Most Popular
1. It’s a New Macro, the Gold Market Knows It, But Dead Men Walking Do Not (yet)- Gary_Tanashian
2.Stock Market Presidential Election Cycle Seasonal Trend Analysis - Nadeem_Walayat
3. Bitcoin S&P Pattern - Nadeem_Walayat
4.Nvidia Blow Off Top - Flying High like the Phoenix too Close to the Sun - Nadeem_Walayat
4.U.S. financial market’s “Weimar phase” impact to your fiat and digital assets - Raymond_Matison
5. How to Profit from the Global Warming ClImate Change Mega Death Trend - Part1 - Nadeem_Walayat
7.Bitcoin Gravy Train Trend Forecast 2024 - - Nadeem_Walayat
8.The Bond Trade and Interest Rates - Nadeem_Walayat
9.It’s Easy to Scream Stocks Bubble! - Stephen_McBride
10.Fed’s Next Intertest Rate Move might not align with popular consensus - Richard_Mills
Last 7 days
Nvidia Numero Uno in Count Down to President Donald Pump Election Victory - 5th Nov 24
Trump or Harris - Who Wins US Presidential Election 2024 Forecast Prediction - 5th Nov 24
Stock Market Brief in Count Down to US Election Result 2024 - 3rd Nov 24
Gold Stocks’ Winter Rally 2024 - 3rd Nov 24
Why Countdown to U.S. Recession is Underway - 3rd Nov 24
Stock Market Trend Forecast to Jan 2025 - 2nd Nov 24
President Donald PUMP Forecast to Win US Presidential Election 2024 - 1st Nov 24
At These Levels, Buying Silver Is Like Getting It At $5 In 2003 - 28th Oct 24
Nvidia Numero Uno Selling Shovels in the AI Gold Rush - 28th Oct 24
The Future of Online Casinos - 28th Oct 24
Panic in the Air As Stock Market Correction Delivers Deep Opps in AI Tech Stocks - 27th Oct 24
Stocks, Bitcoin, Crypto's Counting Down to President Donald Pump! - 27th Oct 24
UK Budget 2024 - What to do Before 30th Oct - Pensions and ISA's - 27th Oct 24
7 Days of Crypto Opportunities Starts NOW - 27th Oct 24
The Power Law in Venture Capital: How Visionary Investors Like Yuri Milner Have Shaped the Future - 27th Oct 24
This Points To Significantly Higher Silver Prices - 27th Oct 24
US House Prices Trend Forecast 2024 to 2026 - 11th Oct 24
US Housing Market Analysis - Immigration Drives House Prices Higher - 30th Sep 24
Stock Market October Correction - 30th Sep 24
The Folly of Tariffs and Trade Wars - 30th Sep 24
Gold: 5 principles to help you stay ahead of price turns - 30th Sep 24
The Everything Rally will Spark multi year Bull Market - 30th Sep 24
US FIXED MORTGAGES LIMITING SUPPLY - 23rd Sep 24
US Housing Market Free Equity - 23rd Sep 24
US Rate Cut FOMO In Stock Market Correction Window - 22nd Sep 24
US State Demographics - 22nd Sep 24
Gold and Silver Shine as the Fed Cuts Rates: What’s Next? - 22nd Sep 24
Stock Market Sentiment Speaks:Nothing Can Topple This Market - 22nd Sep 24
US Population Growth Rate - 17th Sep 24
Are Stocks Overheating? - 17th Sep 24
Sentiment Speaks: Silver Is At A Major Turning Point - 17th Sep 24
If The Stock Market Turn Quickly, How Bad Can Things Get? - 17th Sep 24
IMMIGRATION DRIVES HOUSE PRICES HIGHER - 12th Sep 24
Global Debt Bubble - 12th Sep 24
Gold’s Outlook CPI Data - 12th Sep 24

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Compound Stock Earnings Programs - Caveat Investor

InvestorEducation / Options & Warrants May 12, 2008 - 03:30 PM GMT

By: Steve_Selengut

InvestorEducation The caller seemed surprised that I had never heard about Compound Stock Earnings Programs, or CSEs. "People are earning three to six percent per month with little or no risk", she continued, "I'm thinking of attending a seminar". A wise man once said: "If it sounds too good to be true, it probably is", but this sure is a creative euphemism for what has to be a rather complicated options strategy.


