WHAT WE DO? WE SELL OPTIONS FOR INCOME. WE USE THAT INCOME TO BUY DIVIDEND GROWTH STOCKS!
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Posted by Martin February 17, 2018
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Trading options process


In order to trade successfully and stay in your comfort zone, I believe you need to know exactly what to do in any situation of your trade outcome.

No analysis, no oscillator, no market prediction will tell you what the market would do next. It is impossible and if anyone tries to sell you a miraculous winning strategy secret, he is lying. If any such secret exists, the one selling it to you would use it for himself and get awfully rich.

Trading is 90% about psychology and the rest is skills and knowing what to do. In order to trade successfully and have consistent returns, you must do the following:

 
1) Have a trading plan and strategy. Always know what to do in any situation.

2) Have enough money in your account so you can manage your trades when they need adjustment. The worst case what can happen to you is to be forced closing your trade at a loss due to a margin call.

3) Never predict the market. Always trade what you see is happening and not what you think will happen because it may not happen at all.

4) Trade only a handful of trades you have time to handle and manage. If you still work a full time job, opening 1000 different trades will knock you out in a sharp sell off. You will not be able to manage them when needed.
 

I am a visual person. It helps to have the process visible. Here is what my strategy decision process looks like:
 

Strategy flow chart
(note, I took the IT classes about 10 years ago and no longer remember exactly how to create the flow charts properly. So some ways above may not be correct and I apologize for it.)
 

When trading options, you must be perfectly OK with anything what’s depicted above. If you are OK with any of the point shown above you will not be surprised, angry or anxious about it and you will trade comfortable. And when comfortable you will also become consistent.




TastyWorks

We all want to hear your opinion on the article above:
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Posted by Martin August 05, 2015
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Strategy


2019 Strategy

 

In April 2019 I decided to modify our strategy so we can reach Financial Freedom in 5 years (and sooner if possible).

It can be a risky plan, but I am aware of the risks and worse case scenario is that I do not reach the goal and deplete my funds. In that case, I will stand up again and start over. But I do not expect it to happen if I will be disciplined, follow the rules and trading strategy in every detail.

I know how I can make money. I know how I can lose money. And I know how I can defend my trades. If I am disciplined and follow the rules, yes, I may have losing trades, but I will survive well and prosper.

I need to reiterate where the strategy came from.

I started learning options in 2010 – 2012. I had a mentor whose trades I was following and who taught this strategy to his clients. It was a very profitable strategy. In about two years, the strategy delivered over 400%.

The basis of this strategy was to collect as little credit as possible (but still reasonable to make it worth it) which would allow you to stay vary far away from the market so it would be very unlikely to get wiped out. With that we were trading Iron Condors at almost 2 standard deviation. During normal trading days, you will never get wiped out. Yes, there will be days when the market will be very crazy and get to 2 SD or beyond, but it will be quite rare. And when that happens, the adjustment strategy comes into play.

This strategy is also in line with Jerry Lee’s strategy of collecting crumbs. He also traded collecting pennies after he learned that it was not important, contrary to what others will tell you, to collect large credits and get wiped out, but collect as small credits as possible, stay in the market as little as possible, and do it every week, month, year. Then, and only then, small drops of water will make an ocean.

I have had many traders telling me that what I do is not worth it. They insisted that in order to make money and make it all worth, one must collect 1/3 of the Condor’s width, some say $100 minimum, others $300 minimum, 30 delta, or whatever other numbers. If it works for them, great. I am happy for them. It didn’t work for me. My trading was like a boom-bust trading. I had years or months of doubling and tripling my account, just to lose it all later in the next few months.

My loses started exactly at the moment when I decided to abandon the strategy I was taught originally.

Just to give you an idea, this is how my trading looked like since 2012 when I decided to change my strategy:
 

Boom Bust Trading
 

Can you see those spectacular peaks followed by the losses? Well, that is what I no longer want to repeat. And therefore I decided to go back to the original strategy.

 

 · Weekly Short Term SPX Iron Condor

 

This is the strategy I was taught and I am going back to.

Here is a quick list of our short term (3-4 DTE) strategy. These trades will be opened every week.
 

1) Open a new trade on Tuesday morning only. In case of holidays or short weeks, Mondays or Wednesdays are acceptable.

2) Open a trade with the same week Friday expiration (3 DTE).

3) Collect min. 0.35 credit per contract.

4) Condor to be no wider than $5 per contract.

5) Multiple contracts based on available buying power (BP). I can use only 70% of available BP. For example, if the BP is 10,000 dollars, I can use 70% of the BP, or $7,000. Divide by the width of the Condor ($500) and I am allowed to open 14 contracts (10000 * 0.70 / 500 = 14)

6) Let the trade expire. All adjustment, or rolling is OK but only within the same expiration cycle. No rolling into next week or further away in time. All adjustments must be done so the trade end the same week. If no adjustment can achieve it, close the trade for whatever it is (even a loss) and move on in the next week.

7) Wings at 5 delta or near as long as credit is 0.35 but no more than delta 10. If delta 5 – 10 is not possible, skip the trade for the week.

8 ) Close one half of the tested side of the position when the tested side reaches delta 30 and roll the entire untested side down (or up) to offset the cost, see example below.

9) Close another half of the trade when the tested side reaches delta 40 and roll untested side lower (or higher).

