Take Your Risk Off the Table Without Jeopardizing Your Returns

by Karim Rahemtulla
leaps options

Is the market overvalued?

Yes. By many measures, this is one of the most overvalued markets in history. Price to earnings and earnings growth are two measures that should tell you this 9-year-old bull market is closer to the top than the bottom.

Volatility, as measured by the VIX, is showing complacency associated with market tops. (You can read my explanation of the VIX and volatility here.)

But thanks to a unique and simple strategy, you can take more than 85% of the risk off the table and still not give up an ounce of upside. Think about that. You can pull 85% of your cash out of the market but still retain the same exposure you had before.

Most investors use a stop loss of some type. At The Oxford Club, we usually recommend a stop loss of 25%. With this strategy, your upside is unlimited, but you could still lose a full quarter of your investment.

LEAPS Options: Even Safer Than Trailing Stops

With a class of options called LEAPS, you can mitigate substantial amounts of risk while still enjoying unlimited upside.

LEAPS is an acronym for Long-Term Equity Anticipation Securities. These are options that you can buy in any account, including your retirement account. They allow you to control the underlying shares for periods of up to three years.

When you consider that most investors today don’t hold stocks for more than a few months, three years is really an eternity.

These LEAPS are usually available on most established mid to large cap stocks on the Nasdaq and the NYSE. You’ll find them on companies like Apple (Nasdaq: AAPL), NVIDIA (Nasdaq: NVDA), Merck (NYSE: MRK), Barrick Gold (NYSE: ABX) and the like. You won’t find them on small cap stocks.

Let’s say you own 1,000 shares of Apple, for example. You are risking $154,000 in the market for your position. You think Apple will go to $220 in the next two years. That would be a fat return. But your 25% trailing stop means you’re willing to lose up to $38,500 if you’re wrong.

Let’s look at how a LEAPS option would work in this situation. You can buy a LEAPS that expires in 840 days (more than two years) that allows you to own Apple at $155. That option would cost you about $23 per contract. For a trade that allows you to control 1,000 shares, your cost would be $23,000.

So, right off the bat you stand to lose less than your 25% stop loss. In fact, the MOST you can lose on this trade is what you invested. Twenty-three thousand dollars is 14.9% of the $154,000 you have at risk for owning Apple shares outright. So you’ve just yanked 85% of your cash and risk off the table.

If Apple hits your $220 target, you would be up $66,000, or 42%. Your LEAPS option would be worth $65 ($220 minus the $155 strike price). You must subtract another $23 for your cost, so your net return would be $42,000 ($65,000 minus $42,000).

You’ve almost doubled your money! Sure, your actual dollar return is less than a regular stock trade... but you have 85% less at risk!

Right now, with volatility being so low, you can control 1,000 shares of a gold stock like Barrick Gold for less than $3,000. This is the right time to use LEAPs, as the market is in nosebleed territory and low volatility allows you to buy call options cheap.

The great thing about LEAPS is that even if the market corrects, you’ll still have time on your side. After all, 840 days is a long time - more than enough time for the market to correct and then resume its upward trend.

And even if it doesn’t, your risk is still limited to what you paid for the option. If the market screams higher, you know that you won’t miss out on that move. But you also know that you have the bulk of your cash squirreled away as well. That makes for a very good night’s sleep!

In my Automatic Trading Millionaire service, we use short-term options and LEAPS in unique ways to generate income with significant downside protection. You can find out how by clicking here.

Good investing,

Karim

Thoughts on this article? Leave a comment below.

 

An Options Play That Smells Great

Karim’s Automatic Trading Millionaire service uses simple, well-planned options plays to earn big gains for subscribers with little risk.

One of his latest recommendations is to sell puts on perfumer and cosmetics company Coty Inc. (NYSE: COTY).

Here’s Karim introducing the play last week...

The sector that Coty operates in is highly competitive, but it’s also one of the more interesting sectors in terms of potential growth.

Competitors in the space are seeing growth as a result of the boom in social-media-related spending, as people tend to be more concerned with how they look in pictures than ever before. I’m serious!

The boom in selfies and online dating has added to the attractiveness of the sector. Just look at the performance of companies like Revlon, Ulta and L’Oréal.

The company operates through four segments: fragrances, color cosmetics, skin and body care and a segment that sells all its products internationally. For example, the company owns rights to the beauty/fragrance segments of some major brands like Gucci, Calvin Klein, Davidoff and Beyoncé.

Despite the merger pains, the company has managed to generate positive cash flow, and the prospects of future growth once the integration is complete look very good. The numbers line up from the standpoint of our needs, so it’s time to take the plunge.

In the case of Coty, more so than our other picks, you REALLY need to use limit orders and not just chase the premium around. We’re looking at trying to get $0.30 or higher. Don’t take anything less! Be patient, because it may take a few days to get filled if it doesn’t happen today.

The stock is currently trading at $16.55. The options are bidding at $0.30 and asking at $0.34. Would you like to own it at less than $13 (adjusted cost) or get paid at least $30 per contract for trying? On a 10-contract trade, that puts you at $300 if the trade is at the bid.

Sell the Coty Inc. $13 puts expiring in February (COTY February 2018 $13 Puts) for $0.30 or higher to take in at least $300 on a 10-contract trade. To pick up more than $1,000, you would need to sell 34 contracts. Of course, you should hold out for the best price possible and get as close to the bid or between the bid and offer. The current share price for Coty is $16.55. Our adjusted cost if we get put will be $12.70, a 23% discount on the current price.

The probability of being put Coty at the $13 strike is less than 20%. The margin requirement based on a 15% margin is $195 per contract, or $1,950 for a 10-contract trade.

The potential return on margin if we are not put the shares and hold to expiration is $30/195, or 15.3% in less than five months. I expect to hold this position until expiration because of the low amount of premium.

Be sure to size your position according to your comfort level. Each contract you sell obligates you to buy Coty at $13 per share. That means you need to set aside or cover $1,300 per contract sold in the event you are put the shares.

- Samuel Taube with Karim Rahemtulla

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