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Portfolio Margin - Useful and Dangerous Leverage

by OptionSage - February 7th, 2009 9:16 am

 

Give me a lever long enough and a place to stand and I will move the entire Earth

 - Archimedes

 

 Margin Basics

Whether you examine the property portfolio of a real estate tycoon or the portfolio of a successful private equity company, you will find a common thread that magnifies returns for each… leverage!  It is no different in the stock market.  In fact, each of us who trades options takes advantage of the leverage they afford us every day.

Leverage simply means using financial instruments, or borrowed capital, such as margin, to increase the potential return of an investment. 

Since we spend our days on the member’s site discussing leverage through options, the use of margin sometimes gets less attention than it should, so here’s a quick refresher:

 1.You CAN use margin (borrow from your broker) to purchase stock.

2. You CANNOT use margin to purchase options but there are MARGIN REQUIREMENTS for certain spread positions that we like to take.

This is intuitive when you think about the movements of options relative to those of stocks.  Options can move by 20%, 50%, 100% or more on any given day, even if the underlying stocks move just a fraction of those amounts.  In fact, the frequency with which a stock will drop 50% in price in a very short time period is so low that brokers are currently willing to lend you your entire cash reserves to purchase stock.

Example

If you were to deposit $100,000 in your account, you can borrow another $100,000 from your broker to purchase more stock.  This is represented in our account as follows:

Cash:  $100,000

Stock Buying Power:  $200,000

Option Buying Power: $100,000

Let’s assume we purchase 2,000 shares of a $100 stock, costing us $200,000.  If the stock doubles in value to $200, our $200,000 turns into $400,000 and since we borrowed $100,000 from our broker, we can pay that back with interest and keep the remaining $300,000 (minus interest).  So, the stock went up 100% and our account went up 200%%!

The benefit of margin is obvious but it doesn’t come without drawbacks.  Had the stock dropped by 50% from $100 to $50, the $200,000 would have turned into $100,000 and since $100,000 was borrowed, the broker will issue a margin call and take back its $100,000 leaving us with $0!  Hence, both the risks and rewards are magnified if we fully use margin under the current system.

Margin Calls

Despite its potential rewards, buying on margin can be very risky. For example, the value…
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Posted in Appears on main page, Education, Immediately available to public | 1 Comment »


The Dawn Breaks…

by OptionSage - January 19th, 2009 11:47 pm

The hammer dropped Thursday.  The market held firm Friday.  And this next week will be seen in retrospect as the week the market bottomed out and started to rise again - at least for quarter 1 2009. 

Detractors might argue that Circuit City is laying off thousands and Bank of America might be closing locations and commercial real estate is dead and shopping malls are vacant and….

And it may all be true.  But the beauty of integrating fundamental and economic analysis with technical and sentimental analysis is that the big picture appears.  The fundamentals of many stocks are certainly impaired.  Even Kudlow will find it hard to argue in favor of a bullish economy.  But the sentiment is changing.  Watch the VIX over the next few months.  I anticipate it will be lower by March than where it is now even if not within the next few days.  And the technical charts tell stories once you know how to read them.  The news is reflected in the charts and the story the charts tell is bullish.  The markets should go higher in the next few months. 

Can I be certain?  With 100% probability, no!  But actions speak louder than words.  And as the dawn breaks on the coming week I plan on backing the rhetoric with purchases and those purchases shall be on the SSO to amplify the expected gains.  And what of Gold…Gold goes higher too.  Time to get on board the train to $1,000/oz.

To confidently predict direction is not enough.  I need to know I can figure out how to protect myself if I am wrong.  That’s how I made money in 2008 when most lost their shirts.  All you need is a system that works.  And the system I use I also teach.  If you’re interested you too can thrive and prosper.



