Stock Market Savings

Options (calls and puts) on stocks opens up all kinds of infinity-type returns and many ways to earn a free ride.

This is not the place to discuss all the aspects of options, but a few things are important to this discussion. Options allow you to control a large amount of stock with relatively small amounts of money. Also, small movements in the stock usu­ally produce magnified movements in the option. Simply put, you can double, even triple your money, a lot faster. With these profits, a whole plethora of opportunities open up.

Remember though, we purchased the option for a specific purpose and at/for a specific time.

1.    CALL OPTIONS (We think the stock will rise). The stock is…

A.   rolling

B.   on a dip (slam, bottom fishing)

C.   doing a split

D.   coming out with news

2.    PUT OPTIONS (We think the stock will go down). The stock has…

A.   bad news

B.   a reverse split

C.   peaked out—run up on good news, unsus­tainable

D.   come within a few days of the split date (give or take two to eight days)

Let’s stick with call options for this example. Put options are the same, but in reverse. The above is for purchasing calls and puts. Selling them is a whole different story.

The stock is at $40. It has traded as high as $50 and has been down to $38. You think it has potential. It seems to have bottomed out in the high $30 to low $40 range. It’s August. You purchase 10 contracts of the October $40 calls for $3.75; your cost is $3,750. You also purchase 10 contracts of the January $45 calls for $4.25. Total outlay is $4,250. By September 8 the stock is at $44. Your October $40 calls are $6.25, or $6,250. The January options are up also, but because they’re further out they haven’t moved as much. They are $5.75—still a $1,500 profit.

Now what do you do? Check again why you bought the options. If you’re following the Wade Cook method, it was not to purchase 2,000 shares of this stock. But wait. What do I see? A nice quick profit—extra cash generated in hours or days.

Look what you can do with these profits. Let’s just deal with the October calls.

1.    Continue to hold for greater profits.

2.    Sell some—say eight contracts for $6.25. That’s about $5,000. We have all our cash back and we can even take some profits and buy more options on this stock or other stocks. In this case we would only have to sell seven to recover our investment and get a FREE RIDE on the other three.

Note: if this run-up of $4 (10% of the stock price) had occurred in a one or two day period, I’d probably sell all of the options. Barring additional news, most of these quick spurts are not sustainable. Sell, then buy back in on a dip at an expiration date a little further out. The October options were purchased in August. If it’s now mid-September we should probably look at the November or December options.

3.   Sell all or part of the options and buy some of this stock.

This point is very important to me. I’ve written on it elsewhere but it is also appropriate here. I am big into building a solid portfolio of well-run companies with good earnings and hopefully in­creasing earnings. I like companies with expan­sion dynamics at work. Most people who read my books and come to my seminars need more cash flow. They, like me in the beginning, need a more aggressive approach with a small amount of money. They need to develop their own money machine.

Then they should diversify into real estate, gold, or other investments like small businesses, energy resources, et cetera. The stock market is too risky for all your money to be in one basket. Some of this diversification could be into stocks in great companies—even recession-proof companies. Get back to fundamentals and doing your homework.

Speaking of homework, part of the homework you did to decide if you wanted this option in the first place—and which option (strike price, expiration date), will now help you decide if you should buy or sell this stock, or hold on to it.

Remember, if we’ve sold ten October contracts for $6.25, that’s $6,250, of which $2,500 is profit. Yes, we could take all of this money ($6,250) and buy more options, but if you follow this thought, your portfolio will be full of risk. Options expire. Be careful. A downturn in the market could wipe out a sub­stantial part of your assets.

Let’s use all of the $2,500, or even half of it, and buy some stock. If you like the $44 stock, buy 10 shares, or 50, or even 100. One hundred shares would cost $4,400, but only $2,200 on margin.

You’re free riding again. Your $2,500 is put to a good, yes boring, but still a good use. Use your $3,750 (your option/profit seed money) for your next quick play.

There is an advantage to owing stock in a lot of companies. One is that shareholders receive news from the companies: updates, reports, and shareholder voter information. Get them, read them. You’re learning about earnings, expansion plans, stock splits, changes in management, et cetera. Part of good investment habits is to get, and act upon, good and timely information. Shareholders get this all the time.

If you think the stock is going up, why not buy a call option? My standard answer is, “You can do that too.” Think about it. You’ve bought a call and sold a put on the same stock. Why both, or why sell the put? Simply because selling gener­ates income. Buying costs money. It’s a way of getting more cash into your account more quickly. Look at Interdigital Communica­tions (IDC) and Gaylord Con­tainer (GCR). There are too many to list.

