Hello Instant Money Traders,

No new trades today but I want to go over a bit more about the subject of margin requirements, account size and what kind of returns we can expect. We had two lengthy questions come in on this subject, so I want to clarify things and give you all an idea of what we’re looking to achieve here.

First, I want to remind everyone what it is exactly we’re doing and why it can be so lucrative.

As I’ve mentioned from day one, selling options is a fantastic way to generate steady income. But you have to know how and which options to sell in order to do it correctly.
It’s true that anywhere from 80% – 90% of out-of the-money options will expire worthless if held to expiration. We want to be the ones selling those options so we can collect all that money and put it in our accounts.

When we sell a put option contract the way that we do (using out-of-the-money options), we’re almost assured that 80% – 90% of them will expire worthless. But in the off chance that it doesn’t, we will be rewarded by buying a good stock at a great price.

Now, as we sell these put options, our brokers will ask us to keep a portion of money aside as collateral (margin requirement) while the trade is active. As I’ve been saying, the margin requirement will be roughly 20% of what it takes to buy the stock in full if we are ever obligated to do so.

Since we only need a portion of what it takes to buy the stock, this allows us to use some of our other funds as margin for other put-sell trades.

As market conditions change, so do the amounts that we can collect from selling puts options, as well as what our margin requirements will be. When stocks are trading lower, it will take less put-sell trades to give us good money and it will take up less of our money to use as margin.

When markets rise, put option values deflate, giving us less money per trade. And as the stock price increases, the margin requirement goes up. The higher the stock price, the larger the margin requirement.

This takes us through periods of great trades with smaller margin requirements to periods of just good trades with larger requirements, and back again.
Bottom line, there should be no reason why you shouldn’t pass up an opportunity to have someone give you money in exchange for your obligation to buy a great stock at a great price.

Even if it’s $20, wouldn’t you still do it? Why not? I do all the time. If most of them are going to expire, you can pretty much bet that you’ll just end up keeping the cash and move on to the next trade.

I know some of you are thinking, “why would I want to put up hundreds of dollars in margin just to make $50?” Using our VZ trade as an example, it would be putting up $553 to make $53.

You’re not seeing the bigger picture. You can’t look at it as “only making $53.” The $53 is a bonus on top of you being able to buy a great stock at a great price. As long as Verizon is a stock that you agree (based on your financial situation) would be a great buy at $25 per share, like I do, then why not let someone pay you $53 in the meantime?

If you end up buying VZ at $25, then that’s great. It’s what you hoped for. You also got $53 for your troubles. So you can’t see it as putting up $553 to make $53. You have to look at it as putting up $553 to possibly buy VZ at $25 ($4 cheaper than its current price). And for tying up that $553, someone will give you $53 for your troubles. That’s the way I look at it.

Lastly, before getting to the questions, remember to understand that there are costs to doing these trades – commissions. That is why you need to be cognizant of what your broker is charging you. If we sell an option for $.50 per contract ($50), you better not be paying more than $50 in commission per contract.

Now, let me post these two questions and I will answer below.

Questions & Answers – Part 1: Question 1

Q: I’m now a bit confused about what the profit objectives are for your service.

1. Exactly what % return on my account balance can I expect? I understand you report the return on each trade as a % of margin used, but that doesn’t seem to fairly represent what our true return will be based on the amount of free cash you indicate we need.

The promotional material I received when I signed up indicated we could easily expect a return of $1000/month on a $10,000 account balance. This results in a return of 10%/month. However, the strategy you propose results in < 10%/year (assuming a $15,000 account trading 5 contracts at a time with a $25 strike price making $50/contract = $250 profit – $10 commissions = $240 net profit with an average hold time of 2 months = $120/month = $1440/year / $15000 = 9.6% or just over $1000 profit after taxes which barely covers my $750 yearly cost of your service).

Even with a substantially larger account, these type of returns hardly seem worth all the time and risk involved. And I honestly do not expect to make 10%/month. But 4-5%/month does seem realistic if we can fully take advantage of the margin availability.

2. What is the likelihood EVERY open position will get assigned? Since supposedly 90% will expire worthless and we may have 5 open positions at any one time, shouldn’t we just need enough free cash in case one of the positions gets assigned and not all 5?

Even if we had another September 11 type event and several positions were tanking at once, I would imagine you would find a way to get us out of most of the positions (by buying back the options or rolling them further out or whatever other tools you have) before the stock price dropped below the strike price and we got assigned multiple stocks?

Otherwise, why do we even care if the margin requirement is 20% or 100% since, according to the advice you give below, we will need to have 100% available at all times anyway?

Questions & Answers – Part 2: Question 2

Q: 1. If we ever do get assigned a stock, as long as it’s not too far below the strike price, why not just sell it outright and not worry about holding it or selling covered calls? It would seem that holding the stock ties up a lot of cash that could otherwise be used to take advantage of more leveraged put buying. Quite frankly, I’m not particularly interested in owning any of the underlying stocks for any length of time, just in collecting the option premiums.
2. In the promotional material that was sent out for your service, it states the following:
So if you have $10,000 in assets in your trading account, you’re likely able to collect $1,000 a month using this strategy.

