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Options Know-How: Lehman, Wachovia

TSC Staff

The following are highlighted options insights and ideas from TheStreet.com.

From Lehman's Options Plays Suggest Fear:

On the heels of the mid-June announcement of a $2.8 billion quarterly loss, Lehman Brothers (LEH Quote) announced $6 billion in fresh financing, and conceded that an additional capital infusion would likely be required. Option traders smelled blood and starting buying chunks of put contracts. Lehman might be in deep trouble, according to their bearish bets.

To be sure, conditions could still materially weaken for Lehman. The investment bank still has $65 billion in risk exposure, which is likely to be subject to greater stress if the economy weakens further. Since the bank has not disclosed certain large illiquid positions, "investors continue to assume that there is something to hide," notes UBS' Glenn Schorr.

As the stock slipped below $23 a share, volume and implied volatility flew to record levels.

Read the full article.

From Mad About Options: Walk Away From Wachovia (Video):

Ed McDaries and Jud Pyle review Jim Cramer's recent bearish comments about Wachovia (WB Quote) and offer options strategies for traders and investors. The Mad About Options crew also breaks down options ideas for AT&T (T Quote) and Exelon (EXC Quote).

Pyle: "If you own the stock [Wachovia], one thing you might want to look at, is selling an upside call and buying a downside put."

To watch the video, click the player below:

From Dykstra: Deep-in-the-Money Calls 101:

Using deep-in-the-money calls allows you exposure to the best companies in the world at a fraction of the price of the common stock... If more investors did their homework, they would realize deep in-the-money calls are one of the few tools that can help you, the retail investor, find an edge.

The strike price, or exercise price, of an option determines whether that contract is in the money, at the money or out of the money. If the strike price of a call option is less than the current market price of the underlying security, the call is in the money; the holder of this call has the right to buy the stock at a price that is lower than the price he would have to pay to buy the stock in the open market.

To sum it up, my strategy for in-the-money calls is to use them when a solid company is being beaten down on Wall Street for one "transgression" or another. My theory is that this overreaction will eventually correct itself as the value of the company reasserts itself over time; those who buy deep in-the-money-calls in advance of this correction will be rewarded.

Read the full article.

From Dykstra: How I Pick Stocks:

Today, I am going to explain the concept of "averaging down" and why it's crucial to my strategy.

My system is designed to pick good companies I feel are beaten down by Wall Street unnecessarily. My expectation is that because these are generally solid companies that are being punished for one transgression or another, or are victims of their overall market sector, they will bounce and recapture at least a chunk of the ground lost. Simple, right?

We don't need them to fully return to past glories, just to move up a dollar from where we entered the position so we can grab a $1,000 win (as a reminder, each contract controls 100 shares of the common stock and we are buying 10 contracts, so essentially we control 1,000 shares).

Now, onto averaging down. Essentially, when the price of an option goes south, it may be necessary to buy more contracts. I do this in order to lower my average entry price.

Here's an example. In April, one of the companies I picked was Frontier Oil (FTO Quote). At the time, the stock was trading around $27 a share. We bought the call option at an average price of $8 -- that was our entry price. I always recommend placing a good-till-canceled (GTC) order $1 above our entry price, so the GTC sell order in this instance was $9.

However, the stock went down, not up. No need to panic though, I expect this to happen at times and am prepared. Through the system I developed, I know that if the stock fell to a certain level, I would need to add to my position to put myself in a better position to grab a win.

Read the full article.

From Dykstra: How to Work a Call:

[On June 23], I told all subscribers to my newsletter, Nails on the Numbers, to place a deep-in-the-money call on Archer Daniels Midland (ADM Quote).

At the time I pointed out that the stock was trading just above its 52-week low. I told them to go all the way out until December, which would allow us several months -- if necessary -- for the stock to turn around.

The order wasn't filled on Monday. However, when the market started to tank last Thursday [June 27], we got our price.

As a reminder, my picks that go unfilled stay on the board just one week. If they are not filled within that time frame, I automatically cancel the order and move my attention to another pick.

Now, getting back to ADM. When the market sank on Thursday, the purchase order filled at $8.50, the price we identified. So, we committed a total of $8,500 to this trade. To put that in perspective, we would have needed to invest well more than $30,000 in AMD's common stock to gain exposure to the same number of shares. This is one of the reasons why I prefer DITM [deep-in-the-money] calls to buying the common stock: You can get exposure to the best companies in the world for a fraction of the price.

Read the full article.

From Dykstra: Playing Through the Pain:

When investors get spooked or can't handle the heat, they make mistakes. The pressure gets to them.

That's especially true when the herd mentality kicks in.

I am often asked about "stop-losses." Readers want to know why I don't employ them.

The main reason: I monitor the market every day, and actively evaluate every position every day.

Read the full article.

Plus, try Lenny Dykstra's options-focused Nails on the Numbers premium service.

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