Environmental Hedging: Get Naked or Stay Covered?

Kia Ora Tackle!

Last week we were part 2 of 3 of the South Island power saga. This week is the final chapter of New Zealand and also my mother and grandmother’s last week in the country. We, obviously, had an incredible time out there and was very glad they got to see it. If any one is curious as to where in New Zealand the montage was taken it would be the Fjordlands National Park, right at the most southernly tip of the South Island. I’d say it is one of the hiking meccas of the world, typically boasted as such by German Alpinists — which evidently have cornered the “trek rating” market. The most beautiful trek, however, according to zee Germans, is one in Peru, the Cordella Blanca trek near Huarez. I’ve taken that trek myself and I would say the Milford trek is better, but what would I know.

Anyways here is a little video of this region, all taken from the comfort of a plane and a boat rather than a smelly pair of hiking boots. I have done portions of the trek myself earlier in my life but my 84yr old grandmother would not have been able to stomach such an endeavor. I’m glad she was able to see it in another light.

In other news, the market seems to be doing as described last blog’s fireside chat. You know, double bottom then northernly jump… But then again I am always open to a breakdown and frankly wouldn’t mind a Bear Market right now. I’ve been waiting for a few years on it and overtly prepared for one…more so than the continuation of a Bull Market. That and I think it could be a healthy occurrence.

That being said, I am sticking to my guns insofar I suspect trade negotiations are going to cool down and this modest correction probably will end sooner than later. However, if the wrong kind of news is submitted in the wrong ways; that or the White House throws another temper tantrum, it could spark a total breakdown. Remember folks, the majority of algos are technically based, and we are in a very delicate position, technically. Remember? From last weeks blog; that testicular fortitude stage of a W formation? Will it hold? Will it breakdown? That whole bit…

Anyways, per common sense, we will have to see what happens. Although I am a slippery Gypsy I cannot, however, predict the future. I can only prepare myself for all potential outcomes and play my cards accordingly. So, as mentioned, I am in the “duck and cover” position and will very soon be uncovering my positions (some of which I did already on Monday) and will be gearing up to potentially “buy the dip” and make some money to the upside.

I will be giving the market some time to flutter about, but as we have seen in the past, the fluttering stage can be very quick and before you know it, were back at resistance again. I will, however, be very mindful of a potential breakdown, thus I will be laddering into Naked Puts, bit by bit until solid direction is set. But before I even commence that process, I have to ladder out of my covered and collar positions first and foremost.

For me, this is a common occurrence in trading. And will be the subject of this weeks blog and I merely want to explore this concept in the world of trading. If inquiring minds want to know, in life, the closest I will ever come to being “naked” in public typically happens on a particular beach in Puerto Rico, wherein neon pink banana hammocks and boat drinks are an annual tradition. Beyond that, I am a model citizen. Just ask Matt, Tim, and Beau Moody about that one.

The point of our teaching moment this week is to explain how to move from a “covered position” (neutral to Bearish) into what I call a “naked position” (neutral to Bullish position) in one’s portfolio. First and foremost, I do this in two separate accounts: One, (which is a non margin LLC account) is where I do Covered Calls and Covered Calls alone. The second account is a Individual Margin Account (with Tier 3 trading authority or above). Which is where I do Naked Puts, Strangles, and Credit Spreads in.

That being said, the rate of return in the “naked” account in much higher than my “covered” account and is where I make the majority of my short-term profits. It is where the Personal Gold System is enacted as well as the first half of Environmental Hedging…But it is not the account where I hold the majority of my money, mind you. The naked put account only comprises 25% of my total investable monies whereas the covered call account and my IRA comprise the other 75%. And further, having these two accounts are important for what I am about to teach you:

Right, lets get on with this. At the moment the market is, obviously, having a modest correction. Which means I am covered at the moment…further meaning all my share positions in my covered account have calls sold against them. There might even be a collar trade or two in there (see Covered Call / Collar Trade videos in the Video Vault). However, my naked account is all but empty beyond a small hedge on SPY, nothing more, nothing less. But like we saw on Monday the 26th there was a nice northernly move in the market. For me this an indicator to start legging in Naked Puts and shedding my Covers. However, I will not completely remove my Covered Calls:

For example, lets say I have 800 shares of XYZ stock and have -8 call options sold against the said position. Well, Monday I would have bought back 4 call options, thus leaving the remaining 4 to run in case it continues downwards. I call this speedo phase of a directional transition in my account…and like a barbed wire fence, it protects the property but does not obstruct the view. But what I also do in this phase I will go to my Margin account and sell -4 put options on the same XYZ stock, thus transitioning premium from one account to another and shifting my beta weight and or delta, bit by bit from bearish or neutral back to bullish…

Typically in these situations a day or two into the bounce the market usually drops again and will retest the support it first bounced off of, which is why we may still may want to have a bit of a cover remaining on XYZ — of which I will gladly take profit on and thus leave my position uncovered. I anticipate this taking place on Wed or Thurs…(otherwise, I will close out my calls and take a lesser amount of profit, or, if I am in the position to do so, I’ll let those calls expire worthless).

Next, I wait for the market to continue upwards wherein, upon proper confirmation, I may add another -4 naked puts to the equation on precisely the same stock or ETF, but do so in the other account, my Margin account. Now, I will not do this to every single position in my portfolio. However 80% of them this method works quite well on. Thus there is a bit of a give and take, a subjective decision-making process to consider. For example, in times of market fear, I am less willing to have any gold or silver positions covered and more willing to issue Naked Puts on them. Although precious metals are primarily inverse to that of the USD, they do, more often than not, benefit from fear in the market. Thus when the fear gauge is on the rise, I am more willing and quick to go bullish on these two positions than I am, let’s say, a microchip processing company like AMD.

And lastly, all of this takes place at the bottom of the second bottom of a W formation. And there is a short window of time to do this as well, its rapid moment of opportunity, that moment of silence between the click and the bang of a rifle. But if you’re there for it and able to pull the trigger, it’s not a bad way to double up on profits and lessen directional reliance in your portfolio. All in all, you’re basically making a glorified strangle in your portfolio and the only trick is pulling off the correct legs at the correct times. And since this is the case, always practice it first folks.

Worst Case Scenario: The market breaks down and after you have already gone bullish. In that case, just strangle your naked puts and reverse the process back to your covered call account. Remember, you have 30 days for things to reverse back to bullish and a lot can happen in that time frame.. so keep it calm, keep it cool. And as I mentioned in last week’s blog, if you are new to trading, sometimes these moments are best left untouched for the novice. What I have just explained works for traders that understand dynamic hedging and are very good at Covered Calls, Naked Puts, and Strangles.

Next week in Environmental Hedging we are bringing Franco Coria back on board for a little fireside chat on his progress in Environmental Hedging. Franco is getting very good at trading this system in a live environment and is beginning to compound. I am sensing his first fruit and vegetable garden is in the mix. Let’s see what he has for us next week.


Bob Shannon.

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