Stock Market Savings

I have given a lot of this information elsewhere: bits and pieces here, brief explanations there. It is probably the most visited area of all my seminars and personal meetings: “When do I get out (sell)?” I think people ask me this because from my real estate days on, I’ve advocated several generalized exit strategies, including:

1.    Know your exit before you go in the entrance.

2.    You capitalize your profits when you sell.

I’ve also made remarks like the following: “it’s easy to get into business; it’s hard to get out. It’s easy to buy real estate; it’s hard to sell. It’s easy to get into personal relationships with people; it’s hard to get out. It’s always easier to get in than to get out, but you make your money when you get out. Sure, you have to buy right going in (and if you do you’ll make a profit), but again, you get the cash (or cash flow) when you sell.”

Also, I mentioned to people at my real estate seminars that I felt sorry for them if they asked me a question about a problem they were having with their properties because I only had one answer: sell.

The reader must also understand my “cab driver” mentality background.

1.    The money is made in the meter drop. You make more by ending one run quickly and getting on to the next. I know this is contrary to all the current advice. I, too, buy and hold some stocks. But the cash flow comes from buying and selling—trad­ing, and getting on to the next deal.

2.    There’s always another cab (or bus or train). I once read an old Irish proverb that makes sense here: “the biggest fish you’ll ever catch is still swimming in the ocean.” I’ll add, “you’ve got to be out fishing to catch it.”

Remember, my style is to turn the stock market into a business. No business buys inventory to keep. The profits are in the selling process.

With all this in mind let me move on to the strategies that have helped me get rich. Remember, I use various formulas and processes, rules, if you will, to get me in and out. Each has a distinctive nature, and only occasionally are the rules the same. For example, selling a call on a covered call play is totally different than selling stock on a rolling stock play.

This chapter is about exiting. Obviously there will be more on getting into the stocks in the various other chapters on these formulas.

Let’s start with my old favorite, rolling stock.

If you want to play more options on this same company, consider the following:

Wait for dips—be patient. Study the charts and pick the most opportune strike price and expiration date.

Sell out, take your profits, and buy back in at a higher strike price. Once again, the assumption has to be that the stock will increase.

 

Selling the option profitable opens up another possibility. If you sell part of your position, and if you think the stock has peaked (you still own a few call options) then buy a put with the profit. You now have created a straddle for FREE.

A pure straddle is one where you own calls and puts on the same stock, at the same strike price, and for the same month. Your straddle does not have to be pure. You can buy a call at one strike price, and buy a put at another strike price.

Either way, as the stock moves up you sell the call, as the stock moves down you sell the put. Something for nothing, I can’t add more. It’s a great way to enhance your cash flow and/or add to your portfolio.

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.

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.

This article was written to dispel the mystery of “put” options and give several serious strategies for generating cash flow from either buying or selling puts.

A put option, as opposed to a call option, gives an investor the right to sell a stock. We will be concerned with stock options only in this chapter. A put option could be defined in street jargon as the right to “put it to someone.” You would want to put a stock to someone when you can purchase the stock at a lower price and sell it (immediately) at a higher price. For example, if you notice a stock consistently climbing above $30 to $33 or $35, and it not only has a hard time getting to the higher level, but also has a hard time sustaining the higher price, then you may want to buy a $35 put. As the stock comes back down, your “right” to sell the stock for $35 increases in value. As with call options, I do not buy the option to sell the stock. I buy the option to sell the option.