“I’ve been walking these streets at night
Just trying to get it right (need some patience yeah)
It’s hard to see with so many around
You know I don’t like being stuck in a crowd”
These Guns and Roses lyrics are ringing true today as we have finally been rewarded for our patience.
For those of you who have followed us for a few years, you know we don’t follow the crowd and we usually try to get things right when it comes to our option recommendations. Most of the times they work (we have nearly a 75% win ratio) and sometimes our trades don’t.
The key to making money in options over time is to try and hit a few homerun trades while at the same time keeping your batting average up. But what makes options so fun and lucrative is that you can speculate on where a stock is headed and use options at a fraction of the cost to make returns of 100%, 200% and even 500%. No kidding.
These numbers may sound crazy but it is true and it is not hype. Did you know you can CONTROL 1,000 shares of stock for as little as $200? If an option is at 20 cents and you buy 1 option contract it would cost you $20. If you buy 10 contracts, your cost is $200. Each option controls 100 shares of stock so in theory you would control 1,000 shares of a stock by owning 10 call (or put) options.
If a stock is at $20 and you wanted to buy 1,000 shares it would cost you $20,000. See the difference?
Now here is the kicker.
If a stock is at $15 and you think it is headed to $20 over the next 6 months you could buy the stock or use options to prepare for the move. The big difference is that while it may cost more money to buy the stock, you own it and you can hold onto it for as long as you wish. With options, you can’t because they expire at some point. The key is figuring how long it might take for the stock or story to play out like you want it to. If shares don’t make $20 you could lose your entire investment.
Additionally, if a stock is at $15 and it moves to $20 your return is 33%. If you purchased 1,000 shares your $15,000 is now worth $20,000. Good job.
Now, let’s look at the options. If a call option is at 22 cents, a 10 contract trade would cost $220, or a 100 contract trade would cost $2,200. So what happens to the options if the stock moves from $15 to $20 before the options expire?
They can move from 22 cents to 85 cents and your return is now 286%. In other words, you $220 is now worth $850 or you $2,200 is now worth $8,500.
For those of you who believed in our Electronic Arts (ERTS, $19.73, up $1.20) trade back in November 2010, this is where we are at.
On a trade that is up nearly 300% it would be prudent to take half off the table and we might but EA looks like it wants to breakout to even higher levels. We have a few other open trades we hope plays out this way, especially the one from earlier today, but the key is look for trades that others don’t see.
We have been following Electronic Arts for years so we now their story. We thought shares were “cheap” back at Thanksgiving when they were under $15 and we said the company was poised to capture a significant part of the growing online gaming business. Today’s news that Monopoly will be available on Facebook must be the mojo behind today’s 6% stock pop. However, the options we recommended are up over 225% today.
As we head to press, the Dow is up 48 points to 12,275 while the S&P 500 is higher by 6 points to 1,334. The Nasdaq is showing a gain of 16 points to 2,821.
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