Stocks With No Options
March 31, 2005
The Smart Profits Report: Issue #196
Thursday, March 31, 2005
Stocks With No Options: A Cautionary Tale About TZOO
By Karim Rahemtulla
Investment Director, Mt. Vernon Research
A while back I mused about the value of put options on Travelzoo (Nasdaq: TZOO). You may recall Travelzoo as the hugely overvalued purveyor of travel services over the Internet.
At the time, the company’s market capitalization was about 50 times sales. Its price/earnings ratio was about 350. I recommended that short sellers should look to put options on the company… Or, if you had the heart to invest, you could have snapped up some call options. Trouble was, and still is, there were no options available.
Travelzoo, nonetheless, provides an invaluable lesson for traders - precisely because it doesn’t have options. As I’ll explain today, if you’re thinking about buying stocks with no options - especially a fast riser like TZOO - you might want to steer clear entirely…
Here’s why…
Two Ways You Could Have Played It
Were there options available on TZOO at the time, you could have used them to limit your risk - if you were in a gambling mood.
When I first panned it, TZOO was around $50. It subsequently soared to $110 and then fell back to $40, all in less than six months - quite a travel experience.
The reason for using options in this case would have been twofold:
- On the call side: You would not want to risk more than a few dollars because, as is the case with stocks that are more hype than reality, the moves up can be significant and quick, a chance to clean up by buying calls.
- On the put side: The move down can be just as quick, allowing for huge share price losses in very little time. On the put side - and here is where I think options really help, generally speaking - owning puts on Travelzoo would have limited your dollars at risk.
If you shorted the shares at $50, you would have been down $60 per share at $110. And if the shares went higher, you would have been on the hook until you covered. With a put option, your risk is limited to the amount you paid for the put.
The lesson here is that if you are going to play short-term volatile stocks, look to the options market. Volatility is the driving force behind options prices.
The only problem with this whole picture - AND the biggest complaint I had against taking ANY position in this farce (TZOO being so overvalued) - was that Travelzoo had NO options available at the time… and still does not.
No Options? Then the Stock’s Not One Either
If a volatile stock does not have options attached to it then there is less liquidity in the situation for traders.
Traders cannot hedge risk and are therefore subject to the vagaries of the market, manipulation, hype and pure investor insanity.
So, when you are pondering an investment in a fast mover, beware of the options market. If it does not exist, the same market that you are seeking to exploit could end up exploiting you.
Great Trading,
Karim Rahemtulla
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Today’s Smart Profits Cribsheet
- For more on Travelzoo, an increasingly dubious stock, check out Smart Profits #146, Timing Your Trades: Two Ways to Expand Your Thinking And Your Profits and Smart Profits #148, My Kingdom for an Option.
- For more on terms like "put option" and "call option," check out our free Smart Profits Glossary.
Related Articles:
- Stock Options: How to Buy $2,446 Worth of MSFT for $1,270
- Quote, Trade and Hedge… In Less Than 30 Seconds
- Options On ETFs: Increased Safety and Profit Potential
How I Use The ESP Profit System & to Make Millions for My Clients
March 25, 2005
The Smart Profits Report: Issue #194
Friday, March 25, 2005
How I Use The ESP Profit System to Make Millions for My ClientsBy Dean Albrecht
About 30 months ago, I created a computer program and introduced it to my private institutional brokerage clients, and it’s literally generated millions of dollars in profits for them so far.
I call it the “ESP Profit System.” ESP stands for EarlyWarning Stock Predictor and it’s an appropriate name, given the fact this system truly does have an amazing knack for knowing when a stock is going to move… by how much… and how quickly.
It uses complex computer modeling, similar to the systems weathermen use to predict storms… but in this case, it’s tracking individual stocks and funds, and telling us exactly when to buy and sell them for maximum profit.
Today I want to reveal the strategies behind the ESP system, and how you can use one of them in particular to find stocks poised to jump up or down, so you can play them long or short. This simple strategy can also help you choose what option play to use with any stock.
Let’s get to it…
Three ESP Strategies for Predicting Stock Moves…
First, let’s take a look at all three strategies that we have honed with our ESP system. Then I’ll go deeper into the one that often produces the most dramatic short-term profits…
Correlation: This strategy is where we identify the leading indicator or leading stock or index and we find which stocks are highly correlated to it. Simply, if we know what stocks follow other stocks or indexes, then we are taking part in a high probability occurrence.
