In this month’s Traders Talk, the Pirate once again invites us into his lair to talk shop and pass on some wisdom. Unlike the first interview, where Preston shared insight and hard-learned lessons (who can forget the indelible visual from Wrong in the Thong…yikes) gained during his many years in the market – as student, trader and teacher – the focus this month is squarely on what he considers to be the most exciting opportunity to ever emerge for the independent trader. In his view, there’s a new paradigm in trading that’s not before existed – one that traders must take heed of and learn to capitalize on.
This time around, Pirate spells out his game-changing approach tailored to individuals – a strategy that the big boys envy, yet are precluded from utilizing. Indeed, a unique opportunity that finally levels the playing field and provides you, me and the rest toiling the markets with a real advantage. I highly encourage you to take your time reading through the interview…and to reach out to Preston and his Crew thereafter to learn more…it may well prove to be the most important financial step you ever undertake.
TEI: Everybody and their brother is offering guesses on what happens with the market up here around record-territory. What are your thoughts on people spending their time trying to decide whether the market is going to take off or not?
PJ: Yeah, it’s in our face more now than ever – the different opinions. It just seems noisier than ever in that respect. I try to mellow people out rather than try to predict where the market is going next. Trade the market that you have at hand and realize that when we talk about market cycle, it takes three out of four stocks with it. If the market is like what we’ve seen lately – a strong market cycle with stocks less punished when they have bad news and a tide that is now rising – one of the aggressive things you can do is go even more on margin. No matter what you hear the market is going higher – it’s just taken out all time highs. Then it’ll inevitably turn and correct – go down the other way. But it’s not going to do that in one day. It just seems like the market wants to fool the most amount of participants. So you never know how high it can go and you never know how low it can go. The point is you want to trade the market at hand.
TEI: Looking at the market cycle as it now stands, how is your trading influenced?
PJ: Well, there’s always little hiccup-type things or it wouldn’t be a market. As we’re recording the Cyprus thing came in and scared it, but it looks like it’s rebounded because that vote didn’t go through. Until we see some breakdown I adjust everything that I’m doing with a more bullish bent to it. That means utilizing margin, but also portfolio margin…which a lot of people still don’t know about. You basically don’t want to be looking at the short-side of the market too much right now. I’m a little forgiving on what a stop loss or protections might be. Those are a little more aggressive, meaning they’re a little further away. If the market cycle were to turn, I’m going to be a lot more selective…it’s going to be smaller size and there’s going to be protections that are a lot closer.
I want to back up for one second to reiterate something [important] about the market cycle. It’s often detached from what the economy is doing. If you listen to the evening national news and heard the first five stories about the economy, that is completely not the market cycle. The other little corollary of that is that some people just can’t do it – they cannot trust the market cycle. They cannot see what is right in front of them. They’re too tainted and clouded, either by the person that just got laid off next to them or a neighbor that just had to move. I don’t blame them. We’re not always wired to see what is plain in front of us. We’re constantly trying to interject and think about things in the world. Some people just can’t ever do it – it’s the most frustrating thing for them. They revert back to old habits – this stock has to go up because of this-and-that reason. They keep interjecting what they think should happen or what shouldn’t happen – and it’s a recipe for disaster.
TEI: One of your primary offerings is the Weekly Options Windfall or WOW service, focused on trading weekly options. Although we talked about them some last month, please share your thoughts on the opportunity they provide traders in today’s environment?
PJ: I think it’s real important to drill into a couple of key things when we’re talking about the weekly options – this animal that was created in the spring of 2010. There’s probably five things I want to hit as to why someone really needs to stop what they’re doing right now and pay attention to why they might want to sell some income on weeklies this coming Thursday, or whenever the next Thursday is.
Securities now get created every Thursday morning and they expire the following Friday. Now when you look at the major component out there that has produced more volatility across the board – near-zero interest rates – it has money flying around. Not only from one stock to another, but out of the market entirely and back into the market entirely. Money is not idly sitting around – it’s actively moving around. The latest Barron’s Round Table said we’re going to have these [low rates] for the next five years at least and some are saying it’s going to be here at least 10 years. So we’ve got these near-zero interest rates that create volatility. Volatility is great when you turn it around and become a seller of options, because options are higher-priced in general. So we have that major underlying factor.
Then there’s the fact that about 80 percent of the trading volume that you and I see every day is being pushed around by these big institutions. It’s not you and me and our friend over our backyard fence who are participants in the market – we’re a small minority. So you have all this major money sloshing around because of low interest rates.