The buyer of a "call" option obtains the right to purchase a specified quantity of a security from the seller of the option, at a stated "strike price", and at any time on or before the contract expiration date. When the option seller owns the security, it is called a "covered" call. The CSE hucksters don't deny that their magic cash flow system is based on selling "covered" call options, but the "come on" includes a laundry list of misinformation, partial truths, and inaccuracies about the stock market and investing.

Covered calls have been around forever, but this is the first time I've seen them touted as safe investment vehicles. They are certainly the safest of a complex array of option strategies, but very few registered, certified, or well known and experienced investment gurus would ever use the word safe when discussing options--- or recommend them. All options are speculations, no matter how well sugar coated and no matter how fail-safe the trading system appears. The risk is in there.

Options are bets about the future price movement of exchange-traded securities--- it's just that simple. The prospect of unusually high returns always signals unusually high risk. Caveat emptor, in spades. Here are some things to consider before you think about attending that free seminar--- not to mention the basic reality that equities are not at all the proper investment vehicle for an income-generating portfolio. That's what income securities are all about.

The pitch begins with the accurate statement that most investment portfolios are chock full of equity mutual funds, and that such funds rarely produce enough income to pay the bills. Consequently, principal drainage occurs when mutual fund shares have to be sold during market downturns. But no mention is made of the fact that really low-risk, monthly-income, and easily traded alternatives (currently ranging upward from above 5% tax free and above 7.5% taxable) are readily available.

The second CSE selling point laments the declining dividend yield on NYSE traded securities. Again, equities have never willingly accepted a job description that includes "provide monthly spending money to shareholders". The purpose of stock ownership is growth in the form of capital gains. When income becomes the purpose of the investment program, proper advice would be to sell the stocks and to buy monthly income producing securities.

Actually, there has never been a time when common stock dividend yields were as high as some of the CSEs report in their propaganda, and historical growth rates of the Dow and S & P have always been calculated ex-dividend. Similarly, the glossies talk about the low yield on individual bonds and treasury securities as though these were the only alternatives an investor has, which they obviously are not. Based on website review alone, it's doubtful that the CSE marketing companies are registered with the Securities and Exchange Commission (SEC).

Even if we pretend that an equity portfolio's growth rate can be enhanced with a covered call strategy, let's look at the things the investor has to think about after he puts the option premium into his pocket. What if someone drops the ball (or if something really good happens over night) and the stock is actually called away? Think of the tax consequences of a gain on low cost-basis holdings, or the actual capital loss if you are writing the calls on stocks that have fallen in price, as you will certainly be doing during corrections.

Additional drawbacks of the covered call program are: (a) limiting the amount of profit on a rising stock; (b) reducing portfolio liquidity and flexibility because the underlying securities cannot be sold unless the option has been bought back; (c) there can be up to four separate commissions paid in one completed transaction; (d) higher premiums are generally associated with higher price volatility and higher risk levels--- which is as it should be. Another possibility is that the call buyer might exercise his option early in order to capture the underlying stock's dividend, or because of take-over rumors.

So as safe as the CSE promoters want you to believe the process is, there is a significant potential for both loss and inconvenience--- enough so that managed municipal, corporate, and government CEFs, REITs, preferred stocks, etc. look better and better and better for investors who need safe (actually safe) income.

While you are thinking about Compound Stock Earnings Programs, consider this. Why aren't our dear friends on Wall Street pushing these programs or mass advertising this revelation? Why are option specialists the pariahs of most brokerage firm offices? Why are special risk acceptance forms required by brokerage firms to separately authorize the use of options? Why are options, commodities, futures, margin programs, and short selling way up there on most qualified investment adviser listings of inherently speculative financial products?

Certainly, the CSE promoters have provided adequate documentation, instructional material, testimonials, and software to describe the workings of their covered call option programs. But in addition to the in-your-face hype, greed food, and numerous pages of disclaimers, can they show you the customer's yachts?

By Steve Selengut
800-245-0494
http://www.sancoservices.com
http://www.investmentmanagemen tbooks.com
Professional Portfolio Management since 1979
Author of: "The Brainwashing of the American Investor: The Book that Wall Street Does Not Want YOU to Read", and "A Millionaire's Secret Investment Strategy"

Disclaimer : Anything presented here is simply the opinion of Steve Selengut and should not be construed as anything else. One of the fascinating things about investing is that there are so many differing approaches, theories, and strategies. We encourage you to do your homework.

Steve Selengut Archive

© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in