Cyclical: This strategy knows the ranges of stocks or other instruments and looks to identify them within certain ranges. For instance, the QQQQ moves within a 7% range. Knowing this, our systems look for it to go up and down approximately 3.5% and then signals entries and exits based on these probabilities. It isn’t a sexy, exciting strategy however it is a high probability play that happens over and over again about 30 times per year.
Distressed or event driven: This strategy is based on our screening capabilities to look for stocks that have either gone up or down anywhere from 10% to as much as 50% in the recent past. Once these stocks are identified, our screener then adds another filter and looks for the stock to move into the entry point that we are looking for. With these types of issues, our systems automatically look for certain traits such as decreasing range and increasing volume. Other traits it tracks are upward momentum, if it is in a long screen, and downward momentum, if it is in a short screen.
Although we receive signals and issue both call and put recommendations using all three strategies, sometimes distressed or event-driven stocks are particularly attractive. The profits here can be massive.
Here’s why…
Let’s say that a stock ESP is tracking has gone up or down in value by 10% to 50%. This is a significant move. Even more so considering that such moves are occasionally followed by corresponding “corrections,” moves back into their normal trading range.
We have seen through our studies that once the stock begins moving back into its pattern - after recovering from the big move up or down - it can produce significant and predictable profit opportunities.
Back-to-Back Profit Pops… On “Distressed” Issues
This happened twice in the last month, in fact, with our research calls on the Biotech Exchange Traded Fund (BBH) and on Research in Motion (Nasdaq: RIMM), which is a cellular telephone and e-mail device manufacturer.
Both issues had retreated more than 10% and we were looking for opportunities in both. On March 1, 2005, RIMM was trading at $67, and we issued a recommendation to buy RIMM when it reached $62.
CHART: RIMM HITS OUR TARGET… THEN SOARS
We were looking for a pullback where we could enter the stock or option, which in our minds would offer us a margin of safety. Well, we got our entry price, and within days RIMM bolted up $19.
In the case of BBH, the price had retreated from the high $140s all the way down to $131.75 when we issued a buy signal on it and a buy signal on the call options on the BBH. And BBH moved north by over $11.
These are excellent examples of opportunistic plays to buy call or put options: good stocks that are experiencing a pullback but look to move back up. All it takes is a little buying interest and the potential to profit is outstanding.
ESP: Using State-of-the-Art Computers to Predict Profits
We currently have a handful of excellent candidates just like BBH and RIMM that our screens have picked up, and the profits could come fast.
If you want to take advantage of them you can by subscribing to our new “EarlyWarning Stock Predictor” service that I’ve decided to make available to a limited number of private traders - starting with readers of the Smart Profits Report.
For more on the ESP system, and the profits it’s about to generate for my high-net-worth clients, click here.
Great trading,
Dean
P.S. I’m convinced that the reason ESP works is that no human has anything to do with the recommendations this system produces. Everything’s based on quantitative research. Our program takes a particular stock - looks at millions of data involving past movement and activity - and then, through a series of algorithmic procedures, decides which direction the stock is likely to move, given its most recent activity. Not only does it tell us the direction - but also how high it’s likely to go… and in what time frame. The good news is, you don’t need to know exactly how it works to make a good deal of money from ESP.
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Related Articles:
- Option Trade Execution: Two Simple Steps for Getting Filled At Your Price
- Short-Term Options - Two Ways to Make Them Work
- ESP Profit System by Dean Albrecht
For more on the ESP system, and the profits it’s about to generate for my high-net-worth clients, click here.
Sphere: Related ContentPosition Sizing
March 21, 2005
The Smart Profits Report: Issue #193
Monday, March 21, 2005
Position Sizing: The Most Powerful Investment Concept
By Karim Rahemtulla
Investment Director, Mt. Vernon Research
I know it’s irresistible to back up the truck when you hear about a good play. We all feel that way when we find one of those special ones. After all, if I am confident enough to buy $10,000 worth of a stock or an option because I think it will double in price, why not take out a second mortgage and then buy it on margin to boot? After all, it’s a sure thing!
Before you take this kind of step, however, try to remember these two rules:
- There is no sure thing in investing unless you are on the inside… and even then you may really be on the inside, wearing stripes and trading recipes with Martha’s former cellmate.
- Don’t forget rule #1.
