Ever since I first introduced this private investment opportunity to my readership the most common question that I get asked is “how does this investment make us money?” My answer is always “with style , grace and a lot of skill” Just kidding, no, that is not my answer. I try to explain it to people in as concise terms as possible, but as of late I received an e-mail update from our main trader which deals with this very topic, and I believe he has greatly lightened my load. Now I can just refer people to his clear and simple explanation of how covered call stock options trading makes us money – in other words how Private Program 2 really works. So without further ado those people who have been invited into this investment program or are thinking of joining should FIRST read this:
How Trading Strategy 1 Works
To enable me to explain this in simplistic terms, I’m going to pretend that we run a car rental business, we don’t, but I find it’s the best way we can explain how we generate our income.
Imagine our blue chip stock we own as a fleet of cars to rent, each option contract of stock = 1000 shares, that in turn represents 1 car lets say valued at $45,000.each . the good part about this fleet, is the older it gets the more valuable it becomes, but in the short term the value could slip,(bad market days) but the rental income still continues no matter how much the car(stock) value has slipped, but NEVER below its insured value!
Now we own 86 cars that’s (86,000+ Blue chip shares approx. $3,870.000),and we rent them out for as much as we can collect each month.
All of these cars (stock) are insured at the time of purchase, at a rate of agreed replacement value, usually below the cost of our purchase price. (The price gap) the price difference between cost, and insurance cost.
Nealy two thirds of cost of this fleet is being financed by the margin bank, and after we collect our rental each month, we must pay our bank interest 9.35%pa., and our drivers (traders – that means me and my crew), and our insurance, and all other related costs, paid monthly, And the % that’s left is profit.
As the profit builds we buy more cars (stock) and add them to the fleet, 10 this month of May hence increasing our profits.
Keep in mind two years ago we started with 1 car or $55,000 to day we operate 86, and growing.
The only way to lose in this business is for a member close their account, or require their funds back (without appropriate notice, as this notice will fluctuate with the amount required it could be up to 1 to 3 months.) that’s their prerogative, but they must realize that to break into a trade mid month we need to cancel out the required contracts (sell 1 car or more) to satisfy the funds amount required back, and if that action results in a loss, that member must be responsible for that loss, not anyone else who have funds in that broken trade.
The other disadvantage for that member closing their account, is his or her tax commitment, remember folks the funds are all traveling (trading) under one name, and if you lose the protection of that name (Company Name) by closing, your tax commitment could be as high as 46.5% without the Australian Tax File Number, add to that a premature close out cost, and it becomes a very large slice of you hard won profit.
I hasten to add in the two years trading we have had approx. 12 people out of 800 members close their accounts, the main reason still seems to be chasing bigger profits, or that pot of gold at the end of the rainbow, and we all know in our hearts is a rear find..
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How Trading Strategy 2 Works
t seems last weeks update got the message over how we trade in Covered Call Trading, using the Rental Car scenario, all seemed to understand the simple example.
This week I would like to explain in the same simplistic terms how we trade in the Strategy 2 dealer book.
If you remember last week we actually OWN the stock (cars) that we forward sell the future price’s, (rentals) in the case of our Strategy 2 trading we forward sell future prices (rentals) on stock we DON”T OWN.
Let’s put in simple terms, just imagine we lease all of our rental cars instead of buying them outright, as we do in out Strategy 1 trading book, this of course allows us to acquire a lot more stock (cars to rent), (we all know to lease a car is cheaper than buying,) and potentially a lot more profit, as we don’t have to pay out the huge cost of buying stock.
To achieve this we go into the market, and lease shares (cars), with an option to buy or sell future prices, (rentals) usually a few weeks in advance, for the best (rental) premium price we can get.
Now lets say we get 75c per share premium (rental) from the market this equates to a gross profit of $7,500.00 for a contract of 10,000 shares, or (10cars) leased over say 6 weeks, this is great, as long as the market behaves and goes in the direction we have placed our trade, we walk away with potentially $7500.00.
To safe guard against the market not going the same way, we can go back into the market, and use some of the lease profit (75c) and buy some insurance on each one of the 10,000 option shares, this may cost say 30c each, hence reducing our gross profit to 45c, 75c -30c insurance =45c profit. or $4500.00.
To put this in simplistic terms, we walk into a car rental company, lease 10 cars, (gee this customer would be the making of a car rental company) and we advertise the loan of these cars at a slightly better price than we paid the leasing company, keep in mind on the options market we’re talking to over a million people every day, so we have a good base of potential customers.
However to safe guard our selves against accidents we buy 10 insurance polices, and pay for them out of the money (75c) we received from the people who in turn leased our cars.
BEST CASE SCENARIO
All of this leasing activity is supported by cash, our cash, now this cash margin required by the brokerage company is the estimated replacement cost of the (cars) stock between the price we nominated in the market, called the “strike price”, and the insured price in this case 30c, all of this cash is taken from our account and held by the brokerage company,and when the lease time is over we will receive our margin cash back, as well as the profit 45c from the lease, this is the best case scenario.
WORST CASE SCENARIO
Worst case scenario is the cars all crash, (market goes in the wrong direction) and we have to buy out our lease, and as the insurance is for less than the cost of the car, (stock) we will walk away with a loss. 45c per share, or ($4500.00) without insurance our loss would be $7500.00 plus commissions ect.
If we feel that the market is recovering, we have the option to roll forward, all of the options in danger of crashing, to another time period, hence delaying our profit for that stock by what ever time period we choose to go forward.
REDUCED RISK ON LOSSES
This risk is reduced by leasing a mix of stocks, up to a dozen blocks at any one time, so some we will win, and some we wont, a double digit profit month requires all the leased stock returning in good order, with no lost stock (cars).
MIXING THE LEASE TERMS
This simply means we can make money no matter which way the market runs by nominating a buying or selling option term.
When we have a requested withdrawal in the middle of a trading month, this can potentially be a loss for that member, if we have to close out some trades to regenerate the margin cash back that’s being held by the brokerage company, in this case to pay out that request, this underlines the importance of giving yourself plenty of time.
OK I think that’s enough.
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Does that make sense to you folks? Incidentally if you wish to learn this method and trade on your own the main trader does give private one-on-one lessons for a modest fee. I am considering doing this myself later on – we shall see.
I think that about does it for this post – it is already overly large enough as it is. I’m anxiously awaiting this month’s returns – hopefully they’ll bring me a big smile :)
Cheers everyone, and happy investing!