But if you understand options, and it’s easier than you may think, you’ll quickly realize just how powerful a means to making profits they can be for you.

What is Superleverage?
You grasp that speculators make their fortunes from changing prices. Chances are, you are also familiar with the benefits of leverage. Leverage is an important tool for speculators.

Leverage involves using OPM (Other People’s Money) to try to make more money than you can with your own. Using OPM may augment rewards when you are right, but it may also greatly accelerate the risk of additional losses when you are wrong.

If leverage can be applied with an always known and strictly limited risk, it takes on a more sensible aspect. It becomes…

…Superleverage, the art of profiting from changing prices, with limited risk AT ALL TIMES, without ever getting a margin call, asked to put up additional funds, or forced to liquidate your position.

The instruments of Superleverage are exchange traded put and call options.

Buyers of puts and calls are the ONLY ONES who possess the full profit power of Superleverage.

Option buyers have several advantages: You don’t need to be a financial wizard or have large sums of money to participate. Only as an option buyer do you have all the benefit of using OPM when right, without the concomitant costs and risks when wrong. Total risk is ALWAYS known and limited to your cost of taking a position (making your bet).

While the option buyer has an always known and strictly limited risk, you will be well-served to remember that the risk is still extremely high, as it should be for the opportunity to earn unlimited gains…it’s the full amount of your bet, but not one cent more.

Here are a couple examples…

Let’s say you’re looking at two different stocks, Chili Co. and PepperTec. (I’m making up these names…as far as I know, there are no companies called Chili Co. or PepperTec…my first dogs were named Chili and Pepper).

First, Chili Co. In October, the stock is trading at $38. You’re thinking the stock will rise to $50 by the end of the year. In volatile market conditions, the stock could also collapse or it could settle down and move quietly sideways.

There are many things you could do, because there are many options to choose from. They come with a variety of strike prices and monthly expirations, and each of those options cost a different price—and therefore offer different opportunity to profit.

Let’s say you buy a Chili Co. January $40 call option for $200 (or $2 a share, since each option represents 100 shares). The price you pay for the option—in this example, $200—is called a premium. The premium depends on a wide range of factors, including the actual price of the stock, time until expiration, and volatility.
“Chili Co.”, in this example, is the underlying instrument, the specific security the option gives you the right, but not the obligation, to buy or sell. “January” is the expiration month for the option. Equity options last trade on the third Friday of the expiration month, with the Saturday immediately following being the official expiration date. “$40” represents the strike price, the price per share you have the right to buy Chili Co. at. And buying the call option means that anytime before the third Friday in January, you can buy 100 shares of Chili Co. stock for $40 a share…no matter what the market price of Chili Co. If Chili Co. is trading at or below $40 on the third Friday in January, your option will expire worthless. That is your risk.

Meanwhile, PepperTec is selling for $117 in October, but you think the stock is headed for a big fall come the new year. The stock could also continue higher or drift sideways. Rather than go through the expensive hassle of shorting the stock, you decide to buy put options instead. Again, options are available with a variety of strike prices and a wide range of expiration months, but you decide on the PepperTec January $115 put option, for $300. Any time between now and January you can, but you are not obligated to, sell (receive money for) 100 shares of PepperTec for $115 a share. If PepperTec. is trading at or above $115 on the third Friday in January, your option will expire worthless. That is your risk.

You, or your broker, are monitoring your positions daily. Chili Co. has just made a major announcement, and its shares have moved up sharply…to $50 a share. Back when Chili was trading at $38 per share, your option had no real value. The $200 premium you paid was for time and volatility only. But, with Chili Co. trading at $50, your call option, your right to buy 100 shares for $40 has a real, intrinsic value of $1,000 (the right to exercise your option and buy 100 shares at $40 and immediately offset by selling them for $50). But you don’t have to exercise options to make big profits. Most of the time, you simply resell the option to close your position. You’re looking at a 400% return, minus commissions and taxes.

Congratulations! You just used Superleverage to turn $200 into $1,000. Throughout the transaction, your risk was completely known and strictly limited.
By the way, if you had bought the 100 shares outright at $38 (for $3,800) and sold at $50 (for $5000) your gain would be just under 32%. Still nice, but paltry compared to the return on the option. That’s the power of Superleverage.

Now, it’s mid-January. You check PepperTec, and it turns out I was wrong (that happens occasionally). PepperTec stock is climbing towards $130. Because your option is to sell the stock at $115, it has no real value…and is headed toward a worthless expiration. At the end of the day, you have a 100% loss of the $300 premium you paid.
You may have lost $300, but that’s far better than if you had shorted the stock. If you had sold short 100 shares at $117 and the stock went up 11%, covering the short would have cost you $1,300 ($13,000 – $11,700). Technically speaking, buying the option saved you $1,000.

Options offer their owners the power of Superleverage—the potential to make spectacular profits in a short amount of time, on relatively small moves in the underlying shares, with an always known and strictly limited risk.

Combining the tools of Superleverage with a disciplined method, sound money management principles, and a good understanding of your personal tolerance for risk gives you the cornerstones of a complete game plan for trading success.

