SURVIVING THE GAME
JANUARY 23, 2009
2009 – 6

Another ugly day. They seem to be coming more frequently. Market sentiment is just plain gloomy. No real enthusiasm for anyone to buy. The next few weeks will show us whether we continue to drift lower or finally buyers step up to take on some risk.

Model portfolio bought 20 DIA MAR 100 calls yesterday for $10. Buy back remaining 20 today. Trading at $2 - $10 now. This leaves you long the DIA MAR 90 calls. Hold on to them for now.

Bought back 20 DIA FEB 90 calls this morning at $20 as per last newsletter. Cancel stop at $60. Flat in those now.

Lower stop on DIA MAR 89 calls from $250 TO $200.
Lower stop on DIA JUN 92 calls from $400 to $300.
Lower stop on DIA SEP 92 calls from $550 to450.

This simply limits risk if we have a rally.

Leave all other positions as they are.

NEW TRADE :

This comes to us compliments of one of the attendees of the seminar Wed eve.

Purchase 1000 Suncor (SU) here at market. Trading at $US 18.87
Sell 10 SU JAN 2010 $20 calls at $510 or better. Currently $510-550
I recommend doing these trades in the US vs Canada. This puts you net long 1000 SU at $13.70. Place stop to exit trade at $14.00 on SU. If hit, buy back short SU JAN $20 calls.

Here is how this trade unfolds.

Duration is 51 weeks. Options expire 3rd Friday of Jan, 2010. You are obligated to sell our shares at $20 each at expiry if SU is anywhere above $20.00. If held to expiry, you have no risk unless SU drops below $13.70.

There are 2 ways to look at the profit/loss on this trade.

1) If you purchase SU outright it costs $18900. You them receive $5200 for selling the options. This leaves you net $13700 invested. If SU is at or above $20 Jan 2010, you receive $20000 back. This is a gain of $6300 on your $13700 investment or a 46% return. You also receive a small .80% dividend but that hardly accounts for anything.

2) If you purchase SU on margin, you will need $5670 in your account, or 30%, to buy 1000 shares. You then receive $5200 for selling the options. This leaves you net $470 invested. Sounds ridiculous but it is true. Now, if SU is at $20 or higher in JAN 2010, you receive $20000 for selling shares, you pay back the $13230 loaned to you as margin and pocket the remaining $6300 profit. I’m hesitant to say this but that is a 1340% return on your initial $470 investment. You still receive the dividend but you will also pay interest on the $13230 margin. Remember, if SU declines, you will have to add additional funds to meet margin call. Eg If SU declines $1.00 per share, you have now lost $1000 on the 1000 shares. You have lost $300 and the broker has lost $700 of the margin loaned to you. You would have to replay the $700 lost margin to keep account square with broker.

This is a great risk:reward either way. The danger is that someone over leverages themselves with the ability to buy SU on margin. I would always suggest that you have at minimum 50% of the cash to purchase the shares outright, then sell the options. Another way to limit risk is to determine your exit point and make the number of shares purchased relative to the risk.

Exit on this trade is if SU drops to $14.00. This would be a new low for stock. Loss would be approx $4.90 per share or $4900. There would be an offsetting gain on the option. The gain would be determined by when the event occurred. If SU dropped to $14.00 in Jan next year, the option would be virtually worthless and you would recoup as much as you lost on the stock. Remember, the breakeven point on SU is $13.70 per share at expiry. If SU dropped quickly to $14.00, say in next month, the option would fall but not to zero. If this were to occur, the option would drop from $510 to approx $340. This would result in a gain of $170 per option or $1700. This would reduce overall loss from $4900 to $3200. This is how I determine how many shares to buy for model portfolio. Portfolio is taking on a 1% risk for portfolio on this trade.

Options Guy
Editor
Surviving The Game
optionsguy@shaw.ca