Your best friend calls you to tell you about a company that has developed a technology so unique that the profits about to be generated will make all investors filthy rich. He read about it on a blog site that his buddy from the the local Pizza Parlor referred him to. Needless to say these two well-meaning, but over-zealous, soon to become poor investors were about to become victims of stock fraud and more specically THE RIG!
The Rig targets those investors looking to hit that grand slam home run….make lot’s of money in a short period of time. We Blue Collar Investors know that this is just a dream, not a reality in most cases. But I’ll bet that each and every one of you know people who are susceptible to such a temptation. Lottery tickets, slot machines,betting at the track, and penny stocks are all strike it rich dreams that oftentimes end in economic nightmares. I first became aware of the Rig in 1996 when David Faber, investigative reporter for CNBC, reported his findings about a company called Solv-Ex. The company announced that it had developed a technology that would reduce American dependence on Middle East Oil.Ultimately, Solv-Ex went from a market value of $1 billion to ZERO and so many average people were hurt.
Here is an example of how a rig works:
The crooks (hope that word isn’t too strong) choose a location like the Cayman Islands (remember the movie The Firm?) where scrutiny is non-existant and legal documentation not required. There, a series of offshore funds are set up with each particiapting crook contributing millions of dollars. They do have full control of these funds but somehow there names do not appear associated with the company. Usually there is a “front man” playing the role of CEO.
The funds then invest in a shell company in the US that has a dormant publicly traded penny stock. This eliminates the need for detailed filings with the SEC. Next warrants (similiar to options) are sold to the offshore funds which now have the right to purchase millions of shares of this shell company for very little money.
Now the stage is set to pull in our friends who met at the pizza parlor. Stories about a business hard to understand, track, or even locate are sent out to inexperienced reporters in the hopes that one will write a story about this future “gold mine”. Once written, this article is mass produced, posted everywhere and anywhere and is the initiator of even more such stories. Incredibly inexpensive options are also given to friends and family of the crooks as well as to experts who may influence average investors and sometimes even mutual fund managers.
More and more investors are now talking about this company. Time for the crooks to act (timing is everything with rigs). They start selling shares back and forth between their funds causing volume to intensify. This seems to give more credence to this company and motivates investors to take a “bite” on this penny stock. Will their investment of 60 cents per share turn into millions? The answer is YES, but not for them….for the crooks!
As volume increases, more and more investors step up to the plate looking for the grand slam homer. Talk of this company, on the cutting edge, is in full swing in chat rooms. Perhaps an institutional investor can be duped, after all, they are human too. As this occurs, we get nearer and nearer the time when the insiders are ready to exercise their warrants and sell their shares. This is when your best friend and his buddy at the pizza parlor are about to lose everything.The share price drops to zero or close to it. Fortunately, as a Blue Collar Investor, you knew better. We continue to hit those singles and doubles and hope to one day put the crooks out of business.
Last Week’s Economic News:
In July, inflation rose at a much higher rate than analysts expected. This was despite a drop in energy prices.Retail sales fell as consumers were more cautious about their spending habits. On a positive note, the trade deficit narrowed for the second month in a row. For the week, the S&P 500 was up .2% to 1298 for a year-to-date return of -10.4%.
My Readers Pick their Favorite Stocks:
Here is a list of stocks that more than one reader has written to me about over the past few weeks:
I randomly selected WAB as an example to sell an in-the-money strike. Here is how the buy-sell would play out:
1- Buy 100 x WAB @ $57.56
2- Sell the September $55 Call (WAB-IK) @ $4.10
3- Deduct the intrinsic value of $2.56 (57.56 – 55) for a true profit of $154 per contract.
4- This represents a 2.8% 1-month return or 34% annualized (154/5500).
5- In addition, we have a downside protection of 4.4% (256/5756).
If you like this equity,this buy-sell is a great example of a relatively safe (downside protection of 4.4%)
investment, with a nice return (2.8%, 1-month profit).
Thanks to all of you for sending in your great selections.
Thanks so much to all of you who asked to be placed on the Early Notification List. I am currently preparing for a series of seminars I will be giving on behalf of Norwegian Cruise Lines in a few weeks (I am forced to take a cruise! Oh well, such is life). Once preparations are complete, I will be finalizing the dates, times and fee for the webinar. Those who choose to sign up from the Early Notification List will be given a REDUCED fee as well as a FREE GIFT as my way of saying thanks for your support and confidence in my system. To sign up for Early Notification, send your contact information to me @:
Just tag it with the words: early notification list.
Wishing you all the best in investing,
Email Question of interest:
Hi Alan –
I looked through my pretend portfolio last night and analyzed what I should do with the 7 stocks I selected because today is expiration. Most of them look as if the stochastics are not confirming the stock advance so I am going to let those that are above the strike get assigned. I ended up (if everything stays the way it looks right now) with a 3.03% return for 3 weeks! This includes taking a pretty hefty loss on one stock and I also employed your “turning dead money into profits” tactic on another one. I will most likely keep paper trading 1 or 2 more months, but I am really excited to put this into action for real after that.
