An update on our Put Strategy

The results of my Put Strategy Report have been so incredibly good that if I simply told you how we've done, you wouldn't believe it. Overall, 77% of the recommendations have been winners. And the average gain is almost 25%, with an average holding period of about 60 days. That equals about 152% a year, annualized. And that's during a period (October 10 until today) when the stock market declined 16.5%.

But that's not the whole story. A few of these recommendations were outside of our core strategy (selling puts). Out of a total of 18 recommendations, 13 were put sales. Out of these 13, we only closed one at a loss. In short, we profited on more than 80% of our put trades. And the average gain was 44% in about 90 days. That's more than 178% annualized.

The reason selling puts is so profitable right now is because the premiums – what people are willing to pay to buy puts – have never been bigger. When investors are afraid, they'll pay ridiculous prices for insurance against further losses in stocks. In my entire career, I have never seen a better time to sell puts – and I doubt I ever will again. I told all of our readers about this opportunity last fall. Only a handful followed my advice. Put Strategy Report was the poorest-selling newsletter we published last year. It was exactly what our readers should have been doing... but we could hardly convince anyone to even try it.

I know selling puts is foreign to most people. I know it seems risky. And I know 99% of the people reading this e-mail won't bother to learn how to do it. But for the 1% willing to stop, think, and learn, I'd like to show you exactly what we've done. I want to tell you why we did it. And I want to ask you to simply try it, even if only once.

Knowing what you know now – that the markets crashed starting in October – wouldn't you have rather been following a simple, low-risk strategy with average gains of 44% and more than 80% winning positions on 13 trades?

Wouldn't you rather have been making a killing over the last six months instead of getting crushed? The answer has to be yes.

Please note: "Expired worthless" is the goal when you're selling puts. That means the option you sold has expired without any further liability for you. Thus, you keep 100% of the premium you were paid.

Now... let me explain what we're doing, using our actual trades as the examples. Take the Tiffany (TIF) trade – which is still open. On February 15, stocks had been falling steadily since mid-January for almost a month straight. High-quality stocks, like Tiffany, began to trade at valuations lower than they did at the market bottoms in 1973-74 and 1987.

In the case of Tiffany, when the stock was at $19.50, you were buying the company for close to the value of its inventory – getting the brand and continuing business (which is profitable) for free. It was a "no-brainer" long-term investment. And a very safe stock. But with the market in freefall, who knew how much lower the price of Tiffany would fall?

So instead of buying it at $19.50 (where it was trading on February 15), what if we simply agreed to buy the stock at $15 for a few months? By agreeing to buy the stock at $15 through May, we could earn a significant amount of money – $1 per option. And because we were only agreeing to the purchase, we only had to set aside part of the money. Typically, brokers require a 20% margin based on the future commitment, which in this case was $15. So, we put up $3 in margin (that's 20% of $15), and we got $1 back for agreeing to buy Tiffany (a stock we'd like to own in any case) at $15 between now and May.

Here's the best part. According to various market studies, about 90% of out-of-the money options – like the $15 Tiffany option – expire worthless. If Tiffany's share price doesn't trade below $15 between February and May, our option expires and we keep the $1. Thus, Tiffany's stock had to fall another 23% in a few months before our $1 was in jeopardy.

So... unless Tiffany falls a lot more, we're going to earn $1 by risking $3. That's a 33% return on our capital in about 100 days. That's more than 100% annualized. If you look up at the track record, you can see the stock price at the time we recommended selling the option and the strike price we recommended. In almost every case, we've only sold way-out-of-the money puts. (There were a few exceptions, like the Budweiser arbitrage and the Annaly put... but those are special situations.)

When you're selling puts (as opposed to buying them), time works in your favor. Everyday that passes, the Tiffany option we sold becomes a little less valuable. That's one of the factors that make this a low-risk strategy. The other is that almost all of the options I've recommended selling have been way out of the money. With stocks down so much, it's increasingly unlikely they'll fall another 25%-30%. Not impossible – but unlikely. Very high-quality stocks that aren't indebted and remain profitable are even less likely to fall that far.

