Character certainly counts.

But I’m not going to talk about the character of any person.

My topic is the importance of the character of price movement in forecasting direction… and how you can use this information to strive for fun and profit.

There is so much noise out there being blared, spouted, and touted in the financial media. The market is down one day on fear and up the next on hope.

How do you make sense of it all?

I strive to block out all that noise and listen to what the market is saying. I believe all the best information is reflected in the movement of market price. Determining the character of that movement is vital to gaining an advantage in your market intelligence.

The name of my research firm is Sarnoff’s Samurai Strategies, Inc. I always get a laugh when restaurant equipment catalogs appear in my mailbox, because I don’t operate a Sushi Bar. My specialty is successfully applying ancient Japanese charting techniques to today’s markets. I’ve been lending that service to bolster the Superleverage power of the Options Hotline since 1995, taking the helm as sole editor in 1999.

How is it that I can use techniques developed for the rice market in mid-18th century Japan to help my subscribers stay a step ahead of the crowd in today’s world of high technology, high frequency, trading?

The answer lies in the fact that all the key information available today was available then: price, volume, and open interest.

When you get a report on the market, you’ll hear the price compared to yesterday’s close. But the Japanese are more concerned with where we are compared to today’s opening price than where we are compared to yesterday’s close. Back in the 1980s, when I first started studying the Japanese methods, it struck me that their technique was simply a superior way of looking at price movement. Japanese candlestick charts provide much more timely and valuable information than typical western bar charts.

My Japanese method focuses on the character (positive, negative, or indecisive) of each day’s trading. This helps reveal the human behavior (buying and selling) that drives price direction. I use the character of the behavior of market price movement to:

• Identify key levels of support (demand) and resistance (supply).
• To determine who is stronger (bulls or bears).
• When that balance of power is likely to shift.

I view each day’s trading as a struggle between buyers and sellers. The intraday action is akin to the second quarter score in an NBA basketball game… but the close, that’s like the final 2-minutes. The closing price determines the winning side on that day.

The news may report that the market is down 30-points and you would consider that negative. But, if the market opened on its low, down 150-points, and came back to close on its high, only down 30, I would view that as a positive session and be looking for higher prices to come.

A closing price above the opening is positive and means buyers were stronger on the day. A close below the opening tells me sellers were stronger in that session. When I see consecutive days of positive character, it tells me buyers have the edge. Consecutive session with a negative character can point to lower prices down the road.

If the market runs up, runs down, and closes back where it started that reflects indecision. This can often stand as the signpost of a turn. Sometimes, such action can catapult prices in their current direction.

I like to say that technical analysis is as much art as it is science. Over the years, I’ve developed something my father had… judgment based on experience.

The Japanese have a saying that a chart is like a cat’s whiskers. I use my charts the way a cat uses its whiskers: as antennae to sense and track the movement of a mouse.

We don’t catch the mouse every time. False signals do occur… they provide valuable information, and lessons, as well.

But if you don’t use the chart, you are like a cat without its whiskers.

Sincerely,

Steve Sarnoff
Penny Sleuth

Options Rundown: How You Can Unlock Unlimited Wealth… was originally featured in the Penny Sleuth.

If anyone ever tries to tell you that you can earn a high return with low risk, zip your wallet!

But if you understand options, and it’s easier than you may think, you’ll quickly realize just how powerful a means to making profits they can be for you…

Imagine putting down $187.50 on an investment and getting back a $1,700 return in three months.  If that sounds unrealistic, I’m sorry.

But—that was an actual trade my elite Options Hotline members could have made using a technique I call “Superleverage.”

What is “Superleverage”?

You grasp that speculators make their fortunes from changing prices. Chances are, you are also familiar with the benefits of leverage.  Leverage is an important tool for speculators.

Leverage involves using OPM (Other People’s Money) to try to make more money than you can with your own.  Using OPM may augment rewards when you are right, but it may also greatly accelerate the risk of additional losses when you are wrong.
If leverage can be applied with an always known and strictly limited risk, it takes on a more sensible aspect.  It becomes…

Superleverage, the art of profiting from changing prices, with limited risk AT ALL TIMES, without ever getting a margin call, asked to put up additional funds, or forced to liquidate your position.

The instruments of Superleverage are exchange traded put and call options.

Buyers of puts and calls are the ONLY ONES who possess the full profit power of Superleverage.

Option buyers have several advantages:

• You don’t need to be a financial wizard or have large sums of money to participate.
• Only as an option buyer do you have all the benefit of using OPM when right, without the concomitant costs and risks when wrong.
• Total risk is ALWAYS known and limited to your cost of taking a position (making your bet).

While the option buyer has an always known and strictly limited risk, you will be well-served to remember that the risk is still extremely high, as it should be for the opportunity to earn unlimited gains…it’s the full amount of your bet, but not one cent more.

Here is an example:

Let’s say you’re looking at Chili Co. (I’m making up this names…as far as I know, there are no company called Chili Co.)

Chili Co. In October, the stock is trading at $38.  You’re thinking the stock will rise to $50 by the end of the year. In volatile market conditions, the stock could also collapse or it could settle down and move quietly sideways.

