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Melvin: Step Into Illiquid

One of the most frustrating exercises in the current market is trying to find an investment security or strategy that can produce sufficient income. The zero interest rate policy (ZIRP) is going to be in place for at least two more years - possibly even longer. We have seen yield chasing push the prices of many income securities, such as real estate investment trusts (REITs) and blue-chip stocks, to unreasonable valuations.

During a recent conversation I had with Jeff Rollert of AMA Advisors, he stressed that the value in income investments right now is illiquidity. I think we can use that concept to find ways to build and maintain an adequate income stream.

The strategy I'm proposing is not for everyone. It will take some time and effort to use and perfect. If you are new to the markets, you should probably stop reading now. You must have some knowledge of stocks and options to make this work for you. You will have to do a fair amount of initial homework; afterward, this strategy will take about an hour or so a day of your time.

I love option writing and am a big fan of the strategy for providing income and for entering and exiting stocks. However, I think most approach this tool in exactly the wrong fashion. The focus is on finding the options that will produce the most income with only casual consideration of the underlying security. I think we should start with valuation first and then design an option selling strategy to produce income.

When you use my deep-value approach to valuation, you find a lot of stocks with very little options activity and fairly illiquid markets in their puts and calls. I think we can make this work for us. I always prefer trading away from the liquid markets that are dominated by supercomputers and daytraders.

Let's use Alpha and Omega Semiconductor (AOSL - Get Report) as an example. The stock trades below tangible book value and is profitable, although just barely. Business will not improve enormously until the economy strengthens, but at 70% of book value, the stock is cheap enough to buy.

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