Over the years, I have heard many subscribers lament about how much they loved the story of Company X just to invest the bulk of their 401k or IRA into the situation. Or, how they knew so much about their own company that they decided to put most of their money in company stock. Then, when the situation did not pan out, they either lost it all (Enron, K-Mart) or got a 50% haircut. All the way down they kept repeating, “This can’t be happening.”
Well, it does happen, often. There is a solution, one that really works, but hardly any trader takes notice of. Every so often I ignore it, just to learn a hard lesson over again. The lesson is position sizing.
Sounds pretty exotic, almost what you would expect to see as a chapter heading for “Everything You Always Wanted to Know about Sex But Were Afraid to Ask.”
If You Don’t Get In Trouble, You Won’t Have to Get Out of It
Position sizing is the most critical and important lesson that I can share with you about investing. It is a simple concept, yet powerful. It’s the one practice that separates investors who succeed (especially in options) from those who periodically wipe out and either have to save up to start over, or just give up entirely. And, easy as it is, powerful as it is, most investors ignore it.
Position sizing means investing the same amount in every investment. Period. End of story.
Position sizing is easy. For example, let’s say you have a $100,000 portfolio. Instead of investing $80,000 in a fuel cell company and the balance across 20 blue chips stocks and options, you would be equally weighted across the board. So if you had 25 positions and $100,000 to invest, then you would put no more than $4,000 in each investment - including that incredible fuel cell company.
How to Turn a Mortal Wound Into a Mere Scratch
Sooner or later, you’re gonna get a bummer. It happens to every investor. But it doesn’t have to hurt anything significant - except your pride for a day or two.
Nervous amateurs tend to remember every loss and fret over each one. They are always trying to make up for it. They want to get even again. Then they get crazy. Successful pros don’t do that. They don’t get even; they stay even. The secret isn’t in better stock picks; it’s in better control.
Let’s say that your surefire investment in fuel cell stocks flamed out and fell by 30% overnight. If you had ignored position sizing and put $80,000 of your $100,000 portfolio in fuel cells, you would’ve lost over $24,000 in a heartbeat. In the position-sized portfolio, equally spread across 25 investments, your loss would only be $1,200.
But there’s a bit more to it than that…
How to Cheat a Little Without Breaking Rule No. 1
No matter how much people want to believe in theory, real life investing is different. Investors all too often invest emotionally. If you are one of these emotional investors, then use a more liberal version of position sizing.
Instead of position sizing with each individual stock or option, position size with sectors. So, if you are big on utilities or telecoms, then position size your portfolio in such a way that you limit your investment in each sector to something like 10%, and add a strict stop-loss system. That way you can be overweight in one company or sector, but not so overweight that you will need radical portfolio surgery to come back from the edge.
With this System, Safe Options Are Possible
Position sizing applies to options, as well. If you have a $10,000 portfolio devoted to options, then you should allocate it in a way so that you are not at risk more than 5% or 10% in any one position, for the safer longer-term options strategies such as LEAPS (long-term options) or covered calls. For short-term trades, which are riskier, 5% is as high as you should go. That way, with a good system, you will still come out profitable in the end as your winning trades carry you forward.
Position sizing in addition to a stop-loss will give you the kind of control over your fate that you can’t get any other way in investing.
Good Investing,
Karim Rahemtulla
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Today’s Smart Profits Crib Sheet
- For more on position sizing, check out Smart Profits #229, Option Position Sizing: How Much to Invest In Each Option Trade.
- Check out the Smart Profits Glossary if you find any options terms that you were unsure of, like “position sizing” or ” covered calls” in today’s article.
Related Articles:
- Position Sizing Safeguards: Prevent Corporate Lies From “Cooking” Your Portfolio
- Options On ETFs: Increased Safety and Profit Potential
- Portfolio Position Sizing: The “10% Rule” for Safe Option Profits
Trading Options 101
March 16, 2005
The Smart Profits Report: Issue #192
Wednesday, March 16, 2005
Trading Options 101: An Options Secret From a 20-Year Trading Veteran
By Karim Rahemtulla
Investment Director, Mt. Vernon Research
I often run into people who don’t participate in options because of fear. This past week I was in Delray Beach, FL, speaking at Investment U and many people approached me with this sentiment. The fear is not so much about the options strategies themselves, but the actual physical trading of options.
After all, there is a whole new set of terminology - contracts, expiration, Black-Scholes, premiums, puts, calls, bull spreads, collars, straddles, etc. - and it can be overwhelming.