There are many things you could do, because there are many options to choose from. They come with a variety of strike prices and monthly expirations, and each of those options cost a different price—and therefore offer different opportunity to profit.

Let’s say you buy a Chili Co. January $40 call option for $200 (or $2 a share, since each option represents 100 shares).

The price you pay for the option—in this example, $200—is called a premium. The premium depends on a wide range of factors, including the actual price of the stock, time until expiration, and volatility.

“Chili Co.”, in this example, is the underlying instrument, the specific security the option gives you the right, but not the obligation, to buy or sell.

“January” is the expiration month for the option.   Equity options last trade on the third Friday of the expiration month, with the Saturday immediately following being the official expiration date.

“$40” represents the strike price, the price per share you have the right to buy Chili Co. at.

And buying the call option means that anytime before the third Friday in January, you can buy 100 shares of Chili Co. stock for $40 a share…no matter what the market price of Chili Co.   If Chili Co. is trading at or below $40 on the third Friday in January, your option will expire worthless.  That is your risk.

You are monitoring your position daily.  Chili Co. has just made a major announcement, and its shares have moved up sharply…to $50 a share.

Back when Chili was trading at $38 per share, your option had no real value.  The $200 premium you paid was for time and volatility only.  But, with Chili Co. trading at $50, your call option, your right to buy 100 shares for $40 has a real, intrinsic value of $1,000 (the right to exercise your option and buy 100 shares at $40 and immediately offset by selling them for $50).

But you don’t have to exercise options to make big profits. Most of the time, you simply resell the option to close your position.  You’re looking at a 400% return, minus commissions and taxes.

Congratulations! You just used Superleverage to turn $200 into $1,000. Throughout the transaction, your risk was completely known and strictly limited.

By the way, if you had bought the 100 shares outright at $38 (for $3,800) and sold at $50 (for $5000) your gain would be just under 32%.  Still nice, but paltry compared to the return on the option.

That’s the power of Superleverage!

Options offer their owners the power of Superleverage—the potential to make spectacular profits in a short amount of time, on relatively small moves in the underlying shares, with an always known and strictly limited risk.

Combining the tools of Superleverage with a disciplined method, sound money management, and a good understanding of your personal tolerance for risk gives you the cornerstones of a complete game plan for trading success.

If you still a little nervous about how you would fair in the options market, there are many resources out there for you. The Chicago Board Options Exchange has an option simulator that will allow you to research and place option trades without putting up real money, just click here.

Sincerely,

Steve Sarnoff
Penny Sleuth

Options Rundown: How You Can Use “Superleverage” to Turn $200 into $1,000 was originally featured in the Penny Sleuth.

The year of the American Contagion; the year of chickens coming home to roost; the year of the bailout — 2008 — is heading into history as a momentous time of tumultuous market moves in stocks, commodities, currencies, and interest rates.

This year too witnessed the onset of a worldwide economic panic with an assault on the global economic system and our form of democracy. The forces of deflation and inflation continue to slug it out in a titanic struggle for dominance. We’ve managed to navigate the stormy seas with a steady hand on the tiller. One of the keys to our success has been keeping a sense of perspective.

As my premium research service, Options Hotline, is set to begin its twentieth year of advocating sensible speculation, I’d like to share some seemingly impracticable musings you may find useful.

In 2008, volatility skyrocketed beyond belief. Most market participants, even professionals, were caught by surprise. Big money was made and lost, both up and down, with astonishing speed. It’s long been known speculators make their fortunes from changing prices, and leverage is an important tool for speculators. Leverage involves using OPM (Other People’s Money) to try to make more money than you can with your own funds. Using OPM may augment your reward when you are right; but it may also greatly accelerate the risk of additional loss when you are wrong. That’s the aspect of leverage that so many forgot during the heady times of money trees growing to the sky.

Even some of the market’s smartest participants are done in by blind arrogance. The famous story of the 1990s rise and fall of hedge fund giant Long-Term Capital Management, excellently chronicled in Roger Lowenstein’s When Genius Failed, comes to mind. That cautionary tale is particularly apropos to today’s financial crisis. Successful trades blinded the firm’s brilliant partners to the possibility of failure, ultimately sealed their fateful demise, and threatened the stability of the entire financial system.

In this business, I believe you are better served by checking your ego at the door. Having a complete game plan includes preparing for the worst in every trade. Remember to always speculate based on what you can lose, not what you can gain. Applying sound money management principles (such as never adding to a losing trade) and utilizing the tools of Superleverage allow you to stay in the game and avoid being knocked out through inevitable times of losing trades.

Always anticipate the possibility of loss, and are prepared to withstand it, no matter the severity, because you positioned with always known and completely limited risk vehicles; never be surprised when the market moves against you.

Over the years, I’ve compiled an impressive record of forecasting the twists and turns of market price. The publisher is happy to provide you with every trade I’ve ever recommended, since taking the helm in October of 1999.

