How do you plan to park your money?

[powayseller]

On the premise that Zeal’s options recommendations carry a lower risk than 90%, I took my Zeal newsletter to confirm my hypothesis. The results were opposite: the value of the calls are down, while the long positions are up.

Details for the current rate of return of the call, and the return if the stock had been purchased long on the first day of the month. Since I don’t subscribe to the Zeal Speculator, these purchase dates and prices may need adjustment.

Every stocks increased since the Zeal recommendation date. So why did the options go down?? Can someone explain this to me? Shouldn’t the options increase in value because the stock went up past the call value?

PCU
Sep 85 calls -7%
Long + 13% (2/1 $81.75, 7/3 $92.54)

CCJ
Sep 37.5 Calls -6%
Long +11% (3/1 $36.92, 7/3 $41.15)

COP
Nov 60 Calls +6%
Long + 4.3% (4/3 $64.04, 7/3 $66.82)

CHK
Jan 30 Calls – 14%
Long 0% (6/1 $30.54, 7/3 $30.74)

[Anonymous]

Chris Johnston

Time decay on the premium is the reason for that difference. This is a big reason why options can become worthless, before they expire. Poway, just call me sometime and I will go through this with you.

[anxvariety]

PS, Zeal performance, enjoy:
http://www.zealllc.com/perf/2006.htm
http://www.zealllc.com/perf/2005.htm
http://www.zealllc.com/perf/2004.htm
etc.
They’re getting better…

Chris, have any links/references to your 90% of options expire worthless statement?

[lewman]

While I don’t know for sure as I haven’t seen any link/reference to the claim but I suspect Chris is right that a large proportion of options expire worthless … it certainly is true in my case when I buy options …
#@$%^&*#$%%^ ha ha ha

On the subject of covered call option, here’s a very good explanation of how to use this strategy to supplement a buy-and-hold one from Trend Rider. It essentially allows you to turn the normally undesirable time decay effect to your own beneifts:

Profit from the Trend:
“Become the Casino” with this simple options strategy …
Chris Rowe

To understand why you should make covered calls a regular part of your investment diet, ask yourself one question:

Why does a casino make so much money?

Because there are millions of people who are okay with taking bets, even when they know that the odds are against them. Every now and again, the casino loses and the gambler wins!

But does the casino ever really lose? I mean, is the casino really gambling at all?

The guests of the casino are doing all of the gambling. The casino is simply running a business. The casino knows that every now and again they will have to pay up. But the amount that they pay out once in a while is dwarfed by the amount that they collect from most of the other guests. Everyone knows that!

But when you are the buyer of short-term, out-of-the-money options, you might not realize that you are the same guy as the gambling casino guest.

When you are the person who is selling (aka writing) covered calls, YOU are the casino!

You are the one who is accepting payment after payment after payment from the guy who wants to see his $2.00 BOBC call option trade up to $10.00.
Once you have sold a covered call and received your payment, either you will keep the premium and your stock position, or else you will keep your premium, and you will sell your stock. BIG DEAL! Just be sure to sell covered calls only if you are willing to sell your stock at the strike price.

Ideally, you want to sell calls with a strike price that’s slightly higher than the stock’s current price. It’s also okay to sell calls with a strike price that’s at-the-money (the same as the stock’s current price) or slightly in-the-money (slightly lower than the stock’s price.) The idea is to profit from the decaying time value of the option that you have sold.

Ideally, you also want to sell calls that will expire in 30-45 days because that is when time value will decay most rapidly.

Now for the comparison:

Let’s say you are NOT that average stockholder (who never sells covered calls.)

Instead, you have taken the time to learn about covered calls, and you now have the advantage of an easily acquired education on the benefits of covered call writing …

You buy 1,000 shares of “Bob’s Car Wash” (BOBC) at $50.00 per share.

The stock now trades to $58.00 per share.

You say to yourself: “I would be willing to sell my stock at $60.00. Let’s see what the BOBC June 60 call options are trading at,” because you know that someone is willing to pay something for the right to buy your BOBC at $60.00.

You find out that you can sell the BOBC June 60 calls for $2.00.

Again, the stock is at $58.00, and so far you are up $8,000.00 on your stock position.

Remember these two keys:

Each option contract represents 100 shares. 10 option contracts represent 1,000 shares. So if you own 1,000 shares of BOBC, and you want to sell someone the right to BUY your 1,000 shares of BOBC, then you would sell 10 call options (to open,) because 10 options represents 1,000 shares.

