How to Flip the Poker Game

Part two of Doc's five-part options series... Why options get a bad rap... And why they can work so well... How to flip the 'poker game' of options trading...

Today, Doc continues his series about options...

Go ahead, you can stop reading today's piece. I (Retirement Trader editor Doc Eifrig) know that most of you probably know enough about options to think they're complex and risky. That's because you didn't dig deep enough.

But then again, the first time you tried to drive a car, it seemed complex and risky, too. Now you do it every day. You put the time into learning how to drive because it made your life better.

Options will do the same for your finances. And just like learning to drive when you were 16 years old, better finances and larger income streams give you more freedom.

I don't blame options skeptics.

I blame those who taught them options. Most folks get introduced to options the exact wrong way... as a way to make big, fast gains in the stock market. But when put into practice, this "big gain" tactic leads to big losses.

That's why we take the opposite approach in my Retirement Trader service. We use options to reduce the risk of our investments while creating returns that don't exist for other investors.

As Porter likes to say, "There is no such thing as teaching. There is only learning." This week I'm going to show you the right way to use options. If you choose to learn, please read on...

If trading options doesn't scare you, does the word "derivatives"?

Options are considered a type of derivative, a broad term for investments that are based on other investments. With derivatives, you don't invest in an asset. Instead, you bet on a contract that "derives" its value from another.

During the 2008 to 2009 financial crisis, you couldn't find a word scarier than derivatives. Remember hearing about those credit-default swaps that nearly blew up Wall Street? Those were derivatives. They were bets that tied their payoff to the default status of mortgage bonds.

Perhaps you read about rogue trader Nick Leeson blowing up Britain's Barings Bank in 1995. He was using derivatives. Or Jérôme Kerviel, who lost 4.9 billion euros for French bank Société Générale with derivatives. And you likely recall when U.S. financial-services giant JPMorgan Chase lost $2 billion to the "London Whale" in 2012, again due to derivatives.

These guys give options and derivatives a bad name. They used them as a way to load up on risk and leverage, allowing them to make massive bets with little capital up front. Of course, their bonuses depended on taking stupid risks.

That's the perception of novice investors regarding options... but it's flat-out wrong.

With options, you can make a bet on whatever sort of market activity you expect.

A typical investor has two ways to play the market: He can buy stocks he thinks will rise, or short the stocks he thinks will fall.

An options trader adds several more tools to his bag: He can bet that stocks will rise, fall, stay the same, move within a certain range, rise then fall, and just about everything in between. Options can be used to increase leverage and risk or, just as easily, to reduce it.

But most investors do it the wrong way...

The standard options pitch goes something like this...

Let's say you think a $20 stock is going to rise. Well, you could buy 100 shares for $2,000. If the stock rises to $25, then you'll have $2,500... a profit of $500. A profit of 25%.

Instead you can buy a call option on that stock for just $150. Since each option contract represents 100 shares of stock, with your $2,000 investment you can now "control" 1,300 shares instead of 100. (Remember, each options contract covers 100 shares.)

Based on this particular option, if the stock rises to $25 within the month, you'll turn your $2,000 into $3,250. That's a 62.5% return. Phew!

Who wouldn't be interested in boosting returns like that?

The trouble comes with the first assumption. You may think a stock is going to rise, but when you trade options like this, you make a leveraged bet that a stock will make that move in very specific period of time.

No matter your investing prowess, you're going to get that wrong most of the time. And when you get it wrong, you'll likely lose your entire investment.

People who learn to use options this way often lose their shirts on the first trade and quickly give up.

We have a better way...

At Stansberry Research, we love to earn higher returns, but we know that true investment success comes from obsessing over risk. In my newsletters, that's what we do all day long.

We reduce our risk by employing the best analysts, focusing on quality and value, monitoring our position sizing, using bonds and other non-traditional investments, and using options to custom tailor our returns.

That allows us to consistently make gains month after month, keeping our capital growing... and keeping our readers in the market.

We do it by doing the exact opposite as the folks who lose money trading options.

Let me ask you a question... Is poker a game of skill or chance?

On one hand, you need to get great cards. You can make all the right moves but still end up busted by a straight flush. On the other hand, making careful moves and controlling your risk tends to pay off in the end.

People argue over poker because it's hard to prove that skill beats luck. Over any single game, month of games, or even years, the best player can lose.

But here's the question that settles it for me: Can you sit down at a poker table and intentionally lose all your money?

Stupid question, right? Of course you can. The reason poker is a challenge is because everyone is pursuing the same strategies and the same ultimate goal. That competition makes any edge held a small one.

But when you take the opposite strategy as everyone else... it's easy to succeed, to reach your goal.

My options strategy makes it easy to reach your goal...

Now, obviously, we're all about making money.

My options strategy flips the game so that we're the only ones playing a certain way... In short, most individual traders buy options. And most of the time, they lose money. Instead we sell options... And we almost always make money (more than 93% of our positions have ended up winners.)

That's the key to our strategy. Selling something you don't own sounds like an impossible arrangement. But it's just the vocabulary that makes it confusing.

On Monday, I'll explain how we sell options and how it allows us to earn real cash returns on stocks.

If you knew you could make double-digit returns in stocks... while reducing your risk... and do so even if the market goes nowhere for the next few years... would you take an hour to learn how?

