The Most Ridiculous Lie They Teach in Business School

The "efficient market" hypothesis is bunk...

 

This is the financial theory Professor Eugene Fama developed at the University of Chicago in the 1960s. Fama argued that no one can consistently beat the market because prices on traded assets already reflect all publicly available information. It soon became the conventional wisdom on markets...

 

The efficient-market hypothesis offers a kind of symmetry... a balance. The market knows all and accounts for everything. It is always in balance, at equilibrium.

 

It's comforting... but the real world doesn't work like that.

 

In finance, one symmetry we're taught is between risk and reward. This makes sense intuitively. And people want to believe it. It seems fair. If you want to succeed, surely you have to take big risks. But that's complete nonsense.

 

In our studies of highly capital-efficient businesses, for example, we've found that investors who simply reinvest their dividends can consistently earn returns of around 15% a year. That's simply investing in high-quality, low-risk, brand-name stocks, like Hershey, Heinz, and McDonald's...

 

And we've discovered another anomaly that gives almost any investor... at almost any time... on almost any stock he wants to own... the opportunity to invest with lower risk and earn profits that are far greater than what's possible by just owning the stock outright.

 

As we'll show you... you can take advantage of this anomaly to amplify the gains you make on stock investments... potentially big triple-digit gains on margin. And you can do that without taking on any more risk than you would by simply buying the common stock – less risk, in fact.

 

Before we get started... you should know something about Stansberry Alpha... the service dedicated to this new trading strategy.

 

To take advantage of the anomaly we're going to describe, you only need to learn a single, simple strategy. And that one technique (which we'll walk you through in a moment) is an options-trading strategy.

 

Many individual investors tune out immediately when they hear 'options.' "It's too risky," they say. "It's too complicated... It's not for me."

 

If you have that kind of reaction to the words "options trading," we urge you to set aside those concerns for a moment. The strategy we're using in Stansberry Alpha is simple and very safe... even safer than simply buying stocks outright.

 

I'll explain the details of how this strategy works in a moment... But for now, just remember, options are simply contracts that give the owner the right (but not the obligation) to buy or sell a stock at a predetermined price by a specific deadline.

 

That's it... Options that give the holder the right to buy a stock are called "calls" – as in, you "call away" someone else's shares. Options that grant the holder the right to sell a stock are called "puts" – as in, you are "putting" your shares to another investor.

 

A trader buys a call if he thinks a stock is headed higher, so he can buy shares at a lower-than-market price. He buys a put if he thinks a stock is headed down, so he can sell shares at a higher-than-market price. All else being equal, the price he pays is based on how much the market expects the stock to move in the future...

 

Here's where the "Alpha anomaly" comes into play... Since puts and calls based on the same underlying stock are subject to the same market moves, you would think they should be priced the same. That's what the conventional wisdom would tell you... But that's not the case. And our strategy takes advantage of this "anomaly" in prices.

 

Why does this anomaly exist? It's simple human nature...

 

Fundamentally, people are more scared of losing money than they are attracted to the promise of making lots of it. That's why they pay more for the protection of puts than the promise of calls. Their twin emotions of fear and greed are out of balance... They are asymmetrical.

 

That's the anomaly. And as simple as that sounds, it gives you a powerful way to reduce your risk... collect income from your trading... and set yourself up for outsized gains down the road.

 

Our Alpha trades are high-conviction investment ideas where we have a strong belief in the company's business and ongoing profitability.

 

But the way we structure Alpha trades can generate bigger returns than we could get by simply buying the stock... And this strategy is safer than just buying stocks outright. No other trading strategy offers a better combination of safety and potential upside...

 

We find stocks we love... that we'd want to own for the long term. Then we buy a call to capture the upside potential, AND we sell a put to reduce our risk.

 

Now, instead of describing our Alpha strategy in theory, I think it will be easier to show you how it works using an actual trade we recommended to subscribers...

 

In the April 23 issue of Stansberry Alpha... we recommended a trade based on the giant data-storage company, EMC Corp.

 

EMC is a great example of the types of companies we focus on in Alpha. It's a $55 billion giant in the "Big Data" space. As the transition to "the cloud" continues to grow, companies will need infrastructure and support to manage Big Data. This presents a massive opportunity for EMC.

 

To take advantage of the investment opportunity we saw in EMC, we recommended subscribers:

 

Buy, to open, the January 2015 EMC $25 call for about $2.15, and

 

Sell, to open, the January 2015 EMC $23 put for about $3.75.

 

The stock was trading around $22 at the time. (Please note: The options prices have moved, and we don't recommend anyone open the trade at current prices.) Here's how we described the trade in the issue:

 

This trade puts a net credit of $1.60 per share of cash in your account. Remember, option contracts control 100 shares. That means for every option pair you trade... you'll receive $160 in your account. That's an upfront cash payment equal to 35% of our margin requirement. (We'll explain "margin" in a moment... but it's essentially the money you tie up to open this position.)   If shares don't rise as we expect and we're required to buy shares... we'll buy the stock at a net entry price of $21.40 a share ($3.75 for the put minus $2.15 for the call). That's a fraction lower than where the shares trade today.   As always... selling the put means you accept the potential obligation to buy shares of EMC at $23 each, if they trade for less than that by January 15, 2015 (when the options expire). That's a $2,300 potential obligation. Buying the call gives you the right (but not the obligation) to buy shares at $25 until that same deadline.

