Option Investor


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Maybe there’s some life left in the market after all – maybe. The last three days have been fun to watch. We’re not used to seeing green numbers. It’s like a visit by a long lost friend.

A long lost friend will have some pleasant memories (of profit) to share. Ah, yes. Those were the days. But, keep in mind that it’s just a visit. Don’t become complacent. The VIX is still almost 63. Be prepared for anything.

Warren Buffet

It’s common knowledge that Warren knows what he’s doing. A living legend, Buffet has been making money hand over fist for decades. Warren’s not perfect. He makes mistakes, but not many. The investing community closely follows his investments carefully and news of his involvement has been known to dramatically move a stock’s price. Something that not everyone knows is that Buffet takes uses option strategies to make a few extra bucks on his holdings.

We know that Warren likes railroads. He has a nice chunk of Burlington Northern (BNI) stock. Apparently, he’s open to acquiring more shares. There are a few different ways to acquire stock. First, you can outright buy the shares on the open market. Second, you can sell puts, take in premium and have a lower cost basis if/when the shares are put to you.

I heard that Buffet recently sold a load of Burlington Northern $75 puts naked (the puts, not Warren) and took in $7 of premium. If you remember your option basics, that means the premium goes immediately into your pocket. If, at expiration, Burlington Northern closes above $75, the naked puts expire worthless and Warren has profited by $7 ($700 per contract).

If Burlington Northern closes below $75, Warren is forced to purchase the stock at $75. Take into consideration the $7 of premium already taken in and the actual cost basis of these new shares is only $68 ($75 - $7).

This process can be repeated over and over again, pocketing premium month after month – as long as you believe in the company and are willing (and able) to take delivery of the shares. Warren can do it because he has more money than God and he’s willing to hold his stocks forever.

Look at the potential return on this transaction. If BNI closes above $75, Buffet makes $7 on a $75 asset. It’s a 9.3% return for the life of the trade. And, he hasn’t taken a nickel out of his pocket. The annualized numbers are scary big. As BNI moves up, assuming he continues the program, Buffet can sell higher strikes and the return might be a bit lower, but BFD. It’s still damn good. Just remember, Buffet believes in the sector and more specifically, the stock.

If you end up with the stock, don’t forget what you’ve learned about collaring the stock – protecting yourself against catastrophic market moves (of which we are much too familiar).

Years ago, Michael Dell, the CEO of Dell Computer (DELL), took advantage of this put selling strategy. Dell Computer stock was doing well for years. We learned that, as Dell stock was moving up, Michael Dell was selling naked Dell puts month after month, taking in a ton of premium.

The story came out that, during this period, Dell Computer was making more on the sale of naked puts on its own stock than it was generating by building computers.

Back in those days, when a company released its quarterly earnings, it would lump all money-generating activities together and come up with an “earnings per share” number. As a result of Dell’s huge success selling puts, the SEC now requires public companies to report their earnings, but to break down the numbers into “investment” income and “operating” income.

Our Positions

With the recent market pop, both of our November positions are looking better and better. With the RUT at 514.18, our 390/380 RUT bull put spread now has a 124 point cushion. Our 360/350 RUT bull put spread has a 154 point cushion. These days, no cushion seems enough, but this makes for at least a few good nights sleep.

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Student Report Card Comments

These are actual comments made on students' report cards by teachers in New York City Public school system. All teachers were reprimanded, but I think they made their point.

1. Since my last report, your child has reached rock bottom and has started to dig.

2. I would not allow this student to breed.

3. Your child has delusions of adequacy.

4. Your son is depriving a village somewhere of an idiot.

5. Your son sets low personal standards and then consistently fails to achieve them.

6. The student has a 'full six-pack' but lacks the plastic thing to hold it all together.

7. This child has been working with glue too much.

8. When your daughter's IQ reaches 50, she should sell.

9. The gates are down, the lights are flashing, but the train isn't coming.

10. If this student were any stupider he'd have to be watered twice a week.

11. It's impossible to believe the sperm that created this child beat out 1,000,000 others

12. The wheels are turning but the hamster is dead.

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CPTI NOVEMBER Position #1 - RUT Bull Put Spread – 514.18 On 10/15, with the RUT at about 436, we sold 20 RUT November 390 puts and bought 20 RUT November 380 puts for a credit of $.80 ($1,600). Maintenance is $20,000.


CPTI NOVEMBER Position #2 - RUT Bull Put Spread – 514.18 On 10/16, with the RUT at about 480, we sold 20 RUT November 360 puts and bought 20 RUT November 350 puts for a credit of $.80 ($1,600). Maintenance is $20,000.

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In the past, I outlined a strategy based on an initial investment of $100,000. At that time, $74,000 was spent on zero coupon bonds maturing in about seven years at a value of $100,000. The principal $100,000 investment is guaranteed. We're trading the remaining $26,000 to generate a "risk free" return on the original investment. We are not compounding our profits by dramatically increasing the number of contracts we trade. With the September profits, our new cash total is $66,440 ($64,220 + $2,100).

ZERO PLUS POSITION – RUT Bull Put Spread – 514.18 On 10/16. we sold 30 of the November 360 bull put spreads and bought 30 of the November RUT 350 spreads for a credit of $.80 ($2,400).

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