Stock Options: Deep in the Money Calls Discussion
04-03-2007, 04:11 PM
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Stock Options: Deep in the Money Calls Discussion
Discuss so that I may learn. Obviously, I do not have plans to do anything like this, but I would like to keep an open mind and always learn new things.
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http://www.thestreet.com/pf/comment/.../10260898.html
Regardless of how long you have been investing, there is always more to learn, new products to understand, altered market conditions to consider, and different investment strategies to suit your changing lifestyle.
Obviously, the main goal of this column is to provide information that enables you to increase your wealth, hopefully in a substantial fashion. Rather than merely providing you with "tips," I believe it is in your best interest to understand the thinking behind the tips. Moreover, recognizing the various vehicles available to you as an investor helps to create lucrative opportunities. To that end, I would like to review my strategy for using deep-in-the-money calls.
Of the numerous emails I receive on a daily basis, unequivocally the most frequent request is for me to explain how to capitalize on in-the-money calls. For many, options remain the most misunderstood investment vehicle out there. But the "buy and hold" days are gone! The sooner you all realize that, the more frequently you will be depositing money in your account! In order to be a winning trader, you have to be willing to change with the times.
Before we get to the nitty-gritty, let me say I relish the opportunity to communicate and interact with you through this vehicle. I am humbled by the large volume of complimentary emails that I have received in support of my column.
I also appreciate, albeit in a different way, the negative emails that I have received, questioning my credentials and my picks. I realize that I am still a rookie, who has to earn respect through sustained performance. Again, I would like to thank TheStreet.com for providing me with this opportunity. I look forward to 2006, where I plan to write regularly about my in-the-money calls strategy, beginning with today's overview.
Understanding the Options
Despite a heightened interest in options, most people do not take full advantage of what options have to offer. By and large, options are considered the ugly stepchild of the investment world. If more investors only did their homework and took the time to understand: This is one of the few areas, you, the retail investor, can find an edge.
If you use and truly understand options -- especially, deep-in-the-money calls -- then you can join the minority of options traders who actually make money on a regular basis. You can become a very wealthy person by just grinding away, finding deep-in-the-money calls where there is very limited downside, with a chance for a whole bunch of upside.
Unfortunately, people who "play" options as a tool for speculation usually get what they deserve. Most people will "take a flyer," and buy an option that is out of the money because they are cheap and it seems easy. They would probably be better served buying a Lotto ticket. (Out-of-the-money calls -- which give the holder the right to buy an asset at a predetermined price -- have a strike price higher than the current market value of the underlying asset. Out-of-the-money puts -- which give the holder the right to sell at a predetermined price -- have a strike price lower than the current market value. For a list of options definitions, please check out the glossary for TheStreet.com's Options Alerts newsletter.)
# Therein lies the reason why most investors lose at options; the majority of volume is short-term, out-of-the-money, cheaper options. In reality, the premium is more expensive and would require almost perfect timing, which leads me to some very important information: I will be writing only about deep in-the-money calls. If someone sends me an email about any other kind of option, I will have to pass and you should look into TheStreet.com's Options Alerts newsletter, written by Steve Smith.
# In order to trade options (or futures), the Commodity Futures Trading Commission (CFTC) requires that a broker provide you with a disclosure document that describes the risks involved, according to the CFTC Web site. You will have to sign the disclosure document before the broker can accept any funds and/or make any trades. I strongly recommend you read this whole booklet, cover to cover, before you trade a single option; if you don't understand what you're doing, you will lose money!
In that same spirit, I strongly suggest you learn about deep-in-the-money calls before you put your money down. I will explain, as best I can, how a deep-in-the-money call works and would like to thank my broker, Paul Hollins of Wachovia Securities, for teaching me the power of options: the ability to control hundreds of thousands of dollars' worth of stock for minimal risk. (Paul is the brother of Dave Hollins, my best friend and former teammate with the Philadelphia Phillies.)
In and Out of the Money
The strike price, or exercise price, of an option determines whether that contract is in the money, at the money, or out of the money. If the strike price of a call option is less than the current market price of the underlying security, the call is said to be in the money; the holder of this call has the right to buy the stock at a price that is lower than the price he would have to pay to buy the stock in the open market.
