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Smart Virtual Portfolio Management III – The $1,000,000 Virtual Portfolio (Members Only)

You can't lose what you don't have.

The reverse is true for people with Millions in a stock virtual portfolio.  Phil points out that the reson you don't run a large hedge fund trying to make 100% gains is that the people who invest in those funds are more interested in what we call "preservation of capital" rather than generating wealth.  Generally, the people who have $1M of investable cash to play the markets have already achieved a great deal of success, often by taking their own risks along the way.  For most of us, $1M is hard to come by and, while we want to put that money to work – we certainly don't want it wondering off and joining the circus.

As a high net-worth investor, you need to decide how to diversify your assets to suit your long-term goals.  We're not going to get into that here – let's just say that if you want to gamble and go for some of our "more exciting" plays, perhaps allocate a portion of the virtual portfolio to those.  Whether that's 5% or 10% or 30% is up to you but it is good to fence off your risk to a sensible, manageable amount that you really can afford to lose while keeping the bulk of your market allocation well diversified and well-hedged. 

I have my own 5% Rule.  Phil's famous 5% Rule deals with the predictable movement of stocks in their trading ranges but my 5% Rule, which Phil also agrees with is simply "Do not put more than 5% of your virtual portfolio in the stock of any one company! This is so much easier said than done for many reasons!!

[1] Transition to Large Numbers

Moving from a 5 or 6 figure account to a 7 figure account has a profound impact on many traders. In fact, our friend Dr. Brett refers to the effect “performance anxiety” can have on a virtual portfolio and notes that one of the causes is the responsibility felt by traders as larger dollar amounts are traded.  Phil advocates a system of "purging" Short-Term Virtual Portfolio gains when they gets too large and shifting money into safer investments in a Long-Term Virtual Portfolio – it is good to have a strategy for balancing out your holdings, not just target goals.

While it might be acceptable to put 15% of your $10,000 virtual portfolio on that long call you just KNOW will make money, it would be a big No-No to consider the same percent allocation to such a trade with a large virtual portfolio. 

Although this might seem very intuitive on the surface, it represents a new rule that must be internalized, one which most traders usually are not compliant with when trading smaller amounts – with good reason – If the dollar amounts traded are small then commissions and bid-ask spread can cannibalize profits.   

The 5% figure is just a guideline and if you believe 6% or 8% is more appropriate then by all means exercise discretion but be very cautious about dedicating more than $100,000 to any position in a $1,000,000 virtual portfolio. It’s one of the reasons Berkshire Hathaway (BRK.A) – closing at $114,000 per share on Friday – has trouble breaking the $150,000 mark.  A sensibly diversified person needs $1M just to buy a single share, over $150,000, they need $2M.  This is why Berkshire capitulated and issued B shares, and then split those B shares 50:1.   

As good a company as Berkshire is, there is surely a Buffett premium that would quickly evaporate (if only in the short-term) should the Maestro trader ever step down or, for any other reason, not remain as figurehead (unless Phil accepts the position – his quote, not mine!). Even a $500,000 virtual portfolio that included a single share of Berkshire could be subject to a sharp account value drop should such a decline occur.

Allocating "just" $50,000 for a position can be frustrating to a person with $1M to play with, especially if you are, as Phil and I advocate, "scaling in" to the position in no more than 25% increments.  The linked article goes into detail on the subject and the main idea is that you begin a $50,000 position with a $12,500 commitment.  If you need to adjust because your stock or options dropped, then it will, logically, require less than $12,500 to double down (if you feel it's appropriate to press your bet) and then, if that 2nd round fails and you are still undaunted, you can then go as far as doubling down on your position again for less than $25,000 more.

This is how you preserve capital and manage risk.  If I buy $50,000 worth of GE at $17.50 a share, I have about 2,800 shares and perhaps I sell the June $17 calls for $1.25 to collect $3,500 over 5 weeks (isn't it great to have money!).  If I am called away, I make net $2,800 and I have $3,500 of downside protection on my long-term position at no cost.  If GE drops $3.50 (20%), like it did last week, and finishes the month at $14, then my 2,800 shares have lost net $6,300.  Fortunately, $6,300 will not break a $1M virtual portfolio but everything dropped last week at once – that would, in the least, be uncomfortable

The problem then becomes – How do you get the money back?  With a 2,800 share commitment to GE at net $16.25 ($45,500) you have very little money left to adjust.  If you then sell the July $15 calls for $1 (estimate) you lower your basis to $15.25 and you may be called away at a loss.  If GE keeps dropping, and it was $5.58 in March of 2009, then you will keep taking hit.  How does scaling in turn this around? 

If you scale into GE, your initial purchase would be 800 shares at $17.50 a share, selling the same June $17 calls for $1.25 to collect $1,000 for 5 weeks on your net $13,000 position.  Now, you may say what if I get called away?  Well, the answer to that is that if you keep entering GE and you keep getting called away every 5 weeks for net $600 every 5 weeks then you will "only" make $7,200 on that $50,000 allocation of capital (14%) without risking more than 25% of it at any time.  You will also get 2.2% dividends on the stock you do hold.  This is you "worst case" to the upside. 

On the downside, if GE falls 20% to $14 and you are in 800 shares at net $16.25 ($13,000) you can buy another 800 shares for $14 (11,200) and then sell 1,600 July $15 calls for $1, collecting $1,600 in month 2.  Now if you are called away on a bounce, you will get back a total of $24,000 on your net $22,600 investment – a profit of 5.8% in 10 weeks EVEN THOUGH the stock fell 20% and bounced back just 5% during that time

Should GE fall an additional 20%, down to $12, you can sell your 1,600 shares for $12 ($19,200) and take a $3,400 loss despite the fact that GE dropped 40% since you bought it.  If you still believe in the company and still want to be in it for the long term, then you can spend an additional $19,200 to buy 1,600 additional shares of GE at $12.  That puts you in 3,200 shares of GE at $41,800, or $13.06 a share.  This is 25% less than you originally intended to enter the position for and now you can sell perhaps 3,200 of the $13 calls for .75 to collect $2,400 for the next month.  $2,400 is close to 5% of $50,000 collected in a single month - not bad for a position you only had to put $41,800 into. 

