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24 Oct 09 Covered Call - Play With House’s Money

Great Gamblers actually have a lot in common with great investors. They know excellent money management is the key to success. Their view is that as long as their money is on the table, it belongs to the game. Their Goal is often to get their own money off the table quickly, so they can play with the house’s money. In the investment world, a Covered call trading strategy is a good way to play with the house’s money. However, there are many different viewpoints. One is that you just find a good stock, and then if it trades options to just sell calls against it until the stock pays for itself. However this is a very limited viewpoint that doesn’t explain what a “good stock” is.

If you are typically a growth and momentum investor, you are generally relying on accelerating earnings and sales growth and price momentum and buying momentum to take over as the stock is bid higher. If you identify a good buy point this will NOT make a good covered call strategy.

The reason is, the premium on the option is generally based on recent volatility, and stocks that set up for a buy point typically consolidate as buyers take profit, sellers try to battle this stock back and buyers and sellers reach a stand still, then buyers gain momentum, and soon right near the buy point the buyers begin to take control. Sometimes the sellers will give-up, and cover their shorts, and the buyers will come in full force. This means that right before the buy point the stock’s premium is fairly low, and it’s not until after the stock breaks out that the price of the premium will be reflected based upon this volatility. In addition, this strategy is generally based on price appreciation. If you sell options on these stocks, you will limit your gain, and you will most likely not increase your potential very much. Generally the best strategy would be to sell out of the money options at your price target. However, generally this will net you a very small amount unless you are buying a lot of shares, and your fees per trade and per contract are very low. Even then, this is just adding a very small premium onto your shares, and usually isnt worth it as much. Instead, you may be better off learning to BUY options if this is your strategy.

On the other hand, If someone is not a momentum trader, and is going to buy stock s perhaps that just received upwards earning guidance, or if they have a strategy where they expect mild price appreciation, or if theyre just index investors, then perhaps a covered call strategy would work well. If you expect a mild price appreciation, you can sell out of the money options, and still gain from price appreciation up to the strike price, while also collecting a premium. Say you Identify a stock that is starting an upward or sideways channel, You are following a trend, you would want to identify the peak of that trend at expiration, and sell a call option near that strike price. This will allow you to adjust price targets, receive the capital appreciation gains, and also collect a premium.

Now generally covered call strategies are better for value investors, or even contrarian investors. You want a stock that you can own for a very long time, but is one that you dont anticipate any short term price appreciation. You can just collect premiums by selling at the money call options, or if you expect the stock to actually decline slightly at the moment, you can sell in the money options, hoping that the stock declines out of the money, and that you dont have to be assigned on your call. This way you can own the call and write another call option month to month, collecting income.

There are other strategies such as just collecting the maximum premiums that are available. This may be a bit dangerous since these are stocks that people expect to make big moves, and those moves arent always up. The price of a call and put are directly correlated, so just because a covered call will yield you a high percentage yield, doesnt mean it is worth it. It is generally associated with higher risks, and most likely, if the stock does go up, it will be a big move, you will be limited in only being able to collect the premium, and you could potentially lose everything if the stock tanks to zero. However, if you do enough research, seeking some of the top yielding covered call options is a good strategy, that can sometimes have you yielding around 10% a month. In addition, you may decide to use this to find stocks that are ready to move, and just buy the stock outright, avoiding additional costs associated with the option (such as the time premium and extra brokerage fees), and still allowing you to profit from the gains. Or perhaps you want to identify the stock and just buy out of the money calls.

Ultimately its up to you to pick a strategy you understand, and learn as much as you can, taking whatever courses you need to and educating yourself so that you are prepared to make money in a way that works for you.

Maclin Vestor teaches about varioustrading systems and teaches you to find a trading system that works for you.

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12 Oct 09 Covered Call Strategies and Option Trading Systems

by Maclin Vestor

The cost of a call and the cost of a put are almost directly related. If you have a $40 stock, a $40 call and a $40 put will be almost exactly the same price most of the time. If there is a difference, the possibility of an arbitrage usually exists meaning that there is a 0 risk strategy (minus commissions) to get something for nothing. This is true whether it’s a collar or another strategy. I don’t completely understand the full process that allows for that to happen, but a complex series of trades usually makes it possible. So if the price of a call and put are going to be the same that means generally the higher priced calls are due to greater risk. Some reasons may be historical volatility, as that plays a roll, but the implied volatility, that is, how much people expect or are betting on the stock to move, becomes important.