10) Roll the remaining tested side higher (or lower), open more contracts, and roll untested side down (or up).

11) If none of the above works, close the trade for a loss, do not let the trade go in the money and expire in the money.
 

Here is an example of above described adjusting strategy:

We open 10 contracts with delta 08.
Put side gets tested and reaches delta 30.
We close 5 put contracts and roll 10 call contracts down.
Put side gets tested further more and reaches delta 40.
We close additional 3 put contracts.
We roll 10 call contracts lower.
The put side gets tested even more (touch).
We roll the remaining 2 puts down and open new 3 (or more) put contracts (at least at delta 16).
We roll 10 call spreads lower.
 

 

 · Monthly long term SPX trading strategy

 

We are also trading long term Iron Condors. We split the buying power to trade between the short term trades (3 – 4 DTE) and long term trades (50 – 60 DTE). However, the traded buying power of both combined trades shall never exceed the total allowed buying power.
 

Here is how I will be trading those long term trades:
 

1) DTE shall be 50 or more.
2) The IC width shall be 25.
3) The collected premium shall be $3 or more, the more the better (12% of margin)
4) The short delta 10 or less as long as collected premium is $3 or more. If a premium at delta 10 is less than $3, increase DTE.
5) Adjust the trade up or down if any short strike reaches delta 30.
6) Close the trade to collect minimum of $1.25 or more (5% of margin).
 

The adjustments for these kind of trades will be rolling the entire trade, when the tested side hits delta 30 or more, down or up. However, as soon as the trade reaches the minimum required credit, we will close the trade and immediately opening a new a new one.

 
 

2018

It is time to review our trading strategy and update it if it no longer fits all our rules and comfort zone of our trading.

Although this strategy will still be based on the basic frame posted earlier on this blog, it is time to tweak it a bit and – update it. Another reason for update is that I no longer trade what I have said that I do…

First, when I started investing / trading in 2006 I obviously had no plan and strategy. I had some, but it was mostly erratic and vague with vague rules which I usually heard elsewhere and which I always broke.

But I had a dream. It was to trade to create income which could be invested in dividend stocks. My journey from a sucker to a trader began. Today, I feel comfortable with my trading, I have a set of rules, and enough knowledge to “trade in the zone”. Although I have rules, time to time these rules need to be adjusted and tweaked. Not that I do not know what I am doing or keep searching for a trader’s holy grail because the previous rules didn’t work. They did work. But still, I realized that time to time I still was making mistakes which needed to be addressed.

But going back to my dream. And that is to use 50% of all my options trading profits to buy dividend stocks, dividend aristocrats.

 
Here is an updated strategy:
 

  1. Trade cash secured (in cash accounts) or naked (in margin accounts) puts to generate income.
  2.  

  3. Trade against dividend stocks only. Trade against dividend aristocrats. The list of dividend aristocrats (Champions) is here.
  4.  

  5. Update watch list every month. All stocks which are removed from the dividend aristocrats list will be removed from our watch list, all open options trades closed or expired, and all open long stock positions closed. Money will be reused for options trading.
  6.  

  7. When a trade goes against us, roll puts as much as possible.
  8.  

  9. If rolling is not possible for any reason (e.g. too deep in the money, no strikes available, a roll would result in a debit trade) accept stock assignment.
  10.  

  11. When assigned, keep the stock, collect dividends, and start selling covered calls.
  12.  

  13. Sell covered calls only when the stock is not too deep in the money. If so, and rolling covered calls (CCs) would not be possible, do not sell CCs and wait. Collect dividends only. It is OK selling CCs only if resulting assignment would sell the stock above the break even point.
  14.  

  15. When selling covered calls above the break even point and the stock starts rising, roll covered calls as much as possible. If rolling not possible, accept assignment or attempt converting calls into puts.
  16.  

  17. Create a watch list of 30 dividend aristocrats (exceptions allowed) and build a portfolio of 30 stocks (DGS).
  18.  

  19. When a monthly income reaches $1,000 dollars, use 50% to purchase DGS stocks and leave the rest to be reinvested into options trading.
  20.  

  21. If the monthly income is below $1,000 dollars, accumulate monthly incomes for 6 months and use 50% of combined 6 months income to purchase the DGS stock. For example, if monthly income is only $200 per month, use 6 months combined income of $1,200 (6 x $200) to purchase DGS stocks. However, the combined income must be more than $1,000. If less, all monthly income will be reinvested in options trading.
  22.  

  23. Limit open trades to max 45% of available buying power (BP). For example, if a BP is $90,000 only $40,500 can be used to trade options. The rest is reserves for rolling and trade repairs. If trade repairs consume more BP than allowed, no new trades can be opened until the available cash for trading is raised back to the limit.
  24.  

  25. Open new trades only when the old ones are closed so not to exceed the cash limit.
  26.  

  27. Trade only 1 contract of each stock at a time. The reason is if the trade goes against us and we have to accept assignment, we will purchase only 100 shares of a stock in lieu of multiple stock lots.
  28.  

  29. Sell contracts with expiration from as little as 3 days up to 45 days based on:
    • available premium (if more credit is available at shorter DTE use shorter DTE)
    • binary event (for example earnings – use shorter DTE for the trade to finish before earnings, or avoid the trade)
    • volatility (the more volatile the stock is the shorter DTE shall be used).
  30.  