Keep in mind we have only allocated 4.2% of the virtual portfolio to this very badly performing stock.  Should GE drop another 20% to $9.60, you may decide to buy another 1,100 shares with your remaining $10,600 (the $2,400 you last collected plus cash), which would give you 4,300 shares of GE for $50,000, or $11.63 a share!  As Phil often says to members during chat – "If you don't REALLY WANT to own 4,300 shares of GE at $11.63 – why would you buy 800 shares for $17.50?"  This is the magic of scaling in, you only end up with large positions in stocks that you are able to buy cheaply.  Stocks that move up too quickly to make rolling your callers practical get called away automatically – it forces a discipline of taking winners off the table, getting back to cash and finding the next bargain stock rather than constantly chasing momentum.

Phil's "Buy/Write Strategy" is a way of accelerating this process by using the margin from your sidelined cash in order to collecting more money up front in stages 1 and 2.  This is useful in many ways and I strongly suggest all members be familiar with Phil's "How to Buy a Stock for a 15-20% Discount."

Note that, even at $9.60 (down 45% from initial purchase), the 3,200 shares could have been cashed in for $30,720 and there was $10,600 on the side for $41,320 – a 17.4% loss on the $50,000 allocation.  That should put your relatively "small" gains into context when we tell you that following this discipline can mitigate almost 2/3 of your losses to the downside.  The $8,640 lost would come about because GE dropped 20% a month, 3 months in a row and did not recover and that, using these very basic techniques off 5% allocations and 25% scales, would limit your loss on the position to less than 1% of your $1M virtual portfolio.   

We do not advocate mindlessly adding to every positions that falls but, hopefully, this example illustrates the power of scaling over the long-term.  Phil tells all new members to watch "The Man Who Planted Trees" and I urge you to do the same as you ponder this system of wealth building in the context of your long-term goals.  Think of your positions as dozens of little acorns that you plant.  Some will take root and become mainstays of your virtual portfolio for many years and some will need to be helped along to maturity while others will need pruning.  Having a long-term perspective and a good risk-management strategy helps you make better decisions (under less pressure) along the way..

[2] Emotion

Long-term success is dependent on adhering to the set of rules that have worked consistently for you. Whatever they may be, stick with them, even if it means placing a post-it on the top of your computer that reminds you of such a rule. 

You’ve certainly heard Phil’s statement ALWAYS Sell into the initial excitement” or one of my favorites “With greater uncertainty should come greater hedging,” and Phil's corollary "When in doubt, sell half.". These rules have arisen from our experiences and we would hope that you too can adopt them and internalize them without experience having to teach you the lessons!  This is why Phil often uses the "I told you so" method of teaching by example – when your money is at stake, it's better to learn from the mistakes of others than to insist on making your own!

[3] Due Diligence

Since smaller account sizes often mean fewer open positions, less due diligence is required to effectively manage each position than is required to manage larger accounts. As the virtual portfolio grows and the number of positions increases in order to still adhere to the 5% rule, the amount of due diligence increases accordingly.  If you don't have time to at least check the news headlines on your positions once every 48 hours – you simply have too many positions!  One of the great things about having a collaborative trading community like ours is that we are looking out for each other's positions and often breaking news hits our daily comment section well before it makes it to CNBC or Bloomberg.

Even some of the greatest of money managers have fallen victim to violating the 5% rule - don’t join them! As Cramer points out “Diversification is the only free lunch in the stock market!”

Global Investments

Although we refer to the dollar declines in a facetious manner at times, it really does have a profound impact on spending power, particularly when taking trips to the United Kingdom, European countries that have adopted Euros and even Australia which has seen its currency strengthen significantly over the past few years relative to the US dollar.   

As your capital base increases, you are likely to be visiting these places more frequently so it’s often worthwhile having some exposure to different world markets. With the inception of Exchange-Traded funds this becomes even easier to achieve. The following is a list of ETFs that might be of interest to you.

  • Australia – EWA (Australia iShares)

  • Brazil – EWZ (Brazil iShares)

  • China – FXI (iShares FTSE/Xinhua China 25 Index Fund)

  • Emerging Markets – EEM (iShares MCSI Emerging Markets)

  • Europe – IEV (Europe 350 iShares)

  • India – INP (iPath MSCP India ETN)

  • Latin America – ILF (Latin America 40 Index iShares) 

As the ETFs trade back towards their all-time highs and media coverage about them increases keep in mind that while some exposure is prudent, investments greater than 10%-15% would be on the higher end of what might be deemed appropriate. The primary reason for this is that the dollar is still the reference benchmark currency for the rest of the world and geopolitical events result in a flight to perceived safety of the dollar, which strengthens it and hence magnifies declines in overseas investments when the dollar is on a run.  However, when the dollar is high, as it is now, taking some US profits off the table and investing in some foreign stocks can be prudent.

Another attractive approach to benefiting from global diversification that we often follow is to purchase stocks of US companies that have global exposure such as:

  • Altria Group (MO)

  • Boeing (BA)

  • Cameco Corp (CCJ)

  • Caterpillar (CAT)

  • Coca Cola (KO)

  • EBAY

  • IBM

  • McDonald’s Corp (MCD)


Account Volatility

An additional feature of established companies such as KO and MO over and above their global reach is their relative lack of volatility. In fact, the beta coefficients of Coca Cola and Altria are less than 1.0

[Beta is a measure of the volatility of a security or a virtual portfolio in comparison to the market as a whole. A beta of 1.0 indicates that the security’s price will move with the market]

  • Coca Cola Beta = 0.59

  • Altria Group Beta = 0.38

For those of you looking to sleep well at night without much concern that your stock is going to spike 10% in one direction or another, stocks such as KO, JNJ, PG, BA are all established companies offering dividends. 

