Stock Market Savings

If the stock is $13.50, you get at least $1.50 for the $15 put because that’s how much the stock is in the money. Let’s say you sell ten contracts. That will generate $1,500. However, that is all intrinsic value. Depending on the time to expiration, there will be added to this the time value, perhaps another 50c. That’s $2 or $2,000. The cash will be in your ac­count   the   next trading day.

 

Stock Price	Strike Price	Option Price
$12.50	$15	$3.50
13.00	15	2.75
13.50	15	2.00
14.00	15	1.25
15.00	15	0.75
15.50	15	0.25
16.00	15	0.125
17.00	15	No bid

 

You now are obligated to purchase 1,000 shares of this stock at $15. I’ll discuss movement and what we have accomplished, but to do so we need to see the relationship between the stock and put option prices.

Obviously, these prices are a snapshot in time. The option prices would be significantly higher if we went out several months, and significantly lower if the stock is not close to $15, or if it’s just a few days until the expiration date.

Back to the strategy. Again, we have obligated ourselves to buy this stock at $15. We have made $2,000 cash and it is in our account. We now play the waiting game. The big question is this: Are we willing to buy the stock at $15, or do we want to buy the stock at all? If the answer is no, then you probably should not have sold the right to someone to sell it to you at $15. Simply put—you had better like this company, AND LIKE IT AT THAT PARTICULAR PRICE, or you should not have done this.

Okay, you have $2,000 cash in your account, now what do you want to happen? If you don’t really want to buy the stock (which is my desire in about 99% of the cases where I’ve sold puts), but wouldn’t mind, then you hope the stock goes up.

If the stock moves above $15 (or close to $15), the stock won’t get put to you and you get to keep the money ($2,000). Remember, that was a deciding factor—you thought this stock was going up.

If the stock doesn’t perform this way, then you will now own the stock. It will be in your account, the Thursday after the third Friday of the expiration month. Before we explore briefly what you can do with the stock, let’s look at what happened.

Okay, here we go. A stock is at $13.50. You really like the company. You think this stock could easily go to $18 or $20. You think this because:

1.    The stock is rolling between $13 and $20, and has done so frequently. You know this from looking at its chart.

2.    You have heard good news from the company— i.e., new products, expansion, great earnings, et cetera.

You could buy the stock or buy the $12.50, $15 or even $17.50 call options. If the stock rises as expected, the value of your investments increases. Both of these choices require an expenditure of money. If you buy the stock on margin, you only have to put up a percentage of the money (in most cases 50%). I bring this up here because margin requirements will be necessary when selling puts—see the section on “cash requirements.”

Let’s not buy the stock or call options. Let’s sell a $15 put, or even the $12.50 put, if you think the stock may go down further. What does this mean? Let’s use the $15 put example first. If you sell a $15 put, you are literally committing yourself to buy the stock at $15. You no longer have just the right (as in buying an option), you now have the obligation to perform, if the stock gets “put to you.”

You see, by writing a put (selling), you have given someone the right to sell you the stock at $15. They don’t know who you are—all they have done is purchase a put option—giving them the right, not the obligation, to sell the stock to someone at $15. When would they do this? When the stock is below $15. Now, if the stock is at $14.75 or $14,875 on the expiration date, it’s iffy whether or not it will get put to you. (See “Selling Calls” in the Wall Street Money Machine for more information on the execu­tion of these close orders.) However, if the stock is at $14 or $13 it will get put to you at $15.

What did you get for selling the put? And when will you get the cash? The premium you receive is determined by how far the strike price is in the money or out of the money, and how long until it expires.

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.

This formula requires volatility, but we also like predict­ability. I’ll encourage you once again to subscribe to a charting service. (I use Telechart 2000® by Worden Brothers. Wade Cook Seminars has a start-up kit for sale. Call 1-800-872-7411. It’s inexpensive, but invaluable.)

To begin, you track a stock. Let’s say it continues to peak (hits resistance) every time it gets to $35. Obviously it could break out at any point and go to a new high, so make sure you can stand the risk, but for the past while it hasn’t gone above $35.

 

Stock Price	$30 put	$35 put	$40 put
$34.75	$1.50	$3.00	$6.75
34.00	1.25	3.375	7.25
33.00	1.75	4.00	8.125
32.00 30.00 28.00 27.00	2.50 4.00 6.00 6.75	4.75 6.50 7.875 8.75	9.00 10.50 12.50 13.50

 

For quite a few months $35 has been the high. Buy the $35 put, or if you think the stock is going to go way down, play the $30 put. Let’s say the stock is at $34³A. The $35 put is $3. That’s a fairly high premium. Very little of the option premium is in the money with this put. “In the money” means the stock is below the strike price. In this case, just 25c is in the money. We check the $30 puts and they’re going for 75$. They’re cheap because the stock, at this strike price, is so far out of the money. The stock has to take a big move down­ward for you to get to the $30 strike price. Now remember, the stock doesn’t have to get to $30 to make money on the option. Depending on the time left to expiration, your option could double to $1.50, then go to $2.50 on a one or two dollar down-tick in the stock. You can sell at a profit anytime, and you can sell the option anytime before it expires.