As a result, people invariably ask me what I think the market is going to do…

I always say that if I knew what the market was going to do, I wouldn’t have to work. The key to success in the markets comes from using technical levels of support and resistance to set your exit strategy for each trade. Make sure that you, or your broker, monitor your positions closely. The market doesn’t ring a bell when it’s time to get out. Have your plan in place ahead of time and you can smile, laugh, take your profit a step ahead of the crowd, and enjoy your accomplishment with a sense of wonder.

No matter your success, always be surprised when the market goes your way.

So, like me, never be surprised and always be surprised. Don’t forget that forecasters, even those with good reasoning and strong opinions, are practitioners of uncertainty. That view will serve you well.

I hope you found the abovementioned thoughts helpful and wish you all good fortune as you vie for fun and profit in the year ahead.

Sincerely,
Steven Sarnoff
Penny Sleuth

February 22, 2011

Musings of an Options Expert: 20 Years of Successful Trades was originally featured in the Penny Sleuth.

I firmly believe it is my job to be as blunt about that as possible. The potential rewards of options are very tempting, and anyone who forgets about the potential downsides is toast.

Unfortunately, those stark warnings also scare away people who could benefit from options. People who have built solid portfolios… and can easily afford to speculate a bit. They’re the complete opposite of traders who blindly rush in focused on the gains. Instead, they only see the potential losses…

That’s why I offer a simple suggestion — try options trading for yourself. With just a few minutes a day, you can learn how profitable options can be, without risking a single cent.

In the old days — as little as a decade ago — the best way to do this was by paper trading. As the name suggests, it doesn’t involve any real money… or even a broker. Instead, you simply chose an option and kept track of it each day. With a few simple calculations, you could see how you would have done if you actually made the trade.

There are still plenty of good things to say about paper trading. For one thing, it forces you to work — tracking down prices and calculating potential profits. If you’re going to put that much time into an activity, you might be more inspired to do well. It’s a good trait to have if you ever decide to trade for real.

“Virtual Trading” Is the Road to Real Profits

Still, the pen-and-paper method is a little outdated now. Today, lots of websites offer “virtual trading” — free computer programs that let you practice trading without putting any money at stake. Most require you set up an account… not an actual brokerage account, but a membership account — containing basic information like your age and interests.

When you sign up, you’ll get a username and password to get to your account. You’ll also get a small sum of virtual money to start trading with. (Beware of a site that offers to give you more fake money in exchange for real money. The point is to avoid spending ANY out-of-pocket cash.)

I must be honest, I haven’t signed up for many virtual trading accounts — so I can’t honestly compare and contrast them all for you. However, a colleague recently opened up a mock account on the Chicago Board Options Exchange (offered by Options Monster)… so I can tell you all about that.

The CBOE virtual trading site starts you off with virtual money that you can use to simulate trading any of the securities the CBOE tracks — from stocks to options, even some futures.

The Web site does its best to make the trading as realistic as possible. Price quotes are based on the actual prices seen on the exchange. When you wish to buy something for your virtual account, you are given the same kind of choices that you’d face if you were actually buying a real security.

You can dictate limit and stop orders. You can make day orders or standing “good to cancelled” orders. You can even choose to write options or use covered calls.

After you make your virtual order, the software does the rest. If you placed a market order, the security is added to your virtual portfolio. If you used a limit order, the program won’t place your order until the real market hits your limit price.

Everything you need to know is spelled out for you — the program even levies a virtual commission charge on each of your trades.

After that, it’s just a matter of logging in to see how you’re doing. You can also set sell orders, even trailing stops.

Programs like this can be a very useful tool for gauging how well you’d do in the options market — making any lingering fears disappear.

Of course, there are some important differences between real investing and virtual investing that you need to keep in mind.

It’s a lot easier to trade when you’re not spending real money. But virtual trading is so lifelike, you might actually lose sight of that when you really start trading. This is especially true since actual trading will involve money you can afford to lose. If you’re not careful, it will all seem like a game… and in games, taking unnecessary risks is part of the fun.

The solution is to treat your virtual account as actual money. Don’t make crazy trades just because you can. Instead, only make trades you’d make in real life. It’s not only the best way to get a feel for how you’d actual do with options, but it’s also the easiest way to transition from virtual trading to real trading.

Once you see how much money you’re missing out on by not using real money, it won’t be long before you’ll want to try your hand at actually trading options.

Picking the Right Virtual Trading Platform

Here’s a rundown of several of the free virtual options trading platforms you can sign-up for right now…

paperTRADE
This full-featured trading platform from tradeMONSTER offers newbie options investors the chance to experience options trading on a realistic trading platform.

CBOE Virtual Trade Tool
While not as robust as other trading platforms, this simple options trading tool still gets the job done without the advanced tools that some beginnings may find confusing or unnecessary.

Trade Smarter Options
This innovative binary options platform isn’t as realistic as the other offerings, but this website shines by simplifying the options investing process to limited outcomes. If you’re having trouble grasping options concepts, this site may be a good intermediary step for you.

PaperMoney
thinkorswim’s virtual trading system is simply their award winning real-time trading platform with virtual money. This system offers investors the advanced features you’d expect from a real options broker.

