The Tycoon Report

Got Profits? How to make this market a win-win situation.

Two weeks ago, the NASDAQ and the S&P 500 traded through levels not seen for 4 1/2 years. The momentum traders have stepped in to follow the trend, but are they getting carried away here?

We keep setting new highs, but each time that we have done this after the bear market bottom, the markets have pulled back. And each time we have done this, it was the perfect time to sell covered calls to take in income on your stock positions.

If you pull up charts on each index, you'll find that the S&P 500 and the NASDAQ have similar stories. For the sake of simplicity, let's focus on the NASDAQ.

After the bear market bottomed out in 2002/2003, all three indices ran higher until running into resistance in January of 2004. By the end of 2004, the three indices broke the Jan 2004 highs (hitting their highest points since June 2001), but they only barely broke those highs, followed by a significant pullback. This is what's happened EVERY TIME we've seen a new high since then as well.

Should you expect this time to be any different? Maybe, or maybe not. But you don't have to place that bet in order to make money or protect profit. What you should be doing here is putting yourself in a win-win situation by selling covered calls and generating income on the stocks that you own.

Now is the time! Remember: Markets usually look very bullish when trading at their short-term tops. Don’t get caught up in the hype. Take control and be disciplined. You don't have to try to "call the market" if you are selling covered calls when the indices are up.

If your stocks continue higher, you can get "called-away" at higher prices and at the same time you can take in the premium paid to you against your stock position. That premium can also reduce your downside risk in case the market does correct.

Check this out:

If you check out the charts of each index, you'll find that every time new highs were set (which were also their highest points since 2001), they only slightly broke those highs, and went through a correction.

For example: 

In January 2004 the NASDAQ traded as high as 2152.10, a level not seen since June 2001.

That was the first resistance point (or top) set since the bear market sent the NASDAQ down 78% from its high of 5132 in year 2000. After hitting that first resistance point in 2004, the NASDAQ corrected over seven months, trading 18.7 percent lower!

Here's where it gets interesting:

on January 3, 2005 the NASDAQ broke that last high of 2153.80 but only traded 1.7% higher, hitting a new 4-year high of 2191.60. Was it time to celebrate and run out and start doubling your stock positions? Apparently not.

After taking out that January 2004 high, and moving on to new 4-year highs, the NASDAQ only continued to run 39 points higher (1.7%). The NASDAQ then traded 4.2% lower within 48 hours. Then within five months, it traded a total of 13.8% lower to a close of 1889 on April 29, 2005.

Then, just over 3 months later on Aug 2, 2005 the NASDAQ set another 4-year high at 2219.91 (only 1.2% higher than the last high). Now was it time to celebrate, or time to take in additional income and sell covered calls? Here's a hint: the NASDAQ went on to trade down 8.8% to close on October 13th of this year at 2025.58.

So it's really been more of a 2.1 steps forward, 2 steps back sort of market each time we tried to break out (for the last two years). As a matter of fact, after the NASDAQ hit its first resistance level of 2153.80 in January 2004, it has only traded 115.5 points (or 5.3%) higher, which was the high that was set just a week ago. Now the long term trend is up.

Don't forget, we ARE making higher highs and higher lows as time passes. But on each attempted breakout over the last two years, the higher high hasn't even been 2% higher than the last recorded high. But, after setting those slightly higher highs, the NASDAQ corrected by 18.7%, 13.8%, and 8.8%.

I know it sounds like I'm trying to make a short-term bearish case for the NASDAQ here, but I really am not. My point is that if history is any judge, this is the time to be selling covered calls on your stock positions. Today the NASDAQ has breached the 4 1/2 year high that it set last week.

Who knows what happens here? If you do know, please, contact me immediately. But if you don't know for sure, the best thing to do here is to ... (say it with me now!) ... SELL-COVERED-CALLS!

You won't be upset.