Posted in Education, Uncategorized | No Comments »


Bankster Quotations

by OptionSage - January 17th, 2009 1:47 am

"If the American people ever allow private banks to control the issuance of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the people of all their property until their children will wake up homeless on the continent their fathers conquered."  Thomas Jefferson
 
"I sincerely believe that banking institutions are more dangerous to our liberties than standing armies.  The issuing power should be taken from the banks and restored to the people to whom it properly belongs"  Thomas Jefferson
 
"History records that the money changers have used every form of abuse, intrigue, deceit and violent means possible to maintain their control over governments by controlling money and its issuance" James Madison
  
"Most americans have no real understanding of the operation of the international moneylenders…the accounts of the Federal Reserve System have never been audited.  It operates outside the control of congress and manipulates the credit of the United States." Sen Barry Goldwater
 
"Neither a borrower nor a lender be" (Shakespeare)
 
"The Federal Reserve definitely caused the Great Depression by contracting the amount of currency in circulation by one third from 1929 to 1933"  Milton Friedman
 
"If our nation can issue a dollar bond it can issue a dollar bill.  The element that makes the bond good make the bill good also.  The difference between the bond and the bill is the bond lets money brokers collect twice the amount of the bond and an additional 20% whereas the currency pays nobody but those who contribute directly in some useful way"  Thomas Edison
 
"It is absurd to say that our country can issue $30m in bonds and not $30m in currency.  Both are promises to pay, but one promise fattens the usurers and the other helps the people"  Thomas Edison
 
"We have come to be one of the worst ruled, one of the most completely controlled governments in the civilized world - no longer a government of free opinion, no longer a government..by a vote of majority, but a government by the opinion and duress of a small group of dominant men" President Woodrow Wilson
 
"The Federal Reserve Board has pumped so many billions of dollars into Germany that they dare not name the total"  Senator Louis McFadden prior to WWII
 
"The powers of financial capitalism had (a) far-reaching aim, nothing less than to create a world system of financial control in private hands able to dominate the political system of…
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Strategies To Hedge Your Portfolio

by Phil - January 16th, 2009 6:51 pm

 

 

Warren Buffett’s Rule #1 of investing is: “Don’t lose money” and the integral part of succeeding at Rule #1 is hedging one’s portfolio.  The question then is: “How do we hedge our portfolios?” 

 

In order to set a context for explaining strategies let’s briefly revisit the Golden Rule of Investing.

 

 

The Golden Rule of Investing

 

 “The more uncertain you are about a position, the more you should hedge your position!”

 

This might be worth sticking right next to Phil’s favorite post-its that state:

 

“It is NOT my Job to Save the Market”

 

and:

 

"When in Doubt - Sell Half"

 

 

Before we figure out how to hedge, let’s evaluate how certain we are of the current direction of the market. On Monday Phil raised concerns over the pending $2Tn Deficit that is predicted that the energy sector would take us down this week (it did) even while calling a bottom on oil at $35 and looking to pick up stocks on our Buy List on the way down.  Obviously the market itself  is all over the place and, while we may guess well, we simply can’t be sure of the direction. 

 

The VIX is a testimony to this, finishing the day at 46.11, still historically way above average and indicating tremendous amounts of market uncertainty.  And we got the drop we were looking for this week and Phil extolled people to buy off THE LIST during both Wednesday and Thursday’s very scary sessions.  When markets drop precipitously, traders generally fall into one of three categories;

 

[1] Panic Sellers [2] Knife catchers and [3] Hedged traders.

 

Panic sellers usually attain instant relief as fear overwhelms them, knife catchers usually experience prolonged pain as hope and greed outweigh fear while hedged traders usually operate at that intersection between greed and fear; they’ve seen it all before and nothing riles them – that’s us (in theory!).

 

Trying to time your entries and exits correctly is always a guessing game.  Here’s a nice video discussing some chart patterns you can look for to identify fear and greed in the markets.

