 year lows, is now the time to buy stock? The answer is yes... and no. If you are short term market timing, today is a good day to raise your market exposure. We may not bounce off the lows, but if we do you could see 5% gains from today's price of $83 for DIA (with futures down almost 2% you may pick up DIA for $81 or $82 on Thurs). Sell if we hit 87 in the next 5 sessions (ending 11/19). If we go down further tomorrow, buy more DIA as low as $80.
Update: I thought this might be a week-long trade, but it actually materialized in one day. On Thurs, you could have bought for less than $82 (and I did) and then you would have hit your stop at $87 (it went on to $88, but you have to leave some profits). 6.5% one day trade. I must admit that this was much more luck than skill, but you have to take them when you get them.

If you are not a market timer, the best strategy is to dollar cost average with a twist. Pick a fixed portion of your cash to invest each week. I suggest 4%, but this number varies based on your time-frame. Unlike traditional dollar cost averaging, we will not blindly invest a fixed amount each week, but rather intelligently invest that fixed amount each week. Pick a day to invest (I like Tuesday). If the market is down on Tuesday more than 1% buy. If it is up wait until Wednesday. If Wednesday is down 1% or more invest this week's allotment now. Again, if Wednesday is also an up-day, wait until the next down day to invest. This method is dollar cost averaging on steroids. Since you are buying on down days only, you should pick up some extra yield from picking off the market noise.

Am I starting to finally sound like a bull? I hope not. I have been bearish for as long as I can remember, but at some point you have to be concerned about the upside if you are short. I now think the upside is far too big for shorts to do anything but sell off the highs of the session. No long term short trades are really safe.