Let’s see how we’d do if we had followed Fortune’s list of “best” stocks for 2008, early in 2008. Here are their 2008 recommendations (if you can’t see the spreadsheet below, please go here):

The crowning recommendation in this list is definitely, without doubt, Merrill Lynch. Just to remind you again of what Fortune said about Merrill:

Question: What do you call it when an $8 billion asset writedown translates into a $30 billion loss in market cap? Answer: an overreaction. Yes, Merrill’s shares deserved a punishment for the firm’s mortgage-related bungling. But the public flogging has far exceeded the transgression, which is why smart investors should buy this stock before everyone else comes to their senses.

Daaaammn. Luckily I wasn’t smart according to Fortune!

Honestly though, I didn’t buy Merrill not because I was smart or better informed than Fortune. I didn’t buy MER because I already work in a bank, and investing in another bank’s stock is just too many eggs in one basket for me. (I, for one, will NEVER buy the stock of the company I work for, unless it’s part of my compensation. Not diversified enough for my taste.)

But anyway. The point I’m trying to make here is that, 2008 has proven to us that the smartest guys with the smartest bunch of people working for them can be totally, irrefutably, horribly wrong. People are even starting to ask whether our most basic assumptions about stocks are no longer valid. What the Fortune magazine is recommending is not necessarily any better than what we can come up with a reasonable amount of homework ourselves.

So I’d say, trust yourself. Hold on to your money. Invest carefully, only after doing your own homework. And Merry Christmas! Here’s to a better 2009 ahead

(Image courtesy of Jeff Kubina @ flickr.)

Bad attempts at making jokes aside–the fact is a lot of people have tons of shares that have gone south, and I don’t see some of them recovering for a long time, maybe many, many years, even. 

So what do you do with those stocks that are sitting in your account looking ain’t so pretty no more? You feel reasonably confident they won’t go down too much anymore, so you want to hold on to them, but at the same time your money is stuck there and as long as the price is not moving up, you’re not making any money off your money. What to do with them?

Selling covered call options is one of the answers.

Examples

So let’s say you have been watching Cisco Systems’ shares for sometime. You thought that $17 would be a good price, so when it hit $17 you bought 1000 shares for $17k. Alas, it went down all the way to 14+ and at the time of this writing is trading at 15+. But at the same time you think it’s probably not gonna hit $13, and it’ll probably go up to $20 in a few months, so you decided to wait it out. 

Selling covered calls can make you extra money while waiting for the stocks to go up. Let’s say you think the shares would go to 20 within 6 months, giving you $3 profit per share. Instead of just waiting passively, you can sell 10 call options that expire in April 2009 with a strike price of $20 (last time I checked such an option costs $90). Here’s what’ll happen:

1. For selling 10 call options, you pocket 10 x $90 = $900 minus commission.
2. If at any time before April 2009 CSCO goes above $20, then your 1000 shares get sold for $20, giving you the $3k profit you wanted. Only this time instead of $3k you get a total of $3.9k, because you got $900 for selling those options.
3. If CSCO never touches $20 until April 2009, the options you sold expired worthless. You’re either losing or making money depending on whether CSCO goes below or above $17. But the fact remains that you still pocket the $900 you get from selling those options.

After April 2009, you’re free to do whatever you want. You can decide to sell the shares, or you can sell more options, even. 

The risks

This strategy is best employed when you have a bunch of stocks that you want to keep because you think they have good prospects, but you don’t see them moving up that much in the near future.  

How about the risks? Well, if somehow CSCO plunges to $10, then you’re obviously losing even more money than what selling the options has earned you. But whether you’ve sold the options or not, if CSCO goes down to $10 you’re losing money anyway. The difference is that if you haven’t sold any options, you can sell the shares anytime. 

The other possibility is that CSCO shoots up to $30, but thanks to the options you can only sell your shares at $20. (Of course, nothing is stopping you from buying more CSCO and riding the move up to $30, but we’re talking about our original investment here.)

(Images courtesy of jpctalbot @ flickr and ericcastro @ flickr, in the order of appearance.)