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Strategies & Market Trends : Strictly: Drilling II -- Ignore unavailable to you. Want to Upgrade?

To: nspolar who wrote (15167)	7/5/2002 4:39:46 AM
From: crustyoldprospector	Respond to of 36161

Hi nspolar, Here is my take on options. An example would best outline my method. Let's take the Dow. When it was around 10300 in May, DJV DEC 100 puts (Dow 10,000) were selling for around 4.50. So, what Mr. Market was saying was, between now and expiration in December, I think the mean of the DJV will be around 100 - 4.5 = 95.5, or DOW 9550. The key there is that Mr. Market is looking at the mean (max pain), not the extreme highs and lows. Now, if I play puts, I'm looking for the extreme low. So in May I asked, can I expect the DOW to go below 9550 before year end? Yes. Now, IMPORTANT POINT, what is the absolute highest I could imagine the DOW bottoming? My answer was 9200. Therefore, the difference between Mr. Market's mean and my read on the extreme was 95.5 - 92 = 3.5. I figured, I could make a minimum profit of 3.5/4.5=78% as late as December, and still not step on Mr. Market's toes. So, I bought the Dec 100 calls at 4.5 and sold most when the DOW hit 9200. Although I retain some Dec puts as insurance against a general market meltdown, I won't be playing the dark side a lot until fall. The coming bottom in the XAU looks like a great time to load up on some calls in gold, however. For example, I filled a stink bid for 15 Oct 15 calls on MDG at 2.20. So, Mr. Market expected MDG to have a mean price of around 17.2 from then until October expiration, while I said that I'm fairly certain MDG will have a peak above 17.20 sometime before October expiration. If MDG stays pretty much in the 14-16 range in July through August, I'll be looking good for an early October sell around 20. That would yield a minimum profit of (20-17.2)/2.2= 127%. Now, ask yourself, will buying stock in CBD or some other company at the August low get you a better return with less risk? At a cost of 2.2, the 127% yield on the MDG calls is still pretty good. But, if the cost of the option is 3.8, yielding (20-18.8)/3.8=32%, I'd say forget the options, go buy CBD stock. There are a ton of caveats about time value on options, fudge factors on your calculations, Mr. Market playing games around expiration (he can put the underlying stocks into play, whereas we cannot), etc., but what I wrote above sort of sums up how I look at the big picture. For all those out there lurking, I'm no expert on options, and definitely don't take this as advice. I'm just explaining how I do it. Regards, crusty