Sincerely,

Steve Sarnoff
Editor, Options Hotline

Superleverage: Limiting Your Risk While Boosting Your Returns originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

Let’s begin by dispelling the myth of undervalued options. There is no such thing as an undervalued option. All options are overvalued. That is the incentive for an option seller to take on unlimited risk for a limited return. My specialty is finding options for buyers who are the only ones to possess the opportunity for unlimited profit with an always known and strictly limited risk.

The premium of a stock option depends partly on its relation to the underlying stock. This is signified by the option’s strike price as related to the market price of the stock at the time of the option purchase. If the strike price of the option is equal to the current market price, the option is considered “at-the-money”.

A call with a strike price above the market price or a put with a strike price below the market value is considered “out-of-the-money”. It is out-of-the-money because it would be worthless if it expired today.

For example, if you buy a Widget Co. $40 call, but the current share price is $37, it is out of the money. If you buy a ComTech $115 put when the stock is at $117, it is also out of the money, because you would not exercise either option. After all, why would you want to pay $40 for a stock when you could get it in the open market for $37? Conversely, why would you sell a stock for $115 when people were willing to pay $117 for it?

You buy an out-of-the-money option because you believe that given your forecast for the price of the shares and the time you are guaranteed until expiration, the shares will move above $40—attain an intrinsic (real) value, a calculable worth, and become “in-the-money”. That’s when the call’s strike price is below the current market price or the put’s strike price is above the market price.

When the time until expiration is equal, in-the-money options have a higher premium than out-of-the- money options. But, if the market makes a strong enough move in your favor, out-of-the-money options may give you a greater percentage return. They also tend to deteriorate more slowly than in the-money options if the underlying stock moves adversely, depending on the time until expiration.

When figuring out your profit target, keep in mind the break-even price. That’s the price the underlying investment must reach for you to recoup your premium by the option’s expiration date. You calculate the distance to the break-even price using the option’s strike price, the price at which the option holder has the right to buy (if it’s a call) or sell (if it’s a put) 100 shares of the underlying instrument, and the price you paid for the option.

For example, you buy a Widget Co. March $85 call option for $5 (a premium of $500). In order to recoup your premium, the stock would have to go up $5 (above $85 a share), so the break-even price is $90 per share. Since you have the right to buy 100 shares of Widget Co. at $85 per share, a price of $90 would gain you $5 per share, or $500 ($5 times 100 shares). This equals the $500 premium you paid to buy the option. Any further increase in the stock price is profit, $100 for every dollar rise in the stock. If Widget shares rise to $100, prior to the third Friday in March, each $85-strike call will have $1,500 of value. If shares are at or below $85 on that same date, your option will expire worthless. That is your risk.

For a put, do the opposite. Divide the premium by 100 and subtract it from the strike price. Once you figure out the break-even point, it’s time to decide if the risks outweigh the potential rewards.

While the option buyer has an always known and strictly limited risk, you will be well-served to remember that the risk is still extremely high, as it should be for the opportunity to earn unlimited gains…it’s the full amount of your bet, but not one cent more. If anyone ever tries to tell you that you can earn a high return with low risk, zip your wallet!

One of the secrets to our success at Options Hotline is that I’ll only recommend an option if it has a reward-to-risk ratio of at least 2-to-1. I compare the cost of an option to the intrinsic value if the underlying shares reach my objective. If the market makes the move I was looking for, within my allotted time frame, and the option play would only break even, I wouldn’t describe that as a sensible speculation. But if the market makes its move and the option price would multiply, in a short time, with an always known and strictly limited risk, then your play takes on a much more sensible aspect. It becomes, as my father liked to say, “the only sensible way to speculate.”

Sincerely,

Steve Sarnoff,
Editor, Options Hotline

The Secret to Valuing Options originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

In my options trading service, Options Hotline, I’ve been able to show readers various triple and quadruple-digit returns. But just as important as understanding how lucrative options can be is how they came about in the first place…

Options have been around since ancient times. Merchants would pay a small amount of capital on anticipated crops or ocean-bound cargo. When the crop was harvested or the shipment arrived, the merchant had the first opportunity to buy the goods. Aristotle tells of a merchant in ancient Greece who anticipated a good olive harvest and bought options on the use of olive-presses. When the harvest came in better than expected, he took control of the olive-presses and made a fortune.

As investing evolved, so did options trading. Futures trading led to futures options. And as companies began to issue stocks, it was only natural that options would evolve to cover them also.

Formal options trading didn’t come to the United States until 1900. Before this, U.S. option trades were made privately, but the Association made it much easier for common investors to get into the market. Unfortunately, there were some problems with the system that allowed unscrupulous brokers to take advantage of those common investors.

In fact, use of options and related instruments got out of hand in the 1920s, exacerbating some people’s losses when the market crashed. In the 1930s Congress stepped in to try and regulate the options market.

In the 1950s and 1960s, the put and call business grew.  My father, Paul Sarnoff, was one of the first people to recognize, utilize, and teach others about the power options provided for earning exciting profits with a limited risk.  During that time, the burgeoning industry was self regulated by the Put & Call Brokers & Dealers Association.

Options became mainstream again in 1973 when the Chicago Board of Options Exchange opened as the first American options exchange, with member marketmakers ready to serve investors with a two-way option market. Risk-takers who wanted to buy or sell options could now be rapidly accommodated.

