Strategy


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.

 

The long and short term yield curve inverted for a moment this morning, meaning that for a brief moment, short term bonds had a higher yield than long term bonds. This inversiThe long and short term yield curve inverted for a moment this morning, meaning that for a brief moment, short term bonds had a higher yield than long term bonds. This inversion has preceded the last 4 recessions that this country has seen. Although listening to analysts speak on Bloomberg today saying there shouldn’t be anything to really worried about, this does bother me. I am thinking cutting my positions between 50-75% and holding the rest in cash until I see some bargain prices. I will post more information as I read up more on this, and will post my plan of action. I must note that even if I do plan on reducing my stakes in my holdings, with True Religion I will be waiting until after their 4th quarter earnings call which will most likely take place the 2nd week of February. After that, I will decide what I want to do.on has preceded the last 4 recessions that this country has seen. Although listening to analysts speak on Bloomberg today saying there shouldn’t be anything to really worried about, this does bother me. I am thinking cutting my positions between 50-75% and holding the rest in cash until I see some bargain prices. I will post more information as I read up more on this, and will post my plan of action. I must note that even if I do plan on reducing my stakes in my holdings, with True Religion I will be waiting until after their 4th quarter earnings call which will most likely take place the 2nd week of February. After that, I will decide what I want to do.

Jeff brings up some valid points in the comments to the post on risk and leverage. Before I elaborate on my discussion in my earlier post, let me point out that Joel Greenblatt’s fund has had an annualized return of 40% over the last 20 years, and let’s not forget Warren Buffett with an annualized return of 22%. There are numerous others, but at the moment I’m too tired to go out and find them. Regardless, it is possible.

I don’t rely on analysts’ opinions to make my purchases, and I don’t claim to know more than them or anybody else that formulates an opinion about a company. All I can do is trust my judgement, which I feel is very good. Before I begin to build my position in a company I will review all the recent press, google management, read the most recent quarterly and annual filings, see the latest insider transactions, and check some internet message boards. I have often times found that analysts will formulate their opinion with an ulterior motive.

And I completely agree with you about external factors influencing prce action of the underlying security. Everyone has experienced it. Interest rates, war, terrorism, oil, exchange rates, and numerous others that I’m sure I’m leaving out. Its for all these external factors that I am developing hedging strategies utilizing options.

As far as being able to achieve 24% growth per year… By utilizing my account’s margin, at 50%, I will only require a 12% return from my investments. I understand it is riskier, but its a risk I am willing to take. I have not mentioned this yet, so there could be some misunderstanding, but I am not a passive investor that picks my stocks and doesn’t check them for another week. I am always tracking them and am always ready to make a move if markets turn. Something I did not state in my original post though, was that I am not looking to achieve these kinds of returns indefinitely. If I do so for 5 years, I will be more than pleased and at that point will be able to “retire” if I desire to do so.

I appreciate your feedback. You seem to have the right idea in mind. Good luck to you.

I love to use leverage. I leverage my money every chance I get. It provides me with the opportunity to make the most of my money in the shortest amount of time possible. It magnifies my gains. I must also note that it magnifies my losses.

I’m a firm believer in having my money working for me at all times. I’m even a firmer believer in having money that’s not mine working for me at all times. Is it riskier? Yes it is. But that’s a risk that I’m willing to take at this time. Let’s face it, I’m not going to reach early retirement hoarding my money in a savings account earning 4% per year. My goal is to double my money every 2.5 – 3 years. Leverage lets me do that.

Even at 4%, putting money in the bank is not risk-free. I’d say the biggest risk you have right now is the of inflation, which is currently a bigger risk than you might think. If the rate of inflation rises above the interest earned in a savings account, you’re actually losing money by putting it in the bank. In fact, if you have the money to do so, you could buy a T-Bill and make more money in what is considered worldwide to be risk-free.

So I’ll take the risk. I’ll make my picks, and I’ll read up on them. I’ll become my own analyst. In fact I’ll know more than the analysts do. Information is king here. Investing is so easy to do, that alot of people don’t do it right. You have to know everything that happens within the company. You have to know everything that could affect it. It’s tough at times, yes, but its reward is ten fold.

As I grow older, and accumulate more money, I imagine that my inclination to take risk will lessen. To be honest, I won’t know until I get there. But for now, my advice for anyone that wants to retire young and retire rich, is that you don’t do so by saving money. You do so by making it work.