Category Archives: Options

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28
Aug

Sunday Edition: The Misunderstood Role of Stock Dividends

By - Dividends, Investiv Daily, Options, Stocks, Sunday Edition

In Today’s reprint of Thomas’ Rebel Income newsletter ($1,164 annual subscription), he discusses the often overlooked but incredibly important role dividends play in your overall returns.  

As you’ll see, over the last 25 years, $1 invested in 1990 has grown to almost $10 today including dividends. Whereas that same $1 without dividends has only grown to $6. That’s a 40% difference in overall wealth creation.

In the Rebel Income picks, Thomas always looks to sell put options on fundamentally solid companies that pay strong dividends, since dividends are the single best indicator of true company strength.

Furthermore, a healthy dividend makes it much easier to hold onto stocks, which have been assigned, even if the stock price drops a fair amount below the strike price of the original put option.   

And finally, your overall long-term returns will be much higher once the stock price recovers, and the stock is either sold or called away because of a subsequent covered call trade recommended by Thomas on stocks which have been assigned.  

This three-prong approach is really what sets the Rebel Income system apart from just about any other income generation system. You have the opportunity to get paid 3 or more times on the same stock.  

First from the initial put sell, second from collected dividends, third from covered calls, and finally any capital appreciation on the stock itself.

I believe this is why Thomas has generated near 30% returns over the last two years turning every $100K into $171K as compared to only $112K investing in the S&P 500.

Here’s Thomas:

Week 5: The Misunderstood Role of Stock Dividends

If you’re a student of the stock market, you look for as much information as you can find about different investing methods and systems. Books, newsletters, videos, seminars, classes – you may not use them all, but even if you learn something you don’t end up using, it’s all useful, because it expands the scope of your knowledge, your perspective about the market’s many different possibilities, and your understanding of what fits you best.

One of the things I’ve found interesting over my more than two decades of studying and investing in the stock market is the role dividends can—and in my opinion, should—play in a successful investing system. Directional trading strategies, which usually emphasize relatively short-term trades based on price swings from low to high points that might last anywhere from a few weeks to a few months, tend to ignore dividends altogether, since in many cases you might not actually hold a stock long enough to be counted for a dividend distribution. The same is true of directional investing strategies that focus on equity options, since buying and selling call or put options on a stock will rarely translate to actual ownership of that stock.

Kinds of Stocks that Pay Dividends

Long-term investing concepts usually differentiate between stocks based on the underlying company’s size and scope of business, how much their business has grown in the past and what analyst’s forecast of future growth is likely to be. Large, established and easily recognized companies, like General Electric Co. (GE), Caterpillar Inc. (CAT), and Microsoft Corp (MSFT) among others are referred to as blue-chip stocks; these stocks are usually included in the major market indices including the Dow Jones Industrial Average and the S&P 500. Medium-sized businesses who have been successful at building their businesses but have not yet reached the status or size of a blue-chip stocks are usually called mid-caps, and smaller, up-and-coming companies are called small caps. Depending on how aggressive or conservative you want to be as a stock investor, these different categories present various levels of opportunity as well as risk. Small-cap stocks, who usually have the largest scope of opportunity to grow, generally provide the largest overall growth potential, with mid-caps coming in next, and blue-chips last, since these stocks already have become the 600-lb. gorillas in their respective industries and sectors. In the same way, blue-chips are usually considered to be the safest overall long-term investments, while small-cap stocks are far more speculative since a minority of these up-and-comers ever actually fulfill their potential.

One of the other reasons that blue-chip stocks are considered to carry a higher level of safety comes from the fact that most of them pay a regular dividend to their shareholders. Why do some stocks pay dividends while others don’t? Because companies are naturally allowed to decide what they want to do with their profits. What they actually do with those profits can tell you a lot about the strength of the business and what management thinks about the future. Dividends are one of the simplest and most transparent means companies have to return a portion of their profits back to their shareholders. Smaller, less-established stocks often don’t pay a dividend simply because their profitability can be widely variable from one year to the next. Dividends have to be approved by the company’s board of directors, and they won’t be likely to commit to pay out a portion of their profits if they don’t believe they will be able to maintain a level of profitability that is higher than the dividend.

The most common line of thought suggests that a stock shouldn’t begin to pay a dividend until the business has reached a size and scope of business that makes a dividend easier to maintain. Microsoft Corp, for example, didn’t pay a dividend to its shareholder for almost 20 years after their initial public offering in 1986 despite their domination of the software industry and the mountains of dollars they held in cash. When they finally declared their first dividend in January 2003, MSFT held more than $43 billion in cash; their initial dividend payout was only $864 million of that amount, or about 1.8% of their total cash. To me, this is a good example of why identifying stocks that pay a dividend—even a small one—is so important; it says a lot about management’s confidence in their business as well as recognizing the important role shareholders play in their overall success.

Another interesting aspect of dividends is that while blue-chip stocks are the most likely places you’ll find attractive dividends, it also isn’t unusual to find mid-cap and in some cases, even small-cap stocks that have committed to a consistent dividend payout. I think there is a lot of power in finding these types of stocks, which are even more in the minority than their larger brethren; most of these companies prefer instead to reinvest their profits in their business to keep driving growth. Those that do decide to pay a dividend, in my opinion, are communicating a different level of confidence in themselves and future of their business than those that don’t. They are using the dividend payout to attract shareholders that can buy in to their long-term plan and prospects, which I think is a smart thing. That’s why you’ll see me write about stocks like SLCA, CBI, GME and others as I find them and they meet my other fundamental criteria.

The Real Impact of Dividends Over Time

The fact of the matter is that on an historical basis, dividends have always made up a significant piece of the overall returns the stock market has achieved for decades. As of now, the average dividend yield for all stocks that make up the S&P 500 is 2.02%; the average yield for the past 25 years isn’t too far from that same level, at 2.07%. Over the same period, the index itself has returned an average 11.29% return. If you take dividends out of the equation, that annual return lowers to only about 9.22%. What does that mean in real dollars? Including dividends, $1 invested in January 1990 would grow to almost $10 today; but without dividends, it only grows to a little less than $6. That’s a 40% difference over the last 25 years, and it’s a major reason I include dividends in the criteria I apply to my income generation system.