 

Since our portfolios are always hedged (or certainly should be!), we have much less fear of the market no matter which way it moves. Obviously after such a significant market downturn, fear is paramount, uncertainty is at a peak and hedging should be a trader’s top priority because as Phil once mentioned: 

 

“Nobody wants you to get out of stocks, not your broker (he wants the commissions), not the media (if you don’t have stocks, why watch CNBC?), not the analysts (same ratings issue) and not the newsletter writers who want you to keep in the markets…
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Profiting from Short Strangles - Part 1, the Basics

by Phil - January 15th, 2009 3:57 am

Peter D Submits:
 
The Short Strangle strategy becomes more attractive with the volatility remaining at historically high level. Part 1 of this article describes the strategy basics, including the complex margin requirement that changes with the underlying stock movement. We’ll deal with the Short Strangle adjustments, as well as how to use Short Strangle if you are an active trader in subsequent parts of the article. If you have been investing in Money Market or Certificate Deposits, then this is the perfect strategy to at least triple your return with manageable risks. 
 
1- The Basics
 
 
The Short Strangle is a neutral position. The investor will profit from the position if the stock stays stagnant and expires within the profitable range.
 
- Sell (short) out-of-the-money (OTM) CALL(s) in a selected target month.
- Sell (short) the same number of out-of-the-money (OTM) PUT(s) for the same month.
- The maximum profit is the net credit (total premiums received).
- The maximum risk is infinite in either direction (infinite to 0 on the put side/decline).
- The position has both an upper break even and a lower break even.
- Profit is realized if the stock price remains between the upper and lower break even points.
 
 
2- Example Spread:
 
Since the maximum risk is infinite in either direction, the most critical factor is to select the underlying stock that doesn’t go to zero or infinite in a hurry. The best hedge is to use a basket of stocks using ETFs. The favorites are SPY, DIA, QQQQ, and IWM.
 
Note that margin is not usually allowed retirement accounts, so selling Short Strangle would not work well for retirement accounts.
 
Let’s look at a practical “Strangle a Spy” example (thanks to GabbyH, the 85 years old PSW member for the catchy phrase) for prices at the close of 1/9/2009:
 
  • Sell SPY Feb 70 PUT (20% downside cushion) and Sell SPY Feb 105 CALL (17% upside cushion) for $0.81 credit. For safety reason, we should have a stop in place for when SPY reaches the strikes that we sold.
  • The margin requirement ATM is $8.9 for the SPY closing price of $89, meaning we need $8.9 in cash to be able to sell the Short Strangle above.
  • The margin requirement increases to approximately $24.2 if SPY rallies to $105 the next day, and it also increases to $18.4 if SPY drops to $70 (See below for margin calculation rules).
  • For profit calculation, let’s conservatively take the highest margin requirement of $24.2, giving us a maximum profit of 3.35% in…
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Posted in Appears on main page, Education, Uncategorized | 5 Comments »


Danger + Opportunity

by OptionSage - December 20th, 2008 2:19 pm

 

As 2007 drew to a close, Phil predicted ‘Asian-style’ moves in US indexes and I wrote an article projecting 2008 would be a very difficult year to trade due to ‘unprecedented volatility’. As 2008 draws to a close it looks like both predictions were realized but pleasure does not necessarily accompany vindication. As John Maynard Keynes wrote: 
“It is usually better to be conventionally wrong than unconventionally right”
In short, when you are right about bad news, little benefit is experienced because so many will have suffered whereas being wrong with the crowd means comfort in numbers.
As I watched CNBC’s Year in Review last night I was struck by how many times the commentators noted that nobody could have foreseen the carnage. In fact, many were anticipating a recovery in the middle of the year including Hank Paulson! When history judges such projections unfavorably, credibility quickly diminishes. And in the financial industry, credibility is more important than almost any other criterion. With the credibility of so many in tatters, the onus is on you the individual to acquire the financial knowledge necessary to protect your own portfolio and to anticipate the future based on facts rather than on opinions.
For example, if we were to evaluate the current economic situation with that of the 1930s we might find interesting comparisons that would lead us to be concerned about the future. For example, the 1930s manufacturing based economy has largely been replaced by a services economy, home owners have been replaced by home borrowers, a national surplus has been replaced by a national deficit, and a reliance on saving has been replaced by a reliance on credit. Counter arguments could be made such as the US, unlike many countries which have experienced economic turmoil, has a substantial capability to be self-sufficient, university education is world class, and an indomitable spirit of optimism pervades the culture.
This same spirit can be the catalyst to success in spite of the perils that may lie ahead. It is well known that in Chinese the word crisis is written as a composition of symbols representing ‘danger’ and ‘opportunity’. But preparation is a pre-requisite to taking advantage of opportunity. So, although the danger may be high, opportunities will present for those who are prepared. And to truly be prepared one must have the knowledge necessary to succeed. The entire faculty of traders at Stock and Options Training are still in the black in ’08. And frankly we’re feeling a little guilty that we’re in…
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Posted in Education, Immediately available to public | No Comments »


