So, I know I ruffled a few feathers with that last title… so I decided to use it again!
😉
In the last post I showed how long call traders and market makers depend on the willingness of covered call sellers to take less when they win, and give up more when they lose.
No wonder covered call selling is the first thing most folks get exposed to in the world of options trading… for people in the know, it’s good to have more patsies at the table!
But you’re probably getting a little hot under the collar about options strategies you’ve been sold right now (No pun intended), so I’m going to illustrate another example that will make you take a second, very HARD look at covered calls and their kissing cousins.. naked puts.
Perhaps I’ll convince you that other alternatives deserve a second look as well. Shall we?
IN the last post there were three traders: the long call buyer, the covered call seller, and the market maker. All three were bullish on a stock and all three won some, lost some. But the covered call seller was the only one with a net loss.
THIS time I’ll show everyone getting a net loss… except for the guy that (wisely) buys INSURANCE when he picks up stock.
So our heroes are bulls. Auspicious Al needs no hedge; he knows how to time the market after all. Bullish Bob like to sell puts… the “parity” trade of a covered call. Which brings us to Conservative Calvin, who can’t bring himself to buy a stock without also picking up a put option to protect himself.
Here’s how these guys’ trades pan out:
Auspicious Al grabs 100 shares of XYZ at $100 a share. That’s $10,000 invested.
Bullish Bob sells the $100 put for $5. He takes in $500 but need to keep $10000 on hand to buy the stock in case he’s assigned: total of $9500 tied up.
Conservative Calvin picks up stock like Al, but also buys insurance: $100 per share PLUS $5 per share to protect himself. His is the highest invested amount: $10,500.
The stock goes up 20%!! Everyone makes money:
Al keeps $2000, when he sells. Based on the $10000 he put up, that’s 20%.
Bob received $500, but it was on a smaller outlay of $9500. Chalk up Bob for 5.26%.
Conservative Calvin gets a stock worth $120, and a put worth nothing. He makes a net 15%, not as impressive as Al of course… but more for the money than the guy that sold him the put!
Next play: say everything was the same… same time frame, outlook, etc. Only this time, something goes wrong. The stock is down 20%!
Assuming that Al does not reinvest his winnings and only uses $10000 of his 12,000 capital… he loses $2000. Back to square one.
(I should pause here and point out that if Al DID reinvest his winnings in 120 shares of a $100 stock that went down 20%… he would be in the hole, NOT back to square one)
Bullish Bob will have to pony up $100 bucks a share… $10,000 total… to pick up a stock that’s now worth $80. He will have received a little premium to do so, $500 from selling the put. That’s $9500 out for an asset now worth $8000. So his loss is not 20%, but 15.78%. Bob does better than Al this way, losing a lower dollar amount AND a lower percentage.
Too bad that Bob is now looking at a net loss though… 🙁 His $500 gain wasn’t enough to offset the $1500 loss so he could break even like Al.
Conservative Calvin, on the other hand, cashes in his put to sell the stock at $100 per share… he paid $105 per share for both the stock and the put, so he loses $5… or 5%.
Calvin makes $1500, then loses $500, for a $1,000 gain. In the SAME market that the other guys couldn’t make work for them. Hmmm…
Hey guys… see the point I’m looking to make? All six of these plays (one winning and one losing play for each trader) were bullish. All three made money on the way up, and all three lost money on the way down.
But in the end, only one trader ended up smelling like a rose: Conservative Calvin with a net gain, even when his win rate was only 50%.
Traders, think about it: we buy insurance for everything else, don’t we?
We buy insurance for our car.
We buy insurance for our house.
Insurance for our health… and if we have family, we buy insurance for our very LIFE.
But when it comes to the stock market we like to play it fast and loose.
Wow. Would you drive without insurance? Woudja own a home… yours, or an “income” rental property… without insurance? Of course not!
But when it comes to trading, everyone thinks they know the future. Their house couldn’t POSSIBLY burn down. You would NEVER get in a wreck…
Hmm. Or does it maybe make sense to take a second, very good look at what “hedging” is really supposed to do? IN the above example, the traders made money in good markets and lost it in bad. But the married put guy is the only one that KEPT enough of his winnings to matter.
