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American Capital Agency Corp. Message Board

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  • ben9471 ben9471 Dec 13, 2010 6:13 PM Flag

    Buy The Shares vs Options?

    Olee, the first thing you need to do is apply for level 1 options. Once that it is done and you are really wanting to give it go, let me know and we can walk you through it. Watch it now (just watch the call prices on yahoo as the stock moves). Maybe, if you get set-up, you can do it next quarter.

    I am not promoting this idea for you to take some huge risk, but to learn to make more with less. YOu can control the leverage you take on. Options allow us small guys to punch above our weight. I would view it as a supplement to your basic stock picking skills and knowledge of AGNC.

    You can also sell covered calls too, assuming there is a good target. There are several conventions I use (and break all of the time):

    1) Buy ITM (option price less than stock price);

    2) Buy far enough out to more than cover the dividend declaration and ex-dividend

    3) Sell before earnings or before declaration of dividend, unless you have to consider otherwise

    4) Sell when the profit margin hits 10% or better unless you can justify staying in.

    Calls have a lot more volatility than the shares, so you find yourself agonizing over a $.10 fall sometimes. That is just the way it it is.

    There are some on the board who would disagree with my conventions, and I respect that too. However, an option loss can set you back by a lot if you get it wrong.

    The more ITM and the longer the date, the more relaxed you can be about it. I always pay for the extra quarter.

    There is something else you need to know which is a real economic issue and also affects psychology. When you buy a call (or a share) there is bid/ask spread. AGNC's calls are considered thinly traded, which means there isnt' as much liqudity as say APPLE. Your account will show a loss until the stock prices covers your instrinsic price.

    So, tomorrow just look at the following just to learn (not to trade);

    March 18 calls, Strike $26. Cost $3.80. (Bid $3.50).

    The intrinsic is $26 plus $3.80 = $29.80

    The share price now is $29.60.

    $29.60 - $29.80 = (.20) loss.

    The stock has to rise to more than $29.80.

    The commission costs are about $15.

    Each contract equals 100 shares, so you have to buy a minimum of 100 x $3.80 or $3,800.

    So, if the underlying hits $31:

    $31 - $29.80 = $1.20

    Total deal

    Cost 100 x $3.80 = $3,800
    Commission = 16
    Total $3,816

    Value .100 x $5.00 $5,000
    Commission 16
    Total $4,984

    Profit $1,168
    Profit percentage 31%

    Underlying Increase 31.00 - $29.60 = $1.40
    Underlying percentage 5%

    So, a 5% increase yields a 31% call return.

    Your risk of loss is $3,816.

    Would you lose it all? Probably not, unless the stock falls to $20 or something or you let the option expire.

    The impact of the bid/ask spread on your acount. Until your day of profit, you will have a negative amount in your account for the spread. The dealer is asking $3.80, but if you turned around and sold them straight away he would only give you $3.50.

    For your investment of $3,816, you will be down by the spread or about $763. You just have to get used to this issue.

    This is why you want (at first - and still true for me today) deep ITM. You want the call to be very responsive to an increase in the price of the underlying price.

    The more in the money, the more money you have to put at risk or the higher the cost of the option. It make sense. YOu bookie will charge you more for a sure bet.

    You can buy more out of the money, like the March 29's, which are $1.10. So, that would only cost you $1,100 for 100 calls, but your intrinsic is $30.10, not $29.80. That is a big deal in the world of calls. However, your return in the above example, will rise to $31 - $30.10 = .90/$1.10 or 82%. So, by buying OTM calls, you get a much better return. The 5% increase results in an 80% return.

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