BUSY WEEK WITH A NEW ONLINE BROKER

A Busy Week

    This has been a busy week in the stock market for me. First, I changed Online Brokers. I have used E*TRADE since 1998 and had been very happy with them. Over the years they changed and as far as I am concerned, their service gone downhill. Earlier in my relationship with E*TRADE, when I transferred money by ACH from my bank to E*TRADE, the money was available immediately. This service changed. I have had to wait for up to ten days before I could use the money I sent to them. This was my main reason for being dissatisfied with their service. I had considered Scottrade for some time. I had considered making the change for a long time but I was not sure about the research capabilities of Scottrade. I must say I was pleasantly surprised. Not only are their research materials as good, but I consider them better. I am glad I made the change. To be sure I would be happy with their online abilities, I traveled to Knoxville, TN to meet with personnel in their office and see firsthand how their systems worked. At the end of our session, I gave them a check to begin my account. Beginning with the day after opening my account, I was able to start making trades. They also advised me that ACH transfers only take three days to clear and after January 31, 2008, ACH transfers will be usable immediately. Needless to say, Scottrade was happy to assist me in transferring my account from E*TRADE, to Scottrade. In fact, they did all the paperwork for me while I was in their office. The only hang-up was, E*TRADE held onto my money for about eight working days.

     I had only opened my account with $5000.00 at Scottrade, so my trading ability was limited. Anxious to begin using my new account and learn my way around their website, I made a couple of hasty trades. The first trade I made I should not have bought, but mistakes will be made when you are trading in the stock market. You must learn how to make the best out of a mistake. On Friday, January 11, I bought 600 shares of Country Wide Financial (CFC). I paid 6.69 per share for the stock. Immediately the stock began to go down as bad news came out. I made other trades and by Thursday I had profited $1026 in my new account. I am going to skip some of those trades but I will tell you what I did about CFC. As CFC dropped, I bought 400 more shares of the stock and paid 5.75 per share. I later wrote a covered call on the 1000 shares at the $5 strike price for $.75 per share. After commissions and fees for the trade my net on the options was $730.50. I can look at these two ways. I can write myself a check for the $730 and spend the money or I can consider this money as reducing my investment in the Equity CFC. My investment now is $5.79 per share. My loss will only be minimal if the stock remains above the strike price. I more than made up the difference by buying "PUTS" on several stocks and when the equities went down, sold the options at high profits.

WHAT IS A DAY TRADER

    I am a day trader. To me, long term means holding equity until the next day. I especially do not like to hold a stock over the weekend and if the weekend happens to be a holiday weekend I want out of all my holdings. For a beginner, this can be a problem and one the broker may not tell you about. If you make three day trades within five days you are labeled as a day trader and will receive a warning letter the first time this happens. The second time you make such trades you will be restricted in your account and will have to wait until you have ample cash in your account or until your trades are settled. The irony is, if you have $25,000 in your account, you can day trade all you want. This is an easy way to make money. Just find stocks moving a nickel every few minutes in a pattern and begin trading in multiples of 2 or 3 thousand shares. It works. Buying options can also be completely cycled within one day. I do this on a regular basis.

LET’S TALK OPTIONS

I like options. I normally trade in equities; nevertheless, I like options. I will briefly explain the good and bad of option trading. The bad side of an option is that options expire. The good side is, not nearly, as much money is needed to trade options. December 23rd Microsoft (MSFT) ended the day valued at $36.58. If I purchased 1000 shares of MSFT it would require an output of $36,580.00 plus commission. With most companies, I could purchase MSFT on margin, but that is another topic and one I do not recommend. Let us look at what I could do with an option on MSFT.

The January 35 option last price was $1.96. Options trade in contracts and one contract is normally 100 shares, thus 1000 shares of MSFT would be 10 contracts. If I purchase 10 contracts of MSFT and control 1000 shares, my outlay would be $1960. plus commission and fees. To make this easier to understand I am going to change the price of MSFT to an even number. Let us assume MSFT is trading at $35. Now my investment would be an even $35,000. If during the coming month before MSFT options expire, MSFT goes up in value to $45 we would make $10,000 profit on our trade. If instead of buying the equity, we bought the $35 January call option at $1.96 our investment would have been $1960. If the equity increased to a value of $45 per share, our option would have increased in value at least $10 per share as well. We can purchase the stock at $35 per share by exercising our option, or we can sell the option at the higher value and take the $10 selling price for the option.

