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Tuesday, January 24, 2006

Buying Option Contracts

MSW Member Question:

Hi Chris,
congrats on your TS calls. I wanted to know about how many contracts do you usually buy for a given stock,and how deep in the money do you buy them? (or do you buy them OTM?)

It seems like: Find a growth stock (60-100 or not) Buy ATM or ITM Calls for 6 months to 1 year out (Leaps). Wait for a decent point move and sell out I've bought a bunch of different Calls for different stocks, I have some on OXPS I bought on the drop and have had some on UPL for a while, but I only have 2 contracts each, not out of lack of funds but feeling I had to be diversified.

This however does not produce big returns for me when the stock moves. Should I be buying more contracts?

thanks for your input.

My Answer:
Good to hear from you!

I only bought 3 call options with (TS) because it was a risky play buying at the bottom of a base formation. The rule of thumb is to only buy as many call options as you would buy shares in the company. So, at $110, three call options controlled $30,000 in shares or 300 x $110. However, I do know option traders that buy many more shares than they could ever handle and do okay for themselves. I like to buy near the money or slightly in the money options. Occasionally I will buy out of the money options but I have had better results with the ladder. Options expiring six months to one year out are not leap contracts. Typically LEAP contracts are two years out from the current date. I rarely buy LEAP contracts.

In the case of Tenaris (TS), I thought out in my mind where the stock could realistically travel. Due to the cup shaped formation, $145 seemed like a very logical position for the pattern to form a handle so I set that as my target. I told myself I would sell when it passes this point. In this case it did, so I sold even thought I still had almost five months left in the contract. A 223% profit in two months is hard to debate when it meets my original objectives. When you start to get greedy and break original objectives, you typically lose money. I have had that happen too many times so I sold with asking questions.

Buy as many contracts as you feel comfortable with. Don’t worry about the overall profits at this point. Worry about the percentage gain you are achieving with each position. When you consistently make large gains, increase the size of your positions.

I am still learning to trade options so I don’t teach my methods just yet. I stick to what I know best: buying stocks making new highs, grabbing shares near support or moving averages and stocks breaking out from strong patterns.



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