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Gold/Mining/Energy : Big Dog's Boom Boom Room -- Ignore unavailable to you. Want to Upgrade?

To: Bob Swift who wrote (43556)	5/5/2005 10:05:42 PM
From: kodiak_bull	Read Replies (1) \| Respond to of 206338

Bob, That is a very difficult question. I really can't even start to answer it. I think of options as proxies for stock positions; in that sense, for me whatever equity I might be interested in, I look for an option to express that interest. They are very complicated from a pricing and timing point of view, but so are equities. It seems to me you have a choice: use a lot of capital and hard stops and trade equities (on whatever timeframe you feel most comfortable with), or use a lot less capital, invest in an options education and create your own instruments to take advantage of your own analytical capabilities in the stock market. I think I showed by example how easy it was to control a $52 share of KWK with a 95 cent option. Think of the option as a stop-loss order. You'd be comfortable buying KWK at $52 but selling if it broke below $52.05? Well, an option not only lets you limit your loss to 95 cents like the stop loss, but it actually stretches that 95 cents a lot further. Let me use another example to make this clearer--you believe that KWK is going to go from $55.40 today to $60 by the middle of June. You can control 1000 shares of the stock for the cost of buying it--$55,400. You want to give it room to run, so you set your stop loss at 51.80. Or you can control the upward destiny of 1000 KWK shares by buying 10 Jun 55 call contracts for $3.60, or $3,600. If you are right and the stock goes to $60 by June, you will get $4,600 in profits for your equity position, or an 8.3% gain. If you are wrong, you will get stopped out with a $3,600 loss, when the stock goes down to $51.80 (assuming it doesn't run past you or gap down overnight--no such problems with options, of course). However, the $3.60 option "stop-loss" will actually s-t-r-e-t-c-h all the way along a risk curve (today) from 55.40 to 44.40, $11 dollars, before it effectively loses all of its value. In 22 days it will still stretch all the way down to about $46 or so, still almost ten dollars of capital preservation. And that's only on the downside. On the upside, well, options are upside wonderful. The stock goes to $60 right away and the $55 call is worth $7 or so. If it takes 3 weeks, it's still worth $6.50. How you want to calculate this, whether a return on the option purchase price (80%+) or as a return on a nominal position ($3 on $55, or 5.5%) is up to you. So, I don't know how much of a portfolio should be in options. I think of them like jalapenos, it doesn't take much to really spice up a meal and if it goes wrong, it can get pretty hot pretty quick. I do believe that most (98%) of punters have no clue how risky their equity portfolios really are.* For that alone, it's worth spending the time and money to study options, synthetics and risk curves to get a good grasp of capital risk. Kb *See 2000-2002, for example.