Some people get confused about selling first and buying second. Traditionally people are trained to understand only buying something first and selling it second. But when you write an option contract (or sell an option contract,) then you are essentially “short” the option contract. You can first sell an option contract at $10 (to open,) and THEN buy the option 3 weeks later at $6 (to close) for a 4-point profit.

So again, BOBC has traded from $50.00 to $58.00 per share.

This time you sell 10 June 60 call options (to open), and you receive an extra $2.00.

That part of the transaction is now done. You now have an extra $2,000.00 in the bank, no matter what happens to the stock.

Now take a look at the difference.

There are four possibilities:

BOBC trades to $60.00+. Your BOBC is called away (sold) at $60.00 per share, and instead of $10,000.00, you net a profit of $12,000.00. ($10k on the stock and $2k on the option that you sold.)

Special note: Your stock will not necessarily be sold at $60.00 just because it trades over $60.00. Your stock may or may not be called away at any time before expiration. If, at 4:00 p.m. on expiration day, the stock is 25 cents in-the-money, or more (which means BOBC would be at $60.25 or higher), the call that you sold will automatically be exercised, and your stock will automatically be called away (sold).
Here is a quick picture of what this would look like.

BOBC trades down. You don’t feel so bad because you picked up that extra $2,000.00. If you didn’t sell that call option, BOBC would have still traded lower, but your account would be worth $2,000.00 less than it is worth right now! Whatever dollar amount the stock trades down by, the decline in value is reduced by $2,000.00.

For instance: If, after you take in that $2.00 premium, your stock trades from $58 down to $55, then instead of losing $3,000.00 in value, your 1,000 shares of BOBC would lose $1,000.00 in value since you will have been paid $2,000.00 for the call option that you sold. (If the stock trades down 3 points, you really only lose 1 point in value, because while the stock lost 3 points, you made 2 points by selling the call option.)
At least you take in an extra $2,000.00, and you will be free of any future obligation once the option contract expires. (Or else you can just close out the call option position by buying the same call back (to close) at its current lower price (see below).

Now here’s a fun twist: You actually have two choices if your stock trades lower.

a) You can do nothing and maintain both the “long” stock position, as well as the “short” call option position until the option contract expires.

b) You can simply buy the option contract (that you previously sold at $2.00) at a cheaper price. Imagine selling a gold watch for $2,000.00 and then buying it back from the person that you sold it to for $300.00. Not bad. That’s a $1,700.00 profit.

As the stock trades lower, the call option that you sold also trades lower. That means that if the stock trades lower, you can always buy the call option (that you’ve sold) at a cheaper price than what you received for it when you sold it. This is a profit on the option trade that will reduce the loss incurred on your stock position.

For example: If BOBC trades from $58.00 down to $55.00, then the call option that you sold at $2.00 (to open) may trade down to 30 cents. You can now buy the call option at 30 cents (to close). That’s a difference of $1.70. Since you originally sold (or shorted) that call option at $2.00, that $1.70 difference is a profit.

Said differently, if BOBC traded from $58.00 to $55.00 the stock position lost $3.00 in value. But since the call option that you sold at $2.00 (to open) is now at 30 cents, you have a profit of $1.70. So the net result is that, instead of your position losing $3.00 in value, it really only lost $1.30 in value.

Stock lost $3.00
Option gained $1.70
Total loss is $1.30

OR – as I said originally, you can let the option expire worthless and realize the entire $2.00 gain on the call. In this case, if the stock traded from $58-$55, then your entire position would have lost $1.00 in value instead of $3.00.

Stock lost $3.00
Option gained $2.00
Total loss is $1.00

After the option expires, you are free of your obligation. If you wish to do so, you can sell another call option and start the process over again.

BOBC doesn’t trade up or down, but sideways. GREAT! As time passes, the call option that you sold (to open) is losing its time value. Since you are “short” the call option, this is a good thing for you. Basically, as time goes by with the stock trading flat, you are making money as the call option loses value due to time decay.
If the stock pretty much trades flat until the option expires, even though the stock did absolutely nothing, you made an extra $2,000.00. This is awesome! Even though the stock never got to $60.00 per share, you still made $10,000.00 as you had originally hoped for! (You made $8,000.00 on the stock and $2,000.00 on the call option that you sold.)

