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International Securities Exchange Options
The Smart Profits Report: Issue #303
Wednesday, April 26, 2006
ISE Options: Two Strategies For Getting Runaway Stocks On the Cheap
By Karim Rahemtulla
Chairman, Mt. Vernon Research
A few weeks back, the International Securities Exchange (NYSE: ISE), the premier electronic options exchange, was hitting 52-week highs and trading around $50. I have always liked ISE, and I’ve recommended it both as an IPO play and a covered call play.
However, I was not fond of the shares at the $50 level. They had shot up on the back of all the exchange run-ups… the Chicago Mercantile Exchange, the New York Stock Exchange, the Nasdaq and the Intercontinental Exchange. There is a feeding frenzy for exchange-related shares, and I just don’t like diving in from such heights.
What to do? I got on the phone with my friend and fellow Mt. Vernon Research Advisor, Lee Lowell…
The Tale Of Two Strategies
Lee and I got to talking about how we would approach the International Securities Exchange. Lee loves selling puts. I love covered calls. Essentially, we are doing the same thing, but with different dynamics. I like covered call writing because I do most of my investing in a tax-deferred retirement account. And, in that type of account, most brokerage firms will only allow covered call writing (there are some exceptions, but not many).
But in order to trade a covered call, I must first buy the stock and then sell the option of my choice against it. Usually, I will rake in a little more premium than the put seller. Also, if there are any dividends, I get them - the put seller does not.
Lee, on the other hand, likes the fact that he can sell puts and not have to put up much in the way of capital for the trade, unless he “gets put” (he can also buy back the put in lieu of buying the shares). Because of his immense experience in the real world of investing, as a market maker and trader on a major global exchange, Lee has what it takes to be a great put seller. He understands the risks and ramifications better than anyone I know. And, I can’t wait until he begins a trading service later this summer. Imagine… Having the ultimate insider on your team!
Own A $44 Stock For Less Than $30
The one thing that we did that was exactly the same was this: We used a deep-in-the-money strategy to mitigate as much risk as possible. Both Lee and I abhor risk. And we have both developed systems that allow us to manage our risk and still produce better-than-market returns.
I went diving deep in the money. I did not like ISE at $50, but I liked it at $40. Still, I really only wanted to own it if it was below $30. Well, with the shares trading at $44, it would be a long wait. But what if I could get paid handsomely for waiting for the shares to come down to my price? I ended up selling the $30 call options against the shares, raking in enough premium to reduce my cost to the $27 level. So, I would either own the shares for $27, or I would get paid more than 10% for hanging around - my type of trade.
Lee decided to sell the lower-strike puts. He picked up some great premium and would be obligated to buy the shares if they fell more than 50%. While he did not bring in as much in cash, he also took less risk by using a lower strike and not owning the shares. In the end, we both should make out like bandits - either by owning a $44 stock at less than $30, or by taking in a nice chunk of change just for trying.
Good Trading,
Karim
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Today’s Smart Profits Cribsheet
- If you are a subscriber to The Income Trader - A Covered Call Strategy, look for a similar type of trade to come your way soon… Learn more about The Income Trader’s profit potential.
- Selling out-of-the-money puts, one of Lee’s favorite moneymakers, allows you to cash in on investors making big, unrealistic bets that a stock will take off… But what happens when their options never move into in-the-money territory? Find out how Lee puts this strategy to work full-time in Smart Profits #255, Out of the Money Options: Buyer Beware, Seller… Take The Money.
- Visit the Smart Profits Glossary for definitions of option terms like “covered calls” or “deep-in-the-money” found in today’s article.
Related Articles:
- Selling Covered Calls: Getting Cash for Stocks You Already Own
- The Chicago Board of Options Exchange: The Website Every Options Trader Should Know
- ISE’s IPO: Finding Value in ISE’s Upcoming IPO