  31. Sell new put contracts at 1 SD (first standard deviation, or delta 16 or less). This is only for naked (cash covered) puts or calls.
  32.  

  33. When selling covered calls go as close to the money (at the money trade; ATM) or in the money (ITM) as long as the strike is above the purchase or break even of the stock purchase price.
  34.  

  35. Avoid opening new trades with earnings event. The trades can be opened so the trade ends before earnings; avoid riding a trade through the earnings.
  36.  

  37. Open a trade with minimum of $15 net credit per trade (including 0.05 debit for closing the trade; thus the gross limit is 0.20 credit).
  38.  

  39. Close the trades as follows:
    • < 7 DTE = let a trade expire worthless
    • > 7 DTE and < 30 DTE = buy the contract back for 0.05 debit.
    • > 30 DTE and 45 DTE = buy the contract back for 50% of received credit.
  40.  

  41. When selling puts or calls, identify trend, supports and resistances on the chart and trade puts or calls when the stock is near the resistances or supports or in a sideways pattern. If the stock is falling wait for the stock to reverse at a major support before selling put.
  42.  

  43. Purchase only stocks from DGS watch list which are in a “correction” mode and “undervalued” at the same time. The correction mode is determined by how much the DGS stock is off of its 52 week high. The valuation is based on a fair value calculation. We will be publishing the list of all stocks from our watch list meeting the above criteria for purchase.
  44.  

  45. If a stock is purchased via put assignment, that stock can be sold via covered call assignment. A stock purchased via 50% reinvestment, that holding becomes a core of a portfolio and shouldn’t be sold (mainly in retirement accounts). If sold, sell a new in the money put to buy it back.
  46.  

  47. If a monthly dividend income reaches $500 a month then that income shall be used for selective reinvestment in lieu of DRIP.

 

 · An example of constructing a trade

 

Rules
 

The goal is to trade options and use proceeds from options to purchase high quality dividend stocks for passive income. This was my dream from day one when I started trading and later on our business. The reason was that my income wasn’t large enough to pay the bills and save enough money to invest. So I wanted to create a sufficient income from trading to invest. I am almost there as many of our accounts are now self-sustainable and can support this strategy of reinvesting options income into dividend stocks.

 

 · Example of our strategy decision process

 

In order to trade successfully and stay in your comfort zone, I believe you need to know exactly what to do in any situation of your trade outcome.

No analysis, no oscillator, no market prediction will tell you what the market would do next. It is impossible and if anyone tries to sell you a miraculous winning strategy secret, he is lying. If any such secret exists, the one selling it to you would use it for himself and get awfully rich.

Trading is 90% about psychology and the rest is skills and knowing what to do. In order to trade successfully and have consistent returns, you must do the following:

 
1) Have a trading plan and strategy. Always know what to do in any situation.

2) Have enough money in your account so you can manage your trades when they need adjustment. The worst case what can happen to you is to be forced closing your trade at a loss due to a margin call.

3) Never predict the market. Always trade what you see is happening and not what you think will happen because it may not happen at all.

4) Trade only a handful of trades you have time to handle and manage. If you still work a full time job, opening 1000 different trades will knock you out in a sharp sell off. You will not be able to manage them when needed.
 

I am a visual person. It helps to have the process visible. Here is what my strategy decision process looks like:
 

Strategy flow chart
(note, I took the IT classes about 10 years ago and no longer remember exactly how to create the flow charts properly. So some ways above may not be correct and I apologize for it.)
 

When trading options, you must be perfectly OK with anything what’s depicted above. If you are OK with any of the point shown above you will not be surprised, angry or anxious about it and you will trade comfortable. And when comfortable you will also become consistent.

 

 · 2018 Dividend stocks watch list

 

Here are the stocks I plan on trading options with, holding them when assigned, and accumulating them. As mentioned above, the list may change over time if any stock gets removed from the aristocrats list or I decide to modify it.

 
2018 Dividend Watch list
 

In my watch list, there are a few exceptions of stocks I consider worth owning and a few dividend contenders.

How a stock makes it into my dividend watch list?

I look at two major things to put a stock into a list:

1) The stock must be a dividend stock (as stated above) although I allow for a few exceptions.
2) The stock or company must have a story (the story makes the exceptions).
3) The stock must offer good strikes and premiums to be tradeable (as I stated above). So if a stock offers no or little available strikes and expiration dates, or small to no premiums (for example I would have to sell an at the money strike and still barely get 0.10 credit, then that would be a stock I skip).

Then I go to a dividend aristocrats list and browse the stocks and simulate my trades with them to see how they trade (creating new trades but do not placing those trades with the broker). If I see that the stock offers a lot of good strikes and premium at least $15 or more I place a trade.
 

Here are a few older posts which describe my stock and their optionability selection process:

Entering a trade
How I trade Strangles
Why selling puts against dividend paying stocks is a win-win strategy
TRADING RULES – RULE #1 – Stay small
TRADING RULES – RULE #2 – Trade often
Are you a trader or loser? Check for yourself!

