Option Investor
Educational Article

A Victim No Longer

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By David Popper

Two years ago, between May and October, I made absolutely no money. I felt fortunate that I made no money because at least I did not lose money. The market was in a trading range. When it appeared to break to the upside, I jumped in. When the run was over and the stock dipped, I jumped out. In a very real sense, I was buying high and selling low. This is not the action that promotes sterling returns. After two or three rounds of being whipsawed, I became like the proverbial deer in the headlights. That is, I doubted every trade.

I also stood in total fear every time an economic report was due, because I was often fully invested and stood to lose with a negative report. I was confused. My whole idea of actively trading was to be in charge of my own account. I believed that passively investing in a mutual fund made you a victim of the whims of the market, and that it made more sense to "make things happen." After a year of trading, I had spent many hours trying to be the captain of my own ship and was still a victim to the whims of the market. I understood that trading takes time and having a busy professional career did not allow me the time to get good quickly. I also realized that short-term trading was a game unto itself and a majority of traders lose. At the same time, the allure of the market beckoned. From a distance, it appears that the market can be tamed and that wonderful profits can be obtained. If only a better approach can be taken.

The first thing I did was to analyze how I reacted during a trade. I realized that for me, purchasing more than 300 shares of a stock caused me great delight when the stock went up but also great consternation when the stock went down. In other words, it became emotional. I also learned that I did not like to see my bottom line dip and I tended to look at that bottom line too often. After a lot of struggle, I finally achieved a strategy which was a correct fit for me.

My strategy has two components. The first component was discussed in last week's article. I use one-half of my funds and purchase great stocks (high earnings per share, high relative strength, in a hot sector of the economy) and will sell calls which will expire in four to six months. Typically, I will receive between 20% and 25% premium. This affords me tremendous downside protection and gives me a comfortable return. Think about it. A 20% return earned three times a year is 60%. A 25% return earned twice a year is 50%. Compare this to any bank account, CD or mutual fund. After these calls are in place, I can take whatever action is appropriate with them as time goes on. These actions were described last week. With the other half of my capital, I simply wait for a market extreme that happens from time to time. For example, when the NASDAQ "dipped" 500+ points in April, I took advantage of the situation to sell out-of-the-money puts. Others took advantage of the situation to sell in-the-money puts. They made more profit than I, however, I had more safety than they did. Still others bought the stock on the major dip and rode it ten to thirty points on the rebound. In short, market extremes yield quick profits.

When these two strategies are combined, your return may equal between 50% and 100% per year. If that is not enough, you could still position trade a very small amount of stock to earn five to ten point profits on a daily or weekly basis. This, of course, enhances your profit even more. The beauty of this system, however, is that it allows you to make healthy returns with much less risk. It also allows you to take advantage of market volatility, instead of being a victim to that very volatility. It also allows you to day trade for extra profits without a lot of extra risk. In short, I am no longer a victim of volatility. Instead, I welcome it and profit from it.

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