Options 101

Options are extremely leveraged, and require very little upfront capital; but, there is a lot to learn. With Guy's book for beginners, I was able to get a full grasp of what options really do. Literally the right to buy and sell stock, which you can also buy and sell, and any combination thereof. Example: you can buy the right to buy a stock, sell the right to buy a stock, or sell the right to sell a stock. Once I got my mind around that, I was excited to finally figure out what the hell was going on.

All of those calls and puts, dates, and small change numbers made sense. No longer was it just $0.55 for December, but an opportunity to buy the stock at XX price for $0.55 x (Number of Contracts) X (100). $0.55 went from pocket change to $55.00. I guess the light bulb was on. (Reader note: this is a dimmer switch bulb).

Guy's book was easy to read, and he laid out basic strategies. I perused the book, and decided that a Vertical Spread, or a Bull Spread strategy was the one for me. The next day, I applied for options permission with E*Trade, for level 3. A day later they came back to me, with authorization for level 1.

I shook my head. Apparently I didn't have enough experience as a trader to qualify for anything higher. My next big question was, what was a level 1 mages abilities? Covered Calls, Buy-Writes, and Roll ups/downs.

To be honest, after having just read the book with about 40 different options strategies laid out, I couldn't tell you what any of those three things were. I made up my mind, and decided, rather than give up on options, I would learn what the hell these things were, and how to profit with them.

Investment Vehicles

Sure real estate is a great investment vehicle that provides great returns, except in the now crashing, over inflated markets. Generally, they require too much time and up-front capital for someone such as myself. Rent prices in Texas don't support 100% financing options, or even 90%.

Still, Allen's book got me thinking. I need a vehicle that I can drive to wealth. And, if it's not real estate, what is it? Real estate might be great, if I had the capital. An apartment complex would be better.

Penny stocks are just the spammers dream, not the realities of millionaires. For me, that seemed to be the only way to get enough leverage in the market to actually make any money, but those stocks are really a crap shoot. I need a safer vehicle, and something that isn't so capital intensive.

Since I had made my first trade, I was vaguely aware of Options, but click on the options page, and I was lost and it was literally (pardon my pun) but all Greek to me. I never bothered to learn what they were and how they worked. That is until I stumbled across a book in the librarys' finance section: Options Made Easy, by Guy Cohen.

This book opened my eyes to the world of Options.

Slump

From the time I sold my mutual fund until May of '08, I did not make a single trade. I had my money tied up, and I continually told myself there are no trades to be made out there. The market is making a dramatic down turn, and it's not the time to jump in.

I was hoping that when the market was done making its down turn, I would have enough cash on hand, to get back into the market. Buy Low, Sell High. Or just wait.

And wait, and wait. I searched occasionally, but often times, I would just throw my hands in the air, and say, "I haven't the sorriest clue as to what to trade."

At one point, I went to my local library, and stood in the financial section just looking. I had some time on my hands, and I wanted to read a book on wealth creation, but which one? There were metric tons. How to get rich quick, millionaires the slow way, turtle your way to wealth, grave robbing for riches.

I went with Robert Allen's Creating Wealth, a book more or less on real estate investment guide--a bare bones layout for creating wealth.

Letting Go

ADVDX had not been fairing well with the coming tide of the banking crisis. They restructured several times, and reduced dividends. My portfolio basically flat lined.

I waited as long as I could, before I sold it, but the fact still remained. I needed to liquidate. I didn't have 10 years to see this fund mature. I had to let go, and cut my losses, especially with WMT.

ADVDX was a lackluster fund and was able to net 1% when all said and done. WMT after commissions proved disastrous.

But, these were some rather cheap lessons to learn. To have a strategy and psychology is huge, and never hold onto a loosing position.

Opportunities Missed

After spring 2007, Exxon began to make a bullish run, from $70 a share in March to $93 a share in August. By that time, my still very lopsided portfolio, sported 1 share of WMT, 175 shares of ADVDX, and 38 shares of XOM, all of which were looking very good.

I still had no trading strategy, and was still feeling around in the dark like a mole in a trash heap. I wasn't thrilled with my mutual fund; and with a gain of 1% against Exxon's glorious ride to the top, who wouldn't be disenchanted?

