Editor's note: Lenny Dykstra will explain his deep-in-the-money calls (now 70-0 for the year) at TheStreet.com Investment Conference on Saturday, Oct. 25. Click for details. I may have a perfect record with 70 wins and zero losses this season, and I may make it look very easy at times. The truth is that I put in a lot of hard work so that it is as easy as possible for my readers. In the end, though, it's worth it. The system works -- in both up and down markets -- and the proof is in the pudding, as they say. I tell readers all the time that it is important to follow the rules. I have gotten a number of questions lately about two of the rules, so let me explain them in a bit more depth.
First, my strategy calls for buying deep-in-the-money calls. I usually pay a premium of $1 or less to purchase these options contracts. Sometimes it's a little over a dollar, but it doesn't happen all that often. That's a main part of my system and it's part of my ground rules. I figure out the basic premium by adding together the strike price of the option I am purchasing plus the amount I am going to pay to purchase each contract. From that total, I subtract the price the stock closed at the previous day. When that calculation is done, I should have a premium of less than $1. Another major part of my system calls for only purchasing the contracts at a price I find attractive. This is really important and the subject of several emails I have gotten recently. So let me explain how I arrive at my purchase price.
These two elements will, at times, cause me to shoot for a purchase price well below the price where the option last traded. Now, you shouldn't let that last trade value dictate the purchase-order price. I don't. It can serve as a guide, but there are many factors that can cause that to be a misleading number as well. If the option is infrequently traded, that price may not reflect the true value. Also, if the stock is performing poorly or if I suspect the stock or the market will go down significantly, I set my purchase order below the last trade and let the market come to me. If my order is filled at that lower price, I have gotten the bargain I was seeking. If it doesn't come all the way down, I have lost nothing and will use that money somewhere else --- on a pick that does come all the way down to me. I will live to fight another day. I sometimes shoot very low, and the market takes a day or two to come down to me. Sometimes it never does. Now this is a very important factor because, as subscribers to my newsletter, Nails on the Numbers, will note, the price you pay will often determine the success of a pick. If I get my lower price, the chances of me winning sooner goes way up. Essentially, the lower purchase price I achieve, the better bargain I have found. The lower the price where the options gets filled, the less ground the option needs to climb in order for me to grab my win. And remember, I set my good till canceled (GTC) sell order $1 above my average purchase price. So, the lower the purchase price, the lower the sell price, the easier it is to achieve a win. I picked Cameco ( CCJ) at a much lower price, and it turned in a win. Other wins I have grabbed recently include Caterpillar ( CAT), General Electric ( GE), Garmin ( GRMN), Yahoo! ( YHOO), McDermott ( MDR), Halliburton ( HAL), Parker Hannifin ( PH) and Frontier Oil ( FTO). Always remember: Life is a journey, enjoy the ride!