Closed-end funds (CEF) are designed to create a stream of income. Readers already know that I prefer CEFs that pay monthly dividends so they can fund my monthly income objective. CEFs have a net asset value (NAV) that indicates the actual value of the fund. However, CEFs trade on the open market so they also have a share price. If the share price is lower than the NAV, then the CEF is trading at a discount. You can find some CEFs trading at a discount that are good investments that are mispriced by the market. These situations offer an opportunity for capital gains if the CEf returns to or exceeds the NAV when purchased at a discount.
CEFs have a fixed number of shares and trade like a stock. The investor can sell the CEF at anytime the market is open at the current share price. In comparison, open funds can’t be sold until the end of day price based on the close. This creates a situation where the fund can take a hugh hit during the day and you must eat the loses because you get the end of day price. CEFs offer the investor total control on both the entry and exit of the security.
The control element allows the investor to trade these funds. You can select an entry price and exit price based on your trading rules. For example, you can select your entry priced based on when a CEF begins an uptrend and set a stop-loss for when to sell the CEF.
If you use this theory with online broker trading orders, you can actually automate this trade on CEFs. For example, you have found a CEF that you are wanting to purchase for the monthly income stream. You can enter a trade order to buy the CEF at a specific share price. Perhaps the CEF is trading at $10.00 and you are willing to pay $10.00 for the CEF. then you would enter a buy order with the purchase price at a limit of $10.10 with the number of shares you want to buy.
Here is where it gets good. You can enter a trailing stop at the same time you enter your buy order. This is called a one-triggers-other trade (OTO). This is added to your buy order so the when the CEF is purchased, it triggers the OTO order. The OTO order is simple a trailing stop on the CEF. For example, you can enter a trailing stop of 5%. In the above example, your purchase at $10.00 would create a sell order if the price declines to $9.60 ( 5% below the trading price). The trailing stop will increase when the share price increases but it will never decline with share price. Your trade will close when the CEF share price decreases to the stop price. In this example, the share price will trigger the sell when it falls 5% from its highest point while you are holding the CEF. In short, your share price risk is established as 5% from the high share price.
Since the OTO is good until cancelled, you are finished with the trade when using a trailing stop. This creates an opportunity to set the trade and then do nothing more after the trade is executed. this is referred to as trading on ‘autopilot” in the trading circles. You simply do some work on finding the right CEF before trading then set-it and get-it. This is one way to sit back and earn a monthly income.