I wanted to hang on to XOM, because I had read an article, that this stock was a likely candidate for a split. Share price had increased dramatically, and a split hadn't happened in some time. I decided that holding onto XOM, rather than buying low and selling high, was the best way to go.

Conoco Phillips was catching my eye. It had also made a similarly dramatic move. And, late August it was coming back down. I told myself, that if it dropped below $80 a share, I would buy it. I would sell my ADVDX fund, and buy COP. COP dipped below $80, but I didn't buy. I sat on it, and missed the opportunity.

COP eventually went back up to over $90. Right around the time I needed to sell ADVDX for a major purchase. Had I sold ADVDX and bought COP at that time, and then sold it in October, I would have increased that positions nearly 11% in the space of 3 months.

I had actually set up a trade with an entrance point, and a time frame of how long I wanted to hold it for, but for some reason, I didn't execute.

Dividends

Come March, my mutual fund was starting to pay dividends. When I purchased these, I had a choice of having these dividends as cash or reinvested and gain more shares. I went with reinvestment.

Dividends eased the pain of an average performing mutual fund. And, I also received my first quarterly dividend from Exxon. Which was also great, because XOM was struggling. I had, at that time, bought high and it was sinking low.

If I had to do it all over again, I would have selected cash dividends for my mutual fund. Keep my cash, cash and stocks, stocks. I came to realize that dividends can play an important part in long term investment.

Round Table

January 2007, I was eating dinner, with the head's of the company I worked for--president, CFO, and foreman, at some roadside kuntry cafe, hole-hole-in-the-wall in south central Texas. I used this opportunity to pick their brains.

Since I had made my first stock trade a month ago, I was ready to make another one, but what? I had been reading everything I could that came across MSN Money, or Yahoo Finance. I read articles predicting the split of stocks such as XOM, and LMT.

Sipping some sweet tea, I asked the question, "Should I buy Lockheed Martin?"

Our CFO, a former VP from Lehman Brothers, advised me against it. At that time I had one major holding. One wrong move and my portfolio would become lopsided and a bad stock would drag whatever earnings I had, down the tubes. He advised me to find a Mutual Fund to balance things out.

I followed his advice of modern portfolio management: diversify so the losers don't bring you down. On a recommendation from my former writing professor and author of Investing Naked, I bought ADVDX. I decided on this one because of its, at that time, dividend yield.

And for a while, the fund did just fine.

Strategy?

Okay, so I was long 38 shares of XOM and 1 share of WMT. I assumed that owning the Fortune #2's in some way would be good, and that their stock would go up, up, (occasionally down) but mostly up. This was sadly the extent of my strategy.

Eventually I got over my anxiety, and let the market do its thing, up/down or flat-linning. This part was a huge pyschological barrier. I decided to accpet the fact that I was going to hang onto these shares (at least XOM) for a long time, perhaps several years.

Still, I entered the trade unprepared mentally, and most critically without any kind of stragtegy--Entrance, Exits, Stops, Limits. I have learned and to my best, have tried to adhere to this policy to never execute an order without a damn good idea of what you want to do, what you expect to see, and a backup plan for when you fail to see your first plan materialize.

Market Introduction

When I placed my first trade, I was sitting in the Portland airport, waiting; linked to the world with my wireless card, and a cup of McDonald's coffee. My new brokerage account was fully funded with my extra cash; the market bell had rung, and I was ready to make a trade; make some of the big bucks.

I punched in the windows calculator, the current selling price of Exxon Mobile (XOM) which was in the neighborhood of $75.75. I divided that out over some 3,000 dollars. And decided I could purchase 38 shares of XOM. I entered a firm Market order. And three seconds later I was the proud owner of 38 shares.

I then decided I had a little money left over. I decided to buy 1 share of Wal-Mart stock (WMT), for some $54.13. I placed another order.

For the time I waited for my plane, I watched the stock ticker. My XOM mobile stock was going up. I felt like a winner--this is how the monies made.

However, by the time I got off the airplane in Houston again, and within a day or two XOM dropped to 70.00 a share. My Wal-Mart stock was down as well. My exuberance over my market gains and flitted away with the market fairy. I thought, "what the hell am I doing?"