Let us now look at the percentages involved in these transactions. If we purchased the equity at $35 per share, our risk is $35,000. However, the risk is not as great because MSFT is not likely to go down in value to $0.00. If we bought the option, our risk would be $1960 and we could lose that amount of money if the equity should go down in value. However, $1960 is the maximum risk of loss.

Here are the percentages:

______ Purchase Price Sale Price__Profit____Percentage

Equity price:..$35............ $45.............. $10 ........28.571%
1000 Shares .$35,000 .......$45,000 .........$10,000 ....28.571%
10 $35 calls ..$1960 .........$10,000 .........$8040 ......410%

The risk with the option trade is if the stock drops enough, your options may be worthless when they expire on the third Friday of January. In reality, I would not expect MSFT to increase $10 in that month although it has happened. I would think a $5 increase would be a reasonable expectation if I have done my research. The point I am trying to show is the percentages involved in the two types of trades. If you trade equities on MSFT and the equity increases in value by $10, you make a profit of $10 per share but if you have traded in call options your investment is a small fraction of what you would have invested in equity trades but the profit would have been equal. Percentage wise, the options trade would have been considerably more valuable.

Please be advised the above scenarios are intended as examples only and should not be construed as actual prices. Their intention is solely to relate possibilities in trading options, and how we can view these types of trades.

AN IMPORTANT STRATEGY

AN IMPORTANT STRATEGY

Today’s blog will be short but important. Strategy is important and an area not to be overlooked is news. Routinely first thing each morning, Monday through Friday, I have all of my televisions in the house preprogrammed to tune into CNBC and find out what they are talking about. The first thing I want to know is what they are expecting the “Futures” to do. Will they open higher or lower? If they are expecting Futures to open at least 3% higher, you can with caution, expect the stocks you are interested in to open higher. This is not a hard and fast rule but simply begins your day with some educated expectancy.

Another strategy I use and have used in the past is listening to what companies CNBC newscasters are talking about. I normally try to start listening to CNBC about one hour before the market opens so I can catch up on any early news about companies I may be interested in. I do not recommend the following strategy, but it worked for me once. CNBC was talking about a cheap stock. I am talking about a $3 or $4 dollar stock. This happened several years ago so there is no way I remember all the details, but I definitely remember the strategy and what happened. A visitor to the program commented the stock was much undervalued and should be worth about $50.00. Immediately the stock began to climb. As it approached the $50 dollar level, I sold the stock. I did not own this stock but I sold abut 1000 shares short. Selling short is selling shares of stock you do not own, you are borrowing the stock from the market. This kind of trading is extremely risky, and I do not recommend it. I had plenty of money in my account and took a chance. Fortunately, the stock did exactly as I expected. It started to tumble and at the end of the day, I bought the stock to cover my short making a tremendous profit. I cannot emphasize enough the risk involved in this type or trading. If the stock had continued to go up, I would have had to buy the shares at the higher price to cover my short sell. I mention it to show the importance of listening to news. Stocks move on news.

Normally I want to watch for stock that is going up. I buy low, and as soon as the stock is bought, enter a high sell order. That is not always possible. A lot depends on the market and the overall picture. A few years ago, Krispy Kreme Doughnuts (KKD) got into financial trouble. The news broke they would file bankruptcy. I was in a motel room away from home. I quickly put all the numbers into my computer and decided to buy a “put.” I have not discussed puts. I will explain puts so you will know what my trade strategy was.

There are two types of options, calls and puts. A call gives you the right but not the obligation to purchase a stock at an agreed on price during the agreed time. A put is just the opposite. A put gives you the right but not the obligation to put the stock to the market at the agreed price during the agreed time. If you are buying calls, you are expecting and hoping the stock will go up. Conversely, with a put you are expecting the stock to go down. In the case of KKD, the bad news would drive the price of their stock down, so I bought several contracts of puts for KKD. Immediately their stock began to fall and as a result, the puts I bought went up in value. True to my nature, I did not own the puts very long. I did not know how long I would be in the motel or how long I would have internet service so I entered a sell order as soon as I owned the puts. I sold my puts before the trading day was over and made a handsome profit. I still like KKD stock but only buy it when it is heavily discounted. I may be a little philosophical but one of the reasons I like the stock is because I like their donuts. Try to figure that out.

