It has often been said on Wall Street that as go the financials, so goes the rest of the market.
And when the news of Wachovia’s (WB) CEO Ken Thompson entering forced retirement, plus lowered debt ratings by Standard & Poor’s of three financial firms — Lehman Bros. (LEH), Merrill Lynch (MER) and Morgan Stanley (MS) — the experts who’ve been calling for a bottom in that sector felt that very same bottom fall out from under them.
Let’s face it, when you hear that the CEO of one of the nation’s top banks — one that has endured significant losses — is being ushered to the door, you can probably “bank” on it that there are more dark days ahead for Wachovia.
Although his ouster was accompanied by a considerably less-impressive exit package in comparison to other exiting executives at Merrill, Bear Stearns (BSC) or Citigroup (C), no doubt the payout isn’t exactly going to help WB’s bottom line — not to mention the next leg of loan write-downs that are likely in store.
Call it a retirement, resignation or simply parting ways — in any case, it serves as a reminder that the head honcho of any publicly traded company is getting paid big bucks to, well, make big bucks for his or her respective empire … to not only make it competitive, but to beat the competition at their own game.
In the case of many financial companies, a series of bad deals, bad timing and maybe even simply bad luck has led not only to the ouster of top executives, but also a loss of faith among its investors — which is evident in charts that are reminiscent of Mr. Toad’s Wild Ride.
It’s no secret that executive shake-ups are meant to show the investing public that the company in question is trying to save face and show that it’s committed to digging itself out of the hole in which it has found itself.
But at the point where hundreds of billions of dollars in loan write-downs are looking like a first step to recovery, it’s probably safe to say that a sea change in leadership is probably not enough to turn the tide anytime soon — not for this particular sector, anyway.
So, how do you play names that are on the move when a bad headline can drive them down several points on a day like today and catapult them up on a better day, particularly when option premiums can shoot through the stratosphere on a volatile day?
I’m glad you asked. …
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MARCH TO YOUR OWN DRUMMER IN THE MARKET PARADE
The market is a moving parade. What appears before you one moment, soon moves on. In just seconds, the spectacle in front of you shifts and you have a new view of the living, breathing market.
What does this moving parade mean to a stock investor? For example, at one moment JPMorgan Chase (JPM) might be priced at $42.15 and, in the next, at $41.73 — barely a 1% move.
What does that same price move mean to us options traders?
A small 42-cent move in an underlying stock could easily be a 10% to 30% surge in an option. This mere 1% stock move a can mean huge, almost instantaneous profits. That’s leverage and that’s what the moving parade means to us.
It’s also precisely why I love trading options.
SAY NO TO NEWSPEAK
However, those moves in the underlying stock aren’t the only reasons that options prices can jump. You see, some options traders create problems for themselves.
Yes, I said “problem.”
Recently I was exchanging the cable video box for one of my televisions since I had a “problem” with it. The customer service rep refused to use the word “problem” — referring to it instead as a “challenge.”
Finally I stopped her and said it was a PROBLEM. She glared back, saying “It’s only a problem if you call it a ‘problem.’ It’s a challenge.”
Well, I’m just old enough to know the difference between a “problem” and a “challenge,” and Houston we have a problem. I will not fall into the silly trap of customer service “Newspeak,” the language of George Orwell’s “1984” in which the vernacular becomes so simplistic that all words essentially mean the same thing.
Well, a problem is a problem is a problem.
AVOID ‘AMATEUR HOUR’ AT ALL COSTS
I’ve been playing the options game for more than 35 years, and I’ve come to learn why the first hour of trading on Monday mornings is called “amateur hour” by many brokers.
Like clowns piling into a tiny car, when the opening bell rings on Monday mornings, many traders jumped right into their new positions and end up paying too much. That’s a problem.
There are hundreds of thousands of traded options, and finding the few that offer a stellar risk-versus-reward picture is no walk in the park.
So how do we solve this problem?
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I am adamant about adhering to a certain price range when initiating any new trade, because any amount by which someone overpays cuts into their profit potential.
But when you’re trying to get into a new trade, you don’t always know how much is too much to pay. One thing you can do is watch how trading shakes out during “amateur hour.” Once the novices have placed their trades and the “big boys” jump in and start their own trading day, you can get a better feel for where the options you’re eyeing “should” be trading.
Although historical price data isn’t readily available for options, you can check out any free financial Web site before the trading day begins to see the prior day’s action. Although option prices “can” increase incrementally, like stock prices, the moves are oftentimes more-dramatic as a small move in the underlying stock can translate into a sudden, huge move in the options.
‘MAKING IT’ IN THE MARKETS
As I said, the market is a moving parade. Market-makers set the opening price for stocks and options every trading day, and that’s why a security closes at one level and can open the next day at a different level.
A variety of factors contribute to this — news over the weekend (i.e., a CEO being told “sayonara” by his or her board of directors) can make stocks and, in turn, their options execute a surprise move on the open. For example, Wachovia’s (WB) shares opened almost a dollar lower after the pre-market buzz surrounding Mr. Thompson’s departure.
In that case, it is what it is — the option price will move out of our range because of the surprise opening gap. But that’s neither the only problem nor the most-common one.
I know from experience that inexperienced options traders — in their honest enthusiasm — will bid with a market order and NOT use a limit order. I outline specific trading parameters in my Fast Options Profits trading service for this reason. Over-enthusiasm and eagerness to get into a trade, no matter what the cost, spoils the market for everyone by setting a temporarily, artificially higher price.
Since you should never, ever pay more for options than your limit price — that is, the highest price you are willing to pay to enter a trade — suppose you don’t get in right away?
Don’t worry. Try again in a few hours — remember, the parade moves on. Then try again the next day. Suppose you don’t get in within a day or two? Bid at the limit on the third day. It’s not necessarily always worth it to bump up your limit price — at least, not by more than a nickel or a dime, at most — because nothing hurts more than paying way more than you intended and the trade doesn’t work in your favor.
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A SECOND SOLUTION
But, if patience isn’t your forte, there is one easy technique that you can follow to get better trade executions or better options prices. When you are determined to buy (as you should be), test the waters first.
For example, let’s say you want to buy an option that I’ve recommended at $1.30 or under. To buy that option right now, you will need to pay $1.30, the ask price.
But take a minute or two to test the water. Enter a limit price of $1.15 and see whether the market-maker will bite. You will be surprised how many times you will get your price (i.e., $1.15) instead of the asked price of $1.30.
If your order at $1.15 is not filled after a few minutes, you can modify your order and pay the asked price by entering a higher limit order or at the asked price.
Don’t get caught at amateur hour. Try these simple solutions the next time you buy options and see how big a difference 15 cents can make. Not only will you avoid “newspeak” but your returns will also be better than “doubleplusgood” — in fact, they’ll be downright amazing!
Don’t let great trades get away. Check out Ken Trester’s “Generate Substantial Returns with Smart Bets” and “Options Prices Can ‘Jump’ in the Night.”
