Options Writing Risk Management

1) Risk management begins not after you enter your positions but before you enter any positions
- Sell far out of the money options. Our objective is not to pick the winners but to avoid the loser. This fundamental difference in thinking is key to a successful trading "career" for the long haul.

2) Plan the trade & trade the plan
Set your mental stop loss limit at (example: 2X or 3X the premium value sold for) & execute it when reached. Period. This value is not fixed & can be adjusted depending on the individual market. This is speaking from experience. I have the battle wounds to show for. Instead of taking a small loss, I have had months of earnings wiped out for waiting too long to cut loss on not 1 but 2 occasions in 2006(N225) & 2007(ER2)....I am a slow learner.

3) Do a credit spread instead of naked options writing
For the more conservative trader, use certain percentage of your proceeds from the short option sales to buy a closer to the money option to offset the far out-of-the money short options which can partially offset your loses if the market goes against you.

Key To Financial Abundance

I came across this simple formula to achieve financial abundance. It may look simple but you would agree too that there is alot of truth in it. You cannot achieve financial abundance unless you learn and consistently apply this simple formula:

"Spend less than you earn, and invest the
difference. Then re-invest your returns for
compounded growth until you reach a
critical mass of investment capital that
creates the annual income you desire for life"

This formula will ensure that there will come a day when you never have to work another day of your life and that if you do work, it’s only because you want to!

Writing options as a strategy..A suggested Approach

Recently, I tried to explain to a friend the options writing strategy I employ with an example using crude oil. I asked him where he thinks crude oil price is going. Up..he said. Do we buy it now at $132? Maybe so, but I am more inclined to believe that the potential for significant price weakness is unlikely due to the onset of the high demand period associated with the US and European driving seasons. In other words, we’re not going to predict where prices are going. As option sellers, we don’t have to. In the current environment, it is unlikely that oil prices will fall substantially. As sellers of puts, that is all we need to profit. Rather than buy crude and risk a correction, we can sell the Aug $100 Put options for $320 against a margin of $9788 resulting in a potential gain of 3.2% gain for a 55 days play. If crude prices are anywhere above $100 per barrel at option expiration Jul 17, the seller keeps all premium as profit.

Writing options strategy in a nutshell:
1) Select markets with very clear long term bullish or bearish fundamentals. (Right now, softs, gold, dollar, market indexes to name a few examples)

2) Sell far out of the money options 2-3 months of time value in favour of these fundamentals

3) Set a risk parameter that we will strictly adhere to against every option that we sell, then sit back & wait. (This is by far the most difficult to execute. To me, its mastery over oneself & will make or break the trader)

Why do so many people always go after the home run in trading? I've seen so many over the years who are in a highly profitable position only to see the profits fade and ultimately turn into a loss all the while waiting for the big hit. Though 'thousands % gains' do occasionally occur, why not generate profits in smaller increments as well. I've heard it said that no one can get rich selling options. I disagree. Let's say you could net 1.5% per month selling those unexciting options. That would be an 18% gain in a year. Using the rule of 72 and compounding at 18%, it would take about 4 years to double your money. $10,000 could grow to $160,000 in 12 years or $100,000 to $1.6 million in 16 years. As one instructor told me, one of the great ways to make money in the markets is the same way you eat an elephant -- one bite at a time. Don't get me wrong here, I am not saying that this is the holy grail here. There are many options strategies out there. I am merely suggesting this approach for the fact that it is one that has performed most consistently for me & my clients over the past years.

How to generate Extra Income against your stock positions

Here is an idea for folks who purchased shares & intend to hold them long term for capital appreciation ....how about generating additional monthly income of 1%-2% while doing so at no additional risk given the risk one already assumed with the purchase of the stocks? One can easily do the covered call strategy which involves selling the out of the money call options against one's stocks. I actually have a friend who owns some HPQ shares purchased through the company's share purchase program.....& who does not mind selling his shares & in fact have a good till cancel (GTC) limit sell order at $50 dollars with his broker for several months already. Since HPQ stock price did not hit $50 in the recent months, his sell order did not get filled. He is still "waiting" for the price to be met. Well, instead of doing only that, he could actually sell the $50 call option at $0.5 - $0.8 every month for the past few months to generate additonal income at no additional risk. If HPQ stock price hits $50, he will get his sell order filled in addition to the premiums he had recieved in the months of waiting. In fact, since HPQ stocks has been trading in a range between $40-$49 in the recent 3 months, the additional income gained with selling call options actually lowered his cost price. Most folks I am aware of don't apply this strategy because they simply are not aware of such a strategy or they are aware but could not be bothered with because it appears complex. On the contrary, its actually very easy to set up this trade & the key thing to recognised here is that it is done so at no additional risk to the seller compared to the risk he/she already has assumed with the purchased of the stocks in the first place. As an analogy, its like owning an apartment & not renting it out while waiting for capital appreciation which may or may not happen (the risk). There are more advance strategy which involves buying a long term put option in addition to selling the short term call options as a form of insurance against steep price declines against one's stocks. This strategy which is known as the Married Put but I won't be talking about them to keep things simple. I like things simple. Are you selling call options against your stock positions positions that you intend to hold for long term capital appreciation? If not, I strongly encourage you to do so.