 

Here you can download some papers I wrote some time ago (and true they need an update) but they indicate my selection process too:

Put selling strategy rules
Rolling ITM or DITM puts

The story of a stock or company is mostly fundamental. For example, recently, I watched a documentary movie about Warren Buffett and his story and success made me think that buying Berkshire Hathaway and get a share of his success (and money cow) is not a bad idea. So this stock story superseded all other rules (stock is not a dividend stock, but it is an optionable stock and I may start trading options using this underlying).

Or another story is – water. Over the years we saw a shift in interest of what people eat and drink. Selling a bottled water for example reach all times high and exceeded sugary drinks. And this trend will continue. Not so long ago I read a story of Nestle which literally bottles water directly from a stream with almost no cost added (no drilling, no refinery, no purifying, etc…). Nestle sold bottled water for billion of dollars last year with little to no overhead. I believe, this trend will continue. Given also a shortage of potable water stocks involved in water treatment will also outperform in the long run. To provide an evidence, see performance of a few stocks such as FIZZ and AWK or AWR. All were going straight up and more than doubled over a short period of time (a few years in fact).

So, if those stocks meet my selection process – dividends, story, options, I include them in the list.

 

 · Why dividend stocks?

 

The reason is simple. Dividend stock (high quality stocks) are less volatile. Yes, they offer smaller premium but they also offer less risk. And as one saying says – “Small drops will make an Ocean” small premiums if collected consistently will grow your account fast too (and you will be surprised how fast this will become over time).

High quality dividend stocks usually raise their dividend every year and it is a well known fact that these stocks tend to grow by the rate of their dividend increase. If a stock increases a dividend by 3% annually, you may well expect the stock to go up by 3% too.

Another reason is that one day I will not be able to trade. You know, Alzheimer… or senility… or laziness, who knows what will hit me when I will be 70 or 90 years old (unless it is a bus what hits me, then it all doesn’t matter). In that case I want a secure income and not only from the retirement accounts.

Next reason is psychological. When trading options using dividend stocks the fear of assignment is eliminated (or significantly reduced). At least this works with me. I am no longer afraid to get assigned because it is now a part of our strategy. Before, when I was trading stocks such as WYNN, X, TECK, LULU, MNK, or index SPX (which I still do sometimes more often sometimes not at all but only in my account with capital exceeding $100,000), these were actually stocks I didn’t want. Yes, I traded them for greed and fat premiums but I didn’t want to be assigned. And when the stock moved against me, I was in panic trying to defend the assignment at all cost. And I still have those stocks (trades) in our trading account and still fight those trades (and I wish so much to end those trades for good, but I can’t as I would suffer losses).

The high quality dividend stocks do not react violently to every day market fluctuations. I call them “lazy stocks”. They are like dinosaurs. It takes them time to move. And should they move against you, you will be able to respond to it fast.

They are also unlikely to disappear or go bankrupt. You may say that there were many high quality companies out there who later on ended in ashes such as recently GE. Well, yes, but should this happen, the dividend stocks will be the first they give you a warning. How? They cut the dividend. When I mentioned trading options against dividend aristocrats, one trader said that GE was once one too. Yes, it was, but before GE got into troubles, it was first removed from the dividend aristocrats list.

However, if a company, still on the list, gets into a trouble and you end up buying shares because your puts get assigned, you will be buying a high quality company. A few years ago, Johnson & Johnson (JNJ) got into trouble due to some product recalls. People were predicting the end of JNJ. While they were selling, I was buying. I bought JNJ at $58 a share. Today, at $140 a share, I still own it, receive dividends, and intend to not sell anymore. If your puts get assigned, you own a quality company, you get paid to own it, and you can sell covered calls. A triple income!

You may look at it from yet another perspective: high quality dividend aristocrats paid dividends for more than 50 years (many in fact for 100 years, just check it for yourself) and increased the dividends every year, for 50 or more consecutive years. How likely a company with such history will suddenly go belly up without you noticing?

 

 · Stock assignments

 

When do we let the put or call options assign?

We will roll our option contracts as much as possible to avoid assignment and preserve capital for trading. The goal is to trade and generate income.

However, at some point, rolling will not be possible, for example, the stock will slide and the option will be deep in the money. Then rolling will not be possible. Or the owner of the put decides to assign the stock to us (so we will not be able to do anything about it anyway) in an anticipation of some event or catalyst unknown to us. Then we will take a stock.

 

 · Any exceptions to the strategy?

 

Yes, I allow myself an exception to the rules spelled above. But such exception must not derail me from the comfort zone! Trading is about being comfortable in the first place in order to be successful.

There are plenty of people out there boasting about their trading and how great they are, but when you talk to them you find out that they have been exposed to the market for a year or less. They are still enjoying the “beginners luck”. I was there myself too. I actually started this blog in 2008 when I felt like the greatest trader in the world. I wish that oblivious ignorance was still with me and I could trade more easily than today.

So, I allow for exceptions and trade stocks such as Amazon (AMZN) or index (SPX) but I only do it on a very small scale and only when I feel comfortable with those trades. As soon as I no longer feel OK, I stop trading those stocks or index and stop trading whatsoever. If you do not feel comfortable do not trade.

I also allow for trades using different strategy than above if I see a good trade opportunity (for example trading Iron Butterflies on earnings) but again, this must be done with enough cash in the account being traded and when feeling in a comfort zone.

The main goal is to preserve capital and not lose it with reckless trading.

