It’s a Poor Craftsman Who Blames the Tools

by Karim Rahemtulla Expertise Expertise
warren_buffett_magnifying_glass

Earlier this month, margin debt on the New York Stock Exchange hit an all-time high, topping $528 billion. News that investors had borrowed more than half a trillion dollars to buy stocks was cited by many pundits as another sign of a market that’s gone to excess... a bubble doomed to implode any minute.

It kills me when I hear people say that trading on margin is dangerous or that options are dangerous...

So are weapons of mass destruction in the hands of a lunatic.

I could make you believe using margin and trading options are worse than black lung disease if I wanted to. And I could overwhelm you with examples of how not to use either one...

But that’s not my goal today. To be clear, I don’t advocate the use of margin by people who don’t know what they’re doing. That’s the key right there.

If you don’t know what you’re doing, don’t use margin, and don’t trade options.

It’s that simple.

I’m here to teach you, but make no mistake: I don’t want you as a subscriber, no matter how much money you could make using my service, if you don’t know what the heck you’re doing and are disinterested in learning.

But getting back to margin...

Margin trading is using other people’s money. In this case, it’s the broker’s money. It’s often referred to as “leverage.”

The brokerage firm asks you to pony up 15% or 20% - or even 50% - of the cost of a trade, and it’ll loan you the rest. It’s not unlike borrowing from your bank to buy more than you could afford paying cash.

That said, you can see how this logic could go wrong really quickly in the hands of people who like to max out their credit cards and make the minimum payments, for example.

And it matters because if the underlying trade goes against you, you’ve got to come up with more cash. That means you can rack up huge losses fast based on a very small initial outlay.

But the opposite is also true.

It’s like putting 10% down on a house. If the house is valued at $200,000 and doubles in value to $400,000, your 10% (or $20,000) has made you $200,000... or 10 times your money versus the person who paid cash. He “only” doubled his money.

The hook’s right there.

Trade Like Buffett

Unfortunately, margin has been misunderstood as a very bad word in most people’s dictionaries... kind of like options.

But if you use margin wisely and for the right reasons - like selling put options to buy shares at much-lower-than-market prices - it’s a win-win.

Warren Buffett has used this exact strategy to his advantage. He wanted to buy Burlington Northern Santa Fe, the big railroad company, back in 2009.

So he sold put options to the tune of $14.8 million.

By selling the puts, he not only collected millions of dollars (in premiums), but also insured that he’d pay a “lower than market” price for shares he had already planned to buy.

I’m sure it wasn’t the first time or the last time the Oracle of Omaha employed a put-selling strategy!

When it’s used for the right reasons (not for speculation), the results are phenomenal.

Selling puts is something we do a couple times a month in my service, Automatic Trading Millionaire. And so far, we’ve collected thousands of dollars. If you’re interested in joining us, click here.

Remember, before you can trade options, you have to understand them. Makes sense, right?

There are no free lunches on Wall Street... and no secret codes for generating cash with no strings attached.

There are, however, bona fide strategies that come close by reducing risk. And it all begins with the essential facts outlined above.

Good investing,

Karim

A version of this piece originally ran in our sister publication, Wealthy Retirement. You can go here to subscribe if you haven’t already. It’s free.

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