Tuesday, May 19, 2015
It's fun to profit on a trade when you're right. But it is even more enjoyable to make money when you're wrong.
That's what recently happened with a trade I recommended in my Stansberry Short Report newsletter...
Six weeks ago, my Stansberry Short Report subscribers bought into major aluminum producer Century Aluminum (CENX). It was a fundamentally cheap stock. And the technical pattern was a typical "bottoming" formation. So I was willing to bet the stock would be higher today.
I was wrong.
Yesterday, CENX was trading about 3% lower than it was when I recommended it back on April 2. But my subscribers still made money on the stock. Here's how we did it...
When looking for a stock to move higher, most traders are either going to buy the stock outright or buy speculative call options on the shares – which go up in value as the stock rallies. Neither of those strategies will profit, though, if you're wrong and the stock actually drops.
In fact, in the case of buying call options, you might lose money even if you're right and the stock goes up. You see, the stock has to go up at least enough to cover your cost of the call options.
That's why the best way to ensure a profit on a trade – even if you're wrong – is to craft a position that gives you some room for error... which is the magnificent benefit of selling uncovered put options. (I have called this the best income-producing trading strategy in the world.) You can be wrong on the direction of a stock and still make money off it.
By selling uncovered puts, you actually get paid just for agreeing to buy a stock at a specified price. If the stock never drops to that price, you never have to buy it... But you still get to keep the money you collected for making the agreement.
If the stock does fall to that price, you'll buy the shares at the price you were willing to pay anyway... and you'll still get to keep the money you collected for making the agreement. So you get a discount.
Here's how it worked with the CENX trade I recommended in the Stansberry Short Report...
CENX was trading at just more than $14 per share on April 2. The CENX May $14 puts were trading for $1.20. So, rather than buying the stock at $14, subscribers sold the uncovered put option and collected $1.20 per share in exchange for the obligation to buy CENX at $14 if the stock was trading below that level last Friday.
Since we collected $1.20 per share up front for selling the put option, it gave us lots of room for error on the trade. As long as CENX closed at more than $12.80 last Friday (the $14 purchase obligation minus the $1.20 received for selling the put option), subscribers would be profitable on the trade.
In other words, we didn't need CENX to go up in order to make money. We just needed it to not fall to less than $12.80 per share.
CENX closed at $13.79 last Friday. Subscribers who sold the CENX May $14 uncovered puts for $1.20 could now buy them back for just $0.25. That's a gain of $0.95 per share – on a stock that fell in value.
On a percentage basis... the $0.95-per-share profit works out to almost a 7% gain on the $14 stock price in just six weeks. That's an outstanding return. But, because the margin requirement (a good-faith deposit) for uncovered put options is only 20% of the value of the stock, my subscribers recorded a 33% gain on the trade – in just six weeks!
That's a terrific result – especially since I was wrong on the trade.
So the next time you're looking at buying a stock, or buying speculative call options on a position, think about selling uncovered put options instead. The strategy will pay off if you're right. But it also pays off if you're wrong.
Best regards and good trading,
"Many individual investors tune out immediately when they hear 'options,'" Sean Goldsmith writes. "'It's too risky,' they say. 'It's too complicated... It's not for me.'" But in this success story, he shows how almost any investor can use options to invest with lower risk... and earn profits that are "far greater than what's possible by just owning the stock outright."
Dr. David "Doc" Eifrig assures readers that selling options is neither too risky nor too complicated. "No other strategy offers a chance to safely profit, no matter what happens to stock markets," he says. "I truly believe it's one of the most valuable investing skills you can learn." Learn how to start selling puts in this interview with Doc.
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