We're changing up the schedule. But let's dig into a way to add some extra coin with a great midstream operator. Also, Warren Buffett's quiet position is quite a doozy.
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You are a free subscriber to Postcards from the Florida Republic. To upgrade to paid and receive the daily Republic Risk Letter, [subscribe here](. --------------------------------------------------------------- [Postcards: Trading Covered Calls on a Natural Gas Titan]( We're changing up the schedule. But let's dig into a way to add some extra coin with a great midstream operator. Also, Warren Buffett's quiet position is quite a doozy. [Garrett {NAME}](floridarepublic) Jun 10
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Republic Risk subscribers can access[the morning update right here.]( [Again… right here](. Highlights Include: Trading Buffett’s New OXY Buy, Sector-By-Sector Updates, 20-day Readings on the Model Portfolio, Why our Portfolio favorite Gravity Popped 15% last week, and major risk assessments in the markets. [Go here, right now](. --------------------------------------------------------------- Dear Fellow Expat: We’re changing things around a bit. You’ll receive Postcards in the morning… Let’s keep life simple. That way, there will be fewer emails and more order in presenting our critical daily ideas. That might be a little difficult for some of us natives… but we’ll ensure you get everything you need every open market session. Starting this week, look for Postcards from the Florida Republic to arrive before the market opens. That way… we can focus on the market during the day, [looking for opportunities for paying community members]( and hitting the chat during trading hours. Now… let’s get weird. [Upgrade to paid]( Equity Strength Signals We’re seeing a lot of selling on the edges, and the last hour of the S&P 500 on Friday, combined with rising pressure on interest rate-sensitive sectors. The S&P 500 Equal Weight is back under pressure (up only 4% on the year) compared to the 13% return of the S&P 500. This tells you everything you need to know about the top-line market - driven by the big three of Apple (AAPL), NVIDIA (NVDA), and Microsoft (MSFT). That said, the story we’re diving into today is the most important of the week - and has little to do with Mister Jerome Powell. This reading is pre-market, so there could be some interesting developments when the Bank of Japan discusses its monetary policy later this week. There’s Nothing Wrong With Hedging I don’t come to this letter Doom and Gloom each morning]( as we follow important signals in insider buying, liquidity, and momentum. But I have to tell you what the signals say: Insider buying compared to selling at the dollar-for-dollar level is at its lowest in three years. The Magnificent Seven stocks have driven momentum, but the rest of the market has seen rapturous selling. Liquidity is cooling off as markets eye rate decisions by the Bank of Japan (likely higher this year) and the Fed (likely no cuts in 2024). In addition, the cost of hedging - or buying protection - against a 10% downturn in the S&P 500 is now at the highest level since… October 2023. That was in the middle of a selloff. Bloomberg shows we’re at very high levels - while at all-time highs. So, if you’re a long-term investor… or bought a company like Ardmore Shipping (ASC) with us back in January… there’s no harm in using options as a proper hedge in this environment. One of the preferred ways is to sell call options on existing positions. These are known as covered calls. This strategy allows you to generate income on top of your existing stock positions and can enhance your returns depending on the market's direction. With our Momentum readings turning positive, we want to talk about how to use covered calls, with a great example of a stock to own right now. Covered Calls - Definition A covered call is an options trading strategy that requires two parts to the trade. You use options on stocks that you already own. So, if you own 100 shares of a stock, you have enough to fulfill the obligations of one option contract. When you sell a call option, you agree to sell 100 shares of the stock at a specific price (strike price) on or before a specific date (expiration) if the stock rises above that price level. Here is how the strategy works. When you sell the call, you receive a payment from the buyer called a “premium.” Here Are the 3 Key Rules - Rule One: Own the Stock. You MUST own 100 shares of the underlying stock. These shares act as collateral to “cover” your obligation to fulfill the order should the buyer execute the option contract. - Rule Two: Know Your Strike Price and Date. You can sell the call option based on the strike