When will this bull market end? I don’t know. More importantly, neither do YOU 😉 But one thing’s for certain: again, as before, I will be vindicated.
The “Champion of Married Puts” urges YOU to learn to hedge in your favor, NOT against. Who was clearly the patsy in the above game? Why, it was the Bullish Bob, the seller of puts. I was even generous enough to give him the spread… instead of selling for $4.90 I gave him the whole $5.00 that Conservative Calvin paid.
Okay Traders! You get the point. Again, the married put strategy is the best way to insulate your stock against losses. In the next post I’ll talk about how to use near-term plays to reduce your cost basis and BULLETPROOF a stock… but that’s for another day.
Didja “like” this post? LOVE it? Or am I your new favorite person to hate? Either way, sound off below. There’s only room for ten comments.
Happy Trading,
Kurt Frankenberg aka “The Champion of Married Puts”
I'm Kurt Frankenberg, and I have discovered how to truly put the odds on the side on the individual investor.
Loved the blog post Kurt.
Appreciate the irony: I was a little leary of “Radioactive Trading” as it sounded dangerous and I needed help after just making a stupid rookie options error. But I read on and Radioactive trading is all about how about making your money while being conservative with it! Makes you smile, lots of other options training advise some crazy risky strategies. Thanks for helping.
Lyle
Another really great email. Each email makes me think & ponder the different scenarios and their outcomes.
I appreciate the way, you get people interested in RadioActive Trading.
Phil
Thanks Phil. You ain’t seen nothin yet! I’ll be talking about expectancy, probablility, and the “Martingale” in the next post. I think you’ll really dig that one.
HT,
K
Martingales, expectancy, probability…read any of Nassim Taleb’s work? I think you would like it.
I’ll check it out! My fave author lately is Van Tharp. Thanks for the recommendation 🙂
Happy Trading,
Kurt
HAW! I guess “RadioActive” DOES sound a bit dangerous, what with nuclear meltdowns and other things associated with radioactivity. You’re welcome, Lyle. If you have my book, The Blueprint (which I believe you do) you’ll see that “RadioActive” refers to the one sure thing in the options market: that any options’ time value go down to zero in an exponential curve that resembles the half-life decay of a radioactive element.
We “bet” on this sure thing by buying puts far out in time (they have a LOWER per-month cost basis) and selling near term plays (they decay quickly, assuring us of an edge when we offset the expense of those puts).
Well ‘put’ my friend: RadioActive Trading is all about making money while being conservative with it. Thanks for the kudos.
HT,
K
To be sure, married put positions are much more conservative than long stock alone or naked puts, therefore the return is necessarily lower than that of long stock. Along with that of course, so is your risk. But the investor considering this type of position management should match it to their overall risk profile.
If they don’t mind losing every penny of their investment in the hopes of greater gains, especially if they’re short-term traders, then they should avoid a conservative system such as this. *I* however can’t think of a situation where it’s okay to lose every penny of your investment – risk 100% to make 3-5% is just crazy to me …
Yes, Carlos… but guess what? BOATLOADS of college-educated, middle or upper class folks get snookered into thinking that the 3-5% is a good return for what they risk. Why? Because the idea of getting “Income” for owning stock is downright SEXY… while buying insurance is not. However, at the end of the day the limited risk, UNlimited potential of trades that cut losers short and allow winners to run… take the cake.
Thanks for your post Carlos!
HT,
K
Great Post. Great point about insurance. I have never seen the parallel drawn so well about how we insure everything else but with investments in the market people treat them like they are a crapshoot and failto buy insurance.
Heh… “WOuld you like to buy the extended service plan with that computer?” Yup, insurance is offered to us in so many ways, and yet when it comes to something that REALLY could use protecting… some folks would rather shut their eyes, blow on the dice, and make a wish. Glad you enjoyed it, John!
HT,
K
Risking 100% (Actually 100% minus the call premium) is exactly what one does when playing with covered calls, with the only bright side being that the investor takes less of a beating if he/she doesn’t use margin. An overnight price gap to the downside is all that it takes to lose 100% (or more!) on margin and there is no protection from a stop order when this happens. And naked put writing is just as horrendous; or horrific?, IMHO.
On the other hand, an RPM married put position is a combination of two investments; long stock and a far month in-the-money put option. From my experience, it is possible to manipulate both the stock and the put option as separate, individual – yet complementary investments that can pull profits out of bull, bear, and sideways stock price conditions.
It is that which makes possible to earn 100% returns with only 3 to 5 % at risk…
Y’know? I’ve actually seen 30%, 40% or better returns with a married put… but I usually don’t pump those kinds of numbers because they ARE unusual and not something you can count on. However, it’s not the double digit return in two or three months that’s impressive; rather, it’s keeping the risk down in the low single digits and STILL getting plays like that every now and again.
James, thanks for your observation about covered calls. One fella that told me he told his broker “I don’t play naked stock” referring to stock ownership WITHOUT insurance. The broker said, “Well technically it’s not naked.” “Oh, yeah? What’s the most I could lose?” “Welll… I guess that would be 100 percent.” Hmm… “How is that NOT ‘naked’ ?”
Thanks for posting James. Looking forward to hearing some of your braggin’.
HT,
K
You seem to get the attention of a lot of newbies who swoon over your set-ups , but you don’t really give equal time to a much less expensive set-up called the diagonal trade.
If you buy the long call (as a stock substitute) and sell a short call (akin to a covered position), you have a much better risk-reward set-up and profit potential than you would ever have with doing the combinations you speak of.
But of course you will never post this for fear of being made to look wrong.
MM
I’d personally hate for the value of the long call to drop to less than the cost of the spread’s debit or even worse to drop to zero and wipe me out, but that’s just me
Perhaps doing it as a ratio call spread would be better, tho the margin requirement for the 2nd call and potentially converting a capped gain on the upside into a loss don’t quite do it for me either *shrugs
A diagonal calendar spread does require less capital, but there are many other differences between an RPM setup and a diagonal call spread:
1. A diagonal spread caps the potential gain on the position. There is no unlimited upside potential.
2. Substituting a Long Call, or using this leveraged spread, falls prey to the LIE of Leverage. You are still risking close to 80-90% of your investment if the stock falls in price. It uses less capital, but if you have $5,000 to invest in an RPM you would only be risking 5-6% of your invested capital. If you enter into 20-30 contracts of a diagonal spread and invest the $5,000, you are risking the entire $5,000.
3. If you look at a profit and loss chart of a Diagonal Spread vs. an RPM with an Income Method #1 adjustment, you will see a similar risk-reward profile. However, if Income Method #1 was applied to an RPM it would have been done so after the fact…meaning the stock would have moved up in price first so you could sell a higher strike and reduce most of the initial at risk amount. The Diagonal Spread typically opens both legs at the same time, thus limiting upside potential.
4. About 3 or 4 years ago, Kurt had someone email him about a long call he had as part of a Diagonal Spread trade. I believe the stock was Boston Scientific – BSX. The investor had purchased LEAP options to use in a Diagonal strategy when the stock was at $20.00 per share. BSX was currently trading at around $8.00 per share, and the investor had lost over 80% of his value in the long call.
The customer wanted to know how he could use the RadioActive Trading techniques to ‘fix’ the 80% loss on the long call. Unfortunately, since the position was not set up correctly to limit the risk, the damage was already done and there was no way for the customer to repair the loss.
Marketmaker,
Now WHY would I miss an opportunity to rebut? 😉 I post anything whether it agrees with me or not; only inappropriate postings fail to make the cut.
There’s no threat to your assertion, of course I’ll print it. A diagonal trade does in fact use less capital. However, it does not:
1) allow winners to run and
2) force money management into single digit percents.
You COULD do something similar by buying a long call (or put), making a large enough deposit to actually buy the stock but instead put it into an interest bearing account. THEN many (not all) of the Income Method adjustments could be made against that option.
But why go to all that trouble? Makes sense just to buy the stock, secure it with a put, and do it all in a tax-sheltered entity.
Nothing special in the diagonal spread, MM! Sorry…
Happy Trading,
Kurt
In dec 2007 I bought stock of Citigroup for $33 because “it can not go lower than this”. However few months before that I read about RadioActive method and just in case I bought protective leap put to insure my positions. For the next 2 years while everybody else around me were telling horror stories of loosing 40%, 60% 80% of their investment I was collecting dividends from C and when my position was automatically executed in Jan 2010 I made money on the stock that was ~$4 at that time. Instead of loosing 85% of my investment I made money. Thank you Kurt.
Woo Hooo! GOOD for you, Alexander. For every naysaying critic of the RadioActive method there are a dozen real live people that have actually had it “Save their Bacon.” I appreciate the affirmation, it’s why I wrote The SKetch and The Blueprint in the first place.
Keep up the…
Happy Trading!
Kurt
I have been trading stocks and options for over 15 years. However, what has really made a difference to my bottom line is the fact that Kurt’s RT methodology is a Money Management System; vice a simple Buy/Hold/Sell trading system.
In the absence of sound money management principles and adherence to a sound money management system, the market will eat any investor/trader alive either little-by-little or all at once.
That’s right 😎 The biggest imperception about RadioActive Trading is that it’s a trading system when in fact it’s a money management system.
James, I’m happy to hear that these ideas have helped you, a veteran trader. You’re right that the market will swallow whole all that ignore the basic principle: address RISK first. The rest will almost take care of itself.
Happy Trading,
Kurt
what about the idea that if you sell naked puts on stocks you would like to own anyway then you win if the option expires worthless & collect and keep the premium and also win if you are put the stock as it is a stock you would like to own and you are getting it at a discount to it’s current price.Recommended for stocks like INTC,MSFT which trade in a narrow range and are are considered blue chip
Thanks for asking Allan!
Well, the problem is that if you’re bullish on the stock, there is only a certain (small) amount that you can profit. It’s limited. Owning the stock, on the other hand… if you’re bullish anyway… yields unlimited upside potential.
By selling a put, you obligate yourself to purchase the stock even if it tanks. This may not even be the fault of the stock itself; AAPL grew BIG time during 2007-2009 but its stock price sure as hell didn’t 😉 By buying a put option to go along with your stock you establish a floor, a LIMIT to your risk. But you have no limit as to your upside. This is the most desirable situation to be in if you are indeed bullish.
Selling puts gives you a great deal of downside risk, but only a tiny amount of the upside potential. That’s why it’s less desirable. Compare the charts of a short put and a married put… if it were any other investment, say real estate or art… would you agree to that much risk if you are wrong versus a limited gain in case you turned out to be right? Or wouldja rather hedge your bet in case you were wrong, but leave the upside wide open? It’s a simple question with an obvious answer, yet many pundits have us talked into believing short puts are the way to go.
Happy Trading,
Kurt
I would go further than that James. You don’t manage money as much as you manage risk. Never strive to be a good stock picker. Strive to manage risk efficiently. That’s the real key to making money with this system.
Thanks to you too, Vinny! I’d even go a FURTHER step: managing risk is the key to making money with ANY trading strategy or system, not just RT.
Happy Trading,
Kurt
One thing I’m noticing in a BRCM postion that I have a married put on is the stock is down 3 dollars but my put prices so I never exceed more than what my max loss on the trade (total cost – put value) is. The stock is down from around 39 to 33 and the put I have is at 40. I like the company and would like to see this thing rocket down thinking that I’ll sell high and rebuy lower. I don’t see how I’ll make money on this thing as long as my put prices to the stock in such a way that I’ll never make money like the guy who said he did with citicorp. I’ll just be stuck with my max loss. What am I missing
ChuckO, , these questions should be submitted to support@radioactivetrading.com and have full information: date, strike and expiries sold and bought, net credit, etc. I’d be happy to put a second set of eyes on your position but need complete infromation. Thanks!
HT,
K