Don’t Panic During This Market Pullback

Market Pullback Panic

Don’t panic! This is not a market crash, this is a market pullback. We have a few of these every year. They tend to pull back roughly 4% to 5%. We had one last October. Have you seen what the U.S. markets have done since? If you’re a buy-and-hold investor, this is not the time to sell off in a frenzy. Instead, you can try something new. You can take advantage of the volatility to engage in an exciting trade. It’s simply known as a Covered Call.

When momentum is negative, you have two choices. You can move to cash as I have historically done. Or you could sell options to the upside. Take a look at a company that I love. Energy Product Partners (NYSE:EPD) is a master limited partnership with a solid upside as oil prices rise. Yesterday, shares fell more than 3.4%, and they’re down again today. What I’d do here is sell one call for every 100 shares I own. A call option gives the buyer the right, but not the obligation, to purchase a stock if it hits or rises above a price by a specific date (known as expiration date.)

How a Market Pullback Works

Let’s say that I own 100 shares of EPD. I could sell a call option with an expiration date of January 21, 2022, and a strike price of $27.00 for $0.65 today. I receive $0.65 for every share, which means I receive $65 for a 100-share contract.

The only way that I would have to sell my stock to the buyer of this contract is if EPD shares go above $27.00 on or before January 21. And regardless of what happens, you get to keep the $65. Let’s do the math here on why I like this trade.

First, EPD has a dividend of more than 7%. So long as stock remains under $27 and/or the buyer doesn’t execute the contract, I’ll receive the dividend two more times this year before the expiration of the call.

Second, you don’t have to sell the stock until it hits $27 from current levels, which represents an upside of 10.8% over the next six months. Even though you’ve capped my potential gains, you should be happy to take that exit the trade at that level, given the double-digit potential.

Third, if the stock continues to drop, you can always buy back the call contract and pocket the gains based on the decline in the value of the call contract.

Fourth – and finally – you’d have a breakeven value on this trade that is higher than the $27. Remember, you need to add the value of the call option to the strike price. That would be $27.65. This means that you’ve capped your gains at 13.6%.

This is a conservative trading strategy and one that can help you squeeze additional gains out of existing positions. The worst-case scenario is that you have to sell the stocks you already own again. Sure, the stock could hit $30 or $50, and you’ll be forced to sell the stock at the strike price. Don’t be greedy, and don’t think about what could have been.

Being a successful trader and investor requires humility, patience, and a different perspective on measuring wins. I’ll talk more about the various ways to measure success in the days ahead.

Garrett Baldwin
Garrett Baldwin
Garrett Baldwin joined Godesburg Financial Publishing as Chief U.S. Markets Analyst in early 2021. A Johns Hopkins-trained Economist, he’s worked with hedge funds, venture capital firms, angel investors, and economic advisors to the U.S. government. Baldwin specializes in market anomalies and alternative investments. He’s written extensively on momentum, value, insider buying, and other unique strategies that provide investors that elusive edge.
Garrett Baldwin
Garrett Baldwin
Garrett Baldwin joined Godesburg Financial Publishing as Chief U.S. Markets Analyst in early 2021. A Johns Hopkins-trained Economist, he’s worked with hedge funds, venture capital firms, angel investors, and economic advisors to the U.S. government. Baldwin specializes in market anomalies and alternative investments. He’s written extensively on momentum, value, insider buying, and other unique strategies that provide investors that elusive edge.

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