I get emails quite often from subscribers asking me when I’m going to get out of a stock I’ve been assigned from a put sale that has seen a major drop from the price I was assigned at. My general answer has always been that as long as I see the stock’s fundamentals holding, I will continue to wait for the stock’s price to recover back to my assignment price; my analysis of the company’s business strength still confirms my belief that the value of the stock should be higher than my assignment price. I also want to continue to hold the stock because when it does recover, I should be able to find opportunities to generate even more income with covered calls. Both of these statements are true; but another reason I don’t mind holding these stocks even for an extended period of time is because of the fact I can draw dividend payments from them. Those dividends are extra income I don’t have to do anything to get except to hold the stock before and through the announced ex-dividend date.

It’s true that in general, I don’t expect to hold a stock long enough to see an entire year’s worth of dividend payments on it; even so, the fact that I can enhance my ability to generate income—even if by just a few cents per share—by doing nothing more than emphasizing dividend-paying stocks in my screening process is more than worth the trouble. It is also one more layer of protection I can add to my system, since I can also lower my overall cost in a stock by the per share amount of the dividend.

Dividends vs. Stock Buybacks

Tech stocks, in particular have historically chosen a slightly different tack over paying dividends, which is to implement a large-scale stock buyback program. The result is that shareholders hold fewer shares than before, but also see an increase in the stock price; the increase in buying activity over time will also often create an extra wave of bullish enthusiasm for the stock that inflates the price even higher than the buyback alone would yield. I prefer to look for stocks that pay a regular dividend because it signifies a greater commitment to return value to shareholders on a consistent basis; stock buybacks are really about letting the company maintain flexibility and control over your shares, since the timing of buybacks, how large they are, and what they mean to you is at their complete discretion. With a dividend, you get to decide what to do with the money; you can spend it at your discretion, or you can invest in back in the stock or the market at large.

Another element that can also make a company more attractive from a fundamental standpoint is whether their dividend payout has grown over time, remained static, or decreased. Ideally, dividends should grow as profitability does, and more proactive companies do this either by increasing their regular dividend or by issuing a special dividend on an annual basis. If I’m trying to decide between two different fundamentally strong stocks, this can be a way to delineate between them. Be aware, though that the dividend itself is the main criteria for my income trading system, even if the company has not increased its payout. I also don’t place a lot of emphasis on the size of the dividend, again unless I’m trying to differentiate from multiple candidates.

Dividends provide a strong reason to hold stocks even when they might be in a downward trend. If the company’s fundamentals remain strong, the dividend adds an element of income above and beyond my ability to write covered calls. While there certainly are undervalued, fundamentally strong stocks out there that don’t pay dividends, the presence of a dividend says a lot about that company’s management, their management style, and the relationship they maintain with their shareholders. That’s why dividends are a big part of my system.

As you can see, dividends are critical to achieving long-term returns that far outpace other investing strategies which ignore this important source of income and overall return.  

Thomas’ subscribers recently got paid 9 different times on Archer Daniels Midland (ADM), by selling puts, writing covered calls and collecting dividend income.  

The total cumulative return on this one trade was 15.38% in only 7 months. In today’s zero yield world, those kinds of returns are nothing short of spectacular.  

We understand that at $1,164 per year, Thomas’ Rebel Income newsletter is out of reach for many investors.

That’s why a little over a year ago we asked Thomas to launch a second newsletter called Retirement Revival as a way to introduce investors to income generation through selling puts, writing covered calls and buying high dividend paying undervalued companies.

Retirement Revival is a monthly rather than weekly publication. Each issue contains one put sell recommendation and one undervalued stock pick.

As of now there are 12 open stock positions with the average gain per trade of 9.56% with one stock up more than 38% in less than a year.  

Eight of these stock picks are still in our recommended buy range with several paying dividends between 4% and 5%.

The average gain per put sell has been 2.54% in less than 30 days. Compounded and annualized that works out to be 35.12%.

Thomas is currently offering new Retirement Revival subscribers a 1-year subscription at an introductory rate that’s less than you’d pay for dinner for two at a modest restaurant.

To learn more, click here.  

Regards,

Shane Rawlings
Co-founder, Investiv

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21
Aug

Sunday Edition: Stop Losses and Value-Oriented Income Generation

By - Investiv Daily, Options, Panic Selling, Stop Losses, Sunday Edition

Today’s Sunday Edition discusses the biggest reason why your investments might be underperforming, and why the Rebel Income system isn’t subject to this one fatal flaw, which might explain the nearly 30% annual returns over the last two years.

In a study conducted by Dalbar Inc.—the nation’s leading financial services market research firm—through 2014, the 20-year annualized S&P return was 9.85% while the 20-year annualized return for the average equity mutual fund investor was only 5.19%, a gap of 4.66%.

The biggest reason for the underperformance, according to their research, is psychology. The study also defined nine of the irrational investment behavior biases specifically, with the biggest culprit being:

Loss Aversion – The fear of loss leads to a withdrawal of capital at the worst possible time. Also known as “panic selling.”

Investing in mutual funds is a little different than investing in individual stocks, however, I believe the fear of loss is heightened when dealing with individual stocks as opposed to mutual funds, since mutual funds have greater built in diversification.

However, 95% of individual stock risk can be mitigated simply by owing a basket of 8 to 10 quality and uncorrelated companies. But that discussion will be saved for another time.  

Today’s focus is on “panic selling” and why the Rebel Income system is designed to help you avoid this fatal mistake, which can kill your overall returns.

The majority of the put sells Thomas recommends do expire worthless, and subscribers just keep the income. However, there are times when the stock price drops below the assigned price, and sometimes by quite a bit. 

For example, Thomas sold a put on CSIQ with a strike price of 29 and the stock dropped to $19 before reversing and moving back above the strike price, allowing us to exit with a profit. Another example is ANF which was assigned at 27.50 and dropped down to $16 before moving higher resulting in a profitable trade.

On average Thomas is assigned a stock 25% to 30% of the time, meaning the stock drops below the put option strike price.  

Of course he never succumbs to “panic selling,” which has even drawn criticism by a few subscribers because he chooses not to use stop loss order to protect capital. But it’s hard to argue with his track record.  

