Stock Forex

One last use for options is a “hedge.” A hedge is like an insurance policy. You hedge to limit your downside.

Let’s say you just spent $10,000 and purchased 100 shares of stock at $100 each. You think the stock is low (either the company is really profitable or that the stock has gone down — hit a low). That’s a lot of money to have tied up. You have unlimited upside potential and all the time in the world because you actually own the stock. Your only risk is a dip in the price of the stock.

To ensure against a loss in your stock value, buy a $100 put, or even a $95 put (if you are willing to lose a little). Yes, you could put in a stop loss, at, say, $97 and only lose $300, but what about a drop to $70 wherein you could lose $3,000. The $100 put is, say, $2. One contract (controlling 100 shares—the same amount you own) would cost $200 plus commission. If you never exercise the put, that’s $200 out the window. You bought the stock hoping it would go up, and if it does your $200 ($2 put) goes down in value. Any increase in the value of your $10,000 investment will be offset by this loss. However, if the stock goes down, and I mean seriously down, this $200 will be money well spent. If the stock goes down to $80 (assuming this is still before the expiration date of the put) your put will be worth at least $20. It could be $22 to $25 depending on any time value still built into the put premium.

Think of this. You could sell the stock for $80 and also sell the put premium for $20. That’s $8,000 and $2,000 respec­tively. You’ve broken even. You see the insurance-against-loss aspect of this. You could lose $200 or at least have your profits offset by this amount, but you can make up all your losses with the proper put.

Two more ideas: the $95 put might be purchased for 25tf when the stock is at $100. One contract would be $25 plus commissions. This lower strike price and the corresponding lower put premium will let you buy a put further out (say 5 to 6 months) for a lower price. Your risk is $500 plus the put premium. Why $500? Because you’ve lost the amount between $100 for the stock and $95. 100 shares times $5 equals $500.

The $100 put is $2 and it’s only out one to two months. I usually buy the short term puts at the higher strike price (out one to two months and then reevaluate the situation: com­pany news, the stock price near the expiration date, et cetera) or further out puts below the strike price. They’re cheaper but also give you more time.

By looking at the company’s chart you can determine how much you want to spend, how much time you want to buy, and how much risk you want to hedge.

Combo

You could also buy a call with a $100 or $110 strike price. If you’re certain this stock is a winner, go ahead and buy the stock for $10,000, but spend $500 and purchase the $105 calls out two to three months. If the stock rises, you’ll see first hand how the riskier option plays produce the greater returns.

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One of my longtime favorite ways to make money on options is to buy when the stock takes a serious dip. Check the company’s story though, to avoid further downturns. Look at the following charts:

Motorola (MOT): The stock was $70 to $80 a share. It’s a great company. Earnings were up but not what analysts expected (the whole high-tech arena was

down) and the stock plunged to the low $50 range. I pur­chased the $55 calls and some $60 calls. When the stock rose, I sold the calls at a nice profit. I’m always doing this play with a dozen or so companies.

I like Orga-nogenesis (ORG). When it dipped down to $19, I jumped back in. I’m do­ing both a pure option play and a covered call play. There are so many companies which fall into this category.

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Supply and Demand. There is a common “wish” that all things be simple. And even if complicated, at least that they be explainable and definable. Do markets move due to a supply and a demand? Yes, to an extent, but there is too much sentiment, too many desires, and far too many biases which come into play.

Market Sentiment

When you have sentimental responses to hard facts, you are bound to get a distortion. Those who believe in equilib­rium or that the market is a zero-sum game are often fooled. A fund manager may make a clever play one day, but then be hoisted on his own petard the next.

Market sentiment is a combination of multiple dynamics at work. If we were to achieve perfect knowledge, have perfect competition, and perfect responses to all this, and more importantly, if we could be detached from the game, then maybe we could pre-guess a movement. But we get nothing perfect and we are not detached. Indeed, we are a part of the course of events.

When we buy stocks, we’re part of the process that drives the stock up; when we sell, we are the opposite. The amount of stock movement depends on where the market is headed— what stage, or cycle it is in.

Influence

We, individually, have little influence, but collectively we have a lot. If we are in the game, buying a stock or many stocks, we contribute. We become part of the trend. We want safety so we go with the numbers—the “herd.”

