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Options Flyer
The Smart Profits Report: Issue #176
Tuesday, January 18, 2005
Options Flyer: Three Rules for Profiting from an Options “Flyer”
By Karim Rahemtulla
Chairman, Mt. Vernon Research
When you trade options you should ALWAYS have a definite goal - something you are trying to accomplish. It should govern what you buy and sell and how much risk you are willing to take. Most of the time, I’ll settle for small, steady gains. I think that’s a smart way to build wealth for the long haul.
But sometimes I don’t feel “conservative.” Sometimes I’m willing to accept more risk (as in, total risk) for tremendous returns. And that would be my definition of “taking an options flyer“…
Contrary to what some experts will tell you, flyers can be both risky and sensible. If you understand your objectives, and accept the risk in taking these positions, why not trade boldly? Taking the occasional flyer is worth it, as I’ll explain in today’s e-letter - but only if you know what you’re getting into to…
The Three Rules of Successful Option Flyer Trading
With my LEAPS Option Trader portfolio, it is sometimes open season on option flyers. We’re certainly not averse to taking on the occasional high-risk/high-reward position.
However, for an option play to represent a good flyer opportunity, it must adhere to these three rules:
- First, the initial cash outlay has to be low. Our two flyers in the LEAPS portfolio cost us $0.35 and $0.55 respectively - not a big investment.
- Second, flyers must be able to have the potential to double or triple in value within a year or so. Both of the LEAPS could double with less than a 20% move in the underlying shares.
- Third, the flyer has to be an all-or-none deal. In other words, when we do a flyer we will usually either win or lose.
One of the reasons for this all-or-none position is that the flyer shares are so hot they require only one good week to make us a ton of money. And that gain of between 20 cents and 30 cents in a week can come at any time. (In the case of our two flyers, they moved enough during one day to yield those results, let alone a week.)
So How Do You Account for the Option Flyer Losers?
Now, the trouble with “option flying…”
When they go south, flyers can have a devastating impact on your psyche - and I assure you, they can have can have a terrible effect on published returns.
So it’s important to keep it in perspective when evaluating how flyers really affect your portfolio, for good or bad.
With an all-or-nothing posture, it is possible to lose 100% of the investment. While that may “only” be $0.35 per share - it is still a 100% loss. This can distort a portfolio’s returns substantially. Let me give you an example.
Option Flyers: Distorting Your Returns?
A few weeks ago we “made” 63% on a position. That 63% was equal to $2.40 profit per share.
For the sake of argument, let’s say we had a flyer that expired worthless at the same time - a flyer for which we originally paid $0.35. That’s a 100% loss. On a percentage basis, the average for both trades would be a negative 37%. Even worse, between these two trades we had a meager 50% success rate.
But in real terms, on the basis of what you saw in your account, you would have netted $2.05.
So in reality, the portfolio would still be making you very good money. Yet someone not looking at all the facts might become convinced that he should never take a flyer again.
And that just leaves more profits for us… because we can accept the risk ahead of time, and are willing to strike when the time is right.
Good trading,
Karim
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Today’s Smart Profits Cribsheet
- Check out the Smart Profits Glossary for definitions of terms like “underlying” or “LEAPS” found in today’s article.
Related Articles:
- Reducing Option Risk: Don’t Take Insane Risks When You Have Options
- Options Straddle: Using a Straddle to Harness “Uncertainty”
- Maximum Fear: How to Turn “Maximum Fear” Into Maximum Profits