One covered call strategy is simply to seek the maximum yielding calls to sell. If you decide on this strategy, you probably want to check the recent put volume on this month’s contracts, and you also may want to make sure the company is solvent. It should have positive cash flow more current assets then current liabilities, and ideally increasing cash flow.

Often times biotech stocks will have negative cash flow because they have to spend money researching and eventually they hope to hit a major discovery. These stocks are very difficult to price as a discovery would make the company worth a lot, an approval of F.D.A. will also catapult the stock much higher. You also should look for some recent strength in the stock, and there should be no bearish chart patterns, that means no chart patterns as well as no sudden high volume sell offs recently and generally a stock that has had a sudden sharp drop is also a warning sign.

If you feel comfortable with selling these higher priced options, you want the sudden move that’s expected to be upward if at all. You are in a way betting that a move will not happen. Once you identify a target, I recommend selling slightly deeper in the money calls as this will cover you more in a decline. You will be collecting the theta, which is the cost of an options potential for gains that the option buyer must pay.

However, if you seek the highest yielding covered calls you can sell, head over to optionsbuddy.com. http://optionsbudy.com is a great way to identify the highest yielding stocks. They also have a rating system, which I have not read about, but my guess is that may be based on historical volatility vs. implied volatility where implied volatility is what the investors expect (and what factors into the options price), not what has happen recently; and perhaps it is also based on the yield compared to the risk, the difference between the bid and ask price, the liquidity, and the market cap and other factors. Google for example, would need a lot more people to sell then a micro cap stock for the stock to crash. A stock with high float has a lot of traded shares already, so if suddenly people were to start selling it may not have as huge of an impact on the price.

About the Author:
Maclin Vestor teaches about varioustrading systems. You can even learn about gold trading systems, and buying Krugerrand at his blog.

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01 Oct 09 Makings Of An Options Trading System Part 2

by Maclin Vestor

A covered call strategy within a cycle will require people to sell options against the stock. If the stock is above the strike price, the stock will be “called” away. The seller receives the premium, but the owner of the call receives the shares at the strike price. There are various strategies involving this covered call strategy.

Some people prefer to have the covered call eventually pay back the stock owner his investment, so that he or she can reinvest that money, and upon receiving the investment back, the person will let the stock run. If this is the strategy, ideally you want to sell covered calls as the stock falls, as it stays flat, and then you want to have your cash back and let the stock run when it is on its way up again. This can allow you to buy an out of favor stock that is still in it’s decline, but in the second half of the decline, reduce your cost basis to zero, and still own the stock near it’s bottom. In the cycle mentioned earlier, depending on how fast the yield will allow you to recover the price of the stock, You will invest in the stock as early as the beginning of “dogs” and as late as contrarian, and recover your cost as early as contrarian, and as late as the start of estimate revision.

Another covered call strategy would be to buy a neglect, contrarian, or positive earnings surprise stock, sell out of the money covered calls, and continue to do so until the end of the growth stage of the stock, and not only stop selling the calls, but to just sell the stock.

Yet another strategy would be to write a covered call until around 20% can be gained, either through capital appreciation or collecting the option, then to convert the stock into a LEAP call as soon as selling the stock plus the premiums collected can pay for the call. This allows you to have a quicker turnover rate in terms of getting your money out, and playing with the house’s money.

This would be great for anyone who intends on having the stock paid for, and expecting to own the stock option through the entire length of the option or longer if they intend on rolling over the gains by buying another LEAP. It is also a good strategy if the stock’s future becomes less certain, and the investor wants to protect his or her initial investment. Now if someone rolls a stock into a stock option that doesn’t necessarily mean they are done collecting income from covered calls. There is far more to be learned about covered calls, so make sure to do your research before considering if its right for you.

About the Author:
Maclin Vestor teaches about trading systems. You can learn more about system trading and find a Trading System that works for you at his blog.

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09 Sep 09 Money Management - The Focus Of Expert Investors

Many people have been through it all, they’ve lost money and made money in stocks, they’ve lost and made money in poker, and they’ve lost and made money in options, and they’ve even lost money and made money in gold. Ultimately the one thing that can make or break you is Money Management. It is what separates the winners from the losers and the haves from the have-nots. What do people that go through those experiences ultimately learn from?