  • KO Dividend 3.3%

  • MO Dividend 6.5%

  • JNJ Dividend 3.3%

  • PG Dividend 3.1%

  • BA Dividend 2.3%

Covered Call strategies can augment any income received from dividends too.

  • KO Jan Short Call Strike 55 Premium = 5.2%, Current Stock Price $53.34

  • MO Jan Short Call Strike 22.5 Premium = 3.7% Current Stock Price $21.61

  • JNJ Jan Short Call Strike 65 Premium = 4.8%, Current Stock Price $63.97

  • PG Jan Short Call Strike 62.50 Premium = 6.2%, Current Stock Price $62.54

  • BA Jan Short Call Premium Strike 70 = 11.8%, Current Stock Price $69.82 

These returns assume no stock price appreciation at all. Factoring in token increases in stock prices and resulting short call option assignments at expirations, the returns on risk including dividends and short call premiums would be:

  • KO – 10.9% (Requires stock increase of 3.1% in 7 months)

  • MO – 10.2% (Requires stock increase of 8.9% in 7 months)

  • JNJ – 6.4% (Requires stock increase of 1.6% in 7 months)

  • PG – 6.2% (Requires stock increase of 0% in 7 months)

  • BA – 11.8% (Requires stock increase of 0% in 7 months) 

Although these returns are less than stellar they can be thought of simply as a cushion against excessive account volatility while producing a reasonable return on invested cash (certainly better than your bank!).  Also, there may be tax advantages to employing a "buy and hold" strategy using the leaps to hedge against a downturn.

For example, if you dedicated 20%-30% of your account to relatively conservative plays such as these, the more volatile plays that may comprise the remaining 70%-80% will obviously have a lesser impact on your overall account volatility than if you accepted higher levels of volatility throughout your entire virtual portfolio. 

Industry Spread 

From Yahoo Finance’s Industry Index,  you can quickly see the breadth of areas in which you can invest. 

  • Basic Materials

  • Consumer Goods

  • Financial

  • HealthCare

  • Industrial Goods

  • Services

  • Technology

  • Utilities

Choosing one stock from each of the areas (while not violating the 5% rule) would be a reasonable approach to mitigating virtual portfolio risk from economic declines affecting a specific industry.  Many people fall into a pattern of trading one area, such as technology and falling victim to virtual portfolio woes simply because one industry or sector is not performing well.

BIG Money

“You only have to get rich once” 

Since this article is concerned with a million dollar virtual portfolio, keep in mind your job is to make reasonable returns and stay rich!

If you have $9,000,000 or $10,000,000 does it really make a difference to your lifestyle? Since the answer is probably not much at all, this article is all about espousing principles that ensure you maintain the level of wealth you have, grow it at a reasonable pace and no matter what, don’t lose it! So many people are working so hard to attain riches that, when they finally have millions of dollars, they often forget to protect them!    

The 4 concepts discussed so far (and listed below) are all designed to protect your capital while ensuring you can still generate reasonable returns.

  1. 5% Rule

  2. Global Diversification

  3. Reducing Account Volatility Through Investing in Blue-Chip Companies

  4. Spreading Risk Across Industries

In order to make BIG money, a ‘play-to-win’ mindset is needed! 

This means be more aggressive, shoot for the winners and if they don’t work out you at least know you have the risk mitigation and virtual portfolio protection aspects well covered so you can easily return to more conservative approaches should they become necessary.

A starting point for playing to win includes finding stocks such as GE, NYSE Euronext and so forth that have reasonable growth projections, catalysts to future growth, appear undervalued, tend to be relatively volatile and most importantly offer attractive option premiums! 

Then take advantage of those option premiums through short call options. It’s free money so take it!  When your outlook is more bullish, it’s a good idea to keep those short calls out-of-the-money so that you can benefit from the premiums plus the stock price appreciation. And when stocks are falling from resistance levels, your outlook is bearish or you are uncertain as to its outcome you can be more aggressive with the short calls by placing them at-the-money or even in-the-money as a way of protecting the stock.

For more conservative traders you may even wish on certain occasions, such as just prior to earnings announcements, to protect stocks with long put options and short calls thereby creating a collar trade. Or if you are leaning more bullish but still want to maintain protection you could simply place the long put against the stock and employ a protective put strategy. This would leave the upside potential open in contrast to a situation where the placement of short calls would obligate you to sell your stock at a specific point strike price.

The cumulative returns from these premiums can be astronomical and it really is a mindset issue deciding that you are going to shoot for a large number of small returns consistently over time rather than a huge return from the next shooting star stock. It all boils down to probability and while it makes sense intellectually to make money consistently each and every month and ultimately become very rich, it is much harder to control the greed devil within, which wants to find the next stock shooting for the moon.

image of juggler with 3 balls: high risk, low risk, and moderate riskFor moderately aggressive investors, allocating up to 50% of a virtual portfolio to these income producers should produce handsome returns over time with acceptable levels of risk.  We discuss dozens of these plays in every week and we encourage you to read about our various strategies in the Education Archives if you haven’t already.  Phil's general ratio is (of the options asset allocation): 75% long-term "hedged" positions and 25% short-term, aggressive positions (but even those he often hedges).

Conservative Speculation

In order to make superior returns from such covered call strategies, it’s usually necessary to commit to stocks with much more volatility. Although this seems might seem somewhat counterintuitive, studies have shown and indeed Buffett has commented that there is “no correlation between beta and risk”.  The reason these volatile stocks can be so attractive is they can return 40%+ per year –  not necessarily because the stock is going to appreciate hugely but because the option premiums reflect the expectations for underlying stock volatility.

Since the underlying stocks might be somewhat speculative, the options can be applied in a highly conservative manner such as at-the-money covered calls that were discussed extensively in last week’s article.   For example, the June short calls at-the-money for MON currently have a value of almost 5% of the value of the stock!  Admittedly these options were particularly high for MON because earnings were imminent and implied volatilities had increased, but each and every month you will see returns as high as 4%.  4% monthly compounds to a 60% return at the end of the year!  WFR is another extreme stock that we took advantage of this week as Phil set up a buy/write that makes "a LOVELY 129% profit if called away in 18 months."

