What is the Secret of Income Method #4?

Just the other day we shared ‘The Role of the Income Methods‘, and presented the goals for using an income method to reduce risk, lower cost basis or generate premium – even presenting ideas for 3 of the 12 Income Methods in The Blueprint.

You can check out the replay HERE.

BUT First! Let’s talk a little bit about Income Method #4. This particular income method can reduce your risk quickly and it is a great example of how the protective put is not just insurance but a 2nd working asset that can be manipulated.

In the webinar we presented an idea of how Ernie could use Income Method #4 on his recent OLLI trade. Here is the initial entry posted to Fusion:

OLLI Married Put

October 26th, 2018:

Buy 100 shares of OLLI at  $87.72

Buy 2019-APR 90 Put at    $ 9.50

Total Invested =                 $97.22

Guaranteed Exit =            -$90.00

Max. At Risk =                    $ 7.22, or 7.4% of investment

 

 

In the webinar we showed how Ernie could use Income Method #4 to reduce his risk. Well, he did it later in the day:

October 30th, 2018: OLLI at $92.82 (up $5.10 from purchase price, or 5.8%)

Sell to Close 2019-APR 90 Put at -$7.40

Profit and Loss After IM #4 on OLLI

Buy to Open 2019-APR 95 Put at $9.75

Total Debit for Roll:                       $2.35

Whoa! Wait! This is not an ‘Income Method’! This was done at a Debit!”

Yes, that is correct. Income Method #4 is done at a debit – but look at the trade off:

  • Ernie paid $2.35 to maneuver his now OTM 90 put to an ITM 95…
  • This increases the Guaranteed Payout to $95.00
  • He ‘Put’ and additional $2.35 into the trade to gain $5.00
  • This reduces the at risk by -$2.65…much more than he could have gotten by just selling the NOV 95 call.

This is just one of about 6 ways the Protective Put can be manipulated to Lower Risk in the RadioActive Trade.

How Does it Work?

Did you notice something interesting about the price of the APR 90 put when Ernie closed it?  Ernie originally paid $9.50 for the APR 90 put, then sold it for -$7.40. So, he lost $2.10 on the put…

That’s OK, because during that same time frame he gained $5.10 on the stock. That is a fair trade off for insurance.

Although the put initially cost $9.50, only $7.22 of that was time, or Extrinsic Value. Let’s look at it again:

October 26th, 2018:

OLLI at                       $87.72

2019-APR 90 put at $9.50

Intrinsic Value, which Ernie is Guaranteed to get back = $90 put strike – $87.72 stock price = $2.28

Extrinsic (or Time) Value = $9.50 Put Price – $2.28 Intrinsic = $7.22

The Extrinsic or Time Value of $7.22 is the true at risk on this initial RadioActive Trade.

 

What do we know about Time Value? Well, it decays over time. When you buy an option you expect the Time Value to decay day by day, right?

Well, on October 30th when OLLI was at $92.82 the APR-90 put was Out of the Money. There was no Intrinsic Value – only Extrinsic or Time Value. And that was at $7.40.

10/30/2018

Sell to Close 2019-APR 90 Put at -$7.40

Well, this was only 4 days of time passing. You might say: “That $0.18 increase is just noise, and was likely due to an increase in Implied Volatility or a wide bid-ask spread”.

The ATM Extrinsic Swell

Let’s consider another IM #4 opportunity on Canada Goose Holdings (GOOS):

Monday, OCT 15th

GOOS at             $50.70

APR 60 Put at     $13.55 ($9.30 Intrinsic, $4.25 Extrinsic, or Time Value)

Total Invested =  $64.25

Guaran. Exit =   -$60.00

Max Risk =          $ 4.25, or 6.6%

Put Option IV = 0.5546

Tuesday, NOV 6th (16 Trading Days Later)

GOOS at             $59.25

APR 60 Put at     $ 8.90 ($0.75 Intrinsic, $8.15 Extrinsic, or Time Value)

Put Option IV = 0.5629

What do we see?

  • The Extrinsic (Time Value) of the put increased by $3.90 after 16 Trading Days (22 Calendar Days)
  • The Implied Volatility (IV) did not have a significant change.
  • Yes, the put declined -$4.65…but the stock gained $8.55. A fair trade.
  • Though not exactly the right time for IM #4 (See The Blueprint), it could be used to cut the risk down to only 3.2% – more than half of the 6.6% initial at risk in a few weeks.
  • The Position could actually be Bulletproofed heading into earnings on NOV 8th.

 

This is the Secret of Income Method #4

Remember the ATM Bell Curve, one of the 3 Core Principles of RadioActive Trading? This principle shows us that at any time the options that are right At the Money for any stock and any expiration, will always have the highest Time Value:

This is the secret of IM #4: Manipulating the Extrinsic increase to our benefit. And, once again, more proof that the Married Put position is not just stock insurance…

You have purchased a 2nd asset (the put option) that can be adjusted several ways to help you lower risk, lower cost basis, potentially Bulletproof the trade or have a structure that can profit in both directions.

And…that is just 1 of the 12 Income Methods we use for RadioActive Trading.  Of course, the when’s, why’s and how’s to do any Income Method properly are only available in Your Blueprint!

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