When it comes to investing … be a Pig not a Hog!
What do I mean by this? I mean you have to have a game plan to make sure your need for growth does not turn into a habit of Greed. Even though Michael Douglas as ‘Gordon Gekko’ in the movie Wall Street said, “Greed is good!” don’t necessarily believe it. It may be for the very wealthy on wall street … but even those hogs get slaughtered from time to time.
Sure you want the best returns possible … or you should not be investing. You should simply save your money in a bank or coffee can buried in a water-proof bag in the back yard (an unmarked grave, of course). You need to understand that all investors lose money from time to time … but the truly smart ones never get completely wiped out.
Why is this?
- They know what to buy,
- When to buy (very hard),
- How to buy,
- What to sell,
- When to sell (very hard but can be made easy)
- How to sell.
Why do I say it is very hard to know when to buy?
Because nobody … and I mean exactly no one person can time the market. I don’t even believe the smartest Artificial Intelligence in the most expensive computer in the world with the most sophisticated algorithm can get it right 100% of the time.
I’ve always believed there are a few chosen occupations who can lie to the general public, understand that they may be lying and still keep their six figure jobs. These are, without exception …
- Politicians,
- Lawyers,
- Weathermen/Women,
- Economists, and
- Stock Analysts.
You will notice I did not include Stock Broker or Financial Advisor in my short list … simply because they are required by law to tell you what they are told. If they are told a lie … they will tell the lie. For example: Because of politicians and lawyers brokers must tell you that investing in stock options are a lot more risky than investing in individual stocks … and this simply is not always true.
Sure, if you are investing in anything without much knowledge, there is a degree of risk.
A few good real estate quotes … and Real Estate does involve risk.
Will Rogers, an American stage and motion picture actor, vaudeville performer, cowboy, humorist, newspaper columnist, and social commentator from Oklahoma – credited with saying, “Don’t wait to buy Real Estate, Buy real estate and Wait.” What he is referring to is that there is no secondary market to sell your real estate holdings on when and if the money is needed. If you need to sell … you must create a market by listing the property for buyers to know it is available. Also, if a sale is needed badly, be prepared to take less for the property than it is worth … or go out and borrow more money against it. When you are in need … Vultures are on the fence waiting.
Mark Twain, Writer and Humorist said, “Buy Land, they are not making it anymore.” This was true back in his day … but if he were alive today he would see land being built in oceans off the coast of various countries. One area currently being “raised from the ocean” is off the coast of Victoria Island and is known as The great Wall of Lagos. You can read about it here: https://www.ekoatlantic.com/education/sea-wall/
China and South America as well as some middle eastern countries are now building land right out in the ocean … so we can’t say They are not making it anymore.
“Ninety percent of all millionaires become so through owning real estate. More money has been made in real estate than in all industrial investments combined. The wise young man or wage earner of today invests his money in real estate.” – Andrew Carnegie, billionaire industrialist. This was probably very true back in his day … remember Stock Options were unheard of back then.
“The best investment on Earth is earth.” – Louis Glickman, real estate investor. I don’t know … it may be Mars soon if Elon Musk, Jeff Bezos, Richard Branson, Paul Allen, Mark Zuckerberg, James Cameron, Naveen Jain, or Yuri Milner have anything to do with it.
“Now, one thing I tell everyone is learn about real estate. Repeat after me: real estate provides the highest returns, the greatest values and the least risk.” – Armstrong Williams, entrepreneur. A down right lie today.
I think I pretty well understand real estate since during my lifetime I have bought and sold 15 rental homes in one town and made a profit on all but one. Incidentally, I bought them all with $0.00 down. It was all 100% financed by stupid bankers. I can tell you it almost bankrupted me in my other business – Financial Planning. Rental Real Estate is a full time job and you either do it or hire someone to do it for you.
Invest with a plan …
When you invest in anything you need to do so with a plan for entry and a plan for exit. There was a time when you had to be glued to the market to be successful in stock and options investing. But today’s computers, high-speed internet and various trading platforms have done away with those days. Today I have taken care of all my trades by 8:45 central time (15 minutes after the market opened) and am now writing this to you.
Have a plan. Know what to buy, When to buy, How to buy, What to sell, When to Sell and How to sell. Don’t be a hog and get slaughtered … be a pig and get fed.
My plan for one account I own:
I have an account that I trade nothing but options in. I started this account in 2016 with an initial outlay of $10,000 in cash. I added another $10,000 to this account at some point later and and cannot provide an exact date since I’ve moved the account from one broker to another, but can tell you that it was sometime in 2017.
