Stock Market Savings

Long before we purchase the stock, and along the way as it is rising, there are still other things we can do to take advantage of the “magnified movement” in the option price.

As the stock rises and gets close to the $15 strike price, the value of the put goes down. If it’s awhile before the expiration date and the option is going for 50cent, we could buy it back. What does this mean? We buy a $15 put for 50cent. Now we have the right to sell the stock at $15. The option costs $500 for ten contracts (plus commissions). You’re now creating a “wash” situation. You sold 10 puts, now you’ve just bought 10 puts and to your broker’s computer it’s a wash. They both go off the screen. You now have no obligation to perform.

You would only buy back the puts if there is plenty of time before the expiration date for the stock to go back down. If the stock is near $15 and climbing, or above $15 with a small chance for a significant decrease, don’t buy the put. Just wait for the option to expire and you get to keep the whole $2,000. Your profit, if you buy back the $15 put for 50cent ($500 for ten contracts) is $1,500. Don’t unnecessarily spend money you don’t have to. However, let’s keep going. What if there is still plenty of time before the expiration date and the stock has shown a lot of volatility? It’s at $15.50, the put options are 25cent, you spend $250 to buy them back. You have a clear profit of $1,750, minus commissions. Now, the stock falls back to $14. At this time the $15 puts are going for $1.25. You sell another ten put contracts and generate $1,250, then one of the following happens.

1. The stock stays down. Your basis is now $12 ($15 minus $3: $2 for the original put sold, minus 25cent for the put buy-back, plus $1.25; the selling of the second $15 put). That is a super wholesale price.

2.    The stock rises above $15. You get to keep the premiums and you have no further obligation.

3.    If there is still time to buy back the put again, try it again—repeat the process. Note: I’ve done two puts, but never three in one month. It’s possible, but highly unlikely. The stock would have to be really volatile, having a lot of quick movement. Look at the following charts and plays:

We sold puts at $15 and the stock went way up. We also had calls on this play.

A good cov­ered call stock can also be a good one for sell­ing puts. We sold the $10 puts, then the stock hit $19. Profit $1,000.

We sold the $15 puts. We ac­tually  got  the stock put to us, but I like this company  and don’t  mind owning   the stock.

Sell Call—Buy Put

Sell the call for $1.50 ($1,500 if you purchased ten con­tracts) buy the put for 25tf. Capitalize on each—depend­ing on the time left before expiration—at the optimum time. Buy back the call or let it expire and sell the put at a profit.

 

Stock Price	Call Price	Put Price
$15.75	$1.50	$0.25
15.00	1.00	.75
14.50	.75	1.00
14.00	.50	1.25
13.50	.43	1.50
13.00	.125	2.25

 

 

Once again, so many more opportunities open up when you sell than when you buy. Don’t misunderstand; I still make most of my money buying calls—on pure option plays. I try, however, to sell as many calls and puts as I can.

Remember, writing covered calls is a great strategy for IRA’s and other pension-type accounts.

Generating income, infinite returns, buying stock whole­sale, double-dipping with highly volatile stocks (selling two calls or puts in one month)—are just so much fun.

Now look at the following charts to see possibilities. I added arrows to show the buy and sell ranges.

Opposite

Buy a put, sell a call.

Sell a put, buy a call.

Look at how many opportu­nities a volatile, but upward-trending stock options.

And on and on…

Read the following example: you find a stock that is rolling, rising from $13 and bouncing off $16. It’s down to $13 and is rising quite rapidly. When it hits $13.50, you sell the $15 put for $2. Ten contracts equals $2,000. Nice cash flow.

Now, when the stock gets to $14.75, the put is going for 50g. You buy it back at a cost of $500. You get to keep the $1,500 with no further obligation. However, why not cross over and sell the $15 call? Do this when the stock is at $15.50 or $15.75. Yes, it might rise or stay above $15 and you’d have to buy the option back at a small loss, but the $15 premium could easily be $1 to $1.50—another $1,500 of income. Remember, check the charts. This one is moving rapidly. It may go under $15 and you’ll have a second premium—yours to keep. Now as it dips down and starts up, repeat the process.

True, when it’s above $15 and you think it’s going down you could do a pure $15 put purchase play. And yes, when it hits $12 or $13 you could do a pure $12.50 call or $15 call purchase play.

You could even do a double play.

1. Sell a $12.50 put and buy a call when the stock is at $13 when you believe it’s on the way up. The premium will be about the same. However, as the stock rises, the money you received for selling the put looks better because the put value goes down (remember, you sold it when it was nice and high). At the same time your call premium goes up in value. Sell the call now for a profit and keep the profit for selling the put, or even buy back the put while it’s low. Wow, I can’t wait for the market to open tomorrow. And yes, we can wax philosophical all day long—hey, if I have to potentially buy the stock at $15 and I’ve purchased the right to buy it at $15, what if it’s close? Your brain might catch on fire.

