This year has been the year of the meme stocks. Price for some stocks have been fluctuating up and down with no reason at all, just because a bunch of people decided, collectively, to trade them.
I would strongly not recommend following this method of “investing”, most of the time you don’t even know what’s happening, and in general, this type of trading doesn’t get you so far ahead in the game. It is just a pure matter of luck.
Just think of it: The retail investors are trying to guess if the stock is moving up or down without caring for how the company is doing at all. This type of trading doesn’t bring any good, but tears once the market dries up.
Imagine there’s no market for the stock. The price of the stock would be just be a reflection of the value of the company. So the stock price would only move up if the company produce better results. The stock price could possibly go down only if the company is not able to produce good results.
Now, think again. Do you think is there any profit on trading based on how hot the market is?
For most part of 2021 the retail market has been trading stocks like if there was no tomorrow, thus creating a true opportunity for whoever wants to place himself for the long term, but in a way that makes sense.
Selling insurance in the form of options to other people
This is where the concept of selling insurance comes to be one of the main strategies that I normally use. Now that people have to move their money into these “meme” stocks, well, guess what, they need to guarantee somehow that the market is not gonna get crazy on them (as ironic as that sounds) and they will need to buy some insurance, just in case things turn around for the worse.
So if you go around and look at companies that have never traded for a price that reflects but a fair valuation and you find them trading at 10 times, 15 times, or even more than 50 times the valuation, that means there’s a possibility that these people trading on those stocks are looking for buying some insurance.
What type of insurance to sell
Take one specific company that I’m just getting into as an example. This company was valuated at no more at $2 or $3 billion just one year ago. This company is now selling in August 2021 at $17 billion with no significant changes, other than covid-19 happening.
The company is surely passing through financial issues, as no revenues are coming in while covid-19 is happening. But the retail investors have decided that this company is worth more than gold itself.
This contradictory situation means that I have a company with an over valuation note of almost 10 X and retail investors that are invested with good money in a company that hasn’t had or done anything especially during this period of time to be worth this valuation.
Of course people is looking for buying insurance! No wonder why… So you see puts with strikes as low as one or two dollars selling for 15 cents while the stock trading at more than $30 at the same time.
This means you can sell insurance to guarantee that you will buy the stock at 1 dollar or 2 dollars per share, and people will pay good premiums for that.
How do I know it is a good time to sell insurance
This is where are normally ask to myself: Is this company worth the 2B? Would I, in a normal situation, pay for this company at anything less than 2B to own it?
We’ll I certainly would, this company has been around for more than six decades, producing good Cashflow as to justify a valuation of 3B or more, and call me crazy, but if someone wants me to buy at 1.6B or less, I would do it without thinking.
That is the reason why I’m more than happy to make a move and sell insurance on this stock at 1 or 2 dollars per share.
What are the risks of selling this type of insurance?
The small print is that I have to buy at that price no matter what happens in the future. And I’m locked into a contract for the whole time.
Also, these are regular options, not European. That means that the buyer can get me executed and assigned at any time they want, so I better have the liquidity for pay for my stocks when that happens.
What are the benefits and final return
These numbers are taken from a real example that I’ve just finished analyzing since the past month or so., This one became my next investment for this next year, and this is what I got to see:
10% return out of the premium in the case the shares continue to be priced at an absurd level or even at a regular level.
The possibility to get the company for less than the value of it current assets, if the price ever gets to go extremely low.
The drawback: Well, In case there’s an immense terrible situation that will affect the company permanently (bankrupcy, stockholder liquidation, or any other abrupt measure that a management team can think of), I’m in for good, no matter what, and will get assigned the contract with no option to get out and suffer the consequences of a terrible management.
Remember, this is a risk only if I’m buying in crazy companies with no Cashflow, revenues or absurd valuations. But it becomes an asset when I run this strategy in companies that I would not mind owning for the next 10 to 20 years. I decide the price I want to get in, where if I see it as a bargain or not it is for me to decide. Then, I receive a premium to sit and wait, and the final result is: I either get a % gain on the premium or get to keep the stock for good.
Piece of cake?