The Alternate Road to Investing

By Doc Severson

The Alternate Road to Investing

By Doc Severson
Copyright 2013 by Doc Severson All Rights Reserved

This training program, or parts thereof, may not be reproduced in any form without the prior written permission of Trading Concepts, Inc.

No claim is made by the Trading Concepts, Inc. that the (option) trading strategies shown here will result in profits and will not result in losses. Option trading may not be suitable for all recipients of this Training Program. All comments, trading strategies, techniques, concepts and methods shown within our Course are not and should not be construed as an offer to buy or sell stocks and options they are opinions based on market observation and years of experience. Therefore, the thoughts expressed are not guaranteed to produce profits in any way. All Opinions are subject to change without notice. Each option trader/investor is responsible for his/ her own actions, if any. Your purchase of the Trading Concepts Comprehensive Options Mentoring Program constitutes your agreement to this disclaimer and exempts Trading Concepts from any liability or litigation.
Important Notice - Risk Disclaimer: Options Trading has large potential rewards, but also large potential risk. You must be aware of the risks and be willing to accept them in order to invest in the options market. Don't trade with money you can't afford to lose. This is neither a solicitation nor an offer to buy or sell options. No representation is being made that any account will or is likely to achieve profits or losses similar to those discussed in our training program. The past performance of any option trading strategy or methodology is not necessarily indicative of future results. Hypothetical or simulated performance results have certain inherent limitations. Unlike an actual performance record, simulated results do not represent actual option trading. Also, since the option trades have not actually been executed, the results may have under- or over-compensated for the impact, if any, certain market factors, such as lack of liquidity. Simulated option trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to those that may be shown.

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Table of Contents
Can You Afford to Retire? ..................................................................4 The US Stock Market .......................................................................5 The US Mutual Fund Market...............................................................6 Bonds and Fixed Income ..................................................................7 Managed Accounts ..........................................................................7 So What Can You Do? .......................................................................8 How Do I Insure the Stock Market?.......................................................9 How Can You Learn this Strategy? ......................................................13

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Can You Afford to Retire?

Ill bet that youre tired of contemplating that question..but its one that we all have to face. Lets look at the hard facts for a minute: Many Americans have under-funded their 401k retirement vehicles. Stock Market and Mutual Fund performance has been flat for the past 13 years, are at the same price as their previous highs, and have suffered two strong Bear Markets (and numerous deep corrections) during this timeframe. Current interest rates for savings are at historical lows and will likely stay low due to the enforced Fed Funds rate.1 The greatest source of wealth for most Americans, their househas taken a huge hit in book value in the past 5 years and no longer contains the equity that it once did. Worse yet, this illiquid asset wont sell for what its worth, nor will it sell quickly when you most need it. Inflation is quietly on the rise, robbing the purchasing power of your available retirement funds. The US Federal Reserve is printing money at an unheard of rate to monetize debt and keep asset Markets stable.

I could go on but you get the point, and if youre reading this youre pondering those same issues yourself and probably more. Because of these factors, 27% of workers aged 45 and over are pushing out their retirement plans2, according to the AARP. So thats the answer? Go back to work? An AP survey found that 73% of Boomers expect to work after retiring 3. What jobs will they go back to, in a struggling economy? Employers are desperate to cut costs and unemployment is not improving. Job Markets are flooded with college graduates willing to work for a song, and are adept at all the latest technologies and social media techniques. There are only so many Wal-Mart and Home Depot jobs to go around, and while they are necessary roles.its a long day standing on your feet for an hourly wage. Youve heard all the doom and gloom your question is: What can I do?!!!! My suggestion is that you learn to trade the US Stock Market to earn income. Oh, I knowI felt the same way when I heard this for the first timethe Stock Market is for suckers. Ill show you a slightly different way to do it that not many folks know about.

http://www.npr.org/2013/03/20/174867741/federal-reserve-to-hold-interest-rates-low-until-unemployment-improves

2 http://money.cnn.com/2008/05/13/news/economy/delaying_retirement/index.htm?postversion=2008051315 3

http://www.cbsnews.com/8301-500202_162-57323056/most-baby-boomers-expect-to-work-after-65-poll/

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Now Im not going to guarantee you anything or overwhelm you with overblown, hyped-up numbers. Im just going to offer you a potential solution to your problem, one that will take some work on your end coupled with your strong desire to succeed. Ready? Lets tackle the problem.

