TACTICAL TRACEY'S CORNER

                                            How to Lose Your Backside Trading Options


Perhaps the name of this article should be how to lose your inheritance or savings, but I’m sure you all know what the title really means.  Hopefully, I will give you some insights on how to save your money for more profitable investments, or how to even gain money in options.

Unless you are extremely dedicated market watcher and knowledgeable technical analyst, please be careful when you wander into the field of buying puts and calls. It is very easy to lose it all in this field. You may stumble into a rut or deep hole like I did. There are real sharks in the options pool and they wait for juicy naïve humans to come by for fresh meat.

Like mutual funds, options sound wonderful when you first hear about them.  They did to me.  For a fraction of the price of a stock you can control 100 or more shares and make a greater percentage gain if the stock and option goes in your direction by the time the option expires. Instead of making 10%, you may make 30% plus if you are right in picking your option. 

Since an option is a contract between the option buyer and seller, it has an expiration date, so you must pick a contract expiration month, such as 2/04, 5/04, 1/05, and 1/06 as well as a strike price (the price you expect the stock to reach or exceed) You must also pick either a put or a call.  When you buy a put, you expect the stock/index to go down. When you buy a call, you expect the stock to go up.

The longer-term options are called LEAPS. This stands for Long term Equity Anticipation Securities. Most LEAPS are more costly than regular options and usually expire in over one year. However, they are safer. You will notice that the few option recommendations on the Market Update buy list are LEAPS and have expiration dates of 1/06.  This gives you almost two years for the stock to reach the strike price. Sol is now recommending DYN with a strike price of $5 and WFT with a strike price of $40. Just because the expiration date is 1/2006, he may recommend selling them at any time he feels is appropriate as you are allowed to sell them at any time.

Most professional options traders don’t bother with LEAPS, as they are looking for the fast buck. The closer to the expiration date and the further the current price is from the strike price, the cheaper the price of the option. Some options will sell for 10 cents.  They sell in groups of 100, so you could control 100 shares of IBM for $1.00 or 1000 shares for $10.00.  What a deal!  Not really. The Pro is hoping the 10 cent option will double to 20 cents, but this is highly unlikely, as most options under $1.00 expire worthless and all the money you put into them is lost. 

So to be good at trading options, you must be right in several aspects: 1) the direction of the stock, 2) the strike price it will hit or exceed, and 3) the date it will hit that price. If you believe you can be right in all three dimensions, you can proceed into the minefield or shark pool of options.

My experience with options is sad. In 2002, when the market was tanking, I bought numerous puts on different stock and indexes such as the QQQs, etc.  Unfortunately, most expired worthless since the expiration dates were wrong.  I had many puts expiring in one of the historically weakest months of the market year.  However that month turned out to be the strongest in 27 years!  So, you never know what will happen.  Seasonality was completely turned around last year too, so you cannot count on it.  The usually strong months were weak in 2003, and the weak months were strong.  

I can remember maybe 5 out of 20 making money for me. Three of them were from Sol’s OEX option service and only one I picked myself.  I also made money on a few from an expensive options service, but my gains never exceeded what the service cost. Most options services are over $1,000 per year and make unrealistic promises.  Some are as high as $5,000. Don’t be sucked in by the hype!!!

Tactical Investor has always two general rules for options.  The first is to never use more than 10% of your portfolio for options trading, and the second is to never let your option go down more than 50%.  In other words, set a stop loss at 50% in your computer or in your head and watch the option every day.  You may make it a trailing stop loss order if you wish.

If you are willing to take 10 to 30% gains, you can possibly make money on 80% of your options. However, if you are looking for 100% gains, expect to lose at least 60% of the time.
It is all very mathematical. There is a professor in mathematics at Northwestern University who studies options full time!  Options have a beta, a delta, a theta, etc. and some are overpriced and others under priced. Since I am not truly knowledgeable about the “Greeks,” I cannot expound on them.  I doubt that they are really very valuable anyway in this unpredictable market. A brokerage service such as Options Express can help in picking options. Of course, if our OEX Options Service opens up and admits more people, this is the ultimate service for options.

One way to play options is to buy a less expensive but popular options service, and with a small amount of your aggressive portfolio buy and sell quickly.  Buy as soon as the issue comes out or is on line.  When all the other subscribers jump in, of course, the option will go up.  After about one week, check the option.  It is probably time to sell.  All of the subscribers are in, and it is probably poised to go down now.  By the way, options do NOT always trade in the direction of the stock or index. They usually do, and theoretically they should, but many times they don’t.  Options trade in a supply and demand situation like anything else in the markets.

Another way to play options is to play LEAPS, which we do in the Market Update.  When you are up 30% to 50% (whatever you choose) sell, and don’t look back.  Whatever happens after you sell is not your concern.  You have made your money and are on to the next play. 

A third way to use options is to buy them instead of buying a high priced stock. I am considering buying LEAPS for the stocks in our large cap portfolio, but I do not recommend that for all of you, unless you have extra money and do not mind watching your LEAP go up and down 10, 20, or 30%.  Options are very volatile.  Remember, as I said last time, it takes 100% to make up for a 50% loss. Here’s another one. It takes a 50% gain to make up for a 33% loss. 

Using options as a hedge means buying a put on a stock when you believe it may correct for a while, but you don’t want to sell the stock.  You need not use a LEAP for this, but I still suggest buying one at least six months out to avoid the sharks from paying a lot of attention to your option and smelling the blood that may be oozing from it at times.  Many of the stocks in our Long-term Gold Portfolio have corrected quite a bit, and a put on 100 shares of them would have been a good hedge at the top of the stock’s range. 

There are many other option strategies you can use, such as strangles and straddles.  Generally the gain is not as great, but the loss is less when you buy both a put and a call on the same stock or index. In a straddle, the same strike price is used for both the put and the call. In the straddle, a different strike price is used for each.  Good Luck.

Selling options usually requires a commodities account.  If you have one, you can sell options, but your risk is unlimited, while the risk on buying an option is the cost of the option, period. Butterfly spreads, where you sell an option and buy one at the same time can be done in a commodity account as well.  Please, please, if you are interested in this, information can be found @CBOE.com on how to get their free CDs on options trading. They will send them to you, and they are invaluable. 

Actually, many think it is easier to trade index or single stock futures than to actually “trade” options because another drawback with options is their lack of liquidity.  It is hard to trade something when it only trades 50 to 60 contracts a day.  If you do pick an option, pick one with high open interest and current volume. I would not buy one that has less than 100 contracts on it – that is the “open interest.”

So please carefully consider what you are doing when you decide to go into the options field.  Education is key.  Make sure you are highly educated and disciplined before you even consider them unless they are recommended by our services. You must judge your time; money and passion or you will end up in a deep hole or a minefield. 

Happy and Profitable Trading,

Tactical Tracey

PS:  Your questions on any terms are welcome at tacticaltracey@tacticalinvestor.com