Now all of the sudden you have this instrument – the weekly option…There are two big hot-zones of time decay in the life of an option – whether it’s a 6-month option, a 3-month option or 1-year option – when it actually declines the most…loses most of its time value. Why do we even care? Because when you turn around to become a seller of these options you become very interested in where the time decay spots are. The two biggest spots are over the weekend before the final week of their existence and between the last Thursday and Friday – that Friday meaning the last day of its existence. So every weekly option created has these two biggest time decay spots built in – that fact can’t be understated! Not to mention that when you add up the Thursday to the following Friday’s premium, and you compare that to the former 1-month premium, four of those 1-week expiring options equals roughly double what a 1-month premium used to bring in if you were selling a 1-month option.
Now there’s reason for that. I was in Austin, Texas last weekend for the South by Southwest Music Festival. There are lots of partiers and revelers there, with 2,200 bands over four days. Well, you’d constantly be seeing people dropped off in taxicabs two or three blocks away from 6th Street. Inevitably they were going into the first bar they could find – they weren’t walking down eight blocks to find a bar. The majority ducked into the first little thing that looked like fun. That’s just like weekly options. Why some of this big premium exists is because it’s the closest thing that’s happening. For some reason in an option market that just seems to attract most of the volume and interest. This is my theory on why they’re pumped up. Why does that exist? Why do 4-weekly options equal double a 1-month premium? Well, I just think it’s the closest bar. It’s the closest action people can go to. These factors I’m laying out are impossible to ignore in terms of what they can do for you when you become a seller – doing spreads and money presses. That’s the backbone and the root of why it’s so damn compelling. They never used to exist.
TEI: You mentioned last month you don’t see this opportunity going away any time soon.
PJ: Oh no. In fact, last Thursday there were eight new stocks carrying weekly options for the very first time. Now that’s a big jump for one week – there are plenty of weeks that go by and we haven’t added any. They’ve actually taken some off from time to time. I was just listening to a seminar that I did in the summer of 2010; there were 18 stocks that had weeklies – I think it’s over 160 now. Now, maybe some have heard these things for the very first time. Sometimes those things are just kind of tucked away, so as we were getting ready to talk, I thought, “I’ve got to dig up the backbone of what is so compelling about these things.” I had sleepless nights when they were first out – just contemplating what this means. For example, right now with these low interest rates, you could purchase stock at a 1 percent margin rate. For someone who is buying a boatload of stocks that pay a 4.5 percent dividend yield, that also happens to have weeklies – just right there you’re making a spread on your money. Of course a stock is going to fluctuate, but when you go out and purchase a 5 or 6-month out protective put option a few dollars underneath the stock, and then turn around every Thursday and become a seller of weekly call premiums… What I’m saying is you put together these low interest rates that we have, [combined with] these volatile options that we have (for the most part – they do go off the behavior of the stock, but overall, you have more volatility today), and you start socking away these weekly premiums. You can see the math. I’m getting a dividend of 4.5 percent and the low cost of my margin. If you wanted to take that $1 million and go $7 million worth of stocks, you can as soon as you buy these put options. It releases this margin and then you’re selling more and more of these weekly calls. You can get ahead pretty quick and really not have a way to lose money after a while. And you’ve got four more months left of premium writing, which means 16 periods of weekly writing or selling. And if you decide not to trade – let’s say an earnings announcement is coming up and you just don’t feel comfortable selling premium that week. Well, you could take that week off. Before you only had a 1-month choice. You’re waiting for four or five weeks not doing anything so you can get earnings out of the way. Now you can sell three weekly premiums, which by the way carry more of a premium because earnings are getting nearer. On some stocks it’s just insane – like a Chipotle Mexican Grill or an Apple. What are they gonna announce? These premiums just start going through the roof. You can be selling those in the weeks leading up to earnings and then choose not to participate over the earnings announcement.
Getting back to market cycle, if we have a general cycle behind us that is bullish, that helps me adjust what strike price I sell. Sometimes I don’t sell options over the full position that I can. Maybe I will sell half. Say it looks like market cycle is going well, you have stock in a nice trend and [during] the last two earnings announcements the stock really started rising into that announcement; maybe you don’t want to sell 100 percent of what you can. Maybe you sell half to bring in some premium and you’re looking for a capital gain on the other half.
TEI: Are you using any kind of different indicators, aside from IBD, to gauge market cycle when you’re trading the weeklies, especially since they are so short term?
PJ: I try to keep it as simple as possible because it’s a never-ending abyss with indicators and all kinds of crazy stuff. If you just look at the names out there with candlestick charting – dojis and hanging man and all this stuff. There’s six and seven-word descriptions. The hanging man doji upside down, a throat slit day… It’s an abyss that you don’t want to stare into.