A Fistfull of Cash

In the last third of 2006 I made a career change, a move and an intellectual paradigm shift. I packed what I could into two suitcases, and took a standby flight to Houston with $237 in my bank account.

My income was high, my expenses were low, I kept my debt to a minimum; and worked my rear into the ground. By the end of December I had an extra $3,000 in savings.

"Not Bad," I thought to myself. "I could go to Mexico and burn it all; sit on a beach for a week and drink rum runners until my tab dried up and they packed my poor lucid body back on a plane home."

No, I decided to invest it. I turned to my cousin and asked him, "What do I do?"

"Buy Exxon," he said. "You can't loose with fortune 1."

"And how do I go about doing that?" I asked.

"Personally, I like E*Trade," he said. "They give you a debit card, and a box full of checks, and will reimburse your ATM fees."

30 minutes later, I was filling out the form on-line, I was really on my way to being a big time investor.

Debt Service

One thing that I noticed and I'm sure you've noticed this too. Everyone who's ever written a book on how to get wealthy, from the Rich Dad, to Suze Orrman, has all touted the debt horn--get out of it!

Growing up, I saw that debt is a bad thing, and fortunately I never buried myself in credit card or other frivolous things. I am grateful for that; what little interest bearing debt I had in the form of a truck note, I was able to pay off by cutting my rent in half. I paid off early and saved over 200 dollars in interest payments.

However, debt is not necessarily bad. I've come to find that without credit (the ability to borrow money, debt/leverage, call the dragon what you will) wealth is not accessible.

Debt to avoid like a rhino in heat: Interest Bearing Consumer Debt. (Paying interest on that new 82" plasma TV for the bedroom?)

Good Debt: Deferred interest loans that can be paid off before interest kicks in.

Better Debt: Purchase something that will make money of it's own accord and at a higher rate.

Investing Naked

There have been several people in my life that have provided me with some understanding of the world of finance. On such gentleman was Barry Lawler, a writing professor at Oregon State University. He wrote a sensical, and quite whimsical how to guide on Investing.

This was my first real finance book that I read. I can't say that I understood everything, or much of anything at that point, except for the basic fundamentals. However, this short how to guide got me excited. It gave me the idea, that yes, with little to no effort, I could invest my money and do well enough for myself, but with enough time, determination, and the right effort vitamins I could invest my way to wealth.

I'll credit this work as the work that got me to care about money--my money, and future.

Getting Started

It was 2006 when I made my first investment, prior to that I was a poor college student with a checking account and a savings account that yielded 0.22%; after that I dropped out of school, in an attempt to make money. It took me several jobs and more hours than I really wanted to, but I did it. My first thousand dollars I could put away.

I called a financial planner at Smith Barney and gave him my thousand dollars, and he invested that money (October 2006) through my IRA in a mutual fund--Franklin Templeton C shares. I had my doubts though.

Since that time, I have not made another contribution to that IRA. Why?

Even through the end of 2007 while the major Indexes were still solid and the Dow flirted with 14,000. My initial portfolio never exceeded much more than a 1,000 dollars, my initial investment.

But, problem number one, they seem to think that charging custodial fees of 4% seems reasonable. That and the Bear Market of 2008.

My portfolio as of 7/18/2008, I owned

FFACX 74.637 for a grand total market value of 837.42!

After almost two years, this is a -13.58% Return on my Investment. Less than Stellar. This doesn't seem to be the way to build wealth. Had I left it in my .22% Savings account, I would have had an account balance close to 1044.

But as my cousin said, "when you go this route you pay people to loose money or just make marginal gains."

The Point of it All

My goal is to build wealth. I am in the process of learning, and this is my journey--triumphs, losses and all.

I grew up learning the tenant, buy low and sell high. I generally equated this with the stock market, and this was the only way to make money. As I learn about investments, and the various vehicles, I find that the premise that I learned young was flawed at best.

Yes buy low, and sell high, this will make you money, but to take just a few thousand dollars and turn it into seven figure wealth I will need to buy a stock and see it increase over a %1000. This isn't realistic.

No, I need real investment vehicles, with realistic returns, and reasonable risk.

Here I will document my attempts at taking a small amount of money and making myself wealthy. You can see the different investment vehicles I use, and what I do wrong, and what I do right. And, hopefully you can learn something through my attempts.