 

 · What about strangles? Will we still trade them?

 

Yes, we will trade strangles but not as often as before. We cannot trade them in our retirement accounts (and other strategies such as call spreads or Jade lizards do not have enough premiums to make it worth trading and our business trading account is currently deadlocked in bad trades with we need to eliminate first. So majority of our trading is now in a personal retirement accounts. However, as soon as our trading account is relieved, we will resume strangles.

 

 · Accounts

 

On this blog we will be reporting the following accounts:
 

IRA (personal retirement account – cash account)
ROTH (personal retirement account – cash account)
TD (our business trading account – margin account)
TW60 (personal trading account – margin account)

 

 · Trades reporting

 

We will be still providing monthly reports to show our trading progress but we are also working on reporting individual trades for our followers and novice traders to follow.

We believe that it can be helpful mainly to novice traders to see the trades, follow them, and mirror them. The best way to learn trading options is by doing it.

Before you start mirroring our trades, please make sure you read and understand our strategy and how we trade options. It is important that you know the strategy before you commit your money in a trade and that you understand that trade.

To trade options successfully you must understand the initial trade and its setup, all possible outcomes of that trade, and your “repair” strategies to all those outcomes. It is not always easy to repair a trade. But you must know what to do when that happens and a trade needs a repair.

Before you commit real money, we recommend that you place those trades in you paper money account and practice trading first to understand. And of course, you can ask us any questions about the trade.

In the past, we experimented with several way on how to post the trades and keep track of them for our readers and followers to best mirror the trades. We did this manually and with the amount of trades, it became impossible to maintain our trades public. But we will keep looking for the best way to publish our trades and show its status so you can follow it the best.

As of today, it seems that the best way to publish our trades (and it still may change over time) is to use Facebook page. So we set up a page ZZ Capital 14 where you can follow the trades.

You can still visit our Trades and Income page to review our trades and accounts progress but if you want to follow our trades, visit the Facebook page.
 

Recommended reading

 

 · 2018 Lending Club Strategy

 

UPDATE 09/07/2017

In my post “A bitter return to Lending Club” I wrote that I would be returning to investing with Lending Club but this time I would be very conservative in selecting notes to invest in.

Originally, I wanted to invest only a very small amount of money ($25 dollars a month) but later on, I changed my mind a bit and decided to invest more ($100 dollars a month). In this strategy update I would like to write down my strategy for investing in Lending Club:
 

Here are my Lending Club screening & investing criteria:
 

1) deposit $100 per month I am still disappointed with Lending Club notes and cannot invest in this type of investment, so no more deposits. But I decided to keep in what I have already deposited ($500 as of now) and I will keep reinvesting. Let’s see if LC investing can change my mind. (Updated: 03/10/2018)

2) invest only $25 per note

3) invest only in “A” and “B” notes

4) invest only in 36 months notes

5) invest in notes with loan payment to income less than 10%

6) invest in notes with employment more than 2 years

7) invest in notes with debt-to-income less than 25%

8) invest in notes with no public records

9) invest in notes with credit score more than 700

10) invest in notes asking less than $10,000 dollars

11) if available cash is sitting in the account screen loans daily as long as all free cash is invested.

12) if no loans meeting criteria show on the list, skip that screen and screen next day.

13) reinvest all interest to new loans.
 


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TastyWorks

We all want to hear your opinion on the article above:
12 Comments



Trading options is dead dangerous! Really?

Trading options is dead dangerous! Really?

If you received or read a disclosure from your broker about options trading stating that trading options is dangerous and you may lose money, do not believe it. If you know what you are doing and what to expect from options, they can be very safe and they actually can be less dangerous than trading stocks themselves.

Do you believe me? No? Then read the next text.

Meet the new Monster – selling options

A friend of mine sent me a risk disclosure given to him by a broker which was describing a few trading strategies and tools investors can use. A portion speaking about selling options was especially interesting.

All they were saying about selling options was scary and very discouraging. According to them, selling option contracts causes you taking an enormous risk which can wipe out all your money. Although they agreed that this risk can be partially mitigated by owning the underlying security or having enough cash.

 
(MORE: Covered Call Trading Plan Update)
 

Unfortunately such disclaimer is usually very generic and vague. It is aimed to protect the broker and not you, the client. But the primary goal is to scare you so you won’t trade options at all. It is now an industry standard to make a hype around options and mystify them as something a normal investor cannot do at all cost. Per brokers, trading options is something accessible only by rich investors and professionals. The opposite is true. Everybody can trade options and it is in many cases less dangerous than trading stocks.

Under certain conditions, options can be dangerous. For example, you have no clue how to trade them and yet you do it. Or if you decide selling naked calls, you really will be undertaking an enormous risk. But all other basic options strategies such as naked put selling, cash secured put selling, and covered calls are actually less risky than trading stocks themselves.

 
(MORE: Getting Paid To Do Nothing)
 

Why brokers came up with such disclosures scaring potential investors to death? It is because of their risk they undertake when their clients use naked put selling using margin. Then, put selling is not your financial problem, it is the broker’s problem. They do not want you to trade options because they are scared of you, and your options trading. Therefore, they will never tell you the truth but they will keep you in ignorance and scared to death. I will try to explain this later.

Why selling options is not dangerous?

