RULE 3: Understand what the goal of each of our trades is
With the majority of our stock positions we are looking for a 4 to 6% gain over a very short period of time. Our average holding period in 2011 has been under three weeks. The goal of our quant model is to find stocks that have moved up too far too fast and short them looking for a quick profit or for our algorithm to look for stocks that have moved down too far and too fast and buy them looking for a bounce. This year this our strategy has proven successful with over 668 points of gains. We feel that an ideal goal of our strategy is to profit by a minimum of 4% per month or a return in the excess of 48% per year.
Naked Options -> Goal 80 to 100% gain with a holding period of one month. Risks – naked options are the most risky of the three types of trades. Drawdowns on a percentage basis on options are the most significant. On the occasion that a naked option does not work on the first expiration cycle we will roll it forward and take in additional premiums. This year our 24 closed naked options have an average return of 84%.
RULE 4: Understand our terminology
With any strategy we would never tell anyone to invest more than 10% of you capital into any stock. For us a full position would be 10% of the assets that are set aside for that particular strategy. A half position would be 5%. We view that on a cash basis. So if you have an account that has $200,000 in buying power and only have $100,000 in the account a 10% investment would be $10,000 – based on the cash value.
ALERT: If you see the word Alert in the subject line on the email we send that means it is something that is actionable.
ALERT: new long suggestion, new short suggestion, new exit strategy
UPDATE: Market update, Stock specific update
RULE 4: Time Horizon
Although 35% of our trades have become profitable within 4 days, do not view this as a day trading strategy. Realize our strategy is to hit a lot of singles and doubles and not many homeruns. All of our singles and doubles this year add up to over 668 points of gains, a grand slam. Our average holding period this year has been 15 trading days. If you only bought 200 shares of each position we mentioned this year, you could have had a closed profit of nearly $140,000, not including commissions. That does not mean that the future success will be the same.
RULE 6: NAKED OPTION RULES
For starters naked options are not suitable for everyone and you need to ask your financial firm if they are suitable for you. Losses can be unlimited.
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We would never suggest to anyone to invest more than 10% of the money allocated to any strategy in any one stock, on a cash basis, not margin basis. On naked options, where the losses are unlimited, we would sell much less than 10% of your allocated monies.
There are two important steps to understanding naked options:
Step 1:
With options the draw down on a percentage can be significant. The goal in selling naked options is to collect the premium and hope the stock at the end of expiration is trading below the call strike price so you keep the entire premium or selling above the put strike price so you keep the entire premium. When this does not work out we will typically look to role to the next month and bring in more premiums while we wait for the price of the stock to move below or above the strike price, depending on if it is a call or put. On a percentage basis you can easily have drawdowns of 100 to 200% or even unlimited losses on an option, so it is important to realize that. Eventually, what we have found is that the options at some point normally expire and we are able to capture the premium, but can have some significant drawdowns before that happens.
STEP 2: Knowing how many contracts to sell
For example,
If a $200,000 account was dedicated to a strategy, this is how we would play naked options, if they are suitable for you. Please talk to your financial adviser about whether or not naked options are suitable for you.
How to convert option contracts to the equivalent of that stock. If we decided to put 10% into a position we would use this formula for an account valued at $200,000.
1) $200,000 x 10% = $20,000
2) $20,000/100 = 200
3) 200/strike price = how many contracts to think about selling naked
Let's look at two examples.
1) ABC Co sells for $48 and we feel selling the naked $50 calls for $5 is a worthwhile trade on a full 10% position. That means we would use this 3 step formula.
- $200,000 (account value) x 10% = $20,000
- $20,000/100 = 200
- 200/ $50 (the strike price) = 4 contracts
2) ABC co sells for $95 and we feel selling the 100 strike makes sense on a 5% position
- $200,000 (account value) x 5%=$10,000
- $10,000/100=100
- 100/ $100 strike price = 1 contract
In the above example you would want to sell 4 ABC October 50 calls to open naked.
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RULE 7: Diversify
DO NOT INVEST MORE THEN 5 to 10% of the assets you decide to allocate to the Short-Stocks.com strategy into any one security we mention. We feel it is prudent to be invested in a minimum of 6 to 10 of our suggestions in a portfolio at all times. During 2011 we have entered and closed on average 13 positions per month. During markets that are not as volatile we feel we will on average suggest 6 to 8 trades per month. Don’t cherry pick. Some suggestions will work faster than others and some will have losses. Of the 125 closed trades this year 119 have been profitable and 6 had losses – don’t try the strategy using 1 or 2 of our suggestions which will not give you the intended return.
RULE 8: Disclaimer
We are not a broker dealer. We do not talk with any publicly traded companies in regard to fundamentals. We take all the fundamental information from available internet sources. Past success does not mean future success. We will not be responsible for any losses. Shorting can result in unlimited losses as can naked options. We typically would never invest more than 10% into any security and less in volatile names. Trading can result in losses.
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