The fact is that it almost doesn’t matter at all how good the method is, if you cannot manage your money well. In stocks although people who can read financial statements and charts, and understand if a stock is likely to go up, or do back testing on certain method and estimate a probability that stocks using that method went up in the past, it is difficult to pin point the exact odds. That makes managing your money more difficult. However, just because you can’t know the exact probability, doesn’t mean you can’t use past results to estimate a probability range, and manage your money well. Lets just assume for a while that you could know the exact probabilities. If you know that you will win 3 times as much as you lose when you win, and you know that the win will take place half the time, do you know for sure that you will make money in the long run?

This is a trick question, you can never know with certainty that you will make money, but is it probable? Again, that still depends. How can this be? It’s easy to say that if you invest $100, you will turn it into $200 (gaining $100) half the time, and you will lose $33 the other half, that in 100 one hundred dollar investments you can expect to make $5000, lose $1667 and net $3333. However, this fails to take into account how likely you are to be able to afford the $1667 in losses and maintain that $100 investment every time out of 100 times.

In other words, the $3333 net gain is theoretical, and takes absolute no consideration on how likely you are to be able to afford those 100 investments. What if you only had $100 and you bet it all, you have a 50% chance that you lose $33 of that 1000… what then? You can’t simply make another $100 investment, So instead you have to make a $66 investment, now your win will be significantly less. If you lose yet again it will become even more difficult to get back to even. Although on paper this is a good investment, it is not a good investment without proper money management. You may have built a very safe car that drives straight, but if you are a bad driver you still could crash.

Unfortunately many people don’t learn how to drive their financial investment vehicles, and instead rely on money managers, financial advisors, mutual fund owners, and company CEOs to do everything for them. This isn’t a bad thing for those unable or unwilling to learn. However, the risk is not only that these people won’t manage your money well, and not only that if they do, you still may pay them so much in fees and expenses that it’s not profitable, but also that by handing the keys to your investment vehicle over to someone else, you lose control and you fail to learn anything. Although you may accomplish your goals with the help of these people, you also could do this yourself with a good trading system that uses good money management.

Maclin Vestor teaches about financial information and advice. You can even learn about finance, money management, and figuring out finance at his System Trading | Stocks Trading Systems blog.

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05 Sep 09 Exit Strategies In Trading Systems

Many good trading systems use multiple exit strategies. In normal trading system, you need to know when to exit from a gain, and when to exit from a loss. Generally you want to be cutting your profits short, and letting your profits run. At a minimum, you generally want nearly a 3:1 gain to loss. This means you should take profits at 3 times the percentage amount as you cut your losses short. We will use this system and do the following

1) Exit stop at a 7% loss. This stop-loss should sell ALL of your shares. The simple method is to just set the stop and leave it. There are dangers of this because people may be able to see someone make the stop order on the floor, and if they have enough money, they can take advantage of that, selling lots of shares of the stock, pushing the stock price down below the stop, then forcing you and others who may have stops out, and then buying the stock below your price, so the stock will stop out, and then quickly rebound. The more advanced mode is to just watch it, and if it is going to CLOSE below your stop, only then will you exit 10 minutes or so before the markets close. The sophisticated way is to just not use stops, and instead buy puts. this increases the cost of the investment and thus limits your win, but you give up a fixed amount for protection against large losses.. This would insure that the stock doesn’t drop overnight. A failed breakout is signaled if a stock drops 7% below breakout point. If you are buying stocks on the pullbacks, a 7% drop should signify a breaking of support.

2) Set a profit target at 20%. You can use a limit sell order to sell here if you would like, particularly for those who don’t have the time to watch the stock. You should be willing to wait a full 4 months for it to hit it’s target. If it hits the target, you should sell 1/2 to 2/3rds of your shares, and let the rest ride. Also, if your stock hits the price target within 8 weeks (2 months), this signals that your stock is a good one, and you want to hold onto your winners. There is a simple strategy and a sophisticated strategy. The simple strategy is to hold onto your stock until the entire 8 weeks is up. The sophisticated strategy is to sell most or all of your shares, and convert them to an option that you should own at strike price, or very close to it. You should ensure that this transaction is such that in a worst case scenario, you still will have a 5% gain. Generally, you will own say 100shares, sell 100, and buy 1 call contract at the same strike price the stock is at, and secure a profit, while still maintaining the same upside leverage minus the cost of the option and the transaction.

