NEW YORK (MainStreet) -- We are taught to buy low and sell high. The problem is most investors don't sell high, and thus don't have the cash to buy low.
While the markets are currently experiencing weakness, many investors may not have trimmed into the strength we experienced after the September FOMC meeting. Thus, while a person may wish to buy at these lower levels, he is unable to because he does not have the available cash.
When the market pulls back and you have strong conviction in your positions, you should increase those positions. However, even if you do not have the cash available, this is still possible. We can use different methods to replace our stocks with more leveraged investments.
The method I am talking about is deep in the money call options.
Selling a portion of a certain stock and replacing it with deep in the money call options enables us to increase conservatively the amount of stock we effectively "control."
Let's say for example, we currently own 100 shares of Gilead Sciences. The current market pullback has brought Gilead down 5% from its high, and it may have even more to fall. To increase our position in Gilead without any free cash, we can sell 50 shares of the stock, and purchase a January 1, 2015 call option with a $50 strike price.Selling 50 shares of Gilead generated $3,085. The purchase of the call cost $1,655. The result of this transaction not only allows us to control 150 shares of Gilead, but we also free up $1,430 in cash. This conservative strategy allows us to increase the amount of Gilead that we control by 50% while also freeing up a significant amount of cash to use if the market falls further.
The market has currently pulled back approximately 5% from its high. If you have raised cash, you are probably feeling pretty good, and you can pick at your favorite stocks as they fall. If you have not raised cash, using deep in the money calls is a conservative and effective method to also pick at your favorite stocks as they fall.