Enhance the Returns of Your Commodity Trend Alert Portfolio
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1 Q A Publication of The Sovereign Society Enhance the Returns of Your Commodity Trend Alert Portfolio By Generating Income through Options Trading By Andy Hecht, Senior Commodity Editor The commodity markets have had some spectacular returns over the past few years. As a Commodity Trend Alert subscriber, you ve been able to capitalize on that trend through purchasing equities, exchange-traded funds and, at times, commodities themselves. It s a strategy that works. Many of the holdings in the CTA portfolio have both outperformed the market and produced very juicy returns. Take a look at some of CTA s most recent closed out winners TransCanada Corp. (NYSE: TRP) 56.3% return ipath DJ UBS Grains TR Sub-Index ETN (NYSE: JJG) 53% return Cameco Corp. (NYSE: CCJ) 34.8% return Petroleum & Resources Corp. (NYSE: PEO) 30.3% return These are solid returns, to be sure. But we re going to kick it up a notch. I m going to show you how to enhance your portfolio s income through buying and selling call and put options on current and future CTA holdings. Before I explain how adding calls and puts will benefit our strategy, it s important you understand options and how to use them. That s why I ve created this guide. The Sovereign Society 98 S.E. 6th Avenue, Suite 2 Delray Beach, FL USA USA Toll Free Tel: (888) Contact: Website:
2 What You Need to Know About Call and Put Options Very simply, an option is a derivative security that gets its value from the underlying stock it covers. Each options contract represents 100 shares of the underlying stock. There are two types of options: call options and put options. Owning a call option gives you the right (but not the obligation) to buy a stock for a specified price by a specific date. A put option gives you the right (again, but not the obligation) to sell a stock for a specified price by a specific date. You can always let the expiration date go by, at which point the option becomes worthless. If this happens you only lose the money that you paid for the option, nothing more. When you buy a call option, you re making a bet that you expect a stock to go up and will make money if it goes up enough. This is similar to having a long position on a stock. When you buy a put option, you re making a bet that you expect a stock to go down and will make money if it goes down enough. The exact opposite applies when you sell a call or put option. When you sell a call option, you re making a bet that you expect a stock to go down, and will make money if it goes down enough. When you sell a put option, your e making a bet that you expect a stock to go up and will make money if it goes up enough. Most importantly, any time you sell an option you are taking on an obligation, not a right, to buy or deliver the stock at a specific, predetermined price. This is a very important distinction. Now let s take a look at how we can use these investment vehicles to enhance our portfolio s returns Turbo-Charge Your Returns with Call and Put Options There are two primary reasons investors use options to speculate and to hedge. We will be doing both in CTA. Speculation, simply put, is betting on the movement of a stock. The good thing about options is that you aren t limited to making a profit only when a stock goes up. Now, options have the reputation of being risky investments. They can be the rewards can be great, but so can the losses. This is because when you buy an option, you have to be correct in predicting whether a stock will go up or down, how much the price will change and the time frame it will take for this to happen. Timing is everything! So why speculate with options? Well, as I told you a moment ago, an option is a derivative security that gets its value from the underlying stock it covers. When you are controlling 100 shares of, say, a $60 stock with one call option that costs pennies on the dollar, it doesn t take much of a price movement on a percentage basis in the underlying equity to generate substantial profits. Hedging is the second function of options. Think of this as an insurance policy, similar to what you d purchase on your home or your car. Just as GEICO would pay to fix the car when your son backed into the neighbor s mailbox, options can be used to insure your investments against a downturn. If you ve been a CTA member since April 2011, you are already familiar with this strategy. Even though Eric Roseman is a long-term commodities bull, for weeks, he advised members that the sector as a whole was long overbought particularly precious metals. So on April 26, he recommended the Silvercorp Metals Sept $13 put options as a bet on the downside and to hedge silver s correction. Less than two weeks later, CTA members closed out the position for a 53% profit.
