How NOT to Trade Income Method #1

The Blueprint, details a complete trading methodology where a unique form of a Married Put trade acts as a platform to generate income. This protective strategy greatly reduces an investors at risk amount, while still giving them the ability to have unlimited upside profit potential.

But, that is not the whole story. The Blueprint also details NINE different Income Methods that can pay for the initial at risk amount, bulletproof the position and add extra income.

One of these NINE methods, Income Method #1, is given away in a free white paper, The Sketch, and in free online webinars that are available during the week and archived as well. Income Method #1 is where an investor will sell a call option against the initial Married Put effectively turning the trade into a Collar spread.

However, there is a correct way and an incorrect way to apply Income Method #1 to this unique form of a Married Put trade, which we call a RadioActive Profit Machine (RPM). Many experienced options investors that have purchased The Blueprint or attended one of the free webinars tend to wonder why we wait to apply Income Method #1 to an RPM instead of selling an At-the-Money call as soon as the RPM is opened to generate the most income.

The answer is: “That is a recipe for potential disaster”. If the rules for Income Method #1 are not applied correctly the investor risks turning the trade into a guaranteed loss. In addition to that, if the rules are not applied correctly the investor will turn a Neutral to Bullish sentiment trade into a Bearish position. If we thought the stock was Bullish when we first entered the trade, why would we want to change the position where we need a Bearish move to make a profit?

The first rule of the Income Methods is that we do not talk about the first rule of the Income Methods…unless you are reviewing The Sketch, attending one of the free webinars or in The Blueprint.

Let’s take a look at the IMPROPER way to apply Income Method #1:

On December 26th, 2008, I entered an RPM on Kraft (KFT):
Bought to Open 100 shares of KFT @ $26.29
Bought to Open 1 June 30, 2009 Put @ $ 4.80
Total Per Share Investment $31.09
Guaranteed Per Share Return $30.00
Total Per Share At Risk Amount $ 1.09
Total Percentage At Risk Amount 3.5%

If Kraft (KFT) suddenly dropped in price due to any unforeseen event, I was never at risk for more than 3.5% of my initial investment amount. Between December 26th and June expiration I have the opportunity to take advantage of unlimited upside potential if the stock rises, or make adjustments using the NINE Income Methods to pay for the minimal $1.09 I have at risk.
Three days later, KFT had moved up in price and was trading at $27.00 or so. Instead of being patient and waiting to apply the rules correctly, I jumped at the chance to sell the FEB 27.5 call for $0.95.

On December 29th, 2008, Apply Income Method #1(incorrectly) on the Kraft (KFT) RPM:
Sell to Open 1 FEB 27.5, 2009 Call @ $0.95
Original Per Share At Risk Amount $1.09
New At Risk Amount (if call expires) $0.14

If everything worked out to my benefit Kraft (KFT) would remain below $27.50 per share through February expiration. My call would expire worthless and I would still have over 5 months to adjust the position and pay for the remaining $0.14 at risk. But, I had succeeded in changing a Neutral to Bullish position into a Bearish position…

I was not trading time, I was timing my trades…a relative sin for a RadioActive Trader! So, what happened? Over the next two weeks I watched as Kraft moved up almost $0.40 per day.

“Surely Kraft won’t break $27.50,” I thought. Kraft did.

“Surely Kraft won’t go above $28.00,” I pondered. Kraft did.

“Surely Kraft won’t go above $29.00 per share,” I hoped. Kraft did.

My Bullish position had gone Bullish, but I had acted too soon and was in a Bearish position. I did not follow the rules of Income Method #1, and now I was in a losing situation. If I moved to buy back the short call option I would add extra risk to my position. If I liquidated the Collar spread I would lock in a significant loss. All because I was greedy and took a great RPM position and turned it into a Bearish trade by selling a call below the protective put strike price.

Let me tell you how embarrassed I was when Kraft was trading at $29.60 per share on January 28th, 2009, and the FEB 30 call could have been sold for $1.10. This would have completely bulletproofed the position and adhered to the rules for applying Income Method #1. Instead, I was holding a position that if liquidated would have had a loss of 2.8%, or added to my risk if I Bought to Close the Call.

Where do we stand now? I decided to hold the call and planned to buy it back closer to expiration, even though the call was now deep In-the-Money and I was risking early assignment. Well, knock on wood, after an earnings announcement and unfavorable projections moving forward into 2009, KFT has now dropped below $25.00 per share. It looks as though my IMPROPER application of Income Method #1 will work out and after February expiration I will only have $0.14 at risk, still having 4 months of protection in place…

But, if I had been assigned early on my short call I would have locked in a loss on a potentially profitable trade. If I had been patient and applied Kurt’s rules correctly, I would have been bulletproof at this point, having sold the FEB 30 call for $1.10 when Kraft hit its peak…when Kraft had reached its Bullish potential as I had expected when I entered the trade. I got lucky. I went against the rules and came out smelling like a rose when I very easily could have been cursing the sky for my impatience. Learn from my mistakes…be patient, and follow the rules in The Blueprint when applying the Income Methods.