So how exactly do you chalk up a $4,600 profit on one of the market’s biggest oil stocks… without even buying the shares, or a risky option?
This little-known strategy combines the best of all worlds:
- A low purchase price.
- Unlimited return potential.
- A downside that was identical to owning the shares.
In fact, the move in the investment was almost dollar-for-dollar on the upside and dollar-for-dollar on the downside, compared to owning the actual shares.
Here’s how the trade worked – and how you can do it yourself…
Do You Want to Pay $36,000 for 1,000 Shares… Or Just $12,000?
We executed the trade on Brazilian oil giant, Petrobras (NYSE: PBR).
At the time of entry, the stock was trading for around $36, so a 1,000-share purchase would have cost $36,000.
However, the Petrobras $25 January 2013 deep-in-the-money call option was trading for $12. So in buying 10 contracts, which equates to controlling 1,000 shares, the dollars at risk were 66% less than if we bought the shares ($12 multiplied by 1,000 = $12,000).
Now, let’s look at the downside…
If you’d bought the shares and assigned a 20% stop loss, the stock would have to fall by $7,200 before you’d be stopped out. That loss would be almost identical to a corresponding loss for the option, which is typical of deep-in-the-money options.
The terminology for this is a high delta trade. Delta simply refers to the change in price. A delta of 100% would indicate an identical change in the price of the underlying stock and option.
Here’s how the trade played out…
Investment Utopia: Bigger Gains With Lower Risk
When Petrobras shares traded up to $40, I recommended selling the options after just a couple of months.
Result? About $16.60 for the sale – a gain of around 38% on the original investment, or $4,600 in net profit ($16.60 minus $12 multiplied by 1,000 shares = $4,600).
Compare that to a regular shareholder, who’d have seen a gain of $5,000 – only $400 more than the return on the option trade, or about 14%. And that was having put 66% more capital at risk, too.
So the next time you want to invest in a blue-chip stock, consider using the high-delta, deep-in-the-money strategy to:
- Reduce the dollars you have at risk.
- Own more companies with your capital (diversification).
- Increase the return on your investment by a factor of three to four times.
- Maintain the same downside dollar risk.
About Karim Rahemtulla
Karim began his trading career early… very early. While attending boarding school in England, he recognized the value of the homemade snacks his mom sent him every semester and sold them for a profit to his fellow classmates, who were trying to avoid the horrendous British food they were served.
He then graduated to stocks and options, becoming one of the youngest chief financial officers of a brokerage and trading firm that cleared through Bear Stearns in the late 1980s. There, he learned trading skills from veterans of the business. They had already made their mistakes, and he recognized the value of the strategies they were using late in their careers.
As co-founder and chief options strategist for the groundbreaking publication Wall Street Daily, Karim turned to long-term equity anticipation securities (LEAPS) and put-selling strategies to help members capture gains. After that, he honed his strategies for readers of Automatic Trading Millionaire, where he didn’t record a single realized loss on 37 recommendations over an 18-month period.
While even he admits that record is not the norm, it showcases the effectiveness of a sound trading strategy.
His focus is on “smart” trading. Using volatility and proprietary probability modeling as his guideposts, he makes investments where risk and reward are defined ahead of time.
Today, Karim is all about lowering risk while enhancing returns using strategies such as LEAPS trading, spread trading, put selling and, of course, small cap investing. His background as the head of The Supper Club gives him unique insight into low-market-cap companies, and he brings that experience into the daily chats of The War Room.
Karim has more than 30 years of experience in options trading and international markets, and he is the author of the bestselling book Where in the World Should I Invest?
