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The No-Brainer Secret To Weekly Income

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I want to let you in on a secret…

Wall Street doesn’t make most of its money from the stock market.

While trading equities constitute a large part of “big banking,” if you were to add the value of all the stocks in the world it would only come out $36.6 trillion.

Don’t get me wrong, that’s a big number. It’s also one reason brokerage commissions have been the bread and butter of Wall Street firms since the New York Stock Exchange was founded in 1817.

But the truth is there’s a much bigger market out there. This market, which is valued at over $790 trillion, has grown exponentially since the Securities and Exchange Commission deregulated it in the 1990s.


Unlike most stocks and bonds, which tend to be “boring” and relatively stable, the securities in this market allow investors to make bets on the outcome of certain asset prices.

You wouldn’t believe the kinds of insane bets we’ve seen traders make in this market. I’m talking about, in some cases, traders betting upwards of $55,000 that Apple or Google will trade 20% higher than where they are now in a matter of two months.

If they’re right, those investments could be worth millions of dollars. But odds are they’ll be wrong. While not impossible, it’s highly doubtful that two blue-chip stocks with market caps in excess of $100 billion will make a 20%-plus move in two months.

The far more likely scenario is that the securities those investors bought will expire worthless, and the money they spent to make these bets will go straight into the banker’s pockets. This process happens every day, and it’s one of the primary methods Wall Street uses to extract huge profits from some of its most aggressive clients.

But the best part about this market is that it’s open to everybody. You don’t have to be a multi-million-dollar hedge fund manager or a Wall Street guru to take advantage of it. All you need is a brokerage account and a few thousand dollars to get started.

Derivatives: Not As Complicated As They Seem…
I’m talking about derivatives — one of the most misunderstood markets in the financial community. Now, before you dismiss derivatives offhand, bear with me. It’s important to understand what they are, how they work — and more importantly, how they can work in your favor.

While derivatives might sound complicated, they’re really quite simple.By definition, a derivative is any security that derives its value from the performance of another underlying asset (such as a stock, bond or commodity). The value of the derivative depends on whether the underlying asset goes up or down in price.

In other words, buying a derivative is like betting on the price movement of an asset. How much the bet costs, and how much it could potentially be worth, depends on the type of derivative that the buyer purchases.

So while derivatives might come with fancy names like “swaps,” “options” and “futures,” in reality they are often used like lottery tickets by speculators — whose winnings depend on whether or not the investor correctly guessed the direction of the asset price’s movement.

At this point I want to make something perfectly clear. We don’t recommend you make these speculative bets yourself. As we said, most investors who buy derivatives are aggressive traders willing to risk a small portion of their portfolio for the chance to earn huge profits.

That’s not how we like to invest here at StreetAuthority.

Instead, we prefer to be on the other side of the trade. That is, we prefer to sell derivatives instead of buying them.

After all, much like a state gaming board gets to keep the money for all the losing lottery tickets, derivative sellers keep the profits from each contract that expires worthless, which happens the majority of the time.

Specifically, one of our favorite derivative strategies involves selling covered call options.

How Covered Calls Can Help You “Skim” Extra Income
Longtime readers have likely heard us talk about covered calls before. Those who are familiar know that a covered call strategy involves selling options (a type of derivative) on stocks that you already own.

To see how it works, consider the world’s largest silver streaming company, Wheaton Precious Metals Corp. (NYSE: WPM).

Because precious metals companies tend to be volatile, many growth investors like Wheaton Precious Metals because it offers the chance to earn big gains. But the really aggressive investors, the ones that place million-dollar bets in the derivatives markets, like Wheaton because it commands some of the highest options premiums.

Right now, shares of Silver Wheaton are trading at around $20.78. Meanwhile, December calls with a $23 strike price are trading at around $0.60 per contract (an options contract controls 100 shares of the underlying stock). That means investors are willing to “bet” $0.60 (per contract) that Wheaton will be trading above $23 when the option expires on December 15.

That means shares would need to be trading above $23.60 for the bet to be profitable ($23 plus the $0.60 the trader paid to make the bet). That means shares would have to rise to $23.60 from $20.78 in 126 days — a 13.6% gain, which may or may not happen.


