Volatility, thy name is stock market

Sheesh! It’s been a trying few weeks to have $ in the stock market. There have been several days where I have “lost” thousands of dollars. Lost in quotes because the losses, like the preceding gains, were on paper. Or at least that’s what I keep telling myself as I try to remain level headed and calm. I’ve taken a keen interest in money management and the stock market for years. I’ve been reading the occasional book by Robert Kiyosaki (of Rich Dad, Poor Dad fame), Peter Lynch (One Up on Wall Street), Benjamin Graham (The Intelligent Investor) and reading Motley Fool web articles for years now. They all discuss the need to remain calm in the midst of market implosions and view it as a time of opportunity, rather than panicking at your losses and quitting. They stress the importance of having a long term view and patience. In one of Kiyosaki’s books, he mentioned that when acquiring a new skill, he gives himself five YEARS before he expects to be good at it. That was a mind boggling revelation. Especially since I had been a legal adult for less than five years at the time. So, by now, I ought to be getting somewhat decent at managing money. And, by in large, I am. But the last month has certainly been a trying time. It is hard not to be paralyzed by fear. I watched as stocks (including Indymac referenced below) lost half their value. I knew that several great stocks were at amazing values (Chipotle, for one), but did not act because the irrational drop and my fear made me worry that they would keep on plummeting. However, in spite of all the losses, I did have one milestone. Chipotle had another excellent earnings report, rebounded, and is now at more than double what I paid for it. My first 100+% gain! I feel somewhat chagrined that I didn’t buy more of it along the way. I’m starting to think that there is something to Mr. Warren Buffet’s quote: “I prefer to keep all my eggs in one basket and watch that basket closely”. At least until you’ve made your first few hundred million and putting all your money in one place becomes impractical because it would sway the overall value of the company. Sigh. That would be one problem I’d be okay having.

Another lesson I’ve learned – selling options is awesome! The common advice regarding options is to stay away because they are too risky. And, by in large, this is probably good advice (If you aren’t familiar with the option concept wikipedia has a basic explanation) because it is impossible to take a truly long term approach. However, you can use this to your advantage if you sell covered calls. This is particularly true when a stock has been beaten down “unfairly” (in quotes because you could very well be wrong). Stocks in this category usually have a high premium because other people are probably optimistic about the stock’s future chances, yet are afraid to jump in completely for fear that the stock will plummet. The combination ought to push the amount they are willing to pay for an option on the stock up. Two current examples.

Immerson Corp (IMMR) Currently trades at $16.22 (and was recently above $20.00). A November contract with a strike price of $17.50 last sold for $2.00. So, if IMMR is worth more than $17.50 in late November, you would earn the $2.00 for the option, plus the $1.28 difference in stock price. That’s a 20% gain in 3 1/2 months! Plus the stock would have to go below $14.22 for you to lose $. Granted, covered calls will not result in a doubling of your money, but with careful selection they ought to help you outperform the market.

Indymac (IMB) is in a similar position. It last traded at $21.39 (and recently was as high as $37.00) and an October contract with a $22.50 strike price last sold for $3.60. Maximum profit would be $4.71 a share, and again over 20%, and this time only 2 1/2 months, with an even bigger cushion prior to loss. Behold, the wonders of volatility!

In the interests of full disclosure, I’ve sold the covered call options for IMMR and own shares in Indymac (‘though I’m still smarting from the sudden drop from $37.00 and haven’t yet convinced myself to sell the options at a lowly $22.50). I think they are both good deals.