Let’s take a look at the two basic options we have – calls and puts. Then you can do four basic trades with those options:

  1. You can buy a call (long) – bullish
  2. You can buy a put (long) – bearish
  3. You can sell a call (short) – generally bearish, but can be a bullish trade
  4. You can sell a put (short) – bullish

Buying calls risk

When you buy a call option, you speculate that the stock price will grow. What you can lose? You can lose 100% of money you paid for the call contract. In order to make money, the stock price must rapidly rise above the strike price of the call option, otherwise your trade will be a loss. The time value (theta) will destroy your option before it can even make some profit.

Well, not for me.

 
(MORE: Gambling Vs Investing – What’s the Difference?)
 

Buying puts risk

When you buy puts, you speculate that the underlying stock will go down. Same as with the call option, the stock must move rapidly down in order to make you money. Otherwise theta will destroy your put option. During violent bearish markets this trade makes sense to protect your portfolio and your current positions. Otherwise not for me either.

Selling calls risk

And now we are getting into the “deadly dangerous, risky option selling” (as per the above mentioned broker). There are two trades, two strategies with selling calls.
 

  1. naked calls
  2. covered calls

To be honest, naked calls can be very dangerous. How do they work? If you sell a call for a stock, let’s say AT&T (T) at strike price of 34 a share and you do not own the stock, you are undertaking an enormous risk. If something great happens with the company, for example over the weekend they announce a very good news, then the following Monday, the stock may open higher with a gap (for example the stock jumps up from $33 a share to $150 a share over the weekend). you will have no time and no option to fix this trade.

 
(MORE: Limited Partnership (LP) & Master Limited Partnership (MLP))
 

Then you are in trouble. You will be forced to sell 100 shares of the stock (which you do not own) and you would have to go and buy it for $150 a share in order to satisfy the call obligation. The loss can be huge. But who would trade such a trade? If you have no knowledge about options you may open such trade as a mistake. Or you need to be a very skilled trader in order to manage such a trade and avoid problems (usually traders cover such trade with a different option creating all sorts of option spreads, so they do not stay fully naked.

This was the only dangerous option trading I know of. And now lets see the “piece of cake” part.

Covered calls risk

There are yet another two strategies with covered calls. Each may have either a bullish or bearish expectations. The strategies are:
 

  1. total return strategy, or buy-write
  2. partial return strategy

I like the total return or buy-write strategy. How that works? You buy 100 shares of a stock, for example AT&T (T) at 34 a share, and at the same time you sell a call at 36 strike and collect, for example, 1.50 (or $150) premium. Your call contract is covered by 100 shares of the stock from the beginning.

 
(MORE: I’m Confused… )
 

What can happen to you? Two things. If the stock stays below 36 strike, the option expires worthless and you can sell another contract. If the stock rises above 36 a share, your 100 shares of the stock will be called away from you. You will have to sell 100 shares of (T) at 36 (strike) a share. You realize a gain by selling the stock ($3,600 – $3,400 = $200 gain) plus collected premium ($200 stock gain + $150 premium = $350 total return).

As you can see, with selling calls you actually make more money, than trading stock itself.

So where is the risk? The risk is in a situation when the stock drops too low. In that case the loss on the stock side is so large that premiums collected cannot compensate for the loss. But if you happen to own a dividend growth stock how often these stocks drop so low that you stop sleeping well at night?

And compare it to a single stock trading. What is the difference between a stock you bought at 34 a share and it dropped over the weekend to 10 a share because of bad news? The risk is absolutely the same as when owning a short call contract. You are losing money in both cases, but with options you are losing less.

 
(MORE: Retire Before Dad 2014 Financial Goals)
 

The total return covered call strategy is a bullish strategy and works well against stocks you want to buy and sell with gain.

What about the partial return strategy?

This strategy can be either bullish or bearish. If you are bullish, it works the same way as the total return strategy where you write call contracts against the stock you already own (so no stock buy portion) and you want to sell the stock.

If you are neutral or moderately bearish, this strategy can help you collecting premiums (sometimes called another dividend) while you are waiting for the stock to grow and make you capital gain. This works well in sideways markets.

 
(MORE: Dividends Aren’t Evil)
 

The third expectation is If are very bearish and expect the stock to drop significantly. This strategy is a protective strategy and again you write the contracts against stocks you already own.

If you expect the stock to fall down in bearish environment, you may decide to sell a deep in the money covered call. As the stock falls down, the value of the contract is diminishing and eliminating the loss on the stock.

For example, you have a stock (T) which currently trades at $34 a share. The markets are turbulent and you expect the stock to fall to $25 a share where you identified next major support. You sell a long term deep in the money call, for example June, or even January 2015 25 strike call. For such contract you will receive 9.6 or $960 premium. If the stock falls back down to 25 a share, the call option will become worthless and you either buy it back or let expire. You keep the full premium $960, but your stock will show $900 loss. The entire trade protected you and you are about 60 dollars in positive territory.

Where is the risk? The risk is in early assignment. If your expectations were wrong and the stock continues rising, the opposite trader who owns your call may exercise the option early and you may lose money. But that would happen if you originally bought the stock too high or high enough that the collected your premium won’t be able to cover the loss. Otherwise this trade will work the exact same way as total return trade.

