401ktimer1 (33.74)

If you missed the rally, what to do?

February 07, 2012 – Comments (0) | RELATED TICKERS: AMAT , SPY , QQQ

In my August & Septmeber 2011 blog posts, I suggested that it was a good time to buy stocks at that time.  The reasons for my bullishness were charted here:

Why it was a good time to buy stocks in August & Septmber 2011

Since then the stock market has rallied considerably.  Continuing the trend, major averages advanced 8 to 10% just since the beginning of 2012.  Many individual stocks rallied even more.  

So, if you missed the rally, what do you do?  Do you get in at these levels and risk a pull back; or stay out and wait for a pull back that may or may not come?

One strategy for entering the market at this point is to sell cash covered put options with strike price below the market price.

For example, Applied Materials (AMAT) is a value stock that rallied 25% from its recent low.  Even at this level, the stock presents a good value as shown below:

Market Cap: 16.63B
Trailing P/E: 8.79
Forward P/E: 11.27
Net Income (ttm): 1.93B
Total Cash (mrq): 6.24B
Total Debt (mrq): 1.95B

Looking at the data above, one can see that backing out the net cash, the market is valuing AMAT at ~$12B and if the company generates around ~2B net income per year, the effective P/E is only 6.  So, if you believe that the economic recovery will continue, AMAT is a good stock to buy at today's price (~$12.75).  However, since the stock rallied 25% non-stop, it may be due for a pull back. Therefore, instead of buying the stock at this level, a safer alternative would be to sell cash covered put options on this stock:

Sell AMAT Jul 21 2012 $12.0 Put for $0.72

With this option trade, if AMAT stock stays above $12 until the expiration date, the profit will be 6%; and if the stock goes below $12, the option will be assigned and net purchase price of the stock will be $11.28 presenting a good entry point for going long on the stock.
To see how such cash covered put option trades worked in the past, see:

September 2011 Trades

October 2011 Trades