I recall when I first delved into the options markets head first, a decade ago. I had the same apprehensions about learning something new and different - I mean, I was dealing with hard-earned REAL money. No paper-trading going on, just real trading.
I was serious about launching a trading service. And the only way I’d continue to put money on the line - mine or anyone else’s - was if I learned options by actually trading them. I knew that I had better be willing to put my money where my mouth - er, my pen - was.
Options 101: Advice From a Guy Named Herb
I looked at the books that were available and gleaned a little bit here and little bit there. For the most part the books were technical and boring. Granted, I had a good education with a master’s degree in business, so I had the right background. But it was still basically gobbledygook that most people, including myself, would not have the patience to wade through.
Instead, I turned to two sources for experience and advice…
The first was the actual options section of the Series 7 test that stockbrokers must pass in order to become brokers. That was helpful because it explained much about options strategy and terminology in a format that was conducive to those seeking a broad overview of the topic - but quickly.
The second source was an old, grizzled options trader named Herb.
Herb had been trading options for more than two decades and he was happy to explain the nuances of options trading that were not found in any school… but the school of hard knocks.
Much of that advice can be found weekly in the Smart Profits Report… but here’s the best advice old Herb ever gave me on options…
A Simple, Actionable Secret for Options Traders
Trade…
It was the best way to get my feet wet and the price was quite low. You don’t have to start with a million bucks, he said. You can buy one contract that is way out of the money and you might spend $50 total, just to understand the dynamics.
And if you want to do a covered call, start out with 100 shares of a cheap $2 stock and trade the $2.50 options - maybe put $300 at risk to understand the strategy. (It was the best $300 I ever spent.)
Today, I would tell you the same thing. You can paper trade all you want, but until you get your feet wet - even with the smallest trade - you will never get the feel for what options really are and how they work.
So, if you are pondering whether you should "try" options, my advice is to take it seriously and spend a little bit of money for a lot of education. Win or lose, it will be the best money you will ever spend in the market. And, who knows, it could be the beginning of a great new relationship between you and your money!
Good trading,
Karim Rahemtulla
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Today’s Smart Profits Cribsheet
- Check out the Smart Profits Glossary for definitions of terms such as "bull spread" or "Black-Scholes" found in today’s article.
- For more on option trading, check out Smart Profits #292, Buying Options: Like Owning a House Without Monthly Payments.
Related Articles:
- Maximum Fear: How to Turn "Maximum Fear" Into Maximum Profits
- Basic Trading Rules: The Four Rules of All "Smart Money"
- Market Maker Downtime: How to Make $1,000 On a Slow Day In the Options Pit
Market Maker Bids
March 14, 2005
The Smart Profits Report: Issue #191
Monday, March 14, 2005
Market Maker Bids: Outmaneuvering the Market Maker’s “Hidden Bid”
By Karim Rahemtulla
Investment Director, Mt. Vernon Research
Sometimes you might wonder who really regulates the options markets. Oftentimes, an option that is out of the money and not very liquid trades at a wide spread of zero on the bid and some amount, say $0.25, on the offer. What is the point, you may ask, of even having such a spread - or even a quote?
The market is telling you that the chances of the underlying stock moving to the strike or higher before expiration are zero, zilch, nada!
But wait… When you try to buy the “worthless” option at some ridiculous price, say $0.05, something strange may happen: You may be joined by a market maker on the bid. This happens sometimes with covered calls…
A Covered Call Bid Snafu - By A Market Maker
For example, let’s say you bought a stock at $20 a share and sold the July 2005 $22.50 calls for $1.
Then the stock goes down, and you wind up a month away from expiration… Now you look at the option’s current price and you notice that it is bidding $0 and offering $0.20. What this means is that you can buy the options for 20 cents and, if you sell, you get nothing.
However, if you decide that you want to close the position early and sell a further dated call, you could pay $0.20… or you could put in your own bid. Let’s say you decide to put in a bid at 5 cents.
All of a sudden, you will find out that you are not the only one who just “upped” the bid from $0.00. A competing bid could suddenly appear: The market maker’s!
Now, why is he seeking to buy the options at a higher price than he was just advertising (zero on the bid)? Is it just coincidence that his bid appeared at the EXACT SAME time as your order? Could you both be clairvoyant and know something about the market that nobody else knows?