3) Set a trailing stop of 25%. This should serve as a function primarily to exit the remaining 1/3rd to 1/2 of shares that you let ride after you hit your price target of 20%. It is possible that the stock goes up near your target, which will raise this stop to 5% below where you bought it, or if you aren’t using a limit sell, it could spike way up to up 35% from where you buy it, and then quickly come down, and sell out a small portion of your shares for a small gain. This is fine. In this case, either the stock will then proceed to drop below your buy point and go and hit the 7% stop-loss, or it will then bounce and gain until it hits your 20% target. In either case, you will sell the rest of your shares. Of course, if this all happens in a short amount of time, you may attempt a swap as a sophisticated strategy, but generally you should be done with it.

4) You should always keep records. Record how many you bought at what price and which exit(s) were triggered. You want to check all these stocks in a year, or so, and see if you could have made more by adjusting your stops, or adjusting the size of which you sell.

5) Enjoy the profits.

If you are a good system trader, you will make sure that they trading system you use has an excellent exit strategy. At System Trading|Stocks Trading Systems you will learn that an exit strategy will allow you make sure that you have a trading system with greater returns on your average gains than you have losses on your average losses. This is only one small aspect of a trading system but it is a very important one. In fact, your exit strategy will be vital in determining how much capital you allocate when managing your money in a trading system.

In addition, if you can find a stock selection vehicle in combination with a good exit strategy, it will insure that any given investment has a positive expected value. In other words, with a good exit strategy and stock selection that picks winners often enough, you will win more than you lose, provided you manage your money right. Learn these tips as a system trader, and you stand a much better chance at being a profitable trader than someone who does not understand the importance of a good exit strategy within a trading system.

Maclin Vestor teaches about variousstock trading systems and has a course coming soon on finding stock trading system that may work for you.

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05 Aug 09 Trading Systems Introduction

by Maclin Vestor

A good trading system is about much more than just selecting stocks. Certainly that is important as well. However, a good trading system will provide the ability for you to protect against losses, manage your money, add proper leverage when necessary, and also select a stock selection maximizing your reward and minimizing your risk.

The guess work is taken out of the way for you. The stock is purchased when criteria is met, the amount of stock purchased is also based on certain criteria. The stock is sold when criteria met, and there are protective measures against a stock’s demise, and where possible and appropriate leverage is created to maximize the returns without taking on more risk than you can handle.

This trading system will be talked about in 5 additional parts in addition to this intro. This post is designed to explain the trading system, its functions and how it operates.

1) Exit strategy. Every good system trader will first know the exit strategy. It doesn’t matter what vehicle selection you use, if you have no exit strategy, you’re stuck. The trick is to understand that unless you want to get trapped in an investment you have to know when you’re getting out.

A good exit strategy has both loss protection, and profit taking, and sometimes even a 3rd stop. The first 2 might be a maximum loss, and a maximum gain before taking profits, while the 3rd one will be a trailing stop that rides the gains up, and will sell the remaining shares. There are other exit strategies such as hold forever and write covered calls against it to collect income, or protective puts in place of a stop-loss.

2) Protection. Although #1 covers most of the protection, there are several other ways to protect yourself. Protection is vital to allow you to stay in the game. Many people know that if you lose 20% you need a 25% gain to make up for it. Losses not only can result in a series of losses that wipe you out, but they also hinder your ability to gain in the future. a 95% loss for example requires a 2000% nearly impossible goal to make up for this loss. So even if you flip a coin and have a 50% chance of gaining 200% or 50% chance of losing 95% of it, you should probably not take it if all your money is at risk, because it doesn’t have the downside protection A series of wins followed by 1 loss would prevent your ability to stay in the game. Even though those odds SEEM fair, they are not without proper protection. Protection ensures that you won’t have that 95% loss, and it absolutely restricts that loss to a fixed amount, rather than take 100% risk.