Note the options name included the data "January 2015." That means the options expire on the third Friday of that month. Anyone holding these options must make his buy or sell decision by then...

 

Margin is another key concept to understand... Since selling the put means you're accepting a potential obligation to buy shares, your broker wants to ensure you're good for it... Margin is simply a kind of security deposit. The amount of margin that each broker requires can vary, but most will allow you to trade options with a 20% margin requirement.

10 Best Medical Stocks To Invest In Right Now

 

So to open this EMC position, subscribers would have been required to make a margin deposit equal to about 20% of the potential represented by the puts. In this case, that's a $2,300 potential obligation. So the margin requirement was $460 per option contract.

 

As we explained to readers, the trade could work out one of three ways by January 2015...

 

1. EMC trades for less than $23. In that case, our calls will expire worthless. The puts will be exercised, and we'll be required to buy EMC shares at $23 each. When you take into account the $1.60-a-share net credit, we will own the stock for a net cost of $21.40 a share. That is about 4% below EMC's current share price of a little more than $22. It's not a massive discount to today's prices. However, we think the stock already trades at a generous discount based on its earnings and free cash flows.   As the cloud-computing boom plays out, EMC's sales and earnings will continue to grow. And we believe that over the next year or two, the market will place a more realistic price tag on EMC's share price.   2. EMC trades between $23 and $25 per share. In that case, both options expire worthless. We would keep the $1.60 per share ($160 per contract sold). This would represent a 35% return on the margin requirement ($460). That's much better than buying the stock outright. Even if we hold on until January 2015, it's still a generous annualized return of 17.5%.   3. EMC trades for more than $25 per share. This is when the upside potential of our Alpha trade starts to kick in.   Let's say the shares return to their September price of $28... Our calls would be worth approximately $3. Added to our initial net credit of $1.60, that brings our total return to a $4.60 profit ($460 per contract) – in other words... 100% on margin – a double.   Of course, the higher shares rise, the better we do. In March 2012, shares traded briefly for as high as $30. That would get us a massive 143% return on margin.   This trade has exactly the same risk parameters as buying the stock at $21.40...   But of course, you can't get shares at that price right now. If you could and assuming the stock did go to $28, you would make roughly 30% in capital gains on your investment. That's great, but it's less than a third of the triple-digit gains we'd get for the same outcome with our Alpha trade. Plus, we're putting up much less capital.

On July 24 – three months after the recommendation – shares of EMC jumped nearly 6% to $26.75 after the company reported solid quarterly earnings. The price increase lowered our chances of being put the stock... And it gave us a huge, early return on our trade.

 

The strong move up in EMC's share price (and the passage of time) meant that the prices for both our options had also shifted... If we were to close the position early by buying back the put we sold and selling the call we hold... the resulting proceeds combined with our upfront net credit would equal a 71% gain on the margin deposit.

 

But we're not closing yet. As we outlined above, we think subscribers could double their money on margin by the time we close this trade.

 

And EMC isn't our only success story at Alpha...

 

At the end of June, we closed out four positions for huge profits and one loser. Our trade on natural-gas infrastructure firm Chicago Bridge and Iron clocked in a 232% gain in just seven months. We got a big, 119% gain in six months on casino operator MGM, another 102% in four months on software giant Microsoft, and a juicy 51% in four months on World Dominating chipmaker Intel. The only real blemish so far is our trade on power-generation firm Exelon, in which we booked a 37% loss. We closed our trade on mortgage REIT Hatteras Financial earlier for a small 5% profit.

 

We've closed six positions so far for an average gain of 79% with an average holding period of 4.67 months.

 

Our open portfolio's average gain of 35% is with a mere two-month average holding period.

 

If we closed the four open positions today and shut up shop... we'd lock an average portfolio gain of 61% over the 10 positions with an average holding period of 3.4 months.

 

Again, we wouldn't be able to make these incredible trades if the efficient-market hypothesis was true. So we encourage MBA professors to continue teaching this drivel. And we'll continue making huge, safe profits using our strategy. We'd encourage you to do the same...

 

I know most people are scared away by options... They immediately think trading options is too risky. I hope you see how these Alpha trades actually have less risk than simply buying the stock in question.

 

And if you want to learn more about these Alpha trades, Porter is hosting his first-ever live training webinar today. It's called "The Alpha Anomaly: How to Make Triple-Digit Gains With Less Risk Than Buying Stocks."

 

During this live presentation, Porter and his research team will explain, in detail, the Alpha anomaly and why his trading strategy works to deliver larger returns with less risk than simply buying a stock. He'll also show you real-world examples of his Alpha strategy at work. And at the end, he'll answer any questions listeners may have.

 

To reserve your spot for Porter's first-ever live training webinar, simply click here.

 

Regards,

 

Sean Goldsmith