by Lee Lowell, Guest Contributor, Investment U
Thursday, November 6, 2008: Issue #882

Did you know that you could get paid to buy stocks at the price you want? That’s right, someone will actually hand you cash today for your promise to buy any stock you want at a cheaper price than where it’s currently trading.

All you have to do is decide which stock you want to buy, at what price you want to buy it, place the trade and collect your money.

Is this for real? Is this a joke? Is this legit?

This is absolutely for real, it’s absolutely not a joke and it is extremely legitimate. When was the last time someone gave you a wad of cash just for buying your favorite stock at rock-bottom prices? I’m guessing probably never, unless you’ve been using this very simple and safe strategy. I personally use it all the time, and many others “in the know” have been using as well.

Being a professional options trader for the last 17 years, I’ve figured out exactly which options strategies are best to use at various times in different market environments. But one strategy can be used at almost any time…

It’s called “put option selling” and it’s a great way to get your hands on instant cash while at the same time giving yourself an opportunity to buy your favorite stock at a price much lower than where it’s currently trading.

Many people have never heard of, let alone used, this option strategy, but in my book there’s no better way to spend your time and effort while you wait for your stock to come down in price. I’m going to show you how you can use it to start collecting some of that cash that’s being handed out.

Being Paid to Wait With Put Option Selling

What do you usually do when there’s a stock you want to buy but it’s too expensive? I’ll bet in most cases, you enter into a limit-buy order for that stock using a price that’s lower than where it’s trading.

That’s how 95% of investors do it, so don’t feel bad.

But what are you doing in the meantime, while you’re waiting for the stock to drop in price? I’ll bet you’re just sitting there twiddling your thumbs and wasting valuable time. Has anyone given you cold, hard cash while you sit there and wait? Nope. Could you be doing something better with your time while you wait? Definitely.

Well, then put option selling might be right for you.

The actual mechanics of put option selling is quite easy:

• When you enter into a put-sell transaction, you’re entering into an obligation to buy the stock you want at the price you want.

• The person on the other side of the transaction, the put option buyer, pays you money today for your obligation to buy that stock sometime in the future at your price.

Put option selling is a bullish option trading strategy while put option buying is a bearish strategy.

When someone thinks a stock is going to fall in price, they can either short the stock or buy a put option contract. If they opt to buy the put option contract, they have to pay for it at the going rate.

That’s where you, the put option seller, comes in. Since you’re bullish, you want to sell that put option and the option buyer will gladly pay you the going rate for it. You keep that money, deposit it into your account and wait for option expiration to come. Easy enough, but let’s go over some specifics.

Options Trade As Easily As Stocks

Options contracts trade in the marketplace just as easily as stocks do. All options have “strike prices.” These are the levels in which you can buy or sell the stock if called upon to do so.

For example, IBM is trading at $90 currently. The options exchanges set up strike prices at various levels, like the $80, $90, $100, $120, $150, etc. You will buy or sell these strike prices at the going rate for each. An option like this, with say five months before expiration, could cost roughly $750.

All options have an expiration date that can span from days to years. When someone buys a put option whose strike price is set lower than the current price of the stock, it’s called an “out-of-the-money” put option.

Option contracts represent 100 shares of stock, so for every option you sell, you’re obligating yourself to potentially buy 100 shares of stock.

If someone chooses to buy the “$80 put option” today when IBM is at $90, they are speculating that IBM will fall below $80 per share by option expiration date.

Why would anyone want to sell IBM at $80 when it’s currently trading $90? Why don’t they just sell it now at $90? Good question. Probably because this person already owns IBM shares in their account and wants protection in case of a disaster.

If IBM happens to fall to $60 per share before expiration, the put option buyer can “exercise” the option and sell IBM at $80 even though it’s now trading at $60. This is how professionals “hedge their position.”

But what happens if IBM never falls to $80 by expiration? Well, the option expires worthless and the put buyer ends up losing the full $750. Who gets to keep that money? You, the option seller! It’s been estimated that up to 90% of out-of-the-money options will expire worthless, so in most cases, you’ll get to keep the money free and clear.

How to Buy Stocks for Less With Put Option Selling

Let’s say that you want to own IBM at $80 per share while it’s trading at $90. Instead of putting in that limit-buy order and waiting, you now know that you could sell the $80 put option and collect $750 for every option that you sell.

If IBM happens to end up trading below $80 per share at option expiration, then you’ll be called upon to buy your shares at $80 per share. That’s a good thing because $80 was the price you wanted to acquire it, and $10 cheaper than where it had been trading. Not only that, but someone paid you $750 extra per option just for your time and effort to buy your stock at your price.

