I wanted to make a few comments today on the comparisons between different stock market strategies. First, let me say I am yet to come across a strategy that doesn't work, given the right circumstances. They can all make money, some just require more skill, more time, or more luck than others. Everyone has their preferences, and I thought we'd compare a couple today.



I'm constantly intrigued by people who decide on an investment strategy without the faintest idea of ‘why' they use that particular strategy, or without having a look at an alternative strategy, with other possible advantages, that achieves the same (or similar) thing.

Of course everyone invests to ‘make money'. The question of ‘why' goes to the specific intention of a particular strategy – “why do you use one form of investing over another?”

The only way to answer that question is to first ask yourself another – “What am I trying to achieve?”

Are you hoping to get the maximum benefit out of the movement in the share price – to get the most profit from a stock rising (or falling) quickly? Are you willing to try and capture these profits on the big winners, knowing that most of the time you may pick losers, but keeping your losses small and your winners big (hopefully)? If so, are you happy to continue trading when you know you may only get 30, 40 or (if you are one of the brilliant few) 50% correct?

Or, are you trying to make money ‘regardless' of the share price movement? Are you happy with steady and very high (if not spectacular) returns on a regular basis.

The question I will address in this article is simple: Would you prefer to be in a position where the share price MUST go up to make money, or would you prefer it if the share price doesn't need to go up (it can stay the same, or even go down a little), yet you still make 100% of your profits?

I'd like to take this opportunity to explain the ‘rationale' behind one particular investment strategy – the Credit Put Spread strategy (sometimes called “Selling Insurance”).

This article is an attempt to explain exactly WHY you may trade the Selling Insurance strategy, rather than any of the dozens (hundreds?) of other option strategies available.

This article does not attempt to explain the intricacies of any particular strategy, nor the various options available to the trader throughout the trade (rolling out/down, closing early etc), rather to explain in simple terms the ‘principles' behind why you may choose this particular strategy over a multitude of other strategies.

Please be aware I have either traded or investigated just about every strategy using options that I know of, and the Selling Insurance strategy certainly has its place in a diversified portfolio, with many advantages over other strategies. More importantly, it satisfies several criteria that we look for in our trading.

Let's look at why. As mentioned, we first need to understand the reasons why we would use a particular strategy, and determine what it is we are trying to achieve. Without that goal, finding the correct strategy for YOU is impossible.

When we first started out, we detailed 5 specific criteria that needed to be met with any investment strategy we use. All of these conditions had to be met, otherwise that type of investing was not appropriate for us.

Now, your criteria may be completely different to ours, and that's fine. Only YOU can choose what is right for you. You may have a completely different set of criteria, but the point is the same: Before choosing any investment strategy, make sure you lay out what you want, then choose the strategy that suits your criteria.

Here's the criteria we settled on, and how the Selling Insurance strategy fits the bill…

1) Trading doesn't take up too much TIME.

Any investment must NOT consume too much of our time. The entire purpose in making money is not for money itself, but to create a lifestyle. Therefore as little time as possible must be spent on any strategy.

The time it takes you to read this article will be greater than the time we have spent in the last 2 months implementing this strategy, and was still able to earn some considerable profit.

Most other type of trading, especially any form of ‘directional' trading, requires a considerably more active mindset, with positions being monitored consistently, stop-losses enforced etc. For the most part, they are not ‘set and forget' investments, and require considerably more time to apply, monitor and manage.

The Selling Insurance strategy enables us to live the lifestyle we want, without the need to be watching the market every second.

2) It must have a High Probability of Success.

There must be a high chance that our investment will return as expected, most of the time.

With the Stock Market, the way we view it is there are essentially 5 things that can happen in respect to the price of the stock…

1) The price can go up a lot

2) The price can go up a little

3) The price can stay the same

4) The price can go down a little

5) The price can go down a lot

With our Selling Insurance strategy, we format our investments so we make 100% of our expected profit if 1) to 4) above occur.

So that's an 80% chance of success - without applying any skill at all!

It is only if 5) occurs that we need to take any action, and we then have several choices to either retain our profits or slightly reduce them. We can only lose a maximum set amount if we choose to close our position entirely.

With most other types of trading, you are essentially making a ‘bet' as to which way the stock will go – commonly known as ‘directional trading'. Therefore, a profit is only realised when the share price goes up a lot if you are long (no 1), or down a lot (no 5) if you are short, giving a substantially less likelihood of a profit on any and every trade.

The flipside to this is that while there is much less chance of making a profit with directional trading, the profit achieved can be considerably higher if the price does go your way, as opposed to the Selling Insurance strategy where profits are capped.

That's fine with us – we're not trying to make millions with one trade – that is not our goal. We're trying to earn a steady, consistent and recurring income on a monthly basis.

This is a point I can't stress strongly enough, and is the reason for this entire strategy! We do NOT require the stock to move in a specific direction to make money. That means we make money more often than any other strategy I know of.

3) We are always PROTECTED on the downside.

With our Selling Insurance strategy, our losses are capped, and if a ‘worse case' scenario happens, I am not wiped out. We know exactly what our possible losses are BEFORE entering the trade, and these are managed to be minimised as much as possible.

With good money management this can be comfortably achieved with most strategies, so while I can't stress enough the importance of ‘loss prevention' and ‘risk management', because it can be achieved with most investment strategies it's not really a deciding factor on choosing one strategy over another.

4) We make a ‘regular' INCOME so we don't have to work.

We need to be able to live our lives the way we want - day in and day out. That means we need income. I've got bills to pay. I've got a wife with a penchant for Italian shoes. Hell, I've got a penchant for Italian shoes!.

The whole point of being wealthy is to live a certain lifestyle, and that lifestyle costs money. So we need an ‘income' to fund that lifestyle.

Investing just for ‘capital gains' or ‘long term growth' is all well and good, but in the meantime any investment strategy must supply enough income to live on, and live well!

The Selling Insurance strategy has only one goal – to provide income on a regular basis (generally monthly). That's it. It's important to understand this strategy is NOT for long term capital growth – although it can be achieved if you re-invest the profits - but was designed purely to replace income. Not too many other strategies can do that as effectively.

5) LOCATION is not important.

We need to be able to manage my investment from anywhere in the world.

Again, most strategies can be done with a laptop and an internet connection or a phone from anywhere in the world, but this point goes hand in hand with the ‘time' factor.

The Selling Insurance has the advantage of being less time consuming, therefore if I'm travelling the world or relaxing somewhere, I don't need to spend hours in front of my computer managing my trades. A few minutes a day is all I need, so this is a big advantage over most types of directional trading.

So, all in all, the main criteria that indicate a better investment strategy for us would be Selling Insurance over most other ‘active' types of investment is 1) Time, 2) Income and 3) Probability of Success and 4) the fact it can be done easily no matter where I am or what I'm doing.

What I consider to be the biggest advantage, and the most important reason I use this particular strategy, is the high probability of success. That's the clincher for me, and the deciding factor that means the Selling Insurance strategy is one strategy I put my money into time and time again.

In Part 2 of this article, we'll examine this part of it in more detail, and compare the results of different strategies to highlight why this point is so important. Understanding that may help to ensure you make money from the markets over the long term. Until then…