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Inside the Buyer’s Mind, Part 2

By Jim Nelson, Editor, Bonner & Partners on November 3, 2014

This past week has been relatively unremarkable, other than its clear proof that investors are trying to shake off the previous month’s problems.

The S&P 500 ended the week 2.7% higher than where it started. And the Dow had three days that saw triple-digit increases.

After their dip to below 2.1% in the middle of last month, interest rates on 10-year U.S. Treasury Notes continue to climb. They now sit at 2.33%, where they were before the panic in October.

Gold – the other big “insurance policy” for investors – also dipped below its long-held $1,200 support at the end of the week.

Clearly, investors are concluding the fears of a post-QE collapse have subsided.

How do we plan on playing this market? Just like we always do… finding companies we want to own and forcing them to pay us double-digit income upfront. We have just such a play in mind. Hopefully, we’ll get a trigger this week.

Now, as promised, we have the second half of our peek inside gamblers’ minds…

A True Greedy Gamble, But Income for Us

Just like fear, greed can be a powerful motivator; instead of protecting an investment, the gambler could also speculate he will make large profits.

This is where the second half of our Endless Income Wheel strategy comes in… call options. We don’t have an example from our portfolio yet this early in beta, but we did cover both puts and calls from the seller side in your intro reports.

Looking at the buyer’s side of this trade, let’s say we have a gambler that thinks a particular stock will see its share price increase. In this case, the buyer doesn’t already own the shares. He is speculating that share prices will increase and wants to lock in his entry price. In exchange he’ll pay today for that right.

The gambler is paying for the right but not the obligation to buy your shares at a specified price. He hopes that the share price surpasses that strike price so that he’ll collect his initial gamble back and then some…but the odds aren’t necessarily in his favor.

For this example, we’ll make up a situation. Shares of XYZ are currently trading for $47. The gambler thinks share will easily pass $50 in the next month, so he’s willing to pay $1 for the chance to buy shares at $50.

If shares prices soar (past $50), he’ll have locked in his entry price and be able to take those gains immediately. But that’s not the only possible outcome…let’s take a look at all the possibilities.

1. XYZ share price could stay the same. If share prices stay the same, the gambler again will not want to buy your shares. Since he doesn’t have the obligation, he won’t be sitting at a loss on shares, but he is still sitting on a loss.

He has paid $1 per share ($100 per contract) and received nothing in return. He’s down $100 on his position in XYZ even though he doesn’t own the shares. And if he continues to place contracts he’ll be down even more. It’s a game of chasing after potential gains instead of looking for steady sure income.

2.XYZ share price could decrease. If share prices decrease, the gambler will not want to buy your shares. Again, the gambler has spent his money and did not get a payout in return.

The slight difference between this outcome and the previous outcome is that here the gambler made a smarter move than just buying shares and hoping that they would increase. Although he’s down $1, he saved himself from buying shares and sitting at a loss.

This, of course, is only the case if shares drop more than $1. If they don’t then the gambler still hasn’t gotten his money’s worth. You could argue that buying the shares and being down 50 cents per share is better than being down $1 and not even owning the shares (therefore not able to collect any dividends that may go to shareholders).

3. XYZ share price could increase. If share prices increase, the gambler is going to want to exercise his right to buy your shares. With shares over $50, he’ll be ready to lock in an entry price of $50.

He can then sell them immediately on the open market and collect a profit… well, hopefully collect a profit.

You see, the gambler needs to take into consideration the $1 per share that he spent on the call option…meaning $51 ($50 for the stock plus $1 on the call) is now his breakeven.

It’s clear here why a gambler would be interested in buying call options. The upside is unlimited. If shares, in this case, had gone to $60, his $1 would have turned into $9 ($60 minus $51).

At the same time, since he doesn’t have to buy shares, he’s protected from the downside (initially, just $1 per share vs. $47 for buying shares outright).

It’s logical until we factor in the fact that the gambler has to pay money upfront for this protection and the small chance that he will win big. He only wins the jackpot is shares rally.

Since the gambler only wins in one out of three scenarios, the odds are – as always – in the house’s favor. That’s the side we choose.

We’d love to hear if you’ve ever participated in the buying side of the options market. Did you win big? Did you lose?

Let us know by emailing us at legacytrader@members.bonnerandpartners.com.

As you can tell, we want to keep the options conversation going in these alerts. Onto this week’s topic of brokers…

Legacy Income Trader Mailbag: Broken Blitzkrieg!

Last week, we opened the conversation about how some brokers might be better prepared to deal with our strategy than others. We asked you to share with us your experiences.

Like we said then, we don’t recommend one broker over another. We have no partnerships, nor do we want them. But we can always share your opinions and experiences if you write in… and that you did.

Two for the Price of One

Mike T. writes to us:

“When I started with virtually no help from an advisory service like yours, I opened an account with Options Express. I thought I was pleased until I started selling cash-secured puts.

Turns out they charge $14.95 on the sell side and the buy side. Since I started with a small amount in the account, that eats quite a hunk of the income. (One would have to buy or sell several options to make it cost effective, but that won’t work for smaller accounts.) They also charge $8.95 for just about any size stock purchase or sale. So that is not too stiff a commission.

Then, I forget how, I discovered Interactive Brokers (IB). Their trading platform is a bit more complex and manual but the fees & commissions are miniscule for both stock and options, which makes learning their platform worth the effort.