The change from over-the-counter options was astounding. Contract terms were standardized, making them more accessible to the average investor, and their popularity skyrocketed. In fact, they became so popular that the Securities and Exchange Commission halted expansion of the industry in 1977 and spent years reviewing it. But finding nothing wrong, more exchanges were opened and more investments were optioned—including futures on the commodity exchanges. Options had come full circle.

Now you can buy options on the American Stock Exchange, the New York Stock Exchange, the Pacific Stock Exchange and the Philadelphia Stock Exchange. For commodities you can trade on the New York Mercantile Exchange or the Coffee, Sugar, Cocoa Exchange. You can also find index options on the Chicago Board Options Exchange and the Chicago Board of Trade.

The point is, the options world is very big. But it is also regulated to keep everyone honest. Options on stocks and other items classified as securities are the bailiwick of the SEC. And options on futures contracts on U.S. commodity exchanges are under the aegis of the Commodities Futures Trading Commission. The close monitoring helps limit your risks, at the very least giving some fraud protection and recourse. That doesn’t mean you don’t have to be careful when trading, but it does mean that trading options is as safe as trading stocks, bonds or futures.

The most important thing to see is that even though there are so many options to choose from, they all share the same basic fundamentals. Once you understand how options in one investment work, you can apply those principles to investment options in completely unrelated fields. This not only gives you diversity, it offers you unlimited opportunity.

Sincerely,

Steve Sarnoff,
Editor, Options Hotline

Options A Brief History originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

Allow me to introduce myself. My name is Steve Sarnoff. You see, I have been helping people make money on options, with the Options Hotline for over 16 years now. But you could say that options have been in my blood since I was a child.

My father, Paul Sarnoff, gained international fame on Wall Street as a master of options and market intelligence. You may have read about him or seen him on the financial channels from time to time.

I worked closely with my father for many years, absorbing his vast knowledge and experience. He shared with me his secrets for making money that only a brilliant man with over 60 years’ experience in the financial markets could ever have. And over time, I built upon this incredible foundation with my own highly successful analysis and methods.

The example I used above, which resulted in a 838% gain, came directly out of my Options Hotline service. Each week, I tell subscribers about which option I think has the most explosive potential based on my personal technical expertise. And over the past several years, readers could’ve turned my advice into more than $1 million (with just $5,000 down) in less than five years. But I’m not writing this to brag. I just want to share the power and profit potential of options.

Before we go any further, we need to get into the nuts and bolts of option investing…

The Basics to the Most Lucrative Investment Strategy You’ve Ever Heard of

To understand option investing, you need to first look at the very basic idea of an option. When you buy an option, you are buying the RIGHT, but not the OBLIGATION, to buy or sell a specific investment at a set price within a set period of time. This gives ONLY option buyers the potential for unlimited gains with an always known and strictly limited risk.

I stop here because I want you to read that sentence carefully. It says everything you need to know about how an option works. “Financial instrument” means it is an investment—it can be bought and sold. Once you buy an option, you can resell it to another investor for a profit or loss.

An option gives you “the right to buy or sell a specific underlying instrument”… but not both. Every option on a security gives you the right to buy or sell 100 shares of the underlying investment. When you buy the option you must choose whether you expect to profit from a rise or fall in the price of the underlying instrument. If you expect the underlying instrument to rise, you buy a call. If you expect it to fall, you buy a put. You do not need to buy or sell the underlying instrument. In fact, you rarely buy or sell the underlying instrument at all. Most of the time you sell the option itself for a profit or loss.

“Within a set period of time.” That means the option has an expiration date. While it could be a matter of weeks, months or up to three years (called LEAPS), always keep in mind that if you don’t exercise your right in that given time, the option is worthless. Securities options last trade on the third Friday of their expiration month, with the actual expiration date being the subsequent Saturday, i.e., an April call expires on the Saturday following the third Friday in April.

I recommend options for stocks (securities), ETFs (exchange traded funds), and indexes that cover a myriad of market sectors (including stocks, commodities, interest rates, and currencies). Each week, I search the universe of thousands of stocks to find my subscribers the best opportunity to multiply their money in a short period of time with limited risk AT ALL TIMES. I encourage you to check out my Options Hotline service for more specific recommendations.

Sincerely,

Steve Sarnoff
Editor, Options Hotline

Steve Sarnoff’s Secret to Turning $187.50 Into $1,700 in 3 Months originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

Speculators get a bad rap. The very word conjures up pictures of some carefree playboy throwing money into any crazy investment – not really caring if they win or lose.

It’s not a flattering picture. And that’s why conservative investors shy away from anything “speculative” – lest they be called speculators, too.

Well, I’m here to tell you “speculating” isn’t a dirty word. You can be a conservative investor and still enjoy that chance at phenomenal profits that speculating can bring.

I learned that lesson from my father, Paul Sarnoff. He was one of the first people to offer an options course – introducing novice investors to the concept of Superleverage. But he also had a strong conservative streak. In fact, he was an avid fan of precious metals, advocating that they should be at the core of every solid investment portfolio. He even wrote books on gold and silver investing.