Danger + Opportunity

by OptionSage - December 20th, 2008 2:16 pm

 As 2007 drew to a close, Phil predicted ‘Asian-style’ moves in US indexes and I wrote an article projecting 2008 would be a very difficult year to trade due to ‘unprecedented volatility’. As 2008 draws to a close it looks like both predictions were realized but pleasure does not necessarily accompany vindication. As John Maynard Keynes wrote: 

“It is usually better to be conventionally wrong than unconventionally right”
In short, when you are right about bad news, little benefit is experienced because so many will have suffered whereas being wrong with the crowd means comfort in numbers.
As I watched CNBC’s Year in Review last night I was struck by how many times the commentators noted that nobody could have foreseen the carnage. In fact, many were anticipating a recovery in the middle of the year including Hank Paulson! When history judges such projections unfavorably, credibility quickly diminishes. And in the financial industry, credibility is more important than almost any other criterion. With the credibility of so many in tatters, the onus is on you the individual to acquire the financial knowledge necessary to protect your own portfolio and to anticipate the future based on facts rather than on opinions.
For example, if we were to evaluate the current economic situation with that of the 1930s we might find interesting comparisons that would lead us to be concerned about the future. For example, the 1930s manufacturing based economy has largely been replaced by a services economy, home owners have been replaced by home borrowers, a national surplus has been replaced by a national deficit, and a reliance on saving has been replaced by a reliance on credit. Counter arguments could be made such as the US, unlike many countries which have experienced economic turmoil, has a substantial capability to be self-sufficient, university education is world class, and an indomitable spirit of optimism pervades the culture.
This same spirit can be the catalyst to success in spite of the perils that may lie ahead. It is well known that in Chinese the word crisis is written as a composition of symbols representing ‘danger’ and ‘opportunity’. But preparation is a pre-requisite to taking advantage of opportunity. So, although the danger may be high, opportunities will present for those who are prepared. And to truly be prepared one must have the knowledge necessary to succeed. The entire faculty of traders at Stock and Options Training are still in the black in ’08. And frankly we’re feeling a little guilty that we’re in the…
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A MUST Read!

by OptionSage - October 3rd, 2008 11:06 pm

"Life will teach you the lessons, it’s up to you to learn them"  

Don’t read any further if you are happy with your trading results this year.

If you know in your heart you could have done better trading this year then you MUST learn a lesson from your trading performance.  You MUST or are you are destined to repeat it again.  And if it feels painful the first time, it will feel much more painful next time around!  The lesson you MUST learn is simple but immensely powerful; it is truly a paradigm shift in trading. 

You MUST learn to adjust your trades to the market trend.  That’s it.  If you understand what that means and how to successfully execute, read no further.

What does this ‘adjusting’ really mean?  It means no longer buying and hoping, it means no longer is a binary trading system appropriate; binary meaning no longer will you win if you are right and lose if you are wrong.  What if you could screw up on picking the direction and still win??  Well, you can when you know how to ‘adjust’  to the market trend. 

The power of knowing how to successfully and competently adjust is immeasurable.  At the very least what it accomplishes is ZERO fear and ZERO greed.  When you pre-define your risk and reward levels prior to every trade AND know exactly what Contingency Exit Plan you should execute EVEN if you are wrong, you reach a trading level few will ever conceive of - let alone reach. 

