Hello, tradeologists. Welcome to Module 11. This is explosive strategy number two. We’re going to talk about flipping stocks. This is a pretty neat strategy, that you’re going to find extremely useful in your arsenal, for making money in the markets. This is a business strategy that allows me to buy stocks cheaper than anybody else, by placing my order in now.
If the market doesn’t cooperate, and I don’t get to buy my stocks at the price I want, they pay me for just waiting around, until the stock does get to my price point. It’s a really neat strategy, for a couple of reasons.
Number one is that we get paid, regardless of whether the stock hits our price or not, that we want to buy it at. Number two, if it does hit our price, then we get into a trade similar to what we did in Part 1 of our explosive strategy number one. That is to purchase stock, and include a protective put, which is basically a covered stock strategy.
The covered stock strategy allows you to protect the value of your stock that you purchased, by buying a put on the stock, so that if it does go down… It doesn’t cover 100% of your loss. There is always risk in the market. You’re not going to get a free trade. Nobody gets free trade in the market.
What it does do is help you offset the cost of declining stock, the loss of your investment, by having that insurance on your stock. That allows you, without putting additional money into that trade – to take that insurance money (the put that you sold if the stock does decline) and use that additional funds to buy more stock.
This lets you leverage your purchase, and get additional stock into your portfolio. When it does make that rise, you can have as much as double the number of stock that you purchased in the beginning, in your portfolio.
Eventually, the stock does rise, and you make money. That is a longer-term trade.
Now, these trades here – this is a kind of trade that is pretty simple to implement, but don’t let the simplicity fool you. It is a pretty explosive strategy. You can make good money with it, whether the stock hits your price point or not.
Let’s take a look at an example. I’ll show you exactly what I mean.
CitiGroup is a banking stock that has really hit some tough times. Let’s take a look at a current graph, here. This is a 2-year graph. You can see that the stock topped up right around $53, going back to June of last year. It’s really gotten killed. It’s really dropped dramatically, especially in this period between October and November.
It had a huge drop here. Almost 50% of its value was lost. Another huge amount of value was lost again, from November of last year until now. It looks like another 20-30%. We’ve had a huge drop from its highs.
Right now, it’s sitting right around $19.30. It was as high as $53, going back to June of 07. At this price, you may find that Citi is particularly attractive.
I’m not saying that this is a good strategy to use on CitiBank. Remember, just like on explosive strategy number one in this module, you only want to buy stocks that you are absolutely sure that are going to be winners for you, in the long term. You only want to put this strategy on, for stocks that you want to own.
If you don’t want to own this stock, don’t do this strategy. This is a strategy only if you want to own the stock. If you think CitiGroup has gotten hit too hard here; if you feel investors have been overenthusiastic about selling this stock, and you feel that CitiGroup stock presents to you a long-term competitive advantage in your portfolio, then this is a stock that you might be interested in doing.
I’m not recommending CitiGroup, though. There are a lot of stocks that you could do this with. Let’s take a look of Bank of America. Bank of America is another stock that has gotten hit extremely hard in the financial markets. It’s currently trading at $27.10. Unlike CitiGroup, though, there is no previous low.
CitiGroup had a previous low right in here, which is approximately $17.76. What does that say? It did rally up from there. It went up from $17.76 all the way up to $27, so it did have a slight rally in there. Then it’s fallen back down again.
There’s a strategy that you can use. Let’s say you didn’t want to jump into the stock right at this point. You could do that. On a stock that’s fallen that far, you can see that you have a number of different options. You can purchase the stock, and you can purchase a covered put for it.
Let’s take a look at the $17.50, here. Actually, I would go with the $20 put. Let’s go ahead and buy it, just like we did in Strategy number one. We’ll go with covered stock.
I’m going to bump that up to 1000 shares. If we go ahead and take a look at an analysis of this, you can see that we would have to put up $30,000 in margin. We would have $940 in total risk on the downside for the stock.
If the stock moved up a couple bucks, we’re going to make about $1000. From there, it’s pretty much a free ride.
If we wanted to, we could go even deeper. We could go down to $22.50. That gives us a total risk of only $250 on the trade. However, our breakeven is now a little bit higher. It’s up around $22.
Let’s take a look at that again. If we use the $20 to put on 1000 shares of stock, our total risk is $940, and our breakeven is just under $21. If we go with the more conservative $22.50 put, our risk is only $250 at the most, on the downside. However, our breakeven is close to the $23 level. We’ve raised our breakeven about 2 points.
You can be very conservative, or you can be a little bit more aggressive, by buying the lower strike put. Our margin requirements are still $30,000, for this trade, for 1000 shares.
What if, instead, we did this? Let’s say we thought that the prospect of CitiBank getting to $17.50 is pretty good, but maybe not that great. Let’s say it goes back down below this $18 level, right where this little island bar is here.
This is where you figure it would be a very attractive opportunity, to purchase just below the bottom of that bar. The bottom of this bar is the lowest, $17.76. At $17.50, you feel like it would be a very attractive opportunity.
Like I said, I am not recommending CitiGroup stock. In fact, it’s been beaten up pretty bad. It could fall lower than this. You felt it was an attractive opportunity to own CitiBank, the CitiGroup stock, at $17.50.
In order to do that, you could simply purchase or sell, the $17.50 put. If you bought the $17.50 put, you can always exercise that put at anytime in the future. Buying a put does allow you to sell that stock at any time in the future. You could buy that call at $17.50, and you can buy that stock at $17.50 at any time in the future, up until the expiration of the July options.
If you wanted to, you could simply buy that call. If you bought that call, what’s the total exposure? Your total exposure, if you wanted to buy 1000 shares of stock, so you bought 10 shares of the $17.50 call. That gives you the right, but not the obligation, to purchase the stock at $17.50.
What happens if the stock moves down to $17.50? Well, at $17.50, if you did want to buy the stock at $17.50, and it did move down to $17.50, you would exercise your option. The problem is that you would have a loss. You would have a loss of $2400.
At expiration, if the price of the stock drops to $17.50, how much is that option worth, that you purchased? It’s worth absolutely nothing. It’s worth zero. You would have a total loss of $2500.
I don’t think that’s a particularly effective strategy.