The Only Way We Recommend Selling Options

  • Covered by cash
  • Conference update

Another day and another opportunity to ram our Options Trader service down your throat.

I acknowledge that talking about this service day in and day out could be tiresome for you.

But I don’t apologise for that. I believe Options Trader is the most important and best of all the service we offer.

It’s a service, and a style of trading, which I believe every serious and experienced investor should consider.

As I’ve said before, it won’t be for everyone. But it’s important not to dismiss it as some people often do, without fully understanding what it’s all about.

I tell you about this service day after day, because I believe that if you had information about something that was important for me to know, you would be keen to make sure that I knew about it.

Plus, the positive thing about continuing to bang on this drum, is that each day, readers drop me a line to ask questions about the service, or remind me about something I haven’t mentioned.

Yesterday, one reader sent me a note. He makes a good point. I’ll show you what he wrote to me below. But first…

Markets

Overnight, the Dow Jones Industrial Average index gained 18 points, or 0.1%.

In Europe, the Euro Stoxx 50 index gained 21 points, or 0.7%.

The FTSE gained just two points, while the German DAX added 0.7%.

In Asian markets, the Nikkei 225 index is down 0.3%, while the Shanghai Composite is down 0.1%.

The Aussie S&P/ASX 200 index is up 36 points, or 0.7%.

On the commodities markets, West Texas Intermediate crude oil is trading for US$41.56 per barrel. Gold trades for US$1,228 per ounce.

The Aussie dollar is worth 77.10 US cents, trading near yesterday’s one-year high.

Covered by cash

Back to Options Trader and my belief that it’s the best service we offer…a service I believe all serious investors should at least consider before they decide that it’s not for them.

This week, I’ve tried to fully explain the Options Trader service, including answering some of the objections to trading options this way.

As a brief refresher, Options Trader recommends two types of trading:

  • Cash-covered put selling
  • Stock-covered call selling

The important point to note with both of these strategies is that by trading this way, if your option is exercised, you know your maximum risk from the outset — providing you follow Matt’s advice to the letter.

For instance, Matt only recommends cash-covered put selling. Matt will never recommend selling a put using borrowed money, or selling a put for an amount of shares you can’t afford to buy if exercised.

In other words, if Matt sends out a trade to sell put contracts with an underlying value of $5,000, Matt does so with the recommendation that you have $5,000 of cash in your bank account or cash management account to cover the purchase of shares if your position is exercised.

On the other side, Matt only recommends stock-covered call selling. That means, if Matt issues a recommendation to sell call options in a particular stock, that trade is only for those investors who own the underlying stock.

The investor should then only sell the number of call option contracts that correspond to the number of shares they own.

If the investor doesn’t currently own shares, then Matt would recommend a ‘buy-write’ strategy. That involves the near-simultaneous buying of the stock and selling (writing) a call option against that stock.

This is important, and it bears repeating, because one of the reasons so many investors get into trouble with options is that they ‘abuse’ the leverage you can get from them.

They’ll see a premium of (say) 50 cents per share. They only have enough in the bank to cover five contracts (usually a total of 500 shares), but they figure if they sell 10 contracts, they’ll earn twice the income.

That’s true, they will. But if they’re exercised, it means they have to buy twice as many shares as the cash they have in the bank. And if the share price is significantly below the price they have to pay (in the case of being exercised after selling a put option), the loss could cause them to lose a significant amount of their capital.

That’s why Matt only deals with cash-covered put selling and stock-covered call selling.

The reason I bring this up is due to the email I mentioned above, sent to me by a subscriber, George. He writes:

You should explain that if you sell a naked put you have to put up margin (that can be more than just buying the stock outright) depending on which broker you use and how far in or out the money the market is compared to the strike price. This will tie up your funds.

No-one ever talks about margin until you try to put on a trade; hope this helps.

George is partly right. If you want to sell puts, your broker will likely ask you to establish a margin account. The reason for that is technically, you’re trading on margin, because you don’t need to deposit the full value of the underlying stock exposure into your account.

As an example, if you sold puts against $5,000-worth of stock, your broker may demand a (say) $800 margin payment. This amount will change daily as the value of the underlying share changes.

This is called mark-to-market.

But here’s the thing. Just because that’s the minimum you have to deposit with your broker, it doesn’t mean that you’re leveraged to the position. As long as you have cash to cover the potential of being exercised, either in the margin account or in a separate cash account, in reality, it’s an unleveraged trade.

