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Strategies & Market Trends : A.I.M Users Group Bulletin Board -- Ignore unavailable to you. Want to Upgrade?

To: D VanSwol who wrote (6772)	2/5/1999 4:02:00 PM
From: JZGalt	Read Replies (1) \| Respond to of 18928

Dennis, You need to have a margin account and fill out some paperwork at your local brokerage house first. As a result of the margin requirement, you cannot do this in a tax sheltered account like an IRA. Once that is done, I strongly suggest you take the Options Industry Council material and study it. It will tell you about the risks and rewards of using options. The one thing that I will tell you is never trade more contracts than you would normally trade in stock. If you deal with 1,000 shares at a clip, then do not trade more than 10 contracts even though they might only be $1.50 each. ---- Dave

To: D VanSwol who wrote (6772)	2/5/1999 4:28:00 PM
From: OldAIMGuy	Read Replies (2) \| Respond to of 18928

Hi Dennis, Good to hear from you. As you know, I don't stray too far from the book with my AIMing, but if I can milk an extra nickel out now and again, I do so. With options, I am always the "seller" with either puts or calls. In this case, the price of JBL was falling, so there's pressure from people to "guaranty" they can get rid of their shares at a certain price in the future if the price continues to fall. Those people "buy" PUT contracts and pay good money for the right to unload their shares at a lower price in the future. That "good money" they pay is for this guaranty. I'm the guarantor! I promise to actually take delivery of those shares if the price is at or below the "STRIKE PRICE" at the time the option expires. They pay for the "right" to PUT the shares to me at a specific price and specific time. To sell a CALL option is the same thing in reverse. I look for someone that is willing to pay me now for the right to take some of my shares from me at a specific time and price. I guaranty that I will give up the shares at a specific price and time if the price exceeds the Option price. They pay me for that guaranty. What happens if the option date comes and goes but the price doesn't go beyond the "strike price?" The contract "expires worthless." However, guess who gets to keep the "insurance premium?" I DO!!! So, let's assume that my JBL contracts expire worthless. I have collected a gross of about $1200 ($6 per share and a contract is for 100 shares of stock) or $600 per contract. I pay about $50 in commissions to execute the trade, so my net would be about $1150. I keep that money - it's mine. What happens if the price of the PUT option closes at or below $55 in June? Well I still keep the $1150 but have to buy 200 shares of stock at $55 to cover the contract obligation. So what's my actual cost per share? Let's see. I pay $11,000 for 200 shares of stock plus normal commissions - let's use $50 for this example. My cost is then $11,050. Wait a minute, I also took in $1150 in "insurance premiums" before this. So, my net cost is $9,900 or $49.50 per share! I've just made a buy at about 10% less than I would have otherwise. When selling CALL options the same works but in this case it gives you that extra premium added on top of whatever profit you made on the sale. I'm sure there's a logical reason for people to buy PUTS and CALLS, but that doesn't work with AIM. AIM already knows it's going to sell a few shares at $X and will buy some shares at $Y. Since we know this in advance, why not sell some Contracts for doing just exactly what we are going to do anyway? There are some reasons for NOT doing this! One is that the Premium for the contracts might be too small to justify it. Let's look at a more normal period of time in the market. Usually when Fear and Greed are equally balanced, nobody's wanting to pay very much for OPTIONS portfolio insurance. Maybe that same JBL PUT contract might generate only $3/8. Let's say there's two contracts that we'd sell at $55 if the price is to move there. Now our gross proceeds for those contracts is only $75! After commissions of say $50, that leaves us with just $25. Is it worth it? Well, it's profit, but the broker made off with more than we did! Another reason for not Selling a CALL option would be if we don't have an adequate cash reserve on hand. If we're not nearly at the IW's suggested Cash Reserve, it's a bad idea. The reason is not that the contracts might not be profitable, but that we must always fund our cash reserve properly before we do anything else. If we have just 10% Cash Reserve and start selling CALLS, it's possible that the price could start to fall and we'd run out of cash in the next buy cycle. We'd have the insurance premium, but not the reserves! On the PUT side, it's never wise to sell PUTS if your Cash Reserve is too low to cover those puts. Also, I never sell more PUT contracts than AIM would have me buy at a certain price. If you think of yourself as an insurance company selling portfolio insurance, it makes much more sense. You collect premiums for the insurance and promise to make good on the policy if the eventuality is what the insurance describes. If the hurricane never comes, you keep the premium. If the hurricane blows through, you're liable for the damages. Hope this helps more than it confuses! It took reading about such things several times until I felt comfortable with the terms and concepts. PLEASE!! Everyone promise me that they will study this stuff VERY CAREFULLY before they attempt it. Just goofing up the terms can cost you money! Once you get the language right, you're most the way there. To summarize, I only SELL PUT or CALL options. I only sell as many option contracts as AIM would have me sell in shares. (Remember that one contract represents 100 shares) So, if AIM would have me sell 100 shares of XYZZ at $75, then I'll only look to Sell ONE CALL Contract at $75. It takes a peculiar bit of market pressure to make the premiums on a stock's options to open up enough to make it practical. If the commission is more than 1/3 if the potential proceeds, I don't bother. I want to NET at least $100 from any transaction. Then I can afford to go out for a nice dinner with my wife! If anyone else has experiences and/or better explanation, please chime in!! Best regards, Tom