You can learn how to do this from the masters but the knowledge is guarded by most and the cost to learn is usually very expensive because you will rarely be told everything at first (and will be charged more to learn the rest!).

So, why am I telling you all this?  Because I paid the price.  I learned a most powerful trading system of adjustments which I am confident is truly the last trading system anybody needs to know.  I learned it so well, I was invited to start hedge funds and teach around the world.  But as the days went by this past year and I realized how tough trading was for many friends and how they were losing their shirts I decided I had to get the knowledge to everyone without them paying crazy fees. 

And then BAM!  Like lightning the idea came to me and I started Stock and Options Training, a company  where real traders like you can learn…
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Posted in Education | 11 Comments »


Wednesday Wipe Out

by Phil - September 17th, 2008 10:27 pm

Can the VIX top 37 for the first time since 2002?

This was a very painful day.  Thank goodness for gold, that hedge was working today even as the trusty SKFs were up a relatively dull $15.  As I expected in the morning post, oil took off as well, closing up near $97, up 5% for the day (less than gold) after a fairly large net draw of 9M+ barrels in the inventory report.  They’ve been telling us high oil prices were good for the economy on CNBC but we’re not seeing it today.

Copper made relatively no move, indicating the jumps in both oil and gold had nothing at all to do with improvements in global demand, just a search for something that would retain some value as the market collapsed and not even money market funds were safe (Reserve Primary Fund is down to .97 on the dollar).

Cramer says "Don’t push the panic button" but it seems like someone already gave it at least a nudge with even GS dropping 19% on the day.  The Dow is down 7.1% for the week and all 30 components were red today led by AIG (-45.3%), JPM (-12.2%) and C (-10.9%).  The Nasdaq finished down at the 5% rule at 2,098, not a good thing at all and the S&P was down 4.7% at 1,156, down 7.6% for the week.  Things were bad enough that the SEC issued rules to curb short selling but they did little to cheer investors up and we closed at the lows of the day.

Europe dropped about 2% today and Russia, who’s market is in massive decline (57% off highs), halted trading for the second day in a row, just 90 minutes after opening so the rise in gold is not a US-only issue, everybody in the World is scrambling to find something that isn’t failing. "Forget about retail investors, all the pros are scared," says one broker. "People have no idea where to put their money."

"It’s unclear who is going to be a credit provider going forward, and if having fewer credit providers means higher costs of borrowing going forward," says Basil Williams, chief executive of hedge-fund managers Concordia Advisors.   Investors tried to reduce their exposures to two more big players in the market, Goldman Sachs and Morgan Stanley. That sent the cost of protection on both Wall Street firms soaring to new highs.

Since the AIG rescue did not protect…
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Posted in Education, Uncategorized | 14 Comments »


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Phil's Favorites

"Today I Think Of Myself As A Government Contractor......"

September 17th, 2009 4:39 pm

"Today I Think Of Myself As A Government Contractor......"

Courtesy of Jan-Martin Feddersen at Immobilienblasen

When you here this kind of quote in context with the mortgage business it should be clear that in the not so distant future another not so "insignificant" bailout is already in the cards..... Looks like the Phony Mae & Fraudie Mac pain wasn´t enough.......

No Easy Exit for Government as Housing Market's Savior WSJ

After a year of extraordinary interventions in the economy, the federal government is st...

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Zero Hedge

Dear FINRA: Pick The "Natural" IOI Out

November 17th, 2009 10:53 am

Courtesy of Tyler Durden

Dear FINRA,

We know you are busy, we also know you are hell bent on intercepting IOI manipulation as per Mr. Jon Kroeper's recent media appearances. Which is why we kindly request that you get back to us at your earliest convenience with information on how many of the IOIs disclosed below are, in fact, "natural." We will make this a recurring topic on Zero Hedge until such time as you respond to our information request. You can contact us at outsourcefinra@zerohedge.com

We appreciate your prompt attention to the matter

Zero Hedge staff.

more from Tyler

Chart School

Never Have So Many Stocks Been So Stretched Above Their 200ma.