Sincerely,
Steve Sarnoff

October 15, 2009

Perfect Your Options Trades for Free with “Virtual Trading” was originally featured in the Penny Sleuth.

They’re the tools I’ve turned to for decades to maximize my gains as an options investor while keeping my risks tolerable. My Options Hotline readers have used these rules to maximize their options gains over the years too, and now, I’m passing them on to you…

Speculators get a bad rap. The very word conjures up pictures of some carefree playboy throwing money into any crazy investment — not really caring if they win or lose.

It’s not a flattering picture. And that’s why conservative investors shy away from anything “speculative” — lest they be called speculators, too.

Well, I’m here to tell you “speculating” isn’t a dirty word. You can be a conservative investor and still enjoy that chance at phenomenal profits that speculating can bring.

I learned that lesson from my father, Paul Sarnoff. He was one of the first people to offer an options course — introducing novice investors to the concept of Superleverage (more on that on Friday). But he also had a strong conservative streak. In fact, he was an avid fan of precious metals, advocating that they should be at the core of every solid investment portfolio. He even wrote books on gold and silver investing.

My father proved that even cautious investors can benefit from speculating. But as he always stressed — and as I still stress today — the key to being successful was to have a complete plan of action. You never, ever throw your money around casually… even if it is money you can afford to lose. And you must take steps to make sure you never get in over your head.

Of course, that’s easier said than done. That’s why my father developed six simple strategies for keeping a level head when speculating. They may sound common sense, but I’ve spent enough time in the markets to know that common sense isn’t that common when money is involved.

So, if you’re thinking of dipping your toe into the speculative markets, here are a few proven ideas to keep in mind:

1. Create a sound money-management strategy.

This one flies in the face of the conventional image of a speculator. But believe me, all consistently successful speculators start with a plan. It doesn’t have to be anything too involved — just make sure you’re clear on your objectives, and set some guidelines for yourself. Figure out your entry and exit strategy for each play, starting with how much to invest, how many open positions you plan to have, how you will monitor positions, what kind of stop-losses you will use to preserve capital, etc.

A sound money management strategy is the most important factor in successful speculation and it allows you to stay in the game.

2. Know your broker and monitor your investment.

When choosing a broker make sure to ask as many questions as necessary and that you get the appropriate answers before simply giving over your money. If you are a beginner, find out about the broker’s history and references, and speak to them frequently to establish a relationship. Make sure that either you or your broker will be constantly monitoring your investment — today’s markets are very volatile and with options the price can shoot up 30% or more in just a few hours… so it is necessary that your broker is able to see the option is performing and be able to execute an order in a timely manner, to ensure that your capital is protected.

With so many discount Internet brokers out there, it seems like more and more people aren’t doing their homework before opening an account. It’s OK to try and go it alone… unless you don’t know what you’re doing. In that case, it’s well worth the time and money to explore more experienced flesh-and-blood brokers.

And if you want a hand in selecting a broker, make sure you check out the Penny Sleuth’s Discount Broker Guide…

3. Stick with your exit strategy if a trade goes against you.

With a good money-management plan, there should never be any surprises. No matter what price your trade is at, the action you need to take should be clear.

That doesn’t mean you have to be inflexible, however. Just because an option has met your profit target, you don’t have to automatically sell. But there has to be a compelling reason to stick with the trade — something more than a feeling that the trade will continue climbing above your target price. (After all, you selected that target price for a reason.) And always use a stop-loss or a trailing stop order to make sure you’re ready for any reversal that might pop up.

For a losing trade, however, you need to be a little more harsh. Options are wasting instruments, and their value dies a little each day. Sometimes it’s better to stick to your strategy and settle for a loss than it is to wait it out and hope for a miracle. That’s money you could be plugging into another play.

4. Always, always, always, ask questions.

The Internet age is creating a generation of independent investors. But some are still too proud to admit that there are things they don’t know. In the speculation game, what you don’t know can hurt you.

If you’ve taken my advice about finding a good broker, you’ve already got a ready source of info to turn to. Dozens of Web sites also offer complete details on options trading. So there’s just no excuse for ignorance any more… and losing money because of ignorance makes even less sense.

5. Learn from your mistakes.

Find out what works for you. There will be losers along the way — but just make sure you know what you did wrong in previous trades (e.g. you set a stop loss of 15% and were stopped out too early and the option rebounded to 56% profits). Take every trade as a lesson and use it to improve as you continue trading.

6. Remember that knowledge is power.

You can never know too much… strive to learn as much as you can about options and their inner workings, strategies, fundamentals, everything… so that you will be better equipped to profit with options trading.

As I’ve said in the past, options trading is more accessible than ever before. And the profit potential hasn’t diminished a single cent. Going out of your way to learn the myriad of ways they can boost your bottom line is the easiest way to discover what works for you.

These are the six strategies that drove my father to success… and they’ve led to fantastic wins for my Options Hotline readers over the years. Now, hopefully they’ll help spur your success, too.

Sincerely,
Steve Sarnoff

October 14, 2009

Maximize Your Options Gains with These Six Trading Secrets was originally featured in the Penny Sleuth.

That kind of talk is just plain dangerous.