As I say, Matt will only ever recommend cash-covered put selling. Compared to some other options strategies, that makes this one somewhat conservative (although compared to others, it’s riskier, that’s the flexibility and beauty of options).

As for George’s claim that it ties up funds, that’s true. But that’s OK. The idea is that with cash-covered put selling, you can keep most of the cash (except the margin amount) in an interest-bearing account.

With low interest rates, you won’t get much, but it all helps to build your returns.

There is a lot of misinformation when it comes to options and options trading. Sure, options can be risky. But then again, pretty much any investment has an element of risk.

But just because it’s risky, that alone shouldn’t be a reason to ignore it. With any investment you have to look at the risks and the rewards. Then you need to decide if the risk is worth it, and if that particular investment approach is for you.

If you’re an experienced investor check it out. Since Matt reacquainted me with the idea of selling put options, I can honestly say that it has completely changed the way I buy blue-chip shares.

For more details, go here.

Conference update

Yesterday I mentioned that we had received a bunch of feedback about the upcoming conference. I asked you to answer three questions. They were:

  1. What do you want the speakers to talk about at the conference?
  2. Who would you like to see speak at the conference?
  3. Where would you like the conference to be held?

We received a great response, with (as you’d expect from our readers!) varying answers, and varying degrees of passion behind those answers.

Here’s a sample…

Subscriber, Herbert writes:

1. What do you want the speakers to talk about at the conference? How to take advantage of worldwide negative interest rates?

Australia will go to federal elections within the next 12 months. What assets or industry will benefit from Liberal Govt vs Labour Govt?

What is likely to be the technology trends in the next 10 years?

2. Who would you like to see speak at the conference? Phil J Anderson and Catherine Cashmore.

‘3. Where would you like the conference to be held? Melbourne.

‘Keep up the good work.’

Then there’s this from Jules:

What I’d like to see is a debate between opposing points of view. A number of your editors have different points of view and I think it would be really good to hear their thought processes and hear them articulate them and argue their points. For instance Vern Gowdie and Phil Anderson. I have to say that I really like both of their writings but they are currently diametrically opposed. This doesn’t bother me at all, in fact I find it really interesting. But hearing both debating their ideas rather than individual presentations would help me decide what to accept and what to reject out of their recommendations and advice.

Keep up the good work!

P.S. Also the earlier you can let us know the date the better. I have to request time off on a roster which gets published up to 3 months before the date I’m working. I’d really like to come to it, so need as much notice as possible please.

Good news. We hope to get full details to you by mid-May. The conference won’t be until later in the year, so plenty of time to plan.

Peter writes:

In response, my pet subjects are mining, precious metals, and because I am one eyed, agriculture.

Speakers, your good self, Vern Gowdie, Jason Stevenson, Marc Faber, Jim Rogers, Jim Rickards.

Venue, Magnetic Island, off Townsville, NQ.’

Jason has a suggestion or two:

For the upcoming seminar it would be great to be held in Perth…unlikely though…

I would like to hear speakers with talks regarding Australia’s market…and where it’s headed…

Talking about options, warrants, futures and CFDs in relation to the Australian market would be great…

I look forward to seeing the list of speakers dates and locations…

Subscriber Michael writes:

If the conference were to be held in Brisbane, that would suit me, however I may travel to attend. A little bit new to this process but looking forward to making better choices and furthering my education/financial position on life…thanks.’

Howard writes:

‘1. What do you want the speakers to talk about at the conference?

Asset price bubbles.

‘2. Who would you like to see speak at the conference?

Phillip J Andersen and Jim Rickards.

3. Where would you like the conference to be held?

Gold Coast.’

That’s all for now. Time is running out. But they’re all good suggestions. I’ll print more letters next week.

Cheers,

Kris

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End of day market data

If you have any ideas about what you would like us to include in our end of day market data drop us a line at letters@portphillipinsider.com.au, and type ‘Market data’ in the subject line.

52-week highs: 43 stocks, including Eden Energy Ltd [ASX:EDE], Hazer Group Ltd [ASX:HZR], IRESS Ltd [ASX:IRE], MACA Ltd [ASX:MLD], Technology One Ltd [ASX:TNE], oOh!media Ltd [ASX:OML], and Vocus Communications Ltd [ASX:VOC].

52-week lows: 13 stocks, including AJ Lucas Group Ltd [ASX:AJL], Keybridge Capital Ltd [ASX:KBC], and SDI Ltd [ASX:SDI].

Note: The stocks listed above are stocks that hit an intra-day 52-week high or low during today’s trading. The stocks didn’t necessarily close at the 52-week high or low.