But here’s where things get interesting…

Regardless of where the stock is at when the option expires, whoever sold the option to this speculative trader will get to keep the $0.60 premium as pure profit.
So, by taking the other side of this trade, you’re getting paid up front to possibly sell your shares in the future at $23. That’s a 10.7% gain from the stock’s recent price. In addition, you will have already pocketed his “bet” of $0.60 per 100 shares (or $60) — leading to a 13.6% total profit.

In this example, that means the worst thing that could happen is that you’re forced to sell your shares of Silver Wheaton at $23 apiece. But as long as you bought the shares for less than that, you’re making money.

It’s this kind of “win-win” strategy that makes the derivative markets so lucrative. Thanks to options-selling strategies like covered calls, investors are able to take advantage of the aggressive bets traders are making.

We like to think of it as “skimming” from the stock market.

Of course, a covered call strategy only works if you own the underlying shares of the stock (that’s what the “covered” part means). So if you don’t already own shares of Wheaton, or have any interest in owning them, then this trade might not make sense to you.

But remember this is just one example. The truth is, as long as the stocks you own are publicly traded, there’s a good chance that at least one aggressive investor is willing to make a wild bet on them. Why not take them up on it to earn a little extra income?

Make no mistake. The derivatives market is like a giant casino. There are thousands of investors making poor, speculative bets every day. But when you use that to your advantage with conservative strategies like covered calls, you can align yourself with the house.

And the house almost always wins.


If you want to learn more about covered calls, ProfitableTrading’s Amber Hestla has just released a brand new research report where she explains how investors are earning up $3,000 a week by utilizing this simple strategy. To learn the details of how Amber and her readers make these conservative income trades, follow this link.

Brad Briggs does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.

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The Role of Gold In Trading

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I’ve been a long time skeptic of gold and remain stubbornly bearish regarding its long term outlook.  To my mind the oft cited purposes that give it value are diminishing or gone; it’s use an alternate currency is quickly being replaced bitcoin; the ability to hedge against inflation has been spurious; and using it as store of wealth or a sage asset in case of thermonuclear war seems silly- if that’s my fear I’d rather own farm land with some cows.

But thanks to recent weakness in the dollar and macro political concerns gold has rallied some 5.5% in the past month and is now approaching the top end of a multi-year range.

And if you are to believe the recent bullish boasts and bets made by some of the highest profile money managers such as Stanley Druckenmiller, George Soros, Jeffery Gundlach and Bill Gross it should be going ever higher in the months to come.

The basis for the bull calls vary a bit but they all underpinned that as Druckenmiller stated at Sohn conference last May, “gold has traded for 5000 years and for the first time has a positive carry in many parts of the globe as bankers are now experimenting with the absurd notion of negative interest rates.”

Bottom line, one of the great knocks against gold was its inert nature and the cost to hold or store it in some fashion. Now with zero to negative rates on bonds which can at best return your original capital, gold with its theoretically unlimited upside looks increasingly attractive.

If gold can break above recent range it could potentially begin a new multi-year bull market.

But what bucket does gold as an “asset” actually fall into and what role can it play in your portfolio? Some of the key determinants were based on how you view gold to begin with; is it a currency, an inflation hedge, a safe haven, a commodity or some combination of all?  A recent article from Pension Partners provided a good overview for each of these labels.

Gold as a Currency

Since the end of the Gold standard in 1972, we see an overall correlation of -0.37 between Gold and the Dollar Index, meaning that on average Gold and the Dollar move in opposite directions.

But on average doesn’t mean always. In looking at calendar year returns, Gold and the Dollar have moved in opposite directions 75% of the time. That means in 1 out of every 4 years they are actually moving either up and down together.

And while Gold and the U.S. Dollar tend to move in opposite directions, the moves are not anything close to proportional. Since 1972, the Dollar Index has fallen 16% (-0.4% annualized) while Gold has risen 2875% (8% annualized). There is clearly more to Gold than just a falling Dollar.

Gold as a Commodity

Is Gold more of a Commodity? Let’s take a look.

Since 1972, the monthly correlation between Gold and the Thomson Reuters Equal Weight Commodity Index (CCI Index) is .39.

While Gold and Commodities tend to move together, they don’t always move together and the cumulative appreciation since 1972 has not been close to proportionate. In 31% of years Gold has moved in the opposite direction to the equal weight commodity index, with an annualized return of 8.0% for Gold versus 3.1% for the CCI Index.

