What is an Insurance Agent Trade?

There are many ways to trade stock options. Each type of options trade has pros and cons. But when all is said and done, the best trade in most cases is a credit spread. Now I can just hear haters jump up and down and criticize the credit spread because the risk/reward isn’t stellar. But “Haters gonna hate…” What is a credit spread? A trade that can have outstanding probability. And while you may not make a zillion dollars next week with a credit spread, odds are you will show a consistent profit. And that’s the name of the game. The credit spread is the best trade there is.

Now a credit spread can sound pretty complicated, but I’ve developed an easy way to explain what’s going on. I have written a report that explains how I trade credit spreads. You can just click the link and grab it. It’s free.

My favorite way to use a credit spread is what I call the Insurance Agent Trade. It goes like this. Suppose you have 100 shares of Amazon stock, and you’re a bit concerned to have $38,000 in one bucket, so you decide to buy some insurance. If you own a house, you buy homeowners insurance to protect your investment. If you own AMZN stock, you can also protect your investment

Since I am an insurance agent, I happily sell you some insurance. The insurance policy for stock is called a Put option. So you buy a Put option from me, your insurance agent. You decide you want a $2000 deductible insurance policy, so I sell you an Oct 360 Put option for $2500.  By selling you that insurance, I have an obligation to buy your 100 shares of AMZN for $360, even if AMZN goes to zero. For you, the most you can possibly lose is $2000. Even if AMZN goes to zero, you can sell your shares to me for $360.

But I’m a little concerned that I might have to pay a bunch of money if AMZN goes way down, so I buy my own insurance. I buy an Oct 340 Put option that gives me the right to sell 100 shares of AMZN for $340. I pay $1800 for that insurance policy. The pair of option trades together is called a credit spread.

The net amount that I receive, the net credit, is $700 (2500-1800). How much can I lose? Well if AMZN goes to zero, I am obligated to buy your shares for $360/share, and I have the right to turn around and sell them for $340/share. I’ll lose $20/share or $2000. That’s the most that I could lose.

If I can potentially make $700 on a maximum risk of $2000, then the return on my risk is 35%. All I have to do is wait until the insurance policies (the pair of put options) expire in about eight months. That works out to about 5% per month. Not bad.

So that’s the Insurance Agent Trade: a Put credit spread placed well below the stock price with an expiration period of 60-90 days

As it turns out, I can usually exit this trade for almost all of the profit in perhaps six weeks. And as an added bonus, I will get all of my profit even if AMZN falls 5%.

Yes, you can make 5% per month with the Insurance Agent Trade, even if the stock that you are investing in falls.

If you want to learn more about this kind of trading, I’ve written a free report for you — How I Target 3-5% Per Month Even When My Stock Goes Down. You can download the report right now.

 

* The above is for educational purposes only; it is not a recommendation to buy or sell anything.

Rights And Obligations Of Stock Options

Whenever you trade stock options, it is important to understand what are the rights and obligations of stock options. Whether you are trading call options or put options, the rights that you have and the obligations that you incur are the same.

Let’s look at a quick example. Suppose I think that Amazon stock is going up. If Amazon is currently trading at $350, and I think it is going to go to $375 by next month, I could buy a Call option. I could buy an April 360 Call option. Buying this Call options gives me the right to buy 100 shares of AMZN any time before late April for $360 per share, regardless of the market price of AMZN. If AMZN goes to $400, and I have the right to buy stock at $360, I can potentially make $40/share instantly. However, if AMZN falls to $350, owning the right to buy stock at $360 is of little value at all.

Suppose I bought this April 360 Call option from you. You sold it to me. By selling a Call option, you incur an obligation. You have the obligation to sell 100 shares of AMZN to me for $360 per share any time before late April. If AMZN falls to $350 per share, you know that I’m not going to ask you to sell me stock for $360. The option would be worthless. However, if the stock rises to $375, I’m going to ask you for 100 shares at $360. You have the obligation to sell them to me. It would be nice if you already own the stock so that you don’t have to go buy the stock for $375 in order to fulfill your obligation to sell it to me for $360.

  • Whenever you buy a call option, you have a right to buy stock at a certain price before the option expires.
  • Whenever you sell a call option, you have the obligation to sell stock at a certain price before the option expires.
  • Whenever you buy a put option, you have the right to sell stock at a certain price before the option expires.
  • Whenever you sell a put option, you have the obligation to buy stock at a certain price before the option expires.

Get my favorite option trade in this free report — How I Target 3-5% Per Month Even If My Stock Goes Down.

Eavesdrop at the Yahoo Finance “Cocktail Party”

Do you have your eye on a stock to invest in? Have you read the reports earn extra incomeand listened to Cramer? Do you wish you could talk to some professional analysts who cover the stock and get great stock tips? And let them do all of the fundamental analysis?

What if you could find that group of analysts and hear what they have to say?

Well let me take you for a little trip… to the Yahoo Finance Analyst Cocktail Party. At this exclusive affair, you can wander from room to room and hear what the people in the know think about your stock.

Come on over here! I’m in the library, and there is a group of 38 experts on Amazon. If you ask them what they think AMZN will do in the coming year, you’ll find that on average, they think it will head up 90 points. There’s even one fellow who thinks it will hit 500!

Let’s stop in the conservatory. Look, there’s Miss Scarlett with a knife spreading some cheese on her crackers. :) The analysts over in the corner are talking about IBM. You ask what they think, and these experts give you a clue. They don’t think it has much hope of going up much at all.