Meanwhile, there is someone out there who was in the same position as you, but since they didn’t sell covered calls, they are sitting on a $58.00 stock, wondering whether or not it will trade to their target price of $60, so that they can make the $10,000.00 that you just made with zero movement in the stock.

The call option expires worthless, you now have two choices: You could either sell BOBC at $58 and skip down the street thinking about how cool you are for making $10,000.00 on a stock that only traded up 8 points, or you could sell another call (to open) that expires the following month or two out. Maybe you can sell the July 60 call (to open), or the August 60 call (to open) and take in yet another extra premium.

BOBC trades somewhere between $58 and $59.99. GREAT! I can’t wait to brag! Let’s say, for example, the option expires worthless, and BOBC is at $59.00 at the time. That means that you made $2,000.00 by selling the call option (you had sold that casino guest the right to buy your BOBC at $60,) and you are also up 9 points on the stock. If my calculations are correct, you are now up $11,000.00, and the stock never even hit your price target of $60.00!
So the moral of the story is this:

When you are long the option contract (said differently: when you are the owner/buyer of the option contract), Time Decay is your worst enemy, because as time passes, your option loses value.

When you are “short” the covered option contract (said differently: when you are the writer/seller of the covered option contract), Time Decay is your best friend, because as time passes, the option that you sold (to open) to someone else, loses value. You can either buy the option back (to close) cheaper, which will result in a profitable option trade (offsetting your stock’s loss of value), or you can let the option expire … which will also result in a profitable trade.

If this covered call lesson has helped you learn something new, then you are probably anxious to get out there and write some covered calls on stock that you own, and start grabbing all of that extra money that you have been leaving on the table each month. But before you do, first consider this last possible outcome …

What would happen, and how do you think you would feel, if you wrote a covered call on BOBC, which obligates you to sell BOBC at $60.00 per share, but 2 weeks later BOBC traded up to $90.00 per share? Hmm.

Before you read any further, think about that for a minute. Do you know what would have to happen in that case?

Well here it is: You would have to sell BOBC to someone at $60.00, even though it is selling at $90.00 in the stock market. Now, that might drive you crazy, even though your original plan was to sell at $60.00 anyway.

Ask yourself, how much of a loser would you feel like if you sold someone the promise that they could buy your stock at $60, only to see it trade to $90, 2 weeks later?

Answer: You should feel like a loser much as the casino feels like when someone puts $2.00 in a slot machine and wins $30.00.

The reason a casino is happy to give up a profit every once in a while is because they make so much more in the long run.

I hope that I have given you a clearer picture of why options can be used as a way to gamble, but also as a conservative way to reduce risk.

Chris Rowe
Chief Investment Officer
The Trend Rider

[powayseller]

246% return with Zeal 2006 options! Very impressive. Maybe I need to subscribe to the Zeal Speculator after all. But you need to buy all their options recommendations, because some lose money, so you wouldn’t want to be the buyer of that one that expired worthless.

My brother used to be a lawyer on Wall Street, and he told me that most options expire worthless, i.e. they are a money maker for the options writer, as Chris said. The same was explained by leung_lewis in the casino example.

I wrote yesterday that Zeal may have a higher rate of success due to their good research. From the links you provided, it is obviously the case. Which leads me to ask: why aren’t we all subscribing to Zeal and getting 200% returns? Their research is excellent. My only other question would be how risky their recommendations are (alpha or beta?), and if they will do just as well in the upcoming bear market.

Regarding the 90% figure cited by Chris, I find it believable. I did a google search on options, and found lots of links on the high loss rate. Here is an article:

“Options, by definition, are a wasting asset. Many first-time option investors learn this fact the hard way by watching their option contracts expire worthless. It is frustrating to have a call option expire on a Friday afternoon only to see the market rally through your strike price the following Monday or Tuesday. The vast majority of options expire worthless; most estimates are somewhere north of 85%. ”

Here’s another article about a CME options study done for a book:

“While there are certainly many viable options-buying strategies available to traders, options expiration data I obtained from the CME covering a three-year period suggests that buyers are fighting against the odds. Based on data obtained from the CME, I analyzed five major CME option markets – the S&P 500, eurodollars, Japanese yen, live cattle and Nasdaq 100 – and discovered that three out of every four options expired worthless. In fact, of put options alone, 82.6% expired worthless for these five markets.
This study analyzes data compiled by the Chicago Mercantile Exchange (CME) for a special options report prepared for this my book, Options on Futures: New Trading Strategies (Wiley & Sons), co-authored by Jonathan Lubow, vice-president of Trader’s Edge, Inc., a futures and options brokerage based in Madison, NJ. ”

[labear]

http://www.investopedia.com/articles/optioninvestor/03/100103.asp

I’ts not 90%, but close enough.
Options are much more complex than most people realize.
They can range from very risky to very conservative (using spreads).
If your trading options without at least knowing the statistical and implied volitility you won’t last very long.
Even then the odds are stacked against you.

