Professional Documents
Culture Documents
Hello, I have been investing since 1997, but actively trading the stock market since
1999. Also, I love business, and real estate. I have written a number of self study
materials, and developed dozens of seminars, focusing on financial strategies.
Whether it is real estate, the stock market, or business, I love to get people on to the
fast track leading to success and wealth.
I travel the country teaching people how to cash in from the stock market, real estate or
business, each and every month. Just a few of my accomplishments:
One of my favorite strategies is Credit Spreads. I heard about Credit Spreads (Iron
Condors), at pretty much every advanced stock program or training, I attended. But I
did not fully appreciate them often thinking they were complicated, or difficult. They are
not. They are truly FANTASTIC. A regular source of income from the stock market.
I heard about them first, by accident. I ended up golfing with a trader, who talked about
only trading a few hours a MONTH. I did not take him, seriously at the time (I should
have). I would be much richer. Much later, a seasoned trader, and trainer
introduced them to me as a concept of spread trading.
Smart Money- The ATM Machine
Later, I had the privilege to work with one of the best traders I know, at the time, a 10
year plus investor. He was kind enough to spend days with me, teaching me trading
strategies. He dramatically improved my Credit Spread trading.
After years of personally trading spreads, I made some personal distinctions to ensure
success, and minimize loss. Often improving ROI. In fact, I broke them down to a
system, and set of rules. If you follow the rules, you will have great success.
In addition, I have taught thousands of folks credit spreads. So, know how to do it
quickly, and what a lot of the questions, and trading circumstances. This manual is the
basic system, and assumes, you know just a little about the market. Obviously, you will
want to become familiar with trading concepts, and terms. This is beginning not the
end of your education.
Credit Spreads are a cash flow system (The ATM machine). It can:
Give you monthly cash flow from the stock market. A never ending ATM,
Protect your current positions from the ravages of the economy.
Allow you to trade 2 hours a month or less, and make full time income.
Ensure you retire with a GOLDEN retirement plan.
Earn 2, 5, or even 10 percent per month.
No guarantees but HIGHLY probable. If you follow our proven system and rules. In
fact, we can back test the system, and see how well it would have done in past years.
Back testing is a great way to learn the system by the way. We will talk more about
back testing later.
Anyone can learn this system. I have taught to: Doctors, Plumbers, hockey players,
real estate investors, nurses, bank managers, financial planners, 16 year olds, and 68
year olds. You don’t have to be a brain surgeon or engineer. And you do not need to
be an expert on the stock market. Some basic terminology and understanding, with
application of the rules, is all you need. Plus a willingness to learn, spend a little time
mastering the rules and paper trading.
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Other accounts available for on line trading, and often paper trading are:
www.etrade.com
www.optionsxpress.com
www.interactivebrokers.com
www.fidelity.com
www.tdameritrade.com
Paper trading allows you to master the concepts, and actual key strokes of buying and
selling stock directly on line. Therefore, you can get good at the system, and key
strokes. So, make sure you pick one with paper trading (virtual money).
Plus if you are going to make a mistake it likely will happen, in the first few months, and
we would rather you do that with fake money, than real dollars. Throughout this
manual, we will be referencing the think or swim on line system. Although any of the on
line brokerages, can accommodate these trades.
Get Ready to in the next 30 DAYS, learn and earn! To get on the path to 10% ROI. To
make significant, monthly cash flow. To create a financial miracle in your life. To build a
rich and wealthy future.
Yours in Success!
Mike
PS: This really works! If you invest the time and effort the Money will follow!
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Disclaimer
Ok. Before we get started, and since we are talking about investing, I am required to
give a quick disclaimer.
The information contained in this manual is for general information and education. The
materials and education is not a substitute for obtaining professional advice from a
qualified person.
M2 Express, Jim Francis, or any affiliates distributing this information are not engaged
in rendering any legal, investment, or professional advice.
Options have risk. Prior to buying or selling an option, an investor should receive a copy
of Characteristics and Risks of Standardized Options. You should download this
document, to know the risks involved in options trading.
Investors must have a broker to trade options, and meet suitability requirements.
All examples are for education. They are not a recommendation to trade a specific
position. Past results are not necessarily indicative of future performance.
These contents are directed to US residents and citizens. They may or may not work in
other countries, and financial institutions. Spend time learning your market.
Neither the information, strategy, education nor any opinion expressed by the author
constitutes a recommendation to purchase or sell a security, or to provide investment
advice. One should consult a registered investment advisor.
lA l associated specifically disclaim any liability, whether based in contract, tort, and
strict liability or otherwise, for any direct, indirect, incidental, consequential, or special
damages arising out of or in any way connected with access to or use of this materials.
You may use this information for your personal use only, you may not reproduce or
distribute the text or graphics to others or substantially copy the information.
Use or reproduction or any of these materials, for any other purpose is expressly
prohibited by law, and may result in civil and criminal penalties.
Now let me tell you want this really means to me. Don’t try this at home, until you have
paper traded the steps for several months. Until you know the rules and follow them.
And NEVER put all your money in to one trading system. Enjoy a great system.
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If you have/had your retirement in mutual funds, you realized a 20-40% loss in
2008/2009. Most individuals who trusted their life’s savings to an investment
“professional” lost their shirt. Think about that, you worked YEARS to build a nest egg,
and got it cracked in a few short months. Frankly it disgusts me. For several reasons!
First, I saw on the TV they honored the BEST mutual fund manager of 2008. He only
lost 19%. Disgusting! How can you honor someone that lost money for you? Many of
these “professionals” got bonuses too. Can you imagine that, getting paid to loose your
money? How discussing. Now some of you are saying, well the guy did not loose as
much as other funds. I mean there are funds out there that lost half their value. True.
But they did not have too loose all that money. They could have simply move a
substantial amount of their portfolio to CASH. CASH is a position. What is worst, is the
kind of knew it was going to happen, and did nothing. We will talk about them knowing
in a minute.
Even if they do well, in a year, the statistics still scare me. It is said, that 80% of the
mutual funds managers out there, cannot do better the S & P 500 (a tracking index).
Well, if that is the case, would we not be better off, just investing in the SP500 or a
derivative? Perhaps the SPY. We would do better than 80% of the “PROS” out there.
Now there are some good people out there (advisors, planners, brokers), but you have
to keep in mind, what is their job? Since, I have in the past held several investment
licenses; I know what the job is all about. It is about SELLING. Getting people to invest
their money in an account, a stock, a trade, or a mutual fund and making a commission
or a fee. They don’t get paid to tell you to take the money out either. That to me is a little
disturbing. They have a conflict of interest. No wonders, sometimes we get conflicting
advice, like buy on the dip, even though the stock is going down the toilet.
I recall a time, when I got a call from a telemarketer (stock broker), telling all about a
luggage stock, and how it was poised for a big gain. He said “Going to the moon”. I took
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a quick look at the chart, and new it was going to move. DOWN. I immediately shorted
the stock and did very well.
Conflict of Interest
If they really were a professional they were telling you in the Nov/Dec 2007 period to get
out of mutual funds, or major equity (stock) positions (at the latest Jan 08). Because
they knew the market was going to crash. That is right they KNEW. Or at least highly
suspected the market was going to go down dramatically. Now how can I say that? Well
every technical analyst in the world (many of whom work for mutual funds), knew that a
major pattern happened in Nov/Dec 2007 (or the latest Jan 08). You see the 200 day,
50 day moving average, crossed over to the downside on most major indexes during
those periods. A dramatic change, which signaled, a major down turn of the market. By
the way, a simple understanding of key moving averages, like the 200/50 day moving
average, can keep your long term investing on track. It is one of the reasons in our
Smart Investing series; we spend a good deal of time on moving averages, and using
charts, for investing. It is worth learning a little more about. Check out
They knew the market would CRASH and did not tell you
See the chart on the next page; it is a snap shot of the Russell 2000 (RUT for short).