My father proved that even cautious investors can benefit from speculating. But as he always stressed – and as I still stress today – the key to being successful was to have a complete plan of action. You never, ever throw your money around casually…even if it is money you can afford to lose. And you must take steps to make sure you never get in over your head.

Of course, that’s easier said than done. That’s why my father developed six simple strategies for keeping a level head when speculating. They may sound common sense, but I’ve spent enough time in the markets to know that common sense isn’t that common when money is involved.

So, if you’re thinking of dipping your toe into the speculative markets, here are a few proven ideas to keep in mind:

1. Create a sound money-management strategy.

This one flies in the face of the conventional image of a speculator. But believe me, all consistently successful speculators start with a plan. It doesn’t have to be anything too involved – just make sure you’re clear on your objectives, and set some guidelines for yourself. Figure out your entry and exit strategy for each play, starting with how much to invest, how many open positions you plan to have, how you will monitor positions, what kind of stop-losses you will use to preserve capital, etc.

A sound money management strategy is the most important factor in successful speculation and it allows you to stay in the game.

2. Know your broker and monitor your investment

When choosing a broker make sure to ask as many questions as necessary and that you get the appropriate answers before simply giving over your money. If you are a beginner, find out about the broker’s history and references, and speak to them frequently to establish a relationship. Make sure that either your broker or you will be constantly monitoring your investment – today’s markets are very volatile and with options the price can shoot up 30% or more in just a few hours…so it is necessary that your broker is able to see the option is performing and be able to execute an order in a timely manner, to ensure that your capital is protected.

With so many discount Internet brokers out there, it seems like more and more people aren’t doing their homework before opening an account. It’s OK to try and go it alone… unless you don’t know what you’re doing. In that case, it’s well worth the time and money to explore more experienced flesh-and-blood brokers.

3. Stick with your exit strategy if a trade goes against you

With a good money-management plan, there should never be any surprises. No matter what price your trade is at, the action you need to take should be clear.

That doesn’t mean you have to be inflexible, however. Just because an option has met your profit target, you don’t have to automatically sell. But there has to be a compelling reason to stick with the trade – something more than a feeling that the trade will continue climbing above your target price. (After all, you selected that target price for a reason.) And always use a stop-loss or a trailing stop order to make sure you’re ready for any reversal that might pop up.

For a losing trade, however, you need to be a little more harsh. Options are wasting instruments, and their value dies a little each day. Sometimes it’s better to stick to your strategy and settle for a loss than it is to wait it out and hope for a miracle. That’s money you could be plugging into another play.

4. Always, always, always, ask questions

The Internet age is creating a generation of independent investors. But some are still too proud to admit that there are things they don’t know. In the speculation game, what you don’t know can’t hurt you.

If you’ve taken my advice about finding a good broker, you’ve already got a ready source of info to turn to. Dozens of Web sites also offer complete details on options trading. So there’s just no excuse for ignorance any more… and losing money because of ignorance makes even less sense.

5. Learn from your mistakes

Find out what works for you. There will be losers along the way – but just make sure you know what you did wrong in previous trades (e.g. you set a stop loss of 15% and were stopped out too early and the option rebounded to 56% profits). Take every trade as a lesson and use it to improve as you continue trading.

6. Remember that knowledge is power

You can never know too much… strive to learn as much as you can about options and their inner workings, strategies, fundamentals, everything… so that you will be better equipped to profit with options trading.

As I’ve said in the past, options trading is more accessible than ever before. And the profit potential hasn’t diminished a single cent. Going out of your way to learn the myriad of ways they can boost your bottom line is the easiest way to discover what works for you.

Sincerely,

Steve Sarnoff
for The Daily Reckoning
May 10, 2007

Do Shanghai skyscrapers have windows that open? If so, they might want to nail them shut.

The Fed’s rate-rigging group met yesterday. They announced that it was leaving the Fed’s key lending rate where it was (5.25%) but that it still considered inflation its number one worry.

What kind of ‘inflation’ were they referring to? Consumer price inflation? Or asset price inflation? Which one is most likely to do the most damage?

Yesterday, for the first time ever, China’s benchmark index climbed over 4,000. Not only that, but almost $50 billion worth of shares traded hands on China’s two exchanges – one in Shanghai, the other in Shenzhen. That’s more than all the rest of Asia combined, twice the level of Japan, and TEN TIMES trading volume just six months ago.

In China, in the next 24 hours, approximately 300,000 new stock market accounts will be opened. Communists, survivors of the Great Hunger, the Great Leaps, the Cultural Revolution, widows, orphans, mental defectives – everyone wants to get into stocks.

Why? Because they are going up!

“Investors will continue to take money out of low-yielding assets and put it into the stock market, and that will continue to exacerbate a supply and demand imbalance in the market, which leads to inflated prices,” said a source close to the action, quoted in the Financial Times.

Wait a minute. Aren’t these the same people who believed Mao’s silly guff? Aren’t they the same dumbbells who took the Long March…who starved each other…who tried to make steel in their kitchen stoves…who wore ugly gray suits, held up copies of Mao’s pathetic Little Red Book, and put dunce caps on anyone with wit enough to object?

But the Red gods failed. And so they’ve found new ones – stock markets. They’ve been victims of collectivism. Now, they seem to want to be victims of the market system too. And when the end comes – there has never been a bubble without a pop – many of them are going to feel like jumping out of windows.