Being an engineer, I had to convince myself how this was possible. Using a $10,000 account and assuming an average strike price of $20, selling one options contract would obligate us to buy $2000 of stock if the option is exercised. If the broker has a 20% margin requirement this will utilize $400 of my account balance. This means I can sell a maximum of 25 option contracts (25 x $400 = $10,000).

Using an average option sell price of $0.50 will generate $50 of profit per contract x 25 contracts = $1250 – $50 commissions (assuming $1/trade x 25 contracts x 2 assuming we sell most of them before expiration) = $1200 profit. Assuming an average holding time of 2 months = $600/month profit or around 6%/month.

Not too bad, but still not $1000/month. However, it’s close enough that small changes in some of my assumptions can get us there. This also assumes my entire $10,000 is being utilized at all times.

My main concern, however, is that to get anywhere near the return advertised, I’ll have to keep my entire $10,000 balance in play at all times. But if all of my money is tied up in the puts, I have nothing left to handle a possible assignment scenario. How do you reconcile this? If I keep enough cash in the account to handle a possible assignment, I can never take advantage of the margin or come anywhere near the advertised return rate. It seems either I have to accept a much lower return than advertised or I have to take on the risk of not being able to afford to buy the stock if assigned.

I’m not looking for personal investment advice here, just a way to maximize my use of leverage. It just seems to me the net effect of being prepared in the event of an assignment is nearly the same as having a 100% margin requirement. Maybe you could give an example using some of your current trades with a theoretical $10,000 account to show how trades could be made that maximize the number of puts bought while still allowing the account to be covered in the event of an assignment.

Part 3 – The Answers

A: Both of these questions came from the same member, are very detailed and cover a lot of ground. They are important questions, so I don’t want to gloss over them. I’m very particular about what goes out in terms of promotional material for my service as I NEVER want to mislead anyone or have someone feel that I’m trying to swindle them.

There are lots of scam artists out there when it comes to financial newsletters and services, and believe me, I’ve seen my fair share. Most of them end up disappointing the member through losing trades and before you can ask for a refund, the author has skipped town. I want none of that and neither do you, so that is why I spend almost 16 hours a day working the markets and devoting my time to making this newsletter the best possible.

Now, let me try to answer these questions best I can:

The core questions comes down to: how can I make the most money using the least amount of funds with a limited account size and replicate the returns we advertise.

When we went to print initially with the IMT service in October 2008, the stock markets and the economy were in the midst of a major sell-off and on the brink of total collapse. The markets proceeded to fall until we hit bottom on March 9, 2009.

Those first six months of the service were some of the greatest times I’ve seen in years when it came to selling put options. Volatility was exploding and stock prices were hitting 10 – 15 year lows. This made the put options extremely expensive and great for us to sell.
At that time, we were concentrating on selling options with strike prices of $5.00, $7.50, $10.00, & $15.00, and getting fantastic money for them. We were setting ourselves up to buy some quality stocks at unheard of cheap prices. And as the stock buy prices per share were potentially going to be very low if we were assigned, the margin requirements were alot smaller than what we’re seeing now.

For example, we sold $5.00 put options on Dow Chemical, $7.50 & $10.00 put options on GE, $12.50 put options on Disney, $17.50 put options on Microsoft & $10.00 put options on UNG.

In addition to the low strike prices, we were getting great sales on the put options too. We received $1.00 per option on Disney, $1.15 per option on Microsoft, and even $1.60 per option on UNG. Those prices were much higher than what the market is giving now, and the expirations were for only a month or two out in time, much less than some of our current five month options.

So if we received $1.00 for each Disney put option for example – that brought in $1000 for a $12.50 strike price with a 10-contract position. At that time, the margin requirement was roughly $2875 total for all ten contracts, much less than a full $10,000 account value.

And as we sold the Microsoft options for $1.15 and the UNG options for $1.60, we were bringing in some solid money on those too, with lower margin requirements. Ten contracts of each gave us $1,150 + $1,600 = $2750 on a margin requirement of $6875 all told.

So, depending on how many contracts you sold, it was definitely attainable at the time to be near the promotion’s stated amount. Between those three trades individually on 10 contract positions, we were taking in much more than the $1000 minimum as stated in the promotional material.

Of course, not all trades were paying that much per option, but it was definitely possible to reach the $1000 per month threshold through a combination of trades using a $10,000 account. On the one or two trades that brought in $1,000 in that specific month, we used much less than the full account size of $10,000 for margin.

In the promotion, we didn’t state a specific percentage return we were looking for because the margin requirements are different for every trade. But we did state that it was possible to bring in $1,000 per month by selling these put options. Now, estimating that we could continue to receive similar dollar amounts into the future, the possibilities of matching the promotional material was there.