FINDING THE RIGHT STOCKS CONTINUED

FINDING THE RIGHT STOCKS CONTINUED

There are a number of things I look for in finding the right stock. Determining stock purchase is an area you may have to experiment with to determine what works for you. I almost never purchase a stock with intentions to hold it long term. If I look for channeling stocks, then 12:00pm is long term. If I plan to write a covered call, then about 30 to 40 days is my long term goal.

Here are some stocks I either own or probably will own at some future date. Some are discounted at this time due to conditions in the market. Each of these stocks pay a dividend. That is one of the first things I look for, in fact I have a portfolio watch with the heading, “Stocks that Pay Dividends.” After finding stocks that pay a dividend I look at their options charts and decide if they are paying good premiums compared to the purchase price of the stock. If you think you may hold the stock for long term, you need to look at their earnings per share and other analysis or performance markers.

I like (MMP,) “MAGELLAN MIDSTREAM PRTNRS.” I bought this stock primarily to capture the dividend. I bought MMP at $41.99 per share online at Zecco so I only paid $4.50 commission. The stock last traded today (December 12, 2007) at $43.70. Unfortunately, it has not run up enough to get a good premium from an “Option,” since the next “Strike” price is $45.00. I have a choice, I can hold for a while and hope it runs up close to $45.00, or I can sell at a profit.

I know Microsoft is a worn out horse so to speak, but at this time because of the price, I like them. The last trade today for MSFT was $34.47, the last $35 strike was 0.30; however, if you roll out to January the price is 0.91. I don’t like to go out into the next month, but the difference is probably worth looking at. It could possibly be better to wait a few days for the market to move a little.

I have owned AT & T several times. While other stocks sold off yesterday and today, AT & T (T) held up nicely. The price may even be to high. I should have bought the stock yesterday when it was almost $2 cheaper. The last trade today was $41.77, and the last option trade today for the $42.50 strike was 0.35.

When you study hese examples, you may notice something you need to look for. Watch for the stock to be discounted. As an example, (T) closed yesterday at $39.48. If you had purchased at that price, you could have sold the $40 strike today for $1.93; and hopefully, you would be called out on Friday, December 21, 2007 at the $40.00 price. Then you will making a profit on the sale of the stock as well as almost $2.00 per share for the option premium.

General Motors (GM) is another discounted stock today. The last close today was $27.36. GM 52 week low was $24.50 so they are just a little over their 1 year low. The $27.50 strike for the Call Option is 0.78. but I believe you could hold out for a few days and maybe get a good premium.

Another thing you need to keep in mind is the amount of commission you must pay. There is a commission when you buy and when you sell. For the Option trade there is an additional charge and it is based on the “contract.” A contract is usually but not always 100 shares. Zecco charges 0.50 per contract, Etrade charges 0.75, and Scottrade charges $1.25.

When considering weather you can make money on a stock and writing a covered call, you must take into account all of these charges. If you only buy 100 shares and pay $9.95 for the purchase, then another $9.95 plus 0.75 for the contract, you have $20.65 in charges added to the price of the stock. Let us look at (FRE) FEDERAL HOME LN MTG CORP COM. Their last trade today was $30.42. If you purchase 100 shares, it will look like this. 100 X $30.42 = $3042. After adding $9.95 for the purchase you have invested a total of $3051.95. For an example, let us sell 1 contract at the strike price of $35. If we write the December option, the price is only 0.20. We have to pay $9.95 for the commission plus 0.75 for the contract. The option this far has cost us $10.70. In order to write the $35 strike we will have a total investment of $20.65, but only be paid $20.00 for the option. We lose 0.65. If you go out to the January option, the price for the last sale was $1.00. Using the same figures, we have now earned $100 less the charges of $20.65, so our profit is $79.35. The advantage of the covered call is, we still own the stock. If the value goes up over $35 we will then sell our stock for $35.00. This will cost us another $9.95 in commissions, but we have made a profit of $438.10. If the price does not go up over the $35 strike, we keep the stock and write another “Covered Call.”

FRE CHART
Etrade Chart© Figure 1[1]

From the looks of the 3 month chart you can immediately see it is considerably discounted, so it appears poised to go up in value.






[1] Etrade.com