Such forms of protections are writing calls, in this situation you are given a premium so if the stock tanks to zero in a worst case scenario you’d still end up with the premium, this is minimal protection, and only protects a marginal amount of decline before the losses continue. The other form of protection would be buying a protective put. This actually in fact does protect against catastrophic losses. The lower your stock goes if/when it crashes, the more you make from your put or puts. You are the one paying a small amount in order to protect against any sort of decline below the designated price. The lower this price, the cheaper the option. If a stock is at $50 and you buy a protective put at a strike price of 40, you will NOT be protected against losses from 50 to 40, but beyond that you will be protected to the downside.

These are somewhat more sophisticated forms of protection. Basic forms of protection are diversifying, and perhaps being short. If you buy a stock at $100, and you short one in the same sector at $100, if the whole sector goes up, you are betting not that the market will go up, not that the sector will go up, but that stock A that you are long will outperform stock B in a bull market, and stock B will under perform stock A in a down market. This offers protection although it may limit the gains as well, Plus, you actually have to be right in your thesis.

In addition, if you are short, and the stock market booms, you may get a margin call and be forced to sell. Also, if you do not use money management, you are at risk of a short term swing requiring you to sell all of your shares of the stock that went up, in order to pay for those that you were short that went up, and if you can’t cover your short, your entire account is in jeopardy of being wiped out.

So rather than being short, I recommend replacing it with buying put options, although this has lots of risks involving time decay as well that you must understand before investing. Using a business entity such as a C Corp or a LLC is another form of protection that can protect you potentially against higher taxes, and personal financial trouble such as a bankruptcy on your record if you intend on using forms of leverage such as loans.

3) Money Management and Control. A good trading system will have a form of control. it will allow you to not give up that control when things go bad. In other words, it allows you to manage your money. Money management is very important. Perhaps one of the most important things is position sizing. If you buy $10,00 of stock for one stock when you only have $10,000 in your account this is very poor money management. Continue to do this, and eventually you will suffer a large loss which will be great, and it will be very difficult to gain enough to make up for it. In addition, if the price goes lower depending on your system, you may want to give yourself flexibility. Extra cash on the sides is another form of money management. It doesn’t have to be cash per say, but some form of safety. Various forms of currency, sometimes some gold, bonds, and money market accounts that are all fairly liquid would be a few examples.

4) Leverage Leverage is about using your abilities to gain, the strength of your trading system and various tools to minimize risk, and increase gain. When you take on leverage, you should be able to reduce your position size in comparison to your capital, and still have a similar reward or gain.

Forms of leverage include options, the further out of money option you purchase, the more leverage you have if that stock does make a strong move. You can also sell options to raise capital to invest in some cases.

Another from of leverage is a loan. Whether it’s a credit card, a home equity loan, going on margin, or a business loan for an asset holding company, or even taking a company public and using the capital to invest, the idea is to gain money at x% and to invest it and make a greater return than x%. if you can do this, and manage money well, and protect yourself, Your gain is only limited to the amount of capital you can borrow at the maximum of slightly less than what you expect to gain. Generally however, if you use a loan, you should have a form of cash flow or income that will cover the costs of the loan just in case your investment goes wrong. That’s another form of money management while using leverage. Money management should be treated much differently under different forms of leverage.

5) Finally, the stock selection vehicle. You need some method to select your vehicle, based on this and your other factors you will determine time horizon and a methodology of trading. The system will help you choose your trading stocks, and exactly what to do with them. You can play around with different trading systems, but generally you should first attempt a good exit strategy and make sure your controls on parts 1-4 of your trading system are sound, and try tweaking them

Stock Trading Systems that are well defined will leave very little room for error. If you learn to use a trading system, you can choose to enhance the essential skills it takes to making your trading system better.

Unfortunately, many day traders are slaves to the computer screen and can miss a moment. Focus on building the better trading system, and not placing the better trade, and you will give yourself some valuable time. If you are really using a system, you don’t need to be the one to place the trades, and can instead higher someone to do the work for you. You can use that extra time to improve your system, or find new ways to invest, or learn how to become a better trader.

You can learn other tips like this at the System Trading|Stocks Trading Systems blog, which is full of tips for day trading, options, swing trading, momentum trading, and advice on building a trading system.

About the Author:
Maclin Vestor teaches about varioustrading systems and teaches you how to buy stock online.

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