Why did I move it? Strictly business. The broker I was using charged a minimum of $35 in commissions to do options trades PLUS a few dollars per contracts over 1. The new broker (when they start charging) will be at $4.95 … but for now I have 500 trades or two years of trades free. In addition, the trading platform for options is far better with this new brokerage firm. If you have a financial advisor working with you I am not suggesting that you change anything. The purpose of this is to tell you what I am doing to make pretty decent gains.
In this brokerage account for options I have been able, since 2017, to purchase a new Chevy Silverado (in 2017) and a new Indian Chieftain Motorcycle (in 2019) for cash using profits generated from the original $20,000 invested.
Some may call this Luck … I call it having a plan!
Let’s take a look first at why I purchase options rather than stocks – in this account.
First of all, with options you invest less money to control the same number of shares. With less money … there is naturally LESS RISK.
Second, due to leverage, if and when the stock price increases, the option price increases even more. I will show this in a moment.
Third, the most you can lose (with no money management) is the amount you invest in the option … which is far less than the amount you would invest in the stock.
Take a look at this graphic for Shopify, Corp. (SHOP) – then I will explain:
On January 18, 2019 Vectorvest Corporation told us we had started an up market. I will not go into how they predict it … but will say it is never 100% correct … but close enough to work with. Shopify (SHOP) on that day was trading at $158.43.
If a person wanted to purchase 100 shares of the stock it would have cost them $15,843 plus a few dollars for commission. However, they could have purchased 1 Call Option Contract (giving the the right to purchase 100 shares of SHOP before expiration for $155 per share) at a cost for the option of $17.20 per share or $1,720. What is easier to lose if you lose it all … $1,720 or $15,843. Heck if SHOP declines by 20% and you held the stock you would have lost $3,168.60 on your investment which is double (almost) of the total option cost.
However, SHOP did not decline much in value (and if it had you could have sold the option and kept some of your money). Three months later the stock was selling for around $220.72 – making your 100 shares of stock worth $22,072. That would be an increase of about $62.69 per share or about 39% Return On Investment (ROI).
The option, on the other hand, could have been sold back to the market for a total of $65.02 per share … providing a profit per share of about $47.82 or 278% in the same six month period.
You tell me … would you rather invest $15,843 for a chance of a 39% return in 6 months or would an investment of $1,720 for a chance of 278% in six months make more sense? Also, can real estate REALLY do this for you and keep the money liquid so that you can have it anytime you want it. Not saying real estate is bad … we should all own some … but we should also all be very diversified in a time when you never know from one day to the next what is about to happen in the investment realm.
So, know what to buy, how to buy and when to buy.
In this account, the What is options in stock on the Dow Jones Industrial Average. Specifically I look for the highest yielding lowest cost five for the past 12 months when I do my search and those are the ones I go with. This is why you will see duplicates in my account later. Some people call these the Small Dogs of the DOW … I lovingly refer to them as “My Puppies.”
The How is with cash I have in the account. At this time, though I could do this with Margin loans (e.g. borrow from the broker to make the investment) I am a little more risk averse than that. If I’m going to lose money it may as well be mine and cost me once, rather than the brokers, and cost me more than once.
The When (regardless of market conditions) is every three months. You will see in this account, for example, several holding in CSCO, KO, PG, PFE and VZ. This is because when I purchased in October 2018, January 2019, March 2019 and June 2019 these were still suggested in my search. There are two stocks that I bought on a whim and are not doing real well right now … AAPL and BA.
Take a look at the account, then we will talk about the Exit Plan:
You may have to enlarge your web page to see all of this. I had to go as high as 150%. Or, if you print it out you may see it better. Here’s the important detail.
Since I started these options in October 2018 I have grown the account from an investment amount of $47,526.98 to $72,989 (and that is only the invested cash and does not include my cash, of which I have some in this account) … that is an increase in value of $25,462.02 (and let’s remember I took out about $22,000 for a new motorcycle in April – though it too came from cash). That is a Return on Investment of 53.57% in roughly 8 months. Not too bad.
If you look at the last column on the right you will see I have gains for between 17.4% and 491.29% on holdings that involves about 52 contracts which controls about 5,200 shares of stock. You will also see that I am down on 5 holdings from -21.93% to -44.71%. These five holdings control 18 contracts and about 1,800 shares of stock.
Pigs get Fed – Hogs get Slaughtered!
THE EXIT STRATEGY
First it is important to understand when I invested $1,170 into my latest purchase of Exxon Mobil Corp (XOM) the question I asked my self is this … “Can you afford to lose this $1,170?” If the answer was no … I would not have invested it.
