Bulls, Bears, and Simple Math

by Martin Dekom

The media often divide the financial community into "bulls" and "bears." Such pigeonholing lends itself to the idea that this exclusive crowd has clearly-drawn battle lines within it. Although, given the country club stereotype, the typical consumer probably imagines this separation to be more along the lines of stockbroker "bulls" having their own secret handshake, snickering at bookish "bears," all while under the shade of ponderous horned hats reminiscent of a Flintstonian Water Buffalo Lodge. Although we do have the handshake and a secret hideout, we've gone to a much more fashionable fez for headgear.

Frankly, I'm not convinced the market is going to crash, despite some compelling writing in The Wall Street Journal and some not so compelling in McUSA Today. However, I'm equally unconvinced that the current tear and rampant speculation is a good thing, or will even continue.

Therefore, I have tightened things up a bit, not by getting out of the market in bearish fashion, but by bracing the funds I manage by selling options on the stocks I hold. Sure, who wants to sift through all this? The investor who is uncertain, that's who.

The sifting begins with a bit of simple math, so Clinton voters may wish to leave the room.

Many stocks have options traded on them. If you buy a stock, you can sell a "call" option on it, which is nothing more than a timed opportunity for someone to buy your stock from you at an agreed upon price.

Sounds yummy, right? So...why not make that price 25% more than what you paid for it? Although some would say only a sucker would take that bet, in rare instances the suckers are paying roughly 14% of the value of the stock for those options, for a flabbergasting total return of 40%, costs included, if the option is exercised by October*. If it's not exercised, you already received that 14%, so in case the market drops or things go wrong, you still have a nice cushion ("Thanks!"). Despite some of the surface complexities, all the math necessary can be done on a dinner napkin.

Martin Dekom is a stockbroker with the money management firm, Profit Management Associates, in Atlanta, Georgia. He can be reached at 404.320.7620, or by Email at MDekom@aol.com. His column is published on the Internet, in The DeKalb Champion, and The Stockbridge Advertiser.

This is an aid to your due diligence, not a substitute; you are solely responsible for your decisions.

*Math notes: This is a sampling from Friday 6/13 of IMP stock and it's October 15 calls. All costs are calculated in: One buys the stock for $12.11 and simultaneously sells the option for $1.67. If the stock stays above $15 by October 18, you must sell for $15, which would be a total return of 40% in four months. If it doesn't, you have already collected $1.67 per share, thus lowering your cost basis from $12.11 to $10.44. So, if the stock merely stays where it is and you sell it at that price in October, your return of 11% would be double the rate of a 1 year CD, in one third the time. If the unthinkable happens and the entire market crashes totally and every stock goes to zero, you still would have 14% of your initial investment left over. Of course, a fat lot of good that would do you in the ensuing anarchy while we build fortresses out of old tires.

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