A thousand million people have asked me to write about options, so I’m fucking going to okay? I mean I always wanted to but its hard to know how to explain a relatively advanced strategy like options in a way the average reader who is just starting out investing would really understand. But I’ll give it my best shot and if all it does is even show you what is possible, then my job is done.
I won’t use my direct trading as examples, at least until I resume my trading challenge which I originally started this year till I shelved it for something else that I’m still keeping under wraps even though some of you know of it already.
For now, I’m going to use the stock everyone used to love but now loves to hate, the pharmaceutical company, Valeant (as an aside, Valeant tore pretty boy Bill Ackman such a glorious new a-hole, it makes Herbalife look like a fucking pin prick. I’m surprised the smug look on Ackman’s face is still there. But don’t get me wrong, I like the fellow). Alright, back to Valeant.
So since last year when high-flying Valeant ran into accounting issues and their story went sour, the stock has crashed from $197.39 to around $26.85 which is damn near 90%. If you were long the stock, i.e. holding it at $197 expecting it to rise, you, like Pershing Capital and Mr. Ackman, just got fucked. If you were short the stock at that price, then congratulations you’ve just made close to 90% in profits. The mechanics of how you did that are pretty simple: in the long case, say you bought 10 shares at $1973.90 and sold it at 268.50 and in the short case, you did the opposite so what was the loss for scenario A is a gain for scenario B.
This is where I come in with scenario C. Options. Now, some of the historical data is no longer available and I didn’t do the trade so I’m only walking you through what would’ve been the potential trade. As of April 2015, a $110.00 put option i.e. an option giving you the right but not the obligation to sell 100 shares of Valeant at $110.00 in exactly one year was going for about $14.00 each for about $1400 out of pocket. If you had held them today, I’m not sure what they’ll be worth (I’d have to Black-Scholes it and I don’t have that kind of time). Instead, I’d assume you actually executed the option today, being 31st of March, 2016. If you did, you’d sell 100 shares of Valeant for $11,000 today and then buy it back for about $268.50 giving you a return of around $10,731.50 or more than 700% return versus 85% for a direct short, or -85% for a long position.
In simpler terms, you would have turned $1400 to $10,000. Of course there are draw backs. If you were wrong on the direction of the trade, you’d lose $1400. Also, the stock could go nowhere. It’s not everyday you find a stock that is going to zoom close to 100% in any direction. So it does take a lot of digging to hit pay dirt. But people do it.
Options essentially allows you to control a bigger block of shares than you would have originally with the same amount of capital. A call option gives you the right to buy a block of shares at a price when you think the price might increase in the future. A put option allows you to sell at a price (known as the strike price) when you think they’re going to go lower. You can also do things like a straddle which lowers your expected pay out but gives you greater certainty of making a return and protects you from losses. Each option is sold in a block of 100 shares so if I bought six options, I’m controlling 600 shares etc.
I will end with this caveat. Don’t trade options until you’ve studied them long enough to understand them and well enough to know what you’re risking at any point in time. They’re risky enough as it is but the rewards are well worth it.