These stocks require investors to have a high degree of risk tolerance since on any given day the stock may be up or down $2, $3, $4 or more! However, the short calls at-the-money offer a relatively conservative hedge to these more volatile stocks and can produce handsome returns over time or, in the case with WFR, the willingness to commit to doubling down by entering the buy/write, gives you spectacular returns on the cash outlay.  Depending on risk tolerance, it would be appropriate to shoot for up to 20% of the virtual portfolio in these positions.

Sample Million Dollar Virtual Portfolio Breakdown: 

  • No Stock Comprises More Than 5% of Entire Virtual Portfolio

  • 15% International Exposure (ETFs, US Stocks with global reach, International Equities..)

  • 50% Fundamentally Strong Stocks (LEAPS options on these stocks should produce at least 20% annualized returns. Cumulative returns from shorter term options should produce higher annualized returns)

  • 20% Conservative Speculation (Volatile stocks that offer high short call premiums)

  • 10% Levered Plays (LEAPS, Call calendars, Ratio Backspreads, Straddles/Strangles, Bear Calls, Bull Puts, Daily Trades Phil Makes,…)

  • 5% Disaster Hedges (see Phil's "5 Plays that Make 500% if the Market Falls")

Have a Fantastic Week!

Options Sage


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  1. thanks for the nice summary article.  could you comment, or add a section, on $1M IRA portfolios, where many of the leveraged plays aren’t possible since calls can’t be sold.

  2. where do I find the WFR buy/write cited inarticle??

  3. do you reccomend for 50% conservative buy/write without sell puts? to reduce volatility of portfolio?

  4. Phil, thank you so much for this educational, insightful and easy to understand write-up.  But just to be clear, you yourself are all or nearly all cash at the moment, correct?

  5. Thanks

  6. Hope to hear more about the lowest cost trades you can deal for us all. I deal with 2 full service brokers if they have a good long idea, but etrade gets too much for the 25% I want to trade fast and hedge with. Will people who pay by the month continue at the same rate? Nick one of those between medium and large numbers!

  7. Very well done. Thanks for all the help and guidance.

  8.  even at the $100k portfolio level much of what you discuss is relevant. Thanks.

  9. lunar. if you can’t even sell covered calls you need to move to another borkerage. thinkorswim, optionsXpress, hell, even Scottrade lets you sell covered calls.  If you mean selling naked calls then yesm you are out of luck as none of the brokers allow that in an IRA account

  10. another issue which I found about disaster play: when market drop and Volatility very high, it is time to close hedge play and buy some longs, but unfortunately volatility of your long calls ( which is ITM) much less than your short calls ( which are close to ATM) and make this play not so profitable as we expected

  11. This was very helpful in that I have been considering closing 1 of 2 full service brokers and increasing ful control on line trade, problem for me as a former businessman is dumping hurts their business, lost jobs, etc. Any hints? Thanks

  12. WFR/Turtle – There were 5 long-term plays last Tuesday, WFR was one of them.

    50%/Tcah – I think for an established portfolio, yes.  The idea is to work your way into those positions over time and, frankly, from my perspective, it’s more than 50% because, as you wear down the basis over time, you can end up with many almost free positions that do nothing but produce an income for you. 

    In other words, let’s say you have the WFR buy/write, which was selling the 2012 $12.50s for $6.70 against the stock at $12.14 for a net $5.44/8.97 entry.  So you allocate $50K to the trade and you work that backwards to being willing to allocated $25,000 to own it at $8.97 (a 2x assignment).  That’s 2,800 shares so you buy 1,400 shares at $12.14 ($16,996) and write 14 contracts for $6.70 ($9,380) for a net cash outlay of $7,616 and about $4,500 in margin. 

    That’s all you do in the first 18 months of your $50K allocation, which is why, when people tell me they have large portfolios and no margin room I get deeply concerned because, if you are playing 1/2 your portfolio conservatively like this, you should ALWAYS have huge amounts of spare maragin. 

    So the only way we own 2,800 shares of WFR is if we get them for net $8.97 in Jan 2012 and that’s still just $25K laid out to the position.  TLAB is a $8.87 stock so let’s use those contracts to look at what we expect for round two in WFR.  TLAB 2012 $7.50 puts and calls can be sold for $3.50 so let’s say we can (assuming we want to keep accumulating) 28 WFR 2014 $7.50 puts and calls for $3.50 against our 2,800 shares at $8.97.  Notice it doesn’t really matter whether the shares are $8.97 (down 25%) or $6.97 (down 45%) because the put/call combo would be about the same.  The sale of the 28 leaps would bring our new net down to $5.47/6.49 and our new "worst-case" outcome is that we own 5,600 shares of WFR at net $6.49 ($36,344) so even at a "full" commitment, I still have $13,656 cash left over from my $50,000 allocation.

    If our 5,600 shares end up being called away at $7.50, we make $2.03 per share or $5,648 on our 2,800 shares, which is 22% of $25,116 or about 11% a year – not a bad escape for a stock that dropped 40% since we bought it.  Meanwhile, since we never triggered the rest, we had tons of spare margin to play our shorter term, margin-intensive plays that tend to do quite well.

    If we do end up with 5,600 share being assigned to us at net $6.49, then we are in for $36,344 and we can (if we LOVE WFR the way I loved CROX or TASR when they were down) keep going by selling (using ENER 2012s as ENER is currently $6.38) 56 2016 $5 puts and calls for $3.90 and that drops our net to $2.59/3.80 with the possibility of owning 11,200 shares of WFR for $42,560.  Isn’t that strange, it almost would seem silly NOT to DD the number of shares from 5,800 for $36,344 since it costs so relatively little)…

    So now it’s 2016 and we either get our 5,600 shares called away for $5, which is a 93% profit on the $15,022 we had left on the table or we end up with 11,200 shares at $3.80, tying up $42,560 long-term but then, if we can sell just .10 per month of calls at $5 or higher, that’s a monthly income of $1,120, which works out to $13,440 (31.5%) and in 3 years you have a free position on WFR.

