3 ways investors can make money from common stock

3 Ways Investors Can Make Money from Common Stock: Let’s Dig Deep

July 10, 2024

In finance, investors are constantly seeking innovative ways to maximize their returns from the stock market. While traditional methods have their merits, it’s time to delve deeper, channelling our inner Sherlock Holmes to uncover hidden strategies that can potentially turbocharge our investment returns. This essay will explore three powerful ways investors can profit from common stock, focusing on unconventional approaches and advanced techniques.

1. The Art of Strategic Accumulation: Beyond Simple Buy-and-Hold

While the buy-and-hold strategy has long been a staple of investing wisdom, savvy investors now employ more nuanced approaches to accumulate shares strategically. One such method is the “Pyramid Accumulation Strategy,” inspired by the ancient Egyptian architectural marvel.

Dr. Richard Thaler, Nobel laureate in economics, suggests, “Mental accounting matters. How we categorize and think about our investments can significantly impact our decision-making and, ultimately, our returns.” This insight forms the foundation of the Pyramid Accumulation Strategy.

Here’s how it works:

a) Base Layer: Establish a core position in a stock with long-term potential. This forms the foundation of your investment pyramid.

b) Middle Layer: As the stock price fluctuates, add to your position during dips, but in smaller increments than your initial investment. This builds the middle of your pyramid.

c) Top Layer: Use technical analysis to identify potential short-term peaks. When these occur, consider selling a small portion of your holdings to lock in profits.

d) Reinvestment: Use the profits from the top layer to reinforce your base and middle layers during subsequent dips.

This strategy allows investors to maintain a strong core position while capitalizing on market volatility. It’s a more active approach than traditional buy-and-hold but can lead to enhanced returns over time.

Real-world example: Consider an investor who started accumulating shares of Tesla in 2019. Using the Pyramid Accumulation Strategy, they could have built a substantial position during the stock’s volatile periods, selling small portions during price spikes and reinvesting during dips. This approach would have allowed them to benefit from Tesla’s upward trajectory while managing risk and capitalizing on short-term price movements.

2. Dividend Harvesting: The Orchard Approach to Income Generation

While dividends are a well-known source of investment income, the “Dividend Harvesting” strategy takes this concept to a new level. This approach, inspired by the cyclical nature of fruit orchards, aims to maximize dividend income throughout the year.

Warren Buffett once said, “If you don’t find a way to make money while you sleep, you will work until you die.” Dividend Harvesting embodies this philosophy by creating a perpetual income stream.

The strategy involves:

a) Diversification across sectors: Build a portfolio of dividend-paying stocks from various sectors with different payout schedules.

b) Seasonal rotation: Adjust your portfolio holdings based on ex-dividend dates to ensure you’re always positioned to receive dividends.

c) Reinvestment with a twist: Instead of automatically reinvesting dividends into the same stock, use the income to purchase shares of the following stock in your rotation approaching its ex-dividend date.

Dr. Robert Shiller, another Nobel laureate in economics, notes, “The most important driver of stock market returns is the dividend yield.” Investors can potentially enhance their overall returns by focusing on dividends and strategically rotating holdings while generating a steady income stream.

Example: An investor could create a portfolio of 12 high-quality dividend stocks, one for each month of the year, based on their ex-dividend dates. By rotating their investments constantly to hold the stock next in line for a dividend payment, they ensure a consistent monthly income while benefiting from potential capital appreciation.

3. The Put-Call Synergy: Leveraging Options for Enhanced Returns

Our third strategy ventures into the world of options, combining the power of put selling with strategic call buying to create a potent wealth-building engine.

Nassim Nicholas Taleb, options trader and author of “The Black Swan,” asserts, “Option sellers, by definition, sell insurance; option buyers buy insurance.” By becoming both an insurance seller and a strategic insurance buyer, investors can amplify their returns while managing risk.

Here’s how the Put-Call Synergy strategy works:

a) Sell cash-secured puts on high-quality stocks you wouldn’t mind owning at a lower price. The premium generated generates immediate income.

b) Use the premium from put selling to purchase long-term equity anticipation securities (LEAPS) call options on the same or different stocks. LEAPS typically have expiration dates over one year, providing ample time for the underlying stock to appreciate.

c) If the put options expire worthless, repeat the process. If assigned, you acquire the stock at a discount (strike price minus the premium received).

d) The LEAPS calls provide leveraged upside potential without additional capital outlay, as the put premiums fund them.

This strategy offers several advantages:

1. Income generation through put selling
2. Potential stock acquisition at a discount
3. Leveraged upside exposure through LEAPS calls
4. Risk management through the combination of short puts and long calls

Dr. Myron Scholes, Nobel laureate and co-developer of the Black-Scholes options pricing model, emphasizes, “Options are a form of insurance, and understanding their true value is crucial for effective risk management and return enhancement.”

Example scenario:

An investor sells a cash-secured put on Microsoft (MSFT) with a strike price of $300 expiring in 3 months, receiving a premium of $10 per share. They use this $1,000 premium (assuming 100 shares per contract) to purchase a LEAPS call option on Amazon (AMZN) with a strike price of $3,500 expiring in 18 months.

If MSFT stays above $300, the put expires worthless, and the investor keeps the premium. They can repeat this process or use the funds for other investments. Meanwhile, the AMZN LEAPS call provides leveraged upside potential if Amazon’s stock price rises significantly over the next 18 months.

If MSFT falls below $300, the investor acquires 100 shares at an effective price of $290 ($300 strike – $10 premium), which could still be attractive for a long-term investor. The AMZN LEAPS call remains active, offering continued upside potential.

This strategy requires careful risk management and a solid understanding of options mechanics. As legendary investor Paul Tudor Jones advises, “Don’t focus on making money; focus on protecting what you have.”

Conclusion: 3 ways investors can make money from common stock

By thinking creatively and applying advanced strategies, investors can potentially enhance their returns from common stocks beyond traditional methods. The Pyramid Accumulation Strategy offers a dynamic approach to building positions; the Dividend Harvesting technique provides a steady income stream with growth potential, and the Put-Call Synergy strategy leverages options for enhanced returns and risk management.

However, it’s crucial to remember that greater sophistication comes with increased complexity and potential risk. As George Soros wisely noted, “It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.”

By combining innovative approaches with sound financial principles, investors can work towards achieving their financial goals in the dynamic world of stock market investing.

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