Any Chance of a Profit?

  • The truth about options
  • My account

From the Wall Street Journal:

Building a mass-market electric vehicle and colonizing Mars aren’t ambitious enough for Elon Musk. The billionaire entrepreneur now wants to merge computers with human brains to help people keep up with machines.

And so the PR machine continues.

At some point, surely, Tesla Inc [NASDAQ:TSLA] investors will ask Mr Musk, ‘When do you plan on quitting all the games, and actually turn Tesla into a profitable company?’

Or maybe they won’t. Maybe we’re in one of those ‘new eras’ when profits don’t matter — it’s the growth and potential, baby.

It’s always that way…during a bull market…until the bull market ends. Then suddenly investors start to ask, ‘Where are the profits?’

And there are none.

But for now, profits appear not to matter. The stock is back near its record high, and Tesla fans can’t get enough…of the stock…the company’s products…and the PR.

Good luck to them.

Markets

Overnight, the Dow Jones Industrial Average gained 69.17 points, or 0.33%.

The S&P 500 added 6.93 points, or 0.29%.

In Europe, the Euro Stoxx 50 index closed up 6.31 points, for a 0.18% rise. Meanwhile, the FTSE 100 fell 0.06%, and Germany’s DAX index gained 0.44%.

In Asian markets, Japan’s Nikkei 225 index is up 125.61 points, or 0.66%. China’s CSI 300 is up 0.25%.

In Australia, the S&P/ASX 200 is currently down 1.13 points, or 0.02%.

On the commodities markets, West Texas Intermediate crude oil is US$50.16 per barrel. Brent crude is US$52.68 per barrel.

Gold is trading for US$1,241.15 (AU$1,623.60) per troy ounce. Silver is US$18.07 (AU$23.63) per troy ounce.

The Aussie dollar is worth 76.46 US cents.

The truth about options

Have you checked out our ‘2-minute challenge’ yet?

If you haven’t, I’m astonished. While I’ll agree that the strategy behind the ‘2-minute challenge’ won’t suit every investor, I believe that every serious investor should check it out to see if it’s right for them.

You can find out all about it here.

Two folks we know who won’t check it out are subscribers, Michael P and Peter G. We know, because they’ve told us. Here’s Michael P’s letter:

I have purchased a few reports from your company recently and have found them quite informative and well put together, however your promotion of the “2 minute technique that makes customers between $120 and $340 virtually on demand”, is most disappointing and does nothing for your organisation’s credibility.

Cash covered writing of options is nothing new and your promotion of this technique is misleading to the uneducated punter until he fully reads and hopefully fully understands that he must have the cash sitting in the account until expiry, it’s not as your demonstration suggests, that is: plug in the codes and walk away with cash and no obligations or commitments.

Also to suggest that this is Warren Buffet’s dirty little secret is nothing short of ridiculous, almost suggesting he is doing something illegal.

There is no doubt that there is a place and strategy for writing options given people’s different portfolios and investment objectives, but promoting it the way you have I believe is not appropriate as the end game of your promotion is you are actually selling a subscription.

And the letter from Peter G:

I am a subscriber to one of your research services which I quite like and think provides high-quality information and advice. Because of this, I was interested in seeing what the “2 minute income challenge” was about.

I have to say that I am extremely shocked and disappointed that you have negligently and recklessly recommended selling naked call and put options to unsophisticated investors as a great way to create income without disclosing any of the massive risks or the fact that the positions may need to be closed out whilst losing not only some or all of the premium collected from the opening of the position but also potentially unlimited losses if the underlying stock goes against the direction inherent to the trade.

I’ll definitely be thinking twice about anything that I read from PPP in the future.

What you have there in both letters are examples of shooting first and asking questions later. We can only think they haven’t really listened to and understood the strategy behind the ‘2-minute challenge’.

It’s simply a knee-jerk reaction to what Michael, Peter, and others, would have you believe is the dreaded ‘O’ word. The ‘O’ word being options.

But rather than just attacking the man, we’ll attack the objections one-by-one, to show that both readers are wrong. Not just a little bit wrong…but majorly wrong.

First, Michael P’s first contention:

Cash covered writing of options is nothing new and your promotion of this technique is misleading to the uneducated punter until he fully reads and hopefully fully understands that he must have the cash sitting in the account until expiry, it’s not as your demonstration suggests, that is: plug in the codes and walk away with cash and no obligations or commitments.

Cash-covered writing of options isn’t new. To be honest, we’re not sure we ever said it was. In fact, we openly state that it’s a strategy used by experienced investors for decades.

What is new is that, as far as we’re aware, there is no other service in Australia that provides recommendations on this strategy in the same way as Matt Hibbard’s Options Trader service.