There’s also knowing that it’s imperfect – there’s a little bit of artwork coming into this. That’s why I think engineers have the hardest time with this; they’re trying to measure every last little thing and the idea is just to determine where the broad stuff is going. Don’t forget if you’re trading these weekly strategies, your universe shrinks down by a big factor. If there’s 150 weekly stock options, that’s probably 1 percent of stocks. That sure shortens your window.
TEI: How do you determine which ones you prefer to play, given the universe of weekly options has greatly expanded from a couple years ago?
PJ: My head is in the paper and kind of looking around every day. A good example is Transocean Offshore – they were in the doghouse stock wise, with a lot of uncertainty regarding the Gulf oil spill. You kind of tuck that away – you’ve read an article here or there and you know the fundamentals. They’re one of the winners in the world and have all these untouchable things…and they’re not going to go out of business. All of the sudden you see news that a settlement has happened and all this uncertainty gets removed.
There’s an opportunity there. It’s got weekly options. When you hunt down when they’re going to announce earnings next and you see that it’s two and one-half months off, and they’ve just got this – not an 800 pound gorilla, but a 3,000 pound car off their shoulders – that’s kind of an event or news-type of opportunity. Not to day trade it in my world, but to say, “Wow, look at all the uncertainty that’s been removed.” It’s likely they’re going to have some fresh new forecasts they can finally talk about – maybe that happens on the earnings podium. But whatever is going to happen, right now I can go buy some protective puts out past that earnings date. I can be in business being a weekly put seller, not even touching the stock…just see if we can make some money off of something that’s not a situation you or I created. We did not create the explosion that happened and we could have never foreseen all these events, but all of a sudden they’re kind of lined up. That’s an example that comes to mind. There are companies like Priceline and Apple and Google. What’s nice about those is they’re not up-and-coming companies that have to prove themselves. You’ve got Apple that has $54 billion in revenues every 3 months. I mean, they won…they’re a winner. There’s not anyone else like them. Consequently, their stock price has got out of control for a lot of small investors.
You’re talking about a $400 or $500 stock – it got up to $700. Well, one thing I love about structuring these weekly trades is that all stocks like that are in play. You’re not shying away from a Google. You’re not shying away from a Priceline that’s $700 or $800 a share. There’s still an intense amount of interest about what Apple may or may not report. Coincidentally, it just so happens that as we’re talking right now it’s about four to five weeks away from their next earnings announcement. And Apple is starting to trade higher on days where the whole market is selling off. It’s having some really curious action right now. There are rumors that they might increase the dividends, rumors of a share buyback and rumors of new products. Well, we don’t have to know what the earnings are gonna be. We can structure trades with these weeklies right now heading into the earnings announcement and be picking off this weekly income – these weekly premiums.
TEI: So you’re always on alert for anything going on with the companies that offer weekly options?
PJ: Absolutely. I’m to the point now where it’s easy to know what weeklies are on – Netflix, Amazon, Priceline, Apple or whatever. When I see LinkedIn breaking out, I’ve looked at the weekly list enough to know, “Hot damn that has weeklies.” I’m all over that more than the 99 percent of other companies that don’t. They might have something that’s worth a look, but if LinkedIn is doing a big break out, that’s got my attention for the entire day. Everything else gets blinded off.
TEI: You used to do the pinning strategies a lot with the weeklies. What has happened with those?
PJ: Pinning has had its own evolution in a way that doesn’t favor us. When weeklies were newer I cancelled all my plans every Friday because Friday was the pinning day. It was just an absolute treat. I don’t know if it is a function of all this volatility, but it’s been knocked off its perch. It’s not the opportunity it was when they were newer, so I’ve migrated away.
TEI: So what is your favorite type of strategy with the weeklies now?
PJ: What I’m doing with weeklies now is a strategy I’ve termed the “money press.” Basically it’s taking advantage of being a weekly seller of option premiums, but rather than buying a 1-week premium underneath, which would decay as fast as the one on top, you’re simply going out and buying an option 2, 3, 4-months out – it just depends on the particular situation. I like to think of it like Baskin Robbins selling a single or double ice cream cone. Say the big 5-gallon tub has a wholesale cost of $10.00. Well, they dig in and get one little scoop out of there and there’s still all this ice cream left, but they’re selling that scoop for $2.00. I think of that ice cream tub as option time – you’re buying time in bulk… Take any stock across the spectrum and look out at a 4-month option and then divide it by 16. And then go check what the quote is on a 1-week option. It’s drastically different. You never want to buy week-to-week protection, you want to buy that bulk and then you want to become a seller. Just like Baskin Robbins, you want to buy your ice cream in bulk and then you want to sell the singles. That’s really what the concept is.