In today’s reprint of Thomas’ Rebel Income newsletter (annual subscription $1,164), he discusses when he believes a stop loss order should be used, but why he chooses not to use them with the Rebel Income system, which has closed 98 winning trades with only 3 small losers and outperformed the stock market 10 to 1 since inception (last two years).

Here’s Thomas:

Stop Losses and Value-Oriented Income Generation

Occasionally I get emails from subscribers about my approach to stop losses on the stocks I hold in my portfolio. If you’ve followed Rebel Income for a while, I expect that you’ve noticed I never write about stop losses on stocks I am assigned from my put selling trades. This isn’t a simple case of omission, but instead a deliberate piece of the income generation system I use. I don’t use stop losses on any stock I am assigned on purpose.

This might sound a little foolhardy or possibly even irresponsible at first blush… especially if you are a new subscriber and are still trying to get used to the system I use and write about. I think that in order to understand why stop losses aren’t useful for my system, it is important to talk about where they are useful first and why in those cases you should never place a trade without them.

When it comes to the stock market, we are all conditioned to think in very directional terms. Buy a stock at a low price, hold onto it a while, and hopefully sell it sometime down the road at a higher price. For a lot of investors, that is the entire scope of their investing experience. If you’ve traded options, you’ve been able to expand your perspective quite a bit more, but again you are still generally encouraged to work with a directional bias: buy call options if you think a stock will increase in price, or buy put options if you think a stock will decrease in price. This directional bias is what drives most of the investing activities of the general public; in this context, stop losses are absolutely critical and should never be ignored.

Most directional trading strategies are designed with a very short-term timeframe in mind. Most focus on trying to take advantage of short-term swings along a trend line or a breakdown of a stock’s current trend, which usually marks the beginning of a new opposite trend. The problem with strategies that are designed around trying to predict what direction a stock is going to follow in the near term is that they have a very low probability of success; a 25 – 30% success rate is considered normal even for the most experienced and skilled technicians and traders. Speaking for myself, in more than 15 years of options trading, I have never been able to achieve a success rate higher than 30% with any of these types of strategies.

To be clear, it IS possible to make money with these kinds of methods, even with such a high degree of failure. It requires a high level of discipline and patience, however, since a low probability of a winning trade also means a high probability not only of one losing trade, but of several in a row. In the short term, losing streaks often seem to mount the losses to the point that the few profitable trades you will see can’t possibly make up the difference. The only way they can is to keep a long-term view and make sure that you apply a hard stop loss on every trade you make. Where the stop loss is set will vary depending on the system you’re using, and I’m not going to take space in this post to elaborate on that detail. The point is that the stop loss is designed to limit the loss per trade enough so that even if you do see a major losing streak, the sum of your losses will be limited enough to keep you in the game for the winning trades.

I write a lot in Rebel Income about how I use put selling as a gateway to value-oriented stock ownership. If you look around the web, you’ll see that even a lot of long-term, value-focused investors use stop losses as well. In fact, if your sole purpose of holding a stock for the long-term is to be able to ride a long-term upward trend, you should absolutely be using a stop loss. I think that in this case, not using a stop loss is irresponsible and foolhardy, because you are still thinking in directional terms.

The stop loss should be wider than it would be a with a short-term trading strategy, because you have to be willing to give the stock enough room to fluctuate in price quite a bit as it rides along its trend line. I think that in these cases, setting a 25% hard stop below your initial purchase price is smart. If the stock moves above your purchase price, recalculate your stop loss; do it each day the stock makes a new high above your purchase price, but once it is raised, it is never adjusted lower. If the stock experiences a short-term swing downward, leave your stop loss at its last adjustment (which should be 25% below the highest price in the last peak). If you get stopped out, so be it; if the trend holds, the stock should swing back upward and eventually move above that last peak, so you can adjust the stop loss higher again. The nice thing about this approach is that you don’t have to worry about “how long do I let the stock go up before I get out”; you just wait until you get stopped out of the trade.

Understand, the method I’ve just outlined requires just as much discipline as any short-term trading strategy. The good thing is that if the stock does form a long-term upward trend, you may see it increase in price by two or three times, or possibly even more. Even waiting for a 25% drawdown from the trend’s highest point means being able to capture a big chunk of the trend. The caveat is that not all stocks will form the kind of long-term trend you need, or move high enough before you are stopped out to make the trade profitable. The probabilities for this system are a little higher than for the shorter-term strategies I mentioned, but generally not by more than 10%, which means that you should still expect to see more losing trades than winning ones. Again, this is why the stop loss is so important; in those trades, you’ll need to make sure your loss is limited enough that your winning trades will be able to make up the difference in the long-term.

I’ve just spent several paragraphs talking about why stop losses are so important and critical to directional systems. Now I’m about to tell you to forget all of that information… at least for the trades you make following my system. I’m not doing this to imply that I know better than people who have been using directional trading strategies; I have made a lot of friends over my years in the market who have been very successful following those systems and continue to make a lot of money with them. I know those methods work. However, I also believe that most investors will not make money following those systems because of the difficulty—emotional and financial—that is associated with the losing side of those systems.

Think about it, if you are the middle of a prolonged losing streak, and watching your account get smaller and smaller with every trade you make, do you think it will be easier or harder to keep the big picture in view and stay the course? Most investors have a limited amount of capital to work with, and watching our hard-earned capital disappear into thin air again and again just isn’t something most of us are equipped to deal with. This isn’t a criticism of human nature, but simply an acknowledgement of reality. It is a fact that only a small percentage of investors have the emotional makeup required to endure the kind of prolonged losses that are normally associated with directional investing and trading. While I’ve used directional strategies in the past and am very familiar with them, the truth is that I put myself in the larger percentage of investors – those that generally shouldn’t be dealing with directional investing. I know how to be successful with directional trading, but it is very hard for me to maintain the discipline it requires. I have to fight my emotions on a regular basis, which only adds stress to my life. I don’t believe investing should create more stress than life brings every day all by itself. That is why my system is built the way it is.

I differentiate between my system and traditional, directionally based value investing by the fact that my approach looks first to generate income by selling puts, and factors stock ownership into the equation second. By selling puts against a fundamentally solid stock trading with a great value proposition, my goal is use the directional bias of most investors in my favor. If that bias keeps that stock above my put option’s strike price through the duration of the trade, the option expires worthless, my first purpose (income generation) has already been achieved and I move to the next trade.

