By Karim Rahemtulla Is the market overvalued?
Yes. By many measures, this is one of the most overvalued markets in history. Price to earnings and earnings growth are two measures that should tell you this 9-year-old bull market is closer to the top than the bottom.
Volatility, as measured by the VIX, is showing complacency associated with market tops. (You can read my explanation of the VIX and volatility here.)
But thanks to a unique and simple strategy, you can take more than 85% of the risk off the table and still not give up an ounce of upside. Think about that. You can pull 85% of your cash out of the market but still retain the same exposure you had before.
Most investors use a stop loss of some type. At The Oxford Club, we usually recommend a stop loss of 25%. With this strategy, your upside is unlimited, but you could still lose a full quarter of your investment.
LEAPS Options: Even Safer Than Trailing Stops
With a class of options called LEAPS, you can mitigate substantial amounts of risk while still enjoying unlimited upside.
LEAPS is an acronym for Long-Term Equity Anticipation Securities. These are options that you can buy in any account, including your retirement account. They allow you to control the underlying shares for periods of up to three years.
When you consider that most investors today don’t hold stocks for more than a few months, three years is really an eternity.
These LEAPS are usually available on most established mid to large cap stocks on the Nasdaq and the NYSE. You’ll find them on companies like Apple (Nasdaq: AAPL), NVIDIA (Nasdaq: NVDA), Merck (NYSE: MRK), Barrick Gold (NYSE: ABX) and the like. You won’t find them on small cap stocks.
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Let’s say you own 1,000 shares of Apple, for example. You are risking $154,000 in the market for your position. You think Apple will go to $220 in the next two years. That would be a fat return. But your 25% trailing stop means you’re willing to lose up to $38,500 if you’re wrong.
Let’s look at how a LEAPS option would work in this situation. You can buy a LEAPS that expires in 840 days (more than two years) that allows you to own Apple at $155. That option would cost you about $23 per contract. For a trade that allows you to control 1,000 shares, your cost would be $23,000.
So, right off the bat you stand to lose less than your 25% stop loss. In fact, the MOST you can lose on this trade is what you invested. Twenty-three thousand dollars is 14.9% of the $154,000 you have at risk for owning Apple shares outright. So you’ve just yanked 85% of your cash and risk off the table.
If Apple hits your $220 target, you would be up $66,000, or 42%. Your LEAPS option would be worth $65 ($220 minus the $155 strike price). You must subtract another $23 for your cost, so your net return would be $42,000 ($65,000 minus $42,000).
You’ve almost doubled your money! …read more
Source:: Investment You
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