2. Sell a call and buy a put when you think a stock may go down a bit. This way you pick up the nice call premium. If you own the stock, you won’t get called out. The dip is offset by the rise in value of the put option premium. You can sell the put option at a profit.

If you don’t own the stock, you keep the premium for selling the call and then get to sell the put at a higher price when the stock goes down. This is a form of hedging, and what a hedge it is!

Now, don’t make this too complicated. You’ve read about rolling stocks and rolling options. You’ve heard me teach about peaks and valleys. You’ve heard of some straddles— buy a call and put on the same stock, same month, same strike prices, and wait for a big move either way. Well, I call this a side-straddle. A calculated, predictable way to capture the up movement, or the down movement—TWICE.

I cover this more extensively at the Next Step Wall Street Workshop. You’d be smart to be there. Call 1-800-872-7411. These seminars sell out, so call now. Note: the Next Step Wall Street Workshop is only available to Wall Street Workshop graduates, or people with more stock and option experience. Come to the “BBQ.”

 

Buying Calls

You buy calls (short and long term) when you think a stock (hence the option value) will increase within a certain time period. You do so to lock in a certain price for the stock or to sell the option at a higher price. Your risk is that the stock (option) won’t increase in value in the time allowed.

 

Selling Calls

You sell calls to generate income. When you sell a call, you are committed to perform. You’ve given someone the right to buy stock from you, whether you own (covered) the stock or not (uncovered, naked). The premium you receive adjusts the basis you pay (paid) for the stock. For example, if you bought a stock at $9 and sold the $10 strike price call for $1 and then had the stock bought from you at $10, your profit would be $2. Your basis is $8, as the $1 premium reduces your basis from $9 to $8.

You can systematically generate monthly income from writing (selling) calls. You sell naked call options when stocks are high and you expect them to go down or stay the same.

Again, you can write covered calls and uncovered calls. If you write uncovered calls you qualify the investment for an infinite rate of return, as you have no cash tied up. You also have an added risk in that you may have to purchase the stock for resale if the stock rises above the strike price and you get called out. Obviously, this risk is mitigated by the pre­mium you’ve received. For example: if you’ve sold a call (when the stock was at $11) for a $2 premium at a $10 strike price, you’d hope for the stock to go below $10. You’d only sell the call if you thought the stock would go, or stay, under the strike price, so you could keep the premium with no further obligation. For other variations, attend the Wall Street Workshop.

I really like to sell uncovered calls. It takes experience and more cash in your account to do these, but it’s fun and very profitable.

 

Buying Puts

Now, let’s get on to puts. The right (option) to sell a stock to someone increases in value as the stock moves downward and away from the strike price. If the stock is $38 and you think it will go down, you could buy a put option with a $30, $35, $40 or $45 strike price. The one you choose depends on:

1.    How far down you think the stock will go.

2.    How much you want to risk (your option pre­mium).

3.    How much time before the expiration date.

4.    Other important factors: a) whether the stock rolls between certain ranges, b) news regarding debt, mergers, new (good, bad) management, et cetera.

A $2.50 premium to buy a $40 put will increase in value as the stock moves to $36, $35 and lower. You can sell or exercise the option any time before the expiration date.

 

Selling Puts

If you sell a put, everything turns upside down. You are selling the right to someone to put the stock to you at the strike price. Why do this?

1.    To generate immediate income. Think of it. If the stock goes above the strike price you won’t get it put to you and you get to keep all of the premium.

2.    You buy the stock wholesale. Let’s say the stock is at $13 and you sell the $15 put for $2.50, the stock doesn’t rise above $15 (maybe it is $14.50) and you get it put to you, your basis is $12.50. You’ve just bought a $14.50 stock for $12.50.

When do you do this?

1.    When you want to own stock in a company, or, at least, you wouldn’t mind owning it.

2.    When you wouldn’t mind owning it at that price— and wholesale, to boot.

3. you want to generate income—now!! Crossover

Now that we’ve established the four plays, look at the following diagram.

You see, there are three things which can happen to the stock (and we assume this movement will affect the option price to a certain degree): it can stay the same, or about the same, it can go up, and it can go down. However, if you sell a call or a put, a lot of opportunities open up. You should see here that you could sell a put in the situation where you normally would think of buying the call (you think the stock is going to rise) and sell a call when you would buy a put (you think the stock will fall). The difference and the key point is that when you sell something you generate income.