Gold as an Inflation Hedge

How about Gold as an inflation hedge?

Since 1972, Gold’s 2875% advance has far surpassed the cumulative rate of inflation in the US of 480% for the overall CPI and 473% for Core CPI.

Digging in a little deeper, though, reveals that Gold is anything but a constant or proportionate inflation hedge. From 1972 through 1980, Gold surged 1256% versus a 110% increase in the CPI. During the next 20 years (from 1981 through 2000), the CPI rose 101% while Gold fell 54%.

Gold as a Safe Haven

How about Gold as a safe haven?

We know that Gold is uncorrelated to the U.S. stock market, with a monthly correlation of 0.00 since 1972.  Meaning it does provide a nice diversification from stocks but whether it’s any safer is up to debate.

The Enigma that is Gold

The truth is that Gold cannot be simply defined as a currency, commodity, inflation hedge or safe haven. At various times it has been some/all of these things and at other times none of these things.

Gold is not a pure play on any one factor but the sum product of multiple factors. If you believe the U.S. Dollar is going lower, short the U.S. dollar. Gold will likely rise but the inverse Dollar ETF (UDN) is certain to rise. If you believe commodities are going higher, go long a basket of commodities. Gold will likely rise with them but a broad-based commodity exposure (DBC) will have better odds. If you are concerned about inflation Gold may end up protecting you in the long run but as we have seen Gold can be a terrible inflation hedge in the shorter run (see 1981-2000).

Long-term bonds and stocks have actually been a much more consistent hedge against inflation than Gold over the past 40+ years. Finally, if you are seeking a safe haven – Gold may provide such an exposure at times – but the odds of that are not nearly as high as the consistency of Treasury bills/bonds.

Perhaps the most important thing we can say about Gold is that it is truly an enigma. Its behavior is unique in terms of its lack of sensitivity to economic activity and non-correlation to stocks and bonds. That uniqueness, while frustrating to those who need to explain its every move, is what make it an interesting component in a diversified portfolio.  It also makes Gold an effective baseline to which you can compare more economically sensitive commodities such as Lumber.

To extract long-term value from Gold, embrace the enigma. Leave the storytelling to those whose job it is to come up with a reason for its every move.

— Steve Smith

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Buffett Uses This Simple Strategy to Boost Returns by 10%

Buffett obviously made a great decision when he bought KO. But he still fought to get the best price possible on his buy. In at least one case, Buffett sold puts to help him get the share price he wanted.

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Among Warren Buffett’s biggest winners is Coca-Cola (NYSE: KO). Buffett owns 400 million shares of KO and paid an average price of less than $3.25 a share. Today, that stake in KO is worth about $18 billion, which means Buffett has made nearly 1,200% on his investment.

Buffett obviously made a great decision when he bought KO. But he still fought to get the best price possible on his buy. In at least one case, Buffett sold puts to help him get the share price he wanted.

In 1993, Buffett wanted to buy KO, but at a price that was about 10% below the market price. Rather than overpay, he sold put options at the price he wanted to pay and pocketed nearly $7.5 million in income while he waited for a price correction.

The good news is any investor can sell puts to bring in income after they find a stock they’d like to buy. To understand the idea, we can look at what Buffett did in a little more detail.

KO was selling for about $39 a share in the spring of 1993, and Buffett wanted to buy about 5 million shares. Based on his analysis, he was only willing to pay $35 a share. Selling put options allowed him to do just that. He created an obligation to buy 5 million shares at $35, and he was paid $1.50 per share for promising to buy KO later at that price.

Put options give the buyer the right to sell 100 shares of stock at a predetermined price — known as an “exercise price” or “strike price” — anytime until the expiration date of the options contract. The investor selling the put promises to buy the shares if the buyer of the put exercises their right to sell the stock. Put options are only exercised when the stock price is in the money, i.e., below the exercise price.

In exchange for their promise to buy the stock later for more than the market price, put sellers are paid a premium by the put buyer. For Buffett, this premium amounted to $1.50 a share for KO. If the option is not exercised, the seller keeps the premium and earns that amount as a profit on the trade. If the option is exercised, the premium reduces the cost basis. If Buffett was forced to buy KO at $35, his cost would actually be $33.50 a share when the premium is considered.

