Option Investor
Educational Article

Above The Fray

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By David Popper

Two years ago in January, I bought 200 shares of YHOO and witnessed the stock rocket 100+ points in one day. I was absolutely dumbfounded. All in all, that was a $26,000 day for me. I floated home believing that I was a genius. Lets see, $26,000 a day times 20 trading days in a month, at this rate I'll retire in 6 months. I told my wife about the conquest and she promptly asked if I had sold to lock in the profit. I said no we did not sell because an analyst gave YHOO an upgrade to strong buy and set a price target at $800. (At this time, I did not recognize the concepts of extreme conditions). Well, YHOO began to show signs of weakness the next day, and within two weeks it had plummeted to $130 from a high of $440. Thankfully, I sold in the low $300's, but I gave back a substantial amount of the profit. What a show, what excitement, and all for the price of $10,000. It was exciting, but not as exciting as a new car, or money in the bank, or 101 different things that could have been purchased. This episode provided me with an opportunity to pause and reflect about my real goals for my account. My real goal was to supercharge my retirement account, not buy a lottery ticket. I wanted steady returns and to be above the fray of everyday trading. I began to assess what I needed to retire and how I could achieve this goal.

What does it take to retire? Everybody has a number. One friend believes that he needs two million dollars to retire. Another feels that five million dollars is a necessity. What are these people really saying? They are saying that they want to have a passive income that is equivalent to a safe return on one, two or five million dollars. Current passbook or certificate of deposit rates are somewhere between 5 and 7 percent. Therefore, what my friends really want is anywhere from $100,000 to $350,000 "risk free" income each year. Unfortunately, these dreamers have absolutely no idea how they will accumulate this type of wealth, except winning the lottery. Most view active trading as too risky and are content with their index funds. So, I ask again, what does it take to retire? It does not take one to five million dollars.

Instead, it takes the ability to generate through investments, the same amount of income that one to five million dollars would generate. Active traders are practicing the very skills that can generate a comparable amount of income with far less capital. Even the most conservative trading strategies discussed in OIN could allow you to generate the synthetic equivalent of these millions on far less. For example, the conservative deep ITM calls and OTM puts section produced every Wednesday typically yield between 3% and 5% monthly. This is an uncompounded return of 36% to 60% a year. At a 36% return, you only need roughly 1/3 of your magic number to achieve the equivalent income. Where $1 mln may seem impossible to obtain, $300,000 seems far more possible, especially if you are accumulating capital through trading for years before you retire.

What is the point of this pontification? It is simply the idea that it may pay to take a portion of your capital and become skilled at an income generating strategy, even if you place the majority of your risk capital into more aggressive strategies. Obviously, practice now will help you learn the subtle refinements that are only learned through experience. I, for one, will be very interested in safety when I finally decide to live on my portfolio; therefore, I want to be already skilled in conservative strategies.

So what is your number? How do you plan to get there? Are the strategies that you are now employing allowing you to make steady progress to that magic number, or are your strategies merely giving you a thrill? I have dedicated a portion of my trading capital to learning the nuances of successfully writing covered calls. Nothing is risk free, therefore I want to learn every subtlety possible. For this portion of my portfolio, I will try to achieve 36% per year. The majority of my trading capital is spent trying to achieve that "magic number" by trading in more aggressive ways.

The point is that trading philosophies and strategies should be designed to fit within and support your larger goals. Trading is not an island unto itself. By understanding your larger goals, one can select market strategies which are appropriate in light of those goals and current market conditions. My larger goals keep me from developing a casino mentality and keep me focused on what really matters. I realize that I do not have to be overly aggressive to achieve my goals. I do not have to make millions. I can do just fine being a synthetic millionaire.

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