As the stock market started to recover over the rest of the year in 2009, we started to receive less money per position while the margin requirement started to move up. This caused us to take note that we either needed to sell fewer positions with the same account value, or add more money to the account. This is the market gyrations taking us to the less-than-ideal conditions we were used to seeing.

Since we’re now currently receiving much less per option – many in the range of $.25 – $.50 per option, we of course are taking in less monthly money. But you also need to realize, as editor of this service, I want to earn everyone the most amount of money using the safest available trades.

I, of course, could pick strike prices closer to the current price of the stock, which could put us easily in the range of $1.00 or higher per option contract. That would easily attain the promotional material of hitting $1,000 (on 10 contracts).

But by selling those higher strike prices for larger payouts, we are putting ourselves in a more probable position to be assigned on the stock. I’m taking this into consideration when I choose a strike price. I believe that most of the members would rather have the options expire than have to deploy a good portion of their funds to buy and hold the stock. Not that there’s anything wrong with that approach, but I’d rather choose options that have a higher probability of expiring worthless. So with that approach, at this point in time, we have to settle for less money right now per trade. I’m using my discretion to choose safety at the moment vs. taking in a larger payout per option.

As far as using your margin funds and account balance to the best of your ability, I cannot offer individual advice, but of course I can offer guidelines. And as for what we’re trying to achieve as far as percentage returns – keep reading.

If using a $10,000 or $15,000 account, you can certainly tie up a good portion of that if selling five or ten contracts with strike prices of $25 or higher, as we’re doing presently. This is a different scenario currently than when we had the opportunity to sell the low strike prices of $5.00 – $15.00 that we had back when the markets were dropping. I’m aware of this and it’s just part of the market cycle.

Since we are assuming that a majority of these options will expire worthless and that the margin requirement won’t increase too much over the course of the trade, we feel that our members will still be able to sell the options and then buy them back to lock in good gains. This will allow us to re-deploy margin funds for other trades, as we won’t have to use the funds to outright buy the stock.

Have Your Funds Ready… Just In Case

The reason why I talk about having the funds ready and accessible if assigned on the stock is because I don’t want anyone to be surprised if we are obligated to fulfill the contract. We will never need 100% margin, but you still need to be aware of what the stock will cost in full based on the number of put options you’ve sold. Our main goal is to have the options expire worthless as that is the quickest way for us to keep capturing profits month after month. But if we have to buy the stock, then so be it.

We aim to keep making new trades every month while closing older trades and locking in gains. My suggestion is to sell just a few contracts per position if using a $10,000 or $15,000 account. If we have four open positions at one time (which is typical), and you use $500 in margin for each contract, then you can sell a few contracts of each of the four stocks, and still should have some cushion left of your maximum account value.

In terms of returns on margin, the only way to truly figure out returns when selling options is to calculate the actual gain against the initial margin requirement. There’s no other way. This has led us to gains as low as 2% to as high as 44% return on margin. If I had to make a ballpark guess as to return on margin for each specific trade, it would be somewhere between 5% – 15%

There’s also no guarantees when trading the markets, nor do we guarantee that we will make you a set amount each month. We can only offer guidelines of what you can expect based on market conditions at the time. We try to live up to the promise of potentially expecting $1000 per month collected from selling put options (assuming 10 contract positions), but we have to be realistic in that we can only take what the market gives.

Don’t concentrate so much on what percentage return you will see, as you should concentrate on how many actual dollars you will receive when doing the trade. Surely as we sell put options on four stocks at once throughout the year – as is typical for our portfolio – we can easily attain $1,000 many times over, which I know will cover the cost of your yearly membership.

I also hope everyone won’t get too hung up on the numbers in here as I want you all to see the long-term benefits of selling put options. It’s simple – it is a great way to bring in passive cash as you wait to see if you have to buy some of these quality stocks. Of course you need to be cognizant of the end result if assigned, but we’re banking on the high probabilities of the options expiring worthless. That’s all there is to it.

I know this alert has been another long one, but I felt it was necessary to answer the questions as completely and accurately as possible. I hope I achieved that goal.
More questions to follow later this week.

Regards,

Lee Lowell

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Current Portfolio:

DD Apr ’10 $27 put
Opened 01/08/10 – sold put for $.30
Current Price: $.22
Current Stock Price: $32.60
Status: Ok to enter new trades at $.30 per contract or higher

GME Apr ’10 $15 put
Opened 01/08/10 – sold put for $.275
Current Price: $.20
Current Stock Price: $18.95
Status: Ok to sell new trades at $.25 per contract or higher

HD May ’10 $22 put
Opened 01/11/10 – sold put for $.25
Current Price: $.16
Current Stock Price: $29.29
Status: Ok to sell new trades at $.25 per contract or higher

JCP May ’10 $17.50 put
Opened 01/13/10 – sold put for $.25
Current Price: $.14
Current Stock Price: $25.64
Status: Ok to sell new trades at $.25 per contract or higher

VZ Jul ’10 $25.00 put
Opened 02/02/10 – sold put for $.53
Current Price: $.53
Current Stock Price: $29.10
Status: Ok to sell new trades at $.50 per contract or higher