Archive for November, 2008

TOOLS OF THE TRADE

THE LONG CALL

OPTIONS BASICS

Options are sometimes referred to as derivatives in that they are related to and are derived from the underlying security. There are two types of options, Calls and Puts. Options are purchased in “contracts”. A contract is usually equal to 100 shares of stock. So, if a trader purchases 10 contracts on an underlying stock, that trader now controls 1000 shares of that stock for a fraction of what it would normally cost to buy the stock outright.

Options are made available for purchase or sale in what is termed “option cycles”. There are three cycles 1) January, April, July, and October. 2) February, May, August, and November. 3) March, June, September, and December. There are tables known as “Options Chains” that represent the prices for both Calls and Puts at various price points called “Strike Prices” for each month in the cycle. There are also long dated options available on many but not all stocks. These options are called LEAPS which stands for “Long Term Equity Anticipation Securities”. These options are available in January and would allow a trader to purchase or sell an option on an underlying security up to 2 ½ to 3 years out.

Options can be used to speculate on price appreciation or depreciation of the underlying security or more conservatively, to hedge stock positions to protect against loss.

THE LONG CALL

Today, we will discuss the “Long Call” at the money (the strike price closest to where the stock is currently trading). When the trader purchases a long option, it gives that trader rights. A long call gives the trader the right but not the obligation to purchase the underlying security at a predefined price point (the strike) for a stipulated period of time in exchange for the premium paid for that option. We can also sell options, but that will be a future discussion.

Long Call Risk Graph

*Risk graph courtesy of Options Industry Council

As you can see in the risk graph, there is a defined risk which is the cost or net debit of the option. The trader can under no circumstance lose more than the cost of the option. Yet, the upside potential is theoretically unlimited. Options are “decaying assets”. As time move closer to the option expiration, the option loses value. So, in order for the trader to be profitable in a long call position, the stock must move up before the option expires.

 

There are other factors to consider when purchasing long options that effect profitability. Options are not linear like stocks. If you are long stocks, you win if the stock goes up and you lose when the stock goes down. Options on the other hand are multi dimensional in their price structure and are effected by more factors than just the price of the underlying security. We will discuss those factors in greater detail in future posts. Study the graph to gain understanding of your risk and reward in the long Call position. Next week, we will discuss and graph the “Long Put”. Robin

ECONOMIC REPORTS

MONDAY 11/17

NY Empire State Index, Capacity Utilization, Industrial Production

TUESDAY 11/18

Core PPI, PPI, Net Foreign Purchases

WEDNESDAY 11/19

Building Permits, CI, CORE CPI, Housing Starts, FOMC Minutes

THURSDAY 11/20

Initial Claims, Leading Indicators, Philadelphia Fed

FRIDAY 11/21

None

 

 

EARNINGS OF NOTE

MONDAY 11/17

FC, LOW, TGT

TUESDAY 11/18

HD, JBX, MDT, SKS

WEDNESDAY 11/19

CYBX, DBRN, GYMB, HOTT, INTU, LDK, MW, PETM, TSL

THURSDAY 11/20

BKS, DELL, DKS, FL, GME, GPS, HP, HIBB, PERY, CRM BKE, PLCE

FRIDAY 11/21

ANN, HNZ, SJM, KIRK

There continues to be a lot at stake.  The FDIC is once again pushing the idea of a mortgage loan guarantee plan that would provide $1000 to servicers to cover loan modification expenses and backstop the loans should they re-default in the amount of 50% of the losses.  Those eligible would be 1.4 million loans 60 days or more past due and 3 million loans projected to be delinquent by the end of next year. 

Hank Paulson’s announcement to adjust the game plan took many by surprise by infusing capital directly into banks in the form of preferred stock positions in those institutions as opposed to buying up toxic mortgages.  The move was prompted by the frozen commercial paper market which has not allowed big business to raise capital.

I see the largest and most immediate problem as two fold.  1)  We can’t let the Auto Industry go down.  The systemic risk would be massive.  2)  We must help people stay in their homes by restructuring the debt.

I am a free market capitalist, but we need to be practical here. We can’t let GM and F fail and then live with the results which in my opinion would be far worse than throwing them a lifeline.  It bothers me to no end that those that have been fiscally responsible should have to bailout those who overextended themselves with mortgage debt.  Certainly, there were predatory lending practices, but many people just “rolled the dice” and got involved with loans they knew were risky.  Why not extend tax credits to real estate investors to incentivize them to work off the bloated real estate inventory and begin to return the housing market to equilibrium.

We need leadership NOW!  GM won’t last through the end of the year without help.  Is it right to bail them out!? Let me end by saying that there have been times in my life when I have been absolutely right but ended up losing the battle.  At this point, it’s not so much about being right or wrong but rather what is needed.  You don’t ask a soldier who just took shrapnel in his/her leg whether the war is right or wrong, you apply a tourniquet to save a life.  Robin

 

 

 

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John Brasher – LogiCapital and CallWriter

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John Brasher is the President and CEO of LogiCapital Corporation, which owns and operates trading-related web sites. He also is the Editor and Publisher of the company’s flagship web site, www.CallWriter.com, online continuously since mid-1999. John is a respected writer on trading and investing topics and has been trading and investing for approximately 20 years. He has primarily traded stocks and options, including straight stock option strategies and combination strategies such as covered calls, option spreads, straddles and others. CallWriter’s Money Newsletter is highly regarded for its covered call and option trading insights and its nuts-and-bolts approach to explaining option trading.

Along with his colleagues, John developed the CallWriter.com web site, which is renowned for publishing the Real Time Lists™– web-based lists of the highest-returning covered call trades that update based on real-time data every few minutes during the trading day. John played a pivotal role in developing the CallWriter Trade Management Calculator™, which allows traders to actively manage live covered call trades in order to maximize returns – it takes traders all the way through the trade. He also was primarily responsible for developing the CallWriter Method, a complete and innovative methodology for selecting, planning and managing covered call trades for a high, consistent income with few – and small – losses.

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The week began with a very narrow range trading day on relatively low volume closing down 5 points on the DOW.  The ISM report attained the lowest level seen in over 25 years.  Construction Spending was down and Auto Sales were pathetic rounding out the economic news before election day.

Election Day was all about change and the hope of a new beginning as the DOW closed up a robust 305 points.

Wednesday was back to the reality of an extremely poor economy as the ADP report on private sector jobs indicated a loss of 157,000 jobs.  The DOW dropped 486 points.

Initial job claims continued to cast a heavy pall on the economy as claims hit a 25 year high.  Earnings reports continued to guide very cautiously into the fourth quarter and 2009. The DOW recorded back to back massive selloffs moving down another 443 points.

Non-Farm Payrolls, the report we were all waiting for this week came in 30,000 jobs worse than expected at 240,000 jobs and the jobless rate increased to 6.5%.  August and September jobs were also revised dramatically down yet the market responded with a 248 point up day on the DOW.  Volume has been remarkably low this week as the indexes fell week over week.  The DOW, SPX and COMPQ were all down -382, -38 and -74 respectively.

www.marketamer.com

We continue to be in a trading range.  I feel that it is unlikely that we break below the low of October 10th.  Volume is decreasing and the VIX is headed down ever so slowly.  The retail season will determine the picture from now through the holiday season.  There is a feeling  of optimism with the change in the White House.  However, Obama’s plate is very full.  I am cautiously bullish through the end of the year.

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