Options Know-How: Lehman, Wachovia

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.

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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.

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