I now keep both accounts open but IB is my primary trading account. Options Express does have some great (relatively easy to use) tools in the Tools menu. The one I like the most is “Streaming Charts” which gives actual current prices with highly accurate live bid/ask prices for both stocks and options. This is a very convenient tool and helps me place my limit bids with good results.

There is no charge for any of the tools as long as the account is open.

I am liking your service more and more as I read your updates. My accounts are still on the small side so I do not sell large numbers of puts or calls. I missed the AbbVie trade you suggested last week and closed today. I am trying to purchase more of your suggested legacy stock so as to be able to sell more covered calls.

Actually, I am using your suggestion of naming the price at which I would like to purchase. Thus, for example, last week I sold one cash covered GE Nov14 $26 put for $66. I will either be put 100 shares at $26 or will keep the $66 less the 86 cent commission. Seems like a decent way to buy legacy stock.

Thank you,

Mike T.”

Mike, thank you so much for your feedback. We’re familiar with both Options Express and Interactive Brokers. I (Jim) once used Options Express briefly, myself. And I agree that their tools are the highlight there.

We’re also very pleased you are able to use our strategy in Legacy Income Trader to boost your returns in your B&P Platinum legacy plays. We’re looking for more on that front… but that’s for another day.

Some Extra Tools to Consider

One of our most frequent responders, Joe S. adds this:

“First, I want to thank Jim, Kelly and Bonner & Partners for providing this service to all us beta testers for free during the beta test period. I understand you’re burning hours in the hopes of attracting subscribers when you are ready to open it up to the public. However, it is also obvious that you are spending time not only to find trade recommendations, but to inform and educate.

Again Thank You!

On the brokerage account question, I use TD Ameritrade. I’ve had the account for years. I added Level 1 options (no margin) about 5 years ago. It allows me to write covered calls, write cash secured puts and buy protective puts on stock positions I hold.

I’ve had my issues with TD at times, and I’ve used other brokers (boutique, full-service, as well as discount brokers). All in all I can’t complain too harshly about TD, but I also can’t rave about them either.

-Joe”

Thanks, as always, Joe! We’re quite familiar with TD Ameritrade. We’ve used it ourselves.

Just to add quickly to Joe’s suggestion, any TD Ameritrade account also gives you access to a trading platform called thinkorswim. If you have an account through them – and have at least some trading experience – we recommend you download that software.

It does a fantastic job of letting you shape and analyze trades before you ever put a dime into them. Its research tools, especially with options, are great on the research side. We often use it.

Of course, as Joe pointed out, TD Ameritrade and thinkorswim are not without their faults. Thinkorswim, especially, is not meant for novice investors it seems. Some of the language and tools are not well-explained. In fact, it might be an even more “complex and manual” (as Mike put it above) than Interactive Brokers. So be careful, if you go with this choice.

Fees and Further Study

Finally, on brokers, reader Alan writes:

“I have an account with e-trade. It’s been okay, but I’ve learned it is more expensive than some.

Just discovered Merrill Edge, which I am investigating.

Am interested in learning more about brokers and their charges.

I haven’t gotten into either recommended trade at this point. I took some time to sell some stocks to fund this, and missed the opening for BP.

The AbbVie trade is still pending, as I guess I missed that brief window of opportunity.

I am ready for the next one and looking forward to it.

-Alan”

Thanks, Alan! e-trade is definitely a big broker to consider. We have both used it and agree on the fees. But it is truly a no-nonsense online broker, without too many bells and whistles, yet with plenty of its own tools at the offer. Like you, we would need to investigate Merrill Edge ourselves before commenting.

Also, we are sorry there wasn’t much warning prior to either trade. It can often just be the nature of the beast. Our strategy doesn’t always lend itself to mounds of time before something triggers. But that’s also one of its benefits.

You see, we aren’t looking for homeruns. So missing out on a play here or there doesn’t mean you missed out on something that will make or break your portfolio. Our conservative bent, along with our “dealer-side” of the table approach, allows us to find several plays along the way.

And on that front, we definitely have something coming soon. Hopefully, you’ll be able to get in this time.

For now, you can add your voice to this subject. Or even better, let’s kick off next week’s update with any other questions or concerns you have eating at you. Send us an email at legacytrader@members.bonnerandpartners.com…

Or you can reach us on Facebook… or Twitter…

A Note on Our Conversation with Bill

As you might have seen, we sat down with Bill Bonner this week to discuss our options-selling strategy. If you are a long-time reader of Bill, you’ll know that he has strongly held opinions. Around here at Bonner & Partners, that’s common. It’s also common to challenge each other’s ideas, frequently.

Our conversation in person last week spilled over into several emails. They are still going on. In coming weeks, we’re going to share much of this conversation in these Sunday night sends. This is something Bill calls “radical transparency.” After all, his objections are likely ones you have.

So keep an eye out for that!

That’s all we have for this weekend note. This coming week, we are hoping to see some more opportunities from earnings season. Often, that’s where that extra volatility we like to capture (in the form of option premiums) comes from.

The other story to watch this week is gold. While we don’t like to ever try to “catch a falling knife,” its recent tumble below $1,200 makes it as cheap as we believe it is likely to go.

Gold 3yr 11.2.14

Source: barcharts.com

While this one could bounce, giving us any number of potential gold-related plays, we’re going to make sure. So that’s what we’re watching this week.

You’ll hear from us soon. Until then…

Sincerely,

jimsig 

Jim Nelson and Kelly Green

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