[what follows was originally published in 2012 and 2013, it has not been updated (the pitch for the service remains similar, presumably the strategy does as well) but is being brought up to the top of the page because so many readers are asking about it this week.]
It appears that Porter Stansberry is pushing for new subscribers to his Stansberry Alpha options trading service again, the first time he’s pushed very hard for this since the Winter. The spiel this time is that Porter is FURIOUS that brokers are making it tough for people to follow his strategy, and that therefore those people are angry at Porter, so he’s releasing a new special report on how to follow his strategy in more detail, and how to get broker permission.
I’ve written about Stansberry Alpha before, but it was only in the Friday File and that was way back in December — that previous ad of his gave more clues about the specific strategy, and I assume that hasn’t changed, but I thought folks might be interested in seeing how the logic of it works so I’m re-printing that Friday File piece from last December here for everyone.
Porter does not share any hints or clues about the next company that he will use as a “Stansberry Alpha” Trade, but I run through the example of Chicago Bridge & Iron below (using numbers from last December) and he has said that his focus is on companies with blue chip assets that he’s very comfortable with buying — stocks that he thinks have very limited downside, in his opinion, and by way of example (and proof of success) he mentions having recommended similar “Alpha” trades in Intel, Microsoft and Wal-Mart since the service began about eight months ago. So whatever he’s choosing next is likely to be a “blue chip” type company, and, as you’ll see in my comments below, he’s essentially taking the risk of the stock cratering and using the money he receives for taking that risk to make a bet on the stock climbing — in effect, a “double down” of a bet on one underlying stock.
What follows has not been updated in any way since it first appeared on December 12, 2012:
Here’s how Porter has been pitching this new trading service, which is priced at $2,500 a year:
“Porter Stansberry’s ALPHA* Strategy
“A Little-Known Secret of the Options Market that’s so Profitable… We’ve Never Been Willing to Share It…
“*ALPHA has been called “The Single Greatest Investing Secret” in the world’s markets. It allows investors to earn far more than normal stock investments, while actually taking less risk. Most academics will tell you it’s impossible. But the proof is right here…”
You can see the whole presentation here if you’re interested, I won’t go into every detail because he’s not teasing a specific trade on a specific stock this time around, he’s teasing a strategy that he thinks he’ll be able to recommend monthly, over and over, to profit from an “anomaly” in the markets. I’ll just share a wee bit here to give you a taste:
“Alpha is a critical anomaly that could hand you 50% to 100% gains — over and over again — with less risk than almost any trade in the world.
“This anomaly cannot be explained by the “efficient market hypothesis” ….
“I love buying world-dominating, capital-efficient businesses at deep discounts… what I call “no risk” prices.
“I’m talking about companies like Intel, Johnson & Johnson, Exelon, and Hershey.
“These are the kinds of solid stocks you want to grab when the market irrationally sells off… which it does every so often….
“… what if there was a way you could make 50% to 100% gains — every 12 months or so — on safe, conservative stocks like Hershey?
“What’s more… What if you could make these big gains, while taking LESS risk than a regular shareholder?”
So you can see why people are asking — sounds pretty awesome, right?
He does go on to describe the strategy in very general terms, and to say that it’s best for those who already have a decent pile of capital to use (he says $25,000 is a decent minimum account balance) … and that you’ll need approval from your broker, and some brokers won’t let you use this strategy. It’s some kind of options trade on the big, “blue chip” stocks (though he doesn’t use that term, I don’t think) that Porter often recommends in his regular newsletter (and in some other relatively conservative letters, like Ferris’ 12% Letter), but it is apparently not just the selling of puts, which he has tried to build newsletters around before. Here’s a bit more:
“Selling puts is still a great strategy today. You can pile up lots of single- and double-digit returns. You can inch your way to a great year….
“But here’s the thing: You won’t hit home runs just selling puts right now.
“To make outsized gains on a single trade, you need something else… You need an edge in the market.”
That edge? Well, he hints at it with talk about his first recommendation, an “Alpha” trade on Chicago Bridge & Iron (CBI):
“As a shareholder, you could do well. I’d estimate the stock could climb 20% or so in the next year alone.
“But an anomaly in the options market allows us to literally grab 18.5% in guaranteed income right now… While potentially banking 100% gains on CBI in about 12 months….