3 The point here is that by using options you might be able to limit your losses and take advantage of the full upside. To best illustrate how these strategies work, here are some examples #1 Income-Generating Strategy: Buying Call Options to Boost Returns with Limited Risk Let s say there s a sector-wide correction in energy and oil-exploration stock QRS dips to $25 per share. The company is a low-cost producer with high growth prospects thanks to a new oil-well discovery. As such, we expect shares to appreciate in the coming months as QRS brings the new well online and the market rebounds. So we add it to the CTA portfolio. In this situation, I might also recommend a call option. Presently, one-month $30 call options on QRS are $1.00. By purchasing this call option, these are the potential effects on your portfolio: You pay $100 for the option (100 shares x $1). If QRS is still trading below $30 in one month when the option expires, you will only lose $100 the premium you paid for the option. If QRS trades at $35 per share before expiration, your return is 400% ($500 minus the $100 premium you paid for the option). If QRS goes to $50 per share before expiration, your return is 2,400% ($2,500 minus $100). By comparison, if you d only bought the stock at $25, your return would be 100%. Remember, when you buy an option, you only risk the premium that you pay. The upside is unlimited! #2 Income-Generating Strategy: Selling a Call Option Against an Open Position One year ago, we added stock XYZ to the CTA portfolio at $35 per share. You initially purchased 1,000 shares at that price. Today, XYZ is trading at $64 per share, so you re sitting on a nice 83% return. But the company releases lukewarm earnings that were on par with expectations, and its growth potential has leveled off. The stock is trading at fair value at the current price, so we don t really expect it to move much higher from this level in the coming months. We rate XYZ as a Hold. A one month call option with a strike price of $65 is trading at $1.50. In this situation, I might recommend you sell this option against your position in XYZ. Why do this? Because I don t expect the stock to appreciate much above the strike price. I expect it to be stable at currency levels. The objective here is to take the premium and generate some extra income for your portfolio. In our example, each option contract represents 100 shares of XYZ stock. Since you own 1,000 shares, you would sell 10 of the one-month XYZ $65 call option contracts at $1.50. Here are the potential effects on your portfolio: You receive $1,500 cash in your account. If the price of XYZ stock is below $65 on expiration (in one month) you keep the $1,500 and still own XYZ stock. If the price of XYZ stock is above $65 on expiration (in one month) you sell 1,000 shares of XYZ stock at $65 and you keep the $1,500 netting you a total sales price for XYZ stock of $66.50 ($65 sales price plus $1.50 option premium received = $66.50)
4 Remember, when you sell a call option, you have an obligation to sell the stock at the strike price (i.e. $65) if the buyer of the call option decides to exercise his option to buy. In this case, no harm, no foul because you actually bought the stock at $35 per share. Many times, however, options traders who sell calls do not actually own the underlying stock. This means they have to buy it on the open market to sell it to the call buyer. The sellers will lose the difference between their purchase price and the strike price. This can be risky especially if the stock skyrockets unexpectedly. But I m all about limiting risk, which is why I won t typically recommend selling call options unless we own a stock that s yielded a decent return, or the fundamentals have changed. #3 Income-Generating Strategy: Selling a Put Option Against a Future Position Stock ABC is not in the CTA portfolio yet. It is trading at $30 per share. The company has solid fundamentals, and I believe that it should be part of your investment portfolio. That said, shares have appreciated over 20% in the last several weeks alone. I believe it s irresponsible to chase stocks, so I would rather wait for some of the froth to settle and buy ABC on a dip. In the meantime, that doesn t mean we can t make a little extra money while we wait for the share price to come down. The $28 one-month put option is trading at $1.00. I might recommend that you sell this option to open a new position. Remember, selling a put option obligates you take ownership of stock, so this strategy only makes sense if you re comfortable owning it. ABC is a stock we want to own. Since each option contract represents 100 shares of ABC stock, for each one-month ABC $28 put option contract that you sell at $1.00, you receive $100. Here are the potential effects on your portfolio: You receive $100 cash in your account for each put option that you sell. If the price of ABC stock is below $28 on expiration (in one month), you keep the $100 and buy 100 shares (for each put option sold) of ABC stock at $28, netting you a total purchase price of $27 per share for ABC stock ($28 purchase price plus the $100 option premium per contract received = $27 per share) If the price of ABC stock is above $28 on expiration (in one month), you keep the $100 per option sold as free income on a stock that you do not even own yet! The bottom line is that selling put options can be an effective way to generate additional income for your CTA portfolio because the seller receives the premium. We get exposure to stocks we would like to own but want to limit what we pay up front for shares. The upside with this strategy is limited, but if you sell a put and the stock price goes up, you re still turning a profit! Executing These Strategies is Easy You can buy and sell call and put options through your the same stock account you use for CTA. When you look at the price of a stock on your current platform, there should be a link to a page that lists the available options with their respective months and strike prices. (Many platforms refer to them as options chains. ) I will always let you know the specific month and strike price of the call or put options, as well as the price or premium for the call or put option itself, when I recommend options on existing or new positions. And if you ever have any questions about these strategies, just call customer service at I ll do my best
5 to address all of your comments and concerns in upcoming issues of Commodity Trend Alert. I want you to feel comfortable and informed. Using options will not only enhance your CTA returns, but will also make you a better investor in the long run. I look forward to bringing you new and interesting ways to increase the profitability of your CTA portfolio in the coming months! Happy Trade Hunting Andy Hecht, Senior Commodity Editor
6 The Sovereign Society 98 SE 6th Avenue, Suite 2 Delray Beach, FL USA USA Toll Free Tel: (888) Website: Legal Notice: This work is based on what we ve learned as financial journalists. It may contain errors and you should not base investment decisions solely on what you read here. It s your money and your responsibility. Nothing herein should be considered personalized investment advice. Although our employees may answer general customer service questions, they are not licensed to address your particular investment situation. Our track record is based on hypothetical results and may not reflect the same results as actual trades. Likewise, past performance is no guarantee of future returns. Certain investments such as futures, options, and currency trading carry large potential rewards but also large potential risk. Don t trade in these markets with money you can t afford to lose. Sovereign Offshore Services LLC expressly forbids its writers from having a financial interest in their own securities or commodities recommendations to readers. Such recommendations may be traded, however, by other editors, Sovereign Offshore Services LLC, its affiliated entities, employees, and agents, but only after waiting 24 hours after an internet broadcast or 72 hours after a publication only circulated through the mail. Also, please note that due to our commercial relationship with EverBank, we may receive compensation if you choose to invest in any of their offerings. (c) 2011 Sovereign Offshore Services LLC. All Rights Reserved. Protected by copyright laws of the United States and international treaties. This Report may only be used pursuant to the subscription agreement. Any reproduction, copying, or redistribution, (electronic or otherwise) in whole or in part, is strictly prohibited without the express written permission of Sovereign Offshore Services, LLC. 98 SE 6th Ave, Suite 2, Delray Beach FL
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