Stock Market Savings

Sell Put—Buy Call

If you sold the put for $2.50 ($2,500) and bought the call for 25*2 ($250), you would have a net in of $2,250. Now, as the stock increases, you can either buy back the put or just let it expire (in most cases). The call could now be sold for $1.50 or $1.75, generating more income.

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.

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.

It’s about cash flow and a rather unique way of getting it. Everyone has heard that you can make money in any market, but the people saying so fail to give details on how to do it. More specifically, “they” say you can make money whether a stock is going up or coming down. I want to give some specifics on how to make money in options where the stock is increasing or decreasing in value. This is an option chapter. We will explore a cash flow generation strategy which will deal with stocks that you hope are going up—or will at least stay the same. Note: see the chapter “Tandem Plays” for doubling up these strategies.

Selling (naked) puts is a very unique and seldom-used strategy with a host of benefits. We will put some flesh on this skeleton, and some muscle, give it a brain and put it to work for you.

Definitions are in order. Stock option investing gives an investor the right, but not the obligation to buy or sell a particular stock at a set price (strike price) on or before a certain date. Call options give the investor the right to buy a stock. These options can be bought or sold. Put options give the investor the right to sell a stock. They, too, can be bought or sold.

Strike prices for all options are the same. They start at $5, and go up by $2.50 increments to $25, in $5 increments to $200 and in $10 increments thereafter. Options are written in 100 share contracts. Hence, a 75cent option will cost $75 for one contract. Options are derivatives. A derivative is a proxy investment based on an underlying security. Stock options are different than most derivatives in that the investor actually has the right to take control of (own by purchasing or selling) the underlying stock.

Options end—they expire. Because they are a fixed-time investment, investors should not only be wary and very cautious, but should invest in options by keeping an eye on the time clock. You may have the best horse on the track but if it falls behind or gets a bad start, the race may be over before it begins. The price of the option is broken into two parts. Part of the premium is actually purchasing the time until the option expires. This is called time value. If the stock price is above the strike price (call options) or below the strike price (put options), the option is said to be “in the money.” That portion of the option which is in the money is called intrinsic value. I will use several examples and this definition will come to life. Understanding time value (extrinsic) and intrin­sic value is not only important, but sine qua non to effectively making decisions on which option to purchase on a particu­lar stock.

Put options, and a particular angle to using them, is the topic here. Let’s keep exploring them. If you purchase a put option, you are thinking (hoping) that the stock will go down. What if, however, you don’t think the stock is going down? In fact, you think the stock is a winner. Is buying the stock or buying a call option on the stock the only way to take advantage of an increasing stock value?

No, selling puts is another strategy which accomplishes two major objectives:

1.    It generates new income.

2.    If you have to buy the stock, it lets you buy wholesale.

There are other minor strategies which allow for even greater returns.

Most of my stockbrokers are so busy they won’t do this strategy, however, the ones who really watch out for my best interests, will.

WANGO means Watch And Get Out. Let’s say a stock is having a nice run up. You are quite profitable on your option but want to get out at maximum profit. Ask your stockbroker to keep an eye on it. If it peaks and you can catch it at or near the peak, then you can get out with an even greater return.

An example: the stock was at $80 after a slam, or other bad news, or even after good news. It goes to $81. You call your stockbroker and buy the $80 calls for $3 and the $85 calls for $1.25. The stock goes to $83, then $84, and one hour before the market closes it’s at $85—almost $86. The stock hangs around $86, seems to have stalled, backs off to $85.50 with 10 minutes before the close—this is it—(yes, there is tomorrow but this is today). Carpe diem. Seize the moment. Sell and take your profits. The $80 call is $6.25 and the $85 call is $3.75. That’s a $3.25 profit on the $80’s and a $2.50 profit on the $85’s. It’s been a nice day.

Yes, it may still go up tomorrow, but many times they fall back. This stock had a 3%, then 4%, then 5% run up in one day. Surely I can’t tell you what to do, but I usually take my profits and wait for another dip.

Two more points:

A. The options market closes ten to fifteen minutes after the stock market. If you are willing to buy at the ask and sell at the bid (buy or sell at the market), you can still trade options at 4:05 pm, 4:10 pm, sometimes even 4:15 pm (Eastern time). Why do I bring this point up here? Many times, stocks go up or down a few dollars right at the close. If the options have a corresponding move, you could get out at a higher price or get in at a lower price.

However, unless there is really spectacular news (good or bad) which comes out over night, the options are usually pretty much the same the next morning. Just once in a while, I do option trades after the stock market closes.

B. If you have a good profit you could sell part of your position and keep part active. You don’t have to sell all four contracts you’ve purchased. Sell part to capture some profits now and keep some to cap­ture larger profits later.

You might even be profitable enough on the ones you’ve sold to regain all the money spent on all four contracts—you now own the two contracts you’ve kept, for free.