In the living room, there’s a guy sitting in the corner talking to himself. He’s an analyst and a supposed expert on some stock, but if he’s there by himself and he’s not talking to a group, then I wonder if he’s a bit of a crackpot. I won’t pay much attention to what he says; he’s not validated by the crowd.

So how can you get an invite to this party? It’s easy. Just head over to the Yahoo Stock Screener. You can find groups of analyst with scores for any stock and sort them to find the best stocks to buy. You want to weed out tiny companies and those that are barely covered and focus on the companies being analyzed by a crowd.

I’ve made a video to show you exactly how I use the Yahoo Stock Screener to find  great stock tips. Grab the free video. It’s quick and easy.

Once you drop in on a few analyst cocktail parties, you will be surprised how Yahoo Stock Screener can boost your investment returns.

Traders Bookshelf

People often ask me to name my favorite books on the stock market, trading, and investing. Here are some of them.

Stock Market Insurance Trader is my favorite stock options training book. Hey, of course I had to have it on this list :)
Rule#1 is my favorite fundamental analysis book. He trims down all of the gorp and focuses on the 5 key metrics for analyzing a stock and determining its real value.
I wrote Fiscal Cliff Investing at the end of 2012 when Congress was gearing up for the Fiscal Cliff. It discusses the ramifications and illustrates several methods for protecting your portfolio in the event of a downturn.
In this comprehensive book on options spread trading, Gareth Feighery, founder of MarketTamer, covers everything from bull put spreads to ratio backspreads to technical analysis and choosing a broker. Great stuff for beginner to intermediate traders.
Stikky Stock Charts has a bit of a feel of a child’s coloring book, but there is a deceptive amount of value here. I find myself grabbing it off the shelf from time to time just to immerse myself in charting and remind myself of what to look for in the stocks that I follow.
The Volatility Edge in Options Trading is an amazing analysis of option volatility. It will hurt your head, but it’s definitely worth it.
Free Report – If you want to learn more about the trading style discussed in Stock Market Insurance Trader, you can read this report.
Options Strategy – Risk/Return Ratios is another of my favorite head-hurting books. Brian is brilliant and takes the reader through a fascinating lesson in how to reduce risk with multilegged trading.
Although Trading for a Living was written over 20 years ago, it is largely timeless, and still the first book people choose when they want to trade for a living.
  Grab a Kindle reading app to make it easy to read any Kindle book on your computer, cell phone or tablet.

Disclosure: As an affiliate, I’ll get a few nickels from Amazon from time to time for hooking you up with good books.

Option Traders – Get a Free Dinner Each Month

Nobody likes a great dinner better than I do. The problem is how to pay for it. I’m not talking about aearn an extra income for a nice dinner dark meat combo at KFC, I’m talking about a great steak and a bottle of wine with my sweetheart. A nice $100 Saturday night celebration. Well I found a great way to easily grab a $100 for dinner every month, and I wanted to share it with you.

If you trade options every month, you may be leaving money on the table. Over the course of the month, that money could easily be $100. With hardly any work, you can end up with a nice dinner on the house every month. Here’s how it works.

For every option and stock, there is the price at which someone is willing to buy, and the price at which someone is willing to sell. You buy at the ask price and you sell at the bid price.

But are those prices fixed, or are they negotiable? Very negotiable. It’s an auction. If the volume of stock is very high, the spread between the bid and the ask prices will be small. But for options, where the volume is much smaller, the bid/ask spread could be wide – easily 10 cents or 20 cents or more.

Here’s an example. At the time of this writing, a June 150 Call option on BIDU has a bid price of $11.30 and an ask price of $11.50. Some has declared that they are willing to buy the option for $11.30, and someone else has said they are willing to sell the option at $11.50. You could place a market order and you would get that option at $11.50. But don’t you think that person would have let you have it for less? Almost always.

Whenever you buy or sell an option, use a limit order. Start your negotiation at the mid-point between the bid and the ask prices. You will usually get your trade. In this case, if you place a limit order for $11.40, you will likely get filled. If not, try $11.45, and you will most certainly get filled. Every time you shave a dime off of the bid price, you save $10. Do this on a 10-option lot, and that’s $100. And that’s enough to get you and your honey a nice dinner out.

Estimating Returns on Insurance Agent Trades

As you search for the right Insurance Agent Trade, you will sometimes ask yourself something like the following question. “If I can get 46 cents for a 60-day Insurance Agent Trade, what is my monthly rate of return?” You can, of course, calculate that, but it can be a bit tedious to do it for several trades. And what if you ask a question, “I want to get 4% monthly for a 90-day trade. How much credit do I need?” Again that can be calculated, but asking the question backwards like that makes it more difficult.

So I made the following chart. For example, if you want a 90-day Insurance Agent Trade that is $5 wide and that makes you 4% per month, you will need to get 54 cents in net credit. If you get 46 cents net credit on a 60-day trade, that will give you a 5% monthly return rate.

What if you get 56 cents on a 72-day trade? That looks like about 5% if you read between the lines. You can calculate the return as follows:

Monthly Return = (net credit / ($5 – net credit)) x (30 / days till expiration)

Monthly Return = (.56 / (5.00 – .56)) x (30 / 72) = 5.3%

Refer to this chart when you are setting up your trades and it will help you quickly estimate the target credit and return rate for your trades. You might want to print it out and tape it to your monitor for easy reference.

 

TargetCredit