Stock Market Savings

I’ve repeatedly said that two things make stock market investing profitable:

1. Be right more than you are wrong.

2. Be willing and able to act quickly. If you haven’t figured out by now that options move extremely fast and big when the underlying stock moves even a little, then there may be no hope for you. It’s not this aspect that I want to deal with. It’s the first point—being right more often—that I’ll write about. You’ve heard the one about Babe Ruth striking out more than 3,000 times on his way to the home run record, so I won’t bring it up here. And even if I did, that’s only part of the point I’m about to make. I want to help you stack the deck in your favor.

So, after all this set up, let me just say the main point—the theme of this chapter. Then I will explore it, dissect it and put it to work.

Here it is:

The deck is stacked in your favor. I’ll follow up with diagrams and explanations, but first let’s look at the four plays.

All of these deal with options, a derivative based on an underlying stock. I like stock options because they are not a pure gamble (as are index options, currency options and interest rate  options) and  you  actually can buy or sell the underly­ing stock.

Let’s quickly review the basics. A call option is the right to buy a stock. You can buy call options and you can sell call options. A put option is the right to sell a stock. You can buy put options and you can sell put options.

Look at the diagram closely because we’re going to ex­plore variations of these options.

Let’s explain this further and then see how you win two out of three times—and maybe every time if you do it right.

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This article is about winning—and winning big. No time for mediocrity and no time for second best. My continued drive as an educator is to consistently find new, better, faster ways to make money. I love a barbecue (BBQ). To me it stands for Bigger, Better, Quicker Returns. In dealing in the stock market this means returns, yields—money back in. In short, more INcome—INfaster, INbigger quantities, and INmore often.

I’m not alone in this endeavor. My students, countrywide, share ideas, hints, and techniques that have helped them make more. I’ve become a clearinghouse of ideas—some boring, some not too hot, but many are great ways to enhance our earning potential. For years, I’ve said I want to help people get their money working as hard as they work. Now, after nearly two decades as an educator, I realize why people had a quizzical look when I said that. They actually want their money to work harder than they do. I also realize one other thing: you’ve all heard the one about working smarter, not harder; well the real-life application of that is to improve upon those investors who are “true doers,” who really think about what they’re doing—who can and do improve upon their methods, their results, and their applications.

If you like to deal in stock options, these new ideas— actually variations of how we look at and use old ideas, will help you see new avenues, fortify your resolve for perpetual and consistent income, and actually help you generate more cash flow.

This is a tough order for some of you, because you’re doing so well. Others need this information to get off dead center. Maybe by explaining option alternatives this will be accom­plished.

However, no matter who you are or why you’re reading this, you should have read other reports or books (hopefully written by Yours Truly) on option investing. You should be familiar with calls and puts. If not, stop now and go back to the basics.

The road back up may take years and it definitely will not be a straight-shot freeway. Look at the fol­lowing charts:

Worldcom (WCOM): this stock shows a nice steady upward climb, and at last report was still going.

Nike (NKE) is another good example. It has steadily made its way to the $105 range over the last year. I like this stock.

Callaway Golf (ELY): again, a typical climb to the top. Stocks as pre­dictable as these can be very prof­itable.

Northern Telecom (NT) has gradually climbed from $35 to $55 in nine months. This chart shows a nice steady climb upward with plenty of rolls.

You can get in and out many times along the way. You can buy the stock and wait it out, or you can buy the stock and sell. Proxy investing with options allows for a greater return and many short term profits. You have less cash tied up and you can jack up your profits by being nimble and quick.

Some of you have read elsewhere about DUCks—or Dip-pingUndervaluedCalls. This is when a company, usually after a split, that has been climbing, pulls back temporarily as investors take their profits. The company is solid and growing, but the stock dips 5-10% for no reason other than profit taking. Around our office, we have a word for this. We call it a “SALE.” The price of the stock and also of the options, has just dropped below value. It is a perfect buy opportunity.

Obviously, any buy opportunity or any rising stock also presents a great opportunity to sell a put. If the stock turns and rises (as it should) you keep the premium and that’s it.

Of course, you want to pick the stock near the bottom of the dip and sell the put for the very next expiration date. And the strike price should be very near the stock price.

That way, if you’re wrong and the stock gets put to you (you are required to buy it), you get it at the sale price where it can rise. And when you buy a rising stock, you can easily sell later at a profit, sell calls, or just hold it. So a DUCk really presents a great opportunity to enhance your cash flow.

You just purchased this stock for $13. You see, your cost basis is adjusted by the premiums you’ve received for selling the put. If you’ve ever wanted to buy wholesale, you’ve done so. You’ve taken in $2 for selling the put and now your $15 purchase price is adjusted by this amount and you have a $13 cost basis. Just think, this stock could be selling at $14.50. You could take the stock and sell it immediately and have a $1,500 profit. You could also:

1.   Hold onto the stock for awhile. Remember, you thought this stock was going up. Is the story line still true?

2.    Sell a covered call on all or part of the stock. You could now sell a call option at a $12.50 or $15 strike price, or wait for the stock to strengthen and sell the $15 call option for more money (hoping to get called out or not) or even the $17.50 strike price if it moves up a lot.

3.   Go short on the stock, so you don’t have to actually purchase it. I’ll explain this later.

One thing I learned from my real estate days is that if you buy wholesale, all kinds of good choices present themselves. You can sell immediately and your payments are lower so you can rent at a profit, et cetera. The same is true with stocks. You have good choices if you buy wholesale.