Options

One of my investor friends forwarded this link from Google Answers.

Finacial gurus,

I am looking for the most probable way of earning $3000 monthly with a $30,000 cash investment. This is all I can commit, no additional monies, no borrowing. I want this to supplement my regular 6am-3pm job.

I have thought about using it to trade common stocks, as a down payment to buy a small apartment or rental properties etc.. but thought maybe there were better or more likely ways to make this happen.I am not looking for a sure/guaranteed way, just the most probable way.

I can afford to loose 10-15% max. I am looking for a situation with monthly spendable cash , not theoretical or tax gains.

I am fairly good with computers and have access to high speed internet all day. I’ll pay a premium for an answer that is applicable and detailed. Vague generalizations like “start a small business” will be ignored

Thanks

The answers range from learning to play poker, selling stuff on ebay, starting online porn site, making money from adsense, day trading, prop trading and scalping nickels and dimes to investing in real estate.

While I don’t have a clue how to make $3k a month off $30k, it definitely got me thinking. If I had $30k and needed to make 10% every month, I would have to try something very high risk. Since I’ve been looking at option trades the past few days I thought I’d give that a try.

Here’s a strategy I came up with. You buy a far out call spread. Lets take the stock GDX. Its currently trading at $38 and change. Its never traded below $32 [coz its new] and it follows the price of Gold. Gold was up today and closed at $625. Just 2 weeks ago it was around $575. If you think Gold is headed up in the next few months you can make this risky bet.

You buy the March 2007 $32 Call for $8.60 and sell the March 2007 $37 Call for $4.20.
You’re out of pocket costs are $8.60- $4.20 = $4.40.[multiply this 100 coz each contract has a hundred shares and you get $440/contract]

If GDX closes at $35.40 at expiration you break even. Above $37 you make your max profit of $160/contract. But at $31 and below you lose a max of $440. $160 on a $440 investment is a 36% return in about 5 months. Annualized thats almost 90%. On a $30k investment you’re making approximately $26k. Not exactly 120% return but still pretty good!

Ok, so why isn’t everyone doing it?

Probably coz they don’t work in the long run. Here are some reasons I can think of:
1. These things only work until they don’t.
They might work a few times, but then something “unforeseen” happens like Gold dropping from $730 to $575 in 2 weeks and you’re entire portfolio is destroyed. Victor Niederhoffer lost 20 years worth of profits in one bad “investment”.
2. These things are also complex.
A lot of people don’t understand how options work. I don’t understand them well enough to explain to lay people.
3. Once everyone starts doing it, it no longer works.
This is just a general rule. If there was a great easy solution to making 100% a year everyone’ll jump in and bid down the price. [Just like people are doing on Prosper!]

But if anyone knows a sure fire way to make money without not having to work please let me know!

In a previous post on WCI, I had mentioned that I had sold some March 2007 Calls.

When you sell a call and you own the underlying stock, its called selling (or writing) covered calls. In my case, where I don’t own the underlying stock, its called selling naked calls. I gave someone the right to purchase a stock from me at a certain price at a certain date in the future and in return I collected a small premium. [That’s right, I don’t own the stock yet I sold the option on it and collected some money. Makes me feel like I’m in the insurance biz!]

There is unlimited risk in selling naked calls (or puts). If the stock rises beyond my strike price [which is $17.50 in the case of WCI] I stand to lose the amount that it rises minus 17.50 minus the premium I collected up front.

When I entered the position last Friday, the stock was trading around $15. So it would have to jump 16.5% before being “in-the-money”. I collected a premium of $1.45 per share or $145 per contract. So the stock would have to be over $18.95 before I would start losing money. If the stock closes below $17.50 on expiration, the option expires worthless and I keep all the collected premium. If however it closes at say $18, then I don’t have to buy the stock at $18 and deliver it to the buyer. I just close the position before then and pay him the difference of $0.50 per share or $50 per contract. So even though the stock closed above $17.50, I’d still make $145-$50 = $95 per contract.

There are also commissions to be factored in. Interactive Brokers is amongst the cheapest[and most difficult to use] and charges $0.75 per contract.

The stock was down 4.5% today on no news so hopefully it’ll continue its slide into BK. The puts I had bought last month are now up 22%!!! The calls I sold on Friday have decreased in value and if I wanted to, I could close my position by buying them back at $1.25 per share or a 13.75% profit per contract.

I also sold some naked puts on a junior mining stock. I think it might move higher in the near future, however I don’t have any money to invest right now, and I’m not a big fan of buying on margin. Its trading at $11.25/share so buying 500 shares would run me around $5625. So I sold some puts with the Nov 06 expiration at $10 strike price and collected $35 per contract. The options expire in about 3 weeks. If the stock does nothing, I keep the premium. If it goes up, I still made my premium on them. If it drops, it would have to drop nearly 14% before I start losing money. But I was willing to buy them at this price anyway, so at least I curtailed my loss upfront!

[NOTE] Naked Option trading involves significant risk of capital. Victor Niederhoffer, a UC, Berkley professor and hedge fund manager lost 20 years worth of profits in 1 year through over-leveraging in naked option trades. Only gamble with risk capital when selling naked options. This is an extreme form of gambling. Do not take it lightly!

Basswood Partners, a hedge fund sent a letter to WCI asking for representation on the board. Its owns about 5% of WCI stock.

“Since becoming a public company almost five years ago, WCI Communities has failed to capitalize on the dramatic growth and profitability expansion experienced by the public homebuilding industry. As of October 13th 2006, WCI Communities’s stock trades -16.5% below its March 2002 IPO price, while its peer group (as defined by the Company in its 2005 proxy statement) is up 88.9% over the same period. This extreme underperformance is due to management’s operating results and strategy,” Bennett Lindenbaum, principal of Basswood wrote.

“We urge WCI Communities’s board of directors to take decisive action to prevent any further loss of shareholder value and to maximize the value of the Company,” Lindenbaum continued. “WCI Communities’s stock is trading at a significant discount to its intrinsic value, especially given its large inventory of entitled land in coastal Florida purchased prior to 2000. WCI Communities and its shareholders would realize this value by selling for a premium to a larger, better capitalized and more profitable homebuilding company.”

Looks like an awful lot of negative sentiment surrounding homebuilding stocks. Whenever the market gets too bearish, it has the opposite affect on a stock. Hope this doesn’t rub off on WCI and push the stock up!!! I just sold some March out-of-the-money calls on WCI to supplement the puts I had already bought.

Just in case you’re new to options, buying a put or selling an out-of-the-money call is a bearish bet. You’re betting the stock will go down. In a put you pay a premium and you make money if the stock goes down. When you sell a call, you hope the stock doesn’t go up and you get to keep the premium you collected up front.