 
(MORE: How To Manage Your TSP Like A Stock Professional)
 

Since I am a visual person I like to see charts and numbers to see the whole picture. If you are like me, here is a flow chart how the entire covered call strategy works:

Covered call


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Posted by Martin February 02, 2019
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January 2019 trading and investing results


S&P 500  2,706.53 +199.68 (+7.96%)  Dow 30  25,063.89 +1,736.43 (+7.44%)  Nasdaq  7,263.87 +628.59 (+9.47%)
 

September results

I just finished reporting December 2018 and we are again at the end of another month. True, I reported December late.

January started off slow, but ended up well. Our accounts are up and recovering from last year slaughter. But the question is, are we out of the forest or is more carnage coming? Boy, I wish I knew.

In January, we continued trading successfully in our IRA account and made nice income of $2,661.00 in received premiums. In our other accounts, TDA and ROTH, we didn’t trade this month. We only managed opened trades to roll what was necessary to do.
 

We are posting our results:
 

 
IRA Equity:

IRA account equity
 

ROTH Equity:

ROTH account equity
 

TD Equity:

TD account equity

 

We post our trades on our Facebook page.

 
 

 · Dividend stock investing

 

Dividend investing is doing great on both accounts – ROTH and IRA. We keep using 50% of all options income and buy dividend stocks. IRA account keeps growing fast with new stocks being purchased every month. ROTH is more or less stagnant.

 

Here is a review of our accounts stock holdings:

 
Traditional IRA
Trading Results
 

ROTH IRA
Trading Results
 

TD account
Trading Results
 

January started very slow and at first, it looked like we will not be able to purchase any shares this month as we didn’t meet cash flow criteria to purchase new shares. However, two weeks before month end our income jumped up and it allowed us to buy a few shares to add to our dividend income portfolio.

In January 2019 we purchased the following shares:

 
IRA purchases:
Dividend growth stocks
 

It wasn’t easy to choose which stock to buy as many great sotcks in our watch list were indicated as “buy”. We decided to add STX in the end.

At the very last week of the month, our income increased enough to allow us more purchases next week.
 

We haven’t purchased any shares in ROTH or TD this month.
 

We keep spending 50% of our options trading proceeds to buy good dividend growth stocks using our screener to get a better entry into the stocks. Although capital appreciation is not our goal but a secondary target, timing the entry creates good results as our positions are mostly up. However, do not be too excited, any large selloff can temporarily send those stocks down again. It is a dividend income what matters to our portfolios, not the portfolio value and capital appreciation. It seems to be evident that using options to grow the portfolio is the right way to do.

 

 · Dividend Income

 

IRA dividend income
Trading Results
 

ROTH IRA dividend income
Trading Results

 

 · What’s next in the stock market?

 

I am unsure what to expect from the market in upcoming month. January 2019 was definitely one of the best months since 3 years ago. We went up +8%, almost 9%. We went up however, too much and too fast.

I wish this rally / recovery continues but, when reviewing historical charts, it could actually be bad for the market if we do not see any pullback or consolidation at the current levels. Many bearish charts from the past since 1955 indicated bad things happening in similar situation when the market hasn’t pulled back.

Thus the market is giving us mixed signals. I can’t say where we are heading from now.

Nevertheless, I held a believe through the entire 2018 year that the market selloff was just a correction and not a bear market. I still think, this is the case. Although we have mixed signals and we should expect any outcome in this market, it is starting to look like more and more as the previous bullish instances in the past:
 

Trading Results
(Source: CCM)
 

I recommend Chris Ciovacco’s (CCM) video who covers the historical charts and market behaviors and compares it to today’s market conditions to assess his equity allocation. I believe, his outlook can be helpful to assess the next market’s move and trade accordingly:

 

 

Happy Trading!




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Posted by Martin October 14, 2018
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Correction not bear market


It is funny watching people panicking about last week market decline.

Many panic and predict bear market. Many are guessing what happens next. Some are drawing their charts drawing lines of the next decline and claiming historicity of their claim.

 
Predictors
 

Claiming historical evidence and predicting the drop all the way down to 2275 indicates more a lack of studying the history than knowing history.

And ignoring broader context.

Bear markets don’t come in 2 days

Bear markets really do not start in a week or 2 days of a sharp drop. Drops are usually smaller not so violent and they are preceded by other warning signs. This market dropped suddenly and violently. Even the “we know all” media were baffled and guessing what may have caused such drop.

The bear markets are preceded by other signs which would warn you in time that bear market is coming: raising interest rates, declining corporate profits, and investors’ optimism.”

Although FED is raising rates, they are still historically low. In December 2007 interest rates were almost 5%, today, the rates are at 2.5%.

Corporate profits are raising with no sign of slowing. And investors’ optimism? They are spooked by any flow of a breeze out there. The amount of bearishness is outstanding. Many people are still sitting aside in cash, spooked by never ending predictions of bear market coming “tomorrow”. According to AAII 63% of regular investors are neutral to bearish. Only about 35% are bullish.

Add to it fear of valuation, trade war, political comments of the President, FED intervention, and fear of slow down in China, Italy, Greece, Egypt and others. The markets do not turn bear upon fears. Corrections? Yes, they do.

Fundamentally, this bear market is not showing signs of being rolling over.

Technically, this market is not showing any signs of a rollover either.

