Get Naked By Taking The Clothes Off of Your Stock Before You Buy It.

Okay, you just sold the family SUV to put a stop to all that gas price gouging out there and purchased a cute little used hybrid for a net credit of 10 grand plus a $200 rebate. The teaser seminar you attended last week convinced you the stock market would make you a millionaire faster than the rule of 72 and eliminate your worries about diversity in world politics. So…Where should you begin?

Before you call your cousin’s broker, to buy stock in your favorite company, probably the one you work for or one whose name is prominently displayed on the lid of your laptop, take a breath and remember your objective is to make money not to please your ego.

Today that might sound impossible, but I would like to invite you to take a short walk with me to the other side for a view of my favorite investment paradigm.

What if I told you that you could sell the stock you want to own before buying it, without borrowing it to sell it short or spending any of your hard earned money on it. What if I also told you that it would be possible each and every month to net more than 10 times the dividend that attracted you to it to begin with; and build a little capital on the side as well.

The truth can sometimes seem stranger than fiction, but it’s still the truth. That is why this is an investment paradigm. It is knowledge that is hiding behind its own language. It’s no secret. It’s just that sometimes we don’t see what we are looking at. It involves selling an option contract that you do not own. It’s legal and it’s done every day. Follow along; I’ll explain the concept. What you do with it is up to you.

First, if you haven’t already, open and online brokerage account. Do a Google search for a good options site. You won’t want to deal with humans in your trading. They are expensive and they always seem to try to persuade you to do something other than what you know you should be doing. You can open the account for free and use their virtual trading to test the site features before you fund your account. Make sure you request and are granted at least a level 4 option trading status. (Uncovered trades on equities)

You will need to meet certain experience, net worth, and risk tolerance parameters on your application to absolve your broker in advance of any wrong doing. Something to do with compliance and SEC Regs.

For Experience and training: Re-read my blogs here at www.SelfInvestors.com or spend a few evenings perusing the free options classes out there like those hosted by the Options Industry Council. Either will be sufficient to qualify you for “extensive or advanced experience/training” in options. You have to put the time in. Go to:

http://www.888options.com/classes.

As for your Net worth: You have my permission to add in the value of your dog or cat to get your net worth up near the max.

Risk Tolerance: Make sure to check “Speculation.” Even though we will only be selling what we don’t own. Whenever you sell an Option contract, you incur an obligation until its expiration. (When you buy one you acquire a right.) Some people call it speculation. Some call it insurance. I call it insurance speculation.

With your account now open and if you have at least “$10,000 in marginable securities or cash” in it you can sell an “uncovered” or heaven forbid, what’s called a “naked” contract. If your balance is less, don’t worry, you can turn your naked trade into one with clothes by purchasing a lower priced contract expiring in the same month as the one you sold. For that, your cash reserve requirement is only the amount of the spread between the two strike prices, nominally $250 or $500 per pair of contracts. You are still selling the same contract but now you have to buy “insurance against its decrease in value. I think my Mortgage Banker has the same rule that allows me to sell my house to him without ever owning it.

In my example you incur the obligation to buy the stock you want to own, at the price you wanted to buy it for; but now under the terms of your contract, you only agree to buy it at that price if it is below the agreed and wanted price. Where you wanted to buy it anyway. If it is above your agreed and wanted price when your obligation expires, you pay nothing. But of course you still want the stock so, you simply keep what you sold it for and agree to sell it again. You will receive money and an obligation to buy it if asked to, which is what you want to do. Right?

Now you are simultaneously hoping to buy the stock to make money and not to buy the stock to make money. What do you want? To make money? Yes! It is available no matter which way you turn.

Oops! The stock you wanted to buy at that price just when down in value and darn…. the contract you sold was exercised. To fulfill your obligation, you must now buy the stock where you wanted to buy it in the first place. Darn!

Now you own the stock you wanted to own, at the price you wanted to pay. You rationalize the 10% gain you received on it over the past 3 weeks (annualized 120%+) as helping you buy it at a discount. Because the value has slipped a little you are not quite so sure you want to own the stock after all. You can’t make any cash money until you sell the stock anyway so you decide to try to sell it for more than you had to pay for it. You can legally sell someone the right to buy it from you at a price higher than it is now by selling the obligation to sell it to them, if they ask for it, for say, another 10% of its value.

Owning the stock, gives you the right to sell a call on it. You enter into a contract with someone to sell them your stock for a little more than you paid knowing your offer will expire automatically in 3 weeks if they don’t exercise their option to buy it. The price of the stock stays about the same neither going up or down. Your obligation to sell expires and you once again have to rationalize the 11% gain (annualized 125%) as possibly putting you into a higher tax bracket.

