Throughout this series on credit spreads, we've really drilled down and taken a hard look at the reality of credit spreads (i.e. vertical spreads such as bull puts, bear calls, and iron condors).
And in order to do that, we've had to cut through a lot of hype.
>> Why Credit Spreads Are So Hard to Repair - Anytime you try to roll or manage a trade that includes a long component (the definition of a credit spread), you're screwed.
These trades quickly get expensive to maintain. Like having kids, but without any redeeming qualities like maybe they'll take care of you when you get old.
>> The Uses and Misuses of Credit Spreads - My controversial - but supported by the evidence - position is that most credit spread trades are overleveraged.
That's how the strategy is almost always taught - big ROI gains if you're right, big ROI losses if you're wrong, and scaled higher to make a difference in terms of real dollars.
And "diversifying" won't make you safer - an army of small positions will still turn on you and stage a coup if the entire market makes a move against you.
But the good news is that there really are safe and conservative ways to trade credit spreads where trade management and repair really is feasible, and we went into how to go about setting those up.
>> Credit Spread False Logic and Faulty Math - When trading credit spreads, you have a choice - high potential ROI, or risk control.
Those who hype credit spreads would have you believe that you can do both at the same time.
The sleight of hand technique they most often use to pull this off is to talk about the returns in terms of percentages and the risks in terms of total dollars.
But if you want those high potential ROIs on more than just a tiny portion of your capital, you're going to have to place some serious dough at risk.
Today, we're going to switch the focus a bit from indicting credit spreads via math and logic and turn instead to the human impact the strategy can have.
(And if any of these stories resonate with you and you want to share your own credit spread war stories, I'd love to hear from you - just hit reply to this email or use the Contact Me link in my signature below.)
The Great Option Trading Strategies website turns 10 years old next spring.
Understandably, I've been privy to a whole lot of trading war stories over that time.
A lot of them have been pretty brutal.
And a lot of them have involved credit spread disasters.
In fact, there's a whole subset inside The Leveraged Investing Club of folks I affectionately refer to as my "Credit Spread Refugees."
(What else are you when you lose big and feel like you no longer have a home or a sense of what's what in the stock market?)
I have one member who lost 75% of his portfolio trading iron condors during the October 2008 Financial Crisis meltdown.
(Easy to say in hindsight that he should've moved to the sidelines - but I don't recall a single pundit at the time who predicted those thousand point intraday price swings in the DJIA ahead of time.)
Now, this was a guy who managed to keep his portfolio more or less intact during the dot-com bear market a few years earlier.
Now imagine a natural disaster and only being able to save one of them.
Who do you save?
Which of the three don't make it?
Know why he joined the Leveraged Investing Club?
Because his first hand experiences resonated 1000% with what I teach and advocate.
He said it was years later at Christmas when he was opening a gift - and not even thinking about the stock market - that he had this total epiphany - "Selling Puts should be the strategy I start every trading campaign with."
“Why? Because of its flexibility and its ability to answer… What is my plan B? What is my plan C?
"During the options course I took back in 2008 they included an article about Warren Buffett.
"And Mr. Buffett stated in much beautiful detail how selling puts is about as close as you are going to get to a perfect strategy. He likes to make it the beginning part of his buy and hold strategy.
"Of course back in 2008, as my introduction to options, I did not realize the power of this statement.
"It wasn’t until 6 years later after a horrendous Iron condor trade, while opening up Christmas presents that it hit me.
"The brain and your subconscious works in mysteries ways."
We have other individuals who joined our private group after having been burned so badly by credit spreads that it took them YEARS to ease their way back into the market.
One member from Australia previously lost his @$$ trading spreads - and took a long time to recover psychologically.
Here's from a post he wrote (in 2015) inside the Leveraged Investing Club forum:
"I’m not sure if you recall, but during 2011 and 2012 I was trained by, and traded options through, a company that only recommended spreads and iron condors. Initially, my trading was reasonably profitable, but then a couple of trades started to perform badly, and proved very difficult (and costly) to repair – which you have warned about several times.
"Bottom line is I lost a great deal of money.
