Response to “Matteo” post on Aussie Stock Forums
I've read the post by Matteo about the Trading Pursuits TradeAbility Income course presented by myself, Daniel Kertcher.
I'd like to respond to his post. I thank Matteo for his feedback, and I’m sorry that he feels some things were misrepresented in my presentation (although he says he doesn't regret doing my course, is trading profitably due to the information we taught him, and had already made back a fair bit of the course costs).
I think his criticisms of the preview presentation and the course fall more into the category of misunderstandings than misrepresentations, as I will seek to explain now… Please note that I teach the entire strategy over 3 days, and there is only so much you can communicate of it in the free 2 hour seminar.
1. Minimum number of options contracts and Brokerage costs
Matteo states that the strategy requires a minimum of 8 options contracts and 800 CFDs to be traded per trade. This is not true.
There is no minimum number of options contracts for Trading Pursuits clients on the options. There is for other clients using the broker and that minimum number is 5 contracts.
So where does this comment from Matteo come from? In the average returns we report to clients, we do make some assumptions that try to be representative of the average client account. Clients’ actual returns will vary based on how they choose to trade, according to their own risk management decisions.
It is completely common and necessary to report average historical returns based on assumptions about what an average client is likely to do. In our assumptions we use 8 contracts as the basis. That’s because some clients have large sums to invest, and some don't, and we estimate 8 contracts represents a typical account.
Matteo also says that if you trade less than that the brokerage commissions eat up the returns.
As explained in the preview seminar, there are costs for brokerage. These costs were clearly listed, as $0.02 per share for the CFD, $0.05 per share for the options, LIBOR + 2.5% for the interest and 0.3% of the value of the shares for the guaranteed stop loss. There is a minimum of $15 per transaction on the share CFDs.
It’s true that because of the minimum $15 per transaction fee on the CFDs, it is more cost effective in terms of brokerage to do more than one options contract and 100 shares per trade. However, I don’t think most people would view a $15 fee as a major obstacle to their investing success.
2. The Volatility of the Market
Matteo says that a more realistic expectation of returns from this strategy would be about 5% per month, or 60% per annum. I agree with that, and I did state that the volatility levels we were seeing at the time were unlikely to continue.
I don’t have a crystal ball, and I don’t promise anything about the future. But I do show my clients what we are doing in the markets every month, and we put our money where our mouth is – every trade we report on has our own real money riding on it.
5% per month is close to the average we have achieved over the last 12 months. As for what the future holds, it could be better or worse. It’s hard to say because past returns are not indicative of future performance.
The market volatility changes throughout the year. I explained how during periods of higher volatility, the option premiums are greater, hence the returns are greater. We saw that recently in fact. With the increased volatility due to the Japanese disaster, the option premiums increased substantially. With the realisation that the Nuclear threat was no longer as great, the market volatility subsided, as did the option premiums.
What this means is that throughout the year as we write options, some months will provide greater returns than other months.
Also, as you learn how to write options, you will see that you can choose which strike price you write. Writing a higher strike price for covered calls will result in greater returns, at the expense of greater risk. In our Monthly Income Report, we show which trades that we ourselves are writing. We always take a very conservative approach, as we have more than 1,500 people reading that report every month.
You however, may choose to write a higher strike price if you are comfortable with the strategy and the risk. Everyone has a different risk/reward appetite. In the course, I teach how the strategy works, and how you can, based on your experience, choose to alter your risk/reward profile with the strategy.
In our reports, we do not tell our clients what to do. We tell them what we are doing. It is our job to explain to clients exactly how it all works, how they can choose their own risk/reward profile, and then show them exactly what we are doing.
3. The Cash Required to Trade
The stock prices on the CFDs we trade are not typically valued at over $100. The average stock price on trades we did for the 12 months from May 2010 to April 2011 was actually about $62. Sure some of them can be $100, or maybe even a bit more, but that is not typical. Many are less than the average of $62.
Matteo correctly calculates that with options at 100 shares per contract, 8 options contracts would mean buying 800 CFDs to cover the options. But as I mentioned before, it’s not necessary to trade 8 contracts – it’s possible just to trade 1 contract. Matteo then comments that at a 10% CFD margin requirement on shares, at $120 per share this would require a margin amount of $9,600. When in fact, the true average of $62 per share would require a margin amount of just $620 for one contract and 100 shares (and it is possible for our clients to trade just one contract). For greater numbers of contracts, the average of $62 per share would require $3,100 in margin for 5 contracts and $6,200 for 10 contracts.
Then Matteo gets on to the point about diversification. If trading one contract per trade, the average $62 per share would allow diversification across 10 different trades for about $6,200 margin.
But, in reality, we don’t always trade 10 different positions. Our average each month is more like 5 or 6 different trades. So, only an average of between $3,100 to $3,720 in margin would be required to diversify across trades each month. Note that I speak in averages here – it will of course vary from month to month depending on the actual share prices and the number of different trades.
In my preview seminar, I did explain that it is important when starting out not to engage all of your capital on the trades. I stated that we suggest a maximum of 40% of total trading capital be engaged on the CFDs.
That’s just what we suggest as a maximum. Some people do more than that, some less, based on their own risk profiles. It’s not our job to make investment decisions for our clients – we just teach the strategy, explain the risks and potential rewards, and then the client, armed with that information, needs to make their own decisions. Our online report of all the trades we are doing can assist in making those decisions.
If an average month requires no more than $3,100 in margin, and that represents no more than 40% of the total account, the total account value would be $7,750. In the FAQs on our website we suggest that $10K to $20K would be needed to trade this strategy effectively. It could be done with less if the client chose not to trade every trade we report on. This would not necessarily affect returns, but it would mean slightly greater risk due to less diversification. I would say certainly an account of no less than $5K would be necessary… and if you don’t have that, and the course fee is a struggle, then you are probably not in a position to be investing this way. As Matteo states, it's designed to be a long term strategy – you learn it once, and as your savings and income grow, so could your account.
4. Guaranteed Stop losses
In the preview seminar, I explained how guaranteed stop losses come at a price (0.3% of the value of the shares). I ask the audience who would be prepared to give up some of their profit in order to have the guarantee of the stop loss. The audience usually unanimously agrees that they would. That's understandable, given they have just learned the strategy and that they want to protect their downside risk.
At the course I explain how once you understand the strategy in its entirety you may not feel the need to engage a guaranteed stop. At Trading Pursuits we only use guaranteed stops sometimes, but we do use them when we feel the downside risk level warrants it.
I also explained that the guaranteed stop is only better than a regular stop if the stock gaps over the stop loss. Considering that we use many different risk management techniques together in concert with each other, including diversification, money management, writing the options deep in the money, engaging only a portion of our capital, etc., then the cost of the guaranteed stop loss in the context of the actual risk can sometimes be an overkill.
When the market is more volatile, the returns are higher but the downside risk is also greater, and it makes more sense to use the guaranteed stop loss – partly because we can afford to as we receive more income, and partly because the markets are more volatile and the risks are greater.
5. Market Analyst
The Market Analyst software is not included in the cost of the course, that's true - it's an optional purchase. People may already have charting software and may not want or need the more advanced features of this software. Calculating trade profitability for this strategy is not complex and does not require specialised software. We now have a calculator in our report to help clients identify if the trade is worth entering at the time they are looking at it, so it is not necessary to buy Market Analyst in order to calculate the profit potential of a trade.
Regards,
Daniel