Trading in A Retirement Account, Part 3
In Parts 1 and 2 of this series, we discussed why it’s important to actively participate in your retirement planning to encourage account growth, especially if you’re late in getting started. We also discussed the advantages of the various IRA types, how to select the best broker to hold your IRAs, and more. In Part 3 of this series, we’ll review some of the strategies that are available to IRA traders that can help grow your IRA accounts, along with the key trait require to make them work for you.
Though we are not Certified Financial Planners (CFP), we relay some of the things you may want to consider as you work toward a comfortable retirement. We suggest that you consult with a CFP in your plans, while at the same time take the opportunity to learn how to potentially and dramatically grow your own accounts to achieve your goals.
Making it Work
By now, you have a better idea of the “why” and the “what” behind retirement accounts (you did read parts 1 and 2 of this series, right?) If you haven’t read those first two parts yet, go ahead and do so now.
Ok, so now we can get to the “how”. We want to identify the kinds of trading we can do in our IRAs to get them to grow. Remember, our goal is to be able to retire comfortably, and perhaps even early, if we can get our accounts to the right level sooner than expected.
How do we get our accounts to grow sooner than expected? Of course, there’s no guarantee that you’ll be able to make it work, but with the right methodologies and diligence, many traders are retiring sooner than they thought once they learned a system that works.
Not only does the system have to work, but it also has to be a system that you can work with.
That means your retirement account must have sufficient funds for the selected strategies. It means that the account that holds your IRA doesn’t have restrictions that prevent the type of trading that’s needed. And it also means that whoever is trading the account knows how to work the system. This last requirement might be the most important part.
You see, many traders lack a key attribute to make a system work. Some traders can take a perfectly good approach and make it work poorly. It takes a specific, trainable trait to make systems work.
What is this key attribute? If you don’t already have it, you’re not going to like it. You won’t even like us talking about it.
Get the Belt!
No, this isn’t about Mom or Dad going to get the belt because you did something wrong. Though many of us may benefit from that kind of corporal incentive, its actually about internal discipline. It’s up to you, not someone else, to be the one to know when you’re acting out of line.
Discipline, when it comes to trading, means that you have a set of rules that you follow, and you do not deviate from those rules. While this sounds easy, what it means is that you have to first have rules to follow. Then you have to follow them.
You also have to know when not to trade, and be ok with not taking a trade. Being flat is actually ok when your rules don’t dictate entry. You do not have to always be in a trade.
Perhaps the biggest part of discipline is being ready when the trade setup occurs. That is, that you have freed-up funds in your account to take the trade when it comes along. Plus, you want to be technically, and emotionally ready to push the button to enter the trade.
For now, I will assume we don’t need to go out behind the toolshed. I will assume for the rest of this article, that you are going to be systematic in your trading, and take a working system and execute it per its rules so you can achieve the desired results – the results the system is capable of. I will also assume that you will prove to yourself that you can do it before you ever use real money. More on that later.
Strategize Your Success with Strategies
Now that you’re committed to being disciplined, it’s critical to make sure you’re using a system that works. I’ve mentioned in earlier parts of this series that having a mentor with proven strategies is important. You can follow the wrong strategies and still be disciplined, and we want to stay away from that sinkhole. We want proven, tested strategies that we align ourselves with to execute, with discipline.
Since we’re trading in an IRA, we have limitations that prevent us from taking certain types of trades. Namely, anything that results in undefined risk. In part 2 of this series, we discussed examples of what “undefined risk” is. We demonstrated this via an example showing the risks associated with shorting a pharma stock just prior to the company making a breakthrough.
What if our strategy has undefined risk? Are we prohibited from using it? Perhaps, but maybe we can exchange the undefined risk to a manageable one. We need to find a way to make our IRA strategies have defined risk.
For example, in that short trade on the pharma stock, how could we define the risk and still take the trade?
Let’s say that we’re very bearish a pharma stock, and we’re confident it’s going to drop. Instead of shorting the stock, we could buy a put option. A put increases in value as a market drops. So as the pharma company stock drops in value, the put we purchased rises in value.
For many new traders, the concept of a put sounds strange to them. There’s some new jargon when working with options like a put. Unlike when buying stocks, puts even have expiration dates.
But what if you learned that you already know about puts? Many are surprised that they’ve been buying puts for years, without knowing it.
If you’re a homeowner or even a car owner, you’ve likely been buying a put every year. You’ve probably guessed what it is: It’s insurance. That’s right. When you buy a homeowner’s insurance policy, it has a price and an expiration date. If your house is currently worth $250,000, you may be able to buy an insurance policy for $1,000 per year. That contract you make with the insurance company promises to repair your house if it loses value due to a covered loss.
