Stock Forex

An  Introduction To Proxy Investing

More bang for the buck! That’s what we all want. Wise use of stock options is one way to get it. This chapter is about using a form of proxy investing to leverage greater returns. And returns, to me, mean extra income, not just an increase in value.

Throughout all my real estate books and courses and now in my stock market educational materials, I stress “cash flow” concepts and techniques. After all, is it not cash flow that pays the bills and lets us get into an ever-increasing upward spiral of income?

Buying or selling options to purchase stock are simple strategies loaded with opportunities. There are variations on purchase and exit strategies, and combination plays both with the underlying stock and with other options. Options are derivatives of an investment on an underlying security. A call option is the right to buy a stock at a fixed strike price anytime before a set date. A put option is similar, but is the right to sell. Both calls and puts expire. They end. This expiration is one inherent risk of option investing.

Why would anyone want such a risk? Simply because of the fantastic profits which can be made in a very short period of time. You see, an option moves up and down in value with the movement of the stock, but to be precise, it moves on an exaggerated scale. I’ll explain this as I go along and illustrate it with examples. Once we’re through with the basics (and I refer you to the book, Wall Street Money Machine for more details) I’ll show you a few, heavy-duty strategies to get you making more money.

Example: you could buy a stock for $86. The stock seems down right now; you think it will go back up to $92 or $96, where it’s been trading for some time. It’s March. You check the May $90 call options (the right to buy the stock at $90 per share before the May expiration date). The call options are $2.50 each. You’ll spend $250 plus commission for one con­tract (a contract contains 100 shares of stock). $2,500 would purchase 10 contracts. You could also buy the $85 calls, the $95 calls or other strike prices, and you might be better served by buying options with a different expiration month than May. (I explore short term and long term plays in my other special reports and in other chapters.)

Your $2.50 option premium gives you the right to buy the stock at $90. Obviously you want the stock to rise. Many people suggest the stock would have to go to $92.50 for you to break even and above that for any profit. A better under­standing of the strategy, though, will help you see that the stock doesn’t have to rise that high for us to be profitable.

Options are bought and sold like stocks. There is a trader (like a market maker or specialist) who buys and sells. Like stock, you don’t know who purchases your option—it just happens. Options have bids and asks. A bid is what you can sell it for, the ask is the price you pay to buy. The bid and the ask move up and down according to several factors: 1) the supply and demand for the option, 2) the time left before the expiration date, and 3) other market sentiments. For ex­ample, with tremendously erratic stock, the market makers keep a high option premium because they know the stock has the potential to make big swings. Also note: you do not have to trade at the current bid and ask. You can place orders to buy below the ask or an order to sell above the bid. These orders can be day orders only or “Good Till Canceled” (GTC) orders. It costs nothing to place the order.

Watch the movement of the option compared with the stock price in the following example. Look at the $88 price. The option is $3.75. This will not stay constant. This $88/ $3.75 quote is, say, six weeks before the expiration date. If it were six days, the option could be $1.25. You see, an option buys time. A part of the premium is the time value. In our example, the $3.75 is all time value. Why did it go down to $1.25? Because “the invisible market” doesn’t believe very strongly that in six days the stock will go up to or above $90. If the stock stays at $88, the option probably will expire worthless. However, look at what hap­pens when the stock goes above $90. The option has be­come more valuable. Someone is willing to pay $4.75 for the right to buy the stock at $90. If the stock goes to $98, the option could be worth $8 to $9 (or more), again depending on the time left before expiration.

If the stock is $92 and the option is $6.50, you see that $2 of the $6.50 is actually paying for stock. The option is “in the money” by $2 (intrinsic value). $4.50 of the option premium is time value (extrinsic value).

Now, the main question: what is our purpose in buying the option? Do we want to buy the stock? Maybe, but this author is waiting for the options to gain value so they can be sold at a profit. If we purchased the options for $2.50 and can now sell it for $4.50 (assuming the bid and ask is something like $4.50 x $4.75), we have a $2 profit. If we had purchased ten contracts, that would be $2,000.