If the stock is below my put option’s strike price at expiration, that doesn’t mean that the market’s natural directional bias isn’t working for me, but it does mean that the second piece of approach—stock ownership—comes into play. This is where the other major difference between what I do and what even most value-oriented, long-term investors do, because I don’t work with a stop loss. Why wouldn’t I work with a 25% hard stop loss, when this number actually sounds pretty reasonable?

My first answer goes back to my first objective: income generation. I emphasize dividend-paying stocks exclusively in my system, which means that when I am assigned, I become a shareholder of record in the stock, which means I receive dividend distributions as they are paid. Some of the stocks I’ve been working with, like BBY, JOY, and others are currently paying dividends in excess of 3% per year – which is better than what you’ll get by putting your money into a CD or money market account at the bank right now.

The other part of the income argument is the second major piece of my system: covered calls. One of the first things I look for an opportunity to do when I am assigned a stock is to sell a covered call and keep the income generation machine churning. Subscribers to Rebel Income have seen me write about several covered call trades that have helped me generate a significant amount of immediate income on stocks I’m currently holding in my portfolio. Unless you’re approved for margin trading and have adequate reserves to cover the trade, most brokers don’t allow you to set a stop loss on a stock you’ve written a covered call against, no matter how far away from the current price it is. This is because if you get stopped out of the stock, the calls you’ve sold are now naked, leaving you exposed to an unlimited amount of risk for the duration of those contracts.

There is a third part of my reasoning for not using stop losses, too. Those who have followed along with my trades for the last year or so know that there are a number of stocks that have seen long, protracted declines in price after I was assigned their shares from a put sale. JOY, SLCA, ANF, CBI, and HAL are just a few examples of stocks I’ve watched drop far more than 25% below my initial purchase price. I’m still holding shares in several of those companies today, not because I’m stubbornly unwilling to admit I was wrong, but because my fundamental analysis of those stocks continues to lead me to believe their long-term value is much higher than even the price I was assigned at. The only circumstance that will ever lead me to finally throw my hands in the air and close the position at a loss is if I see signs of a significant deterioration in the strength of their actual business operations. As long as the fundamentals remain strong and point to a higher intrinsic value than my entry price, I am willing to continue holding these stocks. In fact, readers will have noticed that I’ve used some of those protracted drawdowns as opportunities to sell more put options, since being assigned again would mean that I can average my price even lower than my initial purchase price. Using this third element on JOY, for example, enabled me to average my actual cost in the stock significantly below the $40 per share my initial assignment occurred at. Being able to average my cost down made the position easier to manage and a lot less stressful than it might have been otherwise. When JOY recently announced it had agreed to a buyout at $28.50 per share from Komatsu Ltd. (a new event that clearly changes the value proposition for the stock), the fact I had been able to average my price below the stock’s current price made it possible to close my position with a modest net gain.

This is a pretty long explanation of why I don’t use stop losses, I know; but I think it is important to make sure that you have all of the facts associated with the Rebel Income system as possible. The fact is that even though I don’t use stop losses, I do think about risk management every day. It’s why I’ve built the system the way I’ve outlined, and it’s why you’ll see me continue to provide as many details about the different pieces of the system as I can.

If you are like most investors, the emotions involved in directional trading are simply too powerful to control on a consistent basis.  

Why not follow a system that mitigates the emotions that cause “panic selling” and allows you to sleep well at night?  

Not to mention generates returns that far outpace buy and hold investing, yet keep the bulk of your money sitting safely in cash the majority of the time?

To get a first-hand look at how Thomas manages his put selling trades, we’ve arranged for you to follow his picks for the next 30 days for only $9, with no obligation to continue. You’ll also receive two incredible bonus items free. Click here to get started.

Regards,

Shane Rawlings
Co-founder, Investiv

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14
Aug

Sunday Edition: Why Stock Assignments AREN’T a Bad Thing

By - Investiv Daily, Options, Sunday Edition

If an investors is looking for a quick entry into a highly liquid stock he may choose to use a market order rather than a limit order.  

However, if he wants to guarantee the price he pays for his shares he will always place a limit order, which will typically be at or below the current quote, unless he is a breakout trader, then his buy limit order may actually be above the current stock price.

Another stock entry technique—which is arguably better than a limit or a market order, especially when trying to buy at or below the current market quote—is to first sell a put option on the stock you wish to acquire and hope for assignment.

Doing so not only allows you to guarantee the price you pay for your shares, which can be at, below, or above the current quote, but also allows you to generate additional income which can lower your cost basis even further.

The risk is if on option expiration the stock isn’t trading at or below the strike price of the put option you sold, you never end up buying shares. If the stock then moves higher, you miss out.

In April 1993, Warren Buffett sold 50,000 contracts (the equivalent of 5 million shares) of out-of-the-money Coca-Cola put options for $1.5 per share and generated $7.5 million in up front cash.

If Coca-Cola stayed above $35 per share on expiration, he got to keep the $7.5 million in cash but would not be assigned the 5 million shares.  

If Coca-Cola dropped below $35, through assignment he would effectively purchase the stock at $33.50 ($35-$1.5 option premium), which was a great price anyway. It was a win-win situation.

In Buffett’s case, he was genuinely hoping for the stock to drop below the $35 put option strike price so that he would be assigned 5 million shares of Coca-Cola at an effective price -14% below the current market quote at the time ($39 per share when he initiated the trade).

Put option assignment or stock ownership is not always the intent of every income trader who sells naked or cash-secured put options. In most cases they are hoping to collect the income, have the put option expire worthless and move on to the next trade.

In today’s reprint of Thomas’ Rebel Income newsletter (annual subscription $1,164), he discusses why put option assignment isn’t a bad thing and how you can turn it into a very profitable trade when done right.

Week 3: Why Stock Assignments AREN’T a Bad Thing

A couple of the questions I see quite a bit from new subscribers are how are they supposed to know when to close a put selling trade I’ve written about, or how are they supposed to avoid buying the stock if it drops below their option’s strike price before expiration. I’d like to use today’s post to elaborate on these questions in more detail.

