How to Use Puts and Calls

The Smart Profits Report: Issue # 259
Tuesday, November 15, 2005

How to Use Puts and Calls: For Systematic Short-Term Profits
By Karim Rahemtulla
Chairman, Mt. Vernon Research

Benjamin Franklin once said that there are no sure things in life except death and taxes. I would tend to agree, but not completely. I know of one more sure thing: the uncertainty of the market. But until now, I didn’t think you could use this uncertainty to make much money.

The fact that market timing is a dangerous strategy is not breaking news. Events crop up every day that can throw a wrench into the best of plans. Add to that a list of hedge fund shenanigans, accounting irregularities, an overly aggressive Federal Reserve and nervous investors holding stocks for just a few days at a time, and you have an environment conducive to short-term trading, or trading on the cheap to minimize losses.

But you don’t necessarily have to know which way a stock is going on one particular day to make a lot of money. One type of trading focuses on short-term events, and it’s a way to beat the market at its own game. It allows for the short-term trade, such as using puts and calls, and it allows for explosive profits whether the shares move up or down. How explosive? Recent gains using this strategy have eclipsed 200% in a matter of days.

Today, we’ll take a look at this strategy, and how one of our own expert panelists has been getting it ready for release…

The Four Rules for Successful Short-Term Trading… and the System That Does it All

First, this strategy involves choosing stocks about to experience a specific event. And when this event occurs, the shares will either move up or down sharply. So, the shares must be volatile in nature to begin with.

You then take a “cheap option” position on both sides of the underlying shares - the puts AND the calls. If the shares spike up, we win. And if they sink lower, we win. The key is to know which stock to pick on which date and, most importantly, to be certain that the stock has the ability to make a big move. The only way to figure this out is to have a system that allows you to plug in the right factors.

Over the past few years, we have spent hours discussing the pitfalls and shortfalls in trading short-term options. Our conclusion is that if you are going to trade them, you’d better have a system in place. And to be successful, it must:

Know the stock’s volatility;
Find BIG events that are about to happen that could effect the share price;
Not be afraid to bet against the stock or company; and
Limit your dollar risk to a small amount for short-term trades.

The trick, of course, is to know how and when to put all of these together. And that’s where Steve comes in…

In a few weeks, our very own Steve McDonald, Options Specialist, Mt. Vernon Research, will be writing about this strategy in depth. But first, if you don’t know Steve, let me introduce him to you.

Over the past 20 years, he has been an avid investor and a strong follower of options systems and strategies. As a former Navy aviator - used to risk and action - Steve is a perfect fit for the options market.

Steve has been developing a system for a while now that takes advantage of a specific, recurring event in the stock market - something that happens on a regular, predetermined basis. Each time it happens, people make money. Well, not everyone, but those who know and follow these types of events are making some serious profits. And Steve is one of those people. His strategy wins with uncanny accuracy.

He has figured out - using short-term, cheap options - how to play the market on specific dates and with specific stocks. Now, I am the last person on the planet to espouse any type of short-term options trading, unless there is a bona fide system attached to it.

There are many very successful short-term systems, most of which use technical or quantitative analysis (like Dean Albrecht’s E.S.P. Profit System, see today’s crib sheet). Steve’s is the first one I have seen that is event-driven AND regular.

It’s Not All Smoke and Mirrors

Of course, there is always more to a system or strategy than is apparent on the surface. In the case of Steve’s, there are several additional factors that come into play. The companies have to have volatile share prices, the ability to make strong moves in a short period of time, and have a history of price volatility, among other things. This is the legwork behind the scenes.

I have been tracking the system for several months, and the returns have been nothing short of spectacular. Steve plays not just one side of the market, but both sides. He doesn’t care if the market is up or down - it has little impact on what he has discovered. In fact, he relishes the opportunity to make money regardless of which direction the shares move. They only have to move decisively in one direction.

What’s intriguing about the system, though, is that he is able to participate in these situations for literally pennies. Most of the options are low-priced with short holding periods - usually less than a week to 10 days. And the frequency is a trader’s dream. He has sent me several picks a week on occasion. There is no lack of opportunity.

In the coming weeks, he will be writing more about his strategy in The Smart Profits Report and in many other publications. His system is almost ready for launch, and that is exciting, to say the least. It is one of the few short-term options strategies that is well-tested and thought out. We look forward to sharing the details with you. Until then…

Today’s Smart Profits Cribsheet

Be sure to check out Steve’s last Smart Profits #257, Extracting Three Lessons from a 515% Gain.
Part of the reason Steve’s strategy is so successful is the low pricing he gets on the options. For more on options prices (and how you can use LEAPS to your advantage), see Smart Profits #121, How to Own Almost Any Stock for Pennies on the Dollar. Also, take another look at how time value impacts option prices, Smart Profits #110, With Options, You Need to Be Right On Time.
And speaking of short-term trading strategies, click here for details on the E.S.P. Profit System - a “quant”-based market prediction system for fast profits, run by Dean Albrecht, Mt. Vernon Research’s Quantitative Specialist.