Meanwhile, in the West…shareholders aren’t so naïve. They weren’t born yesterday, like the Chinese. They were born the day before yesterday.

They’re not stampeding into overpriced investments they don’t really understand. Nope. They’re going into them slowly. Yesterday, for example, the Dow rose again…but only 59 points. Like the Chinese markets, the Dow rises every day, but not as much.

And there’s another big difference. The Chinese are investing real money…money they earn and save…money earned from making things and selling them at a profit. They’re not sophisticated enough to know that you can get rich without really working. They haven’t yet discovered the wonders of the financial industry…or learned how to get rich by doing deals with each other, using borrowed money.

In England, for example, there are now about 200 lawyers who earn more than $2 million per year. Today’s TIMES of London tells us why: because the number of deals done in the City, London’s equivalent of Wall Street, is soaring. “The astonishing rise in profitability mirrors the dramatic rise in the volume and value in UK and international corporate takeover work,” says the paper. The value of those deals has already passed the $2 trillion mark this year.

Someday, of course, all this feverish activity will come to an end. The Chinese bubble will burst. The fad for deals will pass. And then, much of this money – now getting passed around like a groupie in a rock & roll band – will disappear. Or go back to its rightful owners. And then, the expansion phase of the credit cycle will be over.

When will that happen? How it will happen? Join your favorite DR editors this summer at the Agora Financial Investment Symposium for a look at not only global market concerns, but also he best investment bets across the globe. This year’s theme is “Rim of Fire: Crisis and Opportunity in the New Asian Era” and you will not want to miss one of the most important investment events of the year.

————–

Addison Wiggin, reporting from Los Angeles…

“‘Is anyone who values people over corporations automatically a “nut job”?’ a reader asked after remarks we made about Venezuelan President Hugo Chavez. Instead of responding, we figured sooner or later Chavez would open his mouth again and validate our claim. Well…it was sooner…”

For the rest of this story, check out today’s issue of The 5 Min. Forecast

————-

And more thoughts…

*** “Living on sponge cake, and Omaha beef steak, watching the shareholders running around,” crooned Buffett at this year’s Woodstock for investors, shareholders and Buffett groupies: the Berkshire Hathaway annual meeting.

No, it wasn’t the Oracle of Omaha himself singing the reworked version of ‘Margaritaville’ (which was aptly named ‘Berkshire Hathaway-a-ville)…it was his distant, and less famous cousin, Jimmy Buffett.

Capital & Crisis’ Chris Mayer milled through the swarms of Buffettheads and sent us back this note:

“More than 27,000 people filled Qwest Center on a cloudy Saturday on the fifth day of May. All of them came to hear two remarkable investors, Warren Buffett and Charlie Munger. The duo sits before the assembled throng and tirelessly answer questions put to them. In two parts, this extended Q&A runs about five hours.

“There are the inevitable grandstanders with their political statements and nutty questions. Then there are the sappy odes of hero-worship. ‘Oh, Mr. Buffett, thank you so much! You are my hero! My wife is pregnant and we are naming our son Warren after you!’ I silently wished the Earth would open and swallow him whole. No such luck.

“On the housing market woes, Buffett noted how Berskshire’s housing-related businesses are getting hit. Unlike many overeager investors today, who feel compelled to run into burning buildings by buying flaming housing-related stocks on the theory that the worst is over, Buffett offered a contrary view: ‘My guess is that it continues for quite a while.’

“No elaboration on how long is ‘quite a while.’ But these guys think in glacial terms. Long-term is a lifetime. Therefore, ‘quite awhile’ could mean at least ‘years.’

“On the private equity bubble – which involves so-called private equity firms raising huge pools of money and then borrowing a lot more to buy whole companies – Buffett noted a great flaw in the scheme. Private equity firms have a ‘great compulsion to invest quickly.’ That way, they can go out and raise another fund and keep the fees coming in. Basically, private equity firms are paid for activity, not results. And the nature of the business means that we won’t know who is successful until many years have passed. Buffett said the ‘score card is lacking.’

“On fears of a crash or meltdown or bad things happening in the market, Buffett offered wise words: ‘Something bad will happen, but you could go back at anytime in the last 100 years and say the same thing…you can freeze yourself out indefinitely.’ Every investor must play the hand he is dealt.”

Chris has been taking Warren Buffett’s investing advice for years now – and it has paid off. He fills his Capital & Crisis portfolio with companies that sweat assets and cash…and are stuffed with hidden wealth. To find out about three new stocks that Chris thinks could soar over 50%.

*** Want a laugh? Take a look at this.

Colleague Merryn Somerset Webb, editor of MoneyWeek, handed us a copy of an article from March 2000.

“The writer clearly wasn’t aware that the dotcom bubble had already begun to deflate.”

The article by Katharine Mieszkowski asked us to pity the poor dotcom CEO, the Internet innovator, the tech mover, and the IP shaker. They were supposed to keep up with all the trends in the fast-moving world of the Internet. But to do so, they had to read a lot of magazines. And the magazines kept getting fatter and fatter.

