The Options Advantage
105 W. Monument Street
Baltimore, MD 21201
Wednesday, March 03, 2004
URGENT EMAIL – #155
** Change Is the Only Constant
Two years is a long time in the stock market. Just look
back. Two years ago stocks were about to hit bottom. Gold
was trading under $300 and the U.S. dollar was riding high
against the euro and the yen. I remember shopping in
Amsterdam in early 2002 when the euro was under $1.00. How
quickly things have changed.
Last year the market soared, and we benefited with some big
wins. Gold rocketed to $400 per ounce, and the dollar was
decimated by the euro, pound and yen. Even the lowly
Canadian dollar soared. What will the next two years bring
us? No one knows, and if they tell you they do, then they
are lying.
The best we can do is manage our money with a close eye
toward risk. There are three things that you as an investor
can do today that will determine if you are winner, a loser
or someone who barely breaks even in the next two years.
I am using the example of two years for two reasons. First,
that is usually how long our LEAP options have before
expiration, and it is also the far end of how long most
people are willing to hold on to a stock in the current
market.
The 15% Solution
You can be one of three kinds of investors. You can stay on
the sidelines and earn 2% on your money with no risk other
than opportunity cost and inflation. You can invest in the
stock market whole hog and be at unlimited risk with
unlimited upside. Or, you can do what we do at the Options
Advantage.
With the OA we take positions in the market with an eye on
risk and returns. We rarely risk more than 15% of our money
on any given stock. And we have ownership of those shares
for up to two years.
Why would anyone in his right mind buy a company like
Hewlett Packard and spend $22,000 for 1,000 shares of stock
when the same shares can be controlled for two years for
15% of the money or less? Look at it another way. A
reasonable stop-loss on your share purchase will lose you
more than you put up for the LEAP option to begin with. In
our case we use a stop-loss that actually limits your risk
even more, usually 50% of what you invested. So, this is
our usual equation: spend $22,000 for 1,000 shares of stock
with a 20% stop-loss or $4,400, or spend $3,000 on a TWO-
YEAR option on the same shares with a 50% stop-loss or a
maximum potential loss of $1,500. The choice is pretty easy
in my mind.
What about time value? That is the usual argument that I
get. Let’s use HP as an example. If you bought the shares
at $22, you would expect a return on your money – right? I
mean no one invests in a tech stock, or any stock for that
matter, unless he thinks it is going up. In the case of HP,
we would probably shoot for $30 as a target price, or about
a 35% return in two years – not unreasonable for a
technology/IT company. After all, the shares moved up close
to 100% in just the last year alone from low to high.
With the stock you stand to make 35%, or about $7,200.
Let’s see what the LEAP does. A two-year LEAP with a $20
strike price ($2 in the money) would cost you about $5 if
HP were at $22 today. That means your net cost is $3 since
it is an in the money by $2. If HP closed at $30 at
expiration, the option would be worth $10. You profit would
be $5,000 on an investment of $3,000 net. That works out to
166%. That is the equation we are trying to achieve with
the Options Advantage service. We want a low entry price,
lots of time on our side, and huge upside potential. As a
matter of record, we usually get in and out of a position
long before expiration.
Our Portfolio
If you look at the current portfolio, we are making several
bets on the market. Three of them are hedged in our favor
to produce gains of 300% to 2,500% if they work out. In
each case, our money invested in any position is 15% or
less than what it would cost to own the shares outright.
So, if the market were to collapse tomorrow (our gold and
homebuilding short would make us a ton of money) we would
lose very little money in comparison to having a portfolio
of the SAME underlying shares.
Here is what our portfolio is positioned to do right now:
HPQ – takes advantage of a continued upward move in the
stock market and a recovering economy – hedged position has
taken more than 40% of our money off the table and
preserved a potential upside of more than 300%.
NOK – same as above, but 50% of our money is off the table
and our upside is more than 700%.
CHK – a play on energy, specifically natural gas. 90% of
our money is off the table and our upside is 2,500% or
more.
TOL – our latest position is a short on the homebuilding
sector – more importantly it is a play on interest rates.
If they begin to rise, look out below.
PDG – our position in PDG is a pure gold/U.S. dollar play.
If the dollar weakens, gold will strengthen and so will our
PDG position.
MCP – these are our MITTS. In effect we have a long
position on the S&P 500 with guaranteed return of principal
of $10 at expiration.
As you can clearly see, we are well positioned for just
about any occurrence in the market, be it stock, commodity
or currency. And we have less than a fraction at risk
compared to a conventional investor. That is, in my
opinion, the ideal position for today’s uncertain market.
Regards,
Karim Rahemtulla
———————————————————–
Current Portfolio:
Company / Symbol Option: Toll Brothers / TOL Jan 06 $25
puts
Symbol: YKW-ME
Date Purch: 2/20/04
Current Price: $2.20
Comment: Hold. Trailing stop is $1.00.
Company / Symbol Option: Placer Dome / PDG Jan 06 $20 call
Symbol: YDI-AD
Date Purch: 1/23/04
Current Price: $2.50
Comment: Hold. Trailing stop is $1.00
Company / Symbol Option: Hewlett Pack. / HPQ Sell Jan. 06
$30 call
Symbol: WPW-AF
Date Purch: 2/3/04
Current Price: $1.75
Comment: Hold. Sold call against Jan 06 $25 position.
Company / Symbol Option: Hewlett Pack. / HPQ Jan 06 $25
call
Symbol: WPW-AE
Date Purch: 12/10/03
Current Price: $3.10
Comment: Hold. No TS.
Company / Symbol Option: Nokia / NOK Sell Jan 06 $30 call
Symbol: WIK-AF
Date Purch: 2/9/04
Current Price: $1.20
Comment: Hold. Sold call against Jan 06 $30 position.
Company / Symbol Option: Nokia / NOK Jan. 06 $22.50 call
Symbol: WIK-AX
Date Purch: 8/29/03
Current Price: $3.40
Comment: Hold. No TS.
Company / Symbol Option: Chesapeake En / CHK Sold Jan 06
$15 call
Symbol: WZY-AC
Date Purch: 11/6/03
Current Price: $1.85
Comment: Hold. Sold call against Jan 06 $12.50 position.
Company / Symbol Option: Chesapeake En / CHK Jan 06 $12.50
call
Symbol: WZY-AV
Date Purch: 7/28/03
Current Price: $2.70
Comment: Hold. No TS
Company / Symbol Option: S&P 500 MITT
Symbol: MCP
Date Purch: 7/18/03
Current Price: $10.18
Comment: Buy under $10. No TS
———————————————————–
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