"Since 2012 I haven’t been able to pluck up enough courage to trade options again, but I have done a lot of reading around the topic. I came across and was attracted by your model a couple of years ago, and still am, because of its conservative, long-term and structurally survivable nature."Since then I have followed your activities closely. But the time has come for me to stop procrastinating and start ‘value investing with options’. I’ll start by paper trading your model for a while. (I certainly will never trade spreads or condors again!)
"The company I was with previously never once recommended a single leg trade, and provided no education on covered calls or written puts (cash secured or otherwise), so I have had to learn from scratch about these two strategies.
"All of which brings me to the main point of this post.
"As I have mentioned to you previously, I have found your written materials and videos to be excellent and they have been most helpful in bridging the gaps in my knowledge.
"When I first joined your Leveraged Investing Club, I skimmed through your book ‘The Essential Leveraged Investing Guide’, but I confess, until recently, I did not return to it to read it properly. I have now done this, and would like to congratulate you on the Guide.
"In terms of explaining the value investing and leveraged investing approaches you use, it is brilliant. It is also right up there with the best I have read on the subject of options in general.
"You have an amazing ability to explain and describe things in a way that is clear, easy to read and understand.
"Many thanks and best wishes."
Club Members like these guys are my heroes.
It takes courage and reveals character to be willing to face a traumatic experience - and let's be honest, losing a $%#load of capital IS traumatic - and then ask the tough questions and try to understand what went wrong and why.
Sadly, not everyone has it in them to do that.
(OK - I don't believe that has to be true, but people sell themselves short all the time.)
But there are a lot of people who just bury the painful experience and try to pretend that it never happened.
Or - and I've seen this, too - sometimes they come real close to getting back up, dusting themselves off, and learning what it really takes to gain a permanent upper hand over Mr. Market.
But, at the end of the day, they just can't do it.
On the ground is a horrible place to make a life, of course, but they're so afraid that Mr. Market will knock them down again if they stand up, that's where they stay.
It's frustrating and sad - because I know I can help them.
I can show them the hows and the whys behind successful and safe trading and investing.
There are specific things we do when selecting, setting up, and managing our trades - and we do these specific things for specific and learnable reasons.
But they don't believe that.
They lack faith in themselves that, yes, they can actually learn to see for themselves what constitutes a structurally safe trade and what constitutes a structurally unsafe trade.
The irony is that, by "protecting" themselves via avoidance, they never understand that the real culprit was the strategy itself, and not their supposed deficiencies as a human being.
Money replenishes itself, and basic skills and insights can be learned.
And when you have a structurally advantaged and eminently forgiving Strategy to work with, that's all you need.
If you're a credit spread refugee yourself, or if you've ever been one, know this - there's a place inside the Leveraged Investing Club with others who have been through similar ordeals and have successfully come out on the other side.
OK - we've covered a LOT of material, ideas, and insights, over the last four newsletters.
I hope you've found these contrarian views - based, I feel, on some pragmatic common sense along with my work and interaction over the years with real traders with real financial scars - to be helpful and refreshing amidst a self-serving industry of rah-rah bullshit.
My main goal for this series is for you to have a clear understanding of the risks of credit spreads - because those risks are rarely articulated.
If you struggle with any aspect of the process . . .
>> Identifying and understanding the best strategies to work with so that you make great returns when you're right and don't give it all back (and more) when you're wrong
>> Being able to consistently find great trade ideas
>> Knowing how to set up your trades optimally - from position size to strike price selection to timing your entry
>> Trade management and - when necessary - trade repair so that you remain firmly in control with all your dealings with Mr. Market
>> Portfolio management and having a longer term plan to structure and maximize the effectiveness and sustainability of your overall portfolio
>> Legacy - the greatest wealth we have is not the money we leave behind to our heirs - it's the knowledge, insights, and skills we give them so they can improve upon what we've built
. . . then you really might want to consider joining our private group during those periodic times when we accept new students and members.
KO - 125 shares
KMI - 100 shares
BP - 100 shares
MCD - 30 shares
JNJ - 25 shares
GIS - 25 shares
PAYX - 25 shares
Open Market Purchase Price: $20,071.83
Less Booked Option Income: $16,341.71
Tot. Discount: 81.42%
Adj. Div. Yield: 19.59%