“Big Companies, Big Gains with Tier-2 Equities” Burritt

Just a quick note, since I’ve had quite a few folks write in with questions about this “Tier-2 Equities” teaser for J. Wayne Burritt’s investing newsletter, Easy Money Options.

I don’t know what Burritt’s track record might be, and the track record of options services should always be taken with a grain of salt, but it is clear that all he’s teasing in his ad is the general idea of trading options. He doesn’t note any particular top secret strategies he might have, nor specifically tease any particular options that he likes right now, just talks up this idea of “Tier Two Equities” in a way that makes them sound much more mysterious than what they really are — which is, of course, just options.

I’ve written about several options trading services before — some are focused on something particular, like the Dark Equities teaser from Karim Rahemtulla about buying long term LEAP options, or the Jeff Clark stuff from Stansberry about selling covered calls for income. They all seem to have decent strategies, at least in their advertising copy, and they all talk about their successful trades and paint a picture of a safe and easy investing strategy.

That may be true, depending on your perspective, but here’s just a quick summary of my thoughts for those who are new to options trading … those of you who are already experts, you can move on along now, nothing more to see here:

1. Options are much more volatile than common stocks.

2. Options are much harder to invest in effectively than stocks — not because they’re that much more complicated, but because they are attached to a particular timeframe. If you’re right about a stock’s future and guess that the shares are underpriced and will go up within six months, you’re probably willing to be patient if you were wrong and it turns out to take eight months instead. With options, if you bet on that six month timeframe and it doesn’t work, you get nothing if the shares shoot up a month later. Timing is everything with options, and timing the market is really hard.

2. By all accounts, most options expire worthless (which is an argument in favor of the covered-call-selling strategy). And when you do get the occasional winner, it is psychologically very hard (for some people) to hold on for outsize returns … it’s difficult to be patient and wait for a 3,000% return when you’re already sitting on a 500% return, but it’s hard to make a lot of money in options if you don’t let those huge returns build.

3. Options selling (covered calls) limits your upside — if the stock booms upward, your gain is limited to the price at which you sold someone the option to buy your shares.

4. Options have a limited downside, but that limit is a 100% loss. You very, very rarely see a common stock go bankrupt and go to zero, but many, if not most out-of-the money options go to zero at some point. Ads for options services almost always tout the fact that this is a safer way to trade because you’re putting less money at risk, but folks who are not familiar with options trading might not readily understand that “at risk” for options means a pretty good chance of a 100% loss, whereas with most equities you’re very unlikely to see the floor fall out from under you nearly as quickly or completely.

5. Options for almost all stocks are dramatically lower volume than the stocks themselves — you can check this by looking at the “open interest” for any options contract, that’s the number of current contracts that are open. You can always open new contracts, but there may not be a huge market for that particular contract. This means that an advisor who has a decent number of avid subscribers is not often going to be able to get them all in at the price he recommends, because the other subscribers will drive the price up. Likewise, they won’t all be able to sell at once. This means that the “paper” gains of these services have to be taken with a grain of salt, they likely have many subscribers who, even if they tried, would be unable to get those gains. This is the same thing that happens with newsletters that recommend microcap OTC or penny stocks, the subscribers can easily jolt the price of the shares.

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I can’t comment much specifically about Burritt’s service because I don’t know it, and have never spoken to one of his subscribers. In the ad he talks extensively about all the great options trades he has made in the last year or two, but as far as I can tell they’re all oil and gas companies. Is he a great options trader who knows how to pick and ride the hot sector, or did he have hundreds of trades during that time and the only ones that were great performers were the ones in the hot sector of the year? I have no idea.

Some of my best options trades over the past two years were in energy companies, too, but my experience with options is that I have lots of 100% or near-100% losers which are swallowed up by the occasional 1,000-20,000% winners — do keep in mind, however, that I generally use options for small-time bets on interesting ideas and trends, with the occasional puts to protect my larger equity positions … I don’t do much active or short-term trading in options.

