Options II

Options are very emotional. Many are purchased to hedge other positions when investors are panicked. For example, if a trader owned $1 million of QQQ shares and he thinks the QQQ are going lower, instead of selling his position, he may just buy put options to hedge the position. If the QQQ falls, his losses would be offset by the gains in his put options. And, he wouldn't have a taxable event since he didn't sell his initial position.

Because options are often purchased in panic, their prices swing wildly. When the market is rising, calls get extremely expensive. When the market is plummetting calls get dirt cheap. There are all kinds of valuation methods to determine whether options are expensive or cheap but they are far beyond the scope of this series. Generally, at market lows, calls are cheap and that is the opportunity we are seeking.

So, one key is obviously determining if we are at a market low. At market lows:

1. The market has fallen significantly.
2. There is a reason that the market is unlikely to fall anymore.
3. There is a reason that the market should turn upward for a few days.

We must have some method of determining whether 1, 2, and 3 above are likely to be true.

Has the Market Fallen Significantly (#1)?
There are many ways to determine whether this is true. We are looking to keep this simple. The simpliest method of determining whether this is true is by looking at the Dow Jones Industrial Average (DJIA) in relation to its 21-day moving average. The DJIA is the stock market index that is the most visible to the dumb money. This is why I like it so much. The DJIA is just 30 big companies stocks added up and divided by some number. Even though it's only 30 stocks, it represents the stock market very well.

The 21-day moving average (21DMA) is just the last 21 days' closing value of the DJIA added up and divided by 21. This 21DMA smooths out all the ups and downs in the DJIA.

Historically, the DJIA oscillates around its 21DMA and this is the key to giving us some of the information we need.

• If the DJIA is far above it's 21DMA, then it's "high".
• If the DJIA is far below it's 21DMA, then it's "low".

Therefore, as long as we can define "far" we have determined whether the stock market is "low" (#1 above).

Historically, the DJIA is "low" when it is 3.5% below its 21DMA.

(click graph to enlarge)

The graph above is the DJIA with three lines. The middle line is the 21DMA the lower line is the 21DMA minus 3.5%. As you can see, the DJIA often makes a significant low at the lower line which is "3.5% below the 21DMA". Therefore, when the DJIA is at the lower line, it has "fallen significantly" and #1 is true.

We still need a reason that "the market is unlikely to fall anymore" (#2 above). Therefore...

To be continued...

--HMG

Options I

I've been asked to write a bit more about options. Again, I highly recommend you educate yourself at the CBOE.

I like to keep things simple so I currently only trade call options on the QQQ and XAU because I've found it's relatively easy to pick short-term bottoms in these indexes with about 70% accuracy. (I may start buying some bond related puts as I believe interest rates are going to rise significantly over the next few months). Generally, I only hold options five days maximum. This way I can pick an option that's traded with high volume (good liquidity) and doesn't experience significant time-decay over the five days. I generally buy "at the money" or slightly "out of the money" calls that are expiring in less than two months.

I expect any investment in calls to have a 40% chance of being a total loss. Therefore, the first thing I must consider is money management. I never invest more than 10% of my option account in a single position. E.g. if you start with $10,000, then the largest options buy you can make is $1,000. You'd have to have ten losers in a row to go bust which is unlikely if you are patient, disciplined, and only utilize proven methods of picking bottoms.

Secondly, you want to use "house money" as soon as possible. What I mean is, you want to pull out your $10,000 intitial investment quickly so you are operating on pure profit from past trades. Also, pull profits out on a regular basis so that this remains fun and not stressful. I also suggest you never take a call option position that is more than 1% of your annual income. Therefore, if you're making $50,000/yr you'd be buying $500 calls maximum. If you want to take larger positions, make more money.

Remember, this is risky stuff. You can easily lose your entire investment and many people do. You should look at this as a game like betting in Vegas. Only, the odds should be in your favor instead of in the favor of the casino. One thing you must be is patient. Good option setups don't occur all that often, but when they do, be ready to pounce. Lastly, if you get good at this, you will have created a money machine.

In this series I am going to be as basic as I can and still give you a chance to make money. I'll tell you right now that this will just be a small subset of the techiques I use. This is a skill that takes time to develop. (I started trading options when I was 18 years old and have studied the markets heavily every since.) But I promise you the payoff can be huge. My best call option profit in 2004 was over 900% (It's a Hyundai).

(To be continued...)

- HMG

(This is not investment advice. This is only an educational discussion of how I invest in options. Any investment you make is totally at your risk. Option trading is risky. You could lose your entire investment in just minutes.)

We need oil.

We have a massive amount of proven, probable, and possible oil reserves in ANWR in Alaska. This land, currently a wildlife refuge, was set aside specifically for oil production. It is crazy that instead of developing this property we are enriching foreign producers.

With $50 oil and the Republican victory, oil will flow from ANWR. Environmentalists, please don't fret...

Drilling an oil well is just a small hole in the ground. Any drilling will be done on snowcover so there will be limited damage to the tundra surface, which is delicate but is also extremely abundant in the world. We gots lots of Tundra.

