May 13, 2004

Using the Real Time Lists™ for other Strategies
By John Brasher, CallWriter Publisher

We get this question a lot: can our members use CallWriter for short sales, writing naked calls and puts and other strategies? Actually, YES! Our Real Time Lists™ are lists of the highest-returning covered call plays, which means that they are showing us the stocks with the highest implied volatility at that time. Traders make money on volatility.

A list by any other name...

So our Real Time Lists™ are good for many different strategies, such as short sales, naked calls and puts, long puts, straddles, strangles and spreads. So here are our thoughts on using CallWriter's Real Time Lists™, based on long experience with them:

Short Sales
To make you money, the stock sold short must decline. We like the Under $15 and the $15 and Over lists for short sales, because these are our most volatile lists, and the stocks appearing on them generally are the most likely to move. This is particularly true of the top 5 stocks on each list. Stocks on these two lists without earnings and showing low call volume and low open interest are promising ones to start with. From a technical standpoint, we look for stocks on these lists that appear to be trending down or pulling back from resistance. Some traders look for channelling stocks that appear to have crested in their channel and started the next decline phase. You can usually find good short candidates on the other lists, too, but these lists consistently have the most of them.

Long Puts
The stock must decline for the long put to win, because as the stock declines, the long put becomes more valuable. Once the long put becomes ITM, it should move dollar-for-dollar with the stock. Since the long put is a debit strategy (meaning that the trade generates a net debit - in other words it costs money to run the trade), you lose money over time unless you can consistently pick stocks that decline before put expiration. Buying puts involves essentially the same analysis as you would apply above under Short Sales and usually involves many of the same trade candidates. However, the long put strategy is different from short sales in a couple of important respects: (1) stocks sold short don't expire, but puts do; and (2) a movement that yields an acceptable profit to a short seller may not be enough for the put buyer, especially if the long put is OTM.

Thus, the put buyer needs a more aggressively declining stock, and the decline should happen quickly. In fact, the classic strategy is to buy the put right before occurrence of the event you expect to cause a decline; and if you don't get the decline, sell the puts. Long puts work best on stocks in a clear downtrend and, generally, in falling markets. For this reason, we likewise would consult the Under $15 and the $15 and Over lists for long put candidates.

Trading Tips: Long option buyers are frequently tempted to buy OTM, sometimes deeply OTM options, because they are so much cheaper. When the stock is $21, the 17.50 call will be cheaper than the 20, and the 15 will be cheaper still. But don't be seduced. The further OTM the option is, the harder the stock has to move (and move on time) to make the option more valuable.

Naked Calls
The naked call wins if the writer is not assigned. This means that the naked call wins if the stock declines or merely holds price. We believe that the only safe way to write naked calls is to write out-of-the-money (OTM) calls in order to leave room for the stock to advance slightly. Our Deep Out of the Money lists show you calls that are at least 10% out of the money. We believe that good naked call candidates are those that appear, based on technical analysis, to be trending down or likely to hold price before expiration. In fact, the above analysis for short sale candidates applies well to naked call writing, except that the naked writer merely needs a stock that isn't going up, whereas the short seller needs a decline.

Trading Tips: Naked calls should not be written when the market or sector is trending up, since a rising tide tends to lift all boats. Remember, the strike of a naked write should be OTM at least 5% - more is better. Stocks wobble, and never forget that you can be called out before expiration.

Naked Puts
The naked put also wins if the put is not assigned. A naked put is a synthetic covered call, and it wins and loses the same as a covered call. That is, if the stock holds price or goes up, the naked put seller wins by keeping the put premium and not having the stock put to him. For this reason, it really is paramount to pick a stock that appears unlikely to go down. This means you want quality stocks with a lower likelihood of declining before expiration, not highly volatile stocks. Thus the naked put writer wants a stable, boring stock, not the fattest premium, since the fattest premiums attach to the stocks with the most implied volatility. The ideal naked put candidate will be in a clear up trend or break out, or will have made a convincing bounce off support. Naked puts should not be written in a declining market or on a declining, since virtually all stocks (or all stocks in the sector) will fall in that event. Our S&P 100 lists generally are the most reliable for naked puts since these are, as a group, the most stable stocks.

But our Real Time Lists™ are lists of covered call trades... so how can they work for naked puts? Easy! A stock with high call premiums also will have high put premiums.

Trading Tips: If you would not write an OTM or ATM call on a stock, it probably is a poor choice for naked puts. As with naked calls, naked puts should be written OTM. For example, if the stock is at $20, don't write the 20 Put. Give it some wiggle room and write the 17.50 Put. Never forget that you can be called out before expiration.

Research Tip: Here is a short cut to finding spreads. Click on the Option Base symbol for the stock on the list, which opens a covered call chain page. Simply switch from the covered call chains to one of the many option chains available, such as call and put chains or put chains alone.

Spreads
The spread is simply the purchase of a put or call, and the sale of another put or call with a different strike price (and possibly a different expiration month). The options both must be calls or puts. A bear spread wins if the stock declines, and the bull spread wins if the stock advances, although both spreads can be constructed to win also if the stock does not move significantly. There is not room in this article to cover spreads, but if you are a spread trader, you can find good trade candidates on the Real Time Lists™ all the time. The reason is that spreads work best where premiums are fat, and our lists show the fattest premium.

Research Tip:  Here is a short cut to finding spreads. Click on the Option Base symbol for the stock on the list, which opens a covered call chain page. Simply switch from the covered call chains to one of the many spread chains available, such as call spreads, put spreads, calendar spreads, diagonal spreads, etc.

Straddles and Strangles
Companies sometimes face potentially wrenching events, such as a critical FDA ruling on a drug or device application. When the news hits, it is a good bet that the stock will move strongly. The problem is that you have no way of knowing if the move will be up or down! If you had good reason to think that a stock will imminently make a significant move, but don't know which direction the move will be, the straddle or strangle is the best play (definitely not covered calls). A straddle is simply the purchase of an ATM call and ATM put on the stock. No matter which way the stock jumps, one leg of the trade will win, and you quickly close out the other leg. A strangle is simply the purchase of an OTM call and OTM put on the stock. The OTM options cost a lot less than the ATM options, but require a larger move in the stock in order to make the same profit. The goal, as with any long option strategy, is to buy the options right before the event.

According to research done by Larry McMillan, the greatest single price movements occur - year in and year out - due to FDE rulings or clinical testing results on bio/pharmaceutical stocks. These work better than earnings plays, splits, lawsuit stocks, etc. Guess what? Our Real Time Lists™ are usually loaded with bio/pharmaceuticals.

Trading Tips: When the event occurs, close the trade. Sometimes the price pop is not nearly as great as expected. You could wait for the price to move, but there are two problems with this: (1) the market makers have a tendency to hold the stock prices up through the next option expiration, and (2) those long options lose a little value every day.

Research Tip: Here is a short cut to finding straddles and strangles. Click on the Option Base symbol for the stock on the list, which opens a covered call chain page. Simply switch from the covered call chains to either the Strangles or Straddles chains.

Thoughts on Analysis
Having made these observations, each potential trade will require analysis. Traders and investors cannot safely run a trade - no matter what strategy is being employed - merely because a stock appears on one of our lists or based merely upon its position on one of our lists. Traders should use whatever analytical process works for them in determining trades.

And you thought we were just a covered call site!

Good luck and good trading!