Archive for August, 2009
Have you ever suggested to your stockbroker that you were interested in trading options? More than likely he (your broker) tried to talk you out of investing in options. Quite possibly, he insisted that options were high risk and only professional traders should use options in their investments.
Well, let me let you in on a little secret. The reason why your broker doesn’t want you to trade options is because your broker does not know how to trade option properly. Understand, most stockbrokers are sales people, not investors. They offer what is hot in the market and usually push you towards managed money. The reason being is because your stockbroker gets paid to direct your capital into funds where portfolio managers manage stocks and bonds in anticipation of beating the market indices.
A true investor and some very well trained stockbrokers (hard to find these brokers, but there are some out there somewhere) will tell you that option trading is a very lucrative investment and less risky than what your broker is suggesting. Option trading strategies can increase your return on your overall portfolio by leveraging and insuring the stocks in your portfolio.
Option trading strategies, range from creating income into your portfolio on a monthly basis, insuring any downside in a particular stock you may be holding in your portfolio and a way to leverage both the upside of the market and the downside, all at the same time.
Now, if you are like me and want to see your portfolio increase in value overtime, while having the opportunity for income, (which everyone reading this is probably saying no $#!t) then you need to learn all the option trading strategies that are available to you.
To give you an example of a great option trading strategy that you can implement right now is the selling of covered calls. This simple option trading strategy will allow you to take an underperforming stock in your portfolio and create a monthly income. How this option trading strategy works is as follows:
Step 1. You own a stock in your portfolio that is either stagnant in your portfolio (meaning not moving up or down), or the stock has dropped way below your purchase price.
Step 2. You sell a call option on this stock. Basically, for every 100 shares of the stock you own, you can sell 1 call option related to that stock. (Example is you own 500 shares of ABC stock, you can sell 5 ABC call option contract). This scenario is selling a covered call.
Step 3. You collect a premium from the sell of the call option. (These premiums vary depending on the volatility of the stock and the amount of time left on the option contract.
Step 4. Now you sit back and see what the market will do for you. For example, the stock may move down in value and the call option will expire worthless, meaning you keep the premium and sell new call options next month, or the stock stays stagnant and does not move during the month. Again you would keep the premium and write another call option against your stock. The last scenario is the stock starts to increase in value and you have to sell the stock for the strike price of the call option. Typically, if the stock you have has a high volatility, you probably would not use this option trading strategy. But, it is your decision.
Now, here are a few items I left out of the above scenario. You can sell your call options in the money, out of the money or at the money. We will discuss the terminology of these positions in a later article. But for now, I hope you see the value of option trading strategies in your stock portfolio.
Please come back soon to learn more about different option trading strategies to increase your overall return in your portfolio. You can also subscribe to this page and get future updates sent directly to your email box. Just click the rss feed at the right.
Here’s an article that recommends some stock options:
Here are a couple of options that might be the perfect thing for your portfolio.
Posted via email from alanmanns’s posterous
You pick up the phone and call your stockbroker to see how your portfolio is doing. He quickly tells you about a great stock that is showing some significant improvement in the market and he suggests you buy some of this amazing company that is trading around its 52 week low. He continues by stating how spectacular the profile of the company is. “Oh, you are not going to believe how strong the balance sheet is of this company” and “This Company is sitting on a huge amount of capital that will allow them to expand by acquiring other companies in their sector.”
Well, if this stock is ripe for the taking, why risk a large amount of money purchasing the stock. You see, there are many strategies you could be using as opposed to buying stock and letting it sit in your portfolio until you make a 10% or 15% return. Why not use option trading strategies to increase your cash on cash return?
One fundamental option trading strategy that can be used based on your stockbroker’s analysis of a great stock is purchasing calls. Purchasing calls is a way to really increase your cash on cash return. For example, you can buy ABC stock at a price of $30.00 in anticipation of making a 15% return over the next couple of quarters. Sure, it is possible for ABC stock, which is near its 52 week low, has a strong balance sheet and is sitting on a large amount of capital to increase from $30.00 to $34.50 ( $30 x 1.15 = $34.50), but why risk $30,000.00 on purchasing 1000 shares at $30.00 for a return of $4500, when you can buy 10 call option (for every 1 option contract, you will control 100 shares of stock) and control 1000 shares of ABC for a buy-in of between $1000.00 to $5000.00.
Now consider this, for every point ABC stock moves up, your call options will increase dollar for dollar. So if you purchased 10 calls options at $5.00 each and ABC stock moves from $30 to $31, your option will move from $5 to $6.
So let’s compare the return on a one point upward move in ABC stock:
- Purchase 1000 shares of ABC stock at $30: Your risk is $30,000.00
- Purchase 10 ABC call options at $5: Your risk is $5000.00
- ABC stock moves from $30 to $31: Your increase in cash for the stock purchase is $1000 and your % return on your stock purchase is 3%.
- Now compare the purchase of 10 ABC call options:
- ABC stock moves from $30 to $31: Your increase in cash for the 10 call option purchase is $1000 and your % return on your 10 call option purchase is 20%
As you can see, your cash on cash return is extremely higher by purchasing an option over purchasing the stock.