From Burritt’s description he does all kinds of options trading — selling calls for income, buying puts for downside protection, trading short term options for quick gains, and investing in long term LEAP options to magnify returns. Perhaps he’s masterful at all of them, or perhaps not.

I don’t have anything against any of those strategies or against options, and as I noted above I myself trade options to a limited degree, but I would always urge investors who are new to this stuff to understand options and the way they work before giving anyone their money to recommend options strategies. Think about what levels of safety and risk you’re comfortable with and how you would react in some hypothetical trading situations, and read up on the basic options information that your broker will almost definitely provide, or that you can get from the folks at the CBOE or any number of investor education websites. After that, it will be at least a little easier to tell whether the folks peddling these services are options trading geniuses, or just full of hooey … or at least, you’ll have a fair chance of evaluating them during the “free trial.”

Many of my readers are active in options trading too, whether because it’s a system they’ve worked out or because they like the income of selling calls or because it simply satisfies the gambling urge with controlled risk parameters … perhaps some of them would like to share their “tier two secrets.”


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SageNot
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SageNot
May 3, 2008 9:52 am

I don’t know much about Dark Equities, Karmin has the service priced way too high, but Jeff Clark has been on a roll for months now, going back to 2007. Many decent hedge funds use Leaps, I cut my teeth with them years ago, yet hardly anybody I know uses them, go figure.

Enjoy your w/e Gumshoe,

Joe

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Elissa Stein
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Elissa Stein
May 3, 2008 10:49 am

Gumshoe, good commentary. I don’t quite understand your observation “#1-Options are much more volatile relative to common stocks”–it all depends on the stock, and the Delta of the option. As you correctly observed later in your commentary, there is lower volume on options than stocks, and volume is necessary for volatility. The options volume/volatility increases when the stock does the same. That’s why the deeper- in- the money the option, the closer it trades to the share price-sometimes it trades dollar for dollar. Gotta love the leverage!

If you are looking for 1000%+ profit, of course, you will find very few “winners”. Buying a simple put or call on very volatile stocks-such as Goldman Sachs,Transocean,Freeport MacMoran, and some of the ETF’s like the XLF, is that you use leverage so that you control
100 shares of stock for each option you buy, and put down a fraction of the cost of those shares. You have to use volatile stocks. Stocks such as ABB, for example, which is a good company with exceptional growth, are lousy candidates for options use (unless you are selling options), because they have so little volume. If you are selling options, little volume works in your favor.
My favorite strategy is to buy deep in the money options on volatile stocks. I am currently using options with expirations of 1/2009 and 1/2010. That way, I have more time on my side. Also,Leaps can go out as long as 39 months. But, I am not looking for heroic gainers–I am content to make anything above 20%-and often see gains of 60-150+% with a few days or weeks. I particularly like buying options on days when the market is terrible-if the Dow has a 300 point swing, you can get some fast pin action.If gold and copper, or oil, is plummeting or soaring, you can effectively play the trend cheaply. And, if you do a spread, you have to be content to limit your profits, since the most you can make is the difference between the two options in the spread. However, you have also successfully limited your risk that way. Personally, I think options trading is divine. Even though there are many times when the options will expire worthless, the winners outweigh the losers and good $ can be made.
You also have to be prepared to try your options strategy several times, when your timing is wrong. That’s just the nature of the beast. I can give you a recent example of that. In January, UNG (the Natural Gas ETF) was trading around $39.00 per share. I bought in the money options that expired worthless in February. Well, natural gas, has been increasing in price. So has the ETF. It is up to $51.85 per share, just a few months later. So, my instinct was right, but time-frame was wrong. Well, with options, when you see a trend like that, nothing prevents you from trying again, with a later expiration date. All in all, options work. You do have to be prepared to lose some money, and to be content on limiting your upside on a spread. However, there are few other investments that yield
these kinds of percentage gains, usually within a short time frame. It’s great stuff. Don’t forget to budget for short-term capital gains on option trading. Most positions are held under a year…