I had one question for you on ETF’s and how to use the calculator with them. Let’s say I have an ETF that I have purchased and write a call on those shares for one month. At expiration the ETF is trading well below the strike price so the call I sold expires worthless and I keep the proceeds. How do the calculations work in this scenario for the next month? I can’t really roll out because this strike is now out of the money. The calculator does not have a place for rolling out and down either. Do I just go back to the multi sheet and start doing the calculations all over again? If so what do I use for the stock price – current price or my cost basis? I figure you have probably run into this scenario with the recent downturn while selling the Q’s for your mom’s account. Sorry for all the questions also, hopefully I’m not clogging up your email box too much .
Congratulations on your 1-month 3% return. I do have a couple of comments:
1- If stochastics do not confirm, I would not necessarily give up on that security. If I did decide to stay with that stock, I would tend to sell the in-the-money strike and get that downside protection. In other words, consider rolling out in that scenario, especially if all other indicators are positive.
2- I’m impressed with your use of the early contract exit strategy!
3- Rolling out and down will not make you any money. That’s why the calculator only shows rolling out and rolling out and up.
4- If the strike is above the market value of the equity, allow assignment and treat the stock or ETF as a new deal with ther current market value. We can’t change the past, only make our best decisions going foward. THERE IS NO ADVANTAGE OF BUYING BACK THE OPTION IN THIS SCENARIO…why spend the money?
Take a look at CALM.
IBD = A+
Scouter = 8
Chart = “Beautiful”
I sold the Sept $45 call
Alan, A question…
Have you considered adding RSI to the selection criteria. In my mind it makes sense because you could have a “tie” with the MACD and Stochastics. The RSI could be the “tie breaker.” StockCharts has room for a third indicator. Am I over analyzing? What has been your experience?
Hi Alan –
So basically you are saying to treat an ETF exactly the same as company stock when using your system? I guess I was thinking that since an ETF, like the Q’s, is somewhat less of a risk since it is instant diversification that I should hold it even through a downturn. Anyway, thanks again for all your assistance. Looking forward to your webinar.
1- Thanks for CALM- I have added it to my watchlist and will give it consideration for my buy-sells this contract period.
2- I have no problem if you decide to add more technical indicators to your analysis. There was a time when I evaluated up to 6 or 7 different indicators but decided that it was too time-consuming and not essential for success. That’s how I ended up with the four I present in my book and DVDs. I have more of a concern for those who under-analyze and buy stocks only because they were told to. Certainly, that’s NOT the case with you. I do feel that the Stochastics indicator along with the other 3 is more than adequate for tremendous success in your investment decisions.
For my readers who are not familiar with RSI, let me give you the definition along with a re-iteration of that of Stochastics:
RSI- A momentum indicator that measures the magnitude of a stock’s recent gains to the magnitude of its recent losses. The indicator oscillates between 0 and 100. Readings below 30 are considered oversold. Readings above 70 are considered overbought.
Stochastics- A momentum indicator that measures the price of a security relative to the highy/low range. The indicator oscillates between 0 and 100. Readings below 20 are considered oversold. Readings above 80 are considered overbought.
In the event that MACD and Stochastics are not in agreement, I tend to sell in-the-money strikes. Using RSI as a tie-breaker may be another approach.
Thanks for sharing your ideas with us.
The one major difference between a stock and an ETF is that with an ETF you are always going to come back to ownership of that security. It could be right after expiration Friday, half-way through the next contract period or the subsequent contract period. With an individual stock, if it no longer meets our system criteria, we may never own it again or at least until it “earns” its way back onto our watchlist.
Email Question from Chris:
I’ve been ‘studying up’ on covered call writing and I’ve got most of it down except for the logic behind writing calls that are in the money. I’ve been looking at a few sites that list covered calls that are in the money to sell against the stock. But, when writing a covered call that is ITM and that option can be exercised at any time, wouldn’t that result in an automatic loss in the stock position? For example, today PAY was trading at 15.69 (ask) and the 12.50 Sept strike is at 3.60 with 31 days to go. If this option is sold against the stock someone could call the option away from you and this would result in a loss of $3.19 per share for ‘me’. Unless the reasoning here is because the volatility is high inflating the option premium and the $360 gained from the option write is greater than the $319 loss (on 100 shares) resulting in a gain of $41 ($360 – $319) per option sold.
In this case my intention would not be to hold the stock at all but to bank the $41 difference. If the stock drops below 12.50 at any time before or at expiration I keep the entire premium from the call write and keep the stock. My break even would be 15.69 – 3.60 = 12.09 and a loss would start accumulating at 12.08 and lower. I think I have this correct so let me know if I have all my ducks in a row.
Your assessment is generally correct. When we sell ITM strikes, we assume that their will be share assignment unless we initiate an exit strategy ( see Chapter 11 in my book).
The option premium consists of intrinsic value and time value. The time value is your profit. The intrinsic value offsets the loss in the sale of the stock and gives us downside protection. I love selling ITM strikes in a volatile market such as we have now. I also make sure that I only sell options on the greatest performing stocks both fundamentally and technically.
I posted your question because I have received many similiar queries regarding ITM Strikes. Because of this, I have decided to devote a special section of my upcoming webinar series (October 23rd and 25th) to this topic.
Hi Alan –
An extreme example of selling ITM strikes was a trade on POT I noticed back in July. The day before expiration the July 210 was selling for 6.10. POT was trading at 213 so there was over $300 of time value with only one day left! And because there was little time left until expiration the risk of the stock moving the wrong way was much less. Anyway, just wanted to share this with the rest of the group.