Weekly Stock Options Trading Tips: September 29, 2009

Option Trading Idea of the Week

Commissions are a Necessary Part of a Conservative Options Strategy

All commission costs are not equal. I'm not talking about the difference between full-service broker commissions (which may go into the hundreds of dollars) with a discount broker's rate, however. Comparing those kinds of commissions is at least an apples-to-apples comparison.

No, I'm talking about the significance of the commission you pay when you buy stock or a mutual fund and when you sell an option. If you bought 100 shares of a $50 stock, you would shell out $5,000 plus about a $10 commission at your favorite discount broker. The only thing you know for certain about this purchase is that it ties up $5,010 that could be earning interest in a savings account.

A year later, unless the stock has increased in value, you still would not have covered the money you paid out for the commission. Even though the commission works out to only 0.2% of the total investment, it is no wonder that commissions are a concern for the stock trader.

Contrast the stock purchase to the sale of a single option for $1.50 (a one-month at-the-money call or put option on SPY could be sold for almost double this amount, but let's take the lower number). On the $150 sale, Terry's Tips subscribers at thinkorswim would pay a commission of $1.50. This works out to 1% of the purchase price, or 5 times the percentage you would have paid to buy the stock.

However, the option seller has sold a depreciating asset that goes down in value every day. Over the course of the next month, the time premium of the option that was sold for $150 will depreciate by an average of $3 per day. In other words, one day after selling the option, if the stock price doesn't change, the commission cost will have been totally recovered two times over.

Of course, if a call was sold and the stock went up, the option that was sold for $1.50 might cost more to buy back the next day, but the option-seller presumably owns an off-setting longer-term call that will also increase in value. But the bottom line is the same - every single day of the short option's life, the entire commission cost will be more than covered by the decay of the option.

The buyer of stock might have to wait a year or more for the stock to go up and finally cover his commission cost while the option seller will cover his commission cost before lunch-time the following day.

In his mind, the option-seller should think of the commission cost as evidence that he has made a good investment that will pay for itself in less than a day. The more commissions you pay, the more decay you will be collecting.

This is just another example that the world of stock investing is far different from the world of option investing. While it may take a year to recover the commission you pay on a stock purchase, you would be disappointed if it took an entire day to recover that cost if you sold an option.


Any questions? I would love to hear from you by email (terry@terrystips.com), or if you would like to talk to our guy Seth, give him a jingle at 800-803-4595 and either ask him your question(s) or give him your thoughts.

You can see every trade made in 7 actual option portfolios conducted at Terry's Tips and learn all about the wonderful world of options by subscribing here. Why wait any longer to make this important investment in yourself?

I look forward to having you on board, and to prospering with you.

Terry

Andy's Market Report

The market experienced broad-based declined which was not entirely unexpected given the recent short-term "very overbought" readings in all of the major indices. The short-term "very overbought" readings coupled with weak housing and durable goods data provided the fuel for bears this past week.

The S&P 500 (SPY), Dow (DIA), Nasdaq 100 (QQQQ) and Russell (IWM) declined 2.2%, 1.6%, 2.0% and 3.1%, respectively. For the year, the S&P 500 is up 15.6%, the Dow has advanced 10.1% and the Nasdaq is leading the way with a 32.6% gain.

On a technical basis, the week of selling has pushed the market back in a neutral state, but on the verge of dipping back into a short-term "oversold" state. If/when it does I expect to see another short-term bounce. Although, the real question is, where is the market headed over the intermediate-term? Of course, no one knows for certain, but I could easily see a flat to slightly higher market as we push closer to the New Year. Only time will tell. One thing is certain, if the market does indeed play out as I described, premium-selling options strategies should thrive.

With regard to economic data, the market struggled with a few key reports this past week. Both new and existing August home sales came in below economists' expectations. New home sales reported a slight increase of 3,000 homes to 429,000 which was well short of the 440,000 they anticipated.

KB Home Chief Executive Jeffrey Mezger said in a conference call with analysts that "the precise timing of a market recovery remains uncertain," and that foreclosures and unemployment are the industry's chief challenges.

"It's difficult for the housing sector to build momentum as long as potential home buyers lack job security," he said.
Also, durable goods orders fell 2.4% which was a big disappointment for the market, as participants expected an increase in orders of 0.4%.

"Durable goods inventories continue to be liquidated at a very rapid pace, which suggests that a slowdown in inventory liquidation could significantly boost fourth-quarter growth," wrote John Ryding and Conrad DeQuadros, economists for RDQ Economics.

Next week, should be quite an interesting week. I will be closely watching how the market responds early next week to the near-oversold readings. Can the market hold the 30-day moving-average at 103 on the S&P (SPY)? This seems to be an important support level and if it indeed holds I expect to see a nice end to the year.

As an aside, Sunday is my birthday and I will be celebrating it by running a 50 mile race (8900' of elevation gain) in Ascutney, VT. So, if you are not doing anything on Sunday I would certainly appreciate some good thoughts. Legs don't fail me now!

Until then have a wonderful weekend!

Andy

Overbought/Sold Condition Report

Overbought/Oversold as of September 29, 2009

Major Benchmarks

• S&P 500 (SPY) - 32.7 (neutral)

• Dow Jones (DIA) - 39.6 (neutral)

• Russell 2000 (IWM) - 33.8 (neutral)

• NASDAQ 100 (QQQQ) - 33.9 (neutral)

Testimonial of the week

"In the past, I have spent a lot of money and time being tutored on trading options. None of these courses came close to explaining how to manipulate and adjust the given strategy as you have so expertly done in your 10K Strategy literature. What I liked about your approach is that you've managed to explain your strategy in terms that the layman can understand." --- Paul D.