My Broker Won’t Let Me

I’ve had many people ask me if they could trade options in their IRA. The answer is Yes and NO. It depends on your broker. I’ve seen numerous firms prohibit their clients from trading options in their IRA and others allow it. You can’t trade naked calls but covered calls, puts, and straddles are often allowed. The IRA allows you to trade options without worrying about creating tax liability. Since you are only taxed when you withdraw funds,  the calls and puts can be used to add additional income to your portfolio. The key to trading in your IRA is having a firm that no only allows the trades but is cost effective. If your firm does not create a beneficial trading experience, you can look at several companies that do. I would encourage you to look for a broker or advisor that has several years of option trading experience.   In addition most platforms now have practice platforms, this way you can practice without placing your funds at risk.

Take The LEAP

A leap is an option who’s life is at least one year out. In other words more than a year before the options expires. If you like consistent income and creating downside protection, you may appreciate the strategy of selling calls a year out. Here are a few companies that currently offer double digit premiums, Alcoa (AA), Caterpillar (CAT), and XOM. You buy the stock at the curent price and sell a call against your stock, providing you double digit returns if the market stays flat, double digit downside protection, and the plus is that any dividends paid are paid to you, the stockholder. This strategy is for those of you who can afford to be the bank. An aggressive investor may buy the calls in hopes of a significant rally as the elections end. It is important to know your limits. I would encourage you to consult your financial professional.

Trader Die Horrible Death

Man crushed by expiration. An options position diminished with time, watching your position expire worthless is like watching a train get closer and closer until it runs you over. The key to trading is to have a plan in place before you place any trade. Ask yourself, how much can you afford to lose, place your stop loss, boundaries in place. If scenarios covered. The trader that places his financial future at risk is a not a trader but a gambler. As a trader you must weigh the risk against the return based on a series of factors. Losing the ability to trade again is not the goal of a professional trader. It is important to mitigate losses, contain costs, and to manage the trade without emotion. One cannot accomplish this without a trading plan in place. The what ifs are close the position, dollar cost average, extend the position, sell against the position to lower your cost basis. Death occurs when you blindly allow the trade to diminish without a plan.

Catch A Cat

The Dow closed above 11400, now the question is, will the rise continue? If so, CAT may be your ticket to a nice return. My research gives CAT a 12 month target price of $140. With this in mind I’m laying out two scenarios. Be the BANK or be the Player. The Bank will buy CAT and sell a covered call. At the present price of $91.37 you can sell the January $92.50 for $8.10, netting a maximum profit of $9.23 or in excess of 10%. You’ll have downside protection to $83.27.  Keep in mind if the stock never reaches the $92.50 you’ll keep your stock and keep the premiums received. This option runs 158 days. However if you want to be the player you can buy that call on CAT for $8.10 plus trading fees, looking for CAT to rise above $101. Just 10 days ago CAT was above $101.  Over the last five months CAT has closed above $101 seventy seven times, with a high in excess of $116.  A rise back to $105 could net the Player a return of 50% or more, depending on the speed of the recovery.  The Player has 100% of their funds at risk but a great potential return.  Keep in mind options involve risk, seek the advice of your advisor or investment consultant.

Insuring profits

If you own stock you have one option to protect your profits, sell your position. If you learn how to use options you can use a PUT instead. Here is how a put works, if you BUY A PUT, you create downside protection, the PUT allows you to sell stock at a pre-determined price regardless of how much it has declined. If you bought apple at $160 per share and now it’s $380 per share you can buy a PUT, granting yourself the options to sell shares at $380 even though it has dropped to $350. This is not free, you pay a percentage of the price to protect your downside, however you give yourself downside protection. If you just sold your stock you could lose the upside if the market rises, and you may create a large capital gain. Think of the PUT as insuring against loss, using a percentage of your profit to protect the remaining shares. The PUT works just like homeowners insurance, only if a event occurs you use the benefits you bought. If the stock does not decline your PUT will be worthless.

The Bank

If you have ever played blackjack, you know you play against the bank. The bank usually wins. You may win on a particular night but overall the odds are in favor of the bank. This is also the case with options. If you want to be the bank you need more capital then being the player, however you acquire the better odds. Let me give you an example. When you sell a call you must deliver stock at a set price. When you buy a call you are investing a smaller amount of money, in hopes that you can turn your smaller investment in to a greater return. The call seller owns the stock, lets say 100 shares of apple at $350.00. The seller has invested $35,000 where as the call buyer puts up a fraction of the stocks value in hopes of the stock moving in the positive direction. The call buyer puts 100% of their investment at risk, but the call seller limits his upside. Now two thirds of the time the bank wins in these situations. So again, do you want to be the bank or the player?