price and date you wish to sell. You sell one option for every 100 shares that you own of the stock. - Rule Three: You get paid. When you sell a call option, the buyer will pay you (minus a fee) the premium. This becomes yours — so long as you don’t buy back the contract — for the duration of the trade, regardless of the outcome. Options in the Midstream Let’s do an example with a company that I like. As you know, I’m a big fan of the midstream energy sector. I expect the crude and natural gas supply to increase, meaning that a company like Kinder Morgan (KMI) will do well. Why? They own 140 terminals for storage, distribution, blending, and logistics. But the stock also has been range-bound this year, and it pays a dividend of 6%. Let’s say I have 100 shares of KMI. At $19.62 per share, my position is worth $1,962. Now, I want to sell a covered call on the position. Let’s look at the breakdown: - KMI Ownership: You own 100 shares of Kinder Morgan (KMI). - Call Option Sale: You’re selling one call option with a strike price of $20.00 for August 20, 2024, and an expiration of $0.37 (or $37—100 shares times $0.37). - Premium Receipt: The call option buyer pays you a premium of $0.37. So, your breakeven for this trade is $19.62 minus the $0.37 in premium — or $19.35… if the stock goes lower. But this is the point. If you’re a long-term investor and the market looks a bit frothy, this strategy is an excellent way to pick up additional income. Outcome Scenarios Let’s look at the possibilities for this trade. Scenario 1: Stock Price Remains Below the Strike Price — If the stock price remains below $20 when the option expires, the call option buyer will not exercise the option, and I keep the premium of $37 (or a 2% gain through mid-August). I still own my 100 shares of KMI and will continue to collect the dividend on the stock. Scenario 2: Stock Price Rises Above the Strike Price — If the stock price rises above $20, the call option buyer may choose to exercise the option. At that point, I must sell the shares for $20 per share, or $2,000 total. In this case, I will miss out on any gains above that strike price, but I will have scored the $37 in premium and the gains from the current price up to $18.00 per share. That means a 4% gain on top of the existing price today. The key is that I’ve specifically targeted a 4% gain on a conservative stock when energy prices and the broader market are under pressure. If we pocket the dividend, feel free to pick up another two shares of the stock on the open market. One of the best things about this strategy is you can do it more than once. If the stock doesn’t rise above that strike price, I can simply sell another one after the contract expires. This is a great way to generate income on top of stocks we already own and compound the returns based on the dividends. Feel free to take any additional premium generated to buy even more stock. You can do this with many other stocks… All you need is a liquid options chain and a willing buyer. Be sure to pick a strike price and a date that meets your comfort if you have to sell the stock. [And be sure to use OptionsProfitCalculator.com]( to help you measure the math behind the trade. And Finally… I think it’s fair to say that the Treasury Market is still very safe. Could you imagine Buffett making it all this way… and having the U.S. Treasury market blow up his investment company? It's not going to happen… But what does it say about Buffett being the guy the government approached in 2008 to help bail out Lehman Brothers… He ultimately had a sweetheart deal with Goldman Sachs (GS). This is quite an interesting measurement… isn’t it? [And people think our love of STEW is crazy?]( A quack with quacks… Stay hungry… Stay positive, Garrett {NAME} Disclaimer Nothing in this email should be considered personalized financial advice. While we may answer your general customer questions, we are not licensed under securities laws to guide your investment situation. Do not consider any communication between you and Florida Republic employees as financial advice. Under company rules, editors and writers cannot recommend their positions. The communication in this letter is for information and educational purposes unless otherwise strictly worded as a recommendation. Model portfolios are tracked to showcase a variety of academic, fundamental, and technical tools, and insight is provided to help readers gain knowledge and experience. Readers should not trade if they cannot handle a loss and should not trade more than they can afford to lose. There are large amounts of risk in the equity markets. Consider consulting with a professional before making decisions with your money. [Like](
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