Stock Forex

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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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.

Here is a micro point on these movements. I think good news plays out in days. However, it can take months for company’s stock prices to recover from bad news.

Now, if you’re playing the stock, either long or short, the length of time is crucial to your profitability. However, if you’re playing stock options, a high point and then small percentage down in the stock, or a bottom and small recovery in the stock ($1 to $5) could produce drastic profits.

Define A Joke

Watching “Data” on Star Trek is a lesson in human behavior. Laughing (getting a joke) is difficult—at least the timing is difficult. Data doesn’t get jokes. He can’t tell one, or understand the punchline. I saw a bad movie (Solo) and the humanoid (machine) questioned why everyone was laughing. “A joke,” he was told. Obviously, he wants to know what a joke is. No good explanation was given. Let me try my hand at it. I’ll then get back to booms and busts. A joke is a story, and at the end a complete surprise occurs, either in the actions of the participants, or a twist in words, with unexpected meaning, hidden meaning, or a nuance to something else. Based on your point of reference, the company you’re in, or the mood you’re in, determines your response—a chuckle, a scoff or a belly laugh, et cetera.

It is the twist, or reversal that interests me. Never has a movie brought tears to my eyes as the end of Steel Magno­lias—then in a half second, everyone is busting a gut laugh­ing. The writer played our emotions like a maestro. The markets also thrive on fear and greed, and unexpected rever­sals.

Change Is Inevitable

When stocks move up or down—either unexpectedly or in reaction to news, especially if they move quickly, there is a high incidence of a major divergence. A favorite play is to buy a call on the low-side turnaround, and buy a put on the top­side turnaround.

A perception of the facts (right or wrong), starts the move­ment. Activity breeds activity and more investors rush in. They listen to current events and future predictions and that subse­quently affects the price. Their purchasing/selling is integral to the process. New information—either right or wrong tests the strength or weakness of the previous assumption/activity, and the price is sustained or divergence occurs. A short term profit can be made. It’s quick and semi-predictable. Get in and out before anyone ever sees (or reacts to) the trend.

Now, use your profits to increase your holdings in great companies. It is the very boom and bust cycle (volatility) which gets me excited. Most investors run from the boom and bust scenario, however, some of us profit big time from this technique.

Markets rise and fall on a perception of what will happen in the future. I have two problems with this.

1.    No one knows what will happen. Too many other things change. What seems logical turns illogical.

2.    We still must take into account our biases—how we as individuals and groups view such things. Life is too fluid to predict.

Most of the future’s news is discounted long before it happens. Look at the last example! We want to discern things, to have peace of mind, to have things fit—to make sense. What twisted logical path did the market (the invisible “they”) walk down to come to a conclusion that a stock’s price will fall in nine to eighteen months, and then have the price fall now? With this type of logic at work and the crazy reaction to it, what are we to do? More importantly, what plays can we make to build up our income?

I’ll give specifics in a few moments, but first, my list of important observations:

A.  Individual Investors

1.    There is in each of us (even at the corporate level) a desire to grow, to build, to achieve.

2.    We all, even companies, have a desperate need to not only survive, but to thrive.

B.   Market Movement

1.    The market has a mind of its own and will usually do that which it must do to make fools out of a majority of investors.

2.    The market is not right. It just isn’t. It’s fluid, it moves unexpectedly.

3.    There are short term plays and long term plays—you decide the length of time.

4.    There are opportunities everywhere.

5.    Investors’ actions shape future events, not predict them. They cause change, not re­flect it.

6.    Investor bias rationalizes (and hence changes) the facts.

7.    You can profit going both ways—up prices, down prices.

8.    The “herd” mentality takes over and when it’s played out (the boom), then prices start down as they bottom out (the bust), then the cycle starts over.

9.   It is at this precise moment when you capital­ize on profits.

That took a lot to get to these points, so let’s keep rolling. Let’s use a stock moving up for whatever reason as our example. We own a stock or have an option on it. The stock moves with a mind of its own. It’s reflective of news—good earnings, higher dividend paid out, prospects for the next few years. Everyone wants in. The price goes up and up. However, it will turn around to some degree. The sentiment will change.

The time comes when the momentum will turn. Perhaps the turn will come when an analyst at a major firm, a person who has loved this stock (to death!), now thinks it shouldn’t be an “aggressive buy,” but a “buy,” or a “hold.” A small downgrade. If you are into buying puts or going short on the stock, wouldn’t it be great to sell at the peak, or buy the puts just as it’s about to fall?