First, when I sell a put option to open a trade, I’m really looking for one of two results:

  1. The stock closes at expiration at or above the strike price of the put I’ve sold. In this case, the put option expires worthless. I don’t have to do anything to close the trade; I just keep the money I brought in when I sold the put and the option goes away.
  2. The stock closes at expiration below the strike price of the put I’ve sold, which triggers an automatic stock assignment. That means I’ll buy the stock at the strike price of the put I’ve sold.

If the stock closes below the strike price I’ve sold, I will initially be in a negative position, since the stock is lower than my purchase price.

Since the stock assignment in the second case is automatic, I also don’t have to take any additional action. My broker handles the transactional details, I pay the commission fee for the stock purchase, and the shares are now in my account. This is why I don’t write about closing the put selling trade. The put will either expire or I will be assigned the stock, and I’m okay with either result. When I am assigned a stock, I begin looking for opportunities to sell call options against it to generate more income and lower my cost basis in the stock. I like to sell out-of-the-money call options so that if I am called out, I can factor a capital gain into my profit analysis along with the income I’ve generated with the put sale and the covered calls. The covered call is the mechanism I use to “close” a stock position. My Tuesday highlights emphasize put selling first and foremost, but if I have been assigned a stock from one of my highlights and a new covered call opportunity comes along, you may see me write about it on either Tuesday or Thursday.

There is a common perception I’ve seen that thinks of put selling as a directional strategy, like buying a call – you’ll only sell a put if you think the stock will go up. The problem I have with this mindset is that it encourages you to think that a stock assignment from a put sale is something to be avoided. I get questions from time to time about why I don’t “roll” my put options from month-to-month when I’m “underwater” (a common term people seem to like to use when the stock is below the put option’s strike price, meaning that an assignment is likely) on the trade. The first answer is that I have no intention of avoiding a stock assignment; buying the stock actually gives me two ways to keep the income machine going, since not only can I look for opportunities to sell covered calls, but I’ll also be able to draw dividends on the stock if I own it through a dividend declaration.

The principle of “rolling” a naked option is something that I know a lot of directionally-biased traders believe in, because the one thing they don’t want to do is to be forced to fulfill the obligation selling the option put them under. The problem I have with that approach is that in order to avoid the stock assignment, you have to buy the put option back from the market to close the trade. Since the stock’s price will be below the strike price you sold, you will have to pay higher and eat a loss on the trade. For a trading system that centers on income generation, this process is extremely counterproductive.

I’ve written quite a bit in Rebel Income about my belief that you should never sell a put option on a stock you are not willing to own. I’ve seen a lot of traders who think that if the stock drops below their put’s strike price, they would rather just buy the put back from the market, absorb the capital loss on that trade, and move on to the next one. Hopefully, I’ve already explained the transactional problems that creates, but you should not ignore the fact that closing the trade eliminates the possibility of capital gains in the stock once it starts to increase in value again. That means that a big component of my system—which relies on covered calls—is taken completely out of the picture. Over time, those covered call trades have made up an important part of my overall success.

The difficulty, as many of you have seen, comes when the stock is several dollars below the strike price you were assigned at, and keeps dropping. Selling out-of-the-money call options is going to help you lower your cost basis sure, but the further the stock drops, the less likely you are to get any premium of real value from any strike price that is close to, much less above, that net cost. That means that to write a new covered call, you have to be willing to sell a lower strike price and run the risk of a reversal that could call you out of the trade before you’re really ready to. So what do you do?

My answer is actually pretty subjective: sometimes I’ll go ahead and write a covered call, and sometimes I don’t. While some parts of my decision-making process in this situation are based around analytics, others are based around nothing more than my gut instinct. I’ll give you a couple of examples from my historical trades to illustrate.

On November 18, 2014, I sold a put on SLCA with a strike price of $41 per share. The trade covered a month, and at expiration the stock was at $28.41. I was assigned the stock at $41 on December 19th; my net cost in the position at that point was $39.50 per share. The stock was still dropping almost in parallel with oil prices, and although the stock rallied a couple of dollars from a low around $23 in late December, it reversed again and started back down. On December 29, I sold a covered call for 18 days (expired Friday, January 16, 2015) on my shares, this time with a strike price of $29. I was taking a risk at that point, but with the strength of the downward trend, and few signs of a recovery in oil led me to believe the stock wouldn’t be likely to get above that price. Turns out I was right – the stock found a low at $27.50 before reversing.

The picture really only got worse from there – the stock dropped as low as $14 on multiple occasions and has only recently started to move up a bit, sitting at around $23 as of this writing. I’m still holding the stock because the fundamental profile still looks good and I think the upside in the stock is still there in the long-term. I sold a covered call on the stock at $41 in April 2015 when it was approaching its latest peak, which then expired worthless but helped me bring my cost basis down to a little below $37. I also made use of the extended decline to sell additional puts against the stock as a way to average my cost lower in the event of an additional assignment. Those options expired worthless, but they brought in more income that I can also use to reduce my cost basis; it is now around $35 per share. For now, I’m holding the stock and waiting for a new opportunity to write another covered call when the stock rises again to the mid-$30 level.

In December 2015, I sold two put contracts on SYNA. The first was on December 10th with a strike price of $62.50, and an expiration date only 9 days away. The stock closed on December 19th above $68, so this contract expired worthless. On the 23rd, I sold another put contract that expired on January 9th with a strike price of $67.50. The stock closed on the 9th below $61, so I was assigned the stock with a net cost of $65.65 after the assignment. On the 12th, I sold a covered call to expire on January 22nd with a strike price of $62 – once again accepting the risk of being called out lower than my actual cost. At the time, the stock looked like its downward trend would continue, or at the very least the stock should hold somewhere between $58 and $62. Instead, it rallied higher, with strong momentum that has since pushed it to new highs.

Now comes the really subjective part of this process I referred to earlier. A day before expiration, as I was looking at the stock and its current momentum and I thought about my options. First, the stock was about $1 above my $62 strike price; I could wait to get called out and absorb a loss of $3.55 per share. Second, I could buy the call I sold back from the market. The call was priced at $4.40 on the Ask, while I sold it at $.90 to open the trade, so in terms of immediate loss, there was practically no difference, numerically speaking, to sway my decision one way or another. I would have about the same amount of loss in the near term either way. What did I do?