The US Stock Market

Lets start by looking at the US Stock Market. What do you know about it? For most folks, they understand what theyve been fed through the media on brokerage commercials and Stock TV. What are you buying today? Whats hot? We are all conditioned from childhood to think that true investing means stock picking, speculation, and finding the needle in the haystack. that stock that billions of dollars of Wall Street research somehow overlooked, and you alone found! Its a very compelling story, until you try it. Many retail traders dip their feet in the trading ocean by starting with stocks. I love the commercials that show investors making spur-of-the-moment decisions about buying stock, such as when they notice that everyone is running with the same brand of shoe. Yes, thats a great idea! Run right into that Internet Caf and buy 200 shares of stock! Guess what? He just bought them at the high. Whats the point? Weve all been conditioned to buy stocks long, and our timing trigger to buy these stocks is generally after good news comes out. Unless were in a raging Bull Market such as the one that we saw in the late 1990s, that method rarely works and the professionals will pummel the new stock trader into mincemeat. The new trader then turns to Jim Cramer to help him pick his stocks. While these might be fundamentally good picks, Jim will often buy beaten-down stocks that likely will go down further before they rebound, especially in todays environment. The new trader will often be unable to bear the pain and will usually sell out right as the stock bottoms. Trading stocks takes a combination of discipline, knowledge, experience, and luck. It also takes a lot of capital. Buying 100 shares of a high-flying stock such as GOOG will cost you tens of thousands of dollars, and cheap stocks are cheap for a reason. Trading stocks to fund your retirement is not my idea of a viable business model for most investors. So for most people that try trading stocks, their next solution is one that they know, which are the Mutual Funds that they held in their 401k or IRA plans. Lets take a closer look at them, and see if theyre the answer.

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The US Mutual Fund Market

If you cant find a needle in a haystack, why not trade the whole haystack? Many investors turn to Mutual funds, either to diversify their holdings and spread out their riskor because they are the only instrument that they can trade within their account. You may have heard this before: there are thousands of Mutual Funds available in the US, however most of them dont even outperform the S&P 500 index. In fact, lets bring up a chart of the granddaddy of them all, the Fidelity Magellan fund: Figure 1

Chances are good that if you have a 401k or managed retirement plan, you own shares of this fund. And the return over the past 20 years has been essentially..NOTHING. And this is the performance that your high-priced financial advisor is getting you! With inflation, your performance is even more negative and the only thing thats allowing you to increase the size of your account has been regular deposits and dollar-costaveraging, the sorry apology of financial advisors everywhere. After all, if an issue is down, then just buy more of it, as its bound to go up over time, right? This chart says that millions of Americans are wrong to trust that concept, and are pushing a stone up the hill. The only positive return that theyre getting is the employer match for their 401k!
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The trap that most investors then fall into is the same one that they found when they bought individual stocksIll do fine if I can just find the right mutual fund thats about to rise! Unfortunately, most Mutual Funds arent beating the stock market either; I heard a radio program recently conducted by Adam Bold of the Mutual Fund Store where he talked of a fund manager whose performance in 2008 was down 25%; his comment was .but hes an excellent fund manager. I think weve been sold these low expectations for far too long.

Bonds and Fixed Income

Lets keep this simple. Is a 2 - 4% annual yield - or less - going to grow your account enough to retire on? Bonds are normally thought of as a safer investment, which is great if you have enough capital that this type of investment vehicle will provide enough income for you. For most, however, theyre too far behind the game and this type of instrument wont even make a dent in their needs. In fact, using the wrong type of instrument creates opportunity cost, where you might be creating more risk by being too conservative, and falling behind the pace of inflation. The Federal Reserve is printing new money at an astounding rate lately; you have to match that rate just to stay even! And Fed Chairman Ben Bernanke has mandated low Fed Funds rates for the next several years, (or until the Unemployment number drops below a specific threshold) which is going to affect all fixed income returns for the near future. And theres a good chance that Bonds are the next bubble to pop.