[anxvariety]

I don’t doubt that figure could be accurate in some situations.. but I thought it was unfair to toss out ‘90% of options expire worthless’ as it was fact.. especially when people who are trying to learn more about options are reading(like myself). Chris, just biatch slap me and I’ll shut up!! 🙂

No way am I holding options even within a month of expiration..

Powayseller, Zeal hasn’t had any expire worthless in 2006.. you can tell which expired worthless in previous years by looking for the -100%. They probably learned their lesson, as you get closer to the option expiration the more you’re playing with fire. I may have found Zeal, only because they are doing well this year? What is the overused saying, a broken clock is right twice a day… Everyone’s happy when they’re winning, looks like Zeals best year is this year – and their focus seems to have been mining companies and energy which has boomed over the last few years.. so I guess we’ll have to wait a couple years to see what happens.

Great reading lueng_lewis!

[anxvariety]

Most cars expire worthless.. do you keep your car until it breaks down on the freeway? Or will you stay away from the freeway when it’s sputtering out rust?

[lewman]

I like Zeal and continue to subscribe to the monthly. They have their own methodolody and are willing to explain that in details unlike most other newsletters I’ve seen and for this I consider them one of the most enjoyable readings (but actually if I were a newsletter writer I would be mum coz that’s like giving away the recipe of my secret sauce). But if you go back to 2003/04, you’d see that they got slaugthered by the general stock market rebound and lost big on repeated PUTs on NASDAQ & S&P500. Like powayseller said, they’re not yet proven on my book either as it would be interesting to see whether they can “turnaround” when the economy slows down and negatively affect resources prices. Having said that I do think that the law of averages is going back to Zeal’s favor and I think PUTing the general stock market will probably yield profitable results over the next few years.

One note on Zeal Speculator, notice the first year there was a loss of 59%, so word of caution, because unlike their stock recommendation which always come with a 20% auto stop loss, Zeal doesn’t use stop loss on options (coz the maximum loss of premium itself acts as a stop loss mechanism), you must prepare yourself for the possibility of total loss.

[anxvariety]

leung_lewis, it’s probably like the people on TV that sell their real estate secrets… at some point it becomes easier to create a cookie cutter pattern and let someone else do all the footwork…

I don’t think Zeal suffers in any way from putting out their strategy, if anything it’s the opposite – just look at Cramer(Mad Money) and his team Cramerica… plus even if Zeal does screw up, or lose their ass on some trades.. they made money providing information well enjoyed.. Sort of a hedge on their strategy.

I trust Adam, even though I’ve never met him I get the feeling from his writing and full disclosure that he’s high integrity.. I do realize trust doesnt’ necessarily mean a successful invesmtment, but I believe Mr Hamilton loves what he does and wants us subscribers to be successful.. I can’t say I believe that someone like Cramer puts his fans first..

[powayseller]

One weakness with Zeal is they are bullish on commodities. I am not. During the 2000-2001 US very small recession, commodities got hammered, and I posted the data a few weeks ago, on which commodity lost how much.

US economy drives world demand, so our next recession, which I expect to be deeper and longer, will cause a commodity downturn. Just look at the IMF and Federal Flow of Funds data for 2000-2001, to see my point.

I wrote Zeal about this, and they did not respond. Zeal’s commodity bullishness will turn around and bite them if they don’t wake up to this fact. China’s boom cannot sustain when American slows down, because they have not stimulated internal demand. They are export dependent. That is China’s weakness (others are high bank loan losses, corruption, and lack of accounting standards).

If you use Zeal, keep the caveat in mind, that the commodities will start weakening as the recession gets going. As far as precious metals, I have no idea what the future holds. Chris J showed in his newsletter that gold prices are affected by changes in inflation, not by the value of the dollar. Get his newsletter to read the whole story. The charts show both the dollar and gold weakening since the late 1980’s, but in 2005 both the dollar and gold rallied together.

