The “Two-Step” Technique, Revisited…

I’ve heard a lot of things on both sides of the argument:

“Should you use margin in your stock trading account?”

Now, if you’ve been paying attention  to my posts at all, you know that I NEVER advocate the use of margin when getting IN to a married put position. That doesn’t mean, however, that there is no room with the RadioActive Trading techniques for applying leverage. Leverage is a tool that no trader should fail to understand and learn to use… correctly.

Besides my job as a trader, writer and creator of trading strategies… I also have made a career of instructing martial arts. Here’s a scenario that has happened at my studio more than once: say a 20 year old, 200 pound six foot athlete comes in my doors wanting to know whose butt to kick to get a black belt… my Students will point my way. Using my grandfatherly, 160 pound, 5’6″ frame I’ll be using LEVERAGE to teach the kid a lesson he will never forget.

Take that same kid six months later, however… once he has learned the same techniques and acquired the coolness of mind to apply them… I will think twice about tangling up with him the same way. After he has the same tools, well! Mercy knows that we’ll have to have an understanding about ‘playing nice’ before I’ll want to step on the mat with him again.

SO it is with leverage in the stock market; if you know what you are doing and choose the proper time to use it, leverage can increase your returns mightily. If you fail to use leverage correctly, however, think of the market as a trained athlete that outweighs you and is thirty years your junior. Ouch.

Leverage can be used AGAINST you as well. That’s why I talk about using margin AFTER one has bulletproofed a stock position.

HOWEVER..!

Once you have “Bulletproofed” your married put… that is, once you have used one or more of the RadioActive Trading Income Methods to reduce the combined cost basis of your stock AND your put option to LESS than the strike price of the put…

THEN margin can be used with no fear of danger from an immediate downturn. This is because your put option completely protects what you’re borrowing against: the current price of your stock. If the cost basis for both your stock and the put protecting it is LESS than the strike price of the put, then what’s stopping you from using margin to borrow against that stock and use it somewhere else that it’s needed?

Think of it…

WHAT do you get when you divide by zero? Well… you really CAN’T divide by zero.. but as your denominator APPROACHES zero then your quotient approaches infinity.

I know what you’re saying: “Wow, great math lesson, Kurt. What does that have to do with me?”

Well, say you have a need for short term cash. You also have capital tied up in a stock and put position that you have “Bulletproofed”. The stock is in a confirmed uptrend and looks to have no end in sight. You HATE to sell the position but you need cash quick in order to:

Get the cash discount for paying for your kid’s braces up front…

Handle an unexpected expense without putting it on a credit card…

Put a down payment on a great real estate deal…

… or any other of a number of things. You just need CASH and need it quick. But you don’t want to liquidate your married put position.

What to do?

Well, here’s the dealio: say your Bulletproofed position is:

XYZ stock at adjusted cost basis of   $45.00
XYZ January 2012 $50 put option at +$ 5.00
Total Net investment                         $50.00
Exit price guaranteed by put             -$50.00
Total amount AT RISK                      $ 0.00

With zero AT RISK you may immediately borrow up to $2500 (half of the stock’s guaranteed value)… and in some accounts, you may be allowed to borrow up to the full amount of the stock’s present value (according to the new margin rules effective April 2, 2007). This margin loan is available at a very low interest rate, no qualifying, no waiting for approval, and this is important: NO RISK.

That is, no risk until the put’s expiration, before which you may need to make decisions about “rolling” the put or selling the stock at a profit. Once your stock is no longer covered by the put, then you would have the danger of a margin call that you may not be able to meet.

Why do I mention all of this? Well, I have the experience of sitting in on a seminar for financial professionals in which the presenters illustrated the possibility that wealthy clients might utilize margin for a short term, “bridge” loan.

I just about screamed! Because encouraging people to borrow against their stock to buy or invest in other things can SERIOUSLY backfire. And this was an audience FULL of professional financial advisors.

Whew. Don’t get me started. Well anyway, though I never encourage borrowing for leverage… in the case of borrowing against your BULLETPROOFED position I think it’s forgivable.

After all, if your orthodontist offers an 18% discount for paying cash… the furnace in your home goes kaput… or you spot a great real estate deal or other investment opportunity…

…if you NEED quick cash for a quick solution…

…your bulletproofed RPM (RadioActive Profit Machine) married put position can be a source. You may effectively “two-step” your money by having it in two places at once: in the market, while your stock trades up or sideways – and yet it’s also in your hands grabbing you a cash discount, a needed item, a good investment.

Oh, and if the market or your individual stock happens to CRASH… so what? Your put option is exercised to pay off the loan and you’re out.

Make sense? See, as you risk approaches zero, then your leverage in such a loan goes to INFINITE.

Like the “Two-Step”? SO do a lot of investors. Want to learn more about HOW to GET a stock to the place of Bulletproof?

Come check out one of the twice-weekly webinars at RadioActive Trading. They’re every Tuesday and Thursday at 12:00 noon Eastern Time. Register for free at www.radioactivetrading.com. Can’t make it to the webinar during market hours? That’s fine, we have a number of webinars archived there as well.

Hey gang, don’t forget to make your voice heard! Comment below and let me know what you think. Like margin? So do I… but only when using it has no danger if the market turns against me.

Happy Trading,

Kurt

About Kurt Frankenberg

Kurt Frankenberg is an author and speaker about entrepreneurship, martial arts, and trading the stock and options markets. One of several "Biznesses" he founded as a teen, The Freedom School of Martial Arts, has been in continuous operation since 1986. Kurt lives in Colorado Springs with his wife Sabrina, German Shepherd Jovi, and his ninja cat Tabi.