My bet is you would. The only thing holding you back is what I call "options baggage." Options trading looks difficult, and many people have traded options improperly in the past and lost money.

Drop that baggage.

Keep an open mind for the next few days, and I promise to show you that absolutely anyone can learn how to make conservative, risk-reducing options trades.

I also urge you to join me next Wednesday, March 22 at 1 p.m. Eastern time for a brief educational webinar where I'll walk you through a real-life options trade you can use to collect safe "income from nowhere" in your own account. It's absolutely free to attend.

I'm also asking folks to submit the ticker symbols of the stocks they're most interested in. I'll tally up the most requested stocks and show you exactly how much income you could be collecting on them with this strategy.

Click here to reserve your spot and submit your favorite stocks now. And be sure to sign up for our free VIP reminder service so you don't forget about the event.

New 52-week highs (as of 3/16/17): Tencent Holdings (0700.HK), Longfor Properties (0960.HK), Apple (AAPL), Allianz (AZSEY), iShares MSCI BRIC Fund (BKF), WisdomTree Emerging Markets High Dividend Fund (DEM), iShares MSCI Italy Capped Fund (EWI), iShares MSCI Singapore Fund (EWS), Facebook (FB), Barclays ETN+ FI Enhanced Europe 50 Fund (FEEU), First Trust Emerging Markets Small Cap AlphaDEX Fund (FEMS), National Beverage (FIZZ), iShares China Large-Cap Fund (FXI), Alphabet (GOOGL), PureFunds ISE Mobile Payments Fund (IPAY), Shopify (SHOP), Sanofi (SNY), Stanley Black & Decker (SWK), U.S. Concrete (USCR), and Direxion Daily FTSE China Bull 3x Fund (YINN).

In the mailbag, we several questions from readers. We'll pick back up with this five-part series on Monday, so be sure to get your questions in so we can answer all of them. Send them to feedback@stansberryresearch.com.

"Doc, I read your Thursday Digest with a smile. In 2008 I lost 40% of my IRA because I was too stupid to follow the stop loss mindset. I have been reading the Stansberry newsletters since the beginning I think. I have been an Alliance Member since 2009. I started reading your Retirement Trader newsletter and decided to try options in 2011. I cannot tell you what a difference it has made for me. I never play with more than $100K. My IRA is with Schwab so I cannot buy/sell options on margin... My results are still good in my opinion. 2011 +$44,325; 2012 +$48,000; 2013 +$44,561; 2014 +$16,940; 2015 +$18,958; 2016 +$25,003.

"I send this along only to demonstrate this is a winning strategy and can make a big difference in spending income for someone who is retired and on social security. As long as the options keep paying off, there is no need to pull from the investment capital (except for the required RMD each year). The education you have provided to me has made my Alliance membership the best investment I ever made. At age 70, I expect this to provide a safe and dependable income for the rest of my life. Thanks, and Regards." – Paid-up Stansberry Alliance member Jim Marshall

Doc comment: Thank you for kind words and for sharing your experience with this strategy. I love it... In fact, I use it to generate extra income in my own IRAs as well.

"Hi Porter and Doc... I have been making the cash from the 'Doc' trades for years. For the people that are new to Doc, the only problem with this series will be having the 24 hour wait between issues! Can I please send this Digest series to a few friends? Thank you!" – Paid-up subscriber Neil Silver

Doc comment: Of course! And be sure to remind them to tune in for my free webinar next Wednesday, March 22 at 1 p.m. Eastern time. They can reserve a spot and learn more at www.retirementtrader.com.

"Hi Doc, Really looking forward to more info on your options trading tutorials. I read each issue of your Retirement Trader, but haven't pulled the trigger on selling puts as of yet. This is primarily because I can't decide how much of my portfolio to risk at any given time. I'm hoping you'll give us an idea of how to make this decision in your future lessons. Thanks again for all your great advice." – Paid-up subscriber Allan R.

Doc comment: As always, I'm unable to give individual advice. But I generally recommend limiting your capital at risk to about 1% of your portfolio. (The reason is simple: Most folks can easily handle a 1% loss. Any more than this and people start to get emotional, and trading on emotion is never a good idea.)

Assuming you use a 20% or 25% stop loss as I usually recommend, this means you would limit individual positions to no more than 4%-5% of your total portfolio (25% of 4% is 1%). Of course, you could adjust these percentages to suit your individual situation or preferences.

"Doc – I've seen your recommendations on the site and in emails, but how does one execute them when you don't already have an open position? If I just opened a position in a stock by buying 100 shares (for example), but hadn't executed an option trade with it, what part(s) do I do? Thank you." – Paid-up subscriber John Z.

Doc comment: In this case, you would create a covered-call position by selling a call option against the existing stock position with a "sell to open" order.

If you didn't already own the stock, you would simply buy the stock and then sell the call option. These days, most online brokers allow you to execute both "legs" of the trade in one easy step and with one commission.

Be sure to join me for my free webinar next Wednesday at 1 p.m. Eastern time where I'll walk you through a real trade example. Again, you can sign up and learn more right here.

"Can you trade options in an Individual Retirement Account (IRA)?" – Paid-up subscriber Bill B.

Doc comment: Yes! In fact, my covered-call strategy is ideal for IRAs and other tax-advantaged accounts. I'll discuss this in more detail next week.

Regards,

Dr. David Eifrig Jr. MD, MBA

Baltimore, Maryland

March 17, 2017