There are a number of high-priced options trading education services. And there are a number of specialist options brokers. But, again, as far as I’m aware, there is no other advisory service like Matt’s, which provides the independent investor with actionable advice, and then allows the investor to make up their own mind as to whether they follow that advice.

As for having the cash sitting in the account. Again, that’s not necessarily true. That’s only true if you don’t own any stocks. If you already have a stock portfolio, instead of depositing cash with the options clearing house, you can deposit stock in lieu of cash.

That means two things. First, you’re effectively using your existing stock holdings as an ‘interest free loan’ to provide the collateral to your open options trade.

Second, it means that you can keep your cash in an interest-bearing cash account. Depending on the size of your existing stock portfolio, the options expiry dates, and your exposure to the market, you may even choose to put some of your cash in a short-dated term deposit — just make sure you have enough at-call cash to spare in order to settle any trades.

Additionally, when you receive the premium, technically, you can do whatever you like with the cash. The cash is yours. It’s paid directly into your cash management account by your broker. As long as you have enough cash in the account to satisfy margin requirements, or you’ve lodged enough stock with the clearing house, there is nothing to stop you from taking the cash.

As for walking away with no obligations or commitments, we’d suggest Michael P concentrates a little closer. We explain exactly how it works, and the risks…and the obligations.

And in Matt’s Fast Cash Alerts, his current subscribers will attest to how thorough Matt is in explaining the various outcomes and scenarios.

No one, repeat, no one who joins Matt’s Options Trader service is left under any misapprehension about what’s involved. The only folks who don’t understand the risks and obligations are those who haven’t bothered to take the time to read our explanatory material.

Michael P also writes:

Also to suggest that this is Warren Buffet’s dirty little secret is nothing short of ridiculous, almost suggesting he is doing something illegal.

Again, wrong. We don’t say it’s illegal at all. In fact, we state how great it is. Our point in referring to it as a ‘secret’ is that most people remember Warren Buffett’s reference to derivatives as ‘weapons of mass financial destruction’.

But what most people don’t realise is that the biggest businesses in Buffett’s Berkshire Hathaway Inc [NYSE:BRK/A] holding company are insurance businesses. The modern insurance business couldn’t possibly survive without the use of derivatives.

Further, people don’t realise that Buffett has often used derivatives in a big, big way. That’s because his use of them is less publicised.

But in his 2009 letter to Berkshire Hathaway shareholders, Buffett wrote:

Our put contracts total $37.1 billion (at current exchange rates) and are spread among four major indexes: the S&P 500 in the U.S., the FTSE 100 in the U.K., the Euro Stoxx 50 in Europe, and the Nikkei 225 in Japan. Our first contract comes due on Sept. 9, 2019, and our last on Jan., 24, 2028. We have received premiums of $4.9 billion, money we have invested.

What Buffett is describing is SELLING PUT OPTIONS. His company received US$4.9 billion in premium from selling puts, and then he used the premium to invest elsewhere.

So, not illegal, but a great idea. We’re not suggesting individuals get exposure to $37.1 billion-worth of stock. We’re suggesting investors take an exposure that they can cover with cash if they have to buy the stock on expiry.

And as for Michael P’s final comment:

There is no doubt that there is a place and strategy for writing options given people’s different portfolios and investment objectives, but promoting it the way you have I believe is not appropriate as the end game of your promotion is you are actually selling a subscription.

Erm, yes, well, selling subscriptions is what we do. We’re not quite sure what else anyone would expect.

I believe the options strategy that Matt uses is the best thing we do at Port Phillip Publishing. I want as many of our readers as possible to know about it and understand it.

As I said at the top, I’m not saying it’s suitable for all investors, but I believe all investors should learn about it.

The best way to do that is to explain it in a way that reaches as many people as possible. Would folks prefer that we instead wrote about the Black-Scholes options pricing model, or that we explain the ‘Greeks’ in depth?

(The ‘Greeks’ is an options term referring to several ways in which you can understand, predict, and determine the price of an option.)

No. We figured the best way to explain this strategy to investors who may have previously been intimidated by options, or have never been presented with them, is to explain it all in plain English, in a simple to understand way.

We make no apologies for trying our best to spread the virtue of using options in an investment plan.

Now for Peter G’s letter. Again, here was his main complaint:

I have to say that I am extremely shocked and disappointed that you have negligently and recklessly recommended selling naked call and put options to unsophisticated investors as a great way to create income without disclosing any of the massive risks or the fact that the positions may need to be closed out whilst losing not only some or all of the premium collected from the opening of the position but also potentially unlimited losses if the underlying stock goes against the direction inherent to the trade.

Wrong, wrong, wrong.

First, nothing anywhere says that we recommend ‘naked call and put options’ selling.

We are clear throughout, and Matt is clear in his trade instructions, that his Options Trader service only recommends ‘cash-covered’ put selling.