By limiting our recommendations to stocks we want to own at prices we'd be happy to pay and by only selling out-of-the-money put options, we aren't taking any big risks. And that's why we've made money more than 80% of the time.

There was one put that I recommended – on MGM Mirage (MGM) – where I completely changed my outlook. A few weeks after I recommended selling a put on MGM, I discovered the stock was likely to go bankrupt. Thus, holding these puts was extremely risky. I immediately told my subscribers to reverse course, buy back the option we'd sold, and close our position. Because some time had expired in the option and because the stock had actually gone up a bit, we ended up making 35% on the trade. So even though we were wrong about MGM, we still profited... Selling options provides investors with a wide margin for error.

(By the way, I have since recommended selling MGM short at $16, earning huge profits for my subscribers when the stock collapsed to under $5.)

Of course, it doesn't always work out. No real investing is totally risk-free. (Just ask Bernie Madoff's clients.) On three occasions, the puts I recommended selling ended up "in the money" and were exercised against us. That meant we were forced to buy the stock at the strike price we agreed to pay. And because the strike price was above the current market price, each of these three investments (SBUX, BAC, and TTWO) started out in the hole.

But all is not lost. You can covert these losing trades into winning long-term investments almost every time. All you have to do is sell a call against the stock you've bought. You simply convert your sold put position into a covered call position. Doing so turned what was a small loss in Starbucks (SBUX) into a big winner for us. I know we'll eventually turn our Take-Two (TTWO) position into a winner, too. The only loser was a big one, though. We got caught in the collapse of Bank of America and took a 54% loss. Nothing is perfect.

If you're interested in this kind of trading – where you should make money more than 80% of the time and earn annualized profits between 50% and 100% on your capital – you must first talk to your broker to determine if you're eligible to sell "naked puts." That's critical. If your broker won't let you, try calling up TradeKing or Interactive Brokers. If your brokerage account has $50,000 worth of assets, you can find a broker who will let you sell puts.

You can find your own puts to sell by looking for safe companies you'd like to own and then selling puts with a strike price you'd be happy to pay. Or you can try subscribing to my Put Strategy Report to see what I'm recommending. If you've never done this kind of trading before, don't let your fear of the unknown stop you. Just trade at a very small size – one option contract at a time – until you're comfortable.

As I told all of you last fall, there's no better strategy for making money in panicked markets than selling naked puts. Hopefully I've opened your eyes to this opportunity, which won't last forever.

I hope you consider signing up for the service. This is truly a once-in-a-lifetime opportunity to sell puts. To get started, click here.

Yale's endowment fund manager, David Swensen, recently did an interview for the school's alumni magazine, telling investors to buy stocks now. Swensen says 18 months ago, investors were bullish. Now they're scared, when they should be "enthusiastic"... Swensen is a major proponent of diversifying your p
ortfolio over several asset classes – stocks, bonds, timber, etc. He's produced positive returns for 20 consecutive years at Yale.

Here's one of the best snippets from the interview...

Q: [Your new book] Unconventional Success delivered a scathing critique of the mutual-fund industry. You rightly pointed out that the vast majority of mutual funds charge high fees, trade too frequently, and under-perform the markets. How did the industry react?

Swensen: I've heard stories of people in the fund management business being irate about the book. That's not surprising. The mutual fund industry is not an investment management industry. It's a marketing industry. And if somebody interferes with your marketing, you're not going to like that. So I was pleased to hear that there were senior people in the industry who were very, very unhappy with me and my book.

You can read more here.

Fitch Ratings downgraded Berkshire Hathaway's so-called Issuer Default Rating (IDR) and senior unsecured debt ratings to double A+ and double A, respectively. Berkshire's insurance arm maintained its triple A, but all divisions are on negative watch. Fitch also said having Warren Buffett as head of the company is a risk...

