The 2 Investing Tools That Led to a Perfect Track Record
July marked another perfect month for Income Trader’s Amber Hestla.
She closed two more winners in her Income Trader newsletter. The recent victories bring Amber’s perfect track record to 63 for 63. She’s yet to close an unprofitable trade since launching her premium service over 17 months ago. (You can view her first 52 winners here.)
Some of you are probably already familiar with Amber’s Income Trader service. If you’re not, the premise is simple: By selling put options on stocks she thinks are undervalued, Amber’s subscribers collect “Instant Income” checks that can range from $50 to $5,000. The value of the check depends on how many put option contracts the investor wants to sell.
These trades can yield some big annual returns, too. For example, Amber’s recommendations that expired in July paid an average annualized return of 57%.
The crazy thing about this story is that she’s done this in today’s calm, low-volatility environment. This is a big deal, because for options sellers like Amber, volatility is crucial.
One of the best ways to judge volatility in the market is the CBOE Volatility Index, or VIX, as it’s commonly referred to. This gauge is nicknamed the fear index because of its ability to judge market sentiment.
As you can see, the VIX is trading at historically low levels. As a result, option premiums have plummeted to some of their lowest values since 2007.
Yet despite today’s low-volatility environment, which has practically crippled most option traders, Amber is still easily finding option trades that are earning double-digit — sometimes even triple-digit — annualized returns.
The value of an option contract is contingent on many variables, two of the biggest being the option’s strike price and the length of time until expiration. Selling options that expire six months out with a more aggressive strike price, for example, will command higher premiums than selling an option that expires in one month with a more conservative strike price.
But while these two factors are important, when it comes to the value of an option, the biggest concern by far is volatility. That’s because the choppier the market, the better the chance an option has of getting exercised.
As result, when stocks are more volatile, options are more expensive. That’s good for option sellers like Amber, because the higher the premium, the more she and her readers earn in Instant Income. The opposite is also true — if volatility is low, option premiums are lower.
So how is she making double-digit returns if volatility is so low?
The answer is a unique, proprietary indicator that Amber developed called the Income Trader Volatility (ITV) Indicator.
Simply put, ITV is a lot like the VIX, except instead of looking at volatility for the entire market, ITV looks at the volatility for individual stocks.
Amber explains it best in her research report, “Unlocking the Income Trader Volatility (ITV) Indicator”:
[I] use ITV to find the best times for selling options. When volatility increases, options prices should also move up. This is a relationship defined in options pricing models. ITV provides a way to quantify when volatility is rising in an individual stock and provides a way to identify when volatility has stopped rising. That point in time, defined as the point where ITV falls below its 20-week moving average, should maximize the gains of an options seller.
Amber goes on to give an example of exactly what she looks for when screening against individual stocks:
ITV has been applied to Apple (NASDAQ: AAPL) in the chart below. There is also a 10-week moving average (MA) applied to the indicator. When volatility rises, ITV (gray line) crosses above the MA (red line), and that is a sell signal. Buys are given when ITV falls below the MA. Only one signal is highlighted in the chart.
By using ITV to time her trades, Amber has captured an average annualized return of 56% on her recommendations since first publishing Income Trader in February 2013. That’s impressive considering today’s low-volatility environment has driven option premiums to near-record lows.
Of course, just because a stock has a high ITV rating doesn’t mean it’s necessarily a good put selling candidate. After all, stocks with higher volatility can be riskier.
That’s why Amber always recommends investors only sell put options on stocks they wouldn’t mind owning. That way even if the option doesn’t expire worthless, you simply end up buying shares of a stock you probably would have bought anyway at a lower price than the market offered at the time.
For Amber, that means only selling put options on stocks that are undervalued. She will only sell a put on a stock if it potentially allows her to purchase shares at what she considers dirt-cheap prices.
But here’s the thing, just because a stock has a low price-to-earnings ratio doesn’t mean it’s undervalued. A lot of “cheap” stocks out there are cheap for a reason. That’s why Amber has a second tool she uses to identify stocks that are truly undervalued. Using this tool in combination with ITV is part of the reason why she’s been able to maintain a perfect track record for over 17 months now.
I’ll tell you more about Amber’s second tool in a follow-up article. In the meantime, if you want to check out the actual results of Amber’s perfect track record, including how she and her readers have pocketed annualized returns as high as 212%, go here.