The Hidden Bid and You - Two Traders Aiming to Cover
The answer is no. What happened was that there was a secret bid there all the time - just not advertised. It existed in the market maker’s head - that elusive “inside market” that exists for all securities (more on this at a later date). But it just was not shown.
The market maker, who is looking to buy the same options, may be short the options, like you - i.e. he sold the call to hedge his stock position. He is looking to cover a month early (he is, as they say, “buying to cover”) for a nickel a contract, just like you.
Why? Well, if you can cover a profitable trade at next to nothing (or a nickel) then you can close out the position early - and actually benefit if the shares move higher and you are able to re-sell the option.
So when you put in an order to buy the options at $0.05 for 40 contracts, another 45 could very well show up at the same price on the same exchange.
Guess who is going to get filled first? There oughta be a law!
How To Turn the Tables On The Hidden Bid
But here’s the good news… This “hidden bid” phenomenon works not only in the market maker’s favor; you can make it work in your favor, too.
If you are trying to sell an option with a bit of time left - be it a call or a put - that isn’t close to the strike price, you may see a ridiculous spread. You may say to yourself: It is not worth selling because the bid is zero or a nickel.
But if the spread is, let’s say, $0.05 by $0.40, you should enter an order at $0.15 or $0.20. And you just might get filled… because there could be a “hidden bid” waiting to snap up your offering.
And that’s how you use the market maker’s own “advantage” against him… a rare but satisfying occurrence.
Good trading,
Karim Rahemtulla
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Today’s Smart Profits Cribsheet
- Check out the Smart Profits Glossary for definitions of terms like “out-of-the-money,” “hedging,” or “maker maker” found in today’s article.
- For more on the Market Maker series by Lee Lowell, check out Smart Profits #205 , Market Maker Tactics: What Market Makers Really Do.
Related Articles:
- Options Market Makers: Two Rules for Beating the Market Makers
- Out of the Money Options - Buyer Beware, Seller… Take The Money
- Hedging & Speculating: How to Enjoy Guaranteed Monthly Income With Options
ISE’s IPO
March 7, 2005
The Smart Profits Report: Issue #189
Monday, March 7, 2005
ISE’s IPO: Finding Value in ISE’s Upcoming IPO
By Karim Rahemtulla
Chairman, Mt. Vernon Research
This week there will be an IPO worth noting.
Unfortunately, and ironically, there will not be options available on this play for a while. Unfortunately, because I think it would be a perfect candidate for both LEAPS and covered calls. And ironic because it is actually the largest electronic options exchange in the world.
This week, the ISE, the International Securities Exchange (NYSE: ISE) is going public. The initial indication is $16 to $18. It will undoubtedly open higher than that, probably in the $20s.
I will be buying some shares when I get the opportunity (I will be speaking in Delray all this week at The Oxford Club’s Investment U conference.) I suggest that you keep a close tab on these shares and, if you can participate in the IPO, you should.
An Options Play… Without Options
The ISE is not so much a play on an exchange, but it is a play on options. Options are a very fast-growing segment of the investment world and one that you as a reader of the Smart Profits Report are quite well aware of.
Still, option trading is in its infancy, with maybe 1% or 2% of the penetration of stocks. This will increase as investors become more educated, and that means better days ahead for the ISE.
So, if you are looking for an excellent opportunity to ride the options wave, look no further than shares of ISE.
Remember, it is an IPO and that means it WILL be very volatile.
NEVER, NEVER, NEVER put in a market order for shares of an IPO stock. Invariably, you will get burned.
Where I’m Buying ISE: Below $22
Based on its growth potential and profitability, I think that ISE shares are fairly valued below $22 per share. And that is where I will be trying to buy the shares.
A close comparison to the ISE is the Chicago Mercantile Exchange (NYSE: CME), which is part of the Oxford Trading portfolio. It went public at $39 in 2002 and the shares are now at almost $200.
However, the CME had more revenues, more profits and more of a reputation than the ISE. But there is potential for the ISE to become a dominant force in options, given time. And that is what I will be betting on.
Great trading,
Karim
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Today’s Smart Profits Cribsheet
- Check out the Smart Profits Glossary for definitions of terms such as “market order” or “covered calls” found in today’s article.
