Tue 10 Jan 2006
My options strategy that has worked for me has consisted of mainly buying long term calls. I like this for the main reason that it allows me to own the shares at a much a cheaper price. Especially with stocks that don’t pay dividends, buying a LEAP will give you ownership of the stock at a fraction of the cost, with no extra costs incurred. When I pick an option, I’ll try to find one for at least 1 year out, preferably 2. It all depends on what I feel would be not only a fair premium, but one that will be attainable by the expiration date. The most important thing that I look at is the company’s growth rate. If I figure the company can grow x% before the option expires, I will calculate what the dollar price will be, and depending on premiums, I will purchase something in that area for what I feel the best value will be. The best value will not always be the cheapest option. I would rather pay more for a contract that I know will be in the money by the expiration date. The reason I choose the LEAP, is because I don’t want time to be a factor, and I’m willing to pay for it.
When I purchase an option, I understand that it is riskier than buying the security. So for this reason, I tend to purchase approximately the same amount whenever I open an options position. It varies depending on how risky I feel it is, and how bullish I am on the stock. The reason I like this strategy, is because with discipline, this can be a very successful formula.
If the stock price moves up, the value of the option will be increasing as well, because TIME IS ON YOUR SIDE. Once the option is in the money, it moves DOLLAR FOR DOLLAR with the stock. Why is this significant? Because your return on investment is significantly higher. We all understand that a $1 increase on $25 is a higher percentage increase than a $1 increase on $100.
If the underlying security does move against me, I will usually let it expire worthless, or try and sell it for whatever value I can. But usually I’ll hold it, just in case it comes back into the money. At that point, if you’re down 75% on the position, I feel you might as well hang onto it, due to the miniscual chance that it shoots up.
I like this strategy, because my downside is limited, while my upside is unlimited. I know that if the stock moves against me, I will at the most lose my entire investment. If it moves up slightly, I’m still making a decent return, because time is not a factor until the expiration date is close. But once the contract reaches the money, my profits start increasing at a ridiculous pace. This is why its extremely important you choose a strike you feel is achievable, even if you pay a higher premium for it.
Using a strategy like this, you don’t need to be right a large percentage of the time. I don’t have exact numbers, but I will go through my options trades over the past 3 years. As a rough estimate I’d say I’ve been right maybe only 40-60% of the time. The reason I’ve been successful, is because on the picks that I’ve been right, I’ve earned so much money that it more than pays for the losers.
When I sold my Apple(January 2008 strike 20) options that I purchased in January of 2004, I sold them at a gain of approximately 4500%. That one position alone has not only paid for all my losers, but has also provided a huge increase in my portfolio. Using a strategy like this can add huge gains to your portfolio while only exposing a small percentage of it to the options game.