    If, at any given time you are working a dozen of these positions in various stages, ideally you will be building a portfolio of very cheap stocks over time.  In this example you may have just 6 positions like WFR that mature over 6 years (and the rest get called away or killed) and perhaps about $250,000 committed that are generating $80,000 in revenues, which is 8% on $1M locked in before you even begin play around with the other $750,000

    Of course, since you are locked down and no longer need to sell puts at that point, your mature positions add to margin, rather than subtract from it and you have EVEN MORE buying power along with your very safe 8% income generators. 

    So, to get back to the original question about committing 50% to these, realistically, over time, it is hoped that your $1M starting portfolio should end up with $4M of these positions and you are still working the $1M the same way you started.  If you maintain this discipline over 20 year, you are sensibly reducing your risk exposure year after year while managing your $1M portfolio every year, transitioning your winners to simple long-term income producers that are no longer part of your active portfolios other than the monthly (or quarterly) call selling. 

    I know it’s very hard to think in terms of 5 and 10-year plans but notice how our very conservative plan to make 8% a year can "accidentally" end up making you millions over time.  As Sage noted – watch "The Man Who Planted Trees" -  watch it until you belive in it!  It is unfortunate that we usually talk about short-term (2012) time-frames and don’t spend enough time on the big picture.  Perhaps that’s one of the things that make some people so impatient.  It’s fun and exciting to play for big money but that should be for the money you can afford to lose.

    What does "afford to lose mean?"  If I have $1M of mature long-term positions that are generating $300,000 a year on option sales and I only need $200,000 to live on then I have $100,000 that I can afford to lose.  That then determines the high-risk portion of my remaining portfolio so even if I have $2M in cash and short-term posiitons, I should only be allocating $1M to Sage’s mix above and the other $1M should remain in cash or something ultra-safe.

    If, on the other hand, I didn’t need any of the $300,000 to live on because I’m still producing another income then I can afford to lose the whole $300,000 in any one year and I can put $300K into levered plays and $1.7M into the rest.  Obviously, if you do lose $300K, you need to re-allocate to something much safer with the remaining $1.7M but all you need to do is wait a year for the safe $300K to come back and then you can be off to the races again. 

    So your penalty for taking a hit in a well-managed portfolio is a forced "time-out" from trading

  13. Cash/Kinki – Since my hedge fund is new and does not have mature positions, yet, we are mainly in cash.  If it were older, the above example would be more appropriate.  When you have an "in-progress" portfolio, being in cash doesn’t have to be all cash as long as you are comfortable slapping your portfolio into neutral through our Disaster Hedges or Mattress Plays

    Oddly, I think the fact that I started driving a stick shift in a metro area gives me an advantage over traders who always drive automatics because I am more aware than they are that there are 3 main gears on a car – forward, reverse AND NEUTRAL.  When you have a stick shift, neutral is a very important position – you are in it any time the you come to a decision point in the road like a stop light or a stop sign or when you are ready to park.

    Most traders have an "all or nothing" view of investing.  Ther is only stop or go, not 1st gear, 2nd, 3rd, 4th and certainly no neutral, which is now derided as either being indecisive or "flip flopping," which have been marketed to you as very negative traits by a PR machine that wanted to get you to choose "The Decider" to lead you.  I’m not trying to be political here but that’s the attitude that’s crept into our culture this past decade and it’s still hammered home to you every time your news station tells you "we report, you decide," as if deciding things empowers you and gives you control, regardless of whether you decide right or wrong (there is no right or wrong to the report – it’s YOUR decision). 

    Look at Cramer’s lightning round, he just celebrated his 1,000th episode and he’s asked about perhaps 20 stocks in each one and NOT ONCE, in 20,000 queries, has he ever said "I don’t know."  He doesn’t have a neutral button!  The same with the Fast Money guys.  They are on CNBC several times a day and all 4, every single day, say we will close up or down and NEVER does one of them say – I have no idea.  The guests always have an opinion on everything and if you ever see one try to be non-commital, you see that they are bullied for a definitive response and I can’t think of one who didn’t buckle. 

    Just last week, I pre-interview person asked me what I was going to call for the week’s end and I said there was no way to tell because we wouln’t know what was going to happen until we saw the retail sales report and they said "so is it going to be up or down" and I explained to here why we could go 2.5% in either direction and I thought she understood but I got a call a half hour later telling me I was bumped.  That’s the game and not just on TV, the pressure at Forbes to write what they want was intense and I hear horror stories from other writers.  The MSM is a total joke but even the bloggers get pressured by their advertisers and, of course, the Analytics (GOOG’s "ratings for traffic") where sunshine and lollipops "outsells" doom and gloom by 2:1. 

    Both sunshine and gloom outsell "I don’t know" by a country mile.  NO ONE wants to read something that doesn’t have a conclusion.  No one wants to put money into a hedge fund that says "we don’t know what the market will do"  and no one wants to read an analysts report on a stock that says "could go either way."  Even with ratings, there are very few neutral ratings.  9,000 stocks with about 90,000 analyst opinions and I’d be surprised if 10% of them think they will not go up OR down despite the fact that that’s what happens in 2 out of 3 12-month time-frames. 

    What was the question again?  Oh yes, cash! 

    So cash is the neutral gear of the stock market.  It is not wrong or weak or stupid to have cash – people work their whole lives to have a few thousand spare dollars and if you have enough of them sitting around that you can afford to play the markets with them, then you are very lucky and cash is a very valid strategic position

  14.  Thanx Phil, great stuff, now I understand very clear what you mean by planting trees

  15.  Phil
    any recomendation for portfolio building : now I have 120k portfolio but I plan to add about 100k each year from my main business during next 5 years

  16. Low cost/82472618 – Contact Scott at thinkorswim dot com and ask him for the PSW rate, which depends on your account size and number of trades etc.  Some people seem to be getting better deals at IB.  Keep in mind though, that splitting your account up like that means you are wasting potential margin power in your other accounts.  As to the monthly thing, we’re working on that too – it’s very complicated trying to differentiate everything….

