by Travis Johnson, Stock Gumshoe | March 9, 2008 5:46 am
When your stock recommendations are going down (along with everyone else’s, to be fair), and everyone seems terrified of the market crashing, you have to resort to selling a “system” — that appears to be what the folks at Oxford/Mt. Vernon Research are doing with Karim Rahemtulla’s Income Trader service.
This isn’t the first time that we’ve heard of these mysterious kinds of underground trading ideas, of course, from Karim or others — we looked at his “Dark Equities” teaser not long ago, and, as you’ll see in a moment, his basic strategy here is another one that is gaining in popularity during the current market turmoil.
And I hate to be the one to tell you (though, as a wise Gumshoe reader, you’ve undoubtedly already guessed), but this is, of course, no great secret.
Here’s the teaser headline:
“Confidential Report: Heads You Win, Tails You WIN! How This Secretive ‘Price-Fixing’ Ring Snatches CASH From Big-Name Stocks LEGALLY … And How YOU Can COPY Them!”
Man, how can you NOT want a piece of that? Let’s sniff our way through the flamboyant promises and take a quick look at what they’re actually selling.
They call it the “World of Win-Win” …
“Right now, you’re probably wondering how something so incredible is possible. But let me assure you IT IS! Why isn’t everyone doing it then? A few are: the lucky few in this legal ‘price-fixing’ ring. I’ll explain later why the big-boys probably can’t join in the fun because they would have a conflict of interest. No one else uses it because they don’t know they can.”
A price-fixing ring? It sounds so illicit … like the robber barons who have conspired over the years to fix the price of airline tickets, or DRAM memory, or beer … come on, you know you want to be a robber baron, too! You can tell me, my lips are sealed. We’re alone here on the internet, just you and I.
But of course, this is a different kind of “price-fixing” — and not as likely to get you in trouble with the Justice Department.
And they stab a knife into the heart of the Gumshoe:
“There’ll be no teasing here. I will explain exactly how this works and then you can decide if you want to play this game (though it’s hard to imagine how you wouldn’t want to!).”
No teasing! Say it isn’t so! The Gumshoe is melting, melting!
But OK, even if they’re not quite “teasing” and they do kind of explain how the process works (you can review the teaser here if you’re interested, I’m too heartbroken by the lack of teasing to excerpt much more of it), just the same they don’t come right out and say exactly what things are called or how to do it.
Rahemtulla essentially says that he lost a lot of money in trading options (as have most options buyers), but that he thought there must be a way to make money on them. And he “discovered” what most investors probably already know: options money, particularly the nice, steady income kind of money, is made by those who “offer” options, not those who invest in them.
So … OK, the Gumshoe isn’t revealing anything exciting here since they didn’t tease us (what do they think the Gumshoe’s going to do with all this free time if they stop teasing? This better not be a trend!) … but I can tell you specifically what he’s recommending, using the actual terms that he avoids.
“Offering” options to make money “instantly” and “price fixing” is all about selling covered call options.
“Covered” means that you own the stock itself — so you buy 100 shares of a stock, and you sell a call option contract on that stock (one contract is for 100 shares) and pocket the payment. A call option confers the right to the buyer to buy 100 shares of a particular stock, at a set price, anytime between the day it’s purchased and the expiration date. Then if the stock stays below the exercise price of the option until the option expiration date, you get to keep the money and the stock. Yay!
Sound familiar? Yes, it’s an old investing strategy — and one that services are cropping up all over to advise you about, including the pretty heavily marketed services from Stansberry & Associated (teased under “Transfer Dividends” and “California Overnight Dividends“)
And Rahemtulla even goes so far as to open up a little bit about his strategy, and he is a little bit more forthcoming than most when he explains the rewards and risks of the strategy:
“1) You make money if the stock goes up in value!
2) You make money if the stock stays the same!
3) You make money if the stock goes down!”
“So what’s the catch? The ‘catch,’ if you want to call it that, is that if the stock completely crashes and/or goes out of business you would lose money. But that’s why I use only big names for this strategy; what are the chances of the likes of McDonald’s and Starbucks going out of business?”
OK, so I said he was more forthcoming, not that he was transparent. As with all things in the investing world, it’s not quite as simple as that — having a binary “made money/didn’t make money” assessment of your investments wouldn’t help you to understand your portfolio very much, what really matters over the long run, as you’re well aware, is how much money you make.
So, with any strategy when you’re selling covered calls, here’s the Gumshoe’s (also simplified) description:
1. If the stock goes up, you make money — but your maximum profit is the money you got for selling the option plus any price appreciation up to the option contract price. If it goes up higher than that before the expiration date of the option, the person who bought the option from you profits at your expense. And if you don’t buy back the option contract to close it out, they can exercise it by buying that stock from you at the option contract price, possibly resulting in you having to incur a taxable capital gain (on top of the gain from selling the options contract).
2. If the stock stays the same or moves just a little, you are the happiest little investor in all of Gumshoeland — if you sell call options against your stock holdings and the price never goes up to approach the exercise price, you just pocket that premium you got for selling the option and it’s all profit.
3. If the stock goes down, you lose money (at least on paper) since you own the stock. But at least you received the premium payment for selling the option, so you lose less than you would otherwise have lost.
So … in my experience, most advisers recommend the same basic kind of strategy — buying megacap or large cap, stable, profitable and growing companies as core holdings, and selling “out of the money” covered calls (meaning, the contract price is higher than the current share price) against those holdings to get some extra income. If you pick the right steady growers that don’t shoot quickly up or down before the expiration date, you can make money on most of your trades.
This can be a nice way to get steady returns if you are very disciplined, but the discipline can be key — as can the stock selection. If you would be angry about losing out when a stock that you thought would be a slow grower went on a sudden 70% run (and your profit was maxed out at 15% because you sold calls against your position), be extra careful about choosing which stocks you sell calls against. Being fairly conservative and only selling near-term call options (that expire in the next few months) can help protect you a little bit more, but it also generates less income.
Oh, and do note that you’ll pay taxes on all these transactions, so many folks recommend that if you’re pursuing a covered call selling strategy, that you do so in a tax-advantaged account like an IRA.
I’ve written about this several times since these strategies are really, really popular when people are terrified that they won’t make any money in the market, so I hate to be repetitive. I know that there are several readers out there who employ covered call strategies with some success, so if you’d like to share your techniques, or mention specific companies where you think the strategy would be particularly well applied, feel free … we’re listening.
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