Greetings again Traders!
So, tomorrow (April 27, 2011) is earnings for both EBAY… which I posted last week… and for ABX, which I am puttin’ forth for you right now.
REAL QUICK… disclaimer time again. Now, I have to point out yet another time that any stock I use to illustrate the RadioActive Trading style of risk management… I am NOT ‘recommending’. I am merely DEMONSTRATING exactly HOW I am (or in this case, would be) setting up the trade such that it keeps me out of trouble if I am wrong, but can take advantage of an upside move if I am right.
Got it? Ah good. Also, past performance does not guarantee future results. That said, here is a play that I just ‘put’ together:
| ABX | Barrick Gold Corp. | Buy to Open | 400 | @ | $50.10 |
| ABX 2011 OCT 55.00 PUT | Buy to Open | 4 | @ | $7.45 |
| Bought shares of ABX | $50.10 | |
| BTO Oct 2011 55 Put | +$7.45 | |
| Total Investment | $57.55 | |
| Guaranteed Return | -$55.00 | |
| Total amount AT RISK | $2.55 | or 4.4% |
SO why did I show getting into 400 shares instead of 4000, or just 100? Well, this is the deal: I like to keep my AT RISK amount in any one RadioActive Trade down to just 5% or so of the capital involved. But to add a further layer of protection… plus to increase the likelihood that I will uncover a winner…
…I will only place about 1% of my total capital AT RISK. In the example above, each share of stock is protected so that it will only risk $2.55 per share. Say I have $100K of capital… I can get in to 400 protected shares… that’s 400 shares ABX plus 4 October $55 put options… and have a total dollar amount of $1,020 AT RISK.
That $1,020 is almost exactly 1% of the $100K capital I have on hand… leaving a lot more that I could ‘put’ (sorry, RadioActive Trading pun intended) into other married put plays.
Result? Well, If one wants to diversify… not only to spread out risk but also to increase the chances that one of the picks will be a runaway winner… The above setup will allow for that and keep risk in each individual trade down to 1% in case you are wrong.
SO! ABX has earnings tomorrow and so does EBAY. My earlier post with EBAY shows a similar risk-reduction setup. There are four possible situations tomorrow:
ABX up, EBAY up. Smile for that one 😉
ABX up, EBAY down. Winnings from one might very well outpace losses from the other.
ABX down, EBAY up. OR..! The losses from one might cut into the wins from the other.
Finally! ABX down, EBAY down. Well, can’t win ’em all can we? HOWEVER..! With this setup we can’t lose very much either, only a MAXIMUM of 2% of total portfolio… which means we would still have 98% of out marbles to put in another game. See how this risk management thing works?
Well Traders… I can’t wait to see what exactly will happen next. I really don’t know how it will turn out. I DO know however, that either way the RadioActive Trading method will be shown to be a champ, win or lose. Either way, no sleepless nights due to pre-earnings jitters.
Hey Traders… do you “like” this post? Be sure and click it thataway. Also, leave your comments and questions. Thanks!
Happy Trading,
Kurt
I'm Kurt Frankenberg, and I have discovered how to truly put the odds on the side on the individual investor.
Kurt, Can you do the above trade using LEAP Call options instead of purchasing the stock outright?
No, Phil. I know your goal: to increase returns by increasing leverage. RadioActive Trading is based on three core principles:
FIST (Force Ideal Sized Trades);
ATM Bell Curve (the phenomenon that an option’s time value is greatest AT the money and cheapest IN or OUT of the money)
REDLine ( the inescapable truth that time value goes to zero…EVERY time… at expiry)
The last two principles work together to assure you the best prices when you buy or sell, and also to construct some very interesting adjustments.
The FIRST principle prevents you from taking too large (or too small) of a position and is arguably the MOST IMPORTANT of the three. That’s why it’s first.
This principle is defeated when you use leverage at the wrong time. It’s not that you can never use leverage, it’s that you shouldn’t to begin a trade.
Say that you did buy a LEAP in place of stock… would you be putting up less capital? YES, but that would mean that you pay for the time value in the LEAP call as well as in the put. I don’t like to pay twice. ESPECIALLY when the Redline is now working against me on both legs of the position!
Furthermore, you would also be putting up less capital than you SHOULD… say you leveraged yourself five to one. Instead of a little bitty 5% loss you would suffer a 25% loss of the capital in a losing trade. Now, a lot of folks don’t realize that to get back to square one, now one must make 33.33% on the next trade.
