Editor’s Foreword: One of the most unique aspects of Fry’s Pinnacle Portfolio is that Eric will recommend both stock trades and options trades. The trades will be tracked in two separate parts of the portfolio.
Eric’s stock recommendations will comprise the “Investor’s Portfolio,” and his options trades will comprise the “Speculator’s Portfolio.”
The service was designed this way for maximum flexibility. As a subscriber, you have the ability to follow both parts of the portfolio or mix and match as you see fit.
For example, some investors may wish to follow the stock recommendations with little to no allocation to options. Others may wish to allocate more heavily to options.
By operating these sections in tandem, you’ll be able to tailor Eric’s Pinnacle System to your personal risk tolerance and capital availability. In other words, you can “season to taste.”
Eric believes options play an extremely valuable role in boosting investment returns while also reducing risks. In this special report, he outlines exactly how that works.
He also shares the specific types of options trades he’ll recommend in Fry’s Pinnacle Portfolio and explains how these trades will deliver a big boost to your investment returns.
Here’s Eric with an explanation of his investment approach…
Part 1: “Season” Your Portfolio Judiciously
Investment success is not only about what you buy… It’s also about how you buy it.
That’s why options play such a valuable role in my investment approach.
Used selectively and strategically, options can provide a tremendous boost to a portfolio’s overall returns while also lowering overall risk.
That’s right: Options can reduce your risk.
But many people are afraid of options either because they’ve heard options are “risky”… or because they don’t understand how to effectively use options.
This anxiety about options is completely understandable… and somewhat justified.
Options certainly can be risky… and option-based strategies can be complex and confusing. But that’s not how it has to be.
In fact, I like to think of options as the “table salt” of the investment world…
Just as salt enhances the flavor of the foods we eat, options greatly enhance the potency of a portfolio.
You wouldn’t want to sit down to a plate of overly salty food though. It’s not appetizing. And in the same vein, you wouldn’t want a portfolio of nothing but options.
When used properly, options can provide very unique and helpful benefits. I’ll explain below exactly how my Pinnacle System utilizes options to outperform the market.
Part 2: Gain an Edge Three Ways
Before you begin using options to amplify your returns, it’s imperative that you understand the risks.
Their primary risk lies in their limited time value.
They are like burning matches: They will all extinguish eventually.
Traders call this “time decay.” Options lose value over time, and the rate at which they lose value accelerates as an option approaches expiration.
You’ll never have to worry about analyzing time decay though. I’ll take care of this for us in Fry’s Pinnacle Portfolio. But here’s the part you need to understand…
Because options expire, they’re very different than owning the shares of a company outright.
If you own shares of a company outright, your time frame of ownership can be indefinite. That’s not the case with options.
With options, not only do you have to be correct about the direction of the underlying stock, but the movement you foresee also has to take place within a specified time frame.
Inevitably, some subscribers may ask, “Why bother with these things?”
The answer is that options are a powerful tool. They can do things a stock simply cannot do.
And because of their unique attributes, options can boost a portfolio’s returns while reducing risk. This why my service includes options recommendations in addition to stock recommendations.
To be clear, you can follow my stock recommendations only and still do very well with this service. But if you’re looking to take your trades to the next level, you’ll want to consider acting on my options recommendations as well.
With my Pinnacle System, the options trades I recommend offer three big advantages, compared with stock trades…
- The “price of admission” to a particular trade is lower. For example, buying call options on 1,000 shares of a stock costs much less than buying 1,000 shares of that same stock outright.
- The second advantage of options is leverage. Leverage is crudely defined as “using a little money to make a lot.” But we’ll use a more conventional definition: “Putting down a small investment to control a large amount of stock.”Because options buying requires less upfront capital than purchasing the stock, a winning trade will typically deliver a much larger return on capital than you’d earn from buying the stock.
- The last advantage of our options trades is a much smaller downside risk, compared with buying stocks. No matter how far the stock might fall, we cannot lose more than the cost of our call option.
Now, let’s dissect one historical option trade to illustrate each of the three advantages outlined above.
Part 3: A Real-Life Example
The Trade:
On December 23, 2016, the iShares MSCI Emerging Markets ETF (NYSE: EEM) closed at $34.28. The ETF’s June 2017 call option, with a strike price of $33, closed at $2.78.
Let’s imagine one investor purchased 1,000 shares of this ETF at its closing price of $34.28.
A second investor purchased 10 of the June $33 call options instead. (Remember, 10 call option contracts represent 1,000 shares).
The Obligation:
The stock investor would have had to plunk down $34,280 for his purchase.
The options investor would have had to commit only $2,780 to her purchase.
Options Advantage #1:
Obviously, $2,780 is a much smaller commitment than $34,280. And yet, both of these trades “controlled” 1,000 shares of the fund.
This is the first main advantage of options – a lower capital commitment than buying the stock would require.
Now, let’s see how the option trade would have delivered greater leverage than buying the stock.
Options Advantage #2:
On May 15, 2017, the ETF closed at $41.64, representing a handsome gain of 21.5% from the hypothetical purchase.
On that same day, the June $33 call option closed at $8.50, for a huge gain of 306%.
That’s what we call getting “more bang for your buck.”
In dollar terms, the stock buyer would have gained $7,260 on his investment, which is slightly more than the $5,720 the options investor would have gained on her investment.
But again, the cost to enter the stock trade was $34,280, while the cost to enter the option trade was just $2,780.
Options Advantage #3:
The third major advantage of options is that they limit your downside risk. Your maximum potential loss with an option is limited to the amount of your investment.
Because an option is a right to purchase or sell shares rather than an obligation, you’re never required to take action on an option you’ve purchased.
This feature of options is a particularly powerful advantage, yet it’s one that many investors overlook.
Using the above example, let’s say the stock fell after your investment instead of moving higher. Specifically, let’s say the stock fell to $20 by the time your option expired.
In this circ*mstance, the call option would expire worthless. The options buyer would have lost her entire $2,780 investment.
However, the stock buyer would be nursing a much more substantial loss… to the tune of $14,280 (purchase price of $34,280 minus the stock’s current value of $20,000). Ouch!
That’s quite a difference.
Part 4: The Pinnacle Approach to Options
Despite the many advantages of options, they are inherently speculative investments.
You’re essentially trying to profit by making an educated guess on the future direction of an index or company.
Most often, our well-informed trades will work out beautifully. But once in a while, they won’t. No one bats a thousand… including me.
It’s critical that you understand this. It’s the reason I’ll be offering options trades in addition to my safer stock recommendations. Please, trade options only if you’re comfortable with the “higher risk, higher reward” profile.
That said, Fry’s Pinnacle Portfolio will focus on options that behave a lot like stocks.
That’s because I will usually be recommending “in the money” LEAPS options. Let me explain what these instruments are…
“In the Money” Option: The strike price is below the current stock price.
LEAPS: Long-Term Equity Anticipation Security, or options with an expiration longer than one year.
These options have a life span of up to three years and can be an effective way for you to own underlying shares of stock for a much longer period than is offered with regular options.
Though you’re still risking money on a position that could expire worthless, you gain an important advantage – a longer time frame for the underlying shares to move in the direction you want.
In Fry’s Pinnacle Portfolio, we will approach options as a stock substitute.
In other words, you shouldn’t buy a particular option unless you would actually want to own the underlying stock. You shouldn’t buy a call option on Amazon, for example, unless you actually want to own Amazon.
Options are simply a different way to invest in a particular stock.
And as I have already explained here, using options to invest in a stock…
- Lowers the capital commitment
- Increases the leverage
- Reduces the downside risk.
Because of these powerful benefits, an allocation to specific options trades can help power your portfolio to market-beating gains.
Part 5: Determining Your Risk-Reward Threshold
In Fry’s Pinnacle Portfolio, the choice of whether to use options is 100% yours.
That’s why this service will feature a dual portfolio: one section for stock trades and one for options trades.
The “Investor’s Portfolio” will hold our stock positions, and options trades will reside in the “Speculator’s Portfolio.”
When I recommend a stock, I’ll also look closely at the available options. If a good opportunity exists (with adequate volume), I will recommend an option trade in addition to the stock.
Again, I might recommend buying a fund like the iShares MSCI Emerging Markets ETF. And if I see a good opportunity to speculate, I might also recommend buying a call option on the fund.
This dual recommendation gives you the opportunity to tailor the trade to your specific risk preferences and capital availability.
In some circ*mstances, you might prefer to buy a stock directly. In other cases, you might want to buy just the option. And at times, maybe both.
In each case, you’ll have the opportunity to “season to taste.”
Sometimes, I will recommend a stock without an accompanying option trade. Other times, I will recommend an option trade without an accompanying stock trade.
The risk-reward particulars of each investment will determine the exact recommendation I make.
Some subscribers might invest in only stock recommendations and turn a blind eye to the recommended options trades. Other investors might want to trade options only.
There is no right answer. Either approach is fine – it just depends on your risk tolerance and time horizon.
But as you’ve learned in this report, a tactical combination of options trades and stock trades will optimize your portfolio returns… and power it toward market-beating returns.
Appendix: A Primer on Options
An option is an investment that gives you the right (but not the obligation) to buy or sell a specific security at an agreed price within a set period of time.
Every option is identified with a specific stock – or in some cases, an entire index of stocks (you can buy options on the S&P 500, for instance).
So whenever you place an options trade, the movement of the underlying stock will affect the success or failure of your investment.
Options come in two standard varieties: calls and puts.
Options trade in lots of 100 shares. One “contract” = 100 shares.
One call option gives you the right (but not the obligation) to buy 100 shares of a particular underlying stock at a specific price (the exercise price or strike price) before a specified date in the future (the expiration date).
One put option conveys the right (but not the obligation) to sell 100 shares of a stock at the strike price by the time the put option expires.
All options have expiration dates. They could be a matter of weeks or months.
LEAPS are special long-dated options with expirations of up to three years.
If you don’t exercise your right within the given time, the option expires worthless.
You can view options prices yourself using a number of websites, including Yahoo Finance and BigCharts – and of course, your own brokerage account.
When you buy an option, it is as if someone is saying to you, “I will allow you to buy or sell 100 shares of this company’s stock, at a specified price per share, at any time between now and the expiration date.”
And it’s further understood that, “For that right, I expect you to pay me a fee.”
That fee is called a premium. The amount of premium will vary considerably depending on the exercise price and time until expiration, as well as the stock’s volatility.
Let’s get a little more granular on what affects the price of an option…
An option has two sources of value. The cost (or premium) of any given option is based on its “intrinsic value” and its “time value.”
Intrinsic value: The portion of the option premium that is “in the money.” Any additional value beyond that is considered time value.
For example, let’s say a call option has a premium of $3 per share and a strike price of $45.
At the time you buy the call, if the underlying stock’s market value is $46 per share, then we say the following about the option’s intrinsic value and time value…
- This option has one point of intrinsic value. In other words, the option’s strike price is $1 “in the money” – the strike price is $1 below the price of the stock.
- That leaves two points (the $3 premium minus the intrinsic value of $1) for the time value.
If the stock’s price stays the same (leaving the intrinsic value at $1), then as the stock approaches expiration, the option’s time value shrinks – decreasing the amount of the premium.
At expiration, the time value will equal zero, leaving the premium value equal to the intrinsic value ($1, in this case).
All options act the same when it comes to intrinsic value.
All options that are in the money (i.e., the strike price is less than the stock’s current price) will reflect that value.
If a call option is in the money by $5 (the option is at a $35 strike price, and the current price of the stock is $40), then the option premium will be at least five points.
If the option moves $10 into the money, the option premium will reflect at least 10 points of value.
Conversely, if the stock declines and the option moves out of the money – for example, if the strike price is at $35 and the stock falls to $34 – the intrinsic value goes to zero and the premium will reflect only time value.
Last, but not least, if there is anything you don’t understand about a specific trade I have recommended, feel free to call our dedicated team at (888)570-9830 or send us an email at mailbag@oxfordclub.com.
