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Editor's note: Today, we're beginning a three-part series from Jeff Clark on advanced options techniques. These strategies take a little more effort. But if you're a serious trader, they're well worth the time.
Tuesday, May 1, 2012
Today, I'm going to describe the best income-producing trading strategy in the world.
When you do this right, you can consistently produce 15%-20% returns per year with much less risk than owning stocks.
I've written about this strategy several times in Growth Stock Wire. Most recently, if you took my advice back on March 24, 2011, you could have made 14.3% in just 10 months on uranium producer Cameco. In the same time period, Cameco shareholders lost almost 40%.
One of the only downsides to this strategy is that it doesn't often make sense for traders looking to speculate on a big movement in a stock's price. But once or twice each year, opportunities pop up where it becomes a "no-brainer" trade.
We've now reached that point in the gold market.
I'm talking about selling uncovered (or "naked") puts...
By selling uncovered puts, a trader receives cash for agreeing to buy shares of a stock at a specified price by some future date. The trader isn't necessarily betting on a rise in the stock price. He's just betting it won't go much lower. And if the share price does fall, he'd be willing to buy it anyway.
Think of it this way...
You walk into your favorite department store and notice the sweater you've had your eye on for a few months is now marked down to half-price. Instead of having to fork over $100 for the sweater, it can be yours for just $50. "What a deal," you think to yourself... "But I'd so much rather pay $40."
So you walk over to the clerk behind the cash register and tell him, "I'll happily buy that sweater from you if it goes on sale for $40 within the next three months."
The clerk opens up his cash register, grabs a $5 bill, and hands it to you. "You have a deal," he says.
You walk away with the $5 in your pocket and an agreement to buy a sweater you want to buy anyway at 20% below the sale price.
Three months from now, if the sweater never gets discounted to $40, your obligation expires and you keep the $5 the cashier handed you. If the sweater is on sale for less than $40, you're going to pay $40 for it anyway – which you were willing to do in the first place – and the $5 you received lowers your actual cost to just $35.
The important thing here is you have to actually want to own the sweater, and you have to be willing to pay $40 for it. If you don't like the thing or you think $40 is still too much, you don't make this deal in the first place.
It works the same way in the stock market.
You ONLY sell uncovered puts on stocks you want to own anyway, and for prices at which you want to own them.
For example, if you think solar energy is a scam and you wouldn't own a stock like First Solar at any price, you shouldn't agree to buy the stock by selling uncovered puts on it – no matter how high a premium you receive.
If you like semiconductor giant Intel, though, and think it's a screaming buy below, say, $25, you can capture a solid income stream by consistently selling put options that obligate you to buy Intel at that price.
That's what my S&A Short Report subscribers did late last year... only we were offering to buy a dirt-cheap silver stock called Silver Standard Resources (SSRI). My readers ended up making 36% in 42 days.
Let me show you how the trade worked. Bear with me. There's a little math. But it'll be more than worth your time to understand this...
At the time, SSRI was going for about $14.40. The SSRI January 14 puts were going for about $1. By selling this option, my readers agreed to buy SSRI at $14 per share if it closed below that price on option expiration day in January. They got paid $1 per share for that obligation, or $100 per option contract (each contract obligates you to buy 100 shares).
Most brokerage firms typically require put option sellers to deposit 20% of the purchase obligation of the underlying stock as a margin requirement. In this example, for each option contract my readers sold, they were agreeing to buy 100 shares of SSRI at $14. So, the margin requirement was $280 per contract (100 shares x $14 x 20%).
The trade was going to work out one of two ways...
If SSRI closed above $14 per share on option expiration day in January, the put options would have expired and my readers would have kept the entire $100 premium as a profit. That's a 36% profit on the margin requirement for the trade in just over a month.
If SSRI closed below $14 per share by January expiration, my readers would have been required to buy the stock at $14 per share – which was a great price. For each $14 share of stock, investors got $2.50 of cash, $3 worth of another precious-metals stock, $72 of silver, and the tremendous potential of increased reserves from several mining properties.
My readers were only going to suffer a loss if SSRI was trading below $13 on option expiration day ($14 buy price minus the $1 premium). In other words, SSRI would have had to fall 10% over about six weeks for them to lose money on this trade.
Instead, SSRI closed above $14 on option expiration. And like I said, my readers ended up making 36% on margin in 42 days. That's about 310% annualized.
The best opportunities to make trades like this right now exist in high-quality gold stocks.
I've written about how cheap the gold sector is relative to the price of gold. And the mining sector has a long way to go to play "catch up" with the broad stock market.
These stocks are on sale. I love the idea of selling puts on them, making money by offering to buy them at even lower prices.
It looks like a "no-brainer" trade.
Best regards and good trading,
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