UNDERSTANDING THE LANGUAGE

LETS TALK STOCKS is still under construction; however, we are making progress.
When I first started trying to learn how to trade in the stock market I was lost because of my lack of knowledge. I turn to the financial pages of the Wall Street Journal and immediately I was LOST. What I needed was an explanation of many of the terms being used. That is where I will start with this blog.

Some of this may seem too simple; however, there may be those reading this blog who need to start at the very beginning. There are different markets you need to know about. There is the NYSE, or New York Stock Exchange, and there is NASDAQ. In addition to these two there are the American Stock Exchange and Over the Counter Stock Exchange. Most of the penny stocks I will mention in later issues will trade as Over the Counter and sometimes will be referred to as “Pink Sheet.”

You will see the words Equities, Options, Calls, Puts, Premiums, and one of my favorite, “Covered Calls” throughout this blog. An Equity is the underlying stock or the company you are researching to possibly buy. Some equities offer options. An easy way to explain an option is compare it to real estate. Let us say you are looking at a piece of property to buy but you don’t want to make that purchase today. You may ask the owner if he will give you an “option” on his property. You will then agree on a price for the property and set a time limit for you to make your purchase. Next you must negotiate the earnest money he requires to hold this property for you at the agreed price and time frame. Now let us look at this as a stock option. You have found a company (equity) you think you would like to own. In this case the market has already determined prices and time frames. You are convinced the equity will increase in value so you want to have the right to purchase the equity at today’s price. You first type in the symbol for the equity on your brokerage account web site and check today’s price. Let’s assume a price of $20.00 so you will understand what I am talking about. You are convinced it will go up to $25.00 within the next 30 days. Next you click with your cursor on “Options Chain.” The next chart that comes up will be a chart telling you different “strike” prices. Example would be $20.00, $22.50, $25.00, $27,50 etc. You believe it will go to $25.00 and you want to be able to purchase it within the next few days for $20.00. You buy the “Call” option of $20.00 and maybe pay $1.50 per share for the right to purchase the equity at $20.00.

There is a difference between a “call” and a “put.” If you own the call, you can call the stock away from the owner any time between the time you purchased the call option and the end of the option period. Options expire on the third Friday of each month, but you can buy options that extend into other months. A put option, on the other hand, can put the stock to the market maker at today’s price or the “strike price.” In this case, you are buying a put because you expect the equity to go down in value. There are two different ways to make money with options. First you can exercise your option and purchase the stock at the agreed upon price or put the stock to someone else if you actually own the equity. The other is you can actually trade or sell the option you own. If the equity goes up a little, the option will go up some as well. Percentage wise, the option will usually increase more than the equity. Option trades are called “Contracts.” A contract is usually the right to control 100 shares of stock. There are times when the number of shares involved in a contract will be different. The important thing is to be sure you know how many shares of stock a contract is actually involving. If you hover your cursor over the option symbol, you may discover this information. I know this is true on the E*trade website. As I use new terminologies, I will try to explain them within the blog.

When I first started trading I did very well for a short period, then I made a very big mistake. I told you in my introduction I would also give you the mistakes. Here is my first one. Most of the books I read about option trading said a “contract” was control of one hundred shares. One of those books went one step further and said a contract was always control of one hundred shares. I should have known better than trust the word “always,” but I was new to trading. On a Sunday night after I went to bed the phone rang. The party on the other end gave me some stock advice. We both had been to the same seminars. He told me about a stock that was “HOT”. His father had made about $75,000 the previous week buying the equity and writing a covered call on the stock. He advised me to be sure and write my covered call on the correct symbol: since there were two different symbols in the column.

Next morning early, I began my research. I searched E*TRADE, CBOE, (Chicago Board of Options and Exchange) and other locations but could not find why there were two symbols. The information was just not available at that time. This is not the case now. On E*TRADE you can move your cursor over the symbol and get a lot of information including how many shares per contract and how many days to expire day. It certainly would have been helpful in 1999. Instinct made me uncomfortable with the trades and the information available, however I bought 100 shares at about $27.00 per share. After the purchase, I wrote a covered call on the $30.00 strike price. The price paid for the option seemed high, but I made the trade anyway, immediately purchased a lot of shares of the equity, and again sold the covered call. I thought, “This is too easy.” My thoughts were right but I had made the commitment and on expire day discovered the reason the situation was too good to be true.

I can not emphasize enough to do your research. This was an early time in online trading when we all had to learn from our mistakes. That one was a costly mistake. Before it was over, I lost approximately $100,000. E*trade issued a margin call, while I was out of town with no way to go to my bank and borrow money to cover my shortage. The only thing I could do was start purchasing back options I had sold on all of my equities in my portfolio and then selling off stock. Almost all of the options had increased in value so I had to pay more to get them back to sell the equities. By that time in my young career, I had several blue chip stocks and I sure hated to dispose of them. Nevertheless, we learn from our mistakes.

Back to why I lost money on the previous mentioned covered call. I told you there were two symbols for the option I was going to sell. The symbol for the equity was USWB. I think the name of the company was US Web. They probably were the larger company. US Web bought the smaller company with stock, forming a merger of the two companies. The smaller company stock was trading at a higher price when it merged with US Web. Due to the merger, US Web had to pay the smaller company’s stock holders 150 shares of stock per contract. I had to pay an extra 50 shares for each 100 shares I purchased just before the merger. Therefore, the caution here is research, research, and research some more before you make your trades. Even after research, be prepared for loses.

From the above writing, you may assume I like covered calls. I do. To me, covered calls are the easiest way to earn money. One of the things I like about covered calls is there is a good possibility of keeping the equity yet having negotiable cash you can transfer to your local bank and buy groceries, pay bills or maybe just take a vacation. Look at the odds. If the stock, or equity, goes up you will probably sell the equity; however if you made the trade properly you will earn money on the sell. If the equity remains at the same level, you will probably keep the equity and have the money paid to you for the option as cash. In addition, of course, if the stock goes down, you keep your stock. In two out of three situations, you are likely to keep your equity.