“You see, like with selling any put or call option, the Alpha trade gives you upfront income.
“In this case, the CBI Alpha trade hands you 18.5% in guaranteed income up front… to do with as you wish. You never have to return this money.
“But in addition to this upfront income, the Alpha trade also offers you a potential 108.6% return on capital by January 2014.”
OK, so I can’t tell you exactly what Porter is recommending on this CBI options trade — CBI options are already pretty liquid, so there isn’t a single options contract that stands out as getting a vast amount of interest, but it sounds very much like he’s recommending you both sell puts and buy calls at the same expiration, with presumably different strike prices to create some income.
And no, you’re not going to generate 20% returns (or 18.5%) in a year with this strategy unless you’re using margin to cover your put selling – you can’t consistently make that kind of money from a great company if your put selling is backed by cash, particularly not if you have to use some of the income to generate more upside potential.
But still, I think this is what he’s doing — he must be using some sort of margin calculation, figuring what your broker will require you to hold in cash to back up the puts you’re selling and then considering that amount (and not the margin that you have tied up in the puts) to be your investment. That’s fine if the margin doesn’t get called, but if the stock falls by 20% because the CEO is bribing the President of Mexico and stealing money for his drug habit (wild example, I suspect nothing of the sort from CBI) then there is a downside risk that has you using that margin account.
Here’s an example, with some guesses as to the kind of trades Porter could be suggesting:
CBI does have LEAP options trading for January 2014, and all of the ad language talks about returns in a year, so I assume he’s doing these kinds of long-term options with these trades — both to give you some real put selling income and to provide more time for a call option to play out and become profitable. So you could, for example, sell a put option on CBI at $35 and get income of about $2.20 for that … so that’s $220 for each options contract of 100 shares.
Then you could buy a call option on CBI for some upside exposure at that same expiration, but if you want net income to put in your pocket right now you have to spend less than $220 on it (we’re ignoring commissions to make it simple) — so let’s say you buy the $60 call options for $1.60. That’s $160 per contract, so your net income is $60 per paired contract.
What happens to the stock? It’s at $45 now, if Porter’s right and the stock goes up by 20% this year it would get to the mid-$50s, and both contracts would expire worthless, you keep your $60 and that’s it.
If the stock falls below $35, which would be a loss of more than 20%, you have to buy it (or buy back that put option you sold, and do so at a loss). If it falls below $34.40 at expiration, you’ve lost your net income of $60 and more.
So if I’m right about what Porter is suggesting, this is really just a bullish strategy to leverage your returns without committing your full capital to a position in the stock — and if you’re right about the stock doing really well you’ll make tons of money because of the leverage of those call options and the fact that you offset the cost of your call options by selling puts.
This is presuming that your broker will let you sell a put backed by margin and only set aside a portion of the cash to cover that margin, which, as Porter said, not all of them will do — and you can’t do it in a retirement account, because those accounts can’t use margin.
How much capital would it take to do this? Well, for each contract of CBI you would need the capacity to buy 100 shares of CBI at $35 to back up your sale of the put contract, so that’s $3,500. If your broker makes you set aside 50% of that you need $1,750 in cash, if he requires 20% it’s $700. I have not done this kind of trade, but I’ve seen margin quotes in that neighborhood from “regular” brokers so that’s a decent guess.
So that’s how the income numbers start to look impressive — if you start with the assumption that you’re only “investing” the $700, then $60 in income plus the potential upside from the call options (if the stock does well) sounds pretty awesome. And it’s probably a bit more than $60 in net income for the kinds of trades he’s suggesting, since he talked about 18.5% “up front” income … maybe because his recommendation has impacted the options prices, or because I guessed at the wrong contracts prices for my example.
Do keep in mind, though, that if CBI dropped to $20 for some reason (it probably won’t fall quickly by 50% or more, which is why you’d want to consider this … but “probably” is an important word) you’d have to buy it at $35, so even though your broker might have only made you commit $700 you’re still on the hook for an additional $800 from your margin account (total of $1,500, to cover buying 100 shares of the stock at $3,500 and selling it right away at $2,000). And if CBI turned out to be a scam and went bankrupt over a weekend — which, again, is extremely unlikely — then you’re on the hook for $3,500, which makes the $60 in income seem like little comfort. That’s why Porter talks a lot in the ad about doing this with the “world-dominating, capital-efficient businesses at deep discounts” that he thinks are at “‘no risk’ prices.”