Since options trade in 100 multiples, the option is quoted as $7.50. When it’s time to collect the money, you will receive $750 (100 shares x $7.50).

Even better, that $7.50 actually lowers your cost basis if you have to buy the stock. Even though you’re buying IBM at $80 per share, it’s really only costing you $72.50 per share when you factor in the $7.50 you received up front – an extra bonus.

Here’s a sample option chain for IBM options that expire in April 2009. The option chain lists all options activity and the options that trade for a particular stock and can be accessed online or from your broker.

Courtesy www.optionsxpress.com

You can see with IBM currently at $88.22 per share, the April 2009 $80 put option can be sold for $7.50 (splitting the bid/ask prices). So for every option you sell, you will instantly collect $750. If you sold 5 put options, you would receive $3750.

Put Option Selling & Option Expiration Day 2009

Here’s what goes down at option expiration day in April 2009:

1. If IBM is trading above $80 at expiration, then the options will expire worthless and you get to keep the full $750, no questions asked. You can then move on and do another put-sell trade for a future expiration period. Unfortunately, you will not be asked to buy any shares at $80. But at least you were compensated $750 per option for your time.
2. If IBM is trading below $80 at expiration, then congratulations, you will be called upon to buy the shares at $80 a piece. This is good news because $80 was the price you wanted to acquire them. Plus, you still get to keep the $750 paid to you on Day 1. The shares will show up in your account and you’ll be required to pay for the shares in full at that time. If you sold five option contracts, which is the same as 500 shares of stock, you will be required to pay out $40,000 at that time.

Just remember, you’ll only get to buy the shares if the price of the stock is trading below the strike price on expiration day

A few points to consider before implementing a put-selling plan of attack:

1. Only sell put option contracts on stocks that you want to own for the long haul, as you might be required to buy them at expiration. We use this strategy to acquire high-quality, top-notch stocks. Don’t sell put options on risky stocks that you have no intention of buying, or only do it just to receive the put option income.
2. You will need to have an option trading account set up with your broker in order to sell put options.
3. Only sell the amount of put options that correspond to your buy levels. If you eventually want to buy 500 shares, then don’t sell more than five option contracts.
4. You will need to keep a percentage of money in your account on hold at all times while the trade is active. This percentage is called the “margin requirement” and is set by your broker. In most cases, your broker will ask you to keep anywhere from 10% to 50% of the full purchase price of the stock while the trade is active. This is great, as you don’t need to keep the full $40,000 (in the IBM example) on hold at all times. This still allows you to use your funds for other trades

That’s it, put selling, in a nutshell. It’s an alternative way to acquire stocks while getting paid for your time and effort. You get to pick the stock you want and the price at which you’re comfortable owning it.

Just remember, stick with quality stocks that you want to keep for the long haul.

Good investing,

Lee Lowell

Editors Note: Lee’s book Get Rich with Options can be accessed through our Investment U Bookstore.

Today’s Investment U Crib Sheet

Options can be confusing at first, but with familiarity, they become just another tool in your investment toolkit. Here’s a quick review of some of the key put option topics.

• Options Chain – listing of a stock’s option contracts of puts and calls. An options chain is broken down by strike price and expiration date, with each option receiving its own security symbol.
• Strike Price – the price at which a contract can be exercised.
• In the Money – if a put contract is lower than the strike price, the contract is considered in the money. It means that the contract will make money for its owner.
• Out of the Money – if a put contract is higher than the strike price, it is out of the money. The price is too high for the transaction to be profitable – it makes no sense for the owner to exercise the contract.
• Expiration Date – date at which the option is either exercised by, or expires worthless.
• Time Decay – while not discussed much, the value of an option contract is based on several things, one of them being time value of the option. The longer an option has control over a stock, the pricier it is. Time decay is the declining value of an options contract as it approaches its expiration date.

by Lee Lowell, Commodities Specialist, Mt. Vernon Research
Wednesday, August 15, 2007: Issue #701

Editor’s Note: Lee Lowell is one of the smartest commodity investors I know. For six years, he worked on the floor of the New York Mercantile Exchange as a market maker, and for the last 11, he’s been making a living trading his own money in commodities. He’s exceptionally good at it, too
More than 80% of the trades in his commodity advisory service have been profitable.

I talked to Lee this morning, and he’s looking at three possible trades right now. So as stocks continue to ricochet down Wall Street, here’s a way to make some money in commodities

A. Williams
Managing Editor, Investment U

I’ve been an active commodities trader for 16 years, both on the floor and off. And one of the reasons I like this market so much is that there are only 15 to 20 commodities that are truly worth trading.