The insurance will pay you to put the house back in order should a loss occur. When a loss does occur, that contract that you created with the insurance company suddenly has a much greater value than the cost of the original policy, because it will make up the difference between the damaged home and what it’s insured for. That’s how you can think of a put. It’s basically an insurance policy. If the put’s underlying stock loses value, the put’s value increases, just like the insurance contract, to make up the difference.
Of course, there are a few more complexities that need to be understood, but it’s basically just that – an insurance policy. In fact, that’s why options were created in the first place, as they allow a very quick way to insure a stock from unexpected moves, especially when you don’t want to sell the underlying stock. The dollar amount exchanged for a put is even called a premium, just like insurance. We even buy or sell options in quantities of “contracts”. And as stated earlier, like homeowner’s insurance, a put has an expiration date.
How does this work? Here’s an example of how we could profit on a stock’s decline using a put. Let’s say the pharma company XYZ is likely to drop from its current $50 share price. You buy the $50 put for $5 per share, that expires 3 months from now. If within the next 3 months, XYZ falls by $5, your put will be worth at least what you paid for it. If it drops more than $5, then your put is worth more than you paid for it. The more XYZ drops, the more your put increases in value. If after 3 months XYZ is down to $35, a $15 drop, your put is likely worth 2 to 3 times what you originally paid for it.
And unlike when shorting a stock, buying a put puts you under no obligation to sell it back. If XYZ unexpectedly rises, your put becomes worthless at expiration, and your loss is capped to whatever you paid for the put. Again, it’s just like insuring your house, where your insurance policy expires worthless at the end of the contract if the house doesn’t have a loss.
And you’re not limited to trading in a negative direction with options. A call option is the opposite of a put. A call rises as the underlying stock price rises. If you believe that XYZ will rise from $50 within the next three months, a purchased 3-month call will rise in value along with the stock.
In this way, we can use calls as a substitute for buying stock, and puts as a substitute for shorting stocks.
Since we’re buying these, we’re under no obligation to sell them if they lose value. That’s what makes a put have defined risk vs. shorting the stock. And it’s a way you can trade to the downside in your IRA without shorting.
There’s a small chance that a call or put could get sold on you early, in which case you get your money earlier (remember, I said there were a few more complications to be aware of). That’s more likely to happen when it’s in your favor, and many traders welcome that when it happens, as they can now use that money to make another trade earlier than they expected.
Taking Advantage of Options
Some of you may be wondering why we’re spending so much time discussing options. It’s because these options give us more opportunities to trade, even if we have a smaller-sized account, and even if we’re trading within an IRA. While you can’t short in your IRA, you can buy a put to get a similar effect.
And there are even more great reasons to learn to trade options.
In the example above, you saw that we paid a fraction of the amount for an option compared to buying the stock. If you were going to buy AMZN outright, and it’s priced at $1600 per share, you’d need to allocate $160,000 in your account to trade 100 shares. Not only do many people have less than that in their account, even if you had that, you may not want to dedicate such a large amount to a single trade. Remember, if you tie up $160K, that’s money that can’t be used in other trades.
If you wanted to control the same 100 shares using options, it requires significantly less money to trade it. For example, the option may only be $25 per share, and controlling 100 shares using options at that price would require just $2,500. In this example, you could control over 60 times the number of shares using options for what trading the actual stock would tie up.
Plus, the gains relative to price paid can be much more lucrative. Let’s look at an example of a $10 rise in the stock. If you owned 100 shares of AMZN at $160K, and it goes up by $10, then your gain would be $1000 ($10 x 100 shares). Not too bad of an increase, and at $1K/$160K, you would pocket a gain of 0.625%. Clearly, you’re outpacing most bank interest rates. But can you do better?
Let’s look at the option. The same number of shares controlled by an option requires $2500. If the stock price rises by $10, the option may rise that much as well. Without getting into more complexity about options right now, it’s possible that the rise equates to just $5 of an increase. Does that sound to you like a better gain than buying the stock outright?
Let’s see. At $5/share, we’d collect a $500 gain. Yes, that’s just half of what we’d have made by buying the stock. But let’s see what the relative gain is. $500/$2500 is a 20% gain on your original $2500 investment. What’s better, a 0.625% gain or a 20% gain? That means you make 32 times as much per dollar at risk with the option trade… even when we only took half of the profit in our example.
Let’s compare this a different way. If we invested the full $160K cash into AMZN options rather than in stock, a 20% gain would bring in a whopping $32,000 in gains, as compared to the $1,000 gained by buying the stock.
Perhaps your head is spinning a bit with all these numbers, and that’s ok. What’s important is that this example is enough to get your attention so it can motivate you. Hopefully it can motivate you to learn more about options, and how they can create explosive growth in your accounts.
Reducing the Risk
And options can generally have less risk. In our example, we made $5,000 in our options trade. If instead of buying enough options to control 100 shares, we buy enough to control 200 shares. That way, we make the same $1,000 amount that buying the stock itself made. This equalizes the gains in our example so we’re comparing apples to apples. By controlling 200 shares, we put $5,000 at risk to make the trade that brought in the same $1,000 gain that buying the stock had.
Now let’s compare the results. How much was at risk with the stock trade? The whole $160,000. While it’s unlikely that Amazon’s value will drop all the way to zero, remember that AMZN can be quite dynamic. In any given time, it could certainly lose a big chunk of that value, perhaps on a missed earnings report, or some other unexpected event. The amazing thing is that we were able to achieve the same gains that risking $160,000 made by only risking $5,000.
And while many retirement accounts lack the $160K, you may agree that most would have $5K.
When done properly, options have the ability to get greater gains, even on smaller accounts, without risking the huge amounts required to invest in pricey stocks.
Now this doesn’t mean that options are without risk. The key aspect the differentiates options from stocks is their expiration date. Purchasing AMZN has no expiration date. If it takes 5 years to go up, your purchase is still valid. Options, on the other hand, do have an expiration date. If your option expires before AMZN makes its move, then your option won’t be as valuable at the time of expiration.
What’s key though, is knowing that you can get significant account growth using options. Just make sure you understand them FULLY before using them.
And There Are Even More Amazing Things About Options
We’re just scratching the surface here with options. With a sound understanding of options, you have the ability to combine options together to control your risk even more. Remember that one of Warren Buffet’s most important rules is “don’t lose money.” Properly managed, options can be much less of a risk than buying underlying stocks. You just need to learn how.
One of those strategies is using credit spreads. Credit spreads use options in combination to be able to trade even high-priced stocks with defined risks. You can use credit spreads when you expect markets to rise, or to fall, and often, even if they don’t move at all. The beautiful thing about credit spreads is that you get your money up front, which can instantly reduce your overall risk, as well as returning some of your capital immediately so it can be used to make other trades.
And speaking of generating income, how would you like to know how to generate monthly cash into your account on the stocks you already own? You can sell monthly options each month and collect the premium, and as long as the stock you’re selling them against acts as anticipated, you get to keep the gains with no further action. Again, this lucrative strategy, similar to what Warren Buffett has used to generate income, can be learned and used in your IRAs, using defined risk within the account.
Directional option trades, Credit Spreads, Debit Spreads, Covered Calls, are just some of strategies that can be used to escalate even a smaller-sized retirement account. Imagine what they can do when they are applied to larger accounts, and when they start to take advantage of the compounding we discussed in earlier parts of this series!
As you’re beginning to see, there are lots of opportunities to grow your retirement account if you know how. You can get greater growth than “buy and hold” strategies, and certainly over bank account interest, if you can diligently apply these learned skills.
Where Can You Learn These Skills?
This is where we can help. If you’re intrigued with even a fraction of what we’ve discussed here, you’re going to be amazed when you learn about what our mentors are doing. Start learning now for just $7, by trying out our Premium membership for a month. If you’re not totally amazed by what you’re learning, you can end your premium membership. Otherwise you’ll be able to continue to learn for just $97 a month.
Remember, if you’re nearing retirement age and your retirement account isn’t ready to support you, it’s time to start now to get that account moving. Please do not do it on your own without the knowledge you need, as there are risks that an untrained trader may not understand. Get the proven systems and experience from our mentors so you can get control of your account and get it growing for you.
Getting It Right On Paper
We want to make sure that you’re ready, so always learn to trade in a “paper” account before trading with real money. A paper account lets you simulate trades so you can learn the systems and strategies without having real money at risk.
Once you’re profitable in your paper account, you can start off small to make sure you prove that you’re able to execute the trades properly. Like all worthwhile skills, experience is the best way to become consistently profitable. Take the first step now, and see what our mentors are doing Click Here to Start Your Test Drive Trial. The sooner you start, the sooner you can begin to make a difference in your retirement accounts. Join today!
Though we are not Certified Financial Planners (CFP), we’ve relayed some of the things you may want to consider as you work toward a comfortable retirement. We suggest that you consult with a CFP in your plans, while at the same time take the opportunity to learn how to potentially and dramatically grow your own accounts to achieve your goals.