I bought the call back. Why? In looking at this stock’s activity over the previous few days, it seemed clear that other investors agreed with my fundamental opinion that SYNA’s price at that time was a bargain, so they wanted to get in while they could. The stock was also due to report earnings on the next Thursday after expiration, and it seemed clear to me that the market was betting on positive numbers. I decided to let the stock ride for a bit and see how it played out. In this case, the result was great – the stock went to nearly $80, where I wrote another covered call that I was not called out on, then finally called me out of a third covered call trade at $81. My net gain (premiums + capital gain) in the trade for holding a two-month position was more than 24%.

So, if I were to sum up my approach? First, I’ll never sell a put option on a stock that I’m not willing to own – even if the stock drops far below my option’s strike price. Once I’m assigned a stock from a put sale, I take a case-by-case approach for each position, since no two positions are going to behave in exactly the same way. I’ve had a number of other stocks over the last several months that were assigned to me when the put expired and gave me an opportunity to get out with very nice net profits on an exercise from the next month’s covered call. In those cases, the stock’s drop below my put’s strike price wasn’t nearly as deep. It’s really not possible to apply a single method to every single case, so you have to be willing to adapt. Remember that the focus for each position you establish is on income generation; trades that facilitate that process and might help make the occasional stock assignment more cost-efficient are embraced, while trades that help you avoid the obligation of an option sale are counter-productive and more, not less costly to the system in general.

Over the last two years Thomas has outperformed investing legends such as Warren Buffett, Carl Ichan, and David Tepper, earning nearly 30% per year applying his unique Rebel Income system selling put options.

Quite frankly, his track record is unheard of in the financial publishing business. He’s closed exactly 101 trades, of which 98 have been winners with only 3 small losers.  

He is the first to admit that much of his success—especially when it comes to his winning percentage—has to do with how he manages stock positions which are assigned, because the stock has dropped below the put option strike price. 

To get a first-hand look at how Thomas manages his put selling trades, we’ve arranged for you to follow his picks for the next 30 days for only $9, with no obligation to continue. You’ll also receive two incredible bonus items free. Click here to get started.

Regards,

Shane Rawlings
Co-founder, Investiv

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07
Aug

Sunday Edition: Setting Reasonable Investing Expectations

By - Investing Strategy, Investiv Daily, Options, Sunday Edition

The story of the tortoise and the hare teaches us that the prize doesn’t always go to the swift, who are sometimes easily distracted, but often ends up in the hands of the one who perseveres regardless of speed.

This apologue is even more true when applied to investing. Many investors are too easily lured by “get rich quick” investing schemes and strategies, rather than safe and consistent compounding month after month, using what some might consider a boring strategy.

I shudder at the thought of comparing Thomas’ nearly 30% annual returns over the last two years to the tortoise. Especially when his returns exceed those of investing greats Buffett, Ichan, and Tepper. But when compared to the pipe dream some investors have of earning 100% + annual returns buying options and futures contracts, then it most certainly appears “boring.”

Sure, some investor might have a banner year buying leveraged options and futures contracts, but lets see him string together two, three, or four years of similar performance. Any trader who more than doubles his account in a year, or even 18 months for that matter, will have been helped by lady luck much more than he cares to admit.  

The fact is, for every gunslinger who doubles, triples, or even quadruples his trading account in less than 18 months, there are 50 other traders who attempted the same thing, and completely blew up their trading account. You don’t want to be one of them.

In today’s reprint of Thomas’ Rebel Income newsletter (annual subscription $1,164), he talks about his own experience trading leveraged futures contracts and why he is sticking to the more “boring” strategy of selling put options.

Week 2: Setting Reasonable Investing Expectations

“How much money can I expect to make if I use your system?”

This is a question I often see from new potential subscribers. It’s essentially the same question I used to deal with on a daily basis when I worked for a major mutual fund in the 1990s. It’s a natural question that many of us ask when we’re thinking about putting our hard-earned money into an investment.

The natural answer, of course, is to point to previous results. I make my trading log available through the Investiv website so you can see my trading results almost as quickly as I make trades, and I’ve used it quite a lot in customer communications to illustrate what I think is a reasonable example of what is possible using the Rebel Income system. At the same time, though, I remember that I got tired very quickly of telling potential customers to look at the historical returns of the funds I was trying to get them to put money into. I came to realize why every performance graph I could show people included the disclaimer “past performance is not a guarantee of future results.”

With mutual funds, performance often varies wildly from one year to the next for any number of reasons. For example, we had a very high profile manager managing our flagship fund who decided to retire. His replacement was highly intelligent, educated and groomed in the same basic approach his predecessor had used to beat the market year after year, and was this manager’s first choice as his successor. And yet in the first few years after the switch, the fund lagged its previous performance in glaringly obvious ways. The fact is, the new guy wasn’t the old guy, and so thinking their approach was going to be the same—and that the fund would just keep chugging along the same way it had—wasn’t actually very realistic. Through it all, the instructions I kept getting from management was to rely on the fund’s average historical numbers, which tended to obscure the more recent data (with the new manager) because the older performance (from the old manager) had been so strong. This was one of the first ways I learned to distrust funds that trumpeted their historical returns for everybody to hear.

Where does that leave individual investors? As you’re trying to make investment decisions that will provide for current or future needs, what are you supposed to hang your hat on? Marketing material out there tends to work with the most impressive numbers they can come up with, because nobody is going to pay attention to an ad promising conservative results. We are all cursed by the the consumption-based society we live in; we want maximum benefit/pleasure/entertainment value with minimum work/effort/money spent. It makes it easy to pay attention to the shiniest, newest, and best-looking thing out there, and hard to care about anything that is dressed up in any other way.

Several years ago, I had a good friend who was achieving some really spectacular investing results as a day trader. He had begun trading futures, which were highly leveraged contracts on commodities like gold, oil, and even on the broad stock market indices. He was doing so well in just a few months of time that he had paid off the mortgage on his house, his college student loans, and every other debt he had, and was living almost entirely off of his trading income. Naturally, I was impressed and asked him to show me what he was doing. His approach seemed simple enough, and so I decided to give it a try. I thought I had everything to gain and little to lose, especially since I started my trading with just a few thousand dollars that wouldn’t have gotten me into trouble to lose.