This is it. Playing this high point and the corresponding reverse (bottom) is point for action. And, it’s just not that tough to make money this way. We’ll call this point a “crossover,” or a conver­gence. Crossovers occur at both peaks and valleys.

We’ll explore this premise after we look at a scenario. This scenario conforms to this strategy. Not all scenarios do, but the ones which do, allow us to get in, then get out with a lot of cash. This scenario plays out frequently, I’m not investing in “the market” but in certain stocks and options within the general market. And if you think the market has a mind of its own, go with the trend. Don’t try to “catch a falling piano.” But only go so far.

Five Sections (Stages) Of A Crossover (The Boom/Bust Scenario)

First: the price movement is unnoticeable. The trend starts, the price rises or falls inordinately quickly, compared to its historical moves. Volume increases as stock momentum builds. Look at the following:

Speedway Motorsports (TRK)

December 1995, stock had been trading between $25 and $30 for the last four months with no big trend. Volume (interest)

in TRK increased in December of 1995 and January of 1996 and the stock started to climb. The stock split in mid March and has been trading be­tween $25 and $30 for the last six months.

K-Mart(KM)

K - M a r t showed a build­ing trend in Sep­tember and Oc-

tober of 1995, with a big trend up in early 1996. K-Mart then showed trend reversal from December of 1995 to February of 1996. As the stock was falling, so was the volume. The stock changed trend in March, volume increased and so did the stock price.

Second: activity reinforces more activity. Recommenda­tions (from the professionals) fly. Everyone wants in. Major purchases oc­cur.

Third:   the strength (or weakness) is tested. Doubts occur in the wis­dom of the rec­ommendation.

New recommendations appear, after all the facts are used, distorted and abused to prove points.

Fourth: the main point, or question, is simple—is the price sustainable?

1.    Where is the market headed?

2.    Check other news.

3.    How was the news received?

4.    How much buying has been going on?

5.    How many institutions jumped in?

6.    When the high and low was tested, did the price return to the previous support level or did it break support?

Fifth: divergence. If there is no compelling reason for it to stay high, it will decline. BUT IF

THERE IS NO COMPELLING REASON FOR A FALL, it may fluctuate, but the stock might establish a new range. The price will be tested repeatedly. The opposite is true for a falling stock, once it hits bottom. The bottom support level will be tested repeatedly.

A Perspective

Go with the “herd” until the time is right. Buck the trend at that time. I have seen very rapid movements up and down. I hope after this next sentence or two, my strategy will make sense. So much doesn’t make sense, but this does. The stock price will change.

If I own a stock at $80 and it gets trendy—caught in an updraft, I’d rather sell at $110—even if it goes to $120, because in two hours it could fall to $90, or a $50 stock could fall to $35 (IOM). A good time to get out would be when you wouldn’t get in.

If you think the stock market is logical, or that a certain move in a particular stock price is logical, then I will show you dozens of illogical moves! Can you predict a price change— 100% of the time? No. Can you do your best to make a calculated risk? Yes.

Try this one on for size. When a stock price starts to rise, it creates excitement. The higher it goes (or the faster the rise) the more investors want in on the action. It rises more. More investors buy in. It rises and rises, sometimes 10 to 20% in a few days. Then … it stops! Does it just stay there? Or does it swing back down? Usually it falls, as investors’ sentiment takes it the other way.

I’ll give a 5-step process in a while, but first, what is happening here? Which price was right—the price two weeks ago at $80 a share, or the price now at $120. And three weeks from now, what will be right? The $90 price which the stock has fallen back to, or the $80 or high of $120?

What did supply and demand have to do with this? What about the market always being right, or a search for equilib­rium, or any other high-falutin’ theory exposed by a guru of Wall Street? Maybe, just maybe, this $30 run up was because a competitor’s Indonesia mining operation turned sour. But look what the “herd” did!

Here’s another one. Throughout this past year employ­ment reports have been good—more people employed. To me this should be good news. It means more people working, paying taxes, and not living off the government. It means more savings, more spending and all the other great things that help make a bigger American pie.

But, no. The stock market (DJIA) falls 80 points. Why? Because, as those wonderful things happen, inflation will go up, then the Feds, in nine months or a year, will edge up interest rates; corporate profits will decline slightly in 12 to 18 months, so the stocks price will fall. But they fall now in anticipation of this chain of events—which no one can predict anyway.

I rest my case for craziness. However, this last point does make a nice segue to a discussion of future events.