Before I end this article on the value of option trading strategies and the value of purchasing call option versus purchasing stock, let me be very clear… anytime you buy options, there is a time value or an expiration date on the call option contract or any option for that matter, whether you are buying or selling options. So understand, an option will expire worthless, so always give your self ample time to earn a return on the purchase of your call option.
Further, in regards to the information scenario above, we only discussed the upside and the return when the stock increases in value. You should also be aware that for every point movement downward, your call option contract will lose point for point with the stock, so make sure your decision to purchase call options is prudent with the understanding that the most you can lose in your trade is the price you pay for the call options.
Lastly, this strategy is best used for a volatile stock that has an obvious trading range. Our example above was based on a hypothetical company that was trading near its 52 week low.
Here’s a few links of interest:
- Stock Replacement Strategy – Introduction – Over on TheStreet.com, Jim Cramer and his partner James Altucher have created a couple of video segments regarding options and a strategy Cramer calls stock replacement. I’ve searched the internet for what stock replacement is and how …
- the best five option trading strategies – these are (in my opinion) the absolute best options trading strategies that minimise risk and give very respectable profits: selling credit spreads – with almost no work, and about 30 minutes a week, it is possible to grow your …
- Trading: Options Trading Strategies For Consistent Approach to … – Options Trading Strategies For Consistent Approach to Leveraged Trading. Options abound methods for the options trader. Options are very flexible trading instruments and are suitable for a variety of viable strategies. …
I can’t believe my stockbroker told me to do this…
My phone rang this morning and it was my stockbroker. He started to regurgitate everything I heard on the news the previous night. He was telling me how he believes that the market is overbought and that more than likely we are going to see a sell off in equities in the coming months. My stockbroker continued by saying how the financial markets are still seeing stress and more than likely we are going to see additional banks shuttering in the near future.
Now, I really don’t care that he is summarizing what he and I both heard the night before. What really irks me was what he suggested I do after he regurgitated the financial news. He suggested that I sell my equities and go into cash and wait out the market. I almost fired him for that comment. However, he and I are very close and I know he means well. Anyway, I had to back him up and explain that I would prefer to use the option trading strategies that are available to me.
He continued to express his position with what he was advising. I told him that there was no way I was selling any of my stock positions based on his fear of what the market may do in the future.
After much debate, I explained to my stockbroker that I was going to use an insurance policy to secure any downward movement in the market over the next 3 months.
How this option trading strategy works:
Anytime you are concerned about any downward movement in the market or an individual stock, you should purchase put options.
Let’s say you have a position in a great stock, but there is pressure on the upside, which in turn may drive owners into taking money off the table (sell their position and go into cash, kind of like what my stockbroker suggested). What you should consider is buying a put option for every one hundred shares of the underlying stock you own. This option trading strategy is like buying an insurance policy.
Purchasing put options allow the owner of the contract (the buyer) to actually put the stock to the seller of that contract at the strike price (or the predetermined price you are willing to put the stock to the seller of the put contract).
For example: Let’s say you own 1000 shares of ABC stock at $50.00 and there is news coming out about the company’s revenues and earnings. Now you are feeling a little unsure about the strength of the company, but think in the long term with the current management team and the superior product, you see the stock increasing in the future.
But, why risk a chance of bad numbers coming out of the company and dropping the value of the stock or why risk good numbers coming out and the stock increases and gets away because you sold your position too early. Why not purchase, in the case of this scenario, ten (10) put option contracts at $50.00. And let’s say those contracts cost you $3 per contract or $3000.00.
What this means is if the stock drops in value, you can put the stock to another investor (the one that sold the put option) at $50 and salvage most of your money.
The most you will lose is $3000.00 whether you sell the stock or keep the stock and let the option expire worthless.
The benefit of this option trading strategy is that the stock can drop to 0 and you will only lose the $3000.00 you spend to insure your position. But, if the stock increases to $53 you will be back at your breakeven point.
Not too bad of a risk position to secure your investment in your stock. Just imagine if you would have listened to my stockbroker and sold out your position and the next morning the stock opens up $5 higher.
This stock option strategy is great for insuring your stock position when you are not willing to sell or not wanting to sell.
Sure, there is a cost to buying your put options, but would you buy a home and not pay for home owner insurance? Or would you buy a car and drive around with no auto insurance? These are just some great reason and analogies when deciding next time whether or not to sell your position in a good or great company.
Here are some possible links of interest:
- InvestorGeeks » Blog Archive » Phil Town & INVESTools – I’ve become very interested recently in fellow investment blogger Phil Town’s site, and so I’ve been reading it from start to finish. After reading much of his site, I’ve come to enjoy his style of writing and investing. …
- Forex Trading Strategies – currency options – … out because right now, there’s a 50/50 split of bearish and bullish traders for the pound. So what do you do in these bearish/bullish instances? Well, there are a couple options trading strategies you can use to play both sides… …
- Options Trading Strategies – Book Review – Guy Cohen, The Bible of … – Options Trading Strategies – Book Review – Guy Cohen, The Bible of Options Strategies. Filed under: Wealth Building — Tags: Core Concepts, Option Strategies, Risk Reward — admin @ 8:02 pm. Clinton Lee asked: …