Now check the $40 put. (To check if one exists, see if a bid and an ask are being written.) It might be going for 6V2 x 6³/4 bid and ask. Think of this: the stock is at $34³A. It’s $5.25 in the money ($40 strike price minus $34.75 = $5.25). Part of your put option premium is intrinsic value ($5.25). The balance is time value. You’re paying $1.50 ($6.75 – $5.25 = $1.50) for time. This is also referred to as extrinsic value. It’s what you’re paying for the time needed for this stock to do something.

This strike price is so far in the money that the relationship between the stock movement and the option movement may be in close ratio. (See Delta Formula in the Wall Street Money Machine.) The stock goes to $33 and your $6.75 option goes to $8. (A $1.75 downward movement in the stock increases your option value of $1.25 up to $8.) Now the stock goes to $30 and your option is worth $11. A nice relationship—a nice profit. Sell it for a nice gain. Even if the stock continues down you have a nice profit. (If you still think it hasn’t hit bottom and you still have time before the expiration date, you may want to wait and try to get $12 or $13.) You’ll kick yourself if the stock starts back up. As the stock price rises, the value of your $11 put option decreases.

Take the profit and use some of it to buy a $30 or $35 call option, or get in on a different play.

1.    Options are a fixed time investment.

2.    You should be doing this with money you can afford to lose.

3.    You should choose a month far enough out for the stock to perform as you hope.

I really like in the money options, but not too far in the money. The $40 put in the last example looked nice, but to double our money we need a large movement in the stock.

$6.75 to $12 or $13 requires a stock at $27 or $28.

No, I don’t have to double my money on the option to be happy—a 20 to 40% profit in a few days is just fine—but it is a calculation I make in my head. Some stockbrokers have a computer model which gives a “% to double” to see how much of a movement is needed in the time available.

 

Stock Price	$30 put	$35 put	$40 put
$34.75	$1.50	$3.00	$6.75
34.00	1.25	3.375	7.25
33.00	1.75	4.00	8.125
32.00	2.50	4.75	9.00
30.00	4.00	6.50	10.50
28.00	6.00	7.875	12.50
27.00	6.75	8.75	13.50

 

The $35 put and the $30 put require much smaller move­ments to be profitable. Look at the previous diagram to see a comparison.

Look at the tremendous leverage in the $30 put. Obviously you can lose if the stock doesn’t move way down, and obvi­ously there’s some safety in the $40 put—because it’s so far in the money, but you get your greatest bang for the buck on the cheaper options.

Also note: in rare cases there may be $32.50 puts and $37.50 puts. You could check and see.

Next point: you should check the option price for several different expiration dates. Look at your charts and make sure you give the stock/option plenty of time to move. If it goes through adverse swings, you still have time to recover.

What if the value of your option goes down? You have three choices:

1.    Wait it out (perhaps get in your order to sell at a price you like, so you don’t have to check on it every day).

2.    Sell it at a loss and lose all or some of your money.

3.   Buy more at the lower price. Jump back in if you still like the story.

 

Examples:

Ford (F): Rolls between $27 and $33. At the time this chapter was written it had broken out to $35. Maybe it will go back down, or maybe it will establish a new roll range or climb to an all time high.

Synopsys (SNPS): This has been a per­sonal favorite. Before it split (2:1) in the sum­mer of ‘95, it was rolling almost weekly between $56/$57 and about $64/ $66. It was incredible. Since the split it has established several ranges. $32 to $36 and $28 to $32, and $38 to $42.

G a y 1 o r d Container (GCR)rWehave also used thisone as a covered call stock. It’s very good. Look at the rolling range between $8 and $11.

Microsoft

(MSFT) is so often in the news that it’s a natural. When this chapter was written it was rolling between $98 and $104. This has been a great cash flow machine. I wish it would never quit—except for perhaps a new stock split just seconds after it dips and I’ve loaded up on call options—well, I can have dreams, too.

The development of this formula has its genesis in my rolling stock strategy. Play options on stocks trading within a specific range. I like the less expensive stocks because it doesn’t take too much movement to make a great profit. However, most stocks that are doing nice, steady rolls between a high and a low are in higher dollar amounts, say between $27 and $33, or $98 and $104. It would take a lot of cash to buy them, and there just may be better uses of our money. If the roll continues, there is definitely a better way to play the roll: proxy investing. Do options on stocks that trade within a certain range.

The strategy is simple: buy call options when the stock is low and wait for the roll up. Next, sell the call option and then buy put options when the stock peaks. Take your profits when it rolls back down. I’ve written about this concept elsewhere so I won’t belabor the call play here. Let’s explore the put strat­egy-Volatility and predictability and using the extra cash you can afford to lose, bring a higher degree of certainty to this risky arena. This is a tremendous formula in which you can get to be an expert.