This strategy can be used with any stock that has options available, which generally includes all large-cap stocks, many mid-cap stocks and a number of ETFs.

How Traders Use It

Traders can use puts to enter long-term positions in stocks. The put premium allows them to generate income while they are waiting for a pullback in a stock they want to own. If the put is exercised, they will be buyers at a price they believe represents a fair value for the stock.

Traders can also sell puts as an income strategy. With this approach, they repeatedly sell short-term puts that will expire in less than three months and have a low probability of being exercised. When an option expires worthless, the seller keeps the premium as their profit. Options pricing models can be used to determine the probability of exercise.

Why It Matters To Traders

Selling puts can be a way to build a long-term portfolio of value stocks without overpaying. When the put is sold, you are setting a maximum price limit for your purchase. It is like buying on a limit order except that you are paid to wait for your order to be filled. With this strategy, you will only buy during pullbacks. Buying at a lower price and generating income from options premiums could lead to returns that are 5%-10% higher on positions than you would obtain by always buying at the market price.

Selling puts can also be a very effective income strategy. Most puts expire worthless, and the seller profits when that happens. It is possible to generate income of 10% or more with this strategy. Aggressive traders can use full margin to increase those returns by up to five times.

Photo: “Fortune The Most Powerful Women 2013” by Fortune Live Media is licensed under CC BY-NC-ND

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Determining the Potential Return for Your Covered Call Trades Options Strategies

When setting up a covered call trade, it is important to estimate ahead of time what that trade is likely to return.

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When setting up a covered call trade, it is important to estimate ahead of time what that trade is likely to return. Not only will this allow you to evaluate the expected return on your current trade, but it will also give you a benchmark for comparing this trade with other opportunities that may be on your radar.

I have set up a simple spreadsheet that allows me to input the necessary data to determine what a covered call setup will return if the position is called away at expiration. The sheet also tells me the amount of risk that the covered call protects me against should the stock trade lower.

Below is a screen shot of the spreadsheet, which can be easily replicated in Microsoft Excel. The blue cells represent numbers that are entered manually, and the white cells represent data calculated by the formulas.

Covered Call Rate of Return

The first three cells are fairly clear. For a covered call setup, we will enter the market price of the stock, the strike price of the call option that we are selling, and the premium (or price) of the option.

So, for the example above, we are interested in buying a stock that is currently trading at $29.03 and we are selling a call option contract with a strike price of $28 for $2.09.

Since we are buying the stock for $29.03 and selling the option contract for $2.09, our net cost is $26.94. This is also our breakeven price point for the trade. So if the stock trades down to $26.94 when the calls expire, we will wind up with a net wash on our trade while still holding our stock position.

The next cell (Net Profit) tells us how much money per share we can expect to make if the stock is called away from us when the calls expire. In the example above, we have a net cost of $26.94 and we will be obligated to sell our stock at $28 if the calls are exercised. This represents a net profit of $1.06 per share.

Net profit in nominal terms isn’t very helpful without understanding the actual percentage return. This is what the next cell is for. In this instance, our net profit of $1.06 represents a 3.93% profit over our cost basis of $26.94. Now we have some helpful information to know what level of return we can expect for the amount of capital we are investing in the trade.

The final piece of data that we need to input into the sheet is the number of days until the contract expires. This allows us to come up with a per-year rate of return estimate. There is a big difference between creating a 3.93% return over a few weeks versus the same return over a year’s time.

I have set up the formula so that I can put in the number of days until the calls expire. Then the formula takes the nominal percentage return and divides it by the number of days until expiration, and then it multiplies that return by 365 days in a year.

This formula gives us a rough per-year estimate return. It obviously doesn’t account for the ability to compound interest throughout the year, but it also doesn’t account for commissions and fees. This isn’t rocket science, but it does give us a decent estimate for an annualized return.

The final piece of the puzzle gives us the amount of protection (or risk avoidance) we receive from selling the calls. In this example, the stock can drop 7.2% before it hits our breakeven level. This can be a very helpful statistic because we can then look on the chart for the individual stock and see if the protection area coincides with a key support area.

Of course, there are many more detailed statistics that you can run on covered call setups (including volatility measures, time decay expectations, etc.), but this simple table can give you a very quick picture of what to expect for a simple covered call setup.

Image by InvestmentZen | www.investmentzen.com

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