Despite my success with options, I would never be vain enough to call my work “investment advice.” When you’re dealing with options, you shouldn’t use the word “investment” at all. It’s speculating. And if you don’t understand the difference, you’re setting yourself up for a massive failure.

You “invest” in things like stocks, bonds, mutual funds, even real estate. You focus on the long-term. Successful investing is like planting acorns and watching them turn into oak trees.

Speculating, on the other hand, is like playing with fireworks on a rainy winter’s evening. You light the fuse, and seconds later, it’s either fizzled out or a huge colorful explosion high up in the sky has illuminated the whole world.

It may sound like gambling. And for people who don’t know what they’re doing, it usually is. But smart traders know how to bend the odds in their favor. Doing that means having a healthy respect for a speculator’s best friend — and worst enemy — leverage.

Leverage is the magic that turns small price movements into large profits…or losses. It is found in many different guises, but the fundamental design is always the same. The leveraged speculator uses OPM (Other People’s Money) in an attempt to make more money than would otherwise be possible with nothing but his own funds. In other words, you augment your position with borrowed money.

It sounds dangerous…and if not managed prudently, it can be bad for your wealth. BUT, if leverage can be applied to situations with strictly limited risk, it takes on a more sensible aspect. It becomes…superleverage.

Superleverage is the art of profiting from changing prices, with limited risk. No margin calls, no demands for additional funds, no forced liquidations.

The instruments of superleverage are exchange-traded stock options.

Options are tradable contracts that give you the right to buy or sell a specific underlying instrument at a specific price within a set time period. Their value closely follows the ups and downs of the stock they cover… yet they usually sell for a fraction of the stock’s price.

That means a small move in the stock’s price can become a huge move in the option’s price.

On the downside, options are wasting assets. They have strict expiration dates. And if the underlying security doesn’t move enough to give you real value, your options will expire worthless. That is your risk.

It was once calculated that 90% of all options expire worthless. That doesn’t mean you have a 90% chance of losing money…a winning options trader will offset one or two spectacular winners against eight or nine losers…and still have money left over. The trick to always coming out ahead is to develop a strategy and stick to it.

My dad, legendary options trader Paul Sarnoff, explained it best: “Every trader with imagination and talent goes into a specific commodity armed with a trading plan.” With his help, I developed a system I call my Complete Game Plan for Trading Success. Followed correctly, it can be a powerful tool to make sure you don’t get in over your head.

It starts with some simple calculations Just ask yourself the following questions before you risk a single cent:

1. How much am I willing to pay for the option? As I said, you can lose 100% of the money you put into an option. So never bet more money than you can afford to lose. Once you’ve set your limit, stick to it. Don’t chase an option that’s more expensive than you want to pay. Either wait for the price to drop, or look for another one to buy.

2. What will I do if I’m right? Have a profit target in mind for each option you buy, and an idea of how long the move will take. Be realistic — what you honestly think will happen, not what you hope will happen. (If you can’t do that, don’t buy the option.) Again, stick to your plan — give the option some time to reach your goal. If you meet your goal, sell right away.

3. When will I get out if I’m wrong? This one’s tough. No one wants to admit they’re wrong. And everyone hopes they’ll eventually be proven right. But that’s where another benefit of options trading comes in — with options, you have always known and strictly limited risk. Or, said a different way, you never stand to lose more than you put up. If you invest in stocks, you may have to worry about where to set stop losses so that you don’t lose your fortune. But with options, your stop loss is already built in. They’re the only sensible way to speculate.

You should always speculate based on what you can lose, not what you can gain. Be prepared to handle trading losses. Never add to a losing position. That is how many players get knocked out of the game. You want to be in there when the market goes your way. You, or your broker, must monitor your positions closely. They don’t ring a bell when it’s time to get out, so make sure you have an exit strategy in place for each trade.

It may sound like a lot of work — but believe me, it’s worth it. I’ve seen options skyrocket 210% in three weeks…472% in less than a month…even 260% in eight days…

Of course, I’ve also seen a good number of trades go nowhere. But following the Complete Game Plan for Trading Success, the odds are good you’ll still come out ahead.

Just never make the mistake of thinking that you’re “investing.”

Sincerely,
Steve Sarnoff

October 13, 2009

The Three Questions You MUST Ask Before Trading Options was originally featured in the Penny Sleuth.

– John Kenneth Galbraith

The year of the American Contagion, the year of chickens coming home to roost, the year of the bailout, 2008, went into history as a momentous time of tumultuous market moves in: stocks, commodities, currencies, and interest rates.  The year witnessed the onset of a worldwide economic panic with an assault on the global economic system and our form of democracy.  The forces of deflation and inflation continue to slug it out in a titanic struggle for dominance.  We’ve managed to navigate the stormy seas with a steady hand on the tiller.  One of the keys to our success is keeping a sense of perspective.  As my Options Hotline is in its twentieth year of advocating sensible speculation, I’d like to share some seemingly impracticable musings you may find useful.