As I have made clear over the last several months in my columns, when it comes to options, we will not be recommending anything but in-the-money calls.
The beauty of in-the-money calls is the leverage they provide, which allows you to control a stock with significantly less money at risk vs. a cash or (certainly) margin purchase for that same stock. Your risk is limited to the cost of the in-the-money call, compared with buying the stock with cash or on margin, which is a very dangerous game that I strongly suggest you avoid playing.
If you're just beginning, make sure you buy deep-in-the-money calls at least four to six months away from your strike price. If you get the anticipated move, your in-the-money call will capture more of the move. If the stock moves against you, the longer-term option has more time to recover.
My strategy for in-the-money calls is to employ them when companies with solid fundamentals are being (in my eyes) overly punished on Wall Street for one "transgression" or another. My theory is that this overreaction will eventually correct itself as the value of the company reasserts itself over time; those who buy deep in-the-money-calls in advance of this correction will be rewarded.
Remember, it takes only one or two bounces, or spikes, in the stock for you to make a profit. But you must act! Options can be very volatile, so if you want to be a winning trader, you need to stay on top of your open positions. Remember, if you don't have the time to watch your stocks all day, you can always put a good-till-canceled (GTC) limit order in to capture the profit you are satisfied with. Don't be greedy, a win is a win, especially in options, because you always have time working against you.
For example, I repeatedly recommended the Symantec (SYMC:Nasdaq) April $15 calls, most recently on Nov. 28 when I wrote:
If you bought 10 of these calls for $3.40 per on Nov. 25, with the expiration date being Friday, April 21, you enabled yourself to control 1,000 shares of Symantec stock at the price of $18.40 (the strike price of $15 plus the option premium of $3.40). Bottom line: For $3,400, you are now in control of 1,000 shares of Symantec until April 21, as opposed to spending $17,640 for an equivalent position in the common stock. What's more, this opportunity comes in a company with a forward P/E ratio of 15.24, $4.43 billion in cash, and $842.7 million in free cash flow. All I can say is, "Lock and load!"
If you followed that advice, you're sitting pretty now as those options settled at $4.45 on Friday. I personally bought 50 Symantec April $15 calls in November for $2.90 for a total cost of $14,500. I sold them at $4.20 on Dec. 4, netting a profit of $6,500. (Remember, an options contract represents 100 shares for one equity option unless it has been adjusted for a special event such as a stock split or dividend.)
Symantec is a perfect example of how deep in-the-money-calls can give you upside exposure to a high-quality stock experiencing short-term weakness.
A second example, ConocoPhillips ( COP :NYSE) , was a stock I wanted to own. I felt it was oversold and being unfairly punished for the Burlington Resources acquisition. But the price to buy the common stock was (and is) just too high. The only way I was able to participate was because I have learned how to use in-the-money calls.
On Jan. 5, I bought 10 May ConocoPhillips calls at $10.70, which I summarily sold the next day at $11.90, netting a profit of $1,200 in just one day.
For my next trick, which hopefully will also be a "treat," I bought 10 Wal-Mart (WMT:NYSE) June $40 calls for $6.70 Monday morning. At this price we're only paying 82 cents in premium to control 1,000 shares.
The end result: For $6,700 (the maximum investment, no matter what happens), we are in control of $45,880 worth of stock of the world's largest retailer, all the way until the third Friday in June.
Why Wal-Mart? With a forward price-to-earnings ratio of 15.40, return on equity (ROE) at 22.79%, and free cash flow coming in at $4.8 billion (yes, that's with a "b") we agree with the title of a Dec. 12 Barron's article: "Wal-Mart's Still a Bargain."
Given our view that the market will come back to re-embrace this world-class company, we will stick with our game plan and buy deep-in-the-money calls.
Remember: Life is a journey, enjoy the ride!
Obviously, the main goal of this column is to provide information that enables you to increase your wealth, hopefully in a substantial fashion. Rather than merely providing you with "tips," I believe it is in your best interest to understand the thinking behind the tips. Moreover, recognizing the various vehicles available to you as an investor helps to create lucrative opportunities. To that end, I would like to review my strategy for using deep-in-the-money calls.
