What is “Stansberry Alpha?”

By Travis Johnson, Stock Gumshoe, June 27, 2014

[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.

Are you getting our free Daily Update
"reveal" emails? If not,
just click here...


“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.


Irregulars Quick Take

Paid members get a quick summary of the stocks teased and our thoughts here. Join as a Stock Gumshoe Irregular today (already a member? Log in)
guest

12345

This site uses Akismet to reduce spam. Learn how your comment data is processed.

54 Comments
Inline Feedbacks
View all comments
Carolyn
Carolyn
7 years ago

If any of the stockgumshoe brigade can give me some advice. I got caught up in the exuberance of the covered call strategy and now find my stock is about to be called away. the stock price and hence call value is well above the strike price. What to do? Amateurs like me should have an exit strategy but alas not me.

Add a Topic
5971
Add a Topic
5971
Michael Hassan
7 years ago
Reply to  Carolyn

Hi Carolyn,

I”m relatively new at options but I believe I know the answer to your question. You sold a call on your stock and received a premium. The way to unwind that position is to buy a call back again. It could cost you more money to buy it back (now that the stock has risen) but if you feel confident you can overcome that loss by holding the rapidly appreciating stock, then do so. If it costs too much, you can sell another call on your stocks, further out in expiration to help pay for the net credit. Then if that one also get s called away (in 3,4 or more months) you simple repeat.

I’m learning options with Motley Fool and I highly recommend that you consider subscribing. They are the best and walk you through each trade plus they have an Options University and a community board where all questions are answered.
Good luck,
Mike

Add a Topic
570
Add a Topic
5971
Add a Topic
5971
takeprofits
7 years ago

I have done quite well with covered calls and expect to experiment with small commitments to PUTS on more expensive stocks I want to own, but it is certainly not a strategy for amateurs. Some good examples have been given about how much it can cost you if you hit a bad streak, even professionals consider a 75% to 90% win rate as exceptional, so the first thing you need to know is that chances are high you will have some losses. If you are lucky you may have several winners to start, which may embolden you to take risks you should not be taking. Not to pick on Michael, but he illustrates the danger, he says in opening, “I am fairly new at options” and then further on says that, “Motley Fool are the BEST” indicating to me his experience SO FAR has been good under their tutelage, which is fine, however my question to Michael is, how MANY options services have you tried? My point is, how can you say “Motley Fool is the best” unless you have tried at least half a dozen for comparison? There are dozens of relative amateurs out there that can lose you a lot of money. Even the best in the business have occasional losers
and this includes well known names like Ken Trestor (40 yrs. experience) Bernie Schaeffer, Steve Sarnoff (2nd generation) Adam Lass and Brian Bottarelli, Karim Rahemtulla, Alex Green and the list goes on and after 10 years it would be difficult for me to hang a “best” label on any them. Paying a thousand or better for guidance and then investing more thousands in a few losing positions can be a painful learning experience for a newbie.

Add a Topic
570
Add a Topic
329
Add a Topic
5916
Michael Hassan
7 years ago
Reply to  Myron Martin

Hi Myron,
I’ve tried 3 options services and you are correct, I can’t say Motley Fool is best, only that from what I have learned by spending $5,000 with others, which included education, hand holding, recommendations and detailed alternatives should you not like or be able to effect their original recommendation, I consider them the best and I can’t imagine what any other service could do better. That is not to say there aren’t others but after my experience with the others, I’m hard put to see how MF could improve or meet my needs better (and my needs are almost overwhelming).

Much of option trading is controllable and you can choose your level of risk by the tactics you sue and I might add, not use. Anyone that can get it right 75% to 90% of the time will be a rich man if he controls his portfolio and positioning. MF also shows you how to do that. Probably the best thing about MF is they can be trusted, at least the Option and MF Pro services that I subscribe to.