Yes, I did the same thing on AAPL and BA … but these were done with multiple purchases: Three on AAPL with dollar amounts ranging from $2,585 to $3,750 while the stock price was falling. My original price per contract was $25.85 … my latest was $9.30 and my average as shown is $15.20. Apple options were down as much as 85% at one time. On Boeing (BA) I had two purchases. The first was at $39.21 per share and the second was at $24.60 per share. Then this option went to as high as $107 per share before two well publicized airplane crashes sent it in a nose dive (like the planes themselves). However, it has come back from $23.77 on June 3rd to $40.95 as of now. The stock itself has risen from $338.20 on 06/03/82019 to $368.79 today … an increase of 9.04% in the same time the option increased by 72.28% — Boy, gotta love those options.
Now this is what I want to draw your attention too. I was doing some traveling over the past week on a Ship – the Carnival Valor. When we were not docked there really was not much to do so I did some studying about options and how other investors are working with them. There is a lot more to understand about options than what you are reading here … things like the Greeks (units of measurement that effect the price), etc. I can get into all of that later. But for now I want to impress upon you some things I did pick up.
Most options buyers are trying to make as much as possible in as short of time as possible. The shorter the time for an option to run … the lower the cost you will pay into the option premium. If you look at the options in my account they all have more than 207 days and as much as 361 days before they expire. This is because part of my strategy in this account is to purchase LEAPS options – those that have a year or more of time before expiration. This allows me to put time on my side. For clarification, look at the three options chains below for Boeing.
In this 452 day chain if a person believed BA would hit or exceed $380 per share by expiration 09/18/2020 (it is currently at about $370 per share) he would pay between $37.30 and $38.70 per share (closer to the high side) – so a 100 share contract would cost him about $3,870.
In this 53 day chain if a person believed BA would hit or exceed $380 per share by expiration 08/16/2019 he would pay between $10.85 and $11.10 per share (closer to the high side) – so a 100 share contract would cost him about $1,110. About a 3rd of the cost for shares in Fig. 3.
In this 25 day chain if a person believed BA would hit or exceed $380 per share by expiration he would pay between $5.40 and $5.55 per share (closer to the high side) – so a 100 share contract would cost him about $555. About a 7th of the cost for shares in Fig. 3 and 1/2 the cost of Fig 4.
Now let’s take a quick look at the Greeks since you need to know something about them.
DELTA: What is it
For every dollar of movement in stock price, the price of the option can be expected to move by delta points. If the delta is 0.5 then a one point change in the stock price will change the option price by $0.50.
Note: Some investors use delta as a quick approximation of the probability that an option will be assigned at expiration. i.e. An ATM (at the money) option that has a delta of 0.50 would be about a 50% chance of expiring in-the-money.
- Figure 1 Delta = 0.5063 – 51% chance of being in the money at expiration
- Figure 2 Delta = 0.4178 – 42% chance of being in the money at expiration
- Figure 3 Delta = 0.3495 – 35% chance of being in the money at expiration
THETA: What is it
In a previous article I warned options can start to decline on day 1 like an ice cube out of a freezer.
The rate at which an option (Extrinsic Value) loses value as time passes. An option with a theta of 0.04 will lose $0.04 in value for each passing day. Therefore, if the option is worth $2.73 today, then tomorrow it will be worth $2.69 and the day after it will be worth $2.65. Remember: Theta only adversely effects time value (extrinsic value) … not intrinsic value.
- Figure 1 Theta = -0.0442 – lose about 4 cents per day if no change in stock price. More if stock declines, less if stock goes up.
- Figure 2 Theta = -0.1394 – lose almost 14 cents per day if no change in stock price. More if stock declines, less if stock goes up.
- Figure 3 Theta = -0.3495 – lose almost 35 cents per day if no change in stock price. More if stock declines, less if stock goes up.
VEGA: What is it?
The sensitivity of an options theoretical value to a change in volatility. If an option has a Vega of 0.13, for each percentage point increase in volatility, the option will gain $0.13 in value. As an example if the value of the option is $3.50 at a volatility of 30%, then it will have a theoretical value of $3.63 at a volatility of 31% and a value of $3.37 at a volatility of 29%.
GAMMA: What is it?
The rate at which an options delta changes as the price of the underlying security changes. Gamma is usually expressed in deltas gained or lost per a one-point change in the underlying security. As an example, if gamma is .05, it means that if the underlying stock/index changes by one point the delta would change by .05
You don’t need to know how these Greeks are calculated to use them … but you need to know why to use them. One other item (not a Greek) that you need to understand is this:
BREAK-EVEN: What is it?