Remember Red Herring? How about eCompany? Now? Wired? Upside? Industry Standard? Business 2.0? At the peak in dotcom fortunes, these magazines were stuffed with ads. The dotcoms had billions and had to spend them some way. And they had to have articles to read to justify the ads. Remember those articles? We couldn’t make heads or tails out of them.

Red Herring’s March issue grew to 440 pages and weighed in at 1lb. 12.5oz. Business 2.0 had 448 pages and a sumo weight of 2lb,5.3oz. And so on.

If you had to read all the ‘essential’ magazines for the dotcom man-on-the-move, you’d have to get through 2,884 pages – which would be like reading War and Peace twice.

Well, every problem resolves itself somehow. As it turned out, reading all these magazines wasn’t so essential after all. And now, the dotcom execs who survived the industry shake-out have light reading loads. Most of the dotcom magazines went out of business in the tech crash. Those that are left – Wired and Red Herring – have been slimmed down…and refocused.

*** “How is your mother?” we asked a young friend last night. We were sitting at a restaurant, overlooking the Tower Bridge on the south bank of the Thames. That whole area is remarkably lively, with many new buildings, restaurants and shops. Our two companions, one of whom was our own daughter, were both aspiring young actresses – both so stunningly beautiful that a young man, passing by, staring, and not looking where he was going, practically fell into the river.

“Oh…you know, she’s 53 now. And now that I’m leaving home, she’s asking herself a lot of questions. I guess she figures that a whole stage of her life is over. I mean, she spent so much of her time looking after me…and now I don’t really need her anymore. So she doesn’t know what to do with herself.

“She’s been living in Paris for, what, 25 years? But now she’s ready to leave. She says she just lived there because she thought it was the best place for me to grow up. But where will she go? She doesn’t really want to go back to England or America. And what will she do?

“I feel a little sorry for her. It must be hard. She has to invent a new life for herself. I don’t know…maybe she’ll get remarried…but I can’t imagine it. She’s so used to being alone. And I don’t think she can start a career in business or a regular job. It will be too much of a shock for her. She’ll probably drift into teaching somewhere. Maybe teaching English as a second language in the South of France.

“You know, when you’re young…having the freedom to move, and do what you want is such a great thing. I mean, it is such a thrill for me to be here in London. There is so much to do…so many people to meet; it’s all so exciting. And then, I’ve got a job – well, it’s not much of a job, but it’s enough for me to eat – at the Avignon Festival this summer. And after that, I’ll probably travel around with friends; it’s really great.

“But when you’re older, I don’t think this kind of freedom is what you want. I mean, I think about my mother and I don’t think she wants to move around and discover new things. She wants a cozy place to live and cozy people to live with. And that’s what she doesn’t have. I don’t envy her.”

Six Secrets of a Master Trader originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

When people find out that I write a financial newsletter, they invariably ask, “What should I do with my money?”

Here’s my polite answer: “The best advice I can give is…make money, don’t lose it!”

Let’s clear something up: My work is not about investment.

Successful investing is like planting acorns and watching them turn into oak trees. I don’t work that way. My specialty is speculation, where the real money is made.

Speculation is more like playing with fireworks on a rainy winter’s evening. You light the fuse, and seconds later, it’s either fizzled out or a huge colorful explosion high up in the sky has illuminated the whole world.

Even though I’m a mild-mannered vegetarian pacifist, with over 20 years spent living in southern California, you won’t find many traders more aggressive than me. When I see the odds in my favor, I jump in with both feet. If I’m wrong, I accept my loss and get out. If I’m right, I don’t get complacent; I take my profits and I run.

Aggressive Trading: The Complete Game Plan

Planning is the key to an aggressive trading style like mine. I operate under what I call: The Complete Game Plan for Trading Success.

For each trade, you should consider what action you will take if you are right (where to take profits and how much of your position to exit) and what you’ll do if wrong (use stop-loss strategies or hold on and risk a worthless expiration).

My dad, Paul Sarnoff, explained it best, “Every trader with imagination and talent goes into a specific commodity armed with a trading plan,” he wrote. “Simply put, the trading plan involves the following factors:

1.Preset entry points – a price level at which the trader will enter the market.
2.Preset exit points, where the trader will realize profits.
3.Stop-loss points, where the trader will absorb his losses and limit his exposure in adverse markets.

The astute trader will have a plan for the useful employment of monies and equity generated if the market is favorable and a plan for averaging prices down by adding contracts if the markets retreat temporarily.”

The only certainty in markets is that they’ll fluctuate. Speculators make their fortunes from those changing prices. In the business, it’s called volatility.

Leverage is an important tool for speculators. In fact, leverage is the magic that turns small price movements into large profits…or losses. It is found in many different guises, but the fundamental design is always the same. The leveraged speculator uses OPM (Other People’s Money) in an attempt to make more money than would otherwise be possible with nothing but his own funds. In other words, you augment your position with borrowed money.

It sounds dangerous…and if not managed prudently, it can be bad for your wealth. BUT, if leverage can be applied to situations with strictly limited risk, it takes on a more sensible aspect. It becomes…

… superleverage.

Aggressive Trading: The Instruments of Superleverage

Superleverage is the art of profiting from changing prices, with limited risk. No margin calls, no demands for additional funds, no forced liquidations.

The instruments of superleverage are exchange traded put and call options.