2000 stocks that give a good cross section of USA stocks. A simple 200 day moving
average and 50 day moving average, tells you the market is going down. Yet I did not
hear any mutual fund managers, say “Get out of fund” or even make major changes in
their own portfolio management. The simple fact is they don’t get paid for telling to move
your money. If you simple used the 200/50 day moving average you would be much
better off in your investing. In fact you have to take charge your own money, and stop
trusting others. Or at least know as much as the folks, that are investing your money.
Telling them what to do, rather than trusting, that they will look after your money.
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Your knowledge about the market, directly affects your rate of return. Even one
strategy, can make a difference. Let me give you two simple examples.
First, the 200 day 50 day moving average is the number one technical analysis tool to
evaluate if the market is going up or down. Certainly, there are others, but this tool can
make a difference in your long term investing. Up or Down. Check out this chart from
2010 of the Russell 2000. The 50 day crossed the 200 moving average, indicating a
positive uptrend. Therefore, you would expect a positive trend for the next several
months (or longer). Just like back in late 2007 and early 2008 the average crossed and
it was a sign of a poor economy and stock market. If we had paid attention, we could
have save a fortune or made a fortune! Simple strategies can make a major difference.
If we spend the time to learn them, and apply them.
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The second strategy can have an even more profound effect. Credit Spreads, which is a
cash flow system, can earn up to 8-12% per month. No guarantees, but highly probable.
That could mean your money doubles each year. Let us look at the average retirement
plan of 36 years of investing, and then think about putting our investing on steroids.
36 years or 36 months?
Most folks have a 30-40 plus year retirement plan. Often they work all their lives to build
a nest egg for retirement. If they are lucky enough to work for a company for that length
of time. There are lots of folks not working at the moment.
They put away some money for their future (often not enough by the way). So let us
look at a simple example. Suppose you had $ 10,000 dollars to invest, you have 36
years to retirement, and you never add another penny to the 10k. Other than to reinvest
the 10k and profits, every year. At a 10% rate of return, a year, in 36 years you will retire
with $309,127.
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Not a great retirement but not bad either. At least you will have some money in
retirement. That really is the power of compounding over time. A solid plan for the
future. The problem too much time, and not enough of a return on the investment.
Now consider this. If what we have been saying is true. You can earn approximately
10% a month using credit spreads. No guarantees, but the back testing and personal
results bear this out. A high probable system.
If that is the case, $ 10,000 could turn in to $309,127 in 36 months. That is 3 years. That
is impressive.
Even if you only, got half way there, you would be better off than, than trusting a “Pro”
money manager.
OK. Since, I am hypothetically talking numbers, time for one of those disclaimers….
In 2008, while the rest of the market was loosing 40%, or more, many of our students
were and are continuing to earn 5-10% a month, on their positions. That is Huge!
In good years and bad years the system works. It is based on high probability, and
proven results. Follow the rules, and the cash machine will work for you.
We like to call it the ATM Machine, because any month, you can go the market and get
approximately 10% on your money. Now, no guarantees, but it is highly probable. The
market does have risk. But thousands of folks are doing Credit Spreads, each and
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every month; taking a small fortune to the bank. Most traders use credit spreads for
cash flow.
Credit Spreads, also called “iron condors” are a type of option that is relatively easy to
master (if you follow the 21 rules). An extremely, high probability system. In fact, we
created the rules, to help folks, stay away from risky positions, and help manage
positions. To maximize profit and reduce risk.
I have spent over 81k on seminars, books, tapes, programs, software, and systems.
Each year, even now, I take one stock seminar (or more) just to see what is new, or
better. I have been to:
Stock Basics
Optiontrue
Profit Strategies Group
TMTT
Spread Trader
Pristine
Fortune Financial
Start Trader
Plus: Hundreds of books, manuals and self study materials on my shelves.
All of them have value. The more you learn, the more you earn. All of them teach you
some technique that makes you a better trader.
One thing that often bothered me was the math was a little flawed. Most of the trading,
is based on looking at hundreds of stocks (if not thousands), and finding a dozen or so.
Then trading the dozen, loosing on several (by getting stopped out), and winning on a
few. Letting those few, run long, and win big. So, maybe you win 4 out of 10 (and win
big), and loose 6 times (small). Not a bad concept but not the greatest winning system
either. Over time you grow your money. What really bothers me is the probability, and
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high number of loses. What happens if the first 12 trades are losses? Many folks will
drop out because of a lack of faith it works, or afraid to lose more money. There has to
be a better system out there. Where you win more than you lose. And there is one
called: Credit Spreads.
Let me give you an example my 17 year old son and I played around with one night. He
had a little more than $ 5000 dollars to invest. We did a quick excel spread sheet (next
page), to see what would happen in 3 years (36 months) if we could hit 10% a month.
The numbers were compelling. Imagine being 17 years old, and seeing, that if you got
10% a month for 36 months, on your $5000, you could potentially have 155k... Not only
that, but if you left the money there, and simply lived off the 10% (after the 3 years of
compounded investing); you would have $15,000 a month, to live on each month.
Needless to say my son got interested in Credit Spreads. In fact, he does Credit Spread
every month. The actual trading is about 2 hours a month which falls into his life style of
studying for school, and playing hard (soccer).
Now just cause printed an excel spreadsheet does not mean you get the result. You
have to actually learn the strategy and practice trading.
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Well what works for him, works for you. A high rate or return each month, compounded
over a few years, can work wonders for your retirement.
If fact, compounding at high rates of return, are a key to rich future. For many folks that
have lost, a small fortune in the market, getting a high rate of return, in a shorter period
of time, is the only way they are going to have a comfortable retirement. Maybe giving
you the ability to have a better lifestyle. More gold in your golden years.
Best of all, you don’t have to spend all day long trading. Once you master the basic
system, it takes only a few hours each month to trade. Kind of like that guy on TV “Set
it, and forget it”
I use to spend hours, even days at the computer, using fundamental and technical
analysis to pick stocks. Even a few software programs, to help quicken the decision
making process. I used all typical trading tools:
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Hours and hours of charting, looking for trading patterns, back testing, and paper
trading. And most of them work, but they took all my time. Hours and hours of work. If
you currently, work for a living, adding all those extra hours of research can be
exhausting. 50 hours at work, 20 hours at research and trading is exhausting.
So let me give you the top reasons, people lose money in the stock market:
If fact this can be far from the truth. Yes, they passed a simple test, to get a license.
But did you know on that test, there was NEVER a question about the stock market
or trading! You heard me right not one question. The questions were all about, the
securities act, and what appropriate risk for folks. How do I know that, I took the test.
I had several licenses at one time. Not any more. I just wanted to know what they
know, and don’t know. I was amazed at what they don’t know.
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In fact, a number of financial folks: brokers, agents, and even mutual fund managers
have come to our programs, just to learn credit spreads. It usually results in a
problem by the way. Once they learn Credit Spreads, it is tough for them to go back
to their clients, and sell mutual funds, or individual stocks.
Think about this. If 2008 your only strategy was investing growth stocks or mutual
funds you lost 40% or your account. ONE strategy is not a smart thing. Multiple
strategies make a great deal of sense. Credit Spreads are a Fantastic cash flow
strategy. High success rate and solid consistent returns.
Don’t know about alternative investments & get less than 15% a year.
There are lots of cool strategies out there, which can earn you more than 15% a
year. Here are a couple of examples:
Real Estate. Investing in property can earn you 50% a year or
more, using the power of leverage.
