In spite of the odds against winning, many people seem to like to invest in individual stocks – sort of like picking horses at the race track (and often for similar sound selection reasons, like the reputation of the trainer or the jockey or the color of his silks, or the horse’s name or his recent race record, or what the touts are touting).
To my way of thinking, picking individual stocks is a lot more like gambling than carrying out a prudent option strategy such as the Mighty Mesa Strategy . But picking individual stocks is a whole lot easier and a whole lot more fun for many people.
If you insist on picking individual companies, the Shoot Strategy is a better way to make an investment than merely buying the stock. While it is not the Mighty Mesa Strategy, it uses the same basic idea – that the decay rate for LEAPS or other long-term options is much less than the decay rate of shorter-term options.
The strategy is outlined in my White Paper as the Shoot for the Stars Strategy. Les Brown said “Shoot for the moon. Even if you miss, you’ll land among the stars. And Confucius said long ago “If you shoot for the stars and hit the moon, it's OK. But you've got to shoot for something. A lot of people don't even shoot.”
So we call this the Shoot Strategy.
How the Shoot Strategy will perform:
- If the stock goes up, the Shoot Strategy will make money. The gain will be considerably greater than the percentage gain would have been if the stock had been bought instead of the LEAPS.
- If the stock stays flat, a small gain should result. Since you are collecting slightly more than the average monthly decay of the LEAPS each month (until they have only a few months of remaining life) you will make a small gain. However, even a small gain is more than you would have made if you had bought the stock and it doesn’t go up a penny.
- If the stock falls, a loss will usually result just like it would if you had bought the stock, and the loss will likely be a greater percentage loss than if the stock itself had been purchased instead. However, in many cases, the loss could be reduced (or eliminated) if the stock fell during those months when our Trading Rules call for selling in-the-money calls, or if more options were sold than was necessary to recoup the average monthly decay of the LEAPS (this tactic reduces the upside potential gain, however).
An example of the Shoot Strategy:
In late October 2007, Terry’s Tips used www.magicformulainvesting.com to select a company called AmerisourceBergen (ABC) as a candidate to demonstrate how the Shoot Strategy could work in the real world. We set up a separate demonstration trading account with $5000. At the time, ABC was trading at $44.50. We purchased 6 call LEAPS that expired in January 2010 at the strike price of 45. We had 27 months over which we could sell short-term calls to get back the money that we paid for the LEAPS.
We paid $8.80 ($880 plus $3 commission) for each of the 6 LEAPS. We calculated that the average monthly decay of our $5,298 worth of LEAPS was about $200 including commissions ($5,298/27 months = $196). Simultaneously with buying the 6 LEAPS, we sold 3 November 45 calls (which would expire worthless a month later) for $125 each, collecting $366 after commissions. Since we sold these calls as a spread at the same time we purchased the LEAPS, we only had to come up with the difference between our cost of $5,298 and our proceeds of $366, or $4,932.
The $366 we collected by selling the November 45 calls comfortably covered the $200 we would be losing for that month in premium decay on our LEAPS. If the stock stayed absolutely flat for 27 months and we gained $166 each month, we would earn 90% on our money over that time span even though the stock had not gone up a penny.
Of course, you probably have figured out that if we sold 4 November 45 calls instead of only 3, we would earn a whole lot more each month. While that is true, if the stock went up strongly, we would not gain nearly as much as we would gain if we had sold only 3 short-term calls. Selling 4 calls instead of only 3 is more similar to the 10K Strategy than it is to the Shoot Strategy.
If we had bought $5000 worth of ABC stock, we would have been able to get 112 shares. Our option positions (owning 6 January 2010 45 call LEAPS and being short 3 November 2007 45 calls) were equivalent to owning 274 shares of ABC, or more than twice as much as we could have bought with the same money. If the stock were to go up by $1, owning stock would result in a $112 gain while owning the 6 LEAPS and selling 3 short-term calls against the LEAPS would result in a $247 gain.
Post-Note: Two months later, on January 25, 2008, the price of ABC had edged up by 1.1% and closed at $44.97. The value of the portfolio (after commissions) was $5,577, or 11.5% higher than the original $5000 starting value. Over the two-month period, we had used proceeds from selling the December and January short-term calls to buy an additional January 2010 45 call LEAP. Over the two month period, the LEAP had fallen in value from our $8.80 purchase price to $8.20, but we now owned 7 LEAPS with a total value of $5,740.
The Shoot Strategy had worked exactly as it was designed. The stock edged up and our return was considerably higher ($577) than the $53 we would have made if we had merely purchased the stock ($.47 gain x 112 shares = $53).
General Trading Rules for executing the Shoot Strategy:
- Pick a stock you believe is headed higher (we suggest using www.magicformulainvesting.com. as a guide – see discussion below).
- Buy slightly in-the-money or out-of-the-money call LEAPS. At least two LEAPS must be purchased. If your budget does not warrant buying at least two true LEAPS, shorter-term calls can be purchased as long as they have at least six months of remaining life.
- Calculate the average monthly decay of the LEAPS (time premium divided by the number of remaining months).
- Sell enough slightly out-of-the-money current month calls to cover the average monthly decay.
