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When Janet Yellen said there was "no fixed timetable" for raising interest rates last week, the markets actually dipped.
It's anyone's guess as to why a market that owes most of its gains to the central bank's low interest rates would dip on news that low interest rates would continue.
It doesn't really matter.
Because I think a rate hike of some kind will be in effect by Dec. 31. They've been under 1% since 2008, and at least three of the FOMC's voting members oppose the decision to hold rates steady.
It's likely to be another token 25 basis points, and the rates might go up just so they can go back down again, but that doesn't matter, either – I think traders have to prepare for a "rate hike event" and some choppy markets before the end of the quarter.
So the best thing we can do now is get into position to protect our money… and make a ton more of it.
Check this out…
A New Way to Use a Very Familiar Trade
The covered call is a great way to make some extra income for a turbulent time when others are likely losing their shirts.
You use the strategy when you already own the stock. You're selling a call option and collecting a premium, but remember: That premium comes with an obligation to sell the stock at a specific price on or before the expiration date.
That means you sell-to-open a call option against the shares you own. Remember, one contract equals 100 shares, so you would need to own at least 100 shares in order to sell (or write) one option contract.
You make money by selling the call option, but you're also giving the markets the right to buy (or call away) your stock at the option's strike price any time up to – and including – expiration. That's an important consideration, so I'd recommend selling options only on shares you're willing to part with.
This is a great strategy for when the Fed raises rates and sends markets tumbling; you'll get to keep the premium from the options you sold and, more than likely, your stocks, too.
Let's look at scenario using Microsoft Corp. (Nasdaq: MSFT).
In this example, you already own at least 100 shares of MSFT and sold-to-open the Oct. 21, 2016 MSFT $59 call. This is what's meant by "writing a covered call." This means the market has the right to buy the 100 shares of MSFT from you at any time up to – and including – Oct. 21.
So if the Fed raises rates and Microsoft plunges along with the markets, you get to keep the $1.01 ($101) from the sale of the MSFT $59 call. And if MSFT is under that $59 strike price at the close of the trade's expiration, then you also get to keep the stock.
Now in the unlikely event that the Fed does not raise rates as expected, and the markets surge, you do face the risk of having your stock getting "called away," or bought from you. All in all, that's not a bad outcome – you'd get rid of 100 shares, but you'll also get to keep that $101 premium you made from selling the Microsoft contracts.
The best part is, you can write covered calls over and over again each month, moving the call's expiration date out a month at a time. It's like getting an extra paycheck.
This is a useful strategy anytime, especially when the Fed decides to pull the rug out from under the markets.
But this next strategy is my absolute favorite way to cope with rising rates. It can be even more powerful, because there's no theoretical limit to the money you can pull in, and your downside is very tightly managed.
About the Author
Tom Gentile is widely known as America's #1 Pattern Trader thanks to his nearly 30 years of experience spotting lucrative patterns in options trading. Now, he's diving into the biggest market in the world - one that almost no one has heard of before.