Limiting your trading to the purchase of puts or calls may be the simplest options strategy, but it’s also the most effective. While more complex “spread” strategies can further limit your risk, they also limit your gain…and generate greater commissions and fees with your broker.

The advantages of using superleverage are: You don’t need to be a financial wizard or have large sums of money to participate. Secondly, you get all the benefits of OPM when you are right, but unlike futures and other leveraged instruments, your liability is capped.

The disadvantages are: The odds are against you. Options are wasting assets. And if the underlying security doesn’t move enough to give you real value, before a specified date, your options will expire worthless. That is your risk.

It was once calculated that 90% of all options expire worthless. That doesn’t mean you have a 90% chance of losing money…a winning options trader will offset one or two spectacular winners against eight or nine losers…and still have money left over.

When I’m wrong, my subscribers can lose 100% of their speculation, but not one cent more. And that’s the important part, because when I’m right, they have an opportunity to multiply their money many times over.

But there’s no easy money in this game and regularly reaping hard-earned rewards is a worthy challenge.

That’s why my father created Options Hotline 16 years ago. I was fortunate to work as his associate editor for four years, before he passed away in October of 1999. He taught me everything he knew about the markets. Now, in my sixth year at the helm, I know he would be proud of how the service has grown and consistently helped so many fine folks beat the odds.

Speculation: The Three Cornerstones of Success

But many speculators fail…even when armed with good picks. I think it was Woody Allen who said, “In life, there are pitfalls and there are opportunities. The idea is to avoid the pitfalls, seize the opportunities, and get back home by six o’clock.”

Here are my brief thoughts on how you can do just that:

We already talked about the importance of a complete game plan. The three cornerstones of your plan should be: psychology, method, and money management.

Psychology is to the trader as fitness to the athlete. You must be of sound mental fitness to speculate successfully. There are two aspects to this or, as we call them in the business, the “Twin Tolerances for Risk.”

Financial tolerance is easier to determine. Do the math…annual income, liquid net worth, etc. You should only speculate with risk capital (money you can afford to lose).

Psychological tolerance requires you to be able to sleep at night and not let rollercoaster markets adversely affect your family life. You must look deep inside yourself to determine if you have the nerve and can handle the pressure of speculation. If a bad trade knocks your confidence, reassess your strategy, don’t just double up your position and hope to win it back…like most people do.

Method is how you make informed market decisions. You must either do your own research, or pay for it. This is what market advisory services, such as Options Hotline, aim at.

The most important factor in successful speculation is sound money management. Trading success is more a function of honing your survival skills than picking winners. Most people have it backwards. They speculate based on hyped up hopes of fantastic profits. You should speculate based on what you can lose, not what you can gain. Be prepared to handle trading losses. Never add to a losing position. That is how many players get knocked out of the game. You want to be in there when the market goes your way. You, or your broker, must monitor your positions closely. They don’t ring a bell when it’s time to get out, so make sure you have an exit strategy in place for each trade.

Okay, now that I’ve bored you to death with my trading strategies, you probably want to know what I see happening now.

The Dow closed yesterday’s session (Wednesday, 01/26/05) at 10,498.59. I see underlying technical support at the following levels: 10,380-10,450, 9,950-10,150, and 9,660-9,750. The venerable index looks like it wants to test support in the low-10k area, and could do it within the next week of trading. That would be a good potential short-term turning area.

My contrarian senses are tingling. Over the longer-term, I think the surprises of the year will be turn out to be: strength in the U.S. dollar, rising long-term rates, and falling Apple shares.

The iPod people’s shares are trading around $70. I know they’re wonderful and selling like crazy, but that’s not what I base my decisions on. I study price movement to determine who is stronger (buyers or sellers) and when that balance of power is likely to shift. Sure, everyone loves them; but the character of the behavior of share price movement tells me sellers are poised to gain the advantage for the first time since July. From Apple’s current level, resistance is at $71.76-$74.42 and support is at: $68.25, $63, and $45-$50.

Oil has support around $40 and gold is trying to hold support around $420. If the dollar rises, gold will face pressure and may need to shake out more of the weaker longs before resuming its rise.

Above all, have fun…if you ever get bored, or tired of speculating, you are toast, and the markets will eat you for breakfast.

This is the most important advice I could give you.

Regards,

Steve Sarnoff
For the Daily Reckoning

January 27, 2005 — London, England

P.S. The most valuable thing you can spend is your time. Much of the financial commentary I see and hear is distracting noise, lacking truly useful information. In writing the Options Hotline, I always keep that in mind and strive to provide my clients only with the valuable information they need to vie for fun and profit in today’s markets. It’s strictly a no-fluff zone.

Since January 4, 2004, of the 34 recommendations Steve Sarnoff made, 30 of them were winners. Not only that, 11 of them doubled in value! Using Options Hotline, Mr. Sarnoff has surpassed a million dollars in gains…and to celebrate, we’re offering this service for one year at $250 dollars off the regular cost.

It is the World Cup, the World Series and the Olympics all in one. The world’s top players are all in Davos, Switzerland. The press. The celebrities. The movers and shakers.

The sport is humbug…and the stakes are huge.