    Disaster/Tcha – If you are looking at the batch from Apr 28th, those were long-term hedges and, no, long-term hedges do not pay off in the short run.  The key is that if you had positions and they were down now, you could happily wait for them to bounce back because, if they don’t, pretty much all of our hedges are in the money for at least 500% returns.  Since we cashed our longs a couple of weeks later – the hedges have nothing to protect – yet, but that means we can allocate 25% (assuming you hedged 5%) of our portfolio to new longs right here because, again, if the market doesn’t go up from here by October, we WILL collect our 500%.   It really doesn’t get better than that.  Don’t forget in late April the S&P was still over 1,200 and we were hedging for the upside plays we intended to take if it held up the next week but it didn’t so we just ended up short and that is AMAZINGLY fortunate now as we are in the driver’s seat with in the money hedges against stocks we haven’t even bought yet. 

    On the other hand, the reason we spread multiple hedges is because it’s good to have different styles.  I had put up some more aggressive June and July hedges that are up huge and even the EDZ play from the April post is a huge winner as those 2012 $45s are now $26 and the $70s are just $20 for a $6 spread that was orignally $3.50 and we sold 1/6 the $35 puts agains them which are still $13.50 but now $12 out of the money.  This trade has a whopping 1,000% upside with time very much on your side. 

    Brokers/82472618 – Unless they took money out of their pockets to cover any losses you had in the crash, you don’t owe them anything.  They work for a commission and they are trained to get you to be empathetic about their families and their financial status so you will feel like you are "responsible" for their future as well as yours.  They love to say they "feel your pain" and that they are right there with you as they skim 2% (maybe more) of your portfolio each year whether they do well or poorly for you.  If they give you good advice and make you money then believe me, as a hedge fund manager I will tell you that they are earning every penny but if you can do better elsewhere, your duty is to yourself first and them much, much, MUCH later.  If you move elsewhere and make a lot of money and you still feel bad – feel free to just send them 2% anyway….

    There’s a reason clients are called "fish" and big clients are "whales." This is how your brokers see you as they look to fill their nets with as many little 2% income engines as possible.  If you can get 1,000 guys to give you 2% of their money every year no matter which way the market goes – why do anything else?   An armed robber couldn’t possibly make that much money and there isn’t enough money in a bank to pay a robber the equivalent of 50 people’s life savings a year. 

    It doesn’t seem like much but if you consider that the average broker is handling 50 clients with $400,000 each ($20M) and they are stipping $400K in annual fees (plus commissions for putting you in certain products plus interest they charge you etc.) and that the brokerage has one or two dozen of these guys sitting at desks – it’s quite a nice little operation!  They then happily pay various consultants (I used to be one) to come in and tell them how to keep those clients and a lot of those consultants are sales consultants, who teach the reps how to use various "hooks" to keep their clients and build relationships.

    They tell your broker to share their faimily information with you, to talk about medical problems, etc – whatever it takes to form a bond and build trust.  Their databases have boxes for your wife’s name, children’s names, birthdays, hobbies, likes and dislikes - it’s like a friggin’ dating web site where they have the cheat codes…  They are encouraged to research you and there are ticklers to remind them to stay in touch with you every so often and a rotation under which they may call you with juicy IPOs (the brokers fight each other tooth and nail for these). 

    I’m not saying all brokers are scum but many are and if the guy you know isn’t, I’ll bet his boss is.  It’s a leech business by nature and the trading functions they once performed are now totally obsolete so brokers today are like the guys who stood in elavators until the 70s pushing buttons because their union contracts wouldn’t allow the buildings to get rid of them just because the new elavators no longer needed an operator.  Those guys are pretty much all gone now and so will brokers be in 20 years.

  17. Hey Phil-
    I saw the posts on Friday about upcoming changes to PSW subscriptions.  I didn’t want to ask there during the trading day because I figured you would be pretty busy.  I have a basic membership and I’m happy with that for now.  The premium would be nice down the line, but my portfolio is a bit small to justify it.  I’ve been following your advice so far and I’ve done pretty well.  I’ve been focusing on trying to generate about $200 a week or so.  Anyway, I like being able to post, ask questions and be involved in my limited, newbie way.  Will the basic membership retain everything it has now?  Should I renew for a year to lock in the price?  What is your recommendation?  Thanks

  18. $120K/Tcha – Well, as long as you are SURE you will be adding $100K for many years to come (so I assume this is newfound wealth as it’s just $120K so far) then THIS is the $120K you most want to take a chance with.  The reason is because, if you double this $120K and then flip half of that to conservative plays, you will still be able to risk $60K next year while $240K begins to go to more diversified wealth building and that can put you very far ahead of the game.  If you blow 50% of the $120K this year, it will have relatively little effect on your future. 

    Also, you need to consider the nature of your business.  If you are generating $100K of investable capital per year and expect to work 10 more years – what is the exit?  Does it just stop or do you sell the business for $1M at the end?   If that’s the case, then you have a savings play of $100K per year and a $1M lump sum addition after 10 years and that makes for a very different strategy than if you have $100K per year and then nothing and you’ll need $100K per year to live on after that. 

    Overall though, if you are not near the end of your earning years and you are highly confident of your $100K per year, I’d be inclined to go for it with a fairly aggressive outlook.  That’s not to say throw money out the window but you can aggressively buy stocks like the WFR play above and commit a little more heavily on the basis that, by 2012, you will have an additional $100K to DD with so you can move in with a $10,000 back-end commitment, rather than 5%. 

    Take ENER, who I just happened to catch when looking at the WFR play.  They are a speculative solar company but fairly solid and not the kind of play I’d take in a less aggressive portfolio but, at $6.38, you can sell the Jan $6 calls for $1.45 and the Jan $5 puts for $1.05 and that’s net $3.88/4.44 with a 54% profit if called away in 8 months.  You can commit $3,880 to buying 1,000 shares and writing 10 contracts which will cost you $1,500 in margin even though it’s a bigger than usual up-front commitment BECAUSE you know you will have $100,000 more cash to convert the play next year. 

