(Author's note: working title was "Call Options, Then Email Derivatives and Text Leverage")
Common Stock is Probably Best
In order to get an informational edge in the market, you have to stick to the smaller stocks, the ones that can't interest big money. Our time is not well spent trying to know Coca-Cola better than the hundreds of analysts covering it.
But the small stocks usually have no options trading at all, and if they do, they are probably illiquid. So usually the common stock is the way to go.
One question we got is "how liquid do the call options need to be?" Our answer was "hold out for your price, if you get it that is liquid enough."
Which begs the question "what is my price?"
So here is our Holy Trinity Strategy for buying call options.
Holy Trinity Strategy
If you do not have a catalyst looming but you like a stock, the common stock is the much better choice. Options lose value with each passing day, everything else being equal, and you do not want to stay long in that situation.
So the first part of the trinity is:
1) Have a catalyst
But not just any catalyst, one that is in the near term. You do not want to stay long in an asset class that loses value every day, so the rule of thumb here, and the second part of the trinity, is:
2) Sell within a single digit number of days
So this can put you there for the action, and time decay does not bite you too much. You still should probably buy the common stock instead of the call options. But you have permission to buy if you:
3) Pay nothing or next to nothing for options
Sound too good to be true? It usually is, and you should usually buy the common stock.
But when options are approaching expiration, you can sometimes get them very cheaply. And if that coincides with your catalyst, and you are right about that catalyst, there is no bigger upside in the stock market.
We have been lucky, and we know we have been lucky, but we have employed this strategy several times, always with bonanza results.
We noted in the comments section of the Tonix article that we did this with MannKind (NASDAQ:MNKD). We were in the common stock, anxiously anticipating a catalyst, and someone started unloading out-of-the-money call options that were expiring in two weeks. They were looking to sell for 2 cents each, just looking to get anything for something that would likely be completely worthless in 10 days. We (foolishly/brilliantly) bought all of them we could, selling out all of our common stock. Within a week those calls were in the money by 35 cents, and we netted more than 1,000%.
The key was that we were not looking to force our way into the options, we assumed they were a bad deal until a motivated seller gave them to us for next to nothing.
But you can actually do better than next to nothing.
On June 28, 2012 we published an article boldly titled: "Get Long Right Now, Market Is Low Risk And High Reward For 30 Hours." Two days later we published an article titled: "30 Hours Later Up 23.2%."
What did we see? In addition to predicting one of Bank of America's biggest one day gains (thank you), we found FREE LEVERAGE in the form of costless call options, call options that had not expired but literally had a time premium of zero. See the articles for more info. And keep this one in mind too, that is the strategy.
Stick with the Common
What to do? Stick with the common stock, keep an eye on the options to see if the stars align, and pounce if they do.
Disclosure: The author is long TNXP.