Tax Liens. You can earn 18% a year or more, guaranteed by the
government. Tax liens are a safe, investment.
Cover Calls. Rent your stock out to others, while you own the stock.
Your returns can top 30% or greater with high yields.
Credit Spreads. 5-10% a month. Very cool;
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Most Americans are lazy about their investing. Trusting a friend or the first person
who solicits their money. Hoping things will get better.
You have to get off your ASSets to build your wealth. Taking action is the key to all
success. It is time you take some action and increase your financial knowledge.
Compounding is a great tool. It can make you a fortune, in time. But that time does
not have to be 30 years. You can make a lot of money in short period of time, by
getting higher rates of return.
You can see above, that compounding can make a major difference over time. A simple
investment of 10k at only 30% a year, can give you 1.9 MILLION in 20 years.
Now imagine if that annual percentage was 100%. The numbers are unbelievable.
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You don’t want to make these mistakes with your financial plan. So, ensure you adopt
these strategies:
I mentioned I spent over 81k on training to improve my real estate, business, and stock
knowledge. Well worth the investment. It is a key to my success and many others, I
know. In fact, I spent time with 50 plus millionaires, and 2 billionaires. All of them were
students first. Often having a few key mentors in their life that made a major difference.
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Mentorship, a student, master relationship, can get you on the fast track to wealth and
happiness.
Pay the price for success
Credit Spreads cost me well over 15K, to become a PRO at Credit Spreads.
First, I had heard about “Iron condors” a couple of times, at various stock courses. At
first, glace they seemed too advanced for me, or too complicated. I skipped them, for
years. After hearing the term a dozen times more, and everyone, raving about them, I
decided I should learn more. Because when you learn you earn. I broke down and
spent several thousand dollars to attend an advanced stock course in Las Vegas. Yes I
had some fun too. The course gave me the basics, but I really want to become an
expert on the topic. I wanted to know everything there was to know about Credit
Spreads. You see you can learn one of two ways. Either through the school of hard
knocks. Trial and error. By the way, stock market trial and error is a very expensive
lesson. OR learn all the keys strategies, and potential mistakes, from an expert. OPM.
Learning from Other Peoples Methods (or Mistakes).
So, second, I paid someone a small fortune to learn the secrets to Credit Spreads. He
spent 3 days with me in Orlando. Teaching me all the tricks, strategies, positions,
management, rules, and revenue streams of Credit Spreads. Over the next couple of
years, I became not only master, but teacher of Credit Spreads. I taught them with my
trader friend, and by myself. A few basic Credit Spread strategies, I will share with you,
in this manual (but not all them).
Here is the basic concept of Credit Spreads. It differs from traditional stock or option
investing. The stock market is generally about direction. Going up or going down.
MOST strategies are directional. The stock market needs to go up or down, for you to
make money. The problem with this strategy is that the market does not always
cooperate. I can’t tell you how many times, I looked at a chart, and said “this stock has
to go up”. Only to see it stay flat for months or even go down. The up & down strategy,
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has too much uncertainly. You have to be really good at the trade, and trade
management. The probability is low.
Here look at the chart below. It is the OEX (S & P 100). Most investors who play the
OEX expect it to go up or down. Buying or Selling a position or option, expecting it too
go up or down. But what happens if it does not? You loose or profit very little. Looking
for that next trade.
For example for about 2 years, the OEX, kind of went sideways (2004-2006). So, if you
playing it to go up or down dramatically, you lost or made very little profit.
Credit Spread
But what if I told you, that every month you can money and it does not matter whether
the stock or index, goes up or down. It does not matter. Each month you make the
same trade, often at similar positions. You make 5 to10% every month.
There is no guessing, no hoping the market moves. You know exactly what your risk
factor is (loss), and your profits. Each month it is automatic. Your time
commitment?........ 30 minutes a month. Could you handle it? I bet.
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This is how the basic strategy works. First look at the OEX chart again. Can you see
that the OEX trades in a Channel? It has a high and low, and tends to stay with in, the
range. For years the price has not dropped below 520, and it seldom gets above 720.
Take a look.
So for the period of time July 2004 to April 2008, the OEX did not go below 520 (at all),
and a couple of times, it went above 720.
Most folks will try to guess if the indice is going up or down. But we are going to look at
this a little different. We are going to take a position that basically says, we feel the
OEX will not go below 520, or above 720, in the next 30 days. Now don’t worry about
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how we do that yet. That is what the rest of the manual is really about. Showing you
how to take positions. These are called Vertical Bull and Bear options.
Well if the OEX has not gone below 520, in years (almost 4 years), what is the chance it
will go below 520 this month. Pretty slim. Literally that is our proposition. A high
probability position, with high success rate, but it only pays 5-10% on you money. 5-
10% on your money for 48 months (actually longer). What a great rate of return.
Likewise we are going take a position above 720. Basically, say we don’t think the OEX
will go above 720, in the next 30 days. Well if the OEX has only gone above 720 3 times
in 48 months, that means we won 45 times, and lost 3 times. WOW, what a great win
loss record. I would take that any day of the week.
And that is the basic concept. We are taking positions, outside the normal range of an
index or indice. Outside the channel. We take the position for 30-45 days. Listen this is
the really COOL thing. They (the market) PAY us to take the position. You heard me
right they pay us. Certainly, we are risking some money (margin), but the day we take
the position, they pay in to our account the money. VERY COOL... Getting paid to
invest.
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Now I don’t want to scare you with terms, but we do need to learn a little about options,
support and resistance, and a minimum of 7 Rules to trade this strategy. Actually, there
21 Rules, but the basic 7 get us started, and keep us out of trouble.
So, we are going trade, Vertical Calls and Vertical Puts. Now Vertical actually means we
are going to have 2 positions in each call and in each put position. More about this,
options, and single position puts and calls later in the manual.
We are going to take a Vertical Call position at the top of the price range (channel), and
also, a Vertical Put position at the bottom of the price range (or channel). Each of these
positions will made up of 2 more positions. So each month we will have a total of 4
positions in each trade, or 2-pairs of trades.
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On the top: Vertical Call at 510/520 (this vertical is made up of two positions)
o Sell the March 510 CALL
o Buy the March 520 CALL
On the bottom: Vertical Put at 290/280 (this vertical is made up of two positions)
o Sell the March 290 PUT
o Buy the March 280 PUT
* Note: This not a recommendation to trade the RUT, at these levels. This reference is
to simply an explanation of Vertical Pairs. Prior to trading you should learn the
complete system, rules, and paper trade. You trade at your own risk. Also, don’t worry it
may look like Greek. It will become clearer.
Unless you went to an advanced stock seminar or have a buddy that is prepared to
take you under his wing and teach you the basics of credit spreads, you simply do
not know about them. Even the Financial experts don’t know how to use these
strategies. They have not spent the time to become a MASTER.
There are not that many Pros teaching the system. Hey if you are making 10% on
your money, and only spending 30 minutes a month doing it, what do you think you
would do with the rest of your time? Teach? Not likely, most are enjoying life. Now
there are a few us, that are type A personalities, and have do some thing productive
with their time, see a business opportunity, or feel a moral obligation to pass along
what they have learn to others (that’s me folks).
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Hey. If someone told you, you can take $ 5000 dollars and literally turn it into 1
million in a few short years, and it would take you 1 hour a week to master the
strategy. Would you make a commitment? You said yes, I know. Now one of you
said, but I only have $500 bucks. Well did you know at 10% a month, with no more
money invested, just the original amount, $ 500 bucks turns to 1 million in 80
months. What’s that less than 7 years? Worth the time my friend? You bet.
This is a million dollar strategy staring you in the face. All you have to do is work the
strategy.
