The great loophole that can make you money every day

May 02, 2011 8:58 PM ET5 Comments
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Contributor Since 2011

I worked for many years in management in the health care industry in the UK, in Bermuda, and for the last 20 years in Florida. The day I turned 59 1/2 I just got out of bed and decided I didn't want to work any more and that I would just take my various pensions from different countries, such as they were, roll them all into one big IRA, and just see if I could live by my wits. My investment objective is, therefore, to make enough so that I never have to work again, although it would be easy for me to do so if I wanted. I could probably get by with a 10% annual yield on my capital, but of course more is more and much more is much more. When I started out investing in stocks, I really didn't know what I was doing, but I had the occasional bit of luck, like investing every penny I had in BP in the summer of 2010, just when it couldn't go any lower. And it didn't. Then again I staked every dime I had on out of the money options on a drug that had a PDUFA date in January 2011. It was approved. Phew! But I was a nervous wreck and figured there had to be a better way. Then about a year ago I started to study the whole business of options strategies, got myself a few books, and found out that you could sell options as well as buy them. This was a bit of a revelation, to say the least, because I had noticed that whenever I thought a stock would go up, it went down,and when I thought it would go down, it usually went up, but by selling options you could let other people's optimism work for you. Then I found out about volatility. I had always known that the whole game was rigged, but now I began to understand how and why I'm hoping that with some blog posts or articles here I can inform others about some of the things that I have learned in my time as a full time investor and personal hedge fund manager (O.K., layabout) so that they can avoid some basic errors, and I hope to attract enough criticism to be able to learn from those who know much more than me.

OK, if you are reading this I assume that your check for $49.99 is in the mail. If not, then I guess you are getting this valuable information for free.

Actually for experienced investors this is like teaching grandma to suck eggs, but here it is anyway.

Stocks have spreads, the bid price is always a bit lower than the ask price, so if you buy a stock and turn right around and sell it, you are going to lose money even if the price of the stock is static.

However, if you buy the stock using a limit order, then you can name your own price and ignore the bid/ask spread. Either you will get the stock or you won't, but at least if you do get the stock you will get it a little cheaper than it is right now, which means that if you wanted to turn right around and sell it again you may be able to place another limit order at the current price and actually get your money back.

In itself this isn't very useful, but consider that you want to take a position in a stock like ZLCS or ZIOP, two small cap biotechs that I have traded in and out of. If you look at a candlestick chart of these stocks you will see that there is frequently an intraday variation of at least 25 cents per share between the daily high and the low. If you have a block of 1000 shares, that represents $250. I don't know about you, but I find that $250 here and $250 there soon adds up to some serious money.

Chart

By hanging out a limit bid at somewhere just above the 3-day low, you will often get filled at a good price, whereupon you can now hang out a limit sell order somewhere close to the 3-day high, and you will also have a good chance of getting filled sooner or later. Remember that in an IRA account, you don't have to worry about that capital gains stuff.

The other "trick", OK it isn't really a trick, but here goes, is this. If you want to buy a position, you can buy half the shares first with a limit order, then put in a second limit order for the rest of the shares at an even lower price. If the first tranche of shares increase in value, you won't be too sad as you are already ahead of the game, but if they fall in value, then at least you will be able to reduce your average basis in the full position. Of course you will pay two commissions, but if you are using a cheap broker, the amount is very slight, and the lower basis will compensate you.

If you can't get the rest of your shares cheaper, then at least if you buy them for more, you do lose a bit of upside, but once your full position is established it is already in credit and you avoid that sinking feeling when you buy a new position and it is already in the red the next day.

Coming next: How to Get Incredibly Rich Selling Puts.

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