Editor's note: In yesterday's Friday Digest, we noted Dr. David "Doc" Eifrig has managed to string together an unheard-of 123 consecutive closed winning positions in his Retirement Trader advisory. Since launching the publication in April 2010, Doc has yet to close a position for a loss.
This weekend, we're sharing a set of essays that originally ran in the Digest last September. At the time, Doc had closed 81 consecutive winning positions. Naturally, readers were skeptical of this claim. But as you'll see today, the claims are true... and we'll show you the secret behind how he did it. If you acquire just one new financial skill in 2013, please make it this one...
The idea we are about to cover regularly gets us accused of "making up" numbers... of fraudulent marketing. We've received loads of hate mail about how we market this idea.
On the other hand, this idea is extremely important. It's an idea we want every single S&A subscriber to understand. We want our parents to understand it. We want our children to understand it. Knowing about this idea – and using it – is one of the real keys of successful investing.
It's a "high level" idea most of our senior analysts and employees use to make money in the market. Some of the more advanced investors on our staff use this strategy almost exclusively. We're proud of this idea... and proud of the claims we are able to make about it.
OK... we hope you're interested... because learning this idea means taking a major step forward in your sophistication as an investor. It's moving from little league to the major leagues.
And we hope you're skeptical of anyone who claims he has profited on 81 of his last 81 positions.
You see, that's the source of controversy surrounding one of our exclusive trading services, Retirement Trader. Editor Dr. David "Doc" Eifrig has put together an unbelievable track record in the service. We mean that literally. People don't believe that going "81 for 81" is possible. We've been accused many times of making up the numbers.
We're actually happy that many of our readers are skeptical of these types of claims. We certainly are. A healthy dose of skepticism is a great thing for consumers of financial services and information. And it's good to be skeptical of a claim that someone has gone "81 for 81." It's just impossible, right? Isn't it too good to be true?
Actually, no. It's not. In the case of Retirement Trader, what Doc has done for his readers is incredible. He has strung together a series of 81 consecutive winning positions.
Doc has shown thousands of retirees how to safely and regularly pull thousands of dollars out of the stock market... and put it into their retirement accounts. It's no wonder we receive more positive – even gushing – feedback about this service than we do any other service we publish. We sometimes worry Doc has so many loyal readers, he has developed a "cult" following.
For example, here's an e-mail we received from subscriber Rick F., an experienced trader...
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As some of our Digest readers know (and Rick alludes), the trading method behind Doc's unbelievable track record is the options strategy of "selling puts."
A "put" is an option. When someone buys a put option, he's buying the right (but not the obligation) to sell a stock at a set price (called the "strike price") by an agreed-upon future date. So when you buy a put, no matter how low a stock's price falls, you can still sell for the strike price.
You can think of a put option as insurance. The buyer of the option is paying a small premium to insure his position against a decline in price. But what most people don't realize is that individual investors can also sell someone that insurance and collect the so-called "option premium."
Most folks find it easier to think in terms of insuring a home.
When you insure your home, you are essentially buying the right to sell your house to the insurance company for a certain value, under certain conditions, for a limited period of time. In return, you pay the insurance company to accept those terms – whether or not you ever exercise the terms of the policy.
Put options work the same way. When you sell a put option, you're acting like the insurance company. You're agreeing to buy someone else's shares of a particular stock for a set price, under certain conditions, for a limited period of time.
In the case of your house, you'd exercise your policy in a disaster... when a fire or catastrophic weather damage wrecks the value of your home. In the case of a put option, the holder would exercise his right to sell us his stock if the market value of his shares falls below the price we agreed to pay.
When you sell a put option, the trade works one of two ways. You either collect the entire premium without any obligation... or you end up buying shares at a discount. Considering the latter outcome, it's important to only sell puts on companies you want to own.
As an example, let's walk through an actual trade Doc recommended in Retirement Trader...
On November 22, 2011, Doc sold January 2012 $25 puts on Microsoft. At the time, shares of Microsoft were trading for $24.79.
In this example, $25 is the strike price. As long as shares of Microsoft traded for more than $25 by the expiration date (in this case, January 20, 2012)... subscribers who followed Doc's recommendation would book the entire premium with no obligation to buy shares. (After all, why would the buyer of that put exercise his option and sell shares for less than he could get in the open market?)
When Doc made his recommendation, the option premium for selling those puts on Microsoft was $1.15... An option contract covers 100 shares, so readers following his recommendation immediately collected $115 for every contract they sold.
On January 20, 2012, the Microsoft options "expired worthless." Shares of Microsoft were trading at $29.71 on the day the options expired – well above the $25 strike price. And Retirement Trader readers kept the entire premium for a 23% return on margin.
That word "margin" is important. When you sell put options, your brokerage requires you to set aside 20% of your potential obligation. Using the Microsoft example... If we sold one option contract, we're responsible for 100 shares at $25 (or $2,500). In this case, we'd deposit $500 (20% of $2,500).
Because we collected $115 in premiums and only had to deposit $500, we made 23% on the trade in about two months... That's a 142.3% annualized return.
