Be careful to leave your sons well
instructed rather than rich,
for the hopes of the instructed are better
than the wealth of the ignorant.
Epictetus
I’m very pleased with our education program so far but I wish you guys would leave more comments on the book site as we would really value your feedback!
This is just a quick update on the status of our first two plays:
On February 5th, we used BOBJ as the example of a long-call option. The stock was at $38.70 and the contract for the March $40s was $1.65. As we had $4,000 to invest and a goal of making or losing 10%, we suggested that, while you could purchase 4 March $40 contracts for $660, it would be wiser to do a calendar spread of 4 April $40s for $860 and sell 4 February $40s for $400.
Let’s compare the results:
Had you purchased the stock itself, you would have committed, let’s say $3,870 for 100 shares. The stock is now at $39.48 so you would have gained $78. On 2/12 the stock bottomed out at $38 so you would have gone down as much as $70 while you held it.
The 4 March $40 contracts are now worth just $520, a loss of $60 so far but those contracts traded as low as .70, a loss of $380, just about our limit! Of course my members know I would have been doing a ‘mon back at .70 but trade management is the subject of another post!
Our recommended April $40s, on the other hand, closed trading on Friday at $2.05, $820 on our 4 contracts while the February $40s we sold expired worthless so we have a net profit of $360 on our $460 (net) investment in just 2 weeks! The lowest level the April contracts fell to was $1.20 on the 13th and, even then, our loss on the spread was only $260, not as bad as the naked March calls.
This was the play we went with on the members site and, now that we’ve made a 74% profit, we need to set a stop at $1.75 to preserve a 50% gain or you can take half off the table, recouping $410 of the $460 that was laid out and setting a stop way down at $1.40, which would still net you 50% if you stop out there (really, do the math) but allows you to ride out another dip to around $38 if you should so choose.
Of course our strict rules say you should stop out at no more than $1.90 but those rules are statistical rules and my call is based on my belief that the stock was pinned down into expiration and still has room to fly. Make no mistake about it, this is effectively a new bet on a naked April $40 where I am now risking $820 of my money (that used to be $460) hoping to get $3 for 2 of my contracts and setting a .50 trailing stop on the last 2. I feel strongly enough about this to risk losing $120 if I stop out at $1.75.
We’ll keep an eye on this one but remember – this is effectively a new bet… If you can’t be satisfied with a 74% gain in 2 weeks, trading is not for you!
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On February 12th, flush with our successful play on BOBJ, we decided to take a closer look at volatility and how and why it can make us money.
This is very apropos as the VIX, the market’s volatility indicator, is sitting near an all-time low at just 10 after peaking out at 23 in June. The last time we had a sustained drop to 10 was 1995, the year before the markets exploded! This is right on track with my August 31st prediction of a history-repeating market rally but I digress, this is an article about education…
Our volatility example was SHLD and we took the June $185s for $12 and ended up selling the March $180s for $7.80, a little shy of our $8.20 goal. Sears had a very good week, gaining $6 quickly, not a good case when you sell a diagonal!
The March $180s jumped up to $3 to $10.80 while our June $185s gained just $2.80 to finish the week at $14.80, putting us .20 behind on the spread. As our net investment was just $4.20 per option, that .20 represents a 5% loss for the first week.
Bear (oops – never say bear!) in mind that our BOBJ contract spread contracted in their first week too, that’s what the volatility game is all about. Our March caller should be taking his quick 40% profit and running, only we control when we sell the contract, not him and we are betting that his $3.54 of premium decays faster than our $12.54 of premium on our June contracts.
What’s more important to us is our basis, which is just $4.20 (we paid $12 and sold $7.80) compared to the value of the June $185s, now at $14.80. We have made a $10.80 profit on our $4.80 investment this week but we made it by "borrowing" $7.80 from our caller, who we are assuring the ability to purchase a share of Sears stock for $180 on March 16th. Earnings are 3/1 so stay tuned for the fun as we may make an adjustment before then but, at the moment, we are hoping for a nice sell-off.
Following this trade through will teach us a lot about volatility as it affects these two contracts over time.
