In tonight’s grad call we discussed the valuation of options.  When purchasing an option, all one sees is a price, but is that expensive, cheap, moderate?  How do we know if we are overpaying?

As a basic rule of thumb, when purchasing a 90 day OTM option, one should pay approximately 10% of the stock value.  That is to say, if we have a $60 stock, we can expect to pay about $6.00 for the option.  If we get the option for cheaper, hoorah for us; but overpaying for the option can lead to significant and frustrating losses. 

 While the above rule of thumb works in a glance, a more detailed understanding of the option value will lead to smarter option decisions.  The part of option pricing that causes an option to become overvalued is implied volatility.  Implied volatility is the premium option sellers require to take on the option risk.  We can think of it as a fear premium.

As fear of stock or market changes creeps in, the implied volatility rises and the option premiums increase.  As the fear dissipates, the option values can fall dramatically even without significant stock price movement.  Savvy option traders purchase options when the implied volatility is low and sell as the implied volatility peaks. 

We looked at the ‘Volatility View’ function at www.optionsxpress.com to determine if the implied volatilities on specific stocks were high or low relative to their 52-week ranges.  As we noted, most stocks are very high meaning their option values are inflated.

In times like this, out of the money options are riskier due to the potential drop in implied volatility.  Some potential ways to combat the high implied volatilities at times like this are to do the following.

1.      Trade stock

2.      Do covered calls

3.      Buy in the money options (subject to less implied volatility risk)

4.      Use option spreads requiring the purchase and sell of similar options.

By understanding the valuation on our options, better trading decisions can be made.  I wish you great success in your trades!

Happy Trades,

Jeff Yaede

I recently had a student who called, and told me they had just purchased thousands of shares of a company who had recently declared bankruptcy. I think it is important for us to talk about what may or may not happen.

With various companies going bankrupt, many people are asking what will happen to shares of those companies who are going bankrupt. There are a few different things that can happen to the shares.

Most the time the stock’s price will drop severely, and loose value. The value is usually nearly 90% of the original stock price. Sometimes the stock will lose all value.

The stock may also be delisted.  A delisting can occur if the company fails to engage in activates that are not for the public interest, their price falls below a certain stock price, or other reasons contrary to the market.

The stock could also be relisted as a penny stock.  This means the stock is traded less than $5.00, and is a very volatile stock. They are very risky investments, and most experts warn against stocks listed as penny stocks. We could have three to five pages about the speculative nature of penny stocks but the important thing is to be careful with such stocks.

If you purchase a stock listed as a penny stocks, you need to fill out additional forms with your broker letting them know you understand the risks that are involved.

These are a couple things which may happen to the shares of companies when the go bankrupt. It is difficult to determine what companies will bounce back and what companies will go under.

It is important to be careful on what is going on, and to follow what you have learned from your coaches.

Micah Richards

Investors unnerved by last weeks bankruptcy filing by Lehman Brother Holding and by Merrill Lynch’s abrupt sale to Bank of America can cross at least one worry off their list.

In general brokerage firms are required to keep clients assets, including 401k and other retirement plans, separate from their own holding.  The assets of mutual funds managed by the firm are also kept separate. (Of course, you still bear the risk of securities declining in market value).

When a brokerage firm fails, customer assets are typically transferred to another brokerage firm in their entirety; investors then can choose to move them to another brokerage firm or remove the funds.

There is a safety net that will help protect your assets it is called Protecting Customer Accounts (SIPC).  The Securities Investor protection Act established procedures for the protection of customer’s funds and securities in the event a broker-dealer becomes Bankrupt.

SIPC provides coverage for each customer up to a maximum of $500,000 of which no more than $100,000 may be for cash losses.  If a customer has both cash and margin accounts, all their accounts are combined to determine the maximum amount of coverage that the investor receives.  If the customer has a joint account with their spouse, the joint account is covered separately.

SIPC coverage applies to public customers only.  It does not apply to other broker-dealers who have securities at the failed broker-dealer.  If a broker-dealer fails, the federal courts appoint a trustee to distribute funds and securities to customers.  The trustee is required to notify customers of the broker-dealer that it is bankrupt and handle its liquidation in an orderly fashion.

In the case of Lehman Brothers, only the holding company declared bankruptcy.  Many of Lehman’s healthy operations are being acquired by Barclay’s.  The SIPC last week stepped in to assist in the transfer of Lehman’s customer accounts.

For more information on SIPC you can to go www.SIPC.org.

Dee Asay

Wall Streets Historic Week. Advice, and Current Events.

By: Carl Anderson

In tonights grad call, we stepped back and discussed some of the historic market conditions that we are currently trading in.  To really understand how to trade this market, we need to look at the market in two parts…News and Technicals.

News Aspects:

1.      Fed keep pumping into the banking

2.      Government took over AIG

3.      Fannie and Freddie taken over

4.      LEH collapsed

5.      Commodities weakening…volatile

6.      Regulations:

a.       Banning Short Selling…UK…banned short sales of all financial stocks till January  –

b.      Talking about doing the same thing in the US

c.       Possible legislation allowing for the banks to sell their bad loans to the government. –Print money—inflation.

d.      Moral Hazard: Fairness

e.       Giving FDIC insurance to Money Market accounts…

     Has everyone recognized the problems that exist? -this is the major question to answer to determine if the situation has hit rock bottom.

Technical or Market Aspects:

1.      VIX

2.      $CPC

3.      $NYHL

An introduction to the above indicators can be found at www.stockcharts.com by doing a search of their site.

Happy Trades,

Jeff

More Market Volatility. $VIX (fear) Index. Blood in the Streets.

By: Carl Anderson

Hey Gang,

 “The key to wealth is to buy when there is blood running in the streets and sell when they are pounding at your door”

This is a quote that I keep on my desk in my home office.  Unfortunately, I don’t have who wrote it, but it has been a quote that has helped spur my confidence in trading and investing in some of the toughest times of the market.  

So when is there blood in the street?  And what does that refer to?  Well, when things look the worst in the market, it is generally an opportunity to buy and when things are at there best, it is often times time to sell.  Today there is blood in the streets.  Just take a minute or two to read the financial headlines as major investment banks collapse and others are on the brink.  Not only are the headlines bad, but market sentiment indicators confirm that market sentiment is extremely bearish. 

Lets look at the $CPC and the $VIX today.

Both of these indicators confirm the oversold nature of the market in the short term.  In my opinion, we have reached a temporary market bottom.  We may retest the bottom, but for my money, I am a buyer for the coming month at least.  For more learning on these indicators feel free to email me at jyaede@prosperlearning.com and I can direct you on where to go.

Happy Trades,

Jeff