The  only hang-up is this. Many beginners reading this chapter will not be allowed to sell naked puts (a covered put would be a situation where you’re in a short position on the underlying stock) until you have more experience and/or more cash in your account. You see, you have the obligation to perform if the stock is put to you so your broker will require you to keep that amount of money (or 20% plus if you are on margin) on hold until the expiration date.

If you are just getting started, you may want to stick to call options. I did and it worked for me quite nicely. But once you get familiar with rolls, peaks and valleys and predictable stock movements, the put option tool gives you a way to truly enhance your income stream. Indeed, you can make twice as much as you catch the stock coming and going.

I’ve written on this in another chapter entitled “Selling Puts.” But in this chapter on puts, it is necessary to mention the gist of the strategy.

Like calls, puts can be bought and sold. Up until now, this chapter has only dealt with buying puts—then selling (closing out a position) on puts we’ve previously purchased.

Now let’s explore selling put options we don’t own. If buying a put gives us the right to put the stock to someone else, then selling this right would allow someone to put the stock to us. We would have an obligation to purchase the stock. (This is the exact opposite of writing a covered call.)

Why would we do this? Two reasons.

1.    To generate cash. When we sell a put we get that premium into our account tomorrow.

2.    We want to own the stock at a lower price, or at least be willing to buy it at the put strike price.

I love this strategy. An example would be in order. A stock is at $13.50. It’s been rolling between $12 and $15 but you think it may break out and go way up.

You sell the October (one or two months out) $15 put for $3.50, or the $12.50 put for $1. One contract would generate $350, the other $100. Ten contracts would get you $3,500 $1,000.

What have you done? You’ve agreed to let someone sell you the stock at $15. (We’ll just use the $15 strike price for the balance of this example.)

If the stock stays below $15, you will get it put to you. But think: your cost basis is $11.50 because you received $3.50 from the put premium. You bought the stock wholesale.

If the stock goes above $15 (remember this is what you thought would happen), the put option becomes increasingly worthless—you get to keep the premium and you don’t have to buy the stock. Why would they sell it to you for $15 if it can be sold on the open market for $16 or more.

A.   Earnings news. Many company stocks have a 5 to 10% jump on good earnings news. Be careful, however. Sometimes earnings are up but the stock goes down. This usually occurs when the earnings are not as good as some analysts projected. This news plays out really fast. Many people buy the stock in hopes of a better dividend. The short run up is truly short. The stock doesn’t always go back down to where it was before the last bit of news, but many times I’ve seen it go lower. I think the reason for this is that the stock was already up in anticipation of good news (company leaks, press speculation, et cetera). There usually is no long-term stability for the “jumped up” higher price. Rather, the direction is down. This is one of my favorite formulas. Why? Because we make money so fast.

B.   Mergers, Acquisitions—especially failed attempts when companies take over other companies. I usually like to play the one being taken over. If the attempt fails, or takes longer than expected, the stocks go down—witness Chrysler (C) a while ago. There are two plays:

1. If there is a lot of debt involved (especially acquisition of new debt), as compared to a stock swap, the bigger company’s (the one doing the takeover or merger) stock may see a quick—usually small—run up and then come down as investor euphoria cools. Sometimes the terms of the deal have a chill­ing effect.

2. The baby com­pany’s stock may run up to the take

over price but quickly cool with the lapse of time. This may be time for call options (not put options) if the takeover is friendly and the price is right.

C Spin-offs: when a big company spins off a division or subsidiary and a lot of cash is to be generated, there is usually a nice up tick in the stock. From my experience, though, it is short-lived. Why? The company selling off usually has other problems (the core busi­ness is in trouble) and the directors are pres­sured by shareholder groups to liquidate assets to get the main business going or to distribute cash dividends, et cetera. The prob­lems don’t go away easily and the stock dribbles back down.

D. Stock splits: stock splits offer so many op­portunities, I cannot do justice to them here. I’ve written extensively on them in the Wall Street Money Machine and I do so many plays (with explanations) on our Computer Bulletin Board Service (WIN = Call 1-800-872-7411 for details). We’ll just deal with the put play in this chapter.

The key is to watch and wait. If the stock runs way up c the announcement of the stock split and continues to climb c other good news announcements like an increase in di\ dends, just be patient. It will probably take a dip.

 

Remember:

1.    The stock is probably entering new territory—it may be ripe for a sell off as investors take their profits.

2.    There are whole market swings, or at least sector swin (sympathy moves?) to contend with.

3.    Other news—competition from others, charge offs, cetera, may affect the stock.

Remember most stocks just don’t go up in a straight lin Wait for true strength, check your charts (stochastic, mark sentiments, et cetera) and ride the stock down with a p option. Look at the following examples:

Accustaff (ASTF) was an awesome play. Many of our in­vestors and stu­dents found this easy. Calls on dips, puts on strength. For a short time it was a roller.

