As I discuss quite frequently on Seeking Alpha and in my options investing newsletter, investors often give options a bad name. There's no question that lots of people get burnt using options, but don't blame the call or the put. Instead, take a look in the mirror and, while you're at, implicate the typical and traditional sources of options information and education.
In my experience, you're no more likely to get hurt with options than you are stocks, provided you use them properly. But what does "properly" mean?
First, before you even make a simulated trade, learn the basics. And the basics are not the Greeks or something that resembles pre-calculus. Don't be fooled by cats who, on an ego trip, like to show you what they know by making options more complicated than they need to be.
Once you get some basic tenets under your belt, start to sim trade. At the same time, dig into some higher-level concepts such as Delta, Theta and implied volatility. Learn about intrinsic and extrinsic value. From there, with a good handle on the basics and a developing comprehension of more intermediate-level stuff, work a couple basic strategies into your portfolio.
Start with a simple, non-threatening covered call. Take a stock you own a considerable amount of. Name a price you would not mind selling a few hundred shares at and sell an OTM call against the position. Sit back, watch and learn as the situation unfolds. Being short a covered call can teach you quite a bit about how options work, particularly the concept of time decay.
After you have a few covered calls under your belt, turn to ITM calls and puts to follow your bullish or bearish conviction. I opt to go ITM for the same reason I have been drilling home in recent Seeking Alpha articles:
If the trade turns on you, you have both time and ... intrinsic value on your side. If you go OTM and near-dated, which lots of bears [and bulls] make the mistake of doing (myself included), the trade has less time, if any, to recover and there's even less value in your OTM put [or call] because it has such low odds of expiring ITM. You'll likely have a worthless put [or call] option on your hands, whereas one that's ITM at least hangs on to that intrinsic value heading into expiration.
It's really as simple as that. No need exists to make it more complicated. Look at an April $5 call and a January 2014 $5 call. Which one costs more? The January 2014 call. Why? Because you effectively pay for better odds. More time stands between now and expiration, therefore that January 2014 option has a better chance of expiring ITM than the April one.
Compare a January 2014 $10 call and a January 2014 $20 call. Which ones costs more? The $10 call. Why? Because the $10 call has a better chance of expiring ITM than the $20 call. If a stock turns against you, you tend to be better off ITM, particularly the closer you are to expiration.
Let me be clear. I never intend to exercise an option. That's not where I focus this discussion. Rather, I want the premium to increase in value so I can sell it for a profit prior to expiration. Just like a stock, except stocks do not have expiration dates. The odds of a contract expiring ITM apply whether you plan to exercise or not. The Surgeon General and the SEC set no rules that say you must exercise with regards to options (unless you hold an ITM contract at expiration, which your broker will automatically exercise unless you instruct it otherwise).
On to the selections and how to play them. I'll include a bit of the "why" in this article, but save a deeper analysis for future articles.
The most speculative stock of the bunch might be Nokia (NOK). We all know that Nokia, even in tandem with Microsoft (MSFT) cannot beat Apple (AAPL). It will never happen. That said, Nokia's new ad campaign that chides iPhone reception problems is just fantastic.
Finally, somebody comes along with a clever way to go after Apple, knowing full well they cannot beat them. It reminds me a bit of my days in radio when the business was still competitive and alive. I worked at a few stations that were basically second rate. You know the number two sports and talk station in the market. We knew we could not beat the long-standing number one, but we went after them, made some waves, picked up a few sympathizers and got free publicity. That's what Nokia designed those spots to do ahead of the launch of its Lumia smartphone. And it's a bold, thoughtful and impressive move.
But that's not the main reason why I will buy the stock. The low-end consumer, particularly in international and emerging markets is huge. The landscape there will shift over the next several months and years. If you think for a second that Research in Motion (RIMM) will own that market, you're incorrect. Looking at what comes from their marketing department tells you much of what you need to know. RIM simply does not get it. While this tale does not directly relate to the low-end market, it should serve as a cautionary tale that informs just how out of the loop RIM is.
Consider the very slick, well-produced television commercial RIM runs in the United States and Canada. Great spot, but there's a major problem with it. As you watch that commercial, what's the first thing that pops into your head? They should be using iPhones! The too-cool poser-hipster crowd does not ride fixed gears into downtown yacking on Blackberries. Sorry.
Unlike RIM, Nokia takes the proper approach in a battle it knows it cannot win. The company will garner some attention in the U.S. and elsewhere with its campaign and go on to take a considerable chunk of the growing low-end market, a segment it has traditionally seen success in.
Consider playing it via options, using the NOK January 2014 $3, $4, or $5 calls. For a fraction of the cost of buying the stock, you can speculate on upside in NOK. It might sound odd to you, but you can put up less capital to make a speculation on a low-priced stock using options than you would buying the stock. And time decay does not become a meaningful issue for another 15-16 months or so.
Burger King made lots of people laugh last night when it announced it would go public yet again. I see this as a nod to Wendy's and the solid turnaround it appears to be putting together. In a nutshell, private money cashes out a bit of its stake and goes to market for much-needed funds to try to jump start an abysmal brand.
You can go out to January 2013 with WEN options. The $2.50 and $5.00 calls both could make some sense. Personally, I own the stock and will continue to accumulate it. I am not so sure, however, that we'll see enough upside this year to make those calls worthwhile, but they could merit a small allocation of funds for investors expecting a quicker move.
Pandora surged on Tuesday, thanks to a positive analyst report that set a $14 price target. While plenty of bears do not believe the hype, Pandora does an excellent job communicating its long-term vision. It seems that whenever CFO Steve Cakebread hits the investor conference circuit, analysts come out with relatively bullish reports. In each one, the analyst appears to "get" what Pandora is putting together, realizing that near-term obstacles could very well make way for sustainable and impressive profits over the long-term.
P just started trading LEAPS options a few weeks ago. Because of this, the January 2014 calls are thinly-traded. Keep your eye on them though. As more money moves in - and it should - I might pick up some more exposure (I am already long the stock) via in- or at-the-money contracts.
Additional disclosure: I am long P and WEN.