More Panic, Please! How Volatility Leads To Income
Look out below! Market volatility is spiking as traders hit the panic button in the wake of the Brexit vote last week.
So what does that mean for your portfolio? Will volatility send your family’s net worth spiraling? Or can you use volatility to accelerate your income and grow your investments? You may be surprised at how easy it is to take advantage of this special opportunity.
How Volatility Affects The Market
When big events catch investors off guard, it can cause significant changes in financial markets. Professional traders as well as amateur investors usually scramble to minimize their risk. This typically involves selling shares of stock and moving to cash.
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All of this selling naturally sends stock prices lower. On Friday of last week, we saw markets tumble, and the selling has continued this week as well. Over just two days of trading, the Dow lost as much as 945 points!
In addition to selling shares of stock, traders minimize risk by buying put options. These put options increase in value as stock prices drop. So as traders anticipate volatility, they buy options, sending option prices higher.
Lower stock prices hurt most conventional investors. But higher option prices give income investors like us a chance to collect big cash payments.
Let’s look at how the current volatility is benefiting our income approach:
The VIX Is Spiking (And So Is Our Income)
We can measure the level of market volatility through an indicator called the CBOE Volatility Index (VIX). This indicator rises when traders expect more volatility, and falls during calmer periods.
Right now, the VIX is moving sharply higher. You can see the spike in the VIX chart below:
The VIX indicator is actually calculated by measuring option prices. So the more traders are willing to pay for options, the higher the VIX reading will be.
One of my favorite income strategies is to sell put option contracts for stocks I would like to own. By selling a put contract, I’m actually making an agreement that I will buy shares of this stock at a certain price. That agreement has a limited time period.
As an income investor, you can get paid to enter this type of agreement. And when option prices are higher (as shown by the VIX chart above), you can get paid more.
That means right now is a great time to be selling puts for stocks that you would like to own. You’ll get more income from selling these contracts, and you can agree to buy shares at a lower price. That’s a win / win scenario!
How to Capitalize On This Window of Opportunity
The first step for capturing income from selling puts is to create a list of stocks you would like to own.
My favorite stocks are those that have stable businesses and pay generous dividends. But there are also a number of strong growth stocks that I keep on my buy list as well. Look for companies that are generating profits and are likely to continue to grow profits in the future.
The next step is to pick a price you would be willing to pay for each stock.
Would you be willing to buy these stocks if they were offered to you at a discount? If so, how much of a discount would make you feel like you were getting a good deal? Remember, if you buy a stock at a discount, you’ll have a better chance at turning a profit than paying a premium price for the same stock.
Your third step is to select a put contract that pays you attractive income.
When you sell a put contract, you’re entering an agreement to buy shares of stock. (Each put contract represents 100 shares.) Since you’re getting paid to enter this agreement, you should make sure that the price of the put contract is high enough to compensate you for the agreement you are entering.
Selling puts is a great strategy to use in your 401(k) account. When you sell put contracts, you’re instantly collecting a cash payment in your account. Plus, you’re also giving yourself a chance to buy a stock on your watch list at a discount price.
Don’t let this period of market volatility cause you to panic. Instead, use this time as an opportunity to collect more income in your investment account. This is a great time to build more wealth for you and your family.