In 2008, volatility skyrocketed beyond belief.  Most market participants, even professionals, were caught by surprise.  Big money was made and lost, both up and down, with astonishing speed.  It’s long been known speculators make their fortunes from changing prices and leverage is an important tool for speculators.  Leverage involves using OPM (Other People’s Money) to try to make more money than you can with your own funds.  Using OPM may augment your reward when you are right; but it may also greatly accelerate the risk of additional loss when you are wrong.  That’s the aspect of leverage that so many forgot during the heady times of money trees growing to the sky.

Even some of the market’s smartest participants are done in by blind arrogance.  The famous story of the 1990s rise and fall of hedge fund giant Long-term Capital Management, excellently chronicled in Roger Lowenstein’s When Genius Failed, comes to mind.  That cautionary tale is particularly apropos to today’s financial crisis.  Successful trades blinded the firm’s brilliant partners to the possibility of failure, ultimately sealed their fateful demise, and threatened the stability of the entire financial system.

In this business, I believe you are better served by checking your ego at the door.  Having a complete game plan includes preparing for the worst in every trade.  Remember to always speculate based on what you can lose, not what you can gain.   Applying sound money management principles (such as never adding to a losing trade) and utilizing the tools of Superleverage (buying exchange traded options) allow you to stay in the game and avoid being knocked out through inevitable times of losing trades.   If you have anticipated the possibility of loss, and are prepared to withstand it, no matter the severity, because you positioned with always known and completely limited risk vehicles; never be surprised when the market moves against you.

Over the years, I’ve compiled an impressive record of forecasting the twists and turns of market price.   The publisher is happy to provide you with every trade I’ve ever recommended, since taking the helm in October of 1999.  People invariably ask me what I think the market is going to do.  I always say that if I knew what the market was going to do, I wouldn’t have to work.  Use technical levels of support and resistance to set your exit strategy for each trade.  Make sure that you, or your broker, monitor your positions closely.  The market doesn’t ring a bell when it’s time to get out.  Have your plan in place ahead of time and you can smile, laugh, take your profit a step ahead of the crowd, and enjoy your accomplishment with a sense of wonder.  No matter your success, always be surprised when the market goes your way.

So, like me, never be surprised and always be surprised.  Don’t forget that forecasters, even those with good reasoning and strong opinions, are practitioners of uncertainty.  That view will serve you well.  I hope you found the abovementioned thoughts helpful and wish you all good fortune as you vie for fun and profit for the rest of 2009.

Sincerely,
Steve Sarnoff

March 13, 2009

Profiting from Superleverage was originally featured in the Penny Sleuth.

I laugh when I think back about those times because my dad — he really loved Options Hotline, and he would say to me, “Sonny, they’re the only one’s that have super leverage and it’s the only sensible way to speculate.” And I would say things to him like, “Dad, how could you do this?”

Options Hotline was the least favorite to me of all the work he did. I said, “How can you possibly recommend that people buy a wasting asset?” And he would say to me, and I say this to my own children now — I have a 17-year-old son and a 13-year-old daughter — and I find myself saying this to them. He looked at me and he’d say, “Parents are the bones upon which children sharpen their teeth.”

Now I’ve been editor of the Options Hotline. I’m in my ninth year, and I’ve come to feel so passionately that using super leverage is the only sensible way to speculate that I find myself here speaking to you about it. So it’s funny the way that life works that way.

First let’s get something clear. What I’m talking about is speculation. Investment has to do with time. You invest over time. Speculators profit from changing prices in a short period of time, and what I’m concerned with is pure speculation. Even though I’m a mild mannered vegetarian living in Southern California, and there’s not much New Yorker left in me, out of all of Agora’s services mine is the highest risk and highest return. It’s the most aggressive of all their services and that’s because it uses super leverage.

Now leverage is an important tool for speculators. It involves using other people’s money to try to make more money than you can with your own funds. Using OPM, or “other people’s money,” may augment the rewards when you’re right, but it also greatly accelerates your risk of loss when you’re wrong as they find out in the futures markets and the mortgage markets. But, if leverage can be applied with an always known and strictly limited risk, it begins to take on a more sensible aspect. It becomes super leverage. I define super leverage as the art of profiting from changing prices with a limited risk at all times without ever getting a margin call, without ever being asked to put up additional funds, without ever being forced to liquidate a position.

The instruments of super leverage are exchange traded put and call options. They’ve been trading in Chicago for over 30 years now. The buyers of puts and calls are the only ones who possess the full profit power of super leverage — only the buyers. The advantages are you don’t have to be a financial wizard or have large sums of money to buy an option.

Now people ask me, “Why don’t you recommend more complicated options strategies?” And my answer is that sometimes the simplest strategies are the best.  When you start doing spreads and mixing buying and selling options at the same time, you can still have a limited risk but you’re also limiting your reward.

Only the call buyer or the put buyer has a strictly limited risk at all times with an unlimited reward. And the risk is always known to you, and it’s always limited to the cost of taking your position or making your bet. Now some people try to say it’s a low risk. That’s incorrect. When you’re an option buyer it’s very high risk. You’re risking 100 percent, but you’re not risking any more than that and you have the opportunity to multiply your money.