When the number is that small, you really get to know the market’s behavior and seasonal tendencies. This allows you to become intimately familiar with each commodity, and that makes trading them much more profitable over time.

I’m always scanning these 15 to 20 commodities to see if any new trading opportunities exist. And at the moment, there are three I’m close to pulling the trigger on. But first, let’s look at how the commodities market works, and the best way individual investors can play it.

The Commodities Market is Pure Supply & Demand

The commodity markets tend to move in more predictable and smoother patterns over the long run, compared to stocks. That’s because they truly end up making their moves based on supply and demand

There are no firms and CEOs running the commodity markets. There are no quarterly earnings reports. And the Fed isn’t trying to intervene.

Many physical commodities are food-based in nature and tend to move according to growing patterns, seasonal tendencies and weather. We’re talking about corn, wheat, soybeans, coffee, sugar, cocoa, orange juice, crude oil, natural gas, etc. Prices are based on how well the crops are growing and how much supply of the product is currently in storage.

Although there are some government reports to contend with, they typically only give us a clue as to how the crop is progressing in the growing cycle. Even though you may read about a hedge fund or two trying to control a certain futures contract, the commodities market is so large and so deep, that the hedge fund may only have a very short-term effect.

With that said, if you’ve never traded commodities before, you may be wondering how you can get involved. It’s actually pretty easy

How To Buy and Sell Commodities

Commodity trading is actually just as easy as stock trading. The best way to get involved is through futures contracts and futures options contracts. Purchasing and selling these is the same as trading stocks or stock options.

Other than buying orange juice or coffee at the local grocery store, speculating on the future movement of physical commodities can be done by buying and selling futures and futures options contracts that trade on one of the designated commodities exchanges around the U.S.

The most notable futures exchanges are the New York Mercantile Exchange (NYMEX), the Chicago Board Of Trade (CBOT), the Chicago Mercantile Exchange (CME) and the New York Board Of Trade (NYBOT).

You can trade both futures contracts and futures options contracts at these exchanges. The only thing you would need to do is open a commodity trading account with a registered commodity broker. (See today’s Crib Sheet for a list.) This is no different than opening a stock trading account.

Once your account is open, you can trade commodities the same way that you trade stocks. Do your research, look at the charts, check the fundamentals, and then enter the trade. For me, the only way to play commodities is through the use of options contracts, for a couple of reasons

• Options keep your risk limited at all times, but the gains can be unlimited. This lets you sleep soundly at night, as you never have to worry about unlimited risk, like the risk associated with short selling stock.
  
• With options, you don’t need to be correct on your directional assessment of the market to have a profitable trade. It’s true. You can be totally wrong on the direction, but your options can still produce a profit. (Selling “option credit spreads” is the strategy that can do this.)

Now let’s take a look at three potential plays I’m keeping my eye on right now

Three Ways to Play the Current Commodities Market

1. Natural Gas

The natural gas market has taken a big beating to the downside over the last two months. My sources in the option pits tell me there might have been another troubled hedge fund that was liquidating futures contracts that led to the big decline.

The other reason is that the large amount of natural gas supplies in storage has been weighing on the market. But, as we have learned over the last few summers, we’re about to hit the major portion of hurricane season, and not too many people want to get caught short this market when hurricanes do decide to come our way.

The chart below shows that natural gas futures have most likely made a bottom and will probably trend higher from here, or at least not retrace much lower.

2. Coffee

Here’s a chart of the December 2007 coffee futures:

Although a major portion of coffee is grown in South America and its winter season is winding down, we’re seeing a push here to the upside that may keep going. If it can stay above the resistance line that I’ve drawn for the next few days, it might be ripe for a bullish trade.

3. Orange Juice

Lastly, we have the orange juice market

Although orange juice is not known for its high volume or huge following, we do know that during hurricane season we can see major moves to the upside.

This is a highly speculative play, but if Florida gets whacked with a few hurricanes over the next two months, we could see the orange juice futures move to all-time new high levels. Considering the massive drop the orange juice market has endured since the spring, taking a limited-risk bullish option position could be the smart play.

Good investing,

Lee

Editor’s Note: To learn more about Lee’s commodity advisory service, and to get his recommended trades delivered to your inbox, here’s how it works.

Today’s Investment U Crib Sheet

Here are three commodities brokers you can use to get started. All of them know Lee, and are familiar with his strategies. We receive no compensation from these groups. This list is for your benefit only:

• 5perside.com
  www.5perside.com
  800.523.7357
  If you contact them, ask for George Sampogna or Chris Brooks.

