The Tycoon Report

How I Elevated My Options Trading Game

Thursday, August 27, 2009 | Bob De Dea

When you're long a stock (i.e., holding the shares in your account), having it go up is the only way you'll make a gain. Likewise, when you're short (i.e., borrowing shares from your broker and selling them), if that stock goes up against you, you are exposed to a potentially unlimited amount of risk.

But in a market where stocks zoom higher and seemingly freefall lower, many investors are turning to a lower-cost, higher-potential-percentage-return alternative: options.

The Trade That Taught Me To Weigh My Options

Back at the dawn of 2008 or, more precisely, the midnight of 2007, I got a signal that the Oil Service HOLDRs (OIH) Exchange-Traded Fund was ready to take off.

I didn't act right away. After all, it closed that day at $189.02. That's a lot of money to put up to establish a position!

It turned out to be a good thing to have waited a bit.

A 'Slick' Entry Point for Oil

When I made my purchase, on Feb. 1, 2008, the OIH was trading at $161.85 (about 10 bucks off its low of $152 in late January).

I sold when the ETF was trading at $210.33, on April 21.

So, if I had bought 100 shares of OIH on Feb. 1, I'd have paid $16,185. I would have then sold those shares for $21,033 on April 1, for a profit of $4,848, or about 30%.

But I didn't make 30% on my purchase and sale.

Not even close.

Getting in on the Game without Betting the Farm

You see, the signal I received was to buy the OIH July 160 Calls, which were trading at $38.90 at the time.

There are many reasons why people use options in their portfolio -- to protect the positions they already have, to spend a few cents or bucks as a "lottery ticket" in hopes of a big move, and to establish an equivalent-share position in a stock/ETF for far-less money (and, therefore, risk), just to name a few.

In this case, $38.90 per share for an option might be in the same price range of a regular stock. But for a stock that was trading just below $200, paying nearly $40 is a fair price for a call option that gives you the right to purchase shares at $160.

However, it's important to know that options are quoted on a per-share basis, and that options are traded in contracts, with each contract representing 100 shares of the underlying stock or ETF.  At $38.90 a share, one options contract costs $3,890, whereas 100 shares of a $200 stock are going to set you back $20,000.

As you can see, this leverage allows you to position yourself in a same-sized position without spending the big dollars to do so!

Making the 'Call'...

Although I was very aware of the advantages of buying calls over owning the stock, still I hesitated in establishing a position at all.

Even if I bought four contracts, honestly, I just couldn't afford to spend 16 grand on one play. (Those of you new to The Tycoon Report may not know that I am an actor/singer/songwriter by profession. We who choose such paths have given up much for our art!)

I kept an eye on the OIH and its options chain, specifically the July 160 Calls.

With the stock market in flux and oil doing a dance of its own, the OIH pulled back significantly. On Feb. 1, I picked up those July 160 Calls ... for just $16.60 per contract.

I didn't have to hold them for five months, till July expiration, to reap a profit. (Although, at the peak of the run, on July 1, 2008, OIH topped out at $224.15.) But it's important to bank your profits  when you have them and not get greedy because you might have to give back those profits if the position turns against you.

On April 1, I sold my call options for a whopping $50 per contract. That, my friends, was a just-shy-of 200% take on each $1,660 investment.

Such is the power that options bring to the table.

The Next Success Story: Yours

It's obvious why this is my favorite trade that I've ever made. But once you understand how options work, and which ones to zero in on to invest in, it's exciting to watch a small amount of money into an investment powerhouse.

Not every trade you make is going to be successful, but the potential to hit home runs with options is there for you. And the winners can far out-earn the losers.

Remember, options might have expiration dates, but you can always buy as much time as you need to let the opportunity work in your favor. And whether you're making profits or the trade turns against you, you can close the position at any time to protect the gains you've made (or the money you haven't lost).

So, take the time to weigh your options and consider taking your options trading to a whole new level!




Bob De Dea
Guest Contributor
The Tycoon Report