Of the numerous emails I receive on a daily basis, unequivocally the most frequent request is for me to explain how to capitalize on in-the-money calls. For many, options remain the most misunderstood investment vehicle out there. But the "buy and hold" days are gone! The sooner you all realize that, the more frequently you will be depositing money in your account! In order to be a winning trader, you have to be willing to change with the times.
Before we get to the nitty-gritty, let me say I relish the opportunity to communicate and interact with you through this vehicle. I am humbled by the large volume of complimentary emails that I have received in support of my column.
I also appreciate, albeit in a different way, the negative emails that I have received, questioning my credentials and my picks. I realize that I am still a rookie, who has to earn respect through sustained performance. Again, I would like to thank TheStreet.com for providing me with this opportunity. I look forward to 2006, where I plan to write regularly about my in-the-money calls strategy, beginning with today's overview.
Understanding the Options
Despite a heightened interest in options, most people do not take full advantage of what options have to offer. By and large, options are considered the ugly stepchild of the investment world. If more investors only did their homework and took the time to understand: This is one of the few areas, you, the retail investor, can find an edge.
If you use and truly understand options -- especially, deep-in-the-money calls -- then you can join the minority of options traders who actually make money on a regular basis. You can become a very wealthy person by just grinding away, finding deep-in-the-money calls where there is very limited downside, with a chance for a whole bunch of upside.
Unfortunately, people who "play" options as a tool for speculation usually get what they deserve. Most people will "take a flyer," and buy an option that is out of the money because they are cheap and it seems easy. They would probably be better served buying a Lotto ticket. (Out-of-the-money calls -- which give the holder the right to buy an asset at a predetermined price -- have a strike price higher than the current market value of the underlying asset. Out-of-the-money puts -- which give the holder the right to sell at a predetermined price -- have a strike price lower than the current market value. For a list of options definitions, please check out the glossary for TheStreet.com's Options Alerts newsletter.)
# Therein lies the reason why most investors lose at options; the majority of volume is short-term, out-of-the-money, cheaper options. In reality, the premium is more expensive and would require almost perfect timing, which leads me to some very important information: I will be writing only about deep in-the-money calls. If someone sends me an email about any other kind of option, I will have to pass and you should look into TheStreet.com's Options Alerts newsletter, written by Steve Smith.
# In order to trade options (or futures), the Commodity Futures Trading Commission (CFTC) requires that a broker provide you with a disclosure document that describes the risks involved, according to the CFTC Web site. You will have to sign the disclosure document before the broker can accept any funds and/or make any trades. I strongly recommend you read this whole booklet, cover to cover, before you trade a single option; if you don't understand what you're doing, you will lose money!
In that same spirit, I strongly suggest you learn about deep-in-the-money calls before you put your money down. I will explain, as best I can, how a deep-in-the-money call works and would like to thank my broker, Paul Hollins of Wachovia Securities, for teaching me the power of options: the ability to control hundreds of thousands of dollars' worth of stock for minimal risk. (Paul is the brother of Dave Hollins, my best friend and former teammate with the Philadelphia Phillies.)
In and Out of the Money
The strike price, or exercise price, of an option determines whether that contract is in the money, at the money, or out of the money. If the strike price of a call option is less than the current market price of the underlying security, the call is said to be in the money; the holder of this call has the right to buy the stock at a price that is lower than the price he would have to pay to buy the stock in the open market.
As I have made clear over the last several months in my columns, when it comes to options, we will not be recommending anything but in-the-money calls.
The beauty of in-the-money calls is the leverage they provide, which allows you to control a stock with significantly less money at risk vs. a cash or (certainly) margin purchase for that same stock. Your risk is limited to the cost of the in-the-money call, compared with buying the stock with cash or on margin, which is a very dangerous game that I strongly suggest you avoid playing.
If you're just beginning, make sure you buy deep-in-the-money calls at least four to six months away from your strike price. If you get the anticipated move, your in-the-money call will capture more of the move. If the stock moves against you, the longer-term option has more time to recover.