For the uninitiated, ‘naked’ put selling is when you sell put option contracts, but you don’t have the cash at hand to cover the trade if the shares are put to you.

That is not, never has been, and never will be part of Matt’s strategy…

Matt’s strategy (as the sales promotion explains) is ‘cash-covered’ put selling. That’s where you have the cash at hand to buy the shares if they are put to you.

Further, Peter G writes that put selling involves ‘potentially unlimited losses if the underlying stock goes against the direction inherent to the trade.

Wrong, wrong, wrong. Couldn’t be more wrong.

Even a beginner knows that selling puts doesn’t involve unlimited losses. The maximum loss from selling a put is the amount of the strike price, less the premium received.

To give you my personal trade example with Woolworths Ltd [ASX:WOW], which I discussed in yesterday’s Port Phillip Insider, I sold two puts on Woolworths with a strike price of $26.

For my trouble, I received 80 cents per share.

The underlying exposure was $5,200 (100 shares per contract x 2 x $26). I used existing Woolworths stock in my portfolio as collateral, so the ‘cash cover’ stayed in an interest-bearing cash management account, at the premium I received $124 (after brokerage) was deposited into that account the next day.

To give you two scenarios, if (as happened) Woolworths remained above $26, I would keep the premium received, and I wouldn’t have to buy more Woolworths shares.

If Woolworths closed below $26 by yesterday, I would have to buy them for $26. But because I received an 80 cent premium, my actual net cost price would have been $25.20.

But what about the worst case scenario? What if Woolworths had gone bust, and the share price had fallen to zero? In that case, I would still have had to buy the stock for $26. Less the 80 cent premium received, my cost would have been $25.20 per share.

All up, my net cost would have been $5,040. But with the shares now worthless, I would have lost $5,040. The point is, that’s the maximum loss. The last time I looked, shares didn’t trade at a negative price.

So Peter G is wrong. Losses aren’t unlimited when you sell puts. They are limited to the strike price less the premium received. And providing investors who follow this strategy don’t go crazy, and only trade in a size they can cover with cash, they will always know their maximum loss.

Where Peter G may be confused is with naked call option selling. Theoretically, losses are unlimited. But again, anyone who took the time to understand Matt’s strategy would know that he doesn’t touch naked call option selling.

He only deals with covered call option selling, where again, the risk of loss is known at the time of placing the trade.

Finally, Peter G writes:

I’ll definitely be thinking twice about anything that I read from PPP in the future.

For fear of taking offence, our advice to anyone is that if one just thinks once, and does it properly, then there’s no need to think twice!

Unfortunately, this is the kind of knee-jerk reaction that too many people have to options.

They read an article on some website, telling them how somebody lost all their money trading options…or they read some junk on a blog, talking about derivatives and ‘weapons of mass financial destruction’, and they think options are the worst thing in the world.

I’ll be clear on this. For all the work we put into the Options Trader service, it’s actually doesn’t make our business that much money.

In fact, I think the subscribers who follow Matt’s advice make more money from his trading than we make in profits from selling subscriptions.

In that case, why do we keep offering it?

Simple. Because I truly believe this is the most important investment advisory we offer. Not only does Matt provide direct and actionable recommendations, but he does a great education job too.

So much so, that Matt regularly receives emails from subscribers telling him how they’re starting to place their own trades, using Matt’s methods.

That’s the best value in the service. You could pay $10,000 for an educational seminar or software service, but I bet it wouldn’t be half as useful or half as valuable as the service Matt provides.

And an annual subscription to Matt’s Options Trader service doesn’t cost anywhere near that.

Look, if, as some folks think, we’re more interested in selling subscriptions to line our own pockets, I wouldn’t waste a minute of my time with the Options Trader service.

If it were all about us making money, I’d just launch another small-cap trading service. I know we could sell millions of dollars of subscriptions without much effort.

We have small-cap trading services. We make a profit from them, and our subscribers have a chance to make a profit from following the advice. But we launched Options Trader because, as I’ve said twice now, I believe all serious investors should understand how the options market works, and then see if it can work for them.

Importantly, we try to explain it in a plain English way. Without all the jargon, without the unnecessary complexity, without the snobbery, and without the ill-educated misinformation that seems to be so prevalent about options.

Hopefully that all makes sense. If you haven’t done so already, check out Matt’s Options Trader service. Once you look beyond the mystique, you’ll see just how fantastic trading options with Matt’s approach can be. Details here.

My account

To prove that the cash received from selling puts doesn’t have to stay in your options account, here are a couple of screenshots from Commsec.

The first shows the transaction on 22 February, with the cash transferring to the cash management account on 23 February:



chart image

Click to enlarge


The next screenshot shows the cash appearing in the cash management account:



chart image

Click to enlarge


Enough said.

Cheers,
Kris