Managed Accounts
When I went through this process a few years ago and got my own baptism by fire to all of these investment vehicles and their liabilities, I got a phone call during a weak moment from a salesman/broker who represented a well-respected, multisyllabic Wall Street firm. His pitch was hard to resist, Sir, with all of the research and resources available to us, do you think we cant do a good job for you? At the time I was thinking, ...Maybe Ive been lucky trading stocks and timing mutual funds, these guys are the professionals. So I folded like a cheap suit and signed my retirement account over to them. What I found out that they were professional at was selling me product at a high commission, and they did nothing during the subsequent 2000 - 2002 recession to protect my account which fell to 30% of its prior value. One of my happiest days in the past few years was being able to fire them and gain control over my retirement fund performance again.

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Its my opinion that there are some really sophisticated, high-performance private fund managers out there, but you need to find them early enough before their client list fills up, and you have to bring some serious cash to the party. For the rest of us, were simply being sold mutual funds, and were paying an enormous premium for this service.

So What Can You Do?

Pretty depressing, huh? No matter where you turn, there are oceans of sharks that are shaking your hand with their right, and stabbing your back with their left. Hang in there; I do have an answer for you. Before I get into what kind of instrument and trading that were going to use to solve our problem, lets first talk about what kind of business model that wed like to emulate. Yes, a business model; if you want to start generating income to kick-start your retirement funding, its time to get hands-on, quit being an employee of your retirement, and start being the boss. Here are some of the characteristics of this Business: Low overhead No employees Low capital equipment costs The ability to work from any location The potential for monthly income You will occasionally have to pay out a claim You will do all of your own due diligence and underwriting

Sound familiar? Yes, youre going to run your own Insurance Company! The last time that I checked, Insurance was a stable business model and a growing field. Insurance companies get paid (premium) for assuming a portion of your risk. The risk could be anything.risk of a house fire, a car accident, or health issues. Yes, they will occasionally pay a claim to you, but over time, they will come out far ahead of the game from your monthly premium payments, as long as your lifestyle fits their normal underwriting models.

OK, What Will I Insure?

The US Stock Market. Am I kidding? No, Im absolutely serious. Its what I do every month.

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There is an almost unlimited river of risk flowing through the US Stock Market every single day. An entire secondary Market exists where you can be paid to take on someone elses risk, and as long as the price does what you expect it to, you get to keep that premium and sell another policy next month. You get to do this again and again, for the rest of your trading life. Sure, there will be times where the price doesnt do what you expect it to. Things happen beyond your control on occasion. Youll pay out a claim as your customer collects on their policy. Youve done such a good job of underwriting the policy and managing your risk, however, that a single claim doesnt upset you at all and you simply go back to collecting those premium checks every month. And if you start to pay out too many claims, you can fire your customer and find a better one that allows you to pay fewer claims. There is no physical limitation to where you can do this from. I would recommend a home office, however this is a business that can be done while you travel. (No laying about in hammocks with your laptop, however!)

How Do I Insure the Stock Market?

Were going to use a trading vehicle called Options. If youve heard of these instruments before, chances are youve been programmed to say Options are risky! Let me state that Options are the Stock Markets power tools and you clearly want to know what youre doing with them before you use them. Can you imagine building a house with a hand saw, though? Neither can I; power tools are safe if you know how to use them, and so are Options. (Required reading for anyone trading Options should be the guide entitled Characteristics and Risk of Standardized Options, found at: http://www.optionsclearing.com/publications/risks/riskstoc.pdf) You may be asking at this point, So how do I insure stocks? In the Stock Market, risk is measured by Volatility, which represents price movement. The more that it moves, the greater the risk of the price moving in a direction that generates risk for a market participant. Sometimes this Market participant who we will never meet will want to insure their risk. Thats where we come in. Lets see how we can build a business around this For our business, were going to use a well-known characteristic of the US Stock Market it spends about 80% of its time moving sideways. Figure 2 shows a chart of the S&P 500 the benchmark stock index of the United States. Note that the closing price as we captured this in late February 2013 is about
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the same as the price in late January, a month earlier. Stocks tend to move 20% of the time, then spend the remaining 80% of the time catching their breath, or walking sideways. You can see several instances of this sideways movement in the chart of the S&P 500 below: Figure 2

