Let's suppose you own a stock that was trading at $23.80 per share and someone offered you $2.60 a share to buy it at $25.00 within the next month. Would you take the offer?

Off the top of my head, it sounds like a pretty good deal to me. But there are several things I would have to consider before accepting it. First, I'd have to decide whether the stock's price would be more likely to go up or down during the offer period. If I thought it would go above $27.60 per share and stay there, I'd reject the offer and keep the stock. If I thought it was likely to go down and stay below $21.20 for a long time, I'd reject the offer and sell the stock. If, however, I thought that the stock's price would stay between $21.20 and $27.60, I'd take the offer. It would be a nice way to generate some cash while the stock's price didn't do very much. So how would I go about making these assessments?

First, I would look at VectorVest's Market Timing Graph to see what the market was doing. Right now it appears that the rally is stalling, so I would conclude that the chances of my stock soaring higher have lessened a bit. Next, I would check the stock's Relative Timing, RT, indicator. If RT were above 1.00, the stock's price would be in an uptrend. If RT were below 1.00, the stock's price would be in a downtrend. This information would definitely affect my analysis.

Then I would use VectorVest's Option Pricing Model to see if the offer of $2.60 per share were fair. I could also see whether it would even be worth considering the offer. Finally, I could get an idea of the probability of my stock closing above $25.00 a share a month from now. If I wanted to see the probability of this stock's price staying between $21.20 and $27.60 per share, I would use VectorVest's Options Analyzer.

To be honest, nobody has actually offered to pay me $2.60 a share to buy my $23.80 stock at $25.00 within the next month. But I know I can cause this to happen by selling September 25th Calls against it @ $2.60 per share. I would then have a "Covered Call" position and it would yield a juicy 157.71% annualized rate of return if the stock closed at or above $25.00 per share at expiration.

If you're interested in finding trades such as this, you would definitely want to use VectorVest's Options Rate of Return tool. It's a marvelous tool and, unfortunately, we don't talk about it often enough. Frankly, we don't talk often enough about any of the VectorVest Option Tools.

On Friday, October 24, 2008, I wrote an essay called "Blue Chip Bargains." It dealt with buying the safest, most undervalued stocks of the highest growth, largest capitalization companies in the VectorVest U.S. database at bargain prices. It also said, "I would be in no hurry to buy these stocks right now. I'd wait at least until the Price of the VectorVest Composite goes up for two consecutive weeks; then I would begin to nibble at the list and I would buy Leaps instead of stocks unless I wanted the cash from dividends and I'd sell Covered Calls against my positions to reduce cost and risk."

So why would I want to buy Leaps instead of stocks and sell Covered Calls against those positions? The answer is to mitigate the uncertainty and incredible volatility we have been facing over the last 15 months. I want to take advantage of potentially rewarding opportunities like buying Blue Chip Bargains, but I don't want to take a lot of risk in doing it. The technique of using Covered Leaps is just one of several ways of "Taming the Tiger." We have demonstrated such techniques on several occasions.

For example, the first "Taming the Tiger" demonstration dealt with a "Safer Way To Short Stocks," and was presented as our "Strategy of the Week" on December 5, 2008. If you're concerned about the risks of selling short, you may wish to see this presentation at the VectorVest University.

The technique of buying Leaps and selling Covered Calls, mentioned above, was illustrated as our "Strategy of the Week" on December 12, 2008. It was called "Taming the Tiger - Part II, and was featured as a "Safe Way to Lock in Low Prices." If you haven't been using it, you may be missing out on some great buying opportunities.

Since selling a Put is mathematically the same as selling a Covered Call, we presented another "Strategy of the Week" on December 26, 2008 which entailed selling Leap Puts of Blue Chip Bargain stocks. We called it "Taming the Tiger - Part III, Raking in Blue Chip Premiums."

A less obvious way of "Taming the Tiger" was demonstrated in our "Strategy of the Week" presentation "VST Mighty Mites" on December 19, 2008. In this case, the high volatility of these stocks required that one employ a large Trailing-Stop setting of 35%. Therefore, only a fraction of the available funds were used to limit the damage a 35% loss on a single stock would have on the overall portfolio. I have used this technique on several occasions in managing the Model Portfolio. If you're buying and selling leveraged ETFs, you'd better know something about Taming the Tiger.

Last week I introduced the subject of generating cash from your stock portfolio. Not only is that a worthy goal, but I've read that dividend paying stocks outperform the market by 1% to 1.5% per month during downturns. This sounds reasonable to me. Why would someone sell their dividend paying stocks if they could make 20% to 30% a year even in a bear market?

Let's see how this might be done. First of all, we need to find an acceptable dividend paying stock. We can do this by simply accessing Stock Viewer and sorting by YSG Desc. As of yesterday, Thursday, 09/04/08, Cal-Maine Food, CALM, was in the top spot. Although it now has an "S" rating and I wouldn't buy it at this time, I want to keep my eye on it because it's making a ton of money and has an excellent Dividend Safety, DS, rating of 87. So let's use it as an example.

CALM closed yesterday at $34.50 per share and is paying cash dividends at the rate of $2.06 for a yield of 5.97%. If I were to buy these shares on margin, the effective DY would be twice as high, i.e., 11.94%. Of course I would have to pay interest to my broker on the borrowed funds, but the interest expense is tax deductable. Although I'm already looking at a juicy return, how could I get more? I'd sell some out-of-the-money Covered Calls. Yahoo!Finance shows that CALM had its last ex-dividend date on July 28, 2008, so I'd assume that its next declaration will be made in late October. Therefore, I'd be selling the November 40 Covered Calls, which are currently trading at $1.75 per share.

Here's how this trade would work: I would buy 100 shares of CALM on margin for about $1,725.00, not counting commissions or interest and I would sell one CALM November 40 Call Option @ $1.75 per share. My account would be charged $1,725.00 for buying the stock and be credited $175.00 for selling the option. The net charge would $1,550.00 not counting commissions or interest. Around the middle of November, my account would receive a dividend credit of about $51.50. The total income from the sale of the Call Option and receipt of the dividend payment would be about $226.50. This would give me a quarterly return of 13.1%. If I could do this four times a year, my annualized rate of return would be 52.5%, not counting commissions and interest.

This sounds great, but there are several other things that can happen to this trade. For example, the stock's price could rise prior to the ex-dividend date and the stock could be called at $40.00 per share. Although I wouldn't get the $51.50 dividend payment, I'd make about $500 on the stock and get to keep the $175 option credit too. This is not a bad deal.

If, on the other hand, the stock's price fell, I'd have to make some decisions. I could hang on to the stock, collect the dividend and option premium, and repeat the process again the next quarter. But that's no fun. I usually buy back the Call Option at a much lower price than I sold it for; then get more income by selling another Call Option at a lower Strike Price. This technique invokes the risk of getting called out of your stock at a price lower than your purchase price, so I suggest that you practice it with only small amounts of money before using it with serious money.

Incidentally, did you know that most of the market's historical gains have come from dividends? Maybe you've heard that selling covered Calls was the most frequently used option trade. Both generate income. Put them together and you have the Cash Machine, Part II.

P.S. Terra Nitrogen, TNH, closed up $8.51 today and is up over $14.00 since I mentioned it last week.