The Safest Way to Profit from Political Uncertainty
The president is surrounded by a host of unsavory characters, and concerns that businesses are using the office for personal profits are beginning to brew. There’s been talk of impeachment, largely along party lines, with the opposition growing increasingly vocal. And while the large, public protests are mostly peaceful, the occasional act of violence generates publicity.
This is the news out of South Korea.
That’s right — the United States isn’t the only country with sharp political divisions. In fact, that’s the situation in many countries around the world right now. South Korea may just be further along the path of turmoil and could offer some lessons for investors in countries that are just starting the journey toward regular chaos.
The political saga is highlighted in the chart below. The iShares MSCI South Korea Index ETF (NYSE: EWY) is a suitable benchmark for our purposes, with a similar pattern showing up in the Korean benchmark KOSPI index.
The market seems to have been unimpressed by President Park Geun-hye, who was elected in 2012 for a five-year term. Prices generally moved sideways for about three years after her election as GDP grew slowly.
Large protests against her policies began in late 2015 as concerns grew that the government’s changes favored business (over workers) too much. The impeachment scandal that generated headlines last year revolved around the president’s relationship with a woman who is perceived to be a cult leader.
I believe the protests and impeachment demonstrate an important point, which is that the mood of a country is largely driven by the economy. Slow growth leads to unrest and demand for political change. A simple analysis of last year’s election in the United States shows as much. The cure for this situation seems to be faster economic growth, and that appears to be developing in South Korea.
Korea’s GDP increased 2.7% in 2016, and its central bank expects growth of 2.9% in 2017. This explains why the stock market seems to have turned up late last year. There seems to be an end in sight for the political crisis, and an election is scheduled for later this year. Given the recent strength in South Korean stocks, now looks like an ideal time to add exposure to the market. One of the most undervalued stocks in the country that is available to U.S.-based investors is Korea Electric Power Corporation (NYSE: KEP), or KEPCO.
KEPCO generates about 82% of South Korea’s electricity and operates 100% of the nation’s power grid. The company is 51%-owned by the Korean government, and the government is required to maintain a majority stake of at least 51% in KEPCO under the country’s laws. This provides KEPCO with a guarantee of financial support from the government in case of a crisis and allows the company to borrow money at low rates.
Given the coming return to political normalcy, KEP’s prospects appear to be at least average, and the stock seems to be undervalued by 50% or more at current prices. I want to take advantage of its undervalued position and use a covered call strategy to reduce the risk in the trade.
This simple strategy involves options — a tool most investors don’t use regularly because of their preconceived notions about options being risky. But when done properly, selling covered calls can be one of the safest and most lucrative ways for income investors to make money.
How Covered Calls Work
A call option gives the buyer the right — but not the obligation — to buy a stock from the call seller if it’s trading above a specified price, known as the strike price, before a specified date.
When you sell (or write) a call option, you have the obligation to sell a particular stock at the strike price if it should rise above that price before the option expires. I only recommend selling covered calls, which means you already own the stock you’re selling the calls on.
Essentially, covered calls allow you to get paid upfront to potentially sell a stock you own at a higher price sometime in the future. Whether the stock goes up or down, you can come out ahead.
That’s not to say covered calls are risk-free — no investment is. But they can actually help reduce risk.
Consider what happens when you sell a covered call:
For every option you sell, you receive income, known as a premium, upfront in exchange. This money is yours no matter what. It’s deposited in your account just like a dividend.
Once you sell a covered call, one of two things can happen — either the underlying stock rises in price or it falls.
If it declines in price, your shares will decrease in value, but you have the option premium to counter the loss. In other words, if the shares fall, you’re better off selling covered calls (and collecting income) than simply holding the stock.
If shares stay below the strike price through expiration, the option expires worthless for the buyer. That’s not necessarily a bad thing for sellers, though, because this means we keep the shares and have a chance to sell another call to capture another income payment. This is why you should only sell calls on high-quality stocks you would be happy to own for the long term.
If the stock rises above the call’s strike price, you will have to sell your shares to the option’s owner. Anything between the price at which you originally bought the shares and what you sell them for is pure profit, in addition to the cash earned when you sold the option.
The only time you really give anything up with this strategy is if a stock’s price soars past the strike price during the option’s short life. In that case, you’ll miss out on some capital gains.
I think that’s an acceptable trade-off when you consider that, lately, my Maximum Income subscribers and I have been able to earn annualized gains of 9%, 42%, and 77% — sometimes even reaching as much as 247%.
What You Can Gain From This Week’s Trade
Coming back to KEPCO, I see a way for my subscribers and myself to make a 34% return on our investment over the next year. The trade involves buying shares of KEPCO and then selling calls for every 100 shares you purchase. This transaction effectively reduces your cost per share (your “cost basis,” in trading terms), allowing you to realize greater returns.
The best thing about this process is that it can be repeated as long as your trade remains profitable. Here, your cost basis should be below $17, a simple task considering that the stock is trading just above $17 and each option reduces your per-share cost basis by about $0.80.
One of these trades will net you a 2.9% gain in a month, or about a 34% annualized return. This can be repeated over and over again until the stock becomes too expensive. But here’s the thing: You’ll still make money when it does cross that level.
Remember that you’ll still own KEPCO shares, so any price appreciation also represents a gain for you. From current prices to the target price for our trade, this means a gain of $0.50 per share. And if KEPCO doesn’t hit our target, we can always hang on to our shares and continue to collect income by selling more calls until prices start to appreciate.
Either way, whether prices go up or down, you’ll be making money. That’s the beauty of the covered calls that I use in my Maximum Income system. I’m saving the specifics of this trade for my paid subscribers, but if you’d like to get started using covered calls, my research staff and I are here to guide you through the process. We’ll tell you which trades to make and when. If you’d like to learn more about this opportunity, I invite you to click here.