If gold is inversely related to dollar weakness, why was there a gold rally while the dollar was rallying? Wouldn’t the gold rally be delayed while the dollar was strong? So, the relationship is not something you could trade on.

Back to Zeal – they’ll probably continue being right while the commodities bull continues.

I got my July Yamamoto Forecast. Irwin T. Yamamoto is currently ranked as a top stock market timer and one of the top bond timers in the nation by Timer Digest. He sees an economic slowdown, and is bearish on gold, stocks, and bonds. He recommends 0% stocks, 100% cash. His cash picks are bank money-market accounts and to check bankrate.com for highest yields.

Yamamoto’s reasoning: stocks are pricey at 18x trailing earnings. Projects for 2007 are for slower economic growth, and even Bush expects GDP to drop to 3.3%. Buased on 2007’s outlook, stocks are too expensive. It’s not ideal to pay a premium for stocks when business activities are descending.
His take on gold and oil: We anticipated a correction in the gold makret, and got a $100 price drop. The bullion should feel moer downward pressue in this rising interest-rate environment. Yet as the economy slows, the loss of value in the dollar means higher metal prices later in the year. Oil prices will be supported by higher demand for the commodity during the summer driving season. Still, sooner or later, a short-term dip in prices is probably due to the negative effects of a softer economy. END QUOTE
Yamamoto Forecast, PO Box 573, Kahului, HI 96733 $350/year

[Anonymous]

powayseller, thanks for Yamamoto information. More for the arsenal.

I’ve been reading here for a few months and Piggington posters are way ahead of the curve. I’m having a hard time convincing my husband that the housing downturn is the harbinger of a consumer-driven recession. He thinks the feds will keep things from getting too bad. He is smarter than me, but doesn’t spend a lot of time pondering the implications of all that debt out there.

We have almost all of our money in individual stocks or funds. If we move over to CDs and t-bills we will take a bath on the capital gains. I think it beats the alternative. Heck, we might as well buy a house if we are going to sit and watch the market ooze away our life savings. How can I convince my husband? What was the tipping point for those of you that are getting out of the market for now?

[Carlsbadliving]

In May I just took all of our money from mutual funds and put into a money market account. The tipping point for me was that I started worrying too much about the money in the mutual funds. I sleep much better at night with it in the money market. I think if you’re that worried about it, you need to move it. What’s the point of having money if it’s going to stress you out. Go with your gut.

[powayseller]

nadorenter, some very smart people are bearish on stocks. Yamamoto Forecast, Barry at TheBigPicture, Bill Fleckenstein.

If you want to see what happens when the consumer stops spending, read the very data-heavy (Federal Reserve and IMF data) Dollar Crisis, written by a former consultant to the IMF.

Also read Ahead of the Curve, from Goldman Sachs analysist Joseph Ellis. He was the #1 retail analyst for 18 years in a row. See aheadofthecurve-thebook.com, for updated charts, and you can see graphically why we are heading into a recession.

Also read iTulip.com, run by a venture capitalist who warned about internet stock bubbles in 1999. All 3 of these guys are brilliant, and all are warning of a recession, based on the excesses of the government deficit and housing bubble.

Read my favorite realtor, Bob Casagrand’s web site. He has the best data on real estate in San Diego. I don’t remember his web address, so you can google him. He tells you what’s going on now in the market, how sales are down, etc.

Read the bubble bloggers, esp. Calculated Risk for the MEW information. Read my analysis of the UCLA Anderson report, from a few weeks ago. Read Part 1, where I dismiss their report for their faulty and weak analysis, and why we are going into a recession.
Tell you husband, that 70% of the US GDP is from consumer spending, and with flat wages and high inflation, consumer spending is due solely to MEW (mortgage equity withdrawal). We don’t even need prices to go down for that gig to stop. Even flat housing prices will eliminate the MEW.

Here’s another book: Sell Now by John Talbott.

I sold my house, I cashed out, and I moved all mutual fund and stock and index fund money to cash. My house proceeds are in cash.

I use about 10% of my cash to dabble in stocks, based on the info in the Zeal newsletter. Several of us on this site subscribe to Zeal, and they are very good.

If your husband loves devouring economic and stock stuff, he will like the brilliance and clear thinking of the resources I cited here. Good luck. We cashed out our index funds just a couple weeks before the sell-off in May.

[Anonymous]

I agree with you, Carlsbadliving. It isn’t worth it to lose sleep. I worry a lot, I guess because I grew up poor. I do think there is a reason to be nervous now.

[Author]

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