    That’s why it’s very hard to have "rules" for managing a portfolio.  Everyone’s situation is a little different, whether it’s age or income or lifestyle…   All those things need to be taken into account when allocating risk and selecting positions – the key is to look at where you want to be in 10 or 20 years and then work backwards to how you will be getting there from where you are now.   If your goal is to have $10M by putting away $100,000 a year – you will very likely be disappointed but, if you are realistic and look at what you might have to accomplish over 10 years to get to 2, 3 and 4 Million then you can decide what kind of risk/reward set-up you feel comfortable with.

    It should be relatively easy to get to $1.5M as all you need to do is make 10% a year while adding $100K.  $2M means you need to make about 15% and $3M means you need 25% annual returns (without a miss) while $4M is going to require LUCK!   So having $120K now and trying to make more than 25% a year is greedy and requires you to outperform pretty much everyone else in the market 10 years in a row.  If that is your investing plan in year one, you are pretty much doomed to fail!

    Even getting to $3M with $120,000 and another $1M over 10 years is a bit of a stretch as the majority of your plays have to be allocated to strategies that make 50% because, if 1/3 of them make 0 or less, you’ll barely be at 25%.  Obviously, plays like ENER, that are designed to make 50% a year, are inherently risky compared to say:

    • Buying 500 shares of MO for $21.61 ($10,805)
    • Selling 5 2012 $20 puts and calls for $5.60 ($2,800)
    • Collecting $2.10 in dividends (1.5 years) – ($1,050)

    So you lay out $8,005 and pick up another $1,050 along the way leaving you in for net $6,995 and, if called away in Jan 2012, you get $10,000 back with a 42% gain in 20 months, about 25% a year.  That’s a fairly safe play in a reliable blue-chip stock that you can own for the rest of your life (as long as you aren’t dumb enough to smoke) and earn 6% dividends for many years.  The margin requirement on this trade is about $2,300 so this is a fine allocation for a $120K portfolio that has additional cash coming in over time. 

    In your first year, you can have 8 plays like this that will make you 25% each with relativley little risk and next year, you will DD or kill some of these and take 8 more so then you will have maybe 12 and in year 3 18, then 27 in year 4 (and I don’t mean literal positions but 27 units that mature to $10,000), then 40, 60, 90, 135, 200 so that’s $2M worth of maturing "safe" positions that survive the gauntlet over 10 years with just a 50% success rate each year.  As long as you don’t totally screw up the rest of the portfolio, you should easily have $3M just following that simple strategy. 

    This is what I tell people who want to invest in the hedge fund – this stuff isn’t hard.  The reason to pay someone to manage your money is because you have something better to do with your time (there are plenty of people who make $1M a year and have a few million to invest but need to work, not watch the markets all day and there are also plenty of people who use a fund to allocate a portion of their portfolio to a riskier strategy than bonds or whatever). 

    Remember the downside to playing MO is just like WFR above but, if you are building a 10 year portfolio with a stream of income, then even if you DD twice from your $7K initial investment, in 6 years it will be less than $25,000 of your $600,000 portfolio – right on schedule and you’ll be in MO for about $10 per share with 2,000 shares.  As I do often say:  If you don’t WANT to own 2,000 shares of MO for $20,000, why on earth would you buy 500 shares of MO for $10,805?

    If you only buy stocks that you REALLY WANT to buy more of if they get cheaper (assuming no major issues that change the long-term outlook) then you should almost be hoping it goes down sharply in your first round so you can get serious with it.  If you only love a stock as long as it goes up, then you are a short-term directional/momentum trader and NOT an investor.  Do not fool yourself into thinking you are an investor when you are not as you will get your ass handed to you on a regular basis.  Both styles have their place but if you think you are investing when you are trading, then like you dissatisfaction with the disaster hedges – you will end up in many trades that are inappropriate to your goals…

  19. Memberships/Jtiff – There will be some normal inflationary price increases but not too much for existing Basic Members.  Mainly, we are creating a new "voyer" category membership with limited viewing and no chat at all and then limiting the number of new Basic or Premium Members and raising those prices for new people substantially as we really don’t want too many more people in chat.   That will allow us to move up to the 10,000 non-participating members Option Monster has (they pay $500 a month for "2-4 trading ideas daily" and no direct feedback!) without compromising what we have going in Premium Chat right now. 

  20. thanx Phil,
    question about your buy list: do all companies in that list for long time holding( accumulate them and hold for years saling calls to generate inclome)?

  21.  Phil,  I just love when you explain to people , especially new members , the way it really is.  I just stop and think about why I’m really offered baseball or golf tourney tickets  by bankers and brokers. 

  22. Phil,
     I have done some reading about creating an LLC company to transfer your portfolio to and then trading within that LLC. The thought is you could actually deduct things like the membership to this website against your profits along with other costs.  Do you think this is worth the time to setup?

  23.  DOStrade,  I have to think there should be at least 5 other reasons to set up an LLC….estate, liability protection, tax, business continuance or spousal reasons…… other than just  to deduct the cost of an annual membership.   

  24. Phil – Can you point me to the posts that have the details on the membership changes? I cant seem to find it.

  25. Phil,
    Advice…. MT…. I am long Sept 43-50 bull call spread (the 43 was ITM when I wrote it). Well, MT is on major sale right now around 33. What’s your opinion on MT with Europe’s instability and how best can I fix this spread? I am scaling in on this one so I have no problem with a DD on it.

  26. Buy List/Tcha – That’s the fishing net you want to cast.  We don’t know which ones will be called away and which ones will be long-term plays we stick with.  The important thing is understanding the long-term goals and that will help you identify the winning prospects that are worth sticking with in your own portfolio.  If you go back and read the "Bye Bye Buy List" post, you’ll see there that we eliminated 2/3 of the last Buy List group but did hang on to 21 of the stock positions that still looked good in the environment at the time.  

