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Author: ejandresen Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 558  
Subject: Re: Options Primer Date: 8/26/2001 2:02 AM
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The Fool has an excellent board in Speakers Corner called "Options- You Make The Call".

Most of the people who are into options are heavily into technical analysis. As such, they don't always see eye to eye with a value guy like me. But most of the people there are nice enough and willing to share their experience with newbies.

PLMD is an excellent example of a stock where it pays to own options. Either owning some puts on the shares you own, or selling your shares and buying calls that represent the shares you used to own would have saved your bacon in the last month.

On that one day when PLMD dropped to 15, a September 15 call was $1.50. This is outlandishly expensive- 10% for an at-the-money call that expires in 6 weeks, but it would have been better owning that call when the stock dropped to 10 than it would have been to own the corresponding shares. Or, buying puts on your shares would have elimated any future downside past the strike price.

If the major reason you're into PLMD is to capitalize on the eventual short squeeze, then options are really better than buy-and-worry. The stock may be irrationally cheap at 10, but there's no reason the irrationality couldn't continue to 5, and it's also possible that the irrationality isn't so irrational.

Besides the preservation of capital, most people get into options for speculation. That is, they want to capitalize on the increase in the price of the option. Personally, I don't have the temperment for it. I end up watching the underlying stock every second of every day and fretting over every 5 cent move.

By contrast, my personality is very well suited for covered call writing, though most options traders couldn't stand it. For instance, the September 17.50 JAKK calls I sold for $1.55 got as high as $5 when the stock was on the rise. This would have driven the average options trader up the wall, but I had to simply stay calm and remind myself that if JAKK is over $17.50 on September 21, I'll have made 13% in 3 months.

Conversely, I was not affected at all when JAKK made its mysterious 3 point dive last week. My call was in the money before the dive and it was in the money after the dive.

The biggest mistake I made so far with covered calls was buying back the call when the stock rallied. In both instances, the stock promptly dropped back to its old level and I got whipsawed. I quickly realized that it's best to be of the mindset that once you sell a call, you should forget about it until expiration no matter how high it rises.

On the other hand, if the stock drops 20-30%, it's prudent to consider either exiting the position (by buying back the call and selling the stock) or rolling down or out (buying back the call and selling a new, more expensive call either at a lower strike price or a longer time to expiration). It's important to remember that as a covered call writer, you are not stealing free money (as Wade Cook would have you believe). You are selling upside potential and accepting full downside risk.

Another pointer is that if the stock is highly volatile, you are better off selling an in the money call and if the stock is conservative and boring, you are better off selling an out of the money call. So if PLMD is $10, you might consider selling a $7.50 call. The converse is true for buying. On the volatile stocks, it's better to look out of the money and on boring stocks it's better to look inside the money.

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