It's worked out even better than we imagined…
Last December, we exposed one of the greatest fallacies in finance… and we showed you a strategy designed to take advantage of the misconceptions. (You can find those pieces here and here.)
As we explained at the time… our strategy was intended to give us outsized returns trading the best and safest stocks on the market. We aim for triple-digit returns with the strategy… while taking far less risk than you normally do simply buying shares.
Now… after showing subscribers how to use this strategy over the past eight months and recommending a series of trades using it… we couldn't be more pleased with the results.
In today's Digest, we're going to update you on this important strategy and share the results of our work with you. But before we give you the details of how our strategy has done… we need to remind you of the "anomaly" we're taking advantage of.
As we wrote last December, the "efficient market" hypothesis is bunk...
This is the financial theory Professor Eugene Fama developed at the University of Chicago in the 1960s. Fama argued that no one can consistently beat the market because prices on traded assets already reflect all publicly available information. It soon became the conventional wisdom on markets...
The efficient-market hypothesis offers a kind of symmetry... a balance. The market knows all and accounts for everything. It is always in balance, at equilibrium.
It's comforting... but the real world doesn't work like that.
In finance, one symmetry we're taught is between risk and reward. This makes sense intuitively. And people want to believe it. It seems fair. If you want to succeed, surely you have to take big risks. But that's complete nonsense. Let's look at some simple examples.
In our studies of highly capital-efficient businesses, we've found that investors who simply reinvest their dividends can consistently earn returns of around 15% a year. That's simply investing in high-quality, low-risk, brand-name stocks, like Hershey, Heinz, and McDonald's…
And we've discovered another anomaly that gives almost any investor... at almost any time... on almost any stock he wants to own... the opportunity to invest with lower risk and earn profits that are far greater than what's possible by just owning the stock outright.
As we'll show you... we can take advantage of this anomaly to amplify the gains we make on stock investments... potentially big triple-digit gains on margin. And we can do that without taking on any more risk than we would by simply buying the common stock – less risk, in fact.
Before we get started... you should know something about Stansberry Alpha... the service dedicated to this new trading strategy.
To take advantage of the anomaly we're going to describe, you only need to learn a single, simple strategy. And that one technique (which we'll walk you through in a moment) is an options-trading strategy.
Many individual investors tune out immediately when they hear 'options.' "It's too risky," they say. "It's too complicated… It's not for me."
If you have that kind of reaction to the words "options trading," we urge you to set aside those concerns for a moment. The strategy we're using in Stansberry Alpha is simple and very safe… even safer than simply buying stocks outright.
I'll explain the details of how this strategy works in a moment… But for now, just remember, options are simply contracts that give the owner the right (but not the obligation) to buy or sell a stock at a predetermined price by a specific deadline.
That's it... Options that give the holder the right to buy a stock are called "calls" – as in, you "call away" someone else's shares. Options that grant the holder the right to sell a stock are called "puts" – as in, you are "putting" your shares to another investor.
A trader buys a call if he thinks a stock is headed higher, so he can buy shares at a lower-than-market price. He buys a put if he thinks a stock is headed down, so he can sell shares at a higher-than-market price. All else being equal, the price he pays is based on how much the market expects the stock to move in the future...
Here's where the "Alpha anomaly" comes into play... Since puts and calls based on the same underlying stock are subject to the same market moves, you would think they should be priced the same. That's what the conventional wisdom would tell you... But that's not the case. And our strategy takes advantage of this "anomaly" in prices.
Why does this anomaly exist? It's simple human nature...
Fundamentally, people are more scared of losing money than they are attracted to the promise of making lots of it. That's why they pay more for the protection of puts than the promise of calls. Their twin emotions of fear and greed are out of balance... They are asymmetrical.
That's the anomaly. And as simple as that sounds, it gives us a powerful way to reduce our risk... collect income from our trading... and set ourselves up for outsized gains down the road.
Our Alpha trades are high-conviction investment ideas where we have a strong belief in the company's business and ongoing profitability.
But the way we structure Alpha trades can generate bigger returns than we could get by simply buying the stock... And this strategy is safer than just buying stocks outright. No other trading strategy offers a better combination of safety and potential upside...
We find stocks we love... that we'd want to own for the long term. Then we buy a call to capture the upside potential, AND we sell a put to reduce our risk.
Now, instead of describing our Alpha strategy in theory, I think it will be easier to show you how it works using an actual trade we recommended to subscribers...
In the April 23 issue of Stansberry Alpha… we recommended a trade based on the giant data-storage company, EMC Corp.
EMC is a great example of the types of companies we focus on in Alpha. It's a $55 billion giant in the "Big Data" space. As the transition to "the cloud" continues to grow, companies will need infrastructure and support to manage Big Data. This presents a massive opportunity for EMC.
To take advantage of the investment opportunity we saw in EMC, we recommended subscribers:
Buy, to open, the January 2015 EMC $25 call for about $2.15, and
Sell, to open, the January 2015 EMC $23 put for about $3.75.
The stock was trading around $22 at the time. (Please note: The options prices have moved, and we don't recommend anyone open the trade at current prices.) Here's how we described the trade in the issue:
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Note the options name included the data "January 2015." That means the options expire on the third Friday of that month. Anyone holding these options must make his buy or sell decision by then…
Margin is another key concept to understand... Since selling the put means you're accepting a potential obligation to buy shares, your broker wants to ensure you're good for it... Margin is simply a kind of security deposit. The amount of margin that each broker requires can vary, but most will allow you to trade options with a 20% margin requirement.
