Stock Options - Should You Trade?

First let me be very clear, I do not recommend individual stocks. Unless you study companies and want to become an owner of one then you should stay with Mutual Funds. You can own all the stocks you want with index funds.

That said I admit that there is a little kid in all of us who likes to take risks. I have a small amount invested in only two stocks. I will not name the stocks but will share with you what I have learned.

There are two ways you can trade with options, one is to buy an option on a block of 100 shares of a stock for a fixed time period. If the stock remains at or below the option price plus what you paid for it and the option expires, then you have lost money. You are gambling that the stock will increase in value more than the option price, what you paid for it and the commission cost of making both trades.

I have not bought and may never buy an option, regulations also help you stay away from buying options also. You have to meet some very tight rules to be able to play in this market.

Selling an option however may not be so risky. If you are a seller of an option you must first own the stock, then be willing to part with it for a given price. Of course the time to do this is when the stock is rising and is already above what you paid for it. In other words you are looking to sell for a profit.

First and Second trades:

Why only own a few stocks? I have owned more stocks in the past but found that I tend to take greater risk when dealing in more stocks. By selecting only a few good companies and investing in them for the long term makes more sense to me. The first stock is involved with railroads and I believe that railroads are getting ready to make a comeback in America. My first option trade was in mid 2007 and I sold the right to someone to buy four contracts (100 shares each), at $5.00 a share above what I paid for the stock. The sell netted me $427.00. I latter bought back the option when the stock fell for $53.00. I was eighteen days in the trade and made $374.02 after commissions with no risk. If the stock rose I would have made a greater profit of $2,000 on the $5.00 a share over what I paid and still kept the $427 for a total of $2,427.00. However I now still own the stock, collect dividends, and make a small profit.

A month later the stock rallied and I sold another option, this time for $1,227.01 after commission and two months later bought it back at a cost of $472.99 after commission, profit $754.02. After that the stocks started to fall and now 2009 I still own the stock which still pays dividends but is only worth 1/4 of what I paid for it. But because I believe in the company and the company is sound. I will continue to hold it.

Third and Last trade before the market decline:

My other stock is an oil company stock that I have owned for many years. I really did not want to lose it so I looked for a long term option to sell that would be much higher than the current price.

I found a three year option and sold 4 contracts (100 shares each), at $14.30 a share. At the then price of the stock, this would insure me a 5.5% per year return paid up front or $5,707.01 after commission. In addition the stock continues to pay a high dividend which I keep. If the stock goes up and the call is executed I will stand to make $4,000 over the already high price that the stock was trading at when I sold the option and I already make $5,707 on the trade.

It has been two years now and the stock is trading $12.00 lower than it was when I sold the option. I have one more year to go before the option expires, so if it does not go up more than $22, I will have made 5.5% plus the dividends during this bear market.

Remain Calm:

As you can see I am not in any hurry for the market to recover to quickly, I would however like it to recover because my automatic withdrawals from my retirement IRA's are costing me quite a bit with the mutual funds down about 30%.

If the market does recover quickly before the end of the year, I will more than likely reinvest the money from the oil stock into the railroad stock and then only own one stock! And of course sell another option if the stock well above what I paid for it and still rising.

Sound to good to be true?

It is! I suggest that anyone who is looking to make money with individual stocks look long and hard at the risks involved and risk no more than about 5% of your portfolio. But if you do own stocks, then selling options and locking in a profit that you can select makes good sense. The market could very well continue to decline to the point that in a few years these two stocks could be worthless. I could then add them to my file of other worthless stocks that I have collected.

Please visit my web page at: http://hubertcrowell.name/.

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