My strategy for in-the-money calls is to employ them when companies with solid fundamentals are being (in my eyes) overly punished on Wall Street for one "transgression" or another. My theory is that this overreaction will eventually correct itself as the value of the company reasserts itself over time; those who buy deep in-the-money-calls in advance of this correction will be rewarded.
Remember, it takes only one or two bounces, or spikes, in the stock for you to make a profit. But you must act! Options can be very volatile, so if you want to be a winning trader, you need to stay on top of your open positions. Remember, if you don't have the time to watch your stocks all day, you can always put a good-till-canceled (GTC) limit order in to capture the profit you are satisfied with. Don't be greedy, a win is a win, especially in options, because you always have time working against you.
For example, I repeatedly recommended the Symantec (SYMC:Nasdaq) April $15 calls, most recently on Nov. 28 when I wrote:
If you bought 10 of these calls for $3.40 per on Nov. 25, with the expiration date being Friday, April 21, you enabled yourself to control 1,000 shares of Symantec stock at the price of $18.40 (the strike price of $15 plus the option premium of $3.40). Bottom line: For $3,400, you are now in control of 1,000 shares of Symantec until April 21, as opposed to spending $17,640 for an equivalent position in the common stock. What's more, this opportunity comes in a company with a forward P/E ratio of 15.24, $4.43 billion in cash, and $842.7 million in free cash flow. All I can say is, "Lock and load!"
If you followed that advice, you're sitting pretty now as those options settled at $4.45 on Friday. I personally bought 50 Symantec April $15 calls in November for $2.90 for a total cost of $14,500. I sold them at $4.20 on Dec. 4, netting a profit of $6,500. (Remember, an options contract represents 100 shares for one equity option unless it has been adjusted for a special event such as a stock split or dividend.)
Symantec is a perfect example of how deep in-the-money-calls can give you upside exposure to a high-quality stock experiencing short-term weakness.
A second example, ConocoPhillips ( COP :NYSE) , was a stock I wanted to own. I felt it was oversold and being unfairly punished for the Burlington Resources acquisition. But the price to buy the common stock was (and is) just too high. The only way I was able to participate was because I have learned how to use in-the-money calls.
On Jan. 5, I bought 10 May ConocoPhillips calls at $10.70, which I summarily sold the next day at $11.90, netting a profit of $1,200 in just one day.
For my next trick, which hopefully will also be a "treat," I bought 10 Wal-Mart (WMT:NYSE) June $40 calls for $6.70 Monday morning. At this price we're only paying 82 cents in premium to control 1,000 shares.
The end result: For $6,700 (the maximum investment, no matter what happens), we are in control of $45,880 worth of stock of the world's largest retailer, all the way until the third Friday in June.
Why Wal-Mart? With a forward price-to-earnings ratio of 15.40, return on equity (ROE) at 22.79%, and free cash flow coming in at $4.8 billion (yes, that's with a "b") we agree with the title of a Dec. 12 Barron's article: "Wal-Mart's Still a Bargain."
Given our view that the market will come back to re-embrace this world-class company, we will stick with our game plan and buy deep-in-the-money calls.
Remember: Life is a journey, enjoy the ride!
http://www.thestreet.com/pf/comment/.../10260898.html
04-03-2007, 07:08 PM
#2
Burning Brakes
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there's nothing special about buying deep in the money calls.
The only thing he mentions is the leverage (you can control more shares with the calls than you would buying the stock outright); but you're paying a premium for the leverage (not much different than if you bought on margin).
And of course, with calls, you cant lose more money than what you used (not 100% true).
But if the stock goes down, you lose a greater % of your money than if you had the stock outright (since you control a greater # of shares). Take his walmart example. If the stock declined from 46 to 40; if you owned the shares, you're down about 15%, but if you owned those 40 calls, your down 100%
The underlying thing about his strategy is he believes the stock is going to go up a good amount in the next 4-6 months. Its not easy to consistently be able to predict that kind of stuff.
If you're good at predicting that, & you wan't to use a call, whether you choose to buy an in,at,out of the money option should depend on how much you think it'll go up (not some set rule like "i always buy deep in the money options")
The fact that he's so much in love with this one strategy, and appears to not even consider alternative strategies makes me weary of him...