So to open this EMC position, subscribers would have been required to make a margin deposit equal to about 20% of the potential represented by the puts. In this case, that's a $2,300 potential obligation. So the margin requirement was $460 per option contract.
As we explained to readers, the trade could work out one of three ways by January 2015...
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On July 24 – three months after the recommendation – shares of EMC jumped nearly 6% to $26.75 after the company reported solid quarterly earnings. The price increase lowered our chances of being put the stock... And it gave us a huge, early return on our trade.
The strong move up in EMC's share price (and the passage of time) meant that the prices for both our options had also shifted… If we were to close the position early by buying back the put we sold and selling the call we hold… the resulting proceeds combined with our upfront net credit would equal a 71% gain on the margin deposit.
But we're not closing yet. As we outlined above, we think subscribers could double their money on margin by the time we close this trade.
And EMC isn't our only success story at Alpha...
At the end of June, we closed out four positions for huge profits and one loser. Our trade on natural-gas infrastructure firm Chicago Bridge and Iron clocked in a 232% gain in just seven months. We got a big gain on casino operator MGM (119%) in six months, another (102%) on software giant Microsoft in four months, and a juicy 51% on World Dominating chipmaker Intel in four months. The only real blemish so far is our trade on power-generation firm Exelon, in which we booked a 37% loss. We closed our trade on mortgage REIT Hatteras Financial earlier for a small 5% profit.
We've closed six positions so far for an average gain of 79% with an average holding period of 4.67 months.
Our open portfolio's average gain of 35% is with a mere two month average holding period.
If we closed the four open positions today and shut up shop... we'd lock an average portfolio gain of 61% over the 10 positions with an average holding period of 3.4 months.
Again, we wouldn't be able to make these incredible trades if the efficient-market hypothesis was true. So we encourage MBA professors to continue teaching this drivel. And we'll continue making huge, safe profits using our strategy. We'd encourage you to do the same...
I know most people are scared away by options... They immediately think trading options is too risky. I hope in today's Digest I've shown you how these Alpha trades actually have less risk than simply buying the stock in question.
New 52-week highs (as of 8/1/13): American Financial Group (AFG), ProShares Ultra Nasdaq Biotechnology Fund (BIB), Bemis (BMS), Chesapeake Energy (CHK), CVS Caremark (CVS), Emerson Electric (EMR), Fidelity Select Medical Equipment & Systems Fund (FSMEX), 1st United Bancorp (FUBC), Hershey (HSY), iShares Insurance Fund (IAK), iShares Nasdaq Biotechnology Fund (IBB), Integrated Device Technologies (IDTI), Johnson & Johnson (JNJ), ProShares Ultra KBW Regional Banking Fund (KRU), Laredo Petroleum (LPI), 3M (MMM), Marvell Technology (MRVL), PowerShares Buyback Achievers Fund (PKW), Qlik Technologies (QLIK), RPM International (RPM), ProShares Ultra Health Care Fund (RXL), Sequoia Fund (SEQUX), ProShares Ultra S&P 500 Fund (SSO), Cambria Shareholder Yield Fund (SYLD), short position in iShares Barclays 20+ Year Treasury Bond Fund (TLT), Targa Resources (TRGP), and Alleghany (Y).
Several folks wrote in response to Porter's request for book suggestions in yesterday's Digest Premium. Send your comments to feedback@stansberryresearch.com.
"Looking for good books to read? None better than God's word, the Bible. Its been the best selling book of all time and all of it is inerrant. You can't beat a book with no lies in it at all. This will also reveal to you where you stand in relation to God's plan for your life. Jesus loves you Porter. Prove you're not afraid and read his word." – Paid-up subscriber G. Hayden
"How the U.S. rejected the prevailing progressive/socialistic leadership of post WWI for a return to a more capitalistic form of government. I hope we are able to do it again, but I have my doubts). Coolidge strikes me as a decent man that was honestly trying to live up to the public trust he was given. A stark difference from today's leadership. A good read in my opinion." – Paid-up subscriber John Schmidt
"I recommend you check out Daemon by Daniel Suarez and its sequel Freedom TM. They are novels in the vein of 1984 or Brave New World, but are quite interesting in how they talk about the government and how the public gets back it's sovereignty from the government. It sounds a little sci-fi-ish, but the technology is all already available in some form or other, and the setting is pretty much 'now' and the immediate future.
"Daniel Suarez is himself an information technology consultant and obviously someone like yourself whom thinks the the government has taken too many steps against its own people, and that therefor the End of America is on the way.
"Anyway, I found the books to be very interesting and the philosophy behind the story to be very much in line with yours. I am sure you are probably more into a non-fiction read, but this is an interesting fiction-that-could-be-non-fiction story." – Paid-up subscriber Kelly
Goldsmith comment: We started passing Daemon around the office a few years ago... It's a great book.
Regards,
Sean Goldsmith
Miami Beach, Florida
August 2, 2013
I (Porter) don't really have a strong opinion about the particular earnings misses in the last quarter. I hadn't seen much rhyme or reason... except for Microsoft, which suffered from a slowdown in personal computer sales.
And natural gas pipeline company Oneok – another Investment Advisory holding – posted great numbers, too. That position is up 11% since April.
Overall, the economy is doing OK with a lot of strength in energy and weakness in technology. But securities prices have run up far too high due to the actions of the Federal Reserve.
I'm convinced interest rates are going higher. And that will cause a lot of companies to report lower earnings in the future. More important, it will put pressure on the market "multiple." In other words, stocks are trading at 16-18 times earnings right now. In an environment with rates at 4% or 5%, you'll see stocks trade at 12-14 times earnings. So if earnings fall... and the market places less value on earnings... that will have a huge impact on stocks...