The Tycoon Report

Profit Like The Casino

Friday, July 22, 2005 | Chris Rowe

A good friend of mine Brock L called me Thursday (yesterday) morning and asked my opinion on Google (SYM: GOOG). He had recently bought in Las Olas Ft. Lauderdale and had a plan how to make a quick $9,000 that he’d use to buy a piece of art that he wanted to go with the new home. I showed him how he could immediately have a check for $9,000 sent to his new house without taking unnecessary risk. Thank GOODNESS he called me before executing his plan.

He said he owns 500 shares of Google that he bought soon after the IPO when the stock was at $120 which means he’s already up over 150%

Anyway, my friend Brock L. called me and said that he was going to try to make a quick trade to pay for the painting that he wanted.

His plan to do this was simple.

He was going to bet that Google, which traded at $310 at the time, would beat the street estimates after the market closed and his price target was $335 (don’t ask why). Although he owned 500 shares of the stock, he didn’t have $155,000 to invest in another 500 shares of stock.

He decided instead to put up $9,000 to buy call options, specifically, the September $320 calls which were trading at $18.00. It would have cost him $9,000. If the stock traded about 25-30 points higher quickly, who knows? He might have doubled the value of those calls! Just enough profit to buy the painting. He thought that Google had about another 25-30 points on the upside.

Ladies and gentlemen: This is the WRONG way to play this sort of situation. This is a perfect example illustrating the importance of understanding how and why you should sell calls.

Lets review:

Had he executed his strategy Brock would have

put his $9,000 at risk of being wiped out completely.
might have made a $9,000 profit if Google traded 25 points higher.

If you own stock, and you want to have money deposited in your account, you don’t have to risk your hard earned money. Instead, you can take advantage of someone else’s risky nature. All you have to do is reverse what almost occurred. Rather than risking 100% of your $9,000 to make an additional $9,000 by purchasing a call option that might trade higher, or might expire worthless, what I suggested was to SELL the same option contract.

He was confused and said “no Chris, I think the stock trades HIGHER”. So I want to BUY the call option since that would trade higher with the stock. I explained that if he buys the call option, the only way to win is if the stock did what he expected.

On the other hand, if the stock traded flat or down, he could lose all of his money on the trade. Then I explained the importance of selling the calls. Rather than hoping that you are right, you immediately have the money deposited in your account (or in Brocks case, have a check sent to his house). THAT part of the trade is done, the check is in the mail as we speak, Brock has already reserved the painting.

Here are the 3 possible scenarios that Brock is left with now.

Google trades higher and on September 16th, if Google is over $320, Brock will have to sell his 500 shares at $320 (10 points higher than where it was when he executed the trade) and Brock has a $9,000 check in his new mailbox.
Google trades flat, and Brock still owns his 500 shares and has a $9,000 check in his new mailbox.
Google trades lower, and Brock still owns his 500 shares and has a $9,000 check in his new mailbox.

That’s right, you heard me! So all you have to do is sell someone the right to buy your stock at a higher price. Let them take the risk. Brock’s risk here is that he sells his stock 10 points higher. Not only is that another $5,000 in profit on his 500 shares of stock, but add the $9,000 check which will be in his mailbox in a few days for a $14,000 profit.

If you ask me, that sure beats the risk of losing the $9,000 he would have spent on purchasing the calls. He told me that every month or two he is going to sell calls on his stock positions. Now he knows that even if he owns a stock that trades flat for 12 months, you could still make 20-40% on it if you sell calls.

He caught on fast because he called me back and told me he realized that by selling calls, he could even own a stock that traded 10% lower, and still be profitable on the position by 20-30%.

Then he thanked me for: