Monday, January 18, 2010

BAGAKOAA Jan 18, 2010 There are options to the game


Jan 18, 2010 There are options to the game.

Yeah, I thought I’d give you all a break and not write anything for a few days. In reality, I did not know what to say. I was still reeling from the miscalculation on INTC. Don’t get me wrong. I still like the stock and I did add to my position on this dip. My frustration lies in having figured it out called the number and still have it come down 5% taking some wind out my sale.

Then there was the breakfast Saturday Morning. Enjoying a cup of coffee with someone who is very knowledgeable about the investment world and who was one of the first to call this last bubble. Someone whose opinion I respect. Finally I asked, “What the hell happen with Intel?” To which he just smiled. In the next 30 humbling minutes he asked me first off if I really thought I could know more than the guys and dolls in New York and Chicago who control billions of dollars. To which I replied that I did not, though the moment INTC reported, I thought I did. Then he explained to me the rules of the game.

He told me, by first prefacing his comments with, “Not to hurt your feelings.”, and then explained I was just one of the monkeys in the casino. Now I lived in Las Vegas for thirteen years and worked very hard not to be one of the Monkeys in the casino. I know a couple of the readers are monkeys in the casino so I know I am in good company. That is right, guessing the market, timing the trade, picking the right stock at the right price are all games in the Wall Street Casino. And just like some games have better odds than others (In 1995 the best odds for the player in all casino gambling was the don’t pass line of the craps table especially taking odds after a four or a ten had been established as the point.), there are certain things you can do to work with the house.

My breakfast companion then explained that just because a good quarter was reported did not mean the company had a good quarter. Most companies to some degree cook the books and then you have some that are just down right crooks. I was prepared for this comment as I scrutinized the INTC quarterly and the last 10Q (Filed quarter report with the SEC) and I looked for Net income versus pro forma figures, exclusions that seemed unusual, operating income comments, hard to understand stock options for key employees, off balance sheet footnotes, interest rate assumptions, revenue recognition, deferred income tax, related party transactions and all of the relevant foot notes. (The Book Financial Fine Print by Michelle Leder is a great tool for anyone who wants to do some forensic study on company financials.)

Then this investment sensei (I have many) started telling me about selling call options to cover a held position. I had heard of this strategy, but it was a bit technical when I first started playing options long and did well so I stopped there. He explained that taking a few wins buying calls was like taking a puff off a funny cigarette, you will want more, you will be main lining calls until you start getting them wrong. (I was beginning to think that he had looked at my portfolio last week.) And just like the bright lights and bells and noises from around the casino you will want to bet more. Then you become a monkey in the casino. He explained that selling a covered call option is a great way to protect a position you already own. That is why it is called a covered option.

Now I will not pretend to tell you I understand all the nuances about this strategy. I will be taking a lot of time to read two great books on the subject. The first is the Bible to Option Investing, Options as an Investment Strategy by Lawrence MacMillian. I have had this 985 page book for about 3 years. It is an everything you want to know about the strategy and mechanics of option trading. Chapter 2 defines how to execute covered calls as protection against an underlying equity. I can’t recommend it enough. The other book which is actually part of a college financial course is Option Spread Strategies by Anthony Saliba from the International Trading Institute. This is real nuts and bolts option stuff, but it does show you the point that my breakfast companion is trying to make. If you are going to put 10,000 on the black jack table, you probably would appreciate limiting the cards you can get to a range of cards that will help you win but at least limit your downside. Writing covered call sell options is one way to do this.

This is risky and it involves a lot of homework so if you want to live vicariously through me, as I learn it I will keep tabs of it here.

Salve Lucrum


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