That’s right; a 25% loss means you need to take the remaining capital, make a 33% win on it, and then you would only be where you started. A second loss would put you in a very dismal place indeed.
OTOH, take a 5% loss and you only need to make 5.26% with the remaining capital to be back where you started. That’s a lot easier to see than a 33% gain, isn’t it? 😉 Two losses in a row can even be weathered by some folks 🙂 because it will actually be a net loss of LESS than 10%.
RadioActive Trading uses an “antimartingale” mathematical setup, one that isn’t based on you having a good trading record… but rather one based on cutting losers short and letting winners run.
Sorry for the long-winded reply but this in veryveryveryvery important to learn: get AWAY from the use of leverage at the wrong time. Now, you may take a bulletproofed trade… one that has been worked to the point that it GUARANTEES a modest return and COULD end up bringing in even more… and then convert it into a leveraged position after the move that bulletproofed it. This will accomplish your aim of using less capital and can be done one of several different ways.
Happy Trading,
Kurt
These are good plays – now if I only had the capital to perform them.
Submitted on 2011/04/27 at 8:16 am | In reply to JIm.
Jim, believe it or not I did my very first RadioActive play back in 2002 with only about $2500 in capital. I bought AMZN at $16.09 and a LEAP put option (yes you can buy LEAPs on the PUT side) and saw AMZN go to about $63 a share well within the term of that put.
Consider this: If, with AMZN at $16.09 I had followed my “guru’s” advice and sold a near term, $17.50 call… I would have felt like a CHUMP giving away all that upside.
So lesson is that you should cut your losers short and let your winners run… NOT the reverse, which is what the covered call strategy inevitably does; it sorts good winning stocks out of our account before their big moves and instead leaves you with the losers. Anyone that’s been doing covered calls for any length of time… through up and down markets… knows what I’m saying is true
The one thing that makes MOST folks lose in the market is not bad luck… it’s the math behind the mentality that one should leverage gains. Sooner or later margin in its many forms will take you down if you misuse it. Most folks trade with too little capital to have a winning experience, or if they do have a lot of capital they use too much of it shooting for the leveraged win.
Jim, I am well within the mark when I say that if you cannot “afford” to buy insurance for your stock, you have no business playing them. A saying that I hear all the time is “using options PRESERVES capital”. Nonsense. Using options incorrectly to leverage returns also leverages losses. If you mess around with long calls instead of stock in an effort to “preserve capital” you will almost certainly end up as part of the 80% that fund the 20% that win long term at this game.
Happy Trading!
Do you use portfolio margin? With married puts, this can enhance leverage a lot.
Frederic,
Yes and No.
Here’s the “No” part: I do not enter RPMs (RadioActive Profit Machines… my name for a married put that’s 5-22 months out in expiration with an ITM put) with margin.
Entering with margin defeats the purpose of keeping my risk to a very small percent (we’re talking single digits here) and keeping myself OUT of trouble.
Here’s the “Yes” part: once an RPM is “Bulletproof”… meaning that by using nested spread trades I have reduced the AT RISK amount to zero or less (yes, I have negative risk in several positions at a time… meaning that I have a guaranteed return but no possibility of losing), THEN I may borrow against my stock.
Say I got in to a stock at $45 a share and a $50, far-out-in-time put option. By doing spread trades on the stock that cannot lose, I take in enough income to reduce the cost basis of both the stock AND the put to less than $50. NOW, I can borrow against the stock… up to $50 per share under the new portfolio margin rules… and still have a married put position in place with unlimited upside potential but infinite leverage.
Pretty cool? I’ll say. I take the money off of the table. If the stock goes up, I win. If it goes down, so what? I am holding a put option that guarantees my right to sell 100 shares at $50 no matter what the stock is doing. I can laugh hysterically at a margin call because there is no problem meeting it, even if the stock goes to zero overnight.
On the other hand, should the stock go up it’s going up based on zero net capital invested (after bulletproofing) and therefore has infinite leverage. Infinity is what you get when you attempt to divide by zero. Any return, divided by how much I have AT RISK… which in this scenario has become zero… is an infinite percent return.
Thanks for asking. Can I use leverage? Yessir you betcha. But not before I have bulletproofed my stock.
There are option-only alternatives that one may use to convert a position to infinite leverage WITHOUT the use of margin, that one can use in an IRA. Since an IRA does not allow margin trading, these are desirable. To learn about them, pick up a copy of The Blueprint!
Happy Trading,
Kurt