I’ve been editor of Options Hotline for 105 months, and I make one recommendation a week for about 40 weeks out of the year, and in that time I’ve had 120 of my recommendations that people have been able to purchase multiply — go over 100 percent.  So that’s the power that you consistently have the opportunity to multiply your money with a limited risk, and that’s why we call it super leverage.

Now you want to be a successful trader and a successful speculator. I look at four characteristics of successful traders. Number one is knowledge. So many people participate in the markets without knowledge, and they’re at a disadvantage to the ones who do have knowledge. So learn as much as you can about whatever it is you’re going to use and however you’re going to trade or speculate. If you have knowledge you have an advantage.

Another is courage. It takes courage to take risk, and it takes courage to go against the crowd. To say the financials, I think, are going up when they’re falling sharply and everyone is betting against them it takes courage to follow your plan and say, “No, they’re reaching an area of support. Now’s a good time to buy and actually take the positions.”

It also takes discipline, discipline to stay with your plan. Have your plan thought out ahead of time and stick with it to push in motion to the side, not let greed or fear influence your trading and just go with what the numbers say. And lastly, the final characteristic of a successful trader is hard work. There’s no easy money in markets. No one rings a bell and says now’s the time to get out. So you have to work hard and you have to monitor your positions and be ready and have a plan ahead of time. If you have all of that, you can be a successful trader.

I also look at what goes into that plan, and to me there are three cornerstones of a complete game plan for trading success. One is psychology and that involves asking yourself questions. Is this right for you? Can I handle speculating? Will it disrupt my life? Is it worth it? Can I do this? Is this something I can really do? You have to ask yourself these questions.

Second is method. You have to know what to speculate on. You have to have a method to buy or sell, to know what to buy or sell and where, and that’s where a service like my Options Hotline comes in or some of the others. They’re the method. So if you have the psychology and you have a method of finding trades then you come to money management.

Now successful speculation is as much about honing your survival skills as it is about finding winning trades. Money management is very important. I’ve had subscribers tell me, “Steve, your recommendation that multiplied, I decided not to do that one. The one that expired worthless, I kept adding to that position.” So you don’t want to be like that.

Now let’s talk about psychology. I’ve broken it down into what I call the twin tolerances for risk, the financial tolerance and the psychological tolerance. The financial tolerance for risk is easy to figure out. You should only speculate with money that you can afford to lose, money that if you lost every penny of it, it wouldn’t change your life.

If you can do that then you have to look inward and see if you have the psychological tolerance for risk. Will trading the market keep you up at night? Will you worry? Will it disrupt your family life? All these kinds of questions are important. Now personally, I have absolutely zero psychological tolerance for risk. If I did, I wouldn’t write a newsletter. I would just trade. I figure if you’re so good at it why would you not just do it and have to sell your information? But since I don’t do it I’m happy to have other people use my information…”

Sincerely,
Steve Sarnoff
Editor, Options Hotline
September 8, 2008

Investing in Options Speculation was originally featured in the Penny Sleuth.

So in light of this uncertainty, I’ll share my father’s strategies for both profit and preservation of risk capital in the face of future wild stock-price swings.

Paul Sarnoff’s Option Trading Rules

1. Never go short any stock. If you think the stock will drop, buy puts. That way, you will limit your losses if you are wrong and you will make a bundle if you are right.

2. Never go long any stock. If you expect the stock to rise, buy calls instead. If it rises, you make a greater percentage profit with the successful call than if you had bought the stock.

3. Never buy any put or call “at market.” I try to select the put or call of the week, which in my opinion and expectation, represents the best value and best promise for profit — if my expectations become reality. When you buy “at market,” you are at the mercy of often not so merciful sellers. You get the seller’s price, not your price. Although your order may not always get filled, you always know your risk with limit orders. Those who buy “at market” sometimes make good profits and sometimes they suffer greater losses. Don’t chase options. Be patient and buy at or lower than my recommended price.

4. Never position long shares of stock without simultaneously buying “protective puts.”

5. Never sell short any shares of stock without simultaneously buying “protective calls.”

6. My final rule for you to ponder is for you to consider any options you buy the way you would for your children. Options, like children, have to be watched. Make sure that you, or your broker, watch over the options you buy. They are very volatile — and many brokers may not care to ride herd on what your options are doing, as they proceed either to success or extinction.

You have to handle your options in the manner suggested by a man my father considered America’s greatest 19th-century poet. No, he wasn’t Walt Whitman. In the last stanza of The Game of Life, the poet recommends:

In battle or business, whatever the game,
In law or in love, it is ever the same;
In the struggle for power, or the scramble for pelf,
Let this be your motto — Rely on yourself!

— J.G. Saxe, 1869

Sincerely,

Steve Sarnoff
Editor, Options Hotline
July 8, 2008

Six Useful Tips When Investing in Options was originally featured in the Penny Sleuth.

That kind of talk is just plain dangerous.

Don’t get me wrong — I love the fact that more people are discovering the profit potential of options. I’ve been analyzing them for a long time. And since 1999, I’ve been recommending specific option plays for the subscribers of my Options Hotline service.