At the time I ran these chains BA was selling for about $370 per share. If is possible for the stock to go up $10 per share in 25 days, 53 days and 452 days … but keep in mind to break-even the stock must climb by the amount you paid for the options plus the strike price. You have a right to exercise the options contracts for $380 per share on the stock. There is no way you would want to exercise them when the stock is at $370 it would be better to go out to the market and buy them for $370. Until that break-even is met … you may not make a lot of money on the options. You could even have stock trend up in value and still lose money on the options.
- Figure 1: the break-even here would be $380 + $38.70 = $418.70 — from present value the stock would have to appreciate 11.63% over the next 1.25 years.
- Figure 2: the break-even here would be $380 + $11.10 = $391.10 — from present value the stock would have to appreciate 5.70% over the next 1.77 months.
- Figure 3: the break-even here would be $380 + $5.55 = $385.55 — from present value the stock would have to appreciate 4.20% over the next 25 days.
Let’s be Pigs – Not Hogs!
Now for the final part of my exit strategy. I hate to sit here and look at my computer everyday and watch things change on the whims of the president of our country and other countries as well as our non-working comrades in congress. I’d much rather write about the idiosyncrasies of politicians, wise investment planning and other things that hold my interest more … or ride my motorcycle or play golf.
So once a trade is “In the Money” … meaning it is now at a profit … I am bracketing a couple of different orders. I have a profit order and a stop loss order on anything that is in green for now. Take a look at the table below:
Notice the column that is highlighted in Yellow … this is telling you that all contracts have been bracketed for sales. This is when they will sell (and this is good for 6 months at a time). From the time I set the order using the then current “Bid Price” (compare with Fig 2 above) … those that are up 400% or more have a gain target of another 50% and a loss target of 25% trailing. Those that are up greater than 100% now but less than 400% have a new profit target of another 200% and a loss target of 50%. Those holdings that are up greater than 0% but less than 100% now have a profit target of another 200% and a loss target of 50%. Those holdings that are in the red (at losses now) have no profit or loss targets set.
Just because I set these gain/loss targets does not guarantee that much of a gain or loss. The top option, PG I set a 50% gain from it’s current price and a 25% loss from it’s current price. This means if the option hits a price of $42.825 on the upside or $22.6875 on the downside it will sell at the very next market price. If this happens during the trading day I should be okay. If it hits $42.82 and sells for $42 or $43 … the next market price I will be happy with that. If it hits $22.6875 and sells for $22 or $23 – the next market price – I will also be happy with that.
If it happens at the end of the trading day and I have to wait all night for the option to sell I may not get anywhere near the $42.82 or $22.68 … so I will still want to watch them from time to time. I can cancel orders after the market has closed if I need too.
You should also notice that most all holdings up in value have a positive intrinsic value. There are two values when it comes to call options. Intrinsic & Extrinsic (also known as “time value.”). There really is no negative intrinsic value. In this report, the last stock option listed is PFE and I paid $3.1201 per share. With the current value being $1.70 or so … it is all extrinsic (time) value with no intrinsic value.
On the other hand, the first stock listed PG is currently (as I look at Fig.2) priced at $30.275. Since I paid $5.1202 for this it has intrinsic value of about $25.15 – however, by the time I screen shot and printed the table in Figure 6 the intrinsic value had increased another $4 to $29.33.
Remember THETA does not decrease an options Intrinsic Value … it only reduces the options Extrinsic or “time” Value.
Bottom Line:
I have a plan with this portfolio. I know what I am buying … when I am buying and how I am buying. I also know due to automation what I am selling … how I am selling and I let the automation figure out when I am selling.
One word of caution … Rarely will I hold an option until expiration … and here is why:
The most rapid time decay on any premium is the last 30 to 45 days of expiration. If I am selling options I sell short-term (30 to 45 days out) as I know time is working against the buyer. If I am buying I am selling before expiration – especially if the option is in an IRA.
If in an IRA and I don’t sell and the option gets exercised (let’s assume BA gets exercised at $380 per share). This means I will be required to buy BA for $38,000 on 100 shares which is considered an over-contribution by the IRS, if I have to pull money from outside the IRA to make the purchase. I’d rather take my tax deferred gain in the IRA rather than face the obstacle of finding money to purchase a stock I did not want.
Remember: While the buyer of an option has the “right” to buy the stock at a set price before a set date and the seller of the option has an “obligation” to sell the stock for a set price before a set date … the Options Clearing Corporation (OCC) who clears all these will assign the stock to the options buyer if he/she has not closed out that option before expiration and it expires in the money (e.g. at a price equal to or greater than the strike price.) So, at expiration it is the OCC that has the rights!
Questions …
Let me know,
Jerry Nix, Freewavemaker, LLC
FreeWaveMaker.com 