Yes there are some new terms. Yes it takes awhile to feel comfortable with the new
information, but it is like anything. After a few weeks, it all makes sense, and more
importantly, makes money. Push past the terminology. Push past the un-known. It is
worth the EFFORT.
A common concern. I lost a fortune in mutual funds. I tried investing myself and
couldn’t pick my nose. I understand. Learning the all the indicators, charts, and
systems out there takes time and effort. And you could loose money. But this is a
different system; we don’t wait for the stock to go up or down. We know exactly what
is going happened each and every month. We even know, what we have to do to not
loose as much money on the very few times, the market goes against us. Maybe the
3 times out of 60 trades, it happens. Loosing a very small amount.
PS: If you did loose a ton of money, that is the exact reason, you need to master this
strategy. To build a wealthy future for yourself and family.
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For moment, let us assume I am right. That if you invested 10k for 60 months, and
you could earn 10% a month, and only loose 3 months what would be the outcome.
Well first, we are not gong to loose the whole 10k only a few thousand, let us say
$2500. So check this out. 57 winning trades, earning us 57k, 3 loosing trades of
$2500 each or $7500. We made 49.5K over 5 years on 10k invested. That is
incredible. What if I told you the rules can actually make you loose less.
Strategy: Don’t be afraid to risk a little bit of money, for huge returns
To begin the process of learning credit spreads, let us take a look at the fundamental
rules of credit spreads. These are “basic” rules to trade and keep us relatively safe.
I would like to make a statement, about credit spreads. The more you know, the less
risk and greater the return. The more money you will make. We are discussing the 7 key
rules and we will go into detail about them later. However, there are more distinctions
about credit spreads (advanced concepts) that give you better returns, better than 10%
a month. The more you learn the more you earn.
7 Key Rules
Rule # 1: Don’t loose money.
Rule # 2: Use high volume positions (liquid).
Rule # 3: Stay way from volatile stocks.
Rule # 4: Always use a contingency buy back.
Rule # 5: 50 cent premium.
Rule # 6: Money management.
Rule #7: Don’t let emotions control the trade.
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I have a friend his name is Phil Town. He speaks with Get Motivated seminars.
Recently, he recently released a book, called RULE number 1. Don’t loose money. I
totally agree with him. Unfortunately, most people don’t subscribe to this philosophy.
They want to, but don’t. They say they will but don’t.
In fact, I can’t tell you how many people, I come across, and they have lost a significant
amount of money in the stock market. Even good traders. Hey listen, this is not
gambling! You must minimize your losses. Never risk it all. Always, protect your seed
corn. Follow the rules to NOT loose money. That means discipline.
We can, but don’t play individual stock, rather indexes and indices. We look for high
volume indices. They give us liquidity. The ability to get in and out of positions, easily. I
tend to play: OEX, RUT and SPX. But there are others (see the indices list later).
Another trader friend of mine says this well “Stay away from DRUGS”. Now what he is
really saying is that we want to stay away from stocks, where “news” can affect the price
by 30-70%! That can kill a position in a day.
Think about it. If we played a stock in the Russell 2000. If there is news article about
that one stock, it can go up or down dramatically. Like the announcement of a drug
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stocks, approval by the FDA. The individual stock moves dramatically, but the whole
indices, does not. One stock has little effect.
Investing in indices therefore, is a little less volatile and therefore less risk of substantial
movement.
Man if I see one mistake, more than any other with credit spreads; it is leaving open
positions, without contingency buy backs. Listen when you buy the position,
immediately you must plan for limited loss. We don’t want the credit spread to the loose
the maximum. We want to plan a buy back when the ATM gets to that level.
Rule # 5: 50 cent premium for $10 point range.
50 cents per share is the goal for premium on each side of our trade. That basically
means if we have 10k at risk, we are getting $ 500 on our vertical put spread and $ 500
on our vertical call spread. The end result is about 10% a month return.
This general rule also, helps us for some other reasons too:
When we are looking for 50 cent premiums, on vertical spreads, they are
usually further away from the money. Getting us into safer trades.
50 cent trades are generally higher probability trades, which will not be in the
money at expiration.
In addition to learning the credit spread system, you must learn a little about money
management and risk. For credit spreads, that means learning things like:
Credit spread layering techniques. Depending if the market is going one way or
another or sideways, we “layer” spreads for maximum profit.
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It is very easy to get wrapped up in the premiums associated with credit spreads. You
keep getting a little bit more, and a little bit more, and then all of a sudden you have
changed the rules.
Same is true with losses. They happen. And you have to be able to just play the
probability. Just realize they are part of the process.
At no point, should we make emotional choices. Better if simply play the game plan.
That means we have to have a trading plan. We know where we are going to enter the
position, and when it will expire.
Special Acknowledgement
I have another good friend who is a solid trader, and great teacher. He was
instrumental, in my advanced understanding of credit spreads. In fact, we kind helped
each other. One day, I asked him, " I want you to teach me EVERYTHING there is to
learn about Credit Spreads." And He did. Mentoring me. Shortly there after, he started
his stock training company, focusing on teaching folks Credit Spreads. I contributed to
his courses (flipping spreads). I recommend his materials, and education.
He was instrumental in the production of this manual. In fact, there about 20 pages of
this content, that he directly wrote. Thank you.
Options Basics
To explain how credit spreads work, we need to understand a little about options.
Options, in their most basic form are the right but not the obligation to do buy or sell
something at a specific price for a specific period of time. Options are basically, a paper
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contract on a real position, and paper is bought and sold in the open market place.
Usually the CBOE (Chicago Board of Options Exchange).
Options give us choices in the trading world. Options serve as a contract between two
parties: he Buyer and the Seller. The buyer of the options has rights where as the seller
has obligations. When an option is purchased, a person is purchasing the right to buy a
stock at specific price (Call Option) or sell a stock at a specific price (Put Option).
Let’s break this down a little further. There are two types of options. The first is known
as a “call option.” When purchased, it gives the buyer the right to call the stock away
from someone else at a specific price and at a specific time in the future.
Let’s demonstrate this using real estate as the example. If you are in the housing
market and identify a nice home in a nice area that you think will increase in value in the
next year, you can do a couple of things to profit from this movement of perception.
Let’s say that you find a home in a rural neighborhood for $250,000 and your analysis
predicts that the home is going to go up to $300,000 in the next year. Your first choice
open to you would be to just purchase the house outright for the $250,000 and a year
later if the house appreciated to $300,000 in value you could sell the house and realize
a profit. If you were right on your assessment you would yield a $50,000 profit off of
your $250,000 investment, a 20% return.
However, there is also another choice open to in this case. You could approach the
homeowner and offer to give him or her 5% of the value of the home or $12,500 to have
the right to buy the home for $250,000 sometime in the future. No matter what the
market does the homeowner gets to keep the $12,500 and can spend it immediately.
Let’s say the home owner gives you one year in which to buy the home for the
$250,000. So just like the previous example you have locked in the right to buy the
home for $250,000 but in this scenario you only had to put up $12,500 for that right.
Should the home appreciate to $300,000 the contract that you have with the
homeowner would be worth $50,000. As you can see, by leveraging yourself a little
better you allowed yourself to invest $12,500 in order to make $50,000 and gave
yourself a 400% return on investment. You bought the right to buy something for an
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extended period of time and you were willing to give up some money up front to have
that right.
However, now let's imagine a scenario in which that same house depreciated by
$50,000 instead of appreciating by $50,000. If you had purchasing the home for the full
$250,000 you would have lost $50,000 in the value of the home, definitely not a good
day at the office. However if you had only purchased an option, you would have put up
only $12,500 to have the right to buy the home for $250,000 within the year. Once you
had realized a year later the home was now only worth $200,000 you could simply allow
our option to purchase the home to simply expire in which you would lose the entire
$12,500. While it is still not a great day at the office you did manage to lose a lot less
money through the use of an option than you would have by simply purchasing the
home.