For about the first six weeks, I did okay; I almost doubled my account value by applying a similar method that my friend showed me with some rules that I customized for my own purposes. I was having a lot of fun, telling people I was a day trader and bragging about how astute I was. After that sixth week, though, the market shifted, and I didn’t shift with it. The thing about futures trading is that the leverage that pays you so well when you’re right takes it away from you even more quickly when you’re wrong. I saw my profits evaporate within days, and didn’t have the sense to stop what I was doing to figure what I needed to change. I was so upset about how things had turned against me that I was convinced I just needed to keep trying. I watched my account drop all the way to $0, and then put in a few thousand dollars more and tried again. Within weeks, all of the money I could put towards futures trading was gone. All I had to show for it were a lot of lumps, a big slice of humble pie and a very hard lesson learned.

As time passed and I was able to think more rationally about my experience and my failure, I realized that one of the problems was that I went into futures trading with guns blazing; I relied on the experience and knowledge I had built by investing in stocks and trading options to make my futures trading decisions. I didn’t take the time to really study and learn about the futures market first. It’s true that futures form trends just as stocks do, but it’s also true that futures behave in ways that are very different from anything I was used to at that time. My ignorance about that reality kept me from recognizing trouble when it was in front of me.

I also learned an important lesson about expectations. I assumed that because my friend had achieved such fantastic results, I could too. I’m not saying that setting ambitious goals is a bad thing – but when you base your expectations of your own success or failure on what somebody else has done, you’ll usually end up disappointing yourself. I was so determined to prove to myself that I was just as good as my friend that it blinded me to the need to apply what I was seeing in the market properly for my own trading system. I stopped thinking about the fact that we were different people, with different perspectives, experiences, and investing styles. My expectations became completely unrealistic because I was trying to be like my friend instead of just being myself.

In the years since that experience, I’ve stayed away from the futures market. I’ve decided that part of what makes me successful as an investor is to work with investments that make it easy for me to stay grounded – not only to what I know works, but also to what I know I can manage effectively and rationally for my own purposes. I’ve realized that I don’t have to trade the coolest, sexiest markets to get what I need out of my investments. My expectations are simpler, and because of that, the system I use is more effective and easier to manage.

The purpose of Rebel Income is to highlight income-generating trades each week that you can use to provide for your own needs; so what does everything I’ve just said about my expectations mean to you? My system is based on my own study and experience of what a fundamentally strong stock with a great value proposition is. I’ve worked hard to ground that system in principles and concepts that have been proven by time and by the wisdom of other investors. Even so, I don’t believe you should take the things I write about in this Rebel Income on blind faith. That’s why we’ve provided a lot of educational resources for you, in the form of the Homestudy Kit (my e-book and training video library) and the videos available in the Getting Started area of the site to Rebel Income subscribers. It’s also why when I write about subjects like position sizing and diversification, or trading based on overnight information, I tell you about what I do. I don’t necessarily want you to do the same thing, but if you know how I approach those concepts, you can decide for yourself if my logic makes sense or whether you need to apply a different method that works better in your case.

Setting expectations isn’t really about how much money you can make with a given investment or system, even though that’s naturally the way we all tend to think about it. Setting expectations  is really about thinking about a given investment or system in the most practical terms you can, against what your own investing style, risk tolerance, and needs look like. In my case, I decided that the futures market didn’t offer the right fit for my investing style or my needs. That doesn’t mean it’s a bad investment, or even that I might not use it at some point in the future, only that I decided it would be easier for me to not spend more time, energy or money on trying to make it fit when I already had a system in place that did. If you work with the Rebel Income system, make sure that you’re evaluating it based on how easily it fits, or can be adjusted to fit into your own preferences and needs. That’s really the only way you’ll be able to get what you want from any system or investment in the long run.

Through his own market experience, Thomas has gained a unique perspective on investing expectations, and has most certainly carved out a niche selling put options to generate income.

Quite frankly his track record is unheard of in the financial publishing business. He’s closed exactly 101 trades, of which 98 have been winners with only 3 small losers.

To become a tortoise and finish the race, we’ve arranged for you to follow Thomas’ put selling income picks for the next 30 days for only $9, with no obligation to continue, and get two incredible bonus items free, click here.

Regards,

Shane Rawlings
Co-founder, Investiv 

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31
Jul

Sunday Edition: Put Selling as a Conservative Investing Strategy

By - Investiv Daily, Options, Sunday Edition

We recently decided to add a Sunday Edition of Investiv Daily to mix it up a bit. We hope you are enjoying the daily content provided by Sven Carlin, one of the sharpest analysts and investors we know.

In the Sunday Edition we plan to publish content which is more educational in nature and can help you become a much better investor.

These first few issues will focus on what we believe is one of the safest and most profitable investing strategies that exists.

Over the last two years this strategy has averaged nearly 30% per year, compared to only 3.3% for the S&P 500.  

The content we will be sharing over the next few weeks is written by Thomas Moore, Chief Editor of Rebel Income, and has been pulled directly from his weekly posts to his paid subscribers.

Thomas’ investment advice doesn’t come cheap (a 1 year subscription is $1,164). At the end of his article we’ve arranged a special offer for you to follow his exact income trades for the next 30 days.

Whatever you do, make sure you read these new Sunday posts. These next few will give you insight and understanding about the most important income strategy for retirees and soon-to-be retirees and can’t be found anywhere else.

Here’s Thomas:

Put Selling as a Conservative Investing Strategy

If you’re new to income-based options trading, you’re probably still trying to get used to placing trades on a “Sell to Open” basis. The thing about covered calls is that they are very simple – buy the stock, then sell an out-of-the-money call on the same stock. Put selling, admittedly, is a different animal. If you haven’t spent a lot of time with put selling, you might struggle a little bit to understand the reasons and risks associated with put selling.

Because put selling requires a higher level of authorization and (outside of an IRA account) setting up a margin account with your broker if you want to sell naked puts, it is almost automatically assumed that put selling is a risky strategy. You may have even heard your broker tell you that put selling was a “very aggressive” investing strategy. That is a true statement – but only if you are selling puts naked and not following my approach.

