Category Archives: Options

Options

REMEMBER YOUR NAKED OBJECTIVE IS TO MAKE MONEY

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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:

clip_image001http://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?

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Cheers, 2dimes  Barry Brush

Options

Put PUTs To Work As Insurance Against Disintermediation

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clip_image001 2DIME’S INVESTOR NOTES By: Barry Brush

April fool’s? With massive withdrawals and disintermediation* facing us to pay upcoming tax bills on April 15th, 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

Technorati Tags: options,puts,taxes
Inspiration, Options

Take the Fear Out Of Options With a Straddle

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2DIME’S INVESTOR NOTES
Monday, January 14th, 2008
 
 

A Simple Trade to Take the Fear Out Of Options

How many times have you selected a stock, evaluated it, chosen an option strategy and entered the trade only to have the stock move against you?
 
When I first started trading options, this seemed to happen to me all the time. It seemed easy to find great picks. I would buy call on a breakout and watch my investment soar often for a gain of 100% or more.
 
As my mood soared with the stock my emotions took over and I would start imagining all of the material treasures I would now be able to purchase. The impish voice of greed would begin talking to me and I would ride the play higher and higher to greater returns never taking any off or moving up my stops.
 
The next market cycle or price wave would kick in as more savvy traders took some profit off the table. My greed would tell me the play still had room to grow; but my fears began to overcome my hopes as the trade inevitably descended below a 100% rate of return. My fear would approach panic as my paper profit evaporated.
 
I would stay in the play until I was back to zero figuring that some how it would revisit 100%. I never sold until I was afraid I might loose everything I’d put at risk. This Battle inside my head between the emotions of Greed and Fear went on until I eventually paid for the luck I had had in my first six months of trading by bringing my account balance back to where it had started.
 
If any of this sounds familiar, you are on the right track. If you are there now, you have probably figured out that you should do something different. If you don’t know what it is that you aren’t doing, I suggest that you begin a trading journal. Who knows, perhaps the weather or what you had for breakfast may be adversely affecting you. More likely than not, it is only greed and fear at play.
 
If you are new to Options, Let me suggest a simple fool proof trade to get a grip on your financial future. The cool thing is that with this one, there is no room for greed or fear. All option traders should be able to make money if the underlying stock changes its price. The only constant is change and change is good. Up or down, it is good. We are going to expect and profit from change. We are not going to buy and hold anything. You can’t buy anything with paper profits, except maybe a failed mortgage company. BO! FA! FA! FA!
 
This trade is not about being right or wrong, it is about winning. You should be able to win with it 85% of the time, while minimizing your risk to about a 15% per trade. There are three steps to it.
 
First, find a stock that you think will move significantly in the next three weeks. You can find one based upon News, Rumor, Earnings or perhaps one of those scanners a lot of sites promote. It can be a good event or a bad event. It just has to be important enough to prompt a move in the stock.
 
Second, simultaneously buy a put and a call on either side of the at-the-money strike price. (Option strike price closest to the stock price)  Try to have your play in place three weeks prior to the upcoming event. Purchase options with approximately 3 months remaining until expiration. There, you’ve “straddled” a price point of an underlying stock. You now have the right but not the obligation to buy or sell 100 shares of your stock pick at the same price, the strike price.
 
Third, relax, don’t worry – make money. If your “event” causes the stock to move in advance of the event or at the event it doesn’t matter. Give it some time, perhaps as much as a week. If its good news and the stock goes up, your call will bring a profit WHEN YOU SELL IT. Or if its good news and the stock price falls because it wasn’t good enough, your put will make you smile WHEN YOU SELL IT. You can sell at a profit or put on a stop at a profitable level. That’s up to you. I personally like to sell. I’m a “now” kind of guy.
 
A normal expectancy would be for the profitable move to yield twice as much as the other side looses. Two to one odds are the norm. One quick note: After you capture your profit, you might hesitate before unloading the opposite option.(s) Often a fast moving stock will reconsider its direction and retrace a bit, giving you the opportunity to recapture some of the initial decline on the loosing side that occurred as the stock made its initial move.
 
A fourth step is a remote possibility if you have picked a mover; but I’ll cover it any way. If nothing happens, nada, no movement, zero; sell both sides and go shopping for another trade. You will most likely be able to limit your loss to around 15% of your initial investment. Say the “Straddle” cost you $100 for the Put and $150 for the Call your total investment would have been $250 and your total risk 15% or $37.50. I’m not a mathematician but you could probably loose on 7 out of 10 of these and still make money.
 
No Greed, No Fear, No Worry. I’d much rather win than be right or wrong. Wouldn’t you?

Cheers, 2Dimes / Barry Brush
To contact me send an email by using the Contact form (link above) and Tate will make sure I get it.  The best option is to submit your comment to the blog here )

Options

Barry on Trading Options: All About Delta

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Below, new SelfInvestors.com contributor Barry shares some more thoughts on trading options.  For more about Barry, please see his first introductory post.  Thank again Barry, another great post!

2DIME’S INVESTOR NOTES

Monday, October 29th, 2007 www.SelfInvestors.com

 

“DELTA is not an airline or a place in Louisiana”.
 
Another week is off to a good start. We finally had some rain here in North Carolina after too many days without a trace. With every drop that fell, I kept thinking about a better place for it and the California fires kept coming to mind. I reconciled that thought with another: that we should always be thankful for what we have and compassionate with those who don’t have as much.
 
Here at home, the week was one of adjusting the items in my trading cart. I normally ask the 30 to 40 equities in my cart to provide me with a weekly paycheck. I took some items out and put others in about 14 moves in all, two stock and 12 option trades.
 
I would never recommend a set way to trade. It’s really up to the individual to develop his or her own successful technique. My personal portfolio is about 25% equity and 75% option contracts at any given time. About one third of my option plays are for the current month the rest being at least three months out or LEAPS (Long-term Equity AnticiPation Securities) of six months or more.
 
My current month option trades come from a number of different sources. One is from Selfinvestors.com. Whenever a Breakout is reported by Tate Dwinnell, I read the email and check the stock to see if the stock is a likely candidate. These short term trades are valuable in that they are normally placed on issues with modest volatility and almost no time value factored into their price. The beauty of this is that when the underlying stock moves, the value of the option moves in lock step.
 
I am not going to go any deeper into option trading fundamentals at this time because the above probably sounds like Greek to you equity traders. A pun is intended because “Greeks” are important to understand when trading options. As a matter of fact, when ever I began explaining options, one of the first things I discuss is not what an option is or how it differs from a share of stock but rather the importance of “Delta.” And I don’t mean an airline or a place in Louisiana. DELTA takes you right to the heart of an options trade. So why not go there first.
 
Before placing an option trade I always make a physical note of the options symbol, theoretical value, open interest and DELTA. My technique is to jot down a short two or three line entry in my Day-Timer/Journal. I do this as a way to cross check myself to make sure I am sticking to my personal parameters. I don’t pay much attention to historical or implied volatility because my analysis of the underlying stock both fundamentally and technically tends nicely to that. In short, if I don’t really like the prospects for a near-term move in the stock, I don’t play the option. Sites like Selfinvestors.com make my life easy. If there is good volume pushing a breakout move and there is positive institutional interest in the stock, I’m in.
 
 
The Delta of an option is a key in determining the productivity of the trade. Delta is simply a ratio, or number, that tells you how many dollars an option will move for every dollar move in its’ underlying stock. Focusing on the desired Delta eliminates the concern over whether the option is “in-the-money” (Has equity value) Has equity value)or “out-of-the-money” (Has no equity value, i.e.; all fluff…Time value and implied volatility)
 
Options hatch from stocks. They are derivatives in that they derive their value from the stock they represent. An option contract gives you the option to buy (call) or sell (put) 100 shares of a stock at a locked in price (the strike price). Some people call it a “right” for a predetermined number of days to buy or sell 100 shares of a stock at a given price. Well, that’s exactly what it is…but, it’s only an option, it is a non-material thing. No votes for the board of directors, no growth diluting dividends and no pretty certificates of ownership to hang on your wall or ferret away in your safety deposit box. One cool thing though….. If the stock splits, so does the option.
 
Back to Delta. If a stock is selling for $48, and an option to buy 100 shares of that stock (called a CALL) is purchased for $8 and that CALL has a Delta equal to 1.0, if the stock moves $2 to $50, the CALL will move 1 to 1 with it and have a new value of $10. If the CALL has a Delta equal to .50, when the stock moves $2 to $50, the CALL will move $.50 for every $1 and have a new value of $9. It’s a percentage move of the stocks move.
 
Got it? If you take a serious look at the choice to buy $48 shares of stock vs. $8 options, it says a lot about the relative value of trading options vs. shares of stock. It reveals the increased “LEVERAGE “involved when using options. Understanding DELTA is also key to understanding the different nature of the risk in an options investment vs. that in an equal dollar investment in shares of stock. That’s a subject for a later date. If you are going to make a living trading, I think you have to understand both stocks and options.
 
Let me add that Delta works the same way with PUTs. When I first started trading options, the concept of a CALL came pretty easy. PUTs took a while. I don’t know why because they are a mirror image of a CALL that can be used to make or save money off of a downtrend. Don’t worry if you are in the same boat; because increased age, with its increased dyslexia seems to help.
 
That’s enough for now. Plenty of food for thought. Whenever I feel I am running low on trading ideas or know how, I pull out and read the following quote from one of my all time favorite books, “The Power of Your Subconscious Mind” by Joseph Murphy. A copy of this book has a permanent place in my blue room and is always within reach at critical moments in my life. I first read it about 15 years ago. I have recently dusted it off and am on my third re-read. Scary stuff!
 
“The True source of wealth
Your subconscious mind is never short of ideas. There are within it an infinite number of ideas ready to flow into your conscious mind and appear as cash in your pocket in countless ways. This process will continue to go on in your mind regardless of whether the stock market goes up or down, or whether the pound sterling or dollar drops in value. Your wealth is never truly dependent on bonds, stocks, or money in the bank; these are only symbols — necessary and useful, of course, but only symbols.
 
The point I want to emphasize is that if you convince your subconscious mind that wealth is yours and that it is always circulating in your life, you will always and inevitably have it, regardless of the form it takes.” Joseph Murphy
 
It’s what’s inside that counts.
Cheers, 2Dimes / Barry Brush (email me at support@selfinvestors.com I look forward to your comments.)
Options

Putting the Plural in SelfInvestors – Options Trading Lessons Begin

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It has long been my desire to bring to my readers another perspective on the market as well as insight into other tools and strategies.  When I first set out to build SelfInvestors.com over 4 years ago my first choice of domain name was SelfInvestor.com but that was taken so I was left with SelfInvestors.com.  As it turns out it was the far better choice.  I am but one Self Investor.  There are many Self Investors who are trading their own accounts and making a living, allowing them to work whenever and wherever they choose.  There are others who are funding their retirement or funding the education of their children.  Trading stocks for a living is in my opinion the best job in the world and I know that those who trade for a living feel as I do.  From here on out it is my goal to bring you perspectives of other successful Self Investors and I begin today (my fault for getting this posted so late) with Barry Brush (aka 2Dimes).  I’m very pleased to have him contributing and know you will be  too.

2Dimes Investor Notes

Good morning and TGIF!  It’s 7 a.m. EDT here in Charlotte, North Carolina.  My daughter is off to high school, the cat’s fed and the dogs are sleeping.  My wife will be back in a few moments from carpool to stir things up.  It’s the last day of the options trading cycle for October and I’m excited about today’s outcome.

This is my first post for SelfInvestors.com. Your friend, Tate Dwinnell, kindly opened his door and invited me to periodically share my insights on trading as I go about making a living in the market.  My name is Barry Brush, I’m an options trader. Call me “2Dimes.”

Before I go farther, I’d just like to say one thing about options: *Please read Characteristics and Risks of Standardized Options before investing in options. Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial Gains.

I think Tate has done an excellent job putting together and managing the SelfInvestors.com site for all of us.  It is a valuable asset for any trader’s toolbox.  It has a clear crisp user interface and is full of meat and potatoes.  The equities he tracks and analyzes are mainstream and pertinent in all respects.  A ‘10’ all the way.

A little about me personally: I’m a graduate of the Vietnam era USAF. After my stint in an O-2A, (a la “Bat-24”), I joined Merrill Lynch, Pierce, Fenner and Smith as an Account Executive. That was during 1974 and 1975 when the CBOE (Chicago Board of Options Exchange) had just opened.  I knew a little about options then; but my love for flying led me back to a 32 year career as a commercial airline pilot.

I was compelled to retire medically at the age of 57, a year after 9/11. It was a two time bankrupt and bought out airline that is still in business today with a whole new Board of Directors and covey of new shareholders.

At a motivational seminar one day, a guy got up and told me how easy it was to make money in the stock market following little red and green arrows.  I said “Wow! That looks easy!”, and I was in.

That was 4 years ago. Now after a lot of trial and error, study, emotion and commissions, I make my living Trading options. I don’t have a million dollars in my trading account but working up from 10 grand to about 400K over 3years has given me the confidence to feel that I may be doing something right. The major thrust of my blog will be to help others do the same.

So here’s a preview what you will have to look forward to from me. Over the next weeks and months, we will focus on how to be successful in Options Trading. I will shed some light on topics such as: Trading Strategies, Basic Options Education, Risk, Money and Emotional Management. I plan to compare different tools, charts, programs, ect. I’ll give you my thoughts on various brokerages, Market Gurus and useful literature. My intent will be to distill for you some of the often overwhelming and voluminous amount of information out there so you can simplify your job of trading successfully.

By now you have probably asked yourself what’s the “2dimes?” Well that’s just it. What is it? 2dimes is a pair of dimes, an anagram that should bring to mind: the word PARADIGM. It’s what you look at; but can not see. What you know but do not understand. That which you don’t know because you don’t know you don’t know it. Check out the guys on the logo again. Neither one of them can see what the other sees; but they both see something. One is profit, one is loss. Which do you want to see?

I have 3 daughters from age 34 to 14 and a 24 year old son. Given the nature of the wealth creation vehicle I have built, it is imperative that I teach one or all of them how to carry on when I return to flight. So, to keep it simple I’ll always try to explain things as if you were one of them.

Let’s start with one of my favorite topics. I call it “The First Law of The Market.” Stated simply, it follows that the only constant in the Market is CHANGE; and it is Price and Volume Action that rules that change.

You already know that you want to buy or sell in the direction of a trend. So, when do you start riding that horse? And when do you dismount? The Law of the Market tells you with out any fancy signals or processor frying algorithms. 2Dime’s First Law of the Market states: “Never Ever Buy or Sell until the Volume confirms your action.” Say it three times to yourself now and once before you go to bed. STLD provided a good example on Wednesday and Yesterday. (See Below)

 


That’s all for now, I’ll leave you with a thought for the day: “Knowledge hides behind its own language”.

Cheers, 2Dimes / Barry Brush (To contact me send an email. To support@selfinvestors.com and Tate will make sure I get it.)