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Sept. 13, 2013, 1:39 p.m. EDT

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About Kirk Spano

Kirk Spano, the winner of the first MarketWatch competition to find the world’s next great investing columnist, is a registered investment advisor and founder of Bluemound Asset Management, LLC  which seeks to provide investors with greater safety, growth, income and freedom. Kirk’s biography and various business endeavors can be found at Follow Kirk on Twitter @KirkSpano or at the Bluemound Facebook page for his columns, company analysis, letters, trade notes and what he is reading.


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By Kirk Spano

This week a client with an equity portfolio came in because he wanted an explanation about what was going on in his account. He recently saw that I had raised cash for the second time this year. He already knew my reasoning about the cash since he reads many of my articles, notes and blogs. What he was particularly interested in was how we have beaten the market despite the high cash balances most of the year.

In January and in several other articles early in the year I noted some stocks I was buying. Among the four that I suggested in January, the former MEMC Electronics, now SunEdison  has done the best. The solar leader has almost exactly doubled, largely on the back of increasing orders for installations and an improving balance sheet. I covered MEMC/SunEdison more fully in February.

Another stock I discussed, this time way back in 2012, was Exact Sciences /zigman2/quotes/206653925/composite EXAS -0.15% . This biotech has regularly been my largest holding the past several years, due to its share-price appreciation, having risen from a dollar and change when I first bought it to the $12 range today. Exact has been moving a step at a time to bring a less invasive screening test for detecting colorectal cancer in the early stages and even in a precancerous state — which is very attractive to Medicare as a potential treatment cost saver. I would have written about Exact earlier, but discussing micro caps in the media is a faux pas, so I had to wait until it had a larger market cap, which currently stands at a little under a billion dollars.

Having a handful of companies that make large gains can do a lot to support a portfolio. Peter Lynch famously pointed out that, "All you need for a lifetime of successful investing is a few big winners, and the pluses from those will overwhelm the minuses from the stocks that don't work out."

What is most helpful to a positive investment experience is protecting your money. By this I mean significantly mitigating losses. It is impossible to avoid some losses if you invest in stocks.

For people who have the stomach to invest in companies, the easiest and most important way to protect your portfolio is to really know what you own. Most people don't. Again, Peter Lynch points out that: "The worst thing you can do is invest in companies you know nothing about. Unfortunately, buying stocks on ignorance is still a popular American pastime." Not much has changed since Lynch said that.

To truly know the companies I invest in, I whittle down ideas so that I am only following about 50. New companies pop up on screens, come from other advisers or appear in various publications, including MarketWatch, but if I add one to my investment universe, I also generally subtract one. Trying to keep up with more companies is almost impossible, and frankly isn't healthy.

Another way to protect your money is to take a more conservative approach to being involved with the stocks of the companies you know.

Using trailing stops is a favorite tactic of mine. With these trades I am simply telling my computer to sell if a stock's price falls too much below its recent high. This isn't rocket science, but it does keep losses small in the event of a sudden market downturn or something bad happening at a company I am invested in.

Recently, I was stopped out of Potash Corp.  when one of the potash fertilizer cartels (yeah, there is such a thing) broke up. It saved me some money and allowed me to evaluate the new investment landscape for Potash Corp., which I think is probably pretty crummy, and at least risky enough to avoid, in the short-term.

In my first article on MarketWatch, I discussed selling cash-secured puts. I use cash-secured puts extensively. With this simple option strategy (discussed at the CBOE ), an investor can receive premium income and not have to buy the stock of a company they like unless it goes lower in price. This is a very simple, and limited, form of hedging your risk.

The put strategy and its effects are what I had to walk my client through. Although we carry very large cash balances, a good deal of the money is attached to the puts that we sell. This happens because in an account without margin — very few of my accounts use margin — in order to sell a put, there must be cash available to buy the stock, should it's share price fall below the strike price of the put option.

Put premiums are generally highest when volatility is high. From time to time, I can sell puts with a good premium income when my stocks are under some sort of pressure. As a result, we are getting paid a very high income on the money-market accounts we are holding. Knowing your companies is obviously very important to making these trades, since often there are very good reasons for falling stock prices, i.e., Potash Corp. You have to know your companies better than the market does. Fortunately, that can be done with some effort, see Lynch's quote above.

Here's an example of a cash-secured put trade I made recently. Because Exact Sciences is under pressure from short sellers (extremely misinformed in my educated opinion) the premiums are fairly high. Last week, I sold October $11 puts for 35¢. That's a 3% return for seven weeks of holding time on the option contract (22% annualized), presuming we don't have to buy more stock. If the stock falls to under $11 in the next seven weeks, then my net cost to buy the stock will be $10.65 ($11 strike price minus the 35¢ premium), which is significantly below the recent $12. For this strategy to be acceptable for somebody, they have to be comfortable buying the stock. In this case, I am.

Next week I will discuss adding an aggressive tactic to your "personal hedge fund" that can be used selectively under certain infrequent circumstances. Being able to pull the trigger on the simple, yet potentially explosive trade, that we'll discuss, for companies you know, can add significantly to your portfolio without putting much cash at risk.

Disclosure: Clients of Bluemound Asset Management, LLC own shares of SunEdison and Exact Sciences, and have sold cash-secured puts on both. No trades are planned in the next three days. Opinions subject to change at any time without notice.

US : U.S.: Nasdaq
$ 68.47
-0.10 -0.15%
Volume: 396,966
Feb. 8, 2023 11:58a
P/E Ratio
Dividend Yield
Market Cap
$11.93 billion
Rev. per Employee

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