Daily Stock Market Equity and Options Trading Commentary

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Wednesday, November 19, 2008

One HOT Option Trade for a Volatile Market

With the November expiration coming this Friday, it would seem that premiums for an unlikely strike price would be getting next to nothing. That is not the case however with some of my holdings, as I wrote some covered calls today for SDS. Today SDS traded as high as 109.40 and as low as 99.50. When the SDS was at about $103 I wrote out 2 contracts for the $120 strike for $225 per contract! Yes I received a premium of $2.25 a share with only 4 days for the option to expire. I bought these shares less than a week ago for roughly $90 and I already pocketed $450 for the right to sell my shares at $120/share or $19 higher than what SDS closed at. For those who are familiar with the SDS you know how volatile it is and for those who don't, learned how volatile it was the minute you read the trading range for the day. Yes the SDS will fetch a better premium due to its volatility.

Okay so let's take a less volatile stock such as Caterpillar (yes I know most of the stocks nowadays are very volatile- but CAT is a stock I own and much less volatile than most I hold). The stock hit a high today of $36.30 and a low of $34.73. Now ask yourself, what do I see CAT trading at the close Friday? Your guess is as good as mine, but my guess is not too much higher than $40, if it can even get there. Then I would look at the $40 strike for November to see if the premium offered would be worth the risk of unloading my shares for $40/share at the close Friday. I see that the last contract that traded was for a premium of 18¢ or $18/contract. The high for that particular option contract was 26¢ or $26/contract. At the open Wednesday I would put a limit order in to sell my contracts for $30-$35 or a 30¢-35¢ premium per share. The chances of CAT getting over $40 by Friday is likely and you may not make as much money as you could have, but if your cost basis for CAT is below $40 and you sell your shares at $40, then so what you still made money on your common shares + the premium you sold your contracts for.

The bottom line is yes this market is horrible, but you will be able to make some income if you hold common shares (in lots of 100) off this market. If you plan on just holding your shares to sell them for a better day, there is no point why you aren't creating income off those shares! There is a way to make money in this market so don't get out of the market because you hear negative news in every direction. Remember this strategy is only for those who plan on holding their common shares no matter how beat up they get...

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