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Dan T
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Dan T
May 3, 2008 10:50 am

Tier-2 Equities are options? What a disappointment.I expect more resourcefulnesses from these cone artists. At least some half baked strategy with options. This guy was associated with Weiss Research.
I wrote a letter to W.R. asking for trade records /and calculation method of it/ of one of their “experts” .
Fair , considering the $2.5G/year price tag. No answer. Dan

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Myron Martin
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Myron Martin
May 3, 2008 10:59 am

I have had mixed results with options (hardly surprising) but there are some analysts with great track records. Travis is probably right that the ACTUAL results for the AVERAGE subscriber are probably much poorer than the PUBLISHED portfolio results because of the difficulty of getting in and out with precise timing.

Analysts with which I have had mostly good results include Steve Sarnoff, Adam Lass (WOW) and Jeff Clark. IF the results are the usual 80% winners/20% losers that the experts claim, then it makes sense that the available leverage based on the same percentage on stock picks many also claim to realize would mean that OPTIONS are much more profitable based on a risk/reward basis.

Not having the capital to buy any meaningful position in the blue chips with stock prices in the $40. to $100+ range means making a BET on a SPECIFIC stock, or sector with ETF,s through OPTIONS, may make more sense than betting on the stock investment itself rising requiring a much bigger investment to get any meaningful gain for a portfolio.

I think Joe is right, there is fantastic potential with LEAPS and I have a list of several dozen stocks I would LIKE to buy but can’t afford, so will look for the best LEAPS plays available for that list. Myron TAKEPROFITS

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Bob Zimmerman
May 3, 2008 11:41 am

Excellent commentary on options.

Personally, I will not trade a stock unless I can elect to buy a protective put option. Sometimes I will sell a out of the money call to pay for the put – thus putting a collar around the price.

I enjoy your comments, greatly.

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John F.
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John F.
May 3, 2008 12:09 pm

I can answer from an informed position.

The differences with the EMO service are that (a) he generally prefers to trade long options rather than short and approaches it with a more conservative, longer-term strategy than most options traders, even foregoing some of the gains (but not much — is track record really is pretty solid) in favor of lower risk), (b) he does the analysis on the stocks as one would buying stocks straight out (fundamental analyst) while many other options players uses less accessible technical strategies and (c) the service isn’t “$2.5G/year” as someone noted. It’s $49. This is specifically because Burritt takes a teaching approach to the recommendations, designed for those who are interested in options but not yet educated on them to risk going with one of the higher end services.

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G IMBURG
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G IMBURG
May 3, 2008 1:31 pm

One of your comments about losing upside price gain when selling covered calls is interesting. The advantage of selling a covered call on a 3 or 4 week time frame is you can resell covered calls after the position closes out. I would rather have a guaranteed profit (bird in hand) than chase 2 birds in the bush, but I guess we are all different.

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G IMBURG
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G IMBURG
May 3, 2008 1:37 pm

I love to buy leaps. If you can identify a bull market like fertilizer,you can make the same profit or more with a cheaper long term option.

Doctrb
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Doctrb
May 3, 2008 5:07 pm

I would like to hear similar comments about “leaper Canadian gold mining stocks” now being teased. Is there any decent chance for above average profits in this arena. They want $1495 (discounted) to complete the “telling of the tease.”

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Jackiegl
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Jackiegl
May 4, 2008 2:12 pm

Because Gumshoe did not mention them, I would like to exchange ideas with Ms Stein about selling naked puts.

Jacqueline.

Jackiegl
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Jackiegl
May 4, 2008 2:28 pm

Doctrb

I searched for “leaper Canadian gold mining stocks”
and can’t find any clue.

Can you tell us *who* is advertising teasing them?

Thanks,

Jacqueline

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Elissa Stein
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Elissa Stein
May 5, 2008 10:29 am