This same type of analysis can often be used in the stock market as well. We feel that a
stock may appreciate in value and instead of purchasing the stock outright we can often
times purchase an option to purchase the stock at fair market value for a later date, for
a fraction of the cost.
Let me give you an example: right now, Apple Computers stock is trading at $140.00
per share. If I thought that Apple computers was going to appreciate to $160.00 in the
next 2 months I could buy 100 shares for $ 14,000.00 and if it went to $160 I could then
sell my shares for $16,000.00 and profit $2,000.00 on the trade for a return of 14% on
my initial investment.
My second choice is that I could purchase an option for $600.00 which allows me to
purchase 100 shares of Apple for $140.00 in three months. If Apple's stock goes up to
$160.00 a share in the next three months then my option will increase to $2,000.00. I
could simply sell my option for $2,000.00 leaving me a credit of $1400.00 in the trade or
a return on investment of 233%.
By purchasing an option—or to be more specific, a “call option” which gives me the right
to call the stock away from the market at $140 per share between now and the next
three months—I am allowing myself to profit if the stock appreciates and I have avoided
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putting up the large sum of money that would have been required for me to purchase
the stock initially..
The opposite of a call option is a “put option.” If you purchase a put option you are
purchasing the right, not the obligation, to “put” the stock to someone else at a specific
price and at a specific time in the future. So, when we think something is going to
increase in price we want to look at buying call options, and when we think something is
going to decrease in price we want to look at put options.
Think of the homeowners insurance you purchase every single month. You buy this
insurance to protect you in the case that your house decreases in value due to some
catastrophic event. If your home was to burn down then you could simply exercise your
insurance policy and “put” your house to your insurance company and they will be
obliged to give you the amount that you are insured for. When you purchase
homeowners insurance you are buying the right to capture your losses should your
home depreciate or go down in value because of some unforeseen catastrophe.
Remember that in the stock market, for every person that thinks something is going up
there is someone else with the opposite opinion. It is easy to understand that if you think
a stock is going to go up in value you want to buy the stock low and sell it higher.
However, let’s talk about what people can do who think that a stock may go down in
price and want to profit off of this bearish biased stock. A trader who believes a stock is
going to depreciate in value “shorts” the stock at a specific price. This means that they
go to their broker and borrow the stock with the promise of repaying it back in the future.
They want to sell high and then buy the stock back at a lower price and then give the
stock back to the broker allowing them to keep the difference between selling high and
buying back at a lower point.
If you were looking at Apple computers which is currently trading at $140 a share and
your analysis said that it was going to decrease to $120 a share in the next couple of
months, then there are a couple of things that you can do.
Firstly, you could go into your brokerage site and short 100 shares of Apple for
$14,000.00. You are borrowing stock that you do not own with the promise to purchase
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stock in the future and return it to your brokerage firm at a future date. If Apple goes
down to $120.00 a share, you could purchase 100 shares of Apple a few months later
for $12,000.00 and give the shares back to your brokerage firm, thereby closing the
trade. Since you sold something for $14,000.00 and purchased it back for $ 12,000.00
you are left with a profit of $2,000.00, a return on investment of 14%.
The second possible scenario is that if you thought Apple's stock, currently trading at
$160, was going to decrease in value you could purchase a put option for $600.00
which allows you the right to put the stock (or sell the stock) to someone else for $160
a share. If after a few months Apple goes down to $140.00 your put option would be
worth $2000.00 (since you could purchase 100 shares of Apple at its lower price of
$120 a share or 12,000.00 for 100 shares and have the right to sell it for $140 a share
or $14,000 for 100 shares). At this time you could sell your put option for the $2,000.00
giving you a profit of $1,400.00, a return on investment of 233%.
As you can see, options lower your cost to get in the trade, thereby lowering your risk.
And when the analysis is correct, using options gives you the opportunity to realize a
larger return on investment.
Below, are a few further components of options that you should become familiar with:
Strike Prices – The strike price is a fixed price for which an option can be purchased
(call option) or sold (put option). Options are available in several different increments
ranging from 1 point increments to 25 point increments. For example Apple computer
has strike prices starting at 90 and moving in 5 point increments up to 240. Therefore,
you the trader could purchase the right to buy (call) or the right to sell (put) Apple
Computer stock in a range of anywhere from $90.00 a share to $240.00 a share.
Months of Options – You will have a choice in determining which month of options you
would like to use. Months available are classified into one of three cycles. So, if it were
June 3rd you would be able to purchase options for June, July, August, or November;
and you would also be able to purchase longer term options called “leaps” which are
available for Jan of 08, and Jan of 09.
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Expiration Date – Every single month, options expire on the third Saturday of the
month. Since the market is not open on Saturdays traders use the third Friday of the
month as there guideline. There are a few indexes however that expire the Thursday
prior to the third Friday of the month. This is why it is essential to understand the
vehicles you are trading.
Option Greeks – There are four main variables represented by Greeks letters that
make up the value of an option. This is not meant to be a thorough evaluation of option
Greeks as one could write an entire manual on this subject alone.
Delta – This is the amount the option will increase in value per one point
movement of the underlying value. Delta can also be thought of as a probability
indicator. An option that has a strike price right where the stock is trading would
have a delta close to 50. What this is saying is that the option has a 50 -50
chance of having value at expiration
Gamma – Gamma is the accelerator for Delta. It tells you how much the Delta
will change after the first 1 point movement in the underlying.
Theta – Theta is measurement of time decay. It tells you how much value is lost
daily based off of the erosion of time.
Vega – Vega is a measure of volatility in the option. The higher the volatility the
more expensive an option can cost. Vega can also be thought of as a fear
indicator. When there is uncertainty in the future people are more fearful
concerning the outcome and hence, volatility will be higher. Conversely, when
fear is low and people feel safe about trading a vehicle, the volatility is lower and
the price for the option decreases.
Understanding the basics and effects of each of the Greeks can greatly enhance your
trading; however, there are some interrelationships that you need to be aware of:
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1. All of the Greeks except for Delta are the most sensitive to the money.
2. Gamma responds opposite to Theta (Time Decay). The more positive Gamma is
the more negative Theta will be.
3. As volatility decreases Theta (the value time holds in your options) decreases. As
volatility increases Theta (the value of time in the option) increases.
Volatility
There are different forms of volatility in the marketplace. Volatility in its most basic form
is uncertainty or fear concerning the marketplace. Volatility can be tracked by looking at
the Vix, and VXN which measures the volatility in the S&P 500, and the NASDAQ.
The chart above is a chart of an Option Chain. You will see the calls on the left and the
puts on the right hand side. This is a chain for Apple Computer when it was trading
$139.00 and it was due to expire in 30 days.
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Contract – When you are buying options you have to purchase them in units of 100.
This is referred to as a “contract.” So, if you see that the price of an option is $3.50, this
is the per option price. However, as the trader, you would have to purchase 100 options
for $350.00 to buy 1 contract.
Intrinsic and Extrinsic Value – Intrinsic value is the amount of the option that
represents real value. So if you are looking at a 135 strike price call option (which would
give you the right to buy Apple for $135.00) it is selling for the ask price of $5.40, or
$540 dollars to purchase 1 contract. Since Apple is trading in the live market for
$139.00 then the 135 call option would have $4.00 dollars of real (intrinsic) value and
the other $1.40 would be considered time value or extrinsic value. So to sum it up
intrinsic value represents the real value in an option and extrinsic value represents the
time value in an option.
ATM – At The Money options are the options that are the closest to where the stock is
currently trading. If Apple was trading at 139 then the 140 strike price “call” and “put”
would be considered the At The Money Option.