We have many different tools that we can use to estimate the price range that the chart will trade within. Our due diligence involves forecasting the price range that the chart will trade within during the duration of this position, then insuring the risk that the price will stay within that range for the period that we define. And on this date in late February, we insured that the S&P500 would stay in the range as shown in Figure 3. Whats great is that were selling a policy that only has a limited lifespan, usually seven weeks or less. That means if the price stays within that range for the policy period, we keep the premium that we collected without paying a claim, and well do it again next month. Thats recurring monthly income, and our job is to make the process as mechanical and consistent as possible.just like an Insurance business. Figure 3 illustrates this concept; for the April 2013 cycle, one of the policies that I wrote was to insure that the S&P 500 did not trade above the 1590 level, nor below the 1380 level a 210 point range! I was paid the premium at the beginning of the trade (the date at Figure 2 above) and the cash is mine to do with as I please while I
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monitor the progress of the trade and prepare any actions that I need to take, which is what I call Defending the Trade.

Figure 3

In this example, the black vertical line represents the specific day that Options expired on April 19th, after which my obligation or insurance policy was no longer in effect. The policy has expired and my obligation has been lifted, and we realized a profit on the trade. The horizontal pink line represents the insurance policy that the chart would not trade above SPX 1590, and the horizontal green line represents the insurance policy that the chart would not trade below SPX 1380. Its important to note that at any time, I can close down either or both legs of the trade if the risk/reward becomes unfavorable to me. This is exactly what we did with the top side of the trade at the beginning of April, as the price was showing the potential to break higher again; we removed the position represented by the pink line. It was a simple matter to close the position early and take early profits, eliminating the risk of any potential continued move, which we eventually saw. In a typical cycle, I will be retiring one months trade while I initiate the next months trade. In this example, as I would be closing down the April trade for a profit, I would also be building the May cycle positions. We just do this mechanically month after month.
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Now this is the exciting part for me I dont have to be right! All Im forecasting is the range that the price will trade within. As long as the price of the stock trades within that range over the next 6 to 7 weeks from when I set up the trade, I keep the premium that I received at the beginning of the trade. I dont have to be right about my forecast about whether the price will go up, or will go down. I just have to get my range forecast in the ballpark, and I think Im good enough to do that consistently. If the price does show the potential to trade beyond my pre-determined range, then there are several very specific, targeted actions that I can take which allow me to very comfortably manage that additional risk. Most Options strategies have unusual names, and this one is no different its called the Iron Condor. The name is significant because it represents the wide wings that your position exhibits every month. Is this some fly-by-night fad thatll dry up like technology stocks did in 2000? No, Equity options have been traded since the early 1970s, and trading volume growth has been rising exponentially. With this growth has come lower commission costs, and more choices for the Retail Trader the story continues to get better and better for us! How much can I make per month with this business? I manage my risk very tightly and use very conservative targets. I typically earn a 10 15% return on the capital at risk, which turns out to be about 1 2% income per month on my total account equity. Over time, this adds up and is the key to my retirement! Perhaps it will be yours as well....

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How Can You Learn this Strategy?

I think its very important to learn the basics of Options trading thoroughly before attempting to trade Options live. Start small and learn by trading on paper first, and use small positions until you learn the mechanics of Options and proper execution through your online broker. In a couple of days, youll get an email to the next video and report that will tell you specifically how to trade this type of Options strategy! If you have any questions please email me at doc@tradingconceptsinc.com or better yet post your questions or comments below the accompanying video online.

Doc Severson April 2013

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