“How to Limit Risk and Leave Your Upside Open” – A review of Radio Active Trading’s “The Sketch”

By June 29, 2015Course Review

When I last left you, I just relinquished my email to the Radio Active Trading site for access to a copy of “The Sketch”. Kurt Frankenburg, the creator of Radio Active Trading, says this document will show us how to maximize our wins and limit losses early, provide clear examples and setups, and is unlike any other strategy.

That’s a lot to promise on, let’s see if Kurt delivers.

 

The Sketch at a Glance

When you get your copy of “The Sketch” you get nine pages of well organized, clearly presented information. This isn’t a fly by night product just thrown together and sold for the price of an email.

As I continue to just flip through the pages, I’m a little concerned with the dated examples. Every example within “The Sketch” is from 2008, prior to the big crash, though still in a downward trending market. Math isn’t my best subject, but that’s seven years ago. It would be nice to see updated trades from within the last year.

Even though the examples are a little dated, the data and stocks used are real. Each of the examples is completely laid out. You get to see at what prices Kurt is buying stock, the associated options to set up his married put positions and the total risk in the position.

Overall, I’d say the first impression is good, but looks alone won’t make us money!

 

The Sketch in Detail

“The Sketch” outlines utilizing a married put to limit your risk and leave the upside of your position open. For those needing a quick refresher, a married put is a put bought at the same time a stock position is opened to protect against the drop in price of the stock.

My exposure to married puts prior to reading “The Sketch” focused on buying the protective put out of the money (OTM). Kurt turns this around by suggesting buying the put in the money (ITM) to reduce the amount at risk.

At first this sounds a little counterintuitive. How does buying a more expensive, ITM put actually lower your risk? Let’s take a look at a totally made up example.

 

June 17, 2015 (all numbers purely fictional to provide an example)

Buy 100 shares of XYZ (an infamous stock)           $40.00

Buy to open Jan 16 $43 put option                           $5.50

Total investment                                                          $45.50

Level at which investment is insured                       $43.00

Total amount at risk                                                   $2.50 or 5.4% of the total investment

Our risk with this trade just went from $4,000 with solely owning the stock, to $250 with the married put. How would this change if we bought an OTM put?

June 17, 2015 (all numbers purely fictional to provide an example)

Buy 100 shares of XYZ (an infamous stock)           $40.00

Buy to open Jan 16 $38 put option                           $2.00

Total investment                                                           $42.00

Level at which investment is insured                       $38.00

Total amount at risk                                                     $4.00 or 10.5% of the total investment

Our risk just doubled even though we have less invested in the trade. Why? The combination of paying less for less insurance actually hurts us in this case. Huh, interesting.

So, we’ve clearly outlined paying for ITM insurance can actually decrease your risk involved with a trade. Kurt actually uses real stock and options pricing information to drive the point home, which is much better than my fake data here.

Where do you go from here though? We’ve defined our limited risk with this trade, but how do we dig ourselves out of the hole?

Enter Kurt’s 11 Income Methods.

These income methods are meant to reduce, and eventually eliminate, the risk in a position. Once all the risk is eliminated, Kurt brands the position as “bulletproof”.

What are the 11 Income Methods? Well, Kurt is kind enough to give away the most obvious…the covered call.

When you add a covered call to this position you create a collar, or a stock position with a protective put and a covered call.

The credit gained with the sale of the covered call reduces the risk associated with your position. Let’s see how this works out with my example.

June 17, 2015 (all numbers purely fictional to provide an example)

Buy 100 shares of XYZ (an infamous stock)           $40.00

Buy to open Jan 16 $43 put option                           $5.50

Total investment                                                          $45.50

Level at which investment is insured                       $43.00

Amount at Risk                                                             $2.50 or 5.4% of the total investment

Sell to open July $44 covered call                             $1.25

Total amount at risk                                                     $1.25 or 2.7% of the total investment

Selling one call and a second if the first expires would completely negate your risk on the position. If you were assigned on the covered call, it wouldn’t really be an issue. You’d sell the stock for $44 and gain the $1.25 for the sale of the covered call. This would net you $45.25.

I know you’re thinking, “that’s less than the total investment by $.25”…but you haven’t sold the put back yet. Yes, the put would be worth less, but because it’s far out in time it wouldn’t decline in value as quickly.

In our example we might be able to sell the put back for $4.00. If this was the case we’d exit the position with $49.25. This is $3.75, or 8.2%, in profit based on the total investment of $45.50. Not too bad.

 

Parting Thoughts

I don’t think “The Sketch” is anything groundbreaking. What I do think is it is another way to approach risk management that I have yet to come across anywhere else, and risk management should be at the top of every trader’s list.

What I’m intrigued by is the other 10 Income Methods. I can envision a couple of ideas on how to pair other options trading concepts with the married put position…but 10 other ones? My imagination doesn’t quite stretch that far.

I think “The Sketch” was worth the sacrifice of my email. Even if it was just to gain a new perspective on managing risk.

Could I move out right now and execute this concept with the information provided? I think so. There are no details on the execution of buying the call. Details such as how far out to sell and at what strike would need to be answered, but I could work that out with some paper trading.

All-in-all I’d suggest you get a copy of “The Sketch”. The best part is you don’t have to go beyond this post to do so.

Kurt graciously surrenders permission to copy and use “The Sketch” in its entirety provided it’s unchanged. You can find access to a copy below!

Click here to download your copy of “The Sketch”

This will give you a chance to pour over Kurt’s real trade examples using real numbers vice my examples above. Spoiler alert, the numbers work out just as well!

Stay tuned for my review of “The Blueprint”, Kurt’s flagship product which covers all 11 Income Methods and setting up your married put position.

Happy Trading!

Patrick

Join the discussion 3 Comments

  • WH says:

    “Selling two of these calls would completely negate your risk on the position.”

    Um, no. The second call written is “naked,” and, therefore, adds unlimited risk to the position.

    If the underlying goes to 80, you will get assigned on both calls. But you can only cover half of
    the assignment with your initial 100 shares. You would then have to purchase another 100 shares
    at $80 and deliver them for $44 strike on the 2nd call written. That scenario puts your position
    in a very deep hole.

    • Patrick says:

      WH, I see the confusion. I’ll go back and edit the text. The intent was the first covered call would expire and you’d sell a second against the same 100 shares.

      Thanks for catching my mistake and I’ll get it fixed!

      Patrick