This has never made sense to me—as most of the stock market makes no sense to me. I love “crazy!” Since I accumu­late wealth through chaos—at least, figuring out part of the chaos and capturing profits amidst it, and since I don’t have to continue in the trend, in fact I can be detached from it (as you can)—then you and I can make incredible returns.

Capitalizing Profits

I wrote my first book almost two decades ago. I have had a wonderful audience—a very supportive following. Those of you who know how I write and how I think will definitely be unsettled by the following chapter!

There is a purpose, a rhyme and reason to my madness. Indeed, it is in my attempt to explain my “stock market madness” that the following is written. Why? People come up and ask me how I can make such fantastic returns. How do I consistently get 10,000% plus annualized returns?

So come along—I hope you’ll come to understand my rationale and my results. It will take a while, but the first part of this chapter is necessary to understand the last part, the crucial part. It may be slow at first, and you’ll have to wade through my “Wade-isms,” as I have never before tried to encapsulate my thinking process and results. This is new territory. Hopefully not the final frontier.

Holy Macro

I hope to give a “macro-view” and use micro examples to justify my reasoning. There definitely is a “herd” mentality and I am not the first one to try to understand it and to figure out how to profit from it, or how to not lose by following it. More importantly, trying to understand this type of stock market mentality is the perfect way to try to figure out just when the “herd” is about to turn. This turning point is the point when a lot of profits can be made. But I’m ahead of myself. That is the conclusion to this chapter. The profit-making point of reversal or correction of a stock is crucial. I bring it up at the beginning so you know where this chapter is heading. I will not be untrue to the theme that has worked well for me, both in my personal investing and my seminars: use a little cash to purchase an asset, get in, then get out with a nice chunk of cash (profits) or smaller cash flows (payments). In short, I want income (cash flow) from dividends, capital gains, option premiums, or whatever income that allows us to live, to pay the bills, and grow rich.

Another theme of my books and seminars is “to whom are we listening?” If you want to make $100,000 a year, why are you listening to anyone making under $100,000 a year? It is to this point that we’ll launch into this area of discussion.

There is a widespread belief that the market is always right. I disagree. There are too many variables. The market is not always right. When it comes to a particular stock, there is definitely too much sentiment to come to any conclusion that a stock’s price is “right.” (I’ll give in on this a little, if you’re determining a stock price based on a “best guess” midpoint price between a high and a low, or a recent support level and resistance level.)

I’ll get back to individual stocks later, but for now let’s deal with the stock market in general.

After a company takes a big dip, the climb back up is volatile. Sometimes it stays down for a while and starts trading between a certain range. I call this rolling stock. If you follow my formula for a pure rolling stock play as outlined in the Wall Street Money Machine and at our live Wall Street Workshop, you’ll realize that $50 to $100 stocks don’t fit the formula. They’re priced too high. Your cash goes a short distance with an $80 stock. $8,000 buys 100 shares. Yes, a move to $85 would make you $500, but a $5 move on a $5 stock would also make you $500, but with only $500 tied up. A better example: $8,000 would purchase 1,600 shares of a $5 stock. A $5 move up would double your money. Upon selling you’d have $16,000—a profit of $8,000. Now to make it more exciting and still double your money (because there are many more companies at $80 which can easily go to $85 than there are companies at $5 which go to $10), let’s play an option.

The stock is at $80. You call your broker and buy the $85 call options, say two months out. You pay $1.25 per option and buy ten contracts for $1,250. The stock moves up to $84. Your option is worth $3.75. You sell for a $2.50 profit and make $2,500. Look at the power of leverage.

Options allow you to invest in the big stocks by proxy, using a small amount of money.

Look back at the chart on Motorola (page 90). Every time the stock goes down to $50 to $52,1 buy the $55 call option. I’m not hoping the stock goes back up to $100, though it would be nice, and I’m not doing this to buy the stock. I’m simply going to sell my $1.25 option for $2.50 or $3.50 when the stock rolls up. Another day, another week, another $10,000 profit.

Some stocks just seem to trade in a certain range (support at the bottom, resistance at the top.) Check out Ford (F). It rolls between $27 and $34. When it gets down to $27 or $28, I buy the $30 calls or the $35 calls if they are cheap. I sell them when the stock gets to $32-$33. Don’t get greedy. Get out, get your profits working better somewhere else. If it gets to $34 or $35,1 then buy the $35 puts. As it falls back to $30 or under, I sell them. This past year, this has been a bankable play.