September 17th, 2009 2:02 pm

More on the subject of overbought stocksm by Rob Hanna at Quantifiable Edges. H/t to The Pragmatic Capitalist. 

My question: are conditions comparable between now and the four other instances of spiking overbought readings that Rob charts below? - Ilene

Never Have So Many Stocks Been So Stretched Above Their 200ma.

Courtesy of Rob's Quantifiable Edges

Near the end of August I discussed that some of the breadth measures tracked by Worden...

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Trading Goddess

Pivotfarm Support and Resistance Levels 9th February 2009

February 8th, 2010 9:13pm

After dropping from the 1063.75-1064.25 PowerZone just before stocks opened on Monday, the ES was sold on the open and fell to the 1056.25-1055.50 PowerZone.
As stated last night: "if a pullback can hold the
initial support, the up-trends will remain intact and
the market should head back up."
That was reversed and after getting over the 1063.50-1064.00 area the move continued to a 1068.50 high. After a small dip, a 123 top set up from 1068.00 and the ES dropped to the new support at 1064.00-1063.50 zone. A bounce failed at 1067.00 and that was it for the upside. The market rolled over and all of the bounces failed as the ES went trend-down to 1053.00 at the 4pm close for stocks.
The early rally off of a good support area was sold on Monday, and for the second half of the day it was all down hill. After the Friday run-up, that was not impressive for a follow-up. The market is back into oversold status, but for now it looks lik...

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Oxen Group Trades

The Oxen Report: The Tech Money Making Pick You Didn't Know

September 16th, 2009 8:19 am

Tuesday was good and bad for the Oxen Report. Our short sale of the day worked very well for us. I chose Ultrashort Proshares Oil and Gas for our short sale of the day due to my expectation...



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The Options Report

By Andrew Wilkinson


Popular Bank Shares Surge as Option Player Stakes a Claim

September 16th, 2009 9:25 pm

Today’s tickers: BPOP, LNCR, EEM, XLK, XL, PALM, LIZ & MI

BPOP - The ‘popular’ bank popped up on our screens this afternoon after a large-volume risk reversal was established on the stock. The massive trade was likely the work of an investor with knowledge of commercial banks as approximately 60,000 contracts were exchanged on BPOP amid a more than 12% rally in shares of the underlying to $2.60. It appears the trader purchased 30,000 now in-the-money October 2.5 strike calls for an average premium of 33 cents apiece. He funded the purchase of the calls by selling 30,000 puts at the January 2.5 strike for 43 cents each. The investor received a net credit on the transaction of 10 pennies per contract. The motivation is perhaps that this individual is swimming with the rising tide of financial names today and expects a far larger...



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Insider Zone


INSIDERS AREN’T THE ONLY ONES BOYCOTTING THEIR OWN SHARES

September 16th, 2009 9:45 am

Click here for a FREE, 90-day trial subscription to our PSW Report!

INSIDERS AREN’T THE ONLY ONES BOYCOTTING THEIR OWN SHARES

Courtesy of The Pragmatic Capitalist

Insiders aren’t the only ones who aren’t buying their own shares.  According to S&P U.S. corporations have reduced buybacks of their own shares to levels that haven’t been seen since 1998.  Bloomberg reports:

U.S. companies spent the least on share buybacks in the second quarter since at least 1998, S&P said, as the recession crimped earnings.St...


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OpTrader


Swing trading portfolio - Week of September 14 th 2009

September 13th, 2009 11:08 pm

This post is for live trades and daily comments. 

To learn more about the swing trading portfolio (strategy, membership etc.), please click here

- Optrader

...

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Philip R. Davis is a founder Phil's Stock World, a stock and options trading site that teaches the art of options trading to newcomers and devises advanced strategies for expert traders...

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