Dykstra Answers Your Mail

Editor's note: Lenny Dykstra will explain his deep-in-the-money call options (now 76-0 for the year) at TheStreet.com Investment Conference on Saturday, Oct. 25. Limited seating. Act now.

Reader questions have been pouring in. People want to know some of the mechanics of my system and how I have achieved many of my wins -- such as recent victories with Cisco ( CSCO), Chesapeake Energy ( CHK), Texas Instruments ( TXN), Pfizer ( PFE), Cameco ( CCJ) or Caterpillar ( CAT).

I have selected three I think are both helpful to rookie and will help readers get on a winning track.

Nails on the Numbers

Q: I'm a big-time fan of yours and ready to start getting into the investment world. I have an unbelievable amount of respect for what you've done, and I am extremely excited about working with your tips each day. My question is that because I am just starting out, I do not have a ton of capital to start with and I noticed that you wrote in your last articles that you made $1,000 by investing $9,500. Do you suggest not subscribing to your newsletter Nails on the Numbers if I do not have a lot of excess cash right now? -- Nick in Milwaukee

A: Thanks Nick, I appreciate the kind words. In short, you don't need a lot of money to get started with Nails on the Numbers. My system is scalable, and when I say that, I mean you do not have to invest the same dollars I write about in my daily picks.

With each of my picks, I shoot for a $1,000 victory. To do that I purchase 10 deep-in-the-Money call contracts. Each one essentially allows me to control 100 shares of the common stock at a fraction of the price. So, if I buy 10 contracts, that's 1,000 shares. Then, I wait for a $1 increase in the option price and I sell for a $1,000 victory.

Let's use my recent win with Microsoft ( MSFT) as an example. I picked Microsoft on Oct. 8 and my order was filled on Oct. 10, which was last Friday. On Monday, it brought me home a $1,000 win. It required me to invest $6,700 to make that $1,000 profit. That's not a bad return, especially considering how quickly I got the win.

If you wanted to get in on the trade but didn't want to lay down $6,700, you could have bought one contract for $670 and aimed for a $100 win. Or, you could have bought five contracts for $3,350 and gone for a $500 win.

Or, if you had more money and wanted to aim for a bigger victory, you could have put down $13,400 and shot for a $2,000 win. The only variable that will have a bigger impact on your profit is the trading commissions. If you purchase fewer options, the trading commissions will eat up a larger percentage of any potential wins.

That said, in order to truly take advantage of my system, you need to have reserves in case a stock goes down. Some picks will go down and you need to follow my rules to reposition yourself as best you can to try and grab a win. That may require you to average down, which leads right into my next question.

Q: On your table of open positions you have a column called "Next Buy." The prices listed appear very high compared to the recommended price. Can you tell me what this is about? Robert

A: Along with my morning picks, I publish my scorecard, which has a lot of important data that is necessary to managing your positions. In addition to including wins and the particulars about my original purchase, it includes information about what to do if a pick goes south. The scorecard can be found under the "Recent Plays" tab on my minisite at TheStreet.com. (Subscription necessary).

The "Next Buy" column is frequently updated and reflects the price the stock (not the option) must fall to before I plan to buy 10 more option contracts. Now, because I buy DITM options, I get exposure to some of the world's best companies at a fraction of the price of the common stock.

And, as you note, the price listed in the rebuy column is much higher than my initial purchase price. That's true, but the "next buy" price isn't the price I am paying. It is the price the common stock must hit before I buy more options. Now, a lot of people ask, how do I know I am getting the right price for the option?

What I do is I place a market order for more of the same option I already own. I am looking to buy more at a lower price. My goal is to lower the average price I am paying. So as long as my order will do that, I let it fly.

When I add more contracts to a position, I call this averaging down.

Q: I'm trying to understand how one selects the time frame relative to the option price. How do you gauge which stock has a cheaper time premium relative to another? -- Bart in Michigan

Bart, thanks for the question. There are a number of factors that go into selecting a pick and one of them is the time frame. With many of my picks lately, I have been going out until 2010 to give myself plenty of time because the market is so crazy right now. In the past, I have typically gone out four to seven or eight months.

Now, as you note, some of the prices on the call options are very expensive and do not match my criteria for being deep in the money. To see if the pick meets my criteria, all you need to do is add the strike price plus my purchase price and compare it to the last price of the common stock.

If it is less than $1 more than the strike and purchase price together, it fits my criteria. Since my columns are published prior to the market's open, I typically compare that figure to the closing price of the given stock.

So, being DITM is a must. Then I look at the time frame. Like I said above, lately I have been looking to give myself more time than I had in the past, so I have been purchasing options that are set to expire in 2010. I hunt for a good price.

Often I will set my price quite a bit lower than what the option is currently trading at. That's because of the value I assign the pick. Often, the market will come down to me to fill my order.

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

Nobody ever made a dime by panicking, says Jim Cramer. Moneymaking opportunities exist despite the market turmoil. So where's a market master like Cramer putting his money these days? Check out his personal portfolio at Action Alerts PLUS. Take a free trial now.

At the time of publication, Dykstra had no positions in stocks mentioned.

Nicknamed 'Nails' for his tough style of play, Lenny is a former Major League Baseball player for the 1986 World Champions, New York Mets and the 1993 National League Champions, Philadelphia Phillies. A three time All-Star as a ballplayer, Lenny now serves as president for several privately held businesses in Southern California. He is the founder of The Players Club; it has been his desire to give back to the sport that gave him early successes in life by teaching athletes how to invest and protect their incomes. He currently manages his own portfolio and writes an investment strategy column for TheStreet.com, and is featured regularly on CNBC and other cable news shows. Lenny was selected as OverTime Magazine's 2006-2007 "Entrepreneur of the Year."

More from Personal Finance

3 Ways for Retirees to Protect Their Portfolios In Volatile Stock Markets

3 Ways for Retirees to Protect Their Portfolios In Volatile Stock Markets

Credit Unions vs. Banks: What's the Difference?

Credit Unions vs. Banks: What's the Difference?

How Much Money Has Bill Gates Made Over Time?

How Much Money Has Bill Gates Made Over Time?

This Should Be Your Retirement Savings Plan When the Stock Market Crashes

This Should Be Your Retirement Savings Plan When the Stock Market Crashes

Preferred Stock & Common Stock: What's the Difference?

Preferred Stock & Common Stock: What's the Difference?