Fitch views this risk as unrelated to Mr. Buffett's age, but rather Fitch's belief that Berkshire's record of outstanding long-term investment results and the company's ability to identify and purchase attractive operating companies is intimately tied to Mr. Buffett.

And yesterday, Standard & Poor's stripped GE of its triple-A rating. That leaves only five triple-A-rated companies. They are ExxonMobil, Microsoft, Johnson & Johnson, ADP, and Pfizer.

New highs: none.

In the mailbag... Someone must be new. He's accused us of being Republicans. To us, that's even worse than being called a Democrat. The Democrats are corrupt... but they at least claim to mean well. And they're not the ones who opened secret CIA prisons and tortured people, either. Send your accusations (and your questions about Put Strategy) here: feedback@stansberryresearch.com.

"If anybody has been brainwashed it is you. You conservatives who follow the leaders such as Newt Ginrich have been sold a bill of goods although with you 'authoritarians,' it is an easy sell." – Paid-up subscriber Rueben

"It never ceases to amaze me when a fellow reader grips about Dan's or Porter's bias concerning bashing the Dems 'Come on now, your bias is glaring on your comment re Obama buying $11.2 billion in new choppers.' They are just either really dumb like most Democrat supporters, or just very casual readers of the Digest. You guys hate the GOP equally as do I. When will the common American realize it's not the Dem's versus the Repub's, but Us against all of Them?" – Paid-up subscriber John A. Jones

Porter comment: Beats me. It boggles my mind anyone believes there's a cow patty of difference between Republicans and Democrats. The entire idea that the government ought to make up almost 30% of our economy is completely absurd. And both parties are equally responsible – one votes for welfare, the other for warfare. Believe me, the deficit doesn't know the difference. Can you imagine what Jefferson, Franklin, Washington, et al would say about the country we live in today?

Why the hell haven't you thrown another Tea Party, you whipped dogs? We took on the most powerful empire in history – we risked our lives, our families and our honor to earn our liberty. And now, look at you, you sniveling cowards. You line up for government handouts. You tolerate the government snooping into your phone conversations, looking at your bank records, and telling you what you're allowed to smoke in your own home.

You praise the idea of unlimited democracy – of allowing people without an education, without any property, without any standing in society – to determine the actions of the government! That's mob rule. You believe in paper money and tolerate the income tax, you miserable fools. You don't deserve to be called Americans... and you are doomed.

"What are your thoughts on the most efficacious ways to reform MTM accounting while still maintaining transparency but not crippling capital in down markets and inflating values in up markets? Five-year rolling average pricing? Allowing value for discounted cash flows?" – Paid-up subscriber LAF

Porter comment: I think your question misses a very important point. The only reason mark-to-market is critical is because the banks are so leveraged even minor decreases to the value of their assets cause enormous drops net asset value. The real solution isn't to change the accounting. The real solution is to stop saving overleveraged banks. That's the only way to make their managers understand the consequences of being so leveraged. And the only way to do that is to stop insuring deposits. Let the banks publish their numbers and then let the customers decide which banks are solvent and which are not. Tell everyone: FDIC ends on June 30. Good luck. The only way to start running the economy the right way is to stop running it the wrong way.

"It doesn't matter if the government is on the right track or not. Shut up about politics and stick to finances – because that is what we your subscribers are paying you for." – Paid-up subscriber Gary Aspenberg

Porter comment: Sadly, in our country there is very little difference between "the economy" and "the government." Welcome to Amerika, comrade.

"Brian Hunt is your man for Inside Strategist, we would be much better served with him there than blurbs at the end of DW." – Paid-up subscriber Byron

Porter comment: I agree. I've been telling him that for years. But he says he won't write a newsletter. He doesn't want to tarnish his reputation.

Or as he told me... "I don't want my mother to know what business I'm in. I tell her I play the piano in a whorehouse."

Regards,

Porter Stansberry
Baltimore, Maryland
March 13, 2009