From there it gets to why this stock and why now? There is some set up and you want to be aware of the market cycle in general…there’s some artwork there too. Some people just like to shortcut that and say, “Just show me what you’re doing,” which is what I do on the Weekly Options Windfall membership [program]… If you just take a look at like a dozen stocks and follow their little lives – they’re the bigger name stocks. I have money press [trades] going on Netflix, LinkedIn and Apple right now. Your universe of choice really shrinks down. Gone are the days of rifling through 250 new highs for the day. I deal with a very small universe of stocks.
TEI: You just mentioned the change that occurred that negated the opportunity built into the pinning strategy. Do you see or anticipate more of this in the weekly market?
PJ: The amount of people who know about this stuff is so miniscule. I know when portfolio margin got passed by the SEC – it happened in the fall of 2007 – it was nine months until the first brokerage firm actually was able to offer that to clients. They didn’t even know what to do with it at first. So I think we’re really in the infancy of weekly options. It’ll be interesting to see, but I don’t think that human nature will change. I know from talking to the Najarian brothers that the volume on these weekly options is outdoing the 1-month options. That just means institutions are in there shoving money around and repositioning options and laying it on, perhaps for the earnings announcements. It just really zoomed into popularity right away, according to the action that they see.
TEI: The good news is they are staying under the radar and the opportunity hasn’t been taken away in them.
PJ: Right. Even still, options have been around for close to 40 years in some shape or form. And it’s always been the case that the 1-month option had the most activity. If you took that 1-month premium and multiplied it by six months, those premiums added up were way bigger than that 6-month option [premium]. So all we’ve done is scrunch the time down. When you do the 1-week option and you add up what that 1-week premium is compared to a 3-month out option, where you take 12 of those 1-week premiums, it’s actually even more skewed in favor of being the seller of those 1-week options.
TEI: What’s your research like? How do you go about doing your research on a daily basis?
PJ: I start early because I have a son that has early morning band – that’s 5:30 in the morning. I pick up the paper about an hour before the market opens. I subscribe to Investor’s Business Daily. I give that a read through and I check the market cycle in it. I’ll look at the new highs list and I look for articles and stories that came over later in the day yesterday, especially if I closed the computer lid early and didn’t see the [market] close. I also love Briefing.com. To be honest, I used to spend a lot longer time doing research because anything and everything was open for opportunity – there could have been opportunity anywhere. Coming back to the scrunched universe of stocks that have weekly options, especially the tippy-top most “Bad A” beasts that roam the jungle, there’s only a handful of them. Physically and generally that’s what I’m doing in the morning. I open the laptop lid and that’s the only screen that I have up. I look at charts from Yahoo Finance…it is not too overbearing. And I never ever have CNBC on during the day.
TEI: You talked last month about trading effectively. What are the one or two things that a trader needs to be doing right now in the market to find success?
PJ: The market cycle is one of those main, effective things. You could have five screens open, the lowest commission rates, the best IQ and health and happiness. But if you’re trying to buy stocks in a down market cycle, that’s super inefficient…no matter how efficient and happy you are, you’re constantly fighting that because of what you think. Well, that’s freaking ineffective. A main thing that I’m always looking at in a stock move is its price action and volume. When you boil everything down at the end of the day, that’s very effective as well. If LinkedIn has a breakout in the first 30 minutes of the day and it’s at an all time high, and volume during that first 30 minutes already surpasses what it trades in a normal day, that’s very important to know. You have to stand up and pay attention to things like that.
TEI: Those things can’t be faked – they’re real.
PJ: Right, there’s some far smarter and more numerous people close to the situation of the company than we’ll ever be. What does it matter living out here by the Rocky Mountains that you think that LinkedIn is overvalued? You’ve got to be kidding me. You’ve got thousands of people with billions of dollars who are keyed into all the little nuances that you’ll never ever know. That’s probably always been like that.
TEI: Touching on your rules. What’s the maximum percentage of your overall bank you’ll risk in a trade?
PJ: Take the money press trade. As you buy protection three or four months out and you’re selling premium on top of that, you’ve already defined your risk in a way that’s more unconventional than just buying 1,000 shares of an IPO that just came out…no options, there’s no margins – you’re just buying it and you’d have some stop losses on that stock and you’d have to determine what that is. Another thing it depends on is market cycle and the setup of the stock, where you can go more aggressive in your size – it’s not going to be the same exact thing across the board. When I start a trade, it seems like I’ve got a 5 percent risk for a money-press position as it relates to my entire account. That could be added to if it starts behaving.