ITM – The In The Money option would be the yellow options shown in the graph above.
They represent the options that have real intrinsic Value.
OTM – The Out Of The Money options are the blue options shown in the graph above
which signify options that have no real value or intrinsic value. They only have time
value.
The option chain above also has a bid/ask spread. The “bid” price is the lowest price the
market makers will consider for the price of the option. The “ask” price is the price the
marker maker guarantees to fill you at. The range between the “bid” and “ask” is called
the spread.
If you look in the third column you will see a heading called delta. This number tells you
how much the option will increase in value per one dollar movement in the underlying.
The delta number will increase in value as you go deeper in the money.
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While this is a very basic overview of options it should help lay a foundation for the
major components of options. We have briefly discussed the benefits of trading options
but now let’s focus on just one strategy that a trader can utilize in the marketplace when
using options.
How would you like to relieve yourself of that pressure—the pressure of knowing you
always have to pick the right direction? You can. Plus, you’ll increase your chances for
success, as well. It’s simple: Just adopt the mindset of an insurance company.
Think about it: Insurance companies sell policies with a high probability that the majority
of those will expire worthless. That way, the insurance companies make more money
than they spend. You can apply the same strategy to your options trades month after
month.
And just like an insurance company, you need to realize that the market is often volatile
and unpredictable. For example, an insurance company recognizes that they are going
to have to pay out some of their claims. So to cap off the maximum amount of loss they
could incur they purchase catastrophe insurance from a re-insurer as protection.
Like the insurance company, you need to protect your nest egg; you need to guard
against unforeseen circumstances and events.
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Keep this “insurance mindset” in place as you learn a brand-new option investing
strategy, and you’ll reduce your risk and put yourself years ahead of the average trader,
who typically invests with 100 percent risk exposure.
Everyone reading this text should have at least a basic understanding of options. To
learn the strategy we’ll be focusing on, you’ll have to look at the world of options with
fresh eyes—and forget most of what you may have been taught before.
We’ll walk through each step of this amazing options-trading strategy together. Stick
with the process, and the prize will come.
Your goal as a trader should always be to make money regardless of market direction.
While that may sound like a lot to ask, keep in mind that you’re simply looking for a
strategy that can survive a bearish, bullish, and sideways-moving market—a strategy
that, when used properly, will result in a profit even if you are wrong on your prediction
of the market direction.
2. Volatility will revert to its mean. If you look at the volatility index (VIX) you will see
that whenever the volatility in the marketplace goes to an extreme level it always
reverts back to its mean. Stocks also have a level of volatility that makes them
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cheap or expensive. If we can identify what stage volatility is at, we can make
money as it reverts back to its average.
As an option trader, you need to learn how to take advantage of these marketplace
guarantees. To use this information to your advantage. Using probability in your favor.
You need to understand how to incorporate these “rules” into a strategy that will bring
you profits, time after time, regardless of market direction. Credit spreads are just such
a strategy.
Let’s look at turning credit spreads into a high-probability system that you can trade
month after month.
Let’s get started with a basic bar chart of the Russell 2000(RUT), on June 1, 2007.
Example 1.1
Looking at example 1.1, let’s assume you’re bullish in the Russell 2000(RUT). With this
knowledge, you can likely generate profits in three separate ways.
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1. You can simply purchase the RUT. As it increases in value, your position will
increase as well. The biggest problem with this strategy is that the cost
associated with buying an index that is trading at more than $850.00 can greatly
reduces your investing capital.
2. As an options trader, you can purchase a call option, which reduces your cost
and investment risk. Why? Because buying an option costs less than buying
individual stocks or indexes. Assuming that your analysis of the trade is accurate,
and you purchased the correct strike price and month of expiration, you can
generate profits as the underlying index increases in value.
3. You can sell a put below the current trading price of the RUT. As the underlying
index increases in value, your put will decrease in value.
Example 1.2
In example 1.2, let’s say you sold a July 810 put for $7.90 or $790.00 a contract. You’ll
keep that entire credit of $790.00 if the RUT continues to increase in value until the
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option expires in July. If the Rut trades sideways for a month, you’ll also keep the
$790.00 credit for every contract you sold.
If you’re wrong and the Rut pulls back to its most recent area of support at 810, you’ve
positioned yourself under that support, which increases the probability that you’ll get to
keep the $790.00 credit.
Essentially, with the third example above, you’ve positioned yourself to make a profit
with the market moving in 2 ½ directions.
But what if your analysis was wrong and the Rut spirals downward below the 810 level
of support? In that case, you’ve left yourself wide open for major losses. Trading with a
strategy that can leave you with major losses in the marketplace will guarantee you a
very short trading career. Selling an option when you don’t own an option is called
“selling naked.” Trading in this manner is so risky; your brokerage firm will ask you to
put up a large amount of money to make sure you can cover your losses.
Instead, you’re going to learn from the example set by the insurance company that buys
insurance from a re-insurer to protect itself in case of catastrophe. To do so, you’ll
purchase insurance and hedge yourself for those times when your trade works against
you.
Example 1.3
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Remember: In example 1.3, you are bullish in the RUT, and you sell a June 810 Put for
$7.90. Your intent is to capture the profit from the expected bullish move. You’ve sold
your put under a strong area of support. Should the stock or index want to retrace, it
should find support, preventing it from dropping below that point of resistance and
enabling you to keep your $790 credit.
To further reduce your risk exposure, you’ll buy a June 800 Put for $6.50. Doing this
leaves you with a credit of $1.40 or $140 per contract.
Although you’ve greatly reduced the amount you can profit from this trade, you’ve also
capped off the amount you have at risk. So as long as the RUT stays above its strong
area of support at 810, you will keep your entire credit of $140 per contract.
Even though this trade is called a credit spread, you can’t buy it on credit; there’s a cost
put on this type of trade. Most brokerage firms will charge a margin requirement equal
to the difference between the strike price sold and the strike price bought minus the
credit received.
In the previous example, the difference between the strike price is $10.00 (810-800) and
the credit received is $1.40 (from selling the 810 put for $7.90 and buying the 800 put
for $6.50). So all we have to do is subtract $1.40 from $10.00 which leaves us with the
maximum risk in the trade, $8.60 in this example. When you multiply $8.60 by the
number of contracts in the trade—in this case, one contract—you’ll find that the margin
requirement to enter this trade is $860, with a possible reward of $140.
What does this mean? Your $860, which will be held in your account as the margin
requirement to enact the trade, it is the maximum amount you can lose should you be
100 percent wrong. There are only two ways to eliminate the margin requirement on the
trade: You can buy back the sold position (i.e. the “short” position); or the short position
could expire.
At this point, the average trader loses interest in credit spreads. After all, investing $860
to make $140 doesn’t exactly seem like a winning proposition.
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Let’s change that mindset. By positioning these credit spreads underneath strong areas
of support, you enhance your chances of making a profit if the market moves in any
number of directions.
This trading method is all about probability. You’re stacking the deck in your favor—
increasing the probability that you’ll win as much as you possibly can. If you’re the kind
of trader who is willing to risk $860 to make $140 when you know you’ll win
approximately 90 percent of the time, then continue reading. You’ll discover some steps
that will bring in additional credit with no addition risks on the trade.
In the previous example, you risked $860 to make $140. By dividing the $140 credit by
the $860 margin, you get an ROI of 16.2 percent. This is your ROI for one trade that will
be on for about 6 weeks.
You’re going to use the ROI calculation to help you determine when a trade is
acceptable and when a trade is too risky for the potential credit you could receive.
This is a vital point to understand before you begin trading. Too many new traders get
overly greedy. For instance, they’ll position trades to bring in an ROI of 40 percent or
greater.
