In yesterday's Digest, we covered one of the more controversial aspects of our business – the unbelievable track record Dr. David "Doc" Eifrig has produced over the past two and a half years in his exclusive Retirement Trader service.
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Many of our readers literally don't believe anyone could close 81 straight winning trades. As we mentioned, it's good to be skeptical of these types of claims. But in the case of Retirement Trader, it's absolutely true.
Most of the skepticism is due to the widespread ignorance of how "put options" work. As we mentioned yesterday, 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.
Yesterday, we walked through the basics of put selling. In case you missed yesterday's essay, please click here to read our explanation. Today, 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).
I 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.
We'll explain on Monday why – and how – you can continue to collect large amounts of income after being put a blue-chip stock.
Also, continuing our put-selling Digest theme, we're publishing several essays from Doc in our weekend Masters Series about how to identify and own elite, blue-chip businesses. If you're an investor... or a put seller looking for safe trades... knowing these blue-chip ideas is incredibly valuable. Watch for these essays in your inbox this weekend...
New 52-week highs (as of 9/20/2012): Berkshire Hathaway (BRK), Fidelity Select Medical Equip & Systems Fund (FSMEX), ProShares Ultra Health Care Fund (RXL), Abbott Laboratories (ABT), First Majestic Silver (AG), Medtronic (MDT), BLADEX (BLX), Enterprise Products Partners (EPD), Chevron (CVX), Procter & Gamble (PG), 1st United Bancorp (FUBC), Target (TGT), and GenMark Diagnostics (GNMK).
We said people don't believe it when we say Doc has never closed a position in Retirement Trader for a loss... Two skeptics write in today. We'd love to hear from more of you. Also, if you've thought about trying a put sale, but haven't, let us know what's holding you back. Send your e-mails to feedback@stansberryresearch.com.
"As an Alliance member I am delighted with the education and investment recommendations that you provide. I have learned more in the past year than I have in the previous 30 years in what makes the markets work and how to avoid my penchant for buying high and selling low. In particular, you helped me to understand and to use selling puts and calls which I believe may be the most powerful investment tools to achieve attractive portfolio performance without a lot of risk.
"Despite my general delight in the Retirement Trader newsletter, I would appreciate it if you could explain the Dr. Eifrig 81-for-81 winners claim. For example, when a stock that Doc has recommended his readers sell puts for drops below the strike price and Doc recommends that we buy to close and sell to open a new contract to avoid being put the stock, is that a winner?
"How about when we sell say, the EXC July 39 put (recommended in the April 20, 2012 newsletter) and we are put the stock at $39, which is now worth $35.45? Even when I combine the put premium and the call premium I sold after I was put the stock I didn't get the $3.55 I am underwater on this recommendation. How exactly is that a winner? I recognize that Exelon is a great company, which pays a great dividend and I didn't buy it at the top to own it. But counting it as a winner surely earns at least one Pinocchio, wouldn't you agree?" – Paid-up subscriber K. Farrell
"I don't like the idea of being put a stock & having to pay the strike price. I don't feel like a winner in that situation. You have to have the cash available in case that happens. If I wanted to own the stock I'd buy it initially. I know the next step is to sell covered calls but that doesn't seem to make up for having to buy the stock." – Paid-up subscriber BH
Goldsmith comment: We will address both of these concerns in Monday's Digest.
Regards,
Brian Hunt and Sean Goldsmith
Delray Beach, Florida and Baltimore, Maryland
September 21, 2012
It's good to be skeptical... The right way and the wrong way to make these trades... How to slash your risks... What happens if we're 'put' a stock... Have we earned a 'Pinocchio'?...