    You always have to make a call based on where things are.  If we bought AAPL at $85 and GOOG at $300 and IBM at $70 in the big crash and, had you asked me then if we were going to keep them for life, I would have said "of course."  As it turns out, they went up so far and so fast that we ended up dumping them again because the stock prices exceed our mid-term optimism.  We WANT to marry our stocks for life but we’re not vowing to stick with them for better OR WORSE, there’s no obligation for us to stick with them in health AND SICKNESS.  Be like a sultan and keep many, many wives and let the best performing favorites stay with you in the palace and sell the rest!

    Thanks Stock!  That’s right, if you ever want to know what businesses in your area are "fishing" just go to your local stadium and see whose names are on the box seats.  One thing you’ll always find is plenty of banks and insurance companies… 

    LLC/Dos – I am fairly positive you can deduct those kind of expenses anyway, check with your accountant but training, subscriptions and even computers and web connections and office space (portion of your home) used to generate and income should be deductable from that income without having to turn yourself into a corporation but, as Stock suggests, there are other good reasons to incorporate but you need a sharp accountant to steer you through that stuff. 

    Membership changes/Trad – There’s no post in particular, the comment above is as detailed as we have so far.  We still have a month of programming ahead of us I’ll bet so it’s business as usual for now. 

    MT/Kur – Better if you give me entry prices but not too important here as the $43 calls are down to .85, probably from about $3.50 I guess.  I assume you sold the $50s for $1.50 or so so a $1.50 spread that’s now worth .60 is not pretty but you are only down about $1 and the Jan $25/30 bull call spread is $3 with a $2 upside and I’d go for that and, IF MT falls further, I’d look at selling the 2012 $25 puts if you have the margin for it, they are currently $4.75 so you only have to sell 1/2 at $6 to pay for your spread but you need to REALLY want to own MT for $25, which is probably a great price after giving them a year to recover. 

  27. Phil, yes you’re guesstimates are close enough on the entries…. I think I would love owning MT at $25 but by the same token I don’t want to be bogged down waiting for the glacier to melt…. so if you think I’d be better just cutting the losses now and moving onto something with better prospects and a quicker turnaround, please advise.

  28. Pardon the very crude post as I am only joining the service and have limited knowledge of options.
    I have very limited portfolio allocation experience, however I went over my head a couple months ago and tried to put $250K "to work"  have now mounting losses, so I am looking to learn quick and see how to recover the lost money (it is still unrealized) so I am hoping to get some help from you and members to scale back the positions or use some option strategies to make ground back and insulate furtther downside. I currently have $75,000 in cash and the following positions with unrealized losses and profits:

    Unrealized Gain/Loss for Individual XXXX- as of  Mon May 17  19:38:39 EDT 2010

    Market Value
    Cost Basis

    A T & T INC NEW











    OTIS GOLD CORP         F




    STD 09/18/2010 12.50 P
    PUT  BANCO SANTANER SA  $12.50      EXP 09/18/10







  29. Welcome Amatta! 

    Well, for one thing, you have way too many positions and a very odd collection too.  I would suggest getting the hell out of your metal positions before they start falling.  Half your losses are C and UCO, both are ones that should be coming back for you and remind me at the end of the day today and we can look over the rest but consider the 12 bullish plays I put up for Members in Monday’s post as a good starting point and make sure you read the commentary under the weekend post re. scaling into a position – something that would have turned most of these losses you have into winning trades. 

    Overall, you are down 6.5% on $250,000 – this is nothing you can’t recover from and now we’re going to teach you many techniques to manage your portfolio better so no worries but, like I said, ditch the metals at least and raise some cash and then we can look at your other stuff but other than C and UCO, only T, TBT, EXC and and AMT are ones I like off the top of my head. 

    Our position selection is very different as option sellers.  We look for stocks that are good to sell against.

  30. Phil, Upon reading a few of your articles, I decided to purchase your top subscription.  After reading your article about the Boeing / SDS trade, I bought into the logic and enter a small position today.  I have had some success selling straddles, over the past few months and wanted to try something different to add to my portfolio.  I am mainly in cash holding positions in AKAM, FFC, PGH and SQNM.  My question as a new subscriber – Should I wait for new recommendations or begin to enter positions that you have recently mentioned?  If so, what are some suggestions?  I look forward to making some money together.

  31. Updated performance/$1 mio. portfolio. I thought it would be useful to see how the stock prices of some of the selections in this post have performed during the intervening period from Friday May 14th 2010 until Friday March 30 2012 (1st and 2nd numbers respectively).
    GE: 16.54/20.07
    MO: 19.16/30.87
    BA: 66.94/74.37
    CCJ: 24.36/21.49
    CAT: 62.64/106.52
    KO: 50.30/74.01
    EBAY: 22.25/36.90
    IBM 127.31/208.65
    MCD: 65.51/98.10
    JNJ 59.55/65.96
    PG: 59.17/67.21
    WFR: 11.79/3.61
    ENER: recently delisted from the NASDAQ
    Phil's approach of buy/writes on all these stocks would have produced a pretty penny (although I have not worked out what the actual returns would have been). Of course, the more speculative plays (WFR and ENER) show the importance of diversification and the need to manage a portfolio regardless of its composition. 
    And of course, the short calls could have been rolled in long before Jan 12 to gain additional premium and to avoid the stock being called away – of which there is a high likelihood on stocks which pay dividends. In the MO play mentioned by Phil he talks about a 25% return per year. With managing positions appropriately, that return could have been ratcheted up significantly – the same for the other stocks. WFR would have required significant management and a strong stomach to keep doubling down. ENER proved itself not to be so solid, and would have been the most difficult to rescue. 
    So, these posts should not only be read for the instructional benefit of creating portfolios, but they need to be actively managed to adjust positions as needed due to the evolving circumstances of the stocks and their prices. This requires more skill than it would seem. Another advantage of being a member with the privilege of asking the Oracle on a realtime basis.
    For those interested in a simple tool to retrieve historical quotes, the following is useful: