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Options

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I’d like to cover down on some information that was sent in by one of RS1’s many caring members. It’s about rolling stocks that are optionable. Optionable; is that a word? I’ll only hit the most important pieces so this isn't too lengthy.

A solid safety net for trading rolling stocks is to buy less expensive stocks that are optionable. It’s part of regular price of any stock. You’re not buying options on the stock, you’re buying a stock that is optionable. To use the options buy your stocks in blocks of 100. The reason is you have to be able to sell your options against that in term of the contracts. One contract equal 100 shares. Here’s how it could work out; we, for example, decide to buy a 1,000 shares of ABC stock at $10.25 and sell it when it reaches $14. ABC hit $10.25 we manage to buy it at $10.5, we now own 1,000 shares. The next thing to do in this example is to place an order to sell the stock at $13.5 good ‘til canceled (GTC). We think it’ll go to $14., but we’ll sell at $13.5, slightly below the resistance mark of $14.

We’ve been watching ABC and know that it consistently bounces and we’ll profit if get hits $13.5 in the next 60 to 90 days. We see the stock hit $11. the next day can see that things are going our way. Happiness, happiness, joy, joy, joy! However, then one of the stocks in its sector hits the news with a bad/poor earnings report. Safety nets have to be beneath each trade. Our stock isn’t a lone tree, the other trees in the forest (sector) are effected accordingly, it’s like a fire or virus. There tends to be a ripple effect on all the stocks in the sector of the one stock that has a bad earnings report. In our example we’ll say that in a sympathy move our stock drops from $11. to $10. We realize we’re losing ground on what looked like a promising venture a very short time ago. What to do, what to do? Sell immediately and eat the .50 loss or hope and pray? You’ll never find hope and/or prayer listed in any investment strategy manual. Here’s what you can do… First cancel your GTC order to sell the stock $13.5, then write (meaning sell) the $10. covered call against your stock. This is a volatile stock so it’ll have a good premium. Someone will pay you $1.5 to sell them the right to buy your stock away from you at $10.

Confused? Think about what has just occurred… You bought the stock for $10.5 and wanted to sell it at $13.5 figuring you’d make a profit of $3. a share. The stock drops and the plan is shot in the butt. Maybe not? We have a choice here, we can take a .50 loss, or have someone pay us to buy our stock, which allows us to collect money for doing it. You paid $10.5 for the stock, took in $1.5 for selling someone the right to buy that stock from you at $10. So, what has happened is that we’ve collected a $1.5 premium. Our basis in that stock is now $9. Wrap your brain around this, you bought the stock for $10.5. Someone then gave us $1.5 to buy the stock away from us at $10. Our cost basis is the $10.5 minus the $1.5. So our cost basis for the stock is now $9. If on the 3rd Friday of the month (expiration Friday) your stock is trading at a price over $10., the person who bought our option will exercise their right to buy the stock from us for $10. Because we have a cost basis of $9. we make $1., not bad huh?

If the opposite occurs and the stock closes just under $10. on expiration Friday what are we to do? Should we have the stock called away from us? Let’s think this through. If, for example, the stock is trading at $9.5 no one will give us $10. for it, right? Right! This means that the stock won’t be called out. We own the stock for $9. and it’s worth $9.5. We can sell for a profit of .50 and forget about the whole thing. Or instead, we can also sell the $10. call option again for the next month out. We can sell it again and take in a $1.25 premium this time. The cost basis is then lowered to $7.75 ($9. Minus $1.25 = $7.75). If on the next expiration Friday the stock closes over $10. we make the difference between $10. and $7.75. I don’t know about you, but I really like that thought. If the stock doesn’t close over $10. what happens? We own the stock with a cost basis that is now $7.75. If the stock is still trading in the $9. range, we’ll sell the $10. call again. If the value of the stock has dropped to, say, $8. and we own it for $7.75 we have a some choices.

Don’t try to sell it for a strike price of $10., sell it at a lower strike price of $7.5. We own it at $7.75 so we can write (sell) to someone else the $7.5 call. This is less than what we own the stock for, right? If that person is willing to give us $1. For that $7.5 call option it equates to $7.5 minus $1. = $6.75. If the stock trades above $7.5 on expiration Friday we will be called out. If we still own it we can still make money, $7.5 minus $6.75 = .75 per contract. The entire event amounts to a safety net. Buying stocks that are optionable provide us with a fall back plan if the rolling stock trade we are counting on goes down the tubes.

The RS1 member that sent in this information says it was derived from an excellent article by Doug Sutton.

More on Options...

From: "Benjamin"

---Rolling Options---

Well, where do I begin? A thorough discussion of this would take a long time, but here's kind-of a short overview of what I've done in the past and will continue to do so periodically. At the end of last year, I went to :http://www.invest-faq.com/articles/stock-index-djia.html since this is the best place I've found that lists the Dow 30 Industrials and provides hot links to the charts on each (with a nice comparison to how it performs versus the S&P; 500.)

It also has hotlinks to each individual company's web site. From there, I pulled up all 30 Dow charts and printed them. Next, I analyzed each one from their charts alone. This got me excited about Du Pont (DD), Goodyear Tire (GT), Coca-Cola (KO), 3M (MMM), and Sears (S). From there, I cruised over to WWW.CBOE.COM (Chicago Board of Options Exchange) and got the prices of all the available 'calls.' From the list of call options, I looked for some out-of-the-money calls that are out a few months. Here are the ones that looked pretty sweet to me:

DD July 60's going for 3 1/2.

GT April 55's going for 2 5/16.

KO Jan (2000 (LEAP)) 100's going for 1 1/4.

MMM April 85's going for 1.

S April 45's going for 3.

The KO LEAP was mostly for fun (I only paper traded these options, since I'm tied up in Budget Group (BD) stock and First Plus (FP) stock.) Now, I realize I should've dumped these pigs and put my money into the 3M option that had me most excited. Here's what the options prices were on Jan. 6:

DD went from 3 1/2 to 4 3/4!

GT went from 2 5/16 to 3 1/8

KO didn't change (since it was so far out of the money, etc).

MMM went from 1 to 2 3/8!!!!

S went from 3 to 3 ½

I chose out-of-the-money calls because they're cheap. But, for an almost tick-for-tick increase in the option price as the base stock goes up, I'd recommend spending a little more and going a little ways into-the-money on the option. Also, for those of you out there familiar with this technique, could anybody tell me where to find (for free on the internet) Gamma values and Percent to Double values on options?

Hope that helps a little bit, if it's all Greek to some of you out there, I'd highly recommend reading one or two of Wade Cook's books. (Either Wall Street Money Machine or Stock Market Miracles) Check your local library (I've never paid a dime--except in fines--for these books.) Oh, and I recommend you don't attend his seminar...your $4000 is better invested in the market! Also, you can cruise over to WWW.OIC.COM (the Options Industry Council) and order their free video and pamphlets (sp?).

A LITTLE MORE ABOUT OPTIONS...

From: "Monte" monte@in-tch.com: just a note which may help some subscribers boost their returns!! I note as an example you have XXX on your list for a buy at $17.00, which is great!! Now take a look at the Sept. options. Let's say you bought 100 shares. Wait for the stock to go up some and check the option prices for the next month out. Currently, the Sept.

$20 calls are going for $1.25. If you put in an order to sell 1 contract (100 shares) at the $1.25 you would make $125!! Plus if you get "called out" of the 100 shares you own at $17.00, You would make and extra $.50 per share over the $19.50 sell price you currently have listed. Hope this helps everyone!! Keep in mind that you get to keep the $125 even if you don't get called out of your 100 shares.
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