Daily Gains Letter

What the World Cup and the Stock Market Have in Common This Year

By for Daily Gains Letter |

How to Make Some Premium Income This SummerLast Wednesday, I had fun watching the World Cup game between Argentina and the Netherlands. As strange as it may sound, I actually found that the tension and apprehension throughout the match reminded me of the stock market.

Despite the Dow Jones Industrial Average recently trading above 17,000 and the S&P 500 at another record-high, I still sense the stock market is vulnerable to selling. I think this will be especially true if the second-quarter earnings season pans out as expected, devoid of any major growth in earnings or revenues.

Alcoa Inc. (NYSE/AA) offered up a nice report, but I’m not sure how much it counts, as the company really is not a major bellwether as to the health of the global economy.

The reality is that consumer spending drives the economy and the stock market. I would rather look at what’s happening at bellwether global retailer Wal-Mart Stores Inc. (NYSE/WMT) than Alcoa. The “Death Star” of the retail sector is struggling for growth around the world—and that cannot be good news. Even discount stores, which tend to be more immune to slowing, are showing signs of weakness.

In other words, while the stock market has edged higher, I still wouldn’t get too comfortable at this time. I think we could see another minor stock market correction should earnings tank. Of course, this would provide us with an investment opportunity to buy shares on weakness in the stock market.

Now there’s some optimism following the Federal Reserve’s dovish remarks from its June meeting, as there’s a sense that interest rates will not ratchet higher until after mid-2015, depending on the economic growth and jobs numbers. The central bank is expected to cut its bond buying completely by its October meeting. The current low rates will allow the economic renewal to continue until the economy can handle higher rates. The problem I see is that by the time interest rates begin to head higher, the amount of debt held by Americans and the government (remember the $17.0-trillion national debt?) will drive up carrying costs and that is not good. I envision an increase in defaults and personal bankruptcies.

On the geopolitical front, you have the rising conflict between Israel and Hamas, but there are also the tensions in Iraq with ISIS (the Islamic State of Iraq and Syria) seeking control, and then there’s Ukraine. Any major upheaval here would likely drive up the price of gold, which is only for traders at this time.

Over the next few months, during the quieter summer session, we could see the stock market trade sideways. Should this happen, an investment strategy could be to look at writing covered call options on some or all of your existing long positions.

I’m a big supporter of writing call options in the stock market, especially if the outlook looks flat, as could be the case this summer.

By writing call options, you can generate premium income and reduce the average cost base of some of your holdings. I often use this simple strategy in my portfolio management, as it’s simple and cost-effective to undertake in the stock market.

Of course, the stock market could run much higher, which could take out some of your covered calls. Make sure the strike price of your covered call option is not too low, otherwise you risk your underlying stock being taken out (exercised) too soon. Set your strike price high enough to generate decent premiums, while also guaranteeing a nice selling price for your stock in case you are called away if the stock price rises above the strike price.

Also make sure you don’t extend the expiry out too long in order to generate higher premiums. At this time, looking at the September expiries may make the most sense.

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