 

• RMB Group
  www.rmbgroup.com
  800.345.7026
  Ask for Bob Meier or Steve Belmont.

 

• Foremost Trading, LLC
  www.TheFuturesBroker.com
  888.262.6455
  Ask for Bob Miller.

by Lee Lowell, Advisory Panelist, Investment U
November 13, 2006: Issue #607

If you’re an investor who’s long on a stock right now, I want to show you how to make money by selling call options while you’re waiting for the stock to move higher.

Selling the “Rights” to Your Shares With Call Options

At this very moment, there’s another investor somewhere who’s willing to pay you cash – today – in return for the opportunity to possibly take your stock from you at a higher price sometime in the future.

That means you can start making passive income right now all due to your having some shares sitting in your account.Here’s how it works

If you own at least 100 shares of stock in your account, you have the opportunity to sell a covered call option against those shares.

What does that mean?

Basically, you can sell one call option (one option contract equals 100 shares) against the shares of the company you already own.

In doing so, you’re giving up the right to own the shares to the person who buys the option from you. So he now has the right to buy the shares from you at a pre-determined price (this is called the strike price) and at a pre-determined date (known as the expiration date). For that right, he must pay you money – yours to keep, free and clear, no matter what happens in the future. That’s your return.

If the stock moves up past the strike price of the option you sold, you will then be obligated to sell your shares of stock to the option buyer at the stated strike price. Is that a bad thing? Not if you do the trade correctly, and have a price in mind that you would be willing to sell the shares anyway.

Let me give you a real-life example of how this covered call trade works

Turning IBM Into An Income Machine

My parents both own 800 shares of IBM that they’ve held for many, many years. Over that time, they’ve obviously experienced the ups and downs, but have still not cashed out of the stock.

But now they’ve finally decided that if they’re going to sell their IBM shares, it’s going to be when the stock is $95 or more. Fair enough. But instead of simply having them enter a sell order limit at $95, I got them to sell some covered calls against their 800 long shares at the $95 strike price instead.

Since each option contract is the equivalent of 100 shares of stock, my parents sold 8 call option contracts each.

Take a look at the IBM chart below:

We sold the first set of call options on March 17, 2006 – selling the January 2007 $95 strike calls for $1.95 each. That brought in an immediate $3,120 (16 x $1.95 x $100 multiplier = $3,120) into my parents’ accounts.

We chose the $95 strike calls because if IBM ever happened to trade above $95 by option expiration in January 2007, my parents would get the stock called away from them at that price. So instead of sitting around, waiting and hoping for IBM to eventually move back up to $95, they got proactive with their portfolio, sold some calls and made easy cash.

Obligation-Free Call Options

Since you’re never obligated to hold onto a call option, we decided to buy back the calls in the middle of July 2006 in order to take a profit on the option side of the trade. Even though IBM was moving down in price (and causing a paper loss on my parents’ long stock), the call options were getting cheaper too, giving us a gain on those.

We bought all the calls back for $0.15 each, which cost us $240 total (16 x $0.15 x $100 multiplier = $240). So in essence, we locked in a real-life gain of $2,880 ($3120 – $240 = $2,880). Sweet!

Since we bought the options back, we were left with no more obligation to sell IBM at $95/share. My parents had their 1,600 shares of IBM just sitting in their account again. And we waited for the next chance to sell a covered call

Using Call Options to Deposit Another $4,800 Into the Account

The next opportunity occurred about three months later, after IBM gapped up to $92 per share on October 18, 2006. Because IBM had rallied back $18 a share, it was a good time for selling more call options.

My parents opted to sell the April 2007 $95 calls this time, and they collected $3 per option, which brought in another $4,800 of fast, easy money. All they have to do now is sit and wait to see if IBM gets to, and then stays above, $95 per share by the April 2007 option expiration.

If that happens, they will sell their shares for $95. If IBM stays below $95 at April expiration, the calls will expire – and my parents will keep their IBM shares and will look to do another trade sometime in the future.

The covered call strategy is a sound and easy way to bring in extra cash every few months. If you have stock sitting idle in your account, and have a pre-determined sell point, don’t just wait for the stock to reach that level, sell call options against your stock at a strike price that coincides with your sell point. Make your stocks work for you, instead of you working for your stocks.

Good trading,

Lee Lowell

Today’s Crib Sheet

• Selling call options is a great way to generate income in your brokerage account. Buying them can also be extremely profitable, especially if you have time on your side.