The S&P 500 dropped -8.2% in May, leaving investors with
some tough decisions to make in June. The downdraft pushed many
solid investments into the loss column, year-to-date.
If you are sitting with a loss on a fundamentally sound investment,
what can you do?
Here are some options:
You could buy more shares now and reduce your cost basis . This, of
course, isn't the easiest thing to do. If the market continues to
drift downwards -- or even sideways -- over the short-term, you'll
have that much more invested in a non-performing asset.
Bite the bullet and sell at a loss. Then, sit on the sidelines and
wait for some positive movement and try to pick up the stock on the
upswing. Of course this strategy isn't without its issues.
If the stock starts to move within 30 days of your sale, there
might be some tax implications if you buy it back. If you need to
wait longer than 30 days to avoid the wash rule, you might miss out
on some nice gains. (Read this explanation of the wash rule
Or you could just invest in something else. But if this is
fundamentally the same company as it was when you bought it, why
wouldn't it still be on your short list to buy?
Just hold on to the stock and ride it out. You'll avoid spending
any more money on trading commissions. And you won't miss any price
appreciation on the upswing. Of course there is the possibility we
are heading into a sideways-trading market -- so you might spend a
long summer staring at your losses.
Or…You Could Get Paid to Hold
Every day, investors get paid to hold stocks in their portfolios.
In fact, it's a tried and true investment strategy employed by
retirees and income investors.
How do they do it? They write -- or sell -- covered call
options. When someone buys a call option , they pay a premium to
buy the right to purchase a stock at a specified price, called the
strike price. They buy the right, but are not obligated, to go
though with the sale. In fact, most options are bought, but not
exercised, by the time they expire.
So to make a little extra income off of a holding, an investor can
sell a call option and collect the premium. When the call writer
owns the underlying stock, it is called a "covered call." The vast
majority of time, the call option is not exercised, and the
investor keeps the underlying shares. Investors can then write
another covered call to collect even more income. If the call is
exercised, the call writer has to surrender the shares at the
Let's say you bought 100 shares of the department store chain
on January 5th for $54.00. The store seemed busy over the holidays
and you believed the performance of the retail sector was going to
be rosier than expected. And to some extent, you were right. Your
position gained throughout the year -- until May came along. Today,
it is hovering at about $51 a share.
You still very much like Kohl's outlook and would like to hold on
to the stock. But May's retail sales were just released and were
lower than expected -- down -1.2%. So it might be a while before
the market bids this stock back up to your breakeven price.
In the meantime, you could write a call on Kohl's at a strike price
of $55.00 and collect a $2.00 a share premium. The option would
expire in October.
By collecting the $2.00 per share call premium, you are now
breakeven at $52 a share -- instead of your original purchase price
of $54 a share. And if the option never gets exercised, you'll keep
the shares and collect even more income by writing subsequent call
options. If the share price runs past $55, you'll have to surrender
you shares, but at a +5.7% profit.
Before the call option is exercised, you can buy a call option at
any time for the same strike price and expiration date to erase the
Options are offered at many different strike prices above and below
the current market price. They also have different expiration
dates. It might take a little shopping around to find the right
combination that fits your needs and goals.
With the tough decisions investors are facing this month, it's nice
to have another choice -- one that can turn a loss into a profit --
or a long unprofitable wait into to an income-producing
Action to Take -->
I've found two securities you can use to put this strategy into
1. With the oil troubles in the Gulf, shares of the offshore
Diamond Offshore Drilling (
lost -20.2% in May. The industry is holding its breath, waiting to
see what new offshore drilling regulations will materialize. This
could keep a lid on the share price in the near term. Right now,
investors can get a $3.80 per share premium to sell a DO call
option at a strike price of $66.75 a share. DO is now trading near
$61 per share and the option expires in September.
2. Shares of the seed and herbicide company
lost -19.3% of their value in May. It's been a tough year for this
agribusiness powerhouse. Crop prices are low, which makes farmers
less likely to spring for Monsanto's state-of-the art products. And
this situation may not change until the next planting season. Right
now, you can get a $2.50 per share premium to sell a call option at
a strike price of $55.00 per share. MON is trading at roughly
$51.25 per share and the option expires in October.
Editor: Stock of the Month, The Daily Paycheck
Disclosure: Amy Calistri does not own shares of any security
mentioned in this article.
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