Gil’s Musings

Buying Stock on the Cheap

Investors have plenty to worry about these days. Is the Fed on hold or not? Are rates rising or collapsing again? Stocks look dependable, but 2008′s meltdown is seared into their psyche. What to do?

Many investors say they would be comfortable buying more stocks in a pullback. Did you know you can get paid for being willing to do that? What? Collect a payment for providing an exit for another investor at lower prices than today? Yep.

Most investors are unaware of more sophisticated techniques that are widely used by hedge funds and institutional investors to hedge risks and generate returns. I am talking about selling puts. I am not suggesting it’s for everyone, but simply understanding it can open up your mind to other possibilities.

Let’s say you own a vacant lot and you hear the city will be using the adjacent lot to store trucks for a year. I don’t think they will, and frankly, I would love to own your lot and wait for them to move away anyway. I could provide you peace of mind that I will pay you $950,000 for your $1 million lot if you decide to sell for any reason. You might need to pay me an “insurance” premium of say $20,000 for a four-month commitment on my part, which I get to keep no matter what you do.

This same arrangement is available for stocks. It can get a bit spooky when individual stocks like Enron or Nortel blow themselves up. But did you know you can use this technique to buy entire baskets of stocks that don’t contain exposure to such large individual stock risks?

The Vanguard Total Stock Market Index mutual fund is available in a traditional open ended share (VTSSX) or a listed stock version as an ETF (VTI). Each contains the exact same securities, and both hold more than 3200 different stocks. The ETF version has listed options. You may be aware that VTI was $75 in January and is $88 today. So let’s say you would love to buy the basket at $85 if the market pulled back, giving you a 4% discount from the current price. And let’s say you would commit to buying 10,000 shares at $85 until this Christmas. That would save you $30,000 over the current price. You could also get paid $14,000 for that commitment right now.

Some feel that this is “free” money. Not so fast. If the market dropped 20% in the next four months, you would feel quite different about the commitment you made. Also, what if stocks jumped by 20%? All you would have is the stinking $14,000 and you could have made $156,000 by buying the ETF today. The point is that we don’t know. But there is $14,000 up for grabs if you are willing to accept either outcome.

This is most appropriate for investors who don’t second guess themselves. Fear of regret is a strong motivator and a primary reason why many investors get caught in a treadmill where they regret fearing regret, only feeding inactivity and thus more regret.

Just food for thought….

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