Look at the following charts with simple moving averages from 1930, 2000, and 2007, in comparison with 2018. Do they look same or similar?

 
technical analysis
 

If you think that they are same then yes, the bear market is coming!

But you may also need to visit an optometrist.

Some spooked investors claimed that we cannot compare long term trends with short term time frames. But the long term time frames determine the short term.

If the long term indicates that we are in a cyclical bullish trend, and in fact, we broke from a long term consolidation (24 year long) in 2016, we are more likely to see a growth than another bear market:

 
technical analysis
 

If you know in what cycle the market is you may rest calm about any corrections or short term bear markets. I recommend watching a video made by Chris Ciovacco analizing the market from a distance. This definitely helps not to panic and stay the course when selling like this happens:

 

 

Corrections are healthy and needed for the stock market to go higher. There is no need to panic. However, there is a need to watch the market because although fundamental and technical reasons for this bullish market hasn’t changed it may change any day. and it will change for sure. But be assured that you will be able to react to the change. The rollover of the market is a process and it takes days and months before you see the market making bearish moves. Last week’s movement wasn’t it, yet.
 




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Posted by Martin May 28, 2018
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Entering a trade


Market fear A reader of mine recently sent me a question: “…is it possible to show me step by step a trade you have recently made with puts?” I decided that it may be a good idea to write a post depicting the entire process step by step with pictures and show how I decide and place a trade.

Although, it may be difficult to do as no trade is exactly same and there will always be the “human factor” in each trade. I try to eliminate as much the “human factor” as possible but it is not always bad idea to have the judgment the computer doesn’t have. Some emotions and fear is good to have, some trade adjustments may be OK to let run or roll earlier than what a computer would do; and there will never be enough space to show all variations a trade may have.

Trading options is not same for every market. It is different when trading equities and when trading indexes. In this post I will explain why and how I trade options using SPX and stocks.

 
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Posted by Martin May 26, 2018
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Weekly results May 25, 2018


S&P 500  2,721.33 -6.43 (-0.24%)  Dow 30  24,753.09 -58.67 (-0.24%)  Nasdaq  7,433.85 +9.42 (+0.13%)
 

Market fearThis post actually contains results from the last two weeks as my internet modem refused to work last week so I was dependent on my phone only.

Last week trading was good for neutral trading. Opening Iron Condors paid the most as the markets got pretty much nowhere. Last week we rolled a few trades which needed attention and opened a few new trades which mostly ended successfully.

We also collected nice dividends last week and added a few new dividend aristocrats to our account. I consider the last two weeks successful.

If you wish to see details and our results on Net-Liq, options income and new dividend stocks we added to our portfolio, please continue reading.

 
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Posted by Martin May 05, 2018
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Weekly results May 04, 2018


S&P 500  2,663.42 +33.69 (+1.28%)  Dow 30  24,262.51 +332.36 (+1.39%)  Nasdaq  7,209.62 +121.47 (+1.71%)
 

Market fearI am trying to get back on track posting regularly our trading and investing results.

Why are we posting our results and financials when we are not a publicly traded company? Can it hurt our business and me personally? Does it make sense and can our readers be interested in these posts which some people consider boasting? And if it is a boasting, should we continue?

What do you think the stock market is going to do next? My outlook is mixed though. I can see bullish pressures but I also see bearishness in the market. Who will win this battle? Bulls or bears?

And at the end review our investing and trading results for the last week.

 
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TastyWorks

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Posted by Martin April 21, 2018
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Weekly results April 20, 2018


S&P 500  2,670.14 -22.99 (-0.85%)  Dow 30  24,462.94 -201.95 (-0.82%)  Nasdaq  7,146.13 -91.93 (-1.27%)
 

Market fearMarkets were again struck by fear selling and media were coming up with tons of reasons why. At first, it was tech stocks such as AAPL driving the markets down, then semiconductors, later oil… all in one day. You could play the miney, miny… game to pick the reason. Granted, they do it all to entertain. However, the selling appeared to be purely technical, as I will present in this article, and quite predictable. Not that I predict the markets, I still have expectations but I do not trade to fulfill those predictions but use them to help me navigate the trade.

Overall, I am still bullish in this market, although my convictions is getting slimmer seeing how weak the bulls are. Look at it this way, media were all in excited expectations of earnings season pushing this market higher. So far, it is not happening.

 
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Posted by Martin April 16, 2018
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Syria not an issue anymore (hopefully), now let’s earnings move the market


S&P 500  2,677.84 +21.54 (+0.81%)  Dow 30  24,573.04 +212.90 (+0.87%)  Nasdaq  7,156.28 +49.63 (+0.70%)
 

Bright FutureInvestors and traders were afraid of what the stock market would do over the weekend due to an air strike in Syria. Myself included. I too was worried about the reaction on Monday. But there was no impact. The air strike ended on Saturday evening and as Trump said: “Mission accomplished” (we have heard this about Iraq once); the markets actually rallied. The S&P 500 futures opened more than 15 points up on Sunday and the market ended Monday trading 21 points up. Is there anything else coming on us we should be worried? I hope not. And if we are good now, no more Trump’s political escapades, no more wars, no other issues, then it will only be earnings season determining the next move. The banking earnings started lukewarm on Friday last week but today a few companies, reported good earnings. I hope this will continue and prop the market.

 
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