It's All About the Comps!
Patrick is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
I recently had the opportunity to go to Vegas at my employer's expense. While meeting his business goals, I met my entertainment goals, spending some time at the slots and playing poker. Over four hours of play, I lost about $12. Money well spent? Yes! Can I relate this to my investment strategies? Yes!
First off, let's discount the entertainment value. I like gambling. You may not. We won't agree on a price for my pleasure.
Since you're reading my words, I conclude that we both enjoy investing. Investing is about about taking sensible risks, and it's about turning time into money.
When I gamble, I take sensible risks. I play games I know well, games that I think I can get an edge in. I don't risk the mortgage, but make only reasonably sized bets on situations with decent odds.
It's the same picking stocks. You do your homework. You don't put all your savings into one investment, no matter how good it seems. You diversify.
When I gamble, I earn "comps." The casinos pay their regular customers for the time they spend gambling, pay in the form of free drinks, food discounts, hotel room discounts. In my recent Vegas visit, my losses were easily covered by the comps. My entertainment was essentially free.
The stock market has the equivalent of comps. When you sell covered calls, the premium you're paid is compensation for the time you've committed to stay in the stock. Those premiums often turn out to be the most profitable part of the trade!
I recently became interested in STMicroelectronics N.V. (NYSE: STM), a semiconductor manufacturer whose stock has been beaten up badly in the past year. That's driven its yield (which appears to be safe) up to an impressive 5.7%, and while its earnings have been under some pressure they are expected to recover, and with its limited debt, STM seems likely to carry through. Still, there are some smart people out there that aren't as optimistic as me, so I wanted to hedge my investment.
Although STM has recently traded at $5.93/share, I bought mine for about $4.77/share, by selling a $5 call at the same time. For being willing to hold STM until July (for spending my time in the casino), I will make $0.23/share (assuming STM stays above 5), almost 5% over 7 months, or an annual rate of about 8%. Note that this does not include any dividends that STM may pay before then!
Now, somebody may choose to steal that juicey dividend from me by calling the shares away early, but that just means that I made my 5% in, say, 3 months, or an annual rate of 20%!
So by taking a reasonable gamble with a stock, and getting comped for committing to spend some time with that stock, I am pretty sure of enjoying myself. Just like Vegas.
The author is long STM and short the July 5 calls.