“Quick Draws” and “No Money Down” Options

This is a new email that people have been sending my way over the past few hours, but for those of you who’ve been around Gumshoedom for a while it will probably sound familiar.

The ad is for Jeff Clark’s Advanced Income service from Stansberry & Associates, and it touts two special reports that describe options trading strategies that he uses to make money for his subscribers.

The first is “Quick Draws”, which are a way of pulling lump sums of income out of stocks on a regular basis. By the description, this must be exactly the same call-selling strategy that he’s been touting for much of the past year, through techniques that were previously sold as “California Overnight Dividends” and “Transfer Dividends.”

You can follow those links to the prior descriptions of the service, which was sold using many of the same testimonials (or at least, they sounded the same to me). The short analysis is that selling covered calls is, as many of you already know, a perfectly reasonable income strategy and a well-respected way to smooth your returns.

The one thing that often surprises small investors, after reading ads like this that promise the moon through this strategy, is that this kind of trading requires a fair amount of capital to start — and it requires a significant level of personal investing discipline, you have to be committed to the trade, not likely to get off track from your plan or start reaching for greater short-term returns than can be gained by selling calls. You see, you have to own the shares to sell calls against them, and you can’t sell the shares while the options are outstanding, so you do have to have a significant amount of capital tied up in holdings of stocks that work well with this option strategy. If that doesn’t make sense to you, go back and read the California Overnight Dividends piece I did last summer, I think I provided some more examples and details there.

The other strategy he’s touting here is a little bit less fleshed-out, but he calls it “No Money Down” options trading. This very likely gets into a more advanced level of options trading, since they say that you don’t have to put any money down to start getting your income.

To me, though as I said, the details are sketchy, it sounds like a description of selling puts (or possibly some kind of shorting of options, if you want to get to a second level of complexity). Depending on your broker that will require you to commit money or to have margin available, but you won’t be really investing your capital — when you sell a put, you’re entering into a contract to buy a particular stock at a particular price at any point before a set date.

So that means you’re essentially providing insurance services for someone else — if someone is buying a put option, they are either betting that the stock is going to go down or they hold the stock and they want a bit of insurance in case it falls too far too fast. The person that sells the put to them, perhaps you in this strategy, is on the other side of that contract.

The downside of selling puts, if you’re not doing anything to hedge that position, is that if the stock craters you will be obligated to pay that contract price for the shares, even if they’ve fallen far further … so you need to pick a stock that you know won’t crater.

Really know. And be careful , it was less than a year ago that people would have said a safe one for this strategy would be something like Citigroup, since it was huge and stable and had a great dividend.

It’s perfectly possible, even probable, that Jeff Clark’s income strategies are more complex than this — he may be using straddles or strangles, or he may be selling short either puts or calls in various situations. Advanced options trading like this is certainly an option for many people, but it does carry more risk, in most situations, than is implied by the ad (and by all ads for like services that I’ve seen). I wouldn’t tell anyone to avoid a particular strategy, but I would suggest, if you’re interested in this Advanced Income or in any of the other options trading services, that you get out on your own and study up on options a bit first — if you go into any service like this without an options education, you’ll probably be disappointed. And if you get the education first, you might just decide that you don’t need a trading service for the level of options trading that’s appropriate for you.

One good place to start learning about options is the CBOE — they have an options learning website that’s pretty good (it’s free — the CBOE is a major options exchange). The Motley Fool also did a pretty good series on options last year (they also would like to sell you newsletters, though they don’t offer options trading services). Your broker also probably has educational materials.

And I know that there are several covered call sellers in my readership, and plenty of folks who use options trading strategies of one stripe or another, mostly for making speculative bets with relatively small investments or to sell puts to insure against losses in their portfolios … if any of you would like to share your strategies, resources, or advice, I’m sure everyone would be happy to hear.

full disclosure: I don’t own any investments mentioned here, though I do trade in options to a limited degree and I do own shares of the Chicago Mercantile Exchange (CME), parent company of CBOE.

The author will always disclose any direct long or short equity, debt or option position in any stocks written about as of the day of publication, and will not trade in any stocks mentioned for three days (72 hours) after publication. Full disclaimer is at the bottom of the page.

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1. I’m not exactly sure what is meant by “no money down” options either, but here’s a guess. There’s an option technique I use occasionally in commodity futures trading called a “bull call spread with a naked leg”. The strategy involves buying an option spread, usually buying an at-the-money call, selling a call 2-4 strikes above the call you bought, and selling an out-of-the-money put. The sale of the put covers the cost of the option spread, so there’s “no money down”. HOWEVER, not only are there additional costs (3 commissions), you’ll have to put up margin on the put you sold. So I’m not absolutely sure that this is what he’s referring to. You’d do the opposite if you were bearish. That is, you’d buy an at-the-money put, sell a put 2-4 strikes below and sell an out-of-the-money call to bring in premium to pay for the put you bought. These trades have limited reward and unlimited theoretical risk; and it’s trading, not investing.

   [Reply]

   Posted by spreadtrader | April 10, 2008, 4:38 pm

2. Credit Speads are a great way to make money, but you need to trade approximately 10 – 15 spreads a month in order to be successful; that would mean making all the work worth the while. I got hooked on them in 2006 and did very well…with one caveat: my IRS Schedule D ended up looking like a workbook for an SEC licensing class. Remember, each side of the spread is a separate trade under the buy and sell rules.

