I want to discuss a lingering frustration of mine - the financial
My complaint stems from a recent call I listened to by a small
financial services firm. They were touting guaranteed returns with,
of course, no risk.
Their answer - fixed annuities. I had to laugh. And then I started
to get upset.
They were preying on the fear that the financial media has created
for individual investors over the past few months. They were taking
advantage of hard-working, worried investors who lack the knowledge
of how to effectively invest their money.
This financial services firm went on to boast about how they were
taking the steps necessary during these times of crisis by moving
into more defensive stocks. They claimed this was the best way to
create a conservative portfolio. The insanity went on and on.
Then I realized... they just don't have all the options available
to them because they don't know what they are. So I stopped being
mad and started writing this letter to explain to you a better
choice then defensive stocks when the market is volatile.
Effective money managers, and everyday investors, should learn how
to appropriately and effectively use options to hedge risk.
Investors, professional and retail alike, tend to ignore options
despite the fact that they are one of the most effective ways to
create steady capital gains while protecting hard-earned assets.
The fact is, most active money managers have no idea how to use
options other than to buy out-of-money calls or puts. They don't
realize that times of crisis lead to above normal volatility that
creates high options premium and the opportunity to make lots of
Why don't they? I don't know. Options are not that difficult. Yes,
it takes a little hard work to understand, but so do stocks.
People are starting to realize the benefits of options. They are
catching on. I truly think the next 10-15 years are going to be
revolutionary for options. I have already witnessed an enormous
change in the options industry thanks to the likes of Tom Sosnoff,
founder of Thinkorswim and David Kalt founder of Optionsxpress.
These are just a few of the major players trying to bring options
to the mainstream.
Thankfully, they are winning the battle.
So how can we take advantage of today's market conditions in an
actionable way using options?
Well we know that fear is in the market. Look no further than the
Volatility Index, or the VIX (otherwise known as the investor's
fear gauge) to see that the fear is palpable. However,
opportunities are plentiful with the VIX trading at 35 - especially
those of us who use credit spreads for income.
In short, a credit spread is a type of options trade that generates
income by selling options.
In this type of atmosphere, fear makes the volatility index rise.
Increased volatility brings higher options premium.
And higher options premium, means that options traders who sell
options can bring in more income on a monthly basis. This is all
working in our favor as options traders right now, so it's an
opportune time for you to learn how to place these types of options
So, I'm selling credit spreads for a nice premium. And I'm making
more money than I was just a few months ago when the VIX was half
what it is today.
Over the past month or so I have explained
how I use credit spreads
bring in income on a monthly basis
Now I want to tell you about another actionable trade that I am
eyeing as we enter the latter part of the week.
As we all know the market has fallen sharply over the past month
and now the small cap ETF,
iShares Russell 2000 (
is roughly 18 percent below its high of a month ago.
So how can credit spreads allow me to take advantage of a market,
and specifically an ETF, that has declined this sharply over the
past few months?
Well, knowing that the volatility has increased dramatically over
the past few weeks causing options premiums to go up, I should be
able to create a trade that allows me to have the same profit range
of 10-15 percent while creating a large margin for error.
Sure, I could swing for the fences and go for an even bigger
payday, but I prefer to use volatility to increase my margin of
safety instead of my income.
Using my strategy I know the IWM can move 9.8 percent higher and my
trade will still be profitable. This is a fairly wide margin, and
shows the true power of options.
So, let's take a look at a potential trade using IWM, which is
currently trading at $70.83:
- Sell to open IWM Oct11 80 call
- Buy to open IWM Oct11 82 call for a total net credit of
Again, the trade allows IWM to move lower, sideways or even
14.2 percent higher
over the next 43 days (October 15 is options expiration). As long
as IWM closes below $80 at or before options expiration the trade
will make approximately 10.5 percent.
It's a great strategy, because a highly liquid and large ETF like
IWM almost never makes big moves and even if it does, increased
volatility allows me to create a larger than normal cushion just in
case I am wrong about the direction of the trade.
So, selling and buying these two calls (creating a credit spread)
gives you a high probability of success - because you're betting
that IWM will not rise over 14 percent over the next 43 days.
Again, my space is limited here. The options-based questions have
been rolling in and please keep them coming . Email me at