Related Articles:
- Covered Calls and Puts - How to Grow Your Equity By Going Naked
- Put/Call Ratio - When this Number Jumps, It’s Time to Trade
- Option Position Sizing - How Much to Invest In Each Option Trade
Understanding Options Risk
March 3, 2005
The Smart Profits Report: Issue #188
Thursday, March 3, 2005
Understanding Options Risk: How to Beat the "Volatility Premium" on Options
By Mt. Vernon Research Team
They say politics makes strange bedfellows, but investing makes stranger ones. At one end, you have the dry-bones academics who objectively juggle information and compute theories. At the other, you have sweaty everyday people who invest knowing nothing of the theory and often don’t behave like they should.
Alongside them are the every-day-in-the-market sharks. The big-money guys, professional traders and other adepts. Theory, they say? It’s just a tool, and they make their money punching holes in it.
Consider the theory of risk. Understanding options risk is central to knowing how to make money trading them.
Academics and market makers understand it alike, but each treats it differently. And, as we’ll see, most amateurs look at it backward.
The Book-Learning Definition of Risk
Let’s pick up with the book-learning definition. Academics most commonly define risk by "beta," a kind of volatility. Beta measures how much the stock moves compared to the overall market. So a beta volatility of 1.0 is about equal to the S&P 500, and .5 is half as mobile.
That’s stocks. In options formulas, volatility is translated in terms of comparing the stock price to itself rather than the market.
When you see a volatility quote of 28% on the Chicago Board of Options Exchange or other options sites, that means the movement in the stock is the equivalent of a normal 28% range either way in the price over a year’s time. It’s based on a formula for calculating the standard deviation over 60 days, then annualizing the result.
Be that as it may, high-beta stocks usually beget high-volatility options. And if beta equals risk, wouldn’t you assume the same for options volatility?
Where do you stand on the issue? Would you side with the academics and say that high-beta Applied Materials is riskier than low-beta Safeway? Let’s get more specific.
Just 18… And Going Places
Both Safeway and Applied Materials stocks were at $18 recently. The prices go up and down, but so far this year, the weekly variation for Applied Materials often exceeds $1. Not so for Safeway, which would count a 50-cent week as a big move. Applied Materials has a beta of 2.5; Safeway’s is only 0.7.
Clearly, Safeway is a much safer stock in academic theory. Actually, for investors, both have been lousy, but Safeway has lost less in the past five years than Applied Materials. Then again, it has lost more in the last year. Still, with a low beta, academics would consider Safeway a safer stock.
Safety Is Risky In Options
Options market makers disagree violently. Remember, they never give anyone a break on purpose. If they see any value in an option, any chance it will pay off, they charge for it.
So with both stocks at $18, let’s compare the prices on the $20-strike April options. Since the stocks may go either way, we’ll consider a straddle for each. That would be one put and one call at $20.
Safe old Safeway had cheap options recently. A full straddle cost 2.00 (.20 for the call and 1.80 for the put).
For Applied Materials, an April 20 straddle cost 2.95 (.10 for the call and 2.85 for the put). That’s almost 50% more than the price for Safeway straddles. Blame it on beta and volatility - everything else was equal.
Do you think the market maker got it wrong, charging more for the weaker investment? Not a chance. That’s what I meant when I said most amateurs look at it backward.
Historical vs. Implied Volatility
He sold the Safeway calls at a price that reflected a 35% volatility, which is very close to the stock’s historical volatility of 31%. The historical volatility is based on real data. It’s objective. The implied volatility isn’t. The market maker estimates the likelihood that the stock will move far enough to cost him money… and that is his measure of implied volatility.
But the difference between reality and market price is pronounced with Applied Materials. Its actual, historical volatility is 28%. Yet the market maker charged an implied volatility of 50% on the puts. He sold the calls at the historical level, no extra.
So which options are safer?
People who know that high volatility is supposed to mean high risk would usually guess Safeway was the safer option, because the market maker charged a much lower implied volatility.
How to Beat the "Volatility Premium"
But the market maker isn’t worried about YOU. He’s worried about himself. He ups the implied volatility when he needs a bigger premium because he’s more likely to get caught having to pay off. High volatility is risky - to him. Given two stocks at $18, the more volatile one is more likely to hit $20.
In other words, lower volatilities are not safer for you - the market maker thinks they’re safe for HIM. But that’s still an incomplete answer. You still don’t want to pay too much for volatility… and that’s what the market maker is always trying to make you do.
The way to make money is to choose an option on a stock that will move even more than the market maker expected. That’s how you beat the volatility premium, and it takes some technical experience to find these plays routinely.