And if you can get your head around that, sure, this might be an impressive strategy to juice your returns beyond basic put selling by using your put selling money to buy calls. So instead of buying the stock, you just promise to buy the stock at a lower price for a year … and then, with the money you get for that promise, you place a bet that the stock will go even higher that year. The “anomaly”, presumably, is that the put options for a stock going down by 10-20% will earn you more money than it will cost for the call options on a stock going up by 20% (or whatever the percentage is he’s using, that I don’t know). If you can indeed get a 20% margin requirement on those put sales you can certainly generate 10-20% income with this strategy with a lot of relatively volatile but strong companies — just look at the companies you are really, really confident in, see what you can earn by promising to buy the stock at a 10-20% “discount” to today’s price, and use maybe 1/2 or 1/3 of that income to buy a call option if you’re really excited about the prospects — you’ll get income and upside exposure, and you’ll also get a pretty solid chunk of somewhat hidden downside risk from your margin exposure (or a much smaller income number if you back up the put sale with cash, as you’d have to do in a retirement account).
Second example? OK, try Intel (INTC), another of the “world-dominating” stocks he mentions and one I happen to own personally. Say you’re absolutely certain that it won’t go back down below $18 again (it’s at $20.75 now) within the next year, and you’re willing to back that certainty up (and maybe would be buying the stock, no questions asked, if it fell to $18 anyway). You sell an $18 put on INTC for January 2014 for $1.40, or $140 for the contract of 100 shares. You have to have $1,800 to back up that sale, let’s say you get a pretty friendly margin requirement of 20% so you actually only have to set aside $360 in cash (20% of the $1,800). That’s a nice return of almost 40% if you ignore the fact that at least some of the margin commitment is real money at risk. Then use less than half of that to buy a call option, we’ll say the January 2014 $25 strike price for a bit under 60 cents. So that gets you a net income of 80 cents, or $80 per contract. A bit more than 20% of the $360 in cash that your broker will set aside.
If the stock falls to $17, you’re losing money … or, if you think of it philosophically, you’re spending $18 a share to buy Intel and it’s worth more than that and dammit, you don’t care that the stock market, for an irrational time, thinks it’s worth only $15 because Congress is fighting and Spain has defaulted and the whole market has crashed by 25%.
If the stock rises to $28, you don’t have to worry about that margin risk you took and you’ve booked profits of better than 100% of the cash your broker set aside (the original $80 of income, plus the $25 call option is now worth $3), and since the put option expires worthless that cash the broker set aside is just quietly returned to your regular balance. It is neat and tidy, and as long as you’re really comfortable with the margined put selling — and stick with companies where you can be 99% certain that you can get out of these trades if you want to trigger a stop loss, it certainly could be a decent way to generate both income and upside gains in a rising market. As long as you stick with companies that are big, that have a lot of options trading, are reasonably valued, and are stocks you understand and want to own…. and as long as you’re either willing to suffer heavy losses if the entire market falls by 20-30% over the coming year, or able to monitor these trades pretty closely and sell (buy back your put options) to take your lumps with stop losses on the way down.
I’m guessing that he’s keeping the price of the newsletter high because it’s an options strategy, so once you get more than a couple hundred people following this kind of strategy closely you get to impact the market enough that none of your subscribers would be able to get the prices you recommend on the options … at least not in that week following the new recommendation when most people are likely to be excited about it. And that’s really all I can do, so do keep in mind that ALL OF THE STUFF ABOVE IS MY GUESSING — I don’t know for sure that this is Porter’s strategy, nor do I have any personal experience using this kind of strategy.
P.S. We also had a long discussion about this following a reader question over the winter, you can see that long thread here if you’re curious.
Personal Capital is an advertiser with Stock Gumshoe, but Travis also uses it every day for his personal accounts and finds it invaluable. Here's what he said: "They offer a great (and genuinely FREE) 'second opinion' for your financial plan, but what I love most is their automated financial dashboard -- it will look at all your assets and debts, tally up your asset allocation, project where you'll be at retirement, and suggest ways to manage risk or improve returns. It's free, I think their free tools are great, and I think it's worth checking out -- you can do so here.