Hope this helps.
Mike

Add a Topic
570
Add a Topic
329
rew
rew
7 years ago

As others have said, the “alpha strategy” is to sell a put at one strike and buy a call at a higher strike. Hardly an original idea. That often works fine in a bull market like we’ve been having. But wait until the next crash (there’s always another crash). Suddenly the calls will be worthless and people with 20% margin will start getting assigned on their puts. You’ll hear the cries of anguish from a state away.

👍 4
Robert P
7 years ago

A fun game until you are naked puts in a stock that melts down. Have made pretty good money overall, but roasted a few times such as once on a sharp Tesla correction and recent bad news from Cree. Key is diversification and position sizing, not too much on any one bet. One additional point – on an option two months out, the premium you are collecting erodes painfully slowly, so you are sitting under guillotine a long time to collect your premium. There is decent premium on options a month out and even on some weeklies.

Add a Topic
5971
Add a Topic
5916
Add a Topic
570
M Q
M Q
7 years ago
Reply to  Robert P

Perhaps the following may help: they are my personal rules, and work for me. They may not work for you.
A. Treat options trading as a business, not a hobby;
B. Create your own spreadsheet with which to calculate for example the break-even points, net cost of the stock if it is assigned to you and maximum profit possible on a spread trade, and check each trade before you trade.
C. Never trade on margin.
D. I prefer to write options because then time decay works in my favour. I buy options only if the stock has fallen a lot and appears to be making a bottom (buying a call) and mutatis mutandis for buying a put.
E. Trade in the options of stocks you would be happy to own outright. Often this means the premiums may be small.
F. Option prices can be very volatile and illustrate very clearly that the market is anything but rational, so don’t be fazed by the apparent profit or loss ( hence why to use your own spreadsheet to maintain perspective).
G. Aim to make income not capital gain
H . I calculate my annual return not by calendar days but by the number of times I can make that return per year. So if I write one month out I can do that 12 times a year. If three months out then 4 times a year.
I. Expect to lose one third of the time.
J. Aim for consistency in small trades, and the income will come.
Someone asked what to do if their covered call went against them (I.e. the stock rose). As long as the strike price of the call was higher than the cost of the stock , the stock will be called away at a profit, and will also have kept the call premium.
Above all be careful, and realise that writing options is a bull market or sideways market strategy. Spreads can work in both bull and bear mkts but you risk losing the entire cost of the spread premium. Hope this helps. Happy to discuss more.
E

Add a Topic
570
Add a Topic
5971
Add a Topic
570
M Q
M Q
7 years ago
Reply to  M Q

One error in my previous text re the covered call. Should read: ” the stock will be called away at a profit to you and you will also have kept the premiun on the covered call you sold”. MQ

Add a Topic
5971
Tony
Tony
7 years ago

To me the key question with a service like Stansberry Alpha is whether you pay a service a very high fee or whether to do it on your own. I have concluded that you can do it on your own and learn from your mistakes. I am relatively happy from my results in writing puts and covered calls. My put win rate is about 75%, and I would like to improve it. As mentioned by others, I have been burned by earnings announcements, even when they were good but the CEO decided to temper expectations.

Would anyone recommend a good forum to intelligently talk about options? Seeking alpha used to be such a forum but the editors decided they did not want options articles per sa.

I do not think anyone addressed the advantages of writing puts in a market meltdown. With puts you are going long, just as if you bought the underlying security. The premium is not much defense for a market meltdown. The advantage in writing puts is that you have to risk a lot less to generate the same level of income. Since option premiums can generate 3-5 times what good companies pay in dividends for a comparable time period, you do not have to have as much money at risk to generate the same level of income.

Add a Topic
3091
Add a Topic
372
Add a Topic
570
balkwill
balkwill
6 years ago

http://www.media-server.com/m/p/hbn93pt7 = S&A’s webinar on Alpha Anomally

carl
carl
6 years ago

S&A webinar on Alpha Anomally = http://www.media-server.com/m/p/hbn93pt7

teagle
teagle
6 years ago

All this options stuff is way beyond me, but I got interested in CBI because of the anticipated 20% gain this year. So … I bought some on August 8th and am up 17% already. Thank you Travis.

Add a Topic
570