Because the stock is not gaining in value you are becoming less and less interested in owning it. So you arrange with someone else to buy it at the same price the last fellow did a month ago. Cha – Ching! You collect another 9% (119% annualized). This month your stock does move up a little and you are asked to sell it for a little more than you paid. Up a buck for a measly 2.5% gain. (only 30% annualized 😉

Now you are back to cash and up 10 + 11 + 2.5 =23.5% in 90 days or 94% annualized. Your stock seems to be headed up now so you reconsider and are entertaining buying some again. But, why not just sell it again before you buy it. Isn’t the whole idea to make money?

Cheers, 2dimes  Barry Brush

2DIME’S INVESTOR NOTES By: Barry Brush

April fool’s? With massive withdrawals and disintermediation* facing us to pay upcoming tax bills on April 15^th, one would be ill advised to buy into this market. That is unless you are selling short. I’ve been standing on my head all week trying to make sense out of what’s up with this market. I found the answer while doing a handstand at my computer and typing with my toes. While looking under my desk, I was able to confirm that we are in a down trending market and as Alice would say, up is down.

What will the Government do with all those tax receipts anyway? Grind them up and re-issue them in Junk Auction-Rate Securities with dividends that are tax credits? Hmmm? No earnings – no taxes – no tax credits – no buyers for Junk Auction-Rate Securities or SIV’s – no earnings? – Hmmmm?

Don’t forget to file your tax return this year so you can get your rebate. Don’t make enough money to file? Hmmm? How much is $168 Billion? Hmmmm?

If you don’t want to shoulder the financial risk and burden of inactive capital while selling short, my advice is to discover PUTs… Buying a PUT on a stock you own is like buying insurance against a decrease in its value. Like Insurance, every month or so, the premium must be paid because the policy will expire if you don’t. Cool thing is that with a PUT you can, in effect, insure anyone’s stock, house or life without owning it or living it and be paid a benefit check if it declines in value or dies.

If you aren’t comfortable with PUTs, remember they are like calls with an opposite expectation of price movement. Look for a strike price with 6 – 8 weeks until expiration and a DELTA of .70 or more. Buy a lower delta strike for longer term options because the delta will increase over time as well. Don’t knock yourself out over implied or historical volatility, their relationship or option price charts showing risk and potential profit zones. All are nice to know; but I think it best to keep it simple. Just like a stock, option selection is all about price, volume, liquidity, momentum and the earnings potential of the company.

There is an optimal risk/reward point between one contract with a high delta and multiple contracts with a lower delta for the same amount of risk/$. Sometimes your ROI can actually increase if you spread the same dollars over more contracts. Just like a call, open interest should be no less than 100 contracts. Theoretical value should be approximately equal to the ask & preferably more. The Bid/Ask spread needs to be reasonably narrow (I’d say not more than a point or two) and ideally divisible by thirds. You want to be able to get in and out whenever.

As far as the current downtrend is concerned, take advantage of it. You don’t have to be wall flowers like the institutions are right now. Try to over come the paradigm of buy low sell high and waiting for a dividend; and acknowledge that traders can and do make money in any market. If you still aren’t sure about PUTs, check out the following ETFs: QID, DXD, SDS, the TWM or the DOG; you can even buy them outright like plain old atavistic shares of stock or you could place a couple of CALLs. J

Yesterday I paid $66.00 at Wal-Mart to fill up the 20 Gal. tank on the wife’s SUV. They even put a little corn syrup in the mix. Driving away from the pumps I noticed that there were no lines to buy more. It gave both me and the car bad vibes. The fill up was a 40% increase from this time last year. It’s the same increase as the price of corn and food over the same period. Hmmmm…? And I hear diesel fuel is going for more than a buck now. ($4.25/gal) Somehow, I don’t think the Trannies are going to let this Bear Market off the hook. (Jets, Trains, Trucks and Tractors all use diesel).

That being said, have you checked out the railroads lately. In my opinion, the value of a train ticket is underpriced and has some room to grow. Check out BNI and CSX. My son recently found that a round trip train ticket from Charleston, SC to Greensboro, NC was only $112 while the cost of gasoline alone to make the drive would run him $120 for the two tank fix his Beemer would need. Go figure. $8.00 is still a savings of 7% which is not a bad rate of return over a two day period. I hear it’s even safe to “text” on the train; and I think he can take his pocket knife with him for the ride.

All this, and the gremlins that keep blowing up pipelines and monasteries will make for an interesting school year; but, go ahead and start studying for the final exam. It’s probably multiple choice and every question will have more than one OPTION for the correct answer.

*Note: Disintermediation
The withdrawal of money from low yielding financial accounts, such as saving accounts, and the reinvestment into higher yielding securities such as Treasury bills. Banks, in an effort to keep the money, may pay depositors higher rates. In order to afford the higher rate, banks will then charge their borrowers higher interest rates. This can possibly lead to tight money and reduced economic activity.

Cheers, 2dimes ;-)     

P.S. Your comments are always welcome