McDonnell Douglas (MD) announced a 2:1 split. It had a nice steady increase going. Then the whole market went down (first part of April, 1996) and McDonnell Douglas went down too. When it hit $94, with almost two months left before the split I fig­ured it was too high. It did go down to $88, then it became a call candidate once again.

Boeing (BA) also climbed close to $90. When it hit $88, I bought the $90 puts at $2⁷/8 on April 17, and sold the $85 calls for a large profit.

Avon(AVP) had a steady in­cline line, al­most too good to be true. When it got into the low $90s, I thought it peaked. The $90 puts were the play.

On the following page are some other charts for your perusal. The point of putting these here is to show volatility.

Look what happens after the split. Sometimes they go up and level off, but sometimes they go down.

Wait for weakness.

Sometimes the stock goes nowhere. It may be so high before the split that there is nowhere to go in the short term (usually due to stockholders selling off to lock in their gains) so the stock falls. These are hard to time. I usually wait for weakness and buy the call before I start playing puts. I want it to establish a roll pattern or run up to a new high. In short: to play puts we need all indicators pointing to a decrease in the stock price.

Buying put options when a stock has had a tremendous run up will have the same timing, and the same in the money, and out of the money pricing as a rolling option which has peaked. However, there is one substantial difference and this differ­ence can make you a lot of money—very quickly.

Here is how it works. Every day there are several stocks which close several dollars higher. They usually move higher on news. Sometimes, but very seldom, they do so for no reason whatsoever. The good news is usually about earnings—and if the earnings are great, the new high might be sustained, but if it’s something other than earnings, i.e. a takeover, a merger, new product, stock split, et cetera, the news can play out very quickly.

As in the “Dead Cat Bounce” strategy, the Peak Strategy happens very quickly. You have to be ready to move—not only on the purchase but also to sell. I usually know my exit (sell price) when I get involved.

There are so many examples it is difficult to only choose three or four for this chapter. There are sometimes hundreds a day. I go for the big moves, so let’s show you how to do this, right after we explain the play.

A stock goes up $8 in one day—on whatever news. It goes from $52 to $60 between 2:30pm and closing at 4:00pm (Eastern Time). It stops right around $60. We wait. There may be additional good or bad news after the market closes. If you think it has peaked, buying it now might be the move.

The next morning we check the news; we see the direction of the stock—waiting for resistance, or a good top. Usually this means the stock starts moving back down. This top may take several days to establish. The $8 run up was great but it goes up $2 the next day and then about noon on the third day, after it’s gone up another dollar, it gives back that $1 and even drops another 50tf.

If you think the news has played out, consider buying the $60 put or the $65 put. Let’s say the $65 put is going for $4 (the stock is at $62.50) while the $60 put is $1. Then over the next several weeks or months the stock gives back one-half of the $10 plus run-up. Your put value will grow drastically.

I usually buy these out a month or two. If I do them short term-two weeks to six weeks—I usually do in the money options ($65 put). If I play out further and there is no new news on the horizon (earnings reports won’t be out for another three months, et cetera), I’ll play out of the money puts—say $60 or even the $55 put if I’m feeling wild.

 

Examples:

1)   Last year Cheyenne Software (CYE) was to come out with great earn­ings. The price of the stock started to move up. Later they announced a multi-hundred-million-dollar write off from some bad deal. The stock went down the next day.

2)   Fannie Mae (FNM) announced a 4:1 stock split. Later it an­nounced a bil-1 i on-d o11ar stock buy back.

3)    Intel (INTC) an­nounced a stock split, then within days, they an­nounced an in­crease in their dividend.

The list is endless. I believe we live in a very short-term society. We forget good news in about three days. It takes three months to forget bad news. This is only my conjecture, “the gospel according to Wade.” I have no empirical evidence to back up the three day/three month statement, only a string of profitable trades using this as a guideline.

 

Examples:

Yes, you can make money on both up and down stock movements. Use these strategies for maximum cash flow.

Motorola (MOT): a long­time favorite rolling stock (not rolling, now) shot up $6 in one day. We had call options and sold out at a nice profit. Then when it peaked, we rode it back down.

United Airlines (UAL) announced a 4:1 split. It shot up. We

got in and out. Then when it peaked at $220, we got in on the puts. There was still plenty of time before the split date—it went down.

Author’s note: just because a stock splits doesn’t mean it imme­diately starts climbing up. Sometimes there’s a sell off (or whatever) and the stock goes down. See how to play these movements under Stock Splits.