- Near or at expiration, roll over the short calls to the next month (if they are in the money), again selling enough out-of-the-money contracts to cover the average monthly decay. If the expiring calls are out-of-the-money, let them expire worthless and sell the next month out, as above.
- If short-term calls that have been sold become in the money (i.e., the stock has go up), they must be bought back during expiration week, and the amount paid must be added to the remaining decay of the LEAPS and a new (higher) average monthly decay bogey established based on the number of remaining months of the LEAPS.
There are a number of other Trading Rules that have proved to be successful for the Shoot Strategy, including how to change tactics if the stock should fall, how to adjust which calls to sell during seasonally positive (and negative) months of the year, and the best time to sell the original LEAPS. These important additional Trading Rules are included in the White Paper that comes with the Terry’s Tips Insider service.
Deciding Which Companies to Buy:
The best single source we have found for selecting individual companies is the Magic Formula system outlined in the small book by Joel Greenblat called “The Little Book That Beats the Market” and is available online at www.magicformulainvesting.com. We consulted this website when we selected Harley Davidson and Phelps Dodge in 2006 – both of them went up too sharply for the Mighty Mesa Strategy but would have been big winners with the Shoot Strategy.
Rather than relying entirely on the Magic Formula, it might be even better to select individual stocks that also rank high at Investors Business Daily (IBD), Value Line, and by composite analyst rankings. In our opinion, using the Shoot Strategy offers considerably higher returns than merely buying the stock, and if you carry it out correctly, you can make money with the Shoot Strategy even if the stock falls in value.
The Second Tip #5 Strategy - Double Your Money The "Lazy Way"
I have compiled a list of companies which will guarantee that you double your money in two years if the stock does one of three things:
- Stays the same in price
- Goes up by any amount
- Falls by no more than 5% (for some stocks, 10% or more).
On the downside, the stock can fall by 30% or so, and you will not lose any money. You can figure out your exact return before you invest. Of course, if the stock falls by over 30%, you will lose money.
I call this the "Lazy Way" strategy because it involves picking a stock you feel will be equal to, or higher than, today's price in two years, and then making only two trades now (I'll tell you exactly what to do). Then you just sit back and wait to make over 100%-300% on your cash investment even if the stock does not go up one cent.
Figure Out Your Profit BEFORE YOU INVEST!
You can figure the exact profit you will make before you invest. This amount will remain the same regardless of whether the stock stays the same, or is 60% higher in two years. I will show you exactly what two trades you should make, and give you the formula which you can use to calculate what your profit will be based on market prices on the day you invest. If it isn't at least 100%, I will give you back DOUBLE THE MONEY that you paid me to learn this trading secret.
If Your Stock Falls 30%, You Still Make A Profit!
Just in case you are wrong, and your stock doesn't stay the same or go up, you still have a chance to come out ahead. In fact, if the stock falls 30%, you still make a profit. In most cases, it wouldn't be a big profit. But how often do you make a profit when your stock falls by 30%?
Two Years Is Often A Blessing
The beauty of having a two-year time frame is that one good year, or several good months, can offset an equally bad year or monthly period. You will make 100% when the stock price is the same (or higher) at the end of the two years, regardless of what happens in between the start and ending dates.
As we know, the market has a natural upside bias - for the last 50 years, the average yearly gain in the market has been somewhere in the 10 - 11% range. Given that we have just had three consecutive downside years, the odds are pretty good that the next two years will at least be stable. That's all we need.
Does This Sound Too Good To Be True?
This may sound too good to be true. I am not asking you to take my word for it, however. You can prove to yourself that you will be guaranteed a 100% return even if the stock doesn't go up one cent, and you can see the mathematics before you make the investment.
If I am wrong, you get DOUBLE YOUR MONEY BACK for what you paid me for disclosing my options trading strategies to you.
Okay, Now For The Fine Print.
Of course, there must be a few "catches" to the system. Here they are. I think you will feel that you can live with them. With the "Lazy Way" strategy,
- You will earn 100% (or so) regardless of whether the stock stays the same or goes up. If it goes up 150%, you will still earn "only" 100%.
- This system cannot be used in an IRA. (If you want to achieve extraordinary returns in your IRA, you might consider my Mighty Mesa Strategy which can be used in an IRA).
- Your returns may be slightly less if you use a full-service broker rather than a true discount broker. My formula calculates your returns based on commissions and fees charged by my discount broker (and I will give you his name in case you would like to open an account there).
- At the end of two years, you may have to pay taxes on all or some of your gains. On the other hand, no taxes may be due at all. It depends on what the stock has done over the two-year period, and whether you decide to sell or continue holding the stock you own.
- The time period may not be exactly two years. It could be as few as 18 months and as many as 30 months, depending on what options are available. In the event that it is not exactly 24 months, your pro-rata gain will still be at least 100% for a 24-month period.
- You may find it boring to wait two years while nothing really happens. But most people don't believe that doubling your money is a boring event.
- As attractive as the "Lazy Way" strategy may seem, it is not the strategy I recommend most highly. I really hope you will take the extra effort to learn a little about stock options and LEAPS, and follow my Mighty Mesa Strategy. This strategy takes considerably more effort, but offers the possibility of earning 36% in a single year, even if the stock does not go up by one cent (and it can be used in your IRA).
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