The Truth According to Your Broker

Here’s why brokers and investment advisors want everybody to believe put selling is risky. Suppose you sell a put on a $50 stock with a $50 strike price. By the time expiration day comes, the stock has dropped all the way to $35. You will be assigned the stock at this point, and you will buy the stock at $50 per share, because the strike price is the price you are contractually obligated to complete the trade at. Right out of the gate, you’re down $15 per share or 30%, not counting the premium you brought in when you opened the trade. This is where brokers and investment advisors stop for a dramatic pause to let you react emotionally to the idea of such a big drop; and then they follow up with something like, “nobody wants to have to take that kind of loss.”

I won’t pretend that the very dramatic picture I’ve just painted doesn’t happen, because it absolutely does. I am sitting on stock positions today that fit this description almost to a T. The truth, fortunately for anybody who really pays attention and understands the opportunity a put sale actually gives you, goes much further than otherwise well-meaning but ignorant advisors and brokers tell you about. The picture is much bigger than the limited view I’ve given to this point, and the fact is a lot of investors are either too ignorant or are unwilling to exercise the patience and diligence a successful implementation of put selling requires.

Let’s expand the view of this trade a little more. Suppose now that before you placed the trade, you noticed that the company had built a solid reservoir of cash reflected by its Free Cash Flow, that earnings had been increasing on a consistent basis along with revenues, and that what debt the business carried was clearly contained by a low Debt to Equity ratio. Additionally, the stock paid an annual dividend of 2%. When you analyzed the stock’s price chart, let’s further suppose you noticed that although the stock was trading at or near historical lows, it had established a solid pattern of support along pivot low points. Because the stock is at historical lows, you also notice that it’s Price to Earnings ratio is quite a bit lower than the average for its industry. Given the fundamental strength of the stock’s business, the likelihood that the stock’s poor price performance is being primarily driven by simple buying and selling dynamics in the market in general rather than on any real problems with the stock itself is pretty high.

Since every stock experiences cycles between highs and lows, the truth is that a fundamentally strong company with a stock price at historical lows should be viewed as a solid opportunity in the long-term. This additional information I’ve just given you is the kind of picture some of the most successful investors in the history of the market, like Warren Buffet, Benjamin Graham and a host of others, have looked for as they built their own fortunes. It’s an approach that you might recognize by its popular name – value investing.

Understanding the Real Truth of Put Selling

I refer to put selling as a conservative way to generate income because when I combine the techniques of put selling with the discipline and patience of value investing, I get a way to generate income while at the same time managing risk in a practical, long-term way. Since the stock is already at historical lows, the odds of seeing the stock go up are higher than for a stock that is already running at historical highs from a long-term upward trend. That means that when I sell a put, there is a good chance the stock will stay above the strike price of my put option at expiration, so the option expires worthless and I can move on to the next trade. It might be another put sell on the same stock, or I might find a new one to work with. An expired put sale is a great result in my book. I try to maximize that possibility even more by selling put options that are at least two, three or sometimes even four strike prices out-of-the-money.

Another truth is that just because a stock is at historical lows and may be consolidating a pivot support, it isn’t a given the stock will go up. There is, frankly, an equal chance the stock will drop below the strike price I’ve sold. That is why I will sometimes state in these articles that the strike price I choose for a put sale is a price I’m willing to buy the stock at. I sell the put with the clear understanding I might be forced to buy the stock at that strike price, and if I’m not okay with that idea, I won’t sell the put at all.

Since I’m screening the stocks I use for these trades based on their fundamental strength and looking for a clear value-based advantage, the put sale gives me a gateway to the second part of my income generation system, which is selling covered calls. If I like the stock and don’t mind owning it at the strike price I sold, why not use my ownership to generate some more income from the stock while I can? Selling out-of-the-money call options let’s me keep generating income while simultaneously letting me lower my cost basis and set up a net profitable scenario if the stock closes above my call’s strike price at expiration.

Seeing the stock drop even several dollars below my assignment price doesn’t scare me away from the trade, primarily because of the fundamental strength my analysis is designed to screen for. In the case of these extreme trades, it usually just means that I need to exercise a little more patience and be very cautious about selling calls against the stock. If the stock appears to be consolidating or building some bullish momentum, I’ll usually just hold onto the stock until it starts to get back into the general price area I was assigned at. If I see a clear downward trend, I’ll look for opportunities to sell out-of-the-money call options that are usually further out-of-the-money than normal to sell to keep lowering my cost basis on and which are within just a couple of weeks or less to expiration. A few stocks in the past year I’ve done this with include Pandora Media (P), Abercrombie & Fitch (ANF), U.S. Silica Holdings (SLCA) and Schlumberger Ltd. (SLB).

To be clear, this last part of my system—dealing with stocks that have dropped significantly below my put option’s strike price—is what requires the most discipline and patience. It requires diligence in paying attention to the company’s fundamental news and earnings information and being willing to act if I see a serious degradation in the strength I identified at the beginning of the trade. Fortunately, it just isn’t that common to see a well-run and effectively managed company suddenly stop being well-run and managed, which is why in the last year I’ve only had to unwind one position out of the several dozen I’ve held. The discipline and patience I’m talking about, however, isn’t something that everybody can exercise. I’ve heard from traders who have subscribed to my Rebel Income blog but who didn’t want to deal with put selling on these kinds of terms. While I find that unfortunate, I recognize and readily admit that if you’re just looking for a quick buck or a way to get in and out in a hurry, my system isn’t for you.

If you’re new to put selling, I hope this explanation gives you some encouragement to stick with it; it’s what I’ve seen the best success at in more than two decades of experience in the stock market.

As you can see, put selling is actually safer than just buying stocks outright. Especially when combined with a deep value approach to stock selection, technically oversold stocks, and strong support levels. 

Over the last two years Thomas has closed exactly 101 trades, of which 98 have been winners with only 3 small losers. Quite frankly his track record is unheard of in the financial publishing business.  

To follow Thomas’ put selling income picks for the next 30 days for only $9, with no obligation to continue, and get two incredible bonus items free, click here. 

Regards,

Shane Rawlings
Co-founder, Investiv