“Quick Draws” and “No Money Down” Options

By Travis Johnson, Stock Gumshoe, April 10, 2008

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.

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April 10, 2008 4:38 pm

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 “