In my pursuit of the most exciting, high-yield investments available, I've zeroed in on a new issue that I believe is a great fit for our Extreme Income Portfolio.
You can buy it until noon Tuesday, Feb. 26, and if you do you'll see it as a deposited holding within your account on the Feb. 28 when it settles.
This recommendation is for those of you who don't think any of the 30 stocks making up the Dow Jones Industrial Average are going to drop by 50% from current prices.
In a nutshell, here's how this Reverse Convertible note works:
1) Call your brokerage and ask for a fixed-income broker.
2) Tell the broker that you want to participate in the new offering of the 34.9% Least of the Dow Reverse Exchangeable Convertible Notes due Feb. 27, 2009. Note: there is no symbol for this trade. It's identified only by its name.
3) Tell the broker the denominations you want -- the minimum is $1,000 per account.
This is an open offering, so there is unlimited supply as long as your broker is participating in the offering -- and most major, full-service and discount brokers will be.
Here's the deal.
You get a one-year note that will give you monthly payments starting March 28, 2008, and paying on the 28th of each month, thereafter. The notes mature on Feb. 27, 2009.
The 34.9% income stream is tied to sophisticated option spreads attached to the basket of Dow stocks that underlie the note. That's where the yield comes from -- extreme market volatility that fuels big premiums for put and call options. If you want to read about the mechanics of this buy, ask your broker for a link to the offering prospectus that is readily available online.
If none of the Dow components drop by 50% during this one-year holding period, you will get 100% of your principle back in cash.
Here's an example of what could happen if one does fall 50%: If one of Dow components, let's say General Motors (GM), which is currently trading at $23, falls by 50% (to $11.50 per share for GM) at any time during the next 12 months, you will be issued a predetermined amount of GM shares instead of your cash back, even if shares of GM recover back to $23 or higher.
In our example, if GM drops to $11.50, the trigger is activated and, if the stock is still trading at $11.50 on maturity date, you will receive a predetermined number of shares worth the value of GM shares at the close -- again, no cash back.
That's the risk, folks. It might mean owning the stock on the Dow that performed the worst in the prior 12 months -- that may have, at some point, lost half its value.
The question to ask yourself after looking at all 30 Dow stocks is whether you believe any of the components stands a reasonable chance of dropping 50% from their current levels?
I do not believe even the most blown-out names -- like GM, Citigroup (C), Home Depot (HD), Bank of America (BAC) and Intel (INTC) -- are going to lose half of their value during the next year, following this current re-test of the January lows. And that's the reason I'm recommending this investment.
I could be wrong, but based on what I'm seeing, a lot of downside risk is already priced into the index. In fact, the timing of this offering could be right-on. Given the latest batch of economic data, the Fed needs to cut rates again soon and then again in late March. Those expected cuts should provide meaningful support for the Dow, while we collect a whopping 34.9% rate of return on our one-year money. Simply put, if you invest $10,000 in these notes, your monthly payment is going to be $290.83 per month, which totals $3,490 at the end of 12 months.
Now that, my friends, is serious cash flow!
Bear in mind, that even if one of the Dow components drops by half and triggers the issuance of shares in that component, you will still receive the monthly payments to maturity totaling 34.9% of your original invested principle.
So in theory, your downside risk is probably no more than about 15% -- assuming the value of your principle is down by one half when the notes mature a year out.
It's that easy.
Again, the offering closes Tuesday, Feb. 26, at noon Eastern. I believe this is an exciting way for us to make upwards of 35% on a portion of our capital and lock in the incredible stated rate of return with a 50% downside barrier.
As is always my advice, don't put more than 3% of your capital in this recommendation. There are other "extreme income" ideas that I'm looking at along these same lines and hope to bring you.
Watch for the Weekly Update later today.
Bryan Perry
Editor The 25% Cash Machine