Lenny's Letters: Book Your Profits

The 'disciplined trader' answers emails about his deep-in-the-money calls strategy.
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One of the pleasant surprises of writing for

TheStreet.com

is the interaction I've had with readers via email. I relish the opportunity to communicate and interact with you through this vehicle. I am humbled by the large volume of complimentary emails that I have received in support of my column.

I also appreciate, albeit in a different way, the negative emails that I have received, questioning my credentials and my picks. I realize that I am still a rookie who has to earn respect through sustained performance.

Given the volume of email -- especially about my deep-in-the-money calls strategy -- and the notion that if one person asks a question, others may be wondering the same thing, I plan to regularly respond to reader emails on the site, beginning here:

I've been wanting for some time to buy calls, and I love Nabors Industries (NBR) - Get Report. When you say 'deep-in-the-money calls,' what exactly do you mean? Define how we get to the 'real premium' we are paying to control 1,000 shares for approximately 'four to six months.' -- Greg Howell, Plymouth, Mass.

Hi Greg,

Let me give you a definition that will make this low risk-high reward winning strategy very easy to understand. A deep-in-the-money call is a call option whose exercise price is

well

below the market price of the stock.

For example, let's use the NBR June $60

"deep in-the-money call" we had a good-till-canceled order in at $14.50 -- after a $16.20 intraday high -- which we filled toward the end of the day. A $60 strike price means we are going well below the price of the common stock, which in our case was $73.10. Also, this means we are

going out

at least four to six months in time. This is the second part of the equation, which makes this strategy so successful.

I don't want to spend $73,000 for 1,000 shares of stock. I definitely do not want to go on margin. You have two choices how you want to pay to control 1,000 shares of NBR stock until mid-June. Would you like to spend $73,000 to control 1,000 shares, or would you like to spend $14,500 to control 1,000 shares? (P.S.: Please keep your eye on this NBR June $60 call; if you bought it, I strongly suggest you enter a new good-till-canceled buy level at $10.50.)

Remember two things: First, we are giving ourselves plenty of time before the option expiration date (the third Friday of the month you choose. We chose June.). Second, we are going "deep enough in the money" so that we are controlling the stock with as little premium as we can afford. This makes sense. Remember, the "deeper" in the money, the less premium (the real-time price of the stock

plus

the amount of the deep in-the-money call) you pay.

As for the real premium, take your strike price and add on to that the cost of the "call" option price, and subtract the "real-time common stock price." That gives you your real premium.

But wait, don't think we have now reinvented the wheel. The deeper in-the-money you go, the more money the call (strike price) costs you to buy. That is why we have to find our "comfort zone." The price I usually pay for a deep in-the-money call will be in a range that varies anywhere from $3,000 to $10,000.

Usually $5,000 or $6,000 are about what they average. If you look back over my columns, that seems to be the approximate level that defines the "comfort zone."

With that great Intel (INTC) - Get Report $17.50 call @$3.80, how do we know how long to wait or how much profit is enough? -- Eddie Howard, Redding, Calif.,

Hi Eddie,

I am happy to help you out. Everyone's profit level is different. When I get filled on my good till canceled limit buy order, I

immediately

put in my good-till-canceled limit sell order for a $1,000 dollar profit. I have been filled many times at the open on the buy side, then later on, during the same day, I was filled on the sell side. I will target a one-point gain on 10 contracts, or $1,000, and will always adjust my target to the market conditions. If the market conditions are volatile, I would lower my price target to secure a win. (This is like adjusting after every at-bat, which I did when I was fortunate enough to play Major League Baseball).

Also, because you are new to this strategy, you must stay disciplined and follow your game plan, which should be conservative, until "you" know you are ready to step it up a little. You might want to lower your target and get some wins under your belt. As to the time frame? Because options move so fast, I think you should set a good-till-canceled limit order to sell immediately after getting filled on your buy order. Remember, you are playing with "real money," money I'm sure you've worked very hard to earn.

Always remember: Life is a journey, enjoy the ride!

At the time of publication, Dykstra was long Nabors and Intel calls, although holdings can change at any time.

Nicknamed "Nails" for his tough style of play during his Major League Baseball career, Lenny Dykstra was an integral member of the powerful Mets of the mid-1980s, including the world champion 1986 squad, and the Phillies in the early 1990s.

Today, Dykstra manages his own stock portfolio and serves as president of several of his privately held companies, including car washes; a partnership with Castrol in "Team Dykstra" Quick Lube Centers; a state-of-the-art ConocoPhillips fueling facility; a real estate development company; and a new venture to develop several "I Sold It on eBay" stores throughout high-demographic areas of Southern California.