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   Posted by Treasurewave | April 11, 2008, 9:30 am

3. What ever happened to simplicity? Oh that’s right, keep it complicated so folks become intimidated, willing to shell out money to avoid feeling inadequate. The investment news letters and their crafty authors certainly know how to find the low hanging fruit. Thank God for our Stock Gumshoe. Thank God there is some common sense left out there.

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   Posted by Captain Obvious | April 11, 2008, 9:42 am

4. As usual it is BUYER BEWARE. It is amazing to me how much spin advertisers are allowed to get away with in this world. It is no wonder that people who aren’t very wary(and there are tons of them) lose money and things that are too good to be true all the time.

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   Posted by WendyG | April 11, 2008, 10:22 am

5. My impression was he is still touting covered calls which appears his specialty. If you write puts, you have to post enough margin in cash if the buyer pulls the stock away to sell it at the lower price. This would be money down. Writing puts is the inverse of writing calls.
   Selling covered calls works if you can a percent difference between the premium sale that is higher than the difference between the strike price and the stock price. The advantage is the money is yours,but you have to leave your stock as security until expiration of the option in case the buyer pulls the stock away(exercise). This could supply a steadt flow of income if your stock position is large enough.

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   Posted by G IMBURG | April 11, 2008, 11:50 am

6. I made a mistake. If the holder of the put exercises,and buys the stock back at the lower price,he reaps the difference between the strike price and the lower stock price which is placed back in the sellers account.Sorry.

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   Posted by G IMBURG | April 11, 2008, 12:00 pm

7. I suspect this is aimed at those that only moderately understand it. Buyer beware – if you don’t understand it, don’t invest in it.

   Best Wishes,
   D4L

   [Reply]

   Posted by Dividends4Life | April 11, 2008, 12:41 pm

8. Does anyone know about a new letter called “FDA Report Trader Alerts”? This was teased on Agora Financial’s site, written by Dr. George Huang. Apparently he has an inside track on companies that will get “approvable letters” from the FDA, thus sending the stock price up.

   Thanks for any info or comments

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   Posted by sstuartmd | April 11, 2008, 1:51 pm

9. I also would like to know about Agora Financial, Dr. Huang’s F.D.A. Report teased at $ 1200 Report
   Richard

   [Reply]

   Posted by Richard E. Lowman | April 11, 2008, 2:41 pm

10. Stansberry does provide a couple of articles to review on these type of plays.

    [Reply]

    Posted by JohnnnyB | April 11, 2008, 2:43 pm

11. I am trying to find info about Gryphon Financial; they have some pretty wild claims – Hedge Fund Trader, Genome Trader that produce some huge gains etc, but I can’t find too much online; I did find a copyright infringement dogfight with Taipan but that’s all. They say thet are unbeatable, can anybody say Yay or Nay, er, No?
    Jim

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    Posted by jim duross | April 11, 2008, 7:46 pm

12. “On Monday April 7, this California-based Internet firm made “Quick Draws” available to any shareholders who wanted them. If you owned just 500 shares of Yahoo!, you could have pocketed $6,725 less than 24 hours after requesting it…”

    “First, “Quick Draws” are only available on about one third of the publicly traded companies in the market.”

    “The third reason you’ve probably never heard of this investment before is because for years, “Quick Draws” were basically off-limits to individuals like you and me – available only to wealthy money managers.”

    [Reply]

    Posted by steelgtr | April 12, 2008, 12:26 am

13. steelgtr, that’s certainly the covered call selling strategy — the key is, of course, that you would have had to buy 500 shares of Yahoo first, so you tie up a bunch of cash, and you have to hold those shares through options expiration even if they go down dramatically. And to make that much of a premium (1,250 per call, or $12.50 per share) you would have had to sell “in the money” options that can be called at any time. I don’t know what the premiums were last week, but that’s probably an April or May 17.50 call, I’m guessing. Which means that most of the cash you get in that “quick draw” is just a return of your capital, only about $2 is profit, or about $600. This assumes that you bought the shares at $28, then sold the $17.50 call for $12.50 a share, which means you’re essentially selling your shares at $30. You do get that $600 profit, before short term capital gains taxes, but only about 10% of that much-more-impressive-sounding $6,750 is actually your profit. As long as the shares stay above $28 until the expiration date, you keep that profit on your books, so it is a nice way to get a small 4% profit in a short time period (you initially put up $14,000 to buy the shares, remember), but it’s a strategy for using capital to generate short term yields, not a strategy for getting rich quickly. You’re not likely to lose much money, since the call is so deep in the money, but if Microsoft raises the offer to $35 in a surprise move next week, you’ll get none of that gain — you essentially already bought at $28 and have no potential “upside” above $30.

    [Reply]

    Posted by StockGumshoe | April 12, 2008, 6:37 am

14. I, too, would appreciate some information upon the Dr. Heung’s approvable letter scenario. He virtually guarantees a return of at least 200% on your money on his companies who are medically related.

    He lists many dates between now and November when various different companies are to receive approvable letters according to SEC. His first such date is April 30, 2008.

    Thanks,

    Jerry

    [Reply]

    Posted by jerry | April 12, 2008, 2:09 pm

15. Can you help with this gumshoe?

    [Reply]

    Posted by gerald | April 12, 2008, 8:41 pm