But despite our success at Options Hotline, I would never be naïve enough to call my work “investment advice.” When you’re dealing with options, you shouldn’t use the word “investment” at all. It’s speculating. And if you don’t understand the difference, you’re setting yourself up for a massive failure.

You “invest” in things like stocks, bonds, mutual funds, and even real estate. You focus on the long-term. Successful investing is like planting acorns and watching them turn into oak trees.

Speculating, on the other hand, is like playing with fireworks on a rainy winter’s evening. You light the fuse, and seconds later, it has either fizzled out or a huge colorful explosion high up in the sky has illuminated the whole world.

Options trading may sound like gambling. And for people who don’t know what they’re doing, it usually is. But seasoned traders know how to bend the odds in their favor. Doing that means having a healthy respect for a speculator’s best friend — and worst enemy — leverage.

Leverage is the magic that turns small price movements into large profits…or losses. It is found in many different guises, but the fundamental design is always the same. The leveraged speculator uses OPM (Other People’s Money) in an attempt to make more money than would otherwise be possible with nothing but his own funds. In other words, you augment your position with borrowed money.

It sounds dangerous…and if not managed prudently, it can be bad for your wealth. BUT, if leverage can be applied to situations with strictly limited risk, it takes on a more sensible aspect. It becomes…”super-leverage.”

Super-leverage is the art of profiting from changing prices, with limited risk. No margin calls, no demands for additional funds, no forced liquidations.

The instruments of super-leverage are exchange-traded stock options.

Options are tradable contracts that give you the right to buy or sell a specific underlying instrument at a specific price within a specific time period. For example, a May $100 Apple Computer call option gives the option-buyer the right to buy one share of Apple Computer for $100, anytime between now and option expiration on May 18, 2007. Today, with the price of one Apple share at $100.80, the June $100 call option costs $2.60. So for under $3.00, an option-buyer can participate in the upside of a $100 stock…but only until May 18.

That means a small move in Apple’s stock price can create a huge move in the price of the call option. In fact, that’s exactly what has happened over the last few trading days. Since April 19, Apple stock has jumped more than $10 a share, for a gain of nearly 12%. But over the same timeframe, the May $100 call option has gone from 75 cents to $2.60 — a gain of nearly 250%. That’s leverage!

But on the downside, options are wasting assets. They have strict expiration dates. If, for example, Apple Computer shares close below $180 on May 18, the May $180 call options would expire worthless. That is your risk.

It was once calculated that 90% of all options expire worthless. But that doesn’t mean you have a 90% chance of losing money. A successful options trader will offset eight or nine losers with one or two spectacular winners…and still have money left over. The trick to always coming out ahead is to develop a strategy and stick to it.

My dad, legendary options trader Paul Sarnoff, explained it best: “Every trader with imagination and talent goes into a specific commodity armed with a trading plan.” With his help, I developed a system I call my “Complete Game Plan for Trading Success.” Followed correctly, it can be a powerful tool to make sure you don’t get in over your head.

It starts with some simple calculations. Just ask yourself the following questions before you risk a single cent:

1. How much am I willing to pay for the option? As I said, you can lose 100% of the money you put into an option. So never bet more money than you can afford to lose. Once you’ve set your limit, stick to it. Don’t chase an option that’s more expensive than you want to pay. Either wait for the price to drop, or look for another one to buy.

2. What will I do if I’m right? Have a profit target in mind for each option you buy, and an idea of how long the move will take. Be realistic — what you honestly think will happen, not what you hope will happen. (If you can’t do that, don’t buy the option.) Again, stick to your plan — give the option some time to reach your goal. If you meet your goal, either sell right away or watch the option carefully and sell before it falls.

3. When will I get out if I’m wrong? This one’s tough. No one wants to admit they’re wrong. And everyone hopes they’ll eventually be proven right. That kind of thinking might fly in the face of stock investing — but when speculating with options, you’re up against the clock. The best thing to do is set strict stop-loss strategies — i.e., orders to sell if the option falls to a certain price. Getting out of a bad position before it’s too late is one of the world’s most overlooked wealth-protection strategies.

You should always speculate based on what you can lose, not what you can gain. Be prepared to handle trading losses. Never add to a losing position. That is how many players get knocked out of the game. You want to be in there when the market goes your way. You, or your broker, must monitor your positions closely. They don’t ring a bell when it’s time to get out, so make sure you have an exit strategy in place for each trade.

It may sound like a lot of work — but believe me, it’s worth it. I’ve seen options skyrocket 210% in three weeks… 472% in less than a month… even 260% in eight days…

Of course, I’ve also seen a good number of trades go nowhere. But following the Complete Game Plan for Trading Success, the odds are good you’ll still come out ahead.

Just never make the mistake of thinking that you’re “investing.”

Sincerely,
Steve Sarnoff
October 18, 2007

P.S.: If you are interested in the unlimited potential of these kinds of “speculations,” then you are in luck. My publisher has given me the chance to give away six free months of my options service, Options Hotline. So be my guest, check out this free report explaining it all to see how you too can pull in profits of 165%, 220% and even 300%, just like my current readers have

Investing with Options Plays was originally featured in the Penny Sleuth.