As I wrote about last week, we understand that income investing is a problem after 10 years of historically low interest rates.
Of course, as the Federal Reserve had been raising rates, concerns have eased for some. But I think the sighs of relief I hear are premature.
That’s because we have macroeconomic trends at work that could keep rates lower than income investors would like to see for many years.
So the strategy I used last year to generate 45.6% in income will be needed in the future, even if rates rise in the short term.
My income strategy is simple. And it has a high probability of success — with a 93% win rate (28 wins in 30 trades).
But it’s not for everyone. The two losses were relatively large. If you trade this strategy, you need to take all the trades signaled to be sure you are there for the wins. So it requires a real commitment to trading.
However, the payoff is that it will allow you to collect income in any market environment. To just that, I simply follow a strict set of rules…
Trading for Income With Limited Capital at Risk
To start with, I find the right stock. I want a stock that is making a big move. I also want to know why the stock is making the move.
By knowing the reason behind the move — maybe it’s an earnings announcement or a product update — I can evaluate whether or not the move is likely to continue.
If the move is likely to last, I open a credit spread in the stock. To do this, I sell an option to generate income. Then I buy another option to limit the risk. After doing that, I have income and limited capital at risk.
The two options need to offer significant income, usually a return of about 5% on the amount of capital risked.
The options also need to carry low risk. Using an options pricing model, I can determine the probability a trade will be successful. I want at least a 90% probability.
That sounds great, but that means there is a 10% risk of a loss. Remember, there were two losses last year.
That’s actually good. It shows the probability model is accurate.
Now, the key to this strategy is staying committed to trading. We’ll continuously find these trades a few times a month.
Market makers will always be willing to take our trades if we use large-cap stocks because of some technical market structure factors. So we’ll always have a few opportunities each month to generate income.
You’re probably thinking: This is too good to be true. What’s the catch?
Well, frankly, the risk is you.
We’ll have some losses with these trades. Committing too much capital to them can lead to large losses. If you contribute too much capital to the trade, a loss can become an issue. Fortunately, this problem is easy to avoid.
Keep your trade size small to reap the benefits of a high-probability strategy.
The best way to prevent overwhelming losses is to decide how much money you’ll allocate to this strategy. Divide that by five, which is the maximum number of positions we would have open at any one time. Then make trades with that amount.
As your account balance grows or shrinks, review your allocation. Have a plan for that. Maybe you will review the allocations after you balance increases 10%. Then, you’ll take half the profits out of the account and take future positions based on your new capital allocation.
This income strategy is just one of several of my favorite ways to trade in Precision Profits that is yielding successful results. You learn more about it and my approach to active investing by clicking here.
Regards,
Michael Carr
Editor, Precision Profits
