How to Put Cash to Work in Sideways Markets

Tuesday, 21 Jun 2011 07:47 AM

By Andrew Packer

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According to bankrate.com, a 1-year bank CD has an average yield of 0.92 percent, yielding $920 in income every year for each $100,000. That’s an insultingly low $76.66 per month.

While it’s always important to keep some cash on hand to take advantage of market opportunities, at today’s rates, there’s little room to beat inflation with CDs. Government bonds have even lower yields.

It’s tempting to put cash to work in quality companies like Proctor and Gamble (PG). The 3.2 percent yield on $100,000 would generate $3,200 per year.

Don’t break out the party hats just yet. P&G’s share price is near a 52-week high and stocks have higher volatility than CDs.

As long as markets are declining, or at least trading sideways, I’m finding opportunities with options. I’ve already written about covered-call writing, which is a strategy to bolster returns on investments that someone already owns.

But what if you don’t want to go long an investment at today’s prices? Consider selling puts.

Just like with covered call writing, selling puts are a way for investors to get a discount to the current “retail” price of a stock. The advantage is that by selling a put option, investors are getting paid to wait.

Using Proctor and Gamble as an example, let’s say I think share prices could come down from $65 to $60. I can currently sell a December $60 put option for around $2.05. If I sell the option now, I’ll immediately gain $205 (each option contract is for 100 shares).

If share prices fall below $60 before the options expire in December, I’ll have to pony up $6,000 for each option I sell to buy shares. If the price is above $60 when it expires, I’ll keep the option premium.

In this case, the $205 generated amounts to a return of 3.4 percent. That’s based on the $6,000 that I would need to pony up if the option is put to me. Annualized, it’s almost a 7 percent return, better than a bank CD and a bigger return than the dividend on P&G shares.

I’ve recently sold puts on Cisco (CSCO), and will probably use down days as an opportunity to take advantage of rising put premiums to sell puts in other companies.

In these cases, I’m shooting for either 8 percent to 15 percent annual return on my cash, or a lower cost basis on quality companies worth owning for the long haul.

An additional advantage is that selling puts takes out some of the emotion of investing. If there’s a crash, you end up buying companies at a price you like, whereas without the put option you might want to wait and miss the true bargain.

I’m not the only one who uses a put-selling strategy to generate better cash returns and buy quality companies at a discount to retail price. Warren Buffett used this strategy to pick up shares of Burlington Northern in 2008.

Add put selling to your investment arsenal. You can beat the ultra-low returns on cash, while getting paid to wait for better prices on quality companies.

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