Most of the skepticism is due to the widespread ignorance of how "put options" work. As we mentioned, by selling a put option to another party, you agree to buy a stock at a predetermined price at a predetermined point in the future.
In return for agreeing to buy the stock, you receive a cash premium from the other party. In some of our readers' portfolios, these cash payments amount to tens – even hundreds – of thousands of dollars per year. Because of the way put options are structured, selling them is a reliable and safe method of generating extra cash. Sophisticated professional investors have always known that incredible track records can be built with put-option strategies.
We just walked you through the basics of put selling. Now, we'll cover a huge factor in the success an investor has with put options. You see, there's a right way to sell puts (the safe way), and there's a wrong way to sell puts (the risky way).
First, the wrong way...
Remember... by selling a put, you agree to buy a stock at a predetermined price at a predetermined point in the future. If you agree to buy a stock at $25 per share two months into the future, and the shares decline to $10 per share, you still have to buy shares at $25. Thus, you lose $15 ($25 minus $10 = $15) for every share you agree to buy, unless you take the loss early and cover the trade, which still results in a large loss.
This is important. So I'll repeat it: By selling put options, you are "on the hook" for buying shares. If the stock you sell puts on plunges, you can suffer large losses. And this is where the vast majority of put sellers go wrong... and where Doc and his readers "go right."
You see, the premiums an investor can collect by selling puts on risky, volatile stocks are typically higher than the premiums he can collect on safe, steady blue-chip stocks, like Microsoft or Coca-Cola.
So tempted by the allure of larger cash premiums, many investors sell puts on risky stocks. And yes, these investors might collect a big cash premium, but they put themselves in great danger... and leave themselves "exposed" to a large loss should that risky stock experience a big price decline.
To put "real money" amounts on the example above... let's say you sell options that put you on the hook to buy 500 shares of a stock at $25 each. And imagine that by the time your options expire, the stock has plummeted 40% to $15 per share. In that case, you would be obligated to buy $12,500 worth of stock (500 shares times $25 per share)... even though the current market value is $7,500 (500 shares times $15 per share). In this example, you would lose $5,000 ($12,500 minus $7,500).
We know a 40% fall sounds drastic... But these types of declines frequently occur in risky stocks. I'm talking about expensive growth stocks and low-margin businesses like airlines and steelmakers. And these types of falls represent a big risk for put sellers.
Doc mitigates this risk by only selling puts on the world's safest blue-chip companies that are trading at bargain prices. He only sells puts on stocks he is happy to own. Porter, and many of our other analysts, have called selling puts on high-quality, blue-chip stocks "the most consistent trading strategy" they've ever used.
Regular Digest readers know about these kinds of stocks. These are "dominator" businesses like Intel, Coke, Microsoft, and Wal-Mart. They hold No. 1 positions in their markets... rake in huge amounts of cash... and usually pay safe, growing dividends. They rarely suffer substantial declines... and when they do, it's usually a temporary stumble. Those dips are almost always a great time to step in and buy them at bargain prices.
Again... these stocks rarely suffer large price declines. So most of the time, Doc's readers never have to buy the stocks. They simply keep the cash premiums because the stock doesn't sink below the price they've agreed to pay. But even when these stocks do suffer a decline... down to bargain prices... you're happy to buy the shares. You're happy to buy "dominator" businesses on the cheap. And you're happy to start collecting steady dividends.
That's what makes this strategy so safe and profitable. It offers lots of ways to win. This is in contrast with many other trading strategies that have only one way to win... and lots of ways to lose.
So far, about 79% of Doc's initial put sales have resulted in the option expiring worthless... In other words, readers who followed Doc's advice kept the premium and did not have shares "put" to them. In these situations, readers simply book the premiums and move on to the next trade.
Here's how one such trade worked out...
On September 6, 2011, Doc sold October $19 puts on Intel. As most every Digest reader knows, Intel dominates the semiconductor industry to such a degree that competing with it is usually a sure path to bankruptcy. It has a "fortress" balance sheet, huge cash flows, and pays a dividend of more than 3%. At the time of Doc's put sale, shares of Intel were trading for $19.54.
The strike price in this case is $19... So as long as shares of Intel were trading for more than $19 when the options expired in mid-October, subscribers would keep the entire premium.
Retirement Trader readers received $0.90 in premium for selling puts on Intel. Remember, each put contract you sell is for 100 shares... So in this example, subscribers would have earned $90 per contract sold. Selling 10 contracts would have produced $900 in premiums.
These options "expired worthless" on October 21, 2011... From the time Doc sold puts on Intel, the stock rallied from $19.54 to $24.03. Readers who followed his recommendation walked away from the trade with hundreds, even thousands, of dollars collected safely.
Now remember... we said there are several ways to win with selling puts. And occasionally, Doc's readers are "put" the shares of these blue-chip dominators. (That means the stock was trading below the strike price at the expiration date, and subscribers were responsible for buying those shares at the strike price.)
Some folks consider this a "losing trade"... But because we only sell puts on companies we'd want to own in the first place, this can actually be a great thing.
Next time, we'll explain why – and how – you can continue to collect large amounts of income after being put a blue-chip stock.
Regards,
Brian Hunt and Sean Goldsmith