Let’s review the word “exaggerated.” In this example a $1 movement in the stock means a 50tf movement in the option. Sometimes the stock to option movement ratio could be “tick for tick,” or dollar for dollar. A dollar rise in the stock produces a dollar rise in the option. The point is you have much less cash tied up. $2,500 controls 1,000 shares of stock. You didn’t invest $86,000 buying 1,000 shares of stock. Also, a $1 move in the stock from $86 to $87 is around a 1% gain. If this creates a 50c move in the option from $2.50 to $3, it is a 20% gain.

If you sell the $2.50 option for $4.50, the $4,500 cash will be in your account tomorrow. Options clear in one day.

After attending the first day of your workshop, I was confident that with some diligence one could in fact use the techniques you taught. The second day in class, with increased confidence, I made my first two rolling option purchases during the morning’s “early bird” session.

To my pleasant surprise, I was able to sell both options the following morning for a profit large enough to cover the complete cost of the workshop. I have contributed around $31,125 in the last 15 days, and thus have been able to clear a net profit of $23,252.35 after commissions. Yes, that’s right, 74.7% in 15 days and an annual percentage rate of 1,817%.

I’m still pinching my self to see if I’m awake! I am now eagerly waiting to attend The Next Step Wall Street Workshop and hold even greater expectations in mind.

Michael—Kent, Washington

Yes, we’ve all seen stock go up $2 to $10 in, or within, a day. Think about buying an option an hour after the market opens for 50c and selling it for $1.50 two hours later. Ten contracts would generate a $1,000 profit.

Let’s do the same on a put. Last year, Fannie Mae (FNM) did a 4 for 1 stock split. A few months later, the stock was rolling between $31.50 and $36. News came out that  the   long bond yield was down 3 points. This is the U.S. Treasury 30-year bond. The stock market was hammered that day. There were other things going on also. Fannie Mae is very interest-rate sensitive, as they borrow money at one rate and lend it out at another, higher rate. If the interest rates go up (that’s why the long bond was falling—fear of inflation and a rise in rates), the stock can really go down. Likewise, if interest rates go down, the stock might go up.

To put it mildly, the stock got slammed. I knew it would go down. I put it on the Wealth Information Network (WIN) immediately, telling my students how I was going to play it. The stock closed Friday at about $33. It opened at $31.75 (on a 30-minute delayed opening). I purchased the March $32.50 puts.

This lets me “put” the stock to someone else at $32.50. If the stock goes under $32.50, my put option becomes more valuable. It’s the opposite of a call. As the stock goes down, the put becomes worth more. I bought these puts for $lVs or $1,125. The stock went down to $27^! /i and as it bounced back up to $29 to $30,1 sold the put for $3⁵/8. That’s a four-hour play and a nice profit of $2,500. $3,625 minus $1,125 = $2,500 (minus commis­sions of about $110 for both trades).

If you buy options, you do not have the obligation to buy or sell the stock. You also don’t have to sell the option—you could just let it expire. You have the “right” to buy or sell. Again, though, I don’t buy the options to buy the stock. I buy options hoping for an increase in value and then sell them. It’s just quick-turn money.

I have a “bear market mentality” in the midst of a bull market. I really don’t like losing money. Options are very risky—only 15 to 20% of contracts ever get exercised. That’s not to say there are many losses, as some investors like me get in and get out rapidly. I have lost on several plays, and each time I do, I vow to never do that again. I want to learn from my mistakes; I’ve cut the losses to a bare minimum. I’m now somewhere in the range of one loser for every 18 to 20 winners. You can watch me do this on WIN, Wade Cook Seminars’ subscription internet service.

Here is how my trades have gone since I started using WIN I bought two Xerox (XRX) $125 April call options for $6.75 and sold them one week later for $10.75, a profit of $663 (49.1%). I also bought two Warner Lambert (WLA) $90 April call options for $6.75 and just sold them nine days later for $10.25, a profit of $562 (41.6%).

I’m shooting for 50% returns on covered call writing, all profits to be reinvested until I’m consistently pulling enough per month to be able to retire and do what I want with my life. Now there’s hope and light at the end of the tunnel. All my thanks go to Wade and everybody there on the WIN staff.

Augustin

You’ll see my “hunker down,” try not to lose a penny strategies permeating the following formulas.