TEI: How many positions do you typically have on and how many do you suggest for the average person?
PJ: I’ll typically have seven to eight of them on. They’re not all dot com type stocks…there will be an oil driller or a yoga apparel maker in there. You end up getting a little diversification, if you want to call it that, from different industries. To me that just seems like a happy medium where it’s not brain frying – where you’re in 25 different positions. What I suggest to the person starting is don’t limit yourself to one – maybe two or three if they can. The best way to learn it is to jump in and do it. Again, you’ve already carved out what you’re risking right from the get go.
TEI: What do you have to say to somebody out there contemplating the Traders Edge trading and training programs in terms of why they should do it and what they should expect?
PJ: People come in with so many different backgrounds and talents and expectations. Maybe they come to the conclusion on their own or because they’ve heard from a financial planner or a stupid retirement calculator…that you’ll need $1.6 million now to have X amount of money peel off from a bank CD. The paradigm now is that person can have a $200,000 brokerage account. Just doing some pretty rudimentary stuff on some no-name companies like Intel – you know, real charlatan companies like that or a tobacco producer – doing small things like that, with a dividend spread against margin interest, and then writing weekly premium. This is a paradigm shift where you could have a tenth of what you thought you needed, according to a financial planner, in order to make the same amount of money as with a big pot of $1 million to $2 million. That gets back to the goal for that person. We don’t want people to come in the door and have unrealistic expectations. “Hey, I need to be doubling my money every four months. What strategy’s best for that?” We want to change people’s paradigm, but we also don’t want to work with unrealistic expectations. It really depends on the person contemplating this. They really have to sit down and re-evaluate what they’ve been told their entire life. That can determine where we want to point them and what we want to get them started doing. Maybe they want to adjust and change their dreams and goals upwards because of some things we can do for them. This is still new, to be brutally frank and honest. This way of trading didn’t exist just three years ago. We think we’ve done a good job getting up to speed with it, but we’re talking about another type of ballgame compared to what people were doing that had a Schwab account for the last 25 years. Hey, hats off to anyone that has been disciplined and set money aside – we’re not talking about that. I have to think we are the only company out there offering this type of game-changing know-how. We’re not teaching someone how to be a better traditional trader. I don’t even like the term trading anymore. We came up with Master Income Trader and Weekly Options Windfall. We’re in a whole different paradigm here. I know that sounds kind of creepy – that’s what everybody says…that’s the language – it’s going to be different this time…You should see the face of someone when they kind of get it a little bit. They walk away going, “Holy crap, I hadn’t thought about this, that and the other.”
TEI: So it boils down to what’s available out there for that individual – the small guy out there. There are opportunities that are created because of the way trading has evolved, because of institutional trading, high-frequency trading, new trading vehicles, the ability to leverage an account with portfolio margin and myriad other factors. In that sense, the training offered is important to individuals in order to understand what the opportunities are and how best to leverage them, correct?
PJ: Absolutely. Look, this is stuff we teach an individual independent investor to do. You’d think that if this is so good, why aren’t all the hedge funds doing it? They can’t because they’re the ones actually creating all this opportunity now. They have to go put gobs of money and takes positions here and there. Najarian was telling me once that even if a $3 billion hedge fund had an idea that, “Hey, this stock’s moving,” they can’t buy enough options to go do that. Even if they buy a 1,000 contracts and make a couple bucks on it, that doesn’t even pay the light bill. These guys have to put billions of dollars in the market constantly. They’re always going to trade a very different way than we can trade as individual people. It’s funny, but it’s the scenario of the world right now that’s created a lot of the opportunity that we get to take advantage of. They’re never going to be able to do it – they can’t trade like we can.
TEI: Anything else you’d like to offer before we wrap up?
PJ: This will likely require a little courage to look at something and realize, “Hey, this is where the opportunity really is and I’ve got to change how I’ve always thought and felt…what I thought was important about making money.”
Also, one of the most awesome things for us, because we’re all sitting behind computer screens, is hugging our folks as soon as we meet someone for the first time. Part of breaking habits and embracing something that’s new like this is getting out from behind that computer. We don’t do seminars all the time, but we love for people to just show up at our doorstep and want to chat. If Chef Paula is about making something, then we’ll sit down and break some bread. We just love, love meeting people. It just seems to forge something that’s an intangible you can’t replace. It helps you break habits – it helps you do things right…I can’t say enough about it! It’s probably the biggest thrill ever to finally put a face with an email address. To know that someone’s out there getting up every morning and doing this is Austin, Texas or New York City or Australia. It’s really heartwarming! That’s my parting thing – let’s meet each other!