But It Can Pay Off Handsomely…
Last week, for instance, Optionist traders took calls on UPS, a stock with a tiny beta of 0.47, meaning it typically moves less than half as much as the market. CBOE’s historical volatility for this stock is also extremely low, just 12.5%.
But my system spotted a move building, and we bought a UPS April $75 call at 2.25 on Feb. 2 when the stock was right at $75. It had just had a huge drop a couple of weeks earlier, and I saw that it was about to make a strong move back upward. The market maker wasn’t thinking that. He sold the option with an implied volatility of around 15% - even after all the recent uproar in the stock.
Two weeks later, UPS made a big move from $75 to $79, and we took a 91% gain.
Most cheap options - the low-implied-volatility ones - don’t pay off. But when you can spot a quiet stock about to make an unexpected move, they pay off best of all.
Good trading,
Mt. Vernon Research
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Today’s Smart Profits Cribsheet
- Check out the Smart Profits Glossary for definitions like "beta" or "historical volatility."
- For more information on what beta or implied volatility is within options, check out Smart Profits #245, Implied Volatility: The Impact of Beta on Your Open Positions.
- Ethanol, ethanol, ethanol, the hottest topic since solar energy. In the Smart Profits Report Forum, Ethanol Investing, four out of five of our editors give their take on what the rising costs of crude oil will unfold for ethanol production and how you can profit from it.
Related Articles:
- Game Theory - Making Profits With Mathematical Precision
- Warren Buffett’s Investing Strategy: The Master of the "Buy and Hold"
- Investing In The Water Market: Turn Water Investments Into Profits From This Looming Global Crisis
Options Trading Experts
March 1, 2005
The Smart Profits Report: Issue # 187
Tuesday, March 01, 2005
Options Trading Experts: How to “Test Drive” an Options Trading Expert
By Karim Rahemtulla
Investment Director, Mt. Vernon Research
I just returned from hosting a very successful options/traders conference in Phoenix, T he Profits at the Peak Traders Conference.
It was a success not because of the weather in Arizona - it rained every day - but because of what I heard from the audience: How important it was to actually hear how the different options strategies and systems work from the people who develop them.
And, they are right: It is the ideal way to learn how you can trade better, and even with whom you may want to trade if you get a chance to do it, a sort of options trading experts test drive.
An Educated Decision vs. The Sales Pitch
It’s just not the same to read about a service or system… especially when you can actually “touch and feel” the product, so to speak, when you are being told about it in person by the editor.
Better still, at a seminar like the one we had in Phoenix, you get a feeling about the people behind the services - the editors AND the customer service people.
While we never give individual advice to anyone at these conferences, the attendees do receive a very good education to get them on their way. When I speak on a strategy like LEAPS options or my service, The Income Trader - A Covered Call Strategy, for example, I actually give the audience the nuts and bolts of the system so they can try it out for themselves.
I don’t want to sell anything without telling you what you are getting… and I mean exactly. Then it’s an educated decision on your part, and not some response to a high-pressure sales pitch.
When people come up and ask how much the service costs, my answer is always the same: I don’t know and, whatever it is, it is too cheap! That usually gets a smile.
Why It’s Important to Teach - Not Just Sell
I don’t know what the service costs, and I personally don’t care. I leave the selling to the sales team. You will see booths and sales people around the perimeters of a conference, but at ours the real action is in the middle - in the room where we talk about what we love - trading - and how we do it.
I know that I go to these events wanting the audience to learn, and that is what I advised the other speakers to do, as well: teach, not sell. If they have a good system, they will explain it well, and you will learn something from them.
To me, the real mark of success is when the person in the audience knows how a system works and understands that he can use it, too. There is no better feeling than realizing you can pass something like that along.
Good Trading,
Karim Rahemtulla
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Today’s Smart Profits Cribsheet
- For more on the importance of trading with systems like the ones we’ll discuss, check out Smart Profits #120, Investment Speculation: 6 Secrets to Creating a ‘300%-Return System’ Using Stock Options.
- Check out the Smart Profits Glossary for definitions of words like “LEAPS” or “covered calls” found in today’s article.
Related Articles:
- Understanding Option Trading: Cut Your Losses… And Watch Your Gains Run
- The Covered Call Strategy - The “Big Daddy” of Options
- The Chicago Board of Options Exchange: The Website Every Options Trader Should Know
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