Stock Market Savings

Damage Control

You can’t say that you have unlimited risk in selling puts because the lowest the stock can go is to zero. That is your downside. If the stock is below the strike price, it will get put to you.

You have one other strategy that can be played right up to and through the expiration date. It is called “rolling out.” Here’s the way it works. Let’s say the stock is at $46. Last month you sold the $50 put for $2.25 when the stock was at $48.50. You had hopes it would go up. It hasn’t. If you have to buy the stock, your basis will be $47.75, as you have received $2.25. One problem is the heavy duty amount of cash you’ll need to purchase the stock—even $25,000 on margin.

You think you could find a better use for the money. The put is currently $4.25—buy it back. Actually, you’re just purchasing the same put (strike price, month) as you sold. This will close the position—it’s a wash on your broker’s computer. If you had ten contracts, you would have lost a little over $2,000 after you add up the commissions. You could just end it here, but don’t. There’s another play.

Remember, you liked this company’s stock at this price. Check it out. Is the story line still in place? Yes, it didn’t go above the $50 like you planned—at least, not yet. If you still think it will do so, roll on out to the next month.

Let’s continue. Try to catch the stock on a dip—even if in a roll or slam in trading. Say it’s going between $46⁵/8 and $46^3/4. It occasionally drops to$46²/8. At that point sell the November $50 put. It’s going for $4.50. That’s $4,500. You’re back in the money again, and you’ve made a profit.

If you don’t think it will go above $4.50, look at the $45 put. It’s going for $2′/8, or $2,125. If you sold this you’d about break even on the original loss. Yes, you have an open position to buy the stock at $45, but your homework says it will go up.

Another method would be to split the contracts. Say, sell five of the $50 puts and five of the $45 puts. You should and could consider purchasing $45 or $50 calls. Maybe the $45s for November, and the $50s for February.

It keeps going down. Believe me, there will be an end to this—you will eventually make money. The next month the stock is at $44. Let’s stick with the $50 puts as that will be most drastic. You sold the November 50 puts for $4.25. It will cost $6.50 to buy them back. This purchase will throw you back in the loss column. Not by much, though.

You’re sure, this time, that the stock will turn around. It just has to (or so you hope). So spend the money—$6,500. Now the December $50 puts are going for $8 and the $45s are going for $2. Sell the $45 puts. You’re profitable again. Also, look at the $40s—there might be some premiums there.

Now the stock moves back up to $47. Your December $45 put expires worthless, and you’ve made over $2,000 for all this trouble.

This could go on several months—but sometime (hopefully) the stock will turn around. When it does, you end it and keep the best batch of each. When you buy back this month’s put, you can always sell the next month out for more money.

And Finally

There are two more considerations.

1.    You may want to consider only selling, or at least primarily selling out of the money puts, i.e. you sell the $50 put when the stock is at $52. This gives you a cushion. The problem is that the premiums are smaller and you have to weigh out the amount of margin tied up for the smaller option premium.

2.    Stick with stocks in the $5 to $25 range. Selling puts and writing calls have a lot of the same risk/reward features—only in reverse. If you want nice premi­ums on stocks which won’t kill you to buy, the lower priced stocks may work better.

Remember, when you sell you have many ways of making money (see “Tandem Plays”). When you buy call options or put options you only have one. This rolling out strategy lets you stay in the game until you make money.

It’s simple: you generate cash whether you have to perform or not. If you do have to buy the stock, you purchased it at a less expensive price than otherwise. I love selling puts because you get the best of both worlds—cash now and wholesale prices.

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.

I know this sounds ambiguous but it’s important to realize that there is not just one time to get out. If you have invested $2,000 in ten contracts of a $2 option and one hour later it shoots up to $3 or $3,000, you have an hour profit of $1,000. If YOU’RE HAPPY, then get out. Take your profits and go to a movie.

Of course you shouldn’t get out if there’s more potential, but if this was initiated as a quick play, then take your profits and look for another deal—dips, new stock splits, et cetera. So what if it goes to $4. The next day it could be at 50tf.

Stocks and options are like ocean waves. They ebb in, they flow out. Nothing stays the same.

There are many opportunities in stock and option invest­ing to get a free ride—ownership of an investment which cost nothing. It may have taken a shrewd play to make the profits needed to now have ownership in an option or stock with no outlay—or, at least having all your initial investment returned and ready to go to work again. The process of making back you initial outlay and then using profits to stay in the game is “Infinity Investing.” Remember, you cannot divide by zero. It is physically impossible. If you have no cash tied up, you can’t lose—except to the extent that you have an opportunity lost, in that your money might have done better elsewhere. Obvi­ously, there is a cost because you could have moved the money elsewhere. Your cost is “what else could you have done?”

For the strategies in this chapter, we begin with the as­sumption that your investment in stocks or in options (whether calls or puts) has grown in value, at least enough of an increase to cover the spread between bid and ask—in short, to be profitable. Now, we are going to sell all or part of the invest­ment. What we do with this profit and the calculated returns is out topic. Let’s start with stocks.