So, if you think a stock is going up, you can sell a put rather than buying a call to put dollars into your account instead of spending it. That’s cash flow: selling rather than buying. If you 1) buy back the option you sold at a lower price, or 2) let the option expire, you get an infinite rate of return. By selling options, two out of the three possible scenarios (stock rises, stock stays steady, or stock falls) are profitable. When you buy options the stock must move one way. Only one profitable scenario exists. Look at the follow­ing examples:

 

Naked Calls

The stock is, say $9, and you write the $10 call and receive $1.50 premium. If the stock rises above the strike price and you are called out, you keep the premium, but you have to deliver the stock.

If the stock stays steady at $9 or falls below $9, you can either buy back the call at a lower price when the time value decays, or you could wait for the option to expire. In either case, you would receive an infinite rate of return.

 

Naked Puts

The stock is, say $11, and you write the $10 put and a $1.50 premium. If the stock stays the same or rises, you keep the premium and you can either buy back the put at a lower premium or wait for the option to expire. Either way, you get an infinite rate of return.

If the stock falls below the strike price of $10, you have the stock put to you. You would have to accept the stock at $10.

 

Covered Calls

If you purchased the stock at $9 and wrote the $10 call for $1.50, you would receive a $1.50 premium. If the stock rises above the strike price ($10), you would be called out, and you would keep $1.50 premium plus make $1 on the sale of the stock.

If the stock stays steady, you would not be called out. You would keep your $1.50 premium and you could write more calls the next month.

If the stock falls, you keep the $1.50 premium which can offset the loss on your stock. Then you have to make a choice, do you wait for expiration or buy back the call at a reduced price? You can find more information in the Next Step and the Wall Street Money Machine.

 

Covered Puts

Covered puts are an odd concept to explain. In a covered call, you own the stock, so you can deliver it if the option is exercised against you. In a covered put, you have to have a place in your portfolio prepared and ready to accept stock if it is put to you, i.e. you must have a short sale position in that stock. This is a very advanced strategy that we cover in detail at the Next Step Wall Street Work­shop.

I like selling puts on a stock that I would like to own in a long-term position even through market turmoil. By selling a pricey put, you can take advantage of the speed of options and, if it all goes well, you can buy it hack at a profit. If it doesn’t all go as planned and it gets put to you, you will just own a stock you wanted anyway. You can start selling covered calls at the strike price you paid (after adjusting for the premium collected) for the stock when the stock has regained strength before a dip. Then, when it dips, you buy the call back. Continue to sell these perhaps deep-in-the-money calls until you get called out.

J have been doing this with Ascend Communica­tions (ASND). It seems to work well because it is such a great stock for this strategy. This strategy could be disaster for someone who tried this with Micron Technology (MU) a while back. Perhaps buying some cheap puts at the same time may work as a safety hedge. Options can be risky this year. I find that buying options when the McClellan Oscil­lator is in an oversold condition can help me not get stung by a correction or market rotation. Keeping track of future event dates like jobs reports can be helpful, too. The bad thing is that one can wait a long time between these safer trading periods. A strong, long-term, up-trending stock can make a big differ­ence.

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.

For this next section to make sense you need to know why you bought the stock.

Was it…

•     a new start-up and/or a new IPO?

•     a bottom fishing stock, i.e. one having a serious dip in price?

•     a rolling stock and you know the roll range (the channel between support and resistance)?

•     purchased for a covered call strategy?

•     a high quality stock added to your portfolio for strength?

If you don’t know why you got involved, it will be difficult to ascertain the best time to sell. Indeed, except for the last pint above, in all the other strategies the “exit” is more important than the “entrance.” Remember, my rock-bottom investment strategy is to build up your cash flow.

This last statement has gotten me into hot water with a lot of traditionalists around the country. There are the investment clubs, the old-time brokerages, and even journalists who can’t bring themselves to try anything new. The Warren Buffett philosophy is rampant. Don’t get me wrong, I love his strat­egy. After you have mastered your own cash flow strategies and have built up your income, start concentrating on building a solid portfolio of “keepers.”

Two points:

1.   If you have a substantial portfolio and seriously want more income, then take a few thousand dollars and try more aggressive strategies. Call it play money. (Note: most of our Wall Street Work­shop attendees with substantial assets have and do make more profits by taking $5,000 of their $100,000 and investing it in rolling stocks, rolling options, option plays on stock splits, slams, peaks, et cetera, than they make on the other $95,000. Sure their $95,000 is safe and growing nicely. Just think, $95,000 at 10% will produce just under $10,000. But, I’ve seen a lot of people (too many to count) take $5,000 and make over $250,000 a year. And not quite so obvious, this is actual cash flow, not just an increase in value. It’ time to head for the Bahamas.)

2. If you only have a few thousand to invest, then you may want to throw caution to the wind and go for the gusto. If that’s where you are in your life and you want to generate income quickly, most mutual funds, stocks, and bonds will not respond fast enough. It’s time to put a formula (system, recipe) to work and quickly “get in and get out.” It’s the formula that works, not a particular stock.