Rather, you must remember that whenever you increase the ROI in the trade, you
reduce the probability that you’ll close the trade at your maximum profit potential. The
smart investor keeps trades conservative. The ROI for the credit spreads I trade never
falls below 4 percent, and it’s never greater than 30 percent. By positioning my trades in
this manner, I maintain a high percentage success rate and more frequently close my
trades at a maximum profit
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Example 1.4
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Example 1.5
By looking at the above chart, you can see that an option suffers very little time decay at
90 days until expiration. However, in the option’s last 30 days, it loses time value
extremely fast.
As an option buyer, you never want to purchase options with less than 45 days until
expiration. And as an options seller—which you are when you trade credit spreads—
you will come to love options that expire in 45 days or less.
You’ll discover a strategy for trading in shorter time frames later in this manual.
Strike Prices
Keep in mind this rule of thumb: You always want the short position and the long
position of your credit spread to be placed at consecutive strike prices.
For example, if you’re trading the previous RUT example and you sell an 810 put, you
would buy the 800 put. If you’re trading the SPY and you sold the 143 put, you would
purchase the 142 put. It’s essential to remember this point when you start to learn about
adjustments.
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Stocks and indexes will also form areas of support and resistance around certain price
points. No matter what the overall direction of the trend—up, down, or sideways—
stocks or indexes will typically move back and forth between pivot points within that
trend.
Example 1.6
In example 1.6 we are positioning a credit spread above the 200 DMA, which is acting
as a strong level of resistance. The trader increases the probability that this trade will
expire worthless; enabling him to close the credit spread trade out at maximum profit.
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In example 1.7 of General Motors (GM), the trader has positioned a credit spread above
a recent pivot point and also above the 50 DMA. By doing so, the trader has increased
the probability of this trade expiring worthless, which enables the trader to close the
trade out at maximum profit.
Example 1.7
You should trade the Bear Call Spread when you’re bearish on the underlying stock or
index. In this instance, you’ll sell a call to bring in a credit and purchase a lower value
call to offset your risk leaving you with a credit.
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On the other hand, you should trade the Bull Put Spread when you are bullish on the
stock or index, in which case you’d sell a put and purchase a lower value put to offset
your risk leaving you with a credit.
Example 1.8
Example 1.9
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The difference between these two numbers is the spread. You never want to buy an
option for the ask price—this is the worst price at which to get your order filled. At the
same time, you never want to sell an option for the bid price as this too is the worst
price at which to fill your order.
When implementing the credit spread system, I like to split the difference between the
bid and the ask price. This will not guarantee that the market maker will take your
position, but on the trades that do get accepted you will got a better price.
Example 1.10
Using the pricing chart example 1.10, let’s say you want to sell the 620 strike price
option and purchase the 615 strike price option for insurance. For each option there is a
spread between the bid and ask price of 25 cents. So you would have a combined 50
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cents of slippage to implement this trade. That is a huge net difference, and it will help
you determine whether this trade makes sense or not.
As a general guideline, you should always offer the market maker around 50 percent
less than what he is asking to get a better fill. In this example, you would offer a credit of
30 cents to put on the trade.
If you only trade credit spreads on large-volume stocks and indexes, you can often split
the spread and still get your order filled. You’ll discover that the higher the open interest
on the option you’re trading is, the better and faster your fill order will be.
When you’re first beginning to trade credit spreads, sticking to the indexes and
Exchange Traded Funds is a safer place to trade as they have large volume, allowing
you to get in and out of the trade easily. In addition, becoming familiar with a few of the
major indexes will help you to feel comfortable with how the market moves and reacts to
investor sentiment. This will allow you to be more consistent and repeat successful
trades, pocketing the profits again and again.
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Pharmaceutical stocks have a tendency to move 30-70 percent in either direction any
time a report about the drug or the drug company is released. Being on the wrong side
of the trade when the report is released can cost you thousands, if not tens of
thousands of dollars.
Because of their volatility, these stocks can seem extremely attractive to options sellers.
But remember: The greater the volatility, the lower your probability of winning.
With credit spreads, it’s better to adopt the mindset that you want to keep your trades
boring and predictable. Boring can be very prosperous!
There’s only one exception to the rule that you should NEVER trade pharmaceuticals—
and that exception is the pharmaceutical index. Why? An index consists of so many
stocks that one bad announcement isn’t going to cause the entire index to make a
drastic movement in one direction or another.
Instead, you might try trading a credit spread after the company releases its report. This
approach makes perfect sense because the volatility should still be high and the news is
already out there. Personally, I’ve been able to put on some very high-probability credit
spreads after the release of these reports.
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Another reason beginners should stick with trading credit spreads on the indexes and
Exchange Traded Funds: You won’t have to worry about these types of reports.
Say you sold an 880 call on the Rut, and during the time of your trade, the Rut
increased to $880.01. You want your order to execute automatically and buy back all
your obligations on the trade. Setting your contingent order as soon as your original
position is filled ensures you’ll be able to make this move.
Although you will take a significant loss on the trade, you will avoid taking the maximum
loss.
This is where credit spreads can prove to be very profitable. Because your analysis
indicated that the RUT was bearish you placed a bear call spread on top of it to capture
profit. But then the RUT turned around and stopped you out of your short position at a
loss.
What are you left with? If you sold the 880 call, then you completed your credit spread
by buying the 890 call, and this option is showing a nice profit.
If the RUT continues to gain in value, you can quite often recoup all your losses and
even turn a nice profit from a trade you got wrong. These positions are frequently
executed the week of options expiration, so you will already collect up to three weeks of
time decay. The end result: many times you can close the entire trade and break even,
despite the fact that you were wrong on the trade.
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Example 1.11
In example 1.11, if a trader was bullish on the RUT and positioned themselves below it
by selling the 710 put and buying the 700 put for insurance they could have created a
bull put spread.
As the trade gets closer to expiration, the RUT traded down to 710. The contingent
order on the 710 put was executed, taking the trader out of the short position. At this
point, you would have been down in the trade. However, if the RUT were to continue
moving down this would give an experienced trader a great opportunity to manage the
trade and possibly close it out at break even. Or, the trader might even realize a much
larger profit than he or she would have realized if the trade expired without ever
touching the short position by holding onto the 700 long put.
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You need the RUT to trade lower in the next few days. Looking at this from the outside,
you have to ask yourself if, since it has decreased over 35 points in such a short time
frame, the RUT has enough momentum to go down another 5-7 points. This is what
happened with the RUT during the next few days.
Example 1.12
Example 1.12 clearly shows how you can take a losing trade and turn it into a profitable
one. If you choose not to set a contingency order with your broker, you could incur the
maximum loss on the credit spread. Losing on just one credit spread can negate seven
to eight profitable credit spread trades. So it is important to get good at the management
aspect of trading credit spreads. Managed correctly it correctly, you can make much
more money being wrong on the trade than you could have if your positions had expired
worthless.
You’ll want to watch your credit spreads carefully during the week of options expiration
which brings with it a lot of movement and volatility.
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Then, you can take your profits and invest them in another credit spread trade. Too
often, investors stay in a trade for two to three weeks, looking for that last $5 per
contract. Instead, they should have taken their profits off the table and invested them in
another trade—with three weeks of time decay working for them.
Now that you understand the Bear Call Spread and Bull Put Spread, you’ll learn how to
apply both at the same time. For example, if you think that an index is in a channeling
range, you can apply both credit spreads simultaneously and bring in additional
premium for the trade.
For most brokerage firms, the margin requirement or cost to put on the trade is the
difference between the strike prices and the credit received. So when you put on one
credit spread, you’ve already paid your maximum margin requirement. The credit from
the other side of the trade will go straight into your account and reduce your overall risk.
