The first thing you've got to know about buying options is that you are expected to lose money. It's like the slot machines at the casino. Some people hit; most people lose. Just like in slots, you don't think you should be a loser.
This piece is about how I turn the odds more in my favor, how I make it more of a game of blackjack than of one-arm banditry. I know what you are thinking: Cramer can't be telling us anything worthwhile, because he's not asking for thousands of dollars in seminar payments and video tapes. Cramer can't know anything, or he would be insisting we meet in the Felt Forum for a closed-circuit lesson at $200 a pop and aggressive follow-on lectures by Cramer minions for $2,500 a year.
Damn that stuff makes me sick. I see guys charging fortunes for lectures that I could give in my sleep, and I would if they weren't wrong and worthless. The guts of these charlatans. I am one of the best options traders on Wall Street but no way would I ever make the kinds of promises these guys make, and let me tell you, I would trash these guys in any trading contest. Options, common, you name it.
So what's my angle? Same as ever. I want to help you make money. I want you to be happy subscribers to
and rave to all of your friends what a bargain this is. I will derive a tremendous amount of achievement and pride if I can make
successful beyond anybody's wildest dreams. If that means I give up some options secrets, so be it.
I give them up fully knowing that you have read my options abyss piece from the other day. (For that story, please click
here.) I give them up with the understanding that you are going to trade them whether I say you should or shouldn't, and for the record, I say you shouldn't. When you trade options you are trading against guys like me, and I have a whole army's worth of data, machines and material to play with. I know those are not good odds. (Just the other day I received an email saying that I had cavalierly recommended using options without giving accurate risk factors, which just shows that, given I have laid out millions of reasons why options are dangerous, you can't caution enough.)
First, the biggest choice you have to make is why bother to buy an option at all? Why not buy common stock? Why put a gun to your head and give yourself that kind of pressure?
There is no good answer to this question. You should buy common stock. You should not put a gun to your head. You should not get caught up in buying something that has a short fuse.
But you've come to me now because your mind is made up. You want to parlay that limited amount of capital into something bigger and you think you are willing to risk it all. May I make a suggestion? Cut in half the amount of money you intended for options. Don't make yourself sick with worry if your stock goes down after you bought calls. Don't get fired from your day job because you keep checking how your net worth of 200
calls is holding up.
Second, don't buy out-of-money calls. Those are for suckers. Buy calls that are a proxy for common. So you think
National Gift Wrap and Box Company
, currently at $45, is going to $50 in two weeks. Don't buy the February 50s for 3/8ths of a dollar. You could be right and make nothing. Don't buy the February 45s for $1.75 and run the risk that the stock goes up two points and you make nothing after commission.
Don't buy the February 40 calls, either. You could be dead wrong about the time frame and be faced with taking in common in two weeks, a decision that may eat up all of your capital.
Go out to March. Buy the March 40 calls. They probably are going to be at $5.85. You will get a one-for-one move about $46. That means if the stock goes to $50 in two weeks you will make four bucks on a $5.85 investment. That's a great rate of return. If the stock does nothing in two weeks, you've got another five weeks where it might do something. If the stock does nothing in 7 seeks, unlike the March 45 calls, which might have cost you about $2.5 and been a wipe out, you can sell the call and say you gave it the old college try.
So, lesson one: if you have a hunch that something good is going to happen that will move a stock ten percent in two weeks, presume you are wrong about the time and go further out. Presume you are wrong about the thrust, and don't gamble on the out of the monies (the 45s). And presume that when the stock get to where you think it is going to go, it will go no further, and don't be wiped out on the 50s.
Now you are already ahead of the game.
James J. Cramer is manager of a hedge fund and co-chairman of TheStreet.com. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Mr. Cramer's writings provide insights into the dynamics of money management and are not a solicitation for transactions. While he cannot provide investment advice or recommendations, he welcomes your feedback, emailed to