The only thing he mentions is the leverage (you can control more shares with the calls than you would buying the stock outright); but you're paying a premium for the leverage (not much different than if you bought on margin).
And of course, with calls, you cant lose more money than what you used (not 100% true).
But if the stock goes down, you lose a greater % of your money than if you had the stock outright (since you control a greater # of shares). Take his walmart example. If the stock declined from 46 to 40; if you owned the shares, you're down about 15%, but if you owned those 40 calls, your down 100%
The underlying thing about his strategy is he believes the stock is going to go up a good amount in the next 4-6 months. Its not easy to consistently be able to predict that kind of stuff.
If you're good at predicting that, & you wan't to use a call, whether you choose to buy an in,at,out of the money option should depend on how much you think it'll go up (not some set rule like "i always buy deep in the money options")
The fact that he's so much in love with this one strategy, and appears to not even consider alternative strategies makes me weary of him...
04-03-2007, 07:20 PM
#3
Moderator Alumnus
If you bought 10 of these calls for $3.40 per on Nov. 25, with the expiration date being Friday, April 21, you enabled yourself to control 1,000 shares of Symantec stock at the price of $18.40 (the strike price of $15 plus the option premium of $3.40). Bottom line: For $3,400, you are now in control of 1,000 shares of Symantec until April 21, as opposed to spending $17,640 for an equivalent position in the common stock. What's more, this opportunity comes in a company with a forward P/E ratio of 15.24, $4.43 billion in cash, and $842.7 million in free cash flow. All I can say is, "Lock and load!"
If you followed that advice, you're sitting pretty now as those options settled at $4.45 on Friday.
If you followed that advice, you're sitting pretty now as those options settled at $4.45 on Friday.
The stock closed at $16.99 today. So if someone bought in at the equivalent of $18.40 and the stock is less than $17.00, how are you "sitting pretty"?
04-04-2007, 12:04 AM
#4
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Originally Posted by Silver™
The stock closed at $16.99 today. So if someone bought in at the equivalent of $18.40 and the stock is less than $17.00, how are you "sitting pretty"?
and this whole concept isnt some earth shattering thing hah. i think he's just pointing it out to jim cramer mad money following joe schmo investors who want to get slightly more advanced. i took it as this is his strategy for companies he thinks are going up in the semi short term, as he states, 4-6 months. this strategy doesnt work for much else. (well, besides doing it with puts of companies you think are going to go down in price). the main point as Slinks pointed out earlier is the leverage. this is what you want to do with expensive stocks that you can't get leverage with (GOOG, XOM, basically anything above 50 bucks a share is hard to get leverage with)
i would love to see some angry emails he will get when people apply for options trading at their brokerage account, go out and try to replicate his tactics and then get burned because they messed up the timeframe and not to mention how volatile the markets been recently
04-04-2007, 03:38 AM
#5
Moderator Alumnus
Originally Posted by moonraker
he's not talking about the price of the common stock. he's talking about the price of the options contract. those trade just like stocks themselves and have their own options chains tickers. the price of any given monthly option contract fluctuates. in this case, it went from 3.40 to 4.45 so he sold the contracts, netting a profit
I had to reread it.
04-04-2007, 06:20 AM
#6
Burning Brakes
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btw...also the article is sales pitch rather than a risk/benefit analysis of in-the-money calls. If you're really interested in options do 2 things:
1. If you don't know more than the average financial planner about stocks, start reading some books (or websites like investopedia).
2. Start reading some options books
The stocks come first because for most individual ppl, an options strategy is just a leveraged play on the stock, so you need to know about stocks first.
I wouldn't venture into options until you feel confident about your stock picks...
unless you're trading options solely on technical factors, or short term options price inefficiencies (much tougher to do for the individual investor); in which cases you dont need to know so much about the underlying stock.
1. If you don't know more than the average financial planner about stocks, start reading some books (or websites like investopedia).
2. Start reading some options books
The stocks come first because for most individual ppl, an options strategy is just a leveraged play on the stock, so you need to know about stocks first.
I wouldn't venture into options until you feel confident about your stock picks...
unless you're trading options solely on technical factors, or short term options price inefficiencies (much tougher to do for the individual investor); in which cases you dont need to know so much about the underlying stock.
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