If you hate oil wells, visit Ranger, Texas some day. This was the site of a huge oil boom with wall-to-wall derricks, pumpjacks, fires, and wellhead blowouts spilling oil all over the ground. I bet they even peed on the ground. It's an absolute environmental disaster. Except that the land has completely recovered and you can't even tell where the old wells were. They're just small holes in the ground now sealed with concrete, overgrown with plants and trees.

Wells don't blowout any more. Drilling has evolved into a relatively clean activity. Oil doesn't mix with dirt. If it spills on the ground, it's easily cleaned up. Oil is money. No one wants to spill any.

If you are against drilling in ANWR or elsewhere on environmental grounds, your case is weak. Schools in West Texas drill wells in playgrounds to generate income to educate kids.

If you're against drilling in ANWR because it's "corporate welfare" to big oil or some other silly accusation, you need to think logically. The US government will require oil companies to pay a lease bonus and standard royalties. The lessee and bonus amount will be determined via auction. This is the standard arrangement between landowner and oil producer. Plus, the US government will generate a massive amount of revenue.

If you're against drilling in ANWR because it will disrupt wildlife, so what. These animals are not endangered and will surely adapt.

It's going to happen so prepare yourselves. You're going to be OK. And you'll spend less money each month on gasoline. If you don't want those savings, send them to me.

-HMG

Never buy an oil drilling share off a sales call.

My parents both grew up in Midland, Texas. My grandfather was a landman for the state of Texas. This means he researched and purchased mineral rights for Texas. Each time he found a good property he bought some for himself and became very wealthy.

Once you have some success you get on investor lists and then get a lot of sales calls to invest in oil/gas drilling projects. I sometimes get five a day. Don't you dare ever buy one of these. Good prospects are easily sold to insiders and professionals. Anyone who needs to cold-call to sell a project has a poor project. It's that simple.

My family owns extremely good land. The companies that drill on it go by the names of Shell and Exxon and such. They don't need to "sell" the projects to investors.

FYI, I've never seen a dime of this money. Someday I will but hopefully not too soon.

--HMG

Money doesn't buy happiness but...

Sometimes it ain't bad.

On election night I went to the Dallas Mavericks season opener against the Kings with a good friend. We had gold parking which means you bypass all traffic and park under the arena with the players. We entered a door where my date and I were greeted by security by name, "Good evening Mr ...

We entered the arena under the bleachers and walked to our seats. We were on the front row under the goal. There was waitstaff and food/beverages were all complimentary.

At halftime we went to the VIP lounge and ate a prime-rib dinner with player's wives and the wife of team owner Mark Cuban (she was very nice and has a beautiful new child). At that point neither Florida or Ohio had been called for Bush. All those texans were very worried watching the returns on plasma TVs.

I'm not a huge sports fan but I have to say that the game was a tremendous experience. A Kings player even fell in my lap and asked me if I was OK. I don't know any of the players by name but my date knows quite a few of them as he often flys on the team plane to games.

After the game we hung out "backstage" and talked to cheerleaders and players as they left.

These are the types of experiences that are just not possible without money. I don't think these seats can actually be purchased and I have no idea how much they would cost. But this experience is very motivating for a young entreprenuer like me.

--HMG

There's always another train.

I closed out my QQQ call at 2.15 near Thursday's close for a profit of 230% in just seven trading days.

The lesson is that even if the stock market is moving higher and leaving you behind, don't fall into the emotional trap of feeling like you're missing out. This is one of the reasons people tend to buy at market highs and lose money.

Because of options and other derivatives you can make massive profits by just being a little right. You don't have to catch exact tops and bottoms. If you miss one opportunity, there's always another one coming, like a train.

I can't sum up my 12 years of studying markets in this column but the US stock market should being moving much higher in the next couple months and there will be many opportunities to make money with QQQ call options.

Sorry for the delay in posting. I was traveling and every time I tried to post, blogger wasn't working.

--HMG (Went to the Dallas Mavericks season opener. Quite a story which I'll tell when I have more time.)

Example of a niche real estate deal.

About ten years ago I bought an old frame house on a corner that had a very large backyard. The house next door was a rental which I also purchased. I spent just $65,000 to acquire both these old homes.

Then I rezoned and replatted the backyards into four duplex lots with a shared driveway. Each of these lots sold for $12,500 immediately. Therefore, I ended up getting both these homes for $15,000. Counting commissions and fix-up expenses I ended up acquiring these houses for about $12,000 each, rental ready.

Both these properties were rented about 95% of the time and generated about $750/month in pre-tax cash-flow for ten years.

This weekend I will be putting both these properties on the market for about $60k each.

Just because someone is trying to sell you an opportunity, don't assume it's a sham. Making money in real estate is easy if you are smart, patient, and don't mind getting dirty. A friend of mine has had a muddy dog paw print from a construction site dog on his back for three weeks. He wears the same fleece pretty much every day. And, he's a multi-millionaire building a $2.7 million house.

--HMG (Looking for her next opportunity...)