I always basically knew what stocks were, but I always thought that you had to be rich and really smart to do anything in the stock market. But that is simply not the case. Before World Was II, the stock market was considered the playground of the rich, but that was before a man named Charlie Merrill (founder of Merrill Lynch) started holding seminars for middle class couples and brought Wall St. to Main St.
I’m sure most of you know what a share of stock is. For those who don’t, owning stocks means you are part owner of a company. Lets use an example. As I write this, the market is closed. I just looked up the ticker symbol YHOO which is a company called Yahoo Inc. Perhaps you have heard of it. YHOO has 1.18 billion shares outstanding. That means that the company is divided up into that many ownership units that people like you and me can buy. Seldom do people own one share of something. Stock is usually bought in multiples of 100 shares.
Sometimes, you can go to the company to buy its stock. Usually, the only people who get stock directly from the company are employees as part of their compensation. Most stockholders buy stock from a stock broker. For this, you pay a small commission. You don’t just walk into a stock broker and buy a stock like cashing a check. You set up an account first. This is basically as easy as opening a bank account. Minimum opening balances were in the thousands of dollars just a few years ago, but nowadays you can open an account most places with just a few hundred dollars. Some brokers don’t even require you to fund your account right away.
The education provided by some brokers these days is simply amazing. The broker I use has a learning center on its web site. I wish those videos were available to me when I first started. I get emails frequently about some live event on the internet explaining some options strategy. My broker holds these types of events frequently, and I am sure that other brokers do as well. In addition, the Chicago Board Options Exchange CBOE, has educational material on its web site. Some of the education out there requires a small fee, but there is a lot of free information as well.
Folks, Understanding stocks is not rocket science. There are several factors that can affect the value of a stock. About the only thing you can predict with good accuracy is that the price will probably be different next week. Even though it is hard to predict the day to day fluctuations of a stock, if you focus on a few fundamentals you should be ok. Look for companies that are well managed. HPQ (Hewlett Packard) stock rose when Meg Whitman took over as CEO simply because of her reputation. Look to see if a company is consistently making a profit. Does the company have a lot of debt? Learn what each of these factors means to the stock you are considering.
I have spent the space above to give a basic view of stocks just to bring you to the point where I tell you that I don’t make most of my money buying and selling stocks. There are a lot of people in this world who buy stocks and hold onto them in the hopes that they will increase in value. I won’t criticize them. Some people have done very well doing that, but it is not for me. Almost all stock market enthusiasts knows about covered calls and cash secured puts. These are the vehicles by which I like to make money.
Some people say that options are too risky. To quote John Pinette, “I say nay nay”. There is risk in everything you do in the market, (or out of it). I bought stock in Eastman Kodak a while back. It didn’t take long for me to regret that. So there is risk in even just buying a stock. Fortunately, I didn’t own very much when they went bankrupt. If you sell an option on a stock, you are not really incurring any risk you would not have incurred from just buying and holding the stock.
Let me explain what a covered call and a cash secured put are. There are basically two types of options contracts. One is a call option, and the other is a put option. A call option is a contract where the seller of the option agrees to sell 100 shares of a particular stock at specified price, on or before a specified date and time. Standard options are governed by the rules of the CBOE, which I mentioned earlier. These options contracts are bought and sold on an exchange. Using the example of YHOO, I see that at the close of the market on 1 March 2013, YHOO was trading at $21.94. If I bought 100 shares, I would pay $2,194 plus a small brokers commission. Looking at the options chain, I see that I can sell an April $22 call option on YHOO for .83. That price is expressed as a per share price, but since options are sold in 100 share contracts, that translates to $83 that I would receive minus a small broker’s commission. By selling this option, I get the premium money as soon as the option is sold. I can withdraw it right away and take someone to a modest dinner, if I choose to.
But since I have now sold an option to someone, I am obligated to sell 100 shares of YHOO to the buyer of the option for the price of $22 per share any time he demands it before the expiration of the option. This option would expire technically at Noon Eastern time on Saturday following the third Friday of the month. Although the option technically expires on Saturday, in actuality, the markets close Friday afternoon for the weekend, so the option is worthless after the close of the market on the third Friday.
No matter how much the stock rises, I have to sell at the agreed strike price. If the stock goes to $25, $50 or even $100 or more, I am still obligated to sell at the agreed price of $22. I have been know to get called out of a stock for a price well below the market, but I don’t consider it a loss because I made money on the premium. On the other hand, If the price of the stock falls or stays the same, I get to keep the stock and the premium. And I get to sell another option for a later month on the stock that I still own. I have been known to sell several call contracts on the same stock before I was called out. I consider it like collecting rent on my stocks. Sort of a rent with the option to buy plan.
What if I want to sell options on YHOO , but I don’t really want to buy the stock right now? How about selling a put option? The offer on the April $21 YHOO put is 43 cents. For a 100 share contract, that is $43. This option also expires on the third Friday (technically Saturday at Noon). With this option, I am obligated to buy 100 shares of YHOO for the strike price of $21. I don’t need to own this stock to sell this option, but I need $2100 in buying power in my account. If the stock goes up, or stays the same or drops but stays above $21, I don’t have to buy the stock, but I keep the premium. Even if the stock dips below $21 but recovers, I would be ok probably. Options are seldom exercised before expiration day. It recently happened to me for the first time. That was on the Thursday before expiration. If the stock falls below $21 and stays there through expiration, the stock would be put to you for the strike price of $21. Then you now have 100 shares which you can write call contracts on.
Folks, If you will just commit a small amount of your income to some sort of program, some day you will be amazed how much it can grow. I like options strategies, and it truly is like following a sports team for me. If you like them too I hope you enjoy options as much as I do. If you don’t like my strategies, I hope you do something to prepare for the future. If you wait for someone else, or the government to plan your future for you, it may not be to your liking.
I used Yahoo as an example only. I have not owned any stock in that company nor have I ever traded YHOO options. I also mentioned HPQ and EK. I have never owned Hewlett Packard or traded their options. I have owned Eastman Kodak stock and sold options on it, but they are no longer traded. I am not a securities professional. I don’t recommend any particular stock or strategy. I wrote in this piece about the strategies I like to use, and how I use them. I did not invent these strategies, nor am I an authority on their use or effectiveness. Before trading options, read the appropriate publications from the CBOE supplied by your broker.