InvestorGeeks

Last Friday, SIRI dipped below $5.50, which was my level to pickup another 70 shares as planned. I’ve been meaning to try out some options trading, and with the stock so low I thought what the hey. Why not buy 500 options rather than 70 common shares?

Here’s my first lesson for options trading:

1. Make sure you can purchase options through your broker before you look for some to buy.

In order to purchase options through E*Trade, I needed to first mail in (no fax option) a four page form to upgrade my account. The form contains some questions on my financials, but is mostly a disclaimer stating some of the obvious risks of trading. Documentation says it should take no more than 5 business days after receiving my application before my account is upgraded. 5 days! SIRI could be at $25 in 5 days.

In the meantime, I put in an order to buy another 70 shares of SIRI at $5.40. This brings me to another lesson in stock trading: “Don’t be greedy with your limit orders.” SIRI opened above $5.40 on the day I placed my orders and never dropped back down. Now the stock is ~$6 and I’m out a modest $35 gain. Limit orders are great, and you should always use them. Limit orders ensure that you’re not going to pay a higher price than you would have on heavily traded stocks. At the same time, you can get burnt trying to save $0.05 per share and miss out on $0.55 per share.

The missed trade isn’t so bad though because I now have $500 lying around just waiting to be thrown at some options. The plan is to re-evaluate my options-options once my account is upgraded. Hopefully I’ll be able to make a trade similar to the one I was planning on making.

FWIW, below is the thinking I went through this weekend when I was planning on buying some SIRI options. I’ll assume the reader has a basic understanding of options trading (big assumption I know). We’ll likely get around to writing something up at some point, but until then you can check out the Investopedia Options Tutorial.

Before we take a look at some options chains that were available for SIRI this past Monday, here is what I stood to make buying SIRI common stock. The amount to the left of the = is a possible price target for SIRI; the amount to the right is what I stand to gain at that price.

Normal Stock - 90 shares @ $5.40 = $486 investment.
- $4 = -$126
- $5.50 = $9
- $6 = $54
- $7 = $144
- $8 = $234
- $9 = $324

Now here are some of the September 2006 call options available for purchase this past Monday.

[Strike Date] - [Strike Price] - [Price per Option] = [Shares to Buy] ([Total Investment])

Sept06 - 3.0 - $2.40 = 200 shares ($480)
- $4 = -$280
- $5 = -$80
- $6 = $120
- $7 = $320
- $8 = $520
- $9 = $720

Sept06 - 5.0 - $1 = 500 shares ($500)
- $4 = -$500
- $5.50 = -$250
- $6 = 0
- $7 = $500
- $8 = $1000
- $9 = $1500
- $10 = $2000

Sept06 - 6.0 - $0.65 = 700 shares ($455)
- $4 = -$455
- $5 = -$455
- $6 = $-455
- $7 = $245
- $8 = $945
- $9 = $1645
- $10 = $2345

Sept06 - 7.0 - $0.35 = 1400 shares ($490)
- < $7.0 = -$490
- $8 = $910
- $9 = $2310
- $10 = $3710

Looking at the above, one can see that options trading can be as risky or conservative as common stock trading. If would have bought 2 (remember 2 options = 200 shares) of the “in-the-money” options striking at $3 for $2.40 per option, I would already have landed a $120 gain vs. the $56 I would have made on a common stock purchase.

Now I expect SIRI to go up to at least $7 between now and September, so I was willing to be a little more aggressive with my investment. With $7 as my target price for SIRI, my best options-option would be the Sept06 options striking at $5 for $1 per option. 5 of these options would put me in control of 500 shares of SIRI; at $7, this would equate to a $500 gain. In fact, I would have gone with this exact purchase. With a break even point at $6, these options offered a quick win when the stock goes to $7 with still a bit of room to grow. Notice that these options offer a greater return at $8 per share and aren’t eclipsed by the more speculative options until $9 or so.

I’ve fallen into the trap of telling you all how much money I would have made IF I had made this trade. I’m not trying to brag. Not at all. Making these kinds of trades requires good timing and fast responses. Make sure you are on top of the numbers. And most important of all, make sure you are able to make the trades at all.

When my application for options trading goes through, we’ll try this again. Happy trading.