When you have both credit spreads executed at the same time, it’s called an iron
condor.
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Example 1.13
In example 1.13 my analysis told me that the RUT was in a channeling range. I applied
both credit spreads at the same time, bringing in a credit of $2.00 and leaving me with
$8.00 at risk and an ROI of 25 percent for the next 6 ½ weeks. This fits nicely into our
guidelines of 5-30% ROI on our trades. During the time frame of this trade the market
was also very volatile which increased the price that options could be sold for.
When you analyze this type of trade at home, you can expect that one side of your “iron
condor” will need adjusting. Keep in mind that you can also buy back one of your short
positions and roll that profit into another trade.
You can either enter the trade using the “iron condor” strategy, or you can put each
spread on at a different time. For example: if you start your trade with a Bear Call
Spread, you can always add the Bull Put Spread later as an adjustment to lock in
profits.
If you’re starting your position as an iron condor, be sure to enter two separate ticket
orders to get the fills you want. If you submit your order for both sides of your iron
condor on one order, the fills will be up to the market maker. This can be risky.
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Smart Money- The ATM Machine
For example, you may get a great fill on one spread and a horrible fill on the other.
Unless you’re fortunate enough to have both spreads expire worthless, you will probably
need to adjust out of the spread that had the poor fill to start. In Example 1.13 you can
see a ticket order provided by the think or swim brokerage firm that shows you what an
iron condor order looks like.
Example 1.13
You can do the same thing with your credit spread trades. Let’s say you place your
credit spread trades with six weeks until expiration and at three weeks until expiration
the market moves in one direction quite heavily. As you view both of your trades you
can see that one trade is showing a loss and the other is showing a nice profit. You the
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trader have an opportunity to close out the profitable trade during the time frame that
the market has to move away from this position, essentially flipping the credit spread for
a nice profit. You will still need to manage the other trade but should the market
rebound you will already have closed out ½ of the iron condor at a nice profit. You may
even be able to replace the exact same position later for another credit should the
market rebound.
For example, on Feb. 27, 2007, the market dropped 542 points before closing the day
down 416 points. Traders who didn’t have enough money to buy back their short
positions on that day could have had incurred maximum losses on some of their
spreads.
Knowing what you know now, you would handle a situation like this differently. You
would have been using good money management tactics. As the market dropped, your
contingent orders would have been triggered; you would have bought back your short
positions, and incurred minimal loss.
Plus, as the market continued to spiral downward, your long positions would have
potentially recouped those minimal losses, and you may have even made significant
gains.
Always plan for the worst-case scenario, and hope for the best!
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Let’s say, for example, that you’re looking at an index. As a guideline, the higher the
ROI in the trade is, the higher the probability that you will have to spend more time
managing the trade. If you stay conservative and look for a return of 5-15% you will find
that you are able to place these out of the money spreads in a location that can
withstand major market movement.
If you start your first position by applying a credit spread with six to seven weeks until
expiration, you can place a very wide iron condor that should also allow you to trade
dispassionately since you are allowing the market to move considerably in either
direction. About a month later you will begin to look at the next month’s options to place
another wide iron condor which would become a hedge to the first position. You will be
trading multiple months in multiple locations so you that your funds will be diversified.
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Often times you will be able to flip one if not both positions within each month, allowing
you to make a profit from the trades and significantly lower your exposure to risk.
Example 1.14
Example 1.14 shows how you could trade multiple months at the same time, allowing
you to have multiple positions and thereby to help hedge your trades and lower your
overall portfolio risk. You would initiate each order with six to seven weeks until
expiration and then as the market moves forward you could look for opportunities to flip
a credit spread and prepare for the next month's credit spread trades.
Depending on the volatility of the market and the liquidity of the instrument you may find
that you are placing trades for multiple months in exactly the same position. However
these trades will have different expiration dates associated with them so you are not
doubling your risk by having twice as many contracts in the same location. By learning
how to trade for multiple months and by patiently trading only what the marketplace
gives you, you are allowing yourself to take profits from a marketplace filled with fear
and greed.
With credit spreads, you’re selling time, or Theta, and you’re capturing one of the two
advantages guaranteed to you by the marketplace. One of the major benefits is that you
make money every day as the premium depreciates out of the option and it approaches
expiration.
Vega will help you bring in premium during times when volatility is high. It will act as a
crystal ball, letting you know how much the underlying security can move in a particular
time frame.
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Also, list any fundamental disadvantages you may have. And be aware of any report
that may be released during the life of the trade.
Type out your trade plan before you enter the trade, and remain unemotional and
unattached to it. Clearly state what your action plan will be in the case that the
underlying stock or index moves in any direction. By developing a plan that covers
every contingency, you can refer back to it if the market pulls and tugs at your emotions.
Remember: There is no place for emotions when you’re trading in the marketplace. In
fact, the trader who can conquer his or her emotions has the greatest advantage of all.
Let this manual serve as your guide to take your credit spread trades to the next level. I
wish good luck as you become that insurance salesman, who month after month brings
in stable, profitable income.
Your Next Step?
Well you made it to the end. Great Start. Now you have the “theory” behind Credit
Spreads, the next step is to put it into practical application. Taking some steps, to
success. I just finished a great 30 day plan for your success.
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Smart Money- The ATM Machine
DAY
1
Open your Think or Swim account
today. Visit www.thinkorswim.com
And open a brokerage account now.
Congratulations. You have made a wise decision to impact your financial future. To be
part of the few, not the many: traders that are making 10% a month or even greater.
Now there is no guarantee, but these types of returns are highly probable.
Credit Spreads are a consistent, regular system of investing, which brings in regular
cash flow. We like to call them the ATM Machine. Because anytime you need to you
can go to the machine and get cash. No matter whether the market is going up, going
down, or sideways. It can be done in a bear market; bull market or even if the market is
going sideways.
Visited www.thinkorswim.com
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Smart Money- The ATM Machine
DAY
2
Read the ATM Machine manual to
understand the basic principles, and
process of credit spread investing.
Most investing systems rely on the market going up or down. You buy stock or options,
and hope, based on some sort of investment analysis that you pick a winner.
However, Credit Spreads (iron condors), is actually a “selling” strategy. That means we
get PAID the day we take a position. What a wonderful concept. We get paid to invest.
The ATM Machine manual outlines that credit spread investing is:
A type of option trading that is low risk, with high probability of success each
and every month.
Credit spreads are best done on indices, like the RUT, OEX or SPY, not
individual stocks.
There are a series of “rules” to follow, that keeps us safer, and minimizes risk
and losses.
We must paper trade credit spreads for several months to get good at the
trade.
On the next page you will find the basic rules for credit spread trading. That
does not mean, all the strategy, or concepts are “explained” in the rules. Just
the key concepts.
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M.A.P. to the Treasure
Not to leave you in the dark, here are some keys to getting started with Credit Spreads:
M.A.P.—My Action Plan. Build your own steps to success and prosperity. List 30 to 60
steps you can take over the new month to put you on the path to trading Credit
Spreads.
M.A.P. #1:
M.A.P. #2:
M.A.P. #3:
M.A.P. #4:
M.A.P. #5:
M.A.P. #6:
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M.A.P. #7:
M.A.P. #8:
M.A.P. #9:
M.A.P. #10:
M.A.P. #11:
M.A.P. #12:
M.A.P. #13:
M.A.P. #14:
M.A.P. #15:
M.A.P. #16:
M.A.P. #17:
M.A.P. #18:
M.A.P. #19:
M.A.P. #20:
M.A.P. #21:
M.A.P. #22:
M.A.P. #23:
M.A.P. #24:
M.A.P. #25:
M.A.P. #26:
M.A.P. #27:
M.A.P. #28:
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