To Borrow or not to Borrow?

I met a friend at a recent seminar event. I found out that he was recently laid off & had a tidy sum of money which he actually used to pay off his home loan. He remarked that "Do you know how much interest they(Banks) are charging"....they'll kill you. Without knowing the specifics, I remarked that actually taking on some debts is not too bad & especially with today's low interest rates & high inflation rate situation. I proceeded to explain further with an example. Lets say you borrow $100,000 from the bank @ 3% annual interest with a duration of 1 year. At the end of the year, you will need to pay off the principal amount which is $100,000 plus $3000 of interest or $103,000 in total. Lets assume that for the year, inflation is at a high of 6% which is true today. With inflation, $1 today is worth more than $1 in the future. $100,000 borrow today is actually worth only $94,000 1 year later at 6% inflation. Even with paying off the $3000 of interest at the end of the year, the future value is only $97,000. So technically, its like you borrow $100,000 today but pay off only $97,000 1 year later. You still stand to make a profit $3000 by being a borrower. This happens because the inflation rate is higher than the interest rate (6% Vs 3%). In fact, for this example, the inflation adjusted interest rate is -2.83% [(1.03/1.06)-1]%. Coming back to my friend, an alternative option for him is to instead of paying of his loan, but perhaps invest the money for higher returns(there are risk of course). He should perhaps stay with the loan & better yet, re-finance it if he hasn't done it for a while since the bank is technically paying him interest for borrowing. There are many investments vehicles to look at such as unit trust, bonds, equities, etc depending on one's risk profile. The worst thing to do of course is to leave his money in the savings account, do nothing & not even paying off his home loan. In that latter case, he is technically paying the bank interest for leaving funds in their care. Please note that I am generalising here. A person's current life cycle, financial objectives, cash flow situation, net worth situation, & financial ratios need to be looked at in totality before we can say whats the best course of action. Its therefore best to seek professional advise regarding one's financial affairs. Example speak with a Certified Financial Planner (CFPTM) for comprehensive financial advise.

How you can thrive when oil cost $200 a barrel...

I recently picked up this book " The Coming Economic Collaspe" by Stephen Leeb....which he proves that with today's escalating historic prices of oil and gasoline, the U.S. economy is on the brink of the biggest crises it has ever faced...that for most people, the result will be severe financial hardship...but for others, it presents a once in a lifetime opportunity for investors to become incredibly rich. Its a good read for me. He reveals several things which includes skills which investors need, how to make a fortune in oil, gold, & other inflation-sensitive sectors, today's leading alternative energy stocks & more importantly, steps the government must take to immediately to avoid crippling energy shortage. I summarise below the recommended porfolio against a backdrop of escalating oil prices & high inflation or deflation if oil prices rises too rapidly.

Inflation Hedges: 50%(inflation) or 20%(deflation)

• Precious metals (gold, silver, platinum stocks)
• Energy (oil services companies, energy funds, alternative energy stocks)

Chindia: 30% (in any case)

• Large Cap American companies expanding into China & India

Deflation Hedges: 20%(inflation) or 50%(deflation)

• Zero coupons bond

Write to me if you want to know the companies or symbols against the recommended porfolio.

Is Trading the Perfect Business? Go Figure

•No employee
•No inventory
•No selling of products to friends & family
•No billing
•No shipping
•No advertising cost
•No office to maintain
•Work anywhere where a computer or an internet connection is available
•You are autonomous and do not need to check in, ask permission, consult with or answer to anybody
•Very little time is required
•Very little capital is required
•Freedom