Warning: Avoid The 'Widowmaker' Trade… And Boost Income Instead

Warning: Avoid The 'Widowmaker' Trade… And Boost Income Instead

Today, I want to show you a chart every investor in America needs to be aware of. 

Not only does this simple graph answer one of the biggest questions facing U.S. investors today, but it could also be painting a picture regarding the state of the U.S. stock market right now. 

It’s our hope that after seeing this chart, you’ll have a better understanding of what the investing future might look like… and how you can start preparing your portfolio for it. 

Take a look… 

The chart above shows the yield on Japanese Government 10-Year bonds since 1986. As you can see, after falling sharply in the 90s, bond yields haven’t topped 3% since 1995 in Japan. 

What do Japanese bond yields have to do with the U.S. stock market? Let me explain… 

Like the U.S., Japan has seen its share of “asset bubbles.” 

In the late 1980s, a bubble in the Japanese housing market caused real estate prices in Tokyo to surge 180%. Stocks also soared, with the Nikkei 225 (Japan’s equivalent to the S&P 500) rising 132% in five years. 

But shortly thereafter, the Japanese economy came crashing down. Between 1989 and 1992, Japanese stocks fell 60%, property values plunged and GDP growth grinded to a meager 1.0% a year. 

In response to the crash, the Bank of Japan (BOJ) slashed interest rates to zero in 1992 to lower borrowing costs and boost economic activity. When their efforts failed to pull the country out of its slump, the BOJ tried to push rates even lower by printing money and purchasing assets like government bonds. 

Yet despite flooding the market with liquidity, economic growth in Japan remains non-existent to this day. According to recent government data, Japan’s economy grew at an average rate of 0.5% in the most recent quarter — significantly below the 2.9% average for the rest of the world. 

Meanwhile, the BOJ’s low-rate policies have rattled the country’s savers. The interest rate situation has gotten so bad that most households don’t even own a savings account because it’s not worth the time to open it. 

If Japan’s story sounds familiar, it should. 

As you know, Federal Reserve Chairman Ben Bernanke lowered U.S. interest rates in late 2008 in an effort to get the economy firing on all cylinders. When those efforts fell flat, the Fed began pumping billions of dollars into the money supply in order to further stimulate growth. 

Five years later, these policies have done little to help the U.S. economy. And the U.S. central bank has kept interest rates low for a lot longer than anyone originally anticipated. 

The biggest question facing U.S investors has become: How much longer can rates remain depressed? 

For the answer, look at Japan… 

Scores of investors have lost their shirts trying to “guess” when Japanese interest rates were going to rise for the past 20 years. At first they thought it would take five years… then they said 10… now we’re hearing it may happen as soon as next year. 

While they could be right, up to this point betting against Japanese bonds has proven wildly unprofitable. This trade has become so notorious for creating devastating losses that many simply call it the “widowmaker” trade. 

In other words, don’t assume rates are to going to rise in the U.S. just because “interest rates can’t stay low forever…” If Japan is any indicator, they can stay low for a long, long time… 

That means investors are going to have to look off the beaten path if they want to earn higher returns… especially from their income investments. Gone are the days when you can earn a 5.0% return on a savings account or an 8.5% yield on corporate debt. Today, you’d be lucky to get 0.1% from a savings account or 3% from AAA-rated bond fund. 

The Best Way To Earn More Income In Today’s Market 
While there are plenty of ways you can protect yourself in a perennial low rate environment (and we’ve discussed many of them here and here), one of our favorites comes courtesy of Amber Hestla, Chief Investment Strategist for Income Trader

Simply put, Amber collects extra investment income by selling put options on stocks she thinks are undervalued. These “Instant Income” checks, as she calls them, usually range anywhere from $100… to $150 … to even $200 per contract. (Many of her readers scale up to collect $2,000 or more in income per trade). 

So far this strategy has worked well. Since Amber launched her premium income and options newsletter, Income Trader, earlier this year, all 32 of her closed trades have been profitable… giving her subscribers an average gain of 8.6% every 48 days. 

The secret to this strategy is Amber’s investing philosophy behind each and every one of her options recommendations. Specifically, she only sells puts on undervalued stocks that she wouldn’t mind owning. 

By sticking to these two criteria, Amber is maximizing the possibility that the put she sells will expire worthless (when a put expires worthless, the seller keeps the premium they collected from selling the option as a profit). 

Take one of Amber’s most recent recommendations, the November put options on ICICI Bank (NYSE: IBN) — the largest bank in India — for example. 

Amber originally recommended this trade in October. At the time, the stock was trading close to $33 a share… but Amber thought the stock deserved a higher price point. As she told her subscribers: 

Only one Wall Street analyst has a price target on IBN, and that target is $46, more than 40% above the recent price. I believe that target could be underestimating the potential of IBN. Based on expected earnings growth, I believe that IBN is worth at least $60 a share. The stock is a buy at current prices and is also a great income trade.

In other words, at $32 a share, Amber thought the company was undervalued by 53%. As a result, she told her Income Trader subscribers to sell November puts on IBN with a $28 strike. Given the company’s discounted valuation, Amber believed there was strong chance the price of the stock would not trade below $28 by November 15 — the day the option expired. 

Her assessment was spot on. Last Friday, IBN closed over $34 a share — 21% above Amber’s recommended strike price. As a result, Amber got to keep the $50 in “Instant Income” she collected from selling the puts as pure profit. 

But even if the stock had fallen below the strike price and Amber would have had to buy the shares… she would only have to pay $28 for them — $32 (Amber’s $60 estimate – the $28 strike price) below her long-term target price. 

That’s the benefit of selling puts on stocks you think are undervalued. Even if the price of the underlying stock falls below the strike price and you have to buy the stock, you’re simply buying shares of a great company you already think is trading at a discounted valuation. 

So if this low-rate environment really is the new normal, then investors may have no choice but to get creative in order to boost their returns. If that’s the case, then consider selling put options… it’s clearly one of the easiest ways to earn more income — regardless of what happens with interest rates. 

Taken from:

Warning: Avoid The 'Widowmaker' Trade… And Boost Income Instead

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