Attendees are all committed to “improving the state of the world.” There are heads of state, such as Tony Blair and Gerhard Shroder. There are heads of business, such as Bill Gates and Michael Dell. There are the various has-beens and wannabes appearing in the press from time to time: Bill Clinton, Lord Carey, Mahmoud Abbas, and so forth. And there are the idealists, the bleeding hearts, and various no-talents on the make, such as Angelina Jolie and Sharon Stone. Judging from her performance in Alexander the Great, Angelina could easily improve the world; all she needs to do is to take acting lessons, or retire from the silver screen.

But as we know, the world improvers are never really interested in private acts of self-improvement. Instead, they favor great public spectacles that flatter their vanity and generally lead to disaster.

The only major league world improvers who are not attending this year’s World Economic Forum are the members of the Bush Administration, who have so many world improvements already in progress they need no further inspiration.

Yesterday, Tony Blair warned the world to get serious about climate change. Jacques Chirac, even more compassionate than Mr. Blair, proposed a tax on air traffic and capital flows into countries that refuse to force banks to blab the details of their customers’ wealth.

“It’s an honor to be here among all you smarty pants,” said Sharon Stone. We don’t know why she thought they were all such smarty-pants. Looking down the list of attendees, what we see are mostly sinners and hacks…with a few delusional artists in the mix.

Conspicuous by his absence is your very own editor, whose invitation to Davos must have gotten lost in the mail. But we are grateful to Fred Bergsten of the Institute for International Economics in Washington; Fan Gang, the director of the National Economic Research Institute in Beijing; and Stephen Roach of Morgan Stanley, for taking his message to Davos.

The “weakest link” in the world economic picture, Mr. Roach told attendees, is the “‘self-indulgent consumer” in the United States, who depends on a “bubble” in real estate prices in order to continue living beyond his means. Yesterday, the consumer, along with a spendthrift government, brought news of a record budget deficit of $427 billion this year, which poses a grave threat to the world economy. If these excesses are not addressed, warned Mr. Bergsten, “the dollar would come down sharply, U.S. inflation and interest rates would be pushed up sharply and the world would follow a much slower growth pattern. Trade would be a big casualty: it would be poison for U.S. trade policy.”

Meanwhile, Fan Gang revealed that his government had lost faith in the dollar. “The U.S. dollar is no longer (seen) as a stable currency,” he said. In the months ahead, China would begin to separate itself from the dollar that ‘will not stop devaluating,’ he told the world improvers. As to why China hadn’t done so already, he explained that it was a bit like fixing a roof. When it rained heavily (such as last fall when the dollar was falling sharply) you can’t do it…and when the sun is shining, you don’t have much interest in doing it: “High pressure…we don’t do it. When pressure’s gone, we forgot.”

This time, we won’t forget, Fan vowed. The Chinese are said to be buying euros.

More news, from our team at The Rude Awakening:

————–

Eric Fry, reporting from New York City…

“Because dollars are plentiful and crude oil is scarce, large holders of the former have become increasingly interested in exchanging them for the latter.”
————–

Bill Bonner, back in London:

*** Next week, G7 will gather in London…

The chin-wagging has already started. You know what Fan Gang told the crowd in Davos yesterday, next we hear Mr. Jin Renqing, China’s Finance Minister, is heading to the G7 meeting with the specific intention of engaging world leaders in “a deep dialogue” on China’s exchange rate.

Is an end of the dollar’s peg in sight?

Hardly says trading wizard Dennis Gartman. “We thought [the statement was] important. However, we thought it less important than did, or has, the rest of the foreign exchange dealing world. To the rest of the world this was a virtual tectonic plate shift. To us it was notable…interesting…. even perhaps important. But earth shattering? Hardly.”

“We must always remember that when dealing with things Chinese, rhetoric is perhaps more important than anywhere else in the world. Subtlety… even obscurity…. is a virtual art form amongst the international foreign relations and economic cognoscenti, and it is especially so at the highest levels of China.”

*** Gold rose to $426 yesterday. We ratchet up our target-buying price once again. This time, we buy below $425…and hope the price falls again so we can buy more.

*** Two fat kids are suing McDonald’s…again. The suit was thrown out once…but it’s back. Surely, the kids are world improvers. They think the world would be a better place if McDonald’s had to print “HAMBURGERS KILL” on their Big Mac boxes…and the kids had $100 million in their bank account.

*** Another reader; with another interpretation of God’s holy writ:

“Regarding the January 20th issue, in which a reader reproaches a previous contributing reader with his understanding of the meaning of ‘Thou shalt not kill,’ I would like to add my two bits worth to the linguistic part of the debate.

“The words translated as, ‘Thou shalt not kill’ are the Biblical Hebrew ‘Lo tirtzach.’ It is clearly not Aramaic, as your reproachful second reader wrongly states. The fest of the two words is not ‘Laa’ but ‘Lo,’ even though it is written with an aleph, so your reproachful second reader is wrong here too.

“More importantly, he is also wrong, along with the King James Version, about the translation of the expression, which clearly means, “You shall not murder,” as the previous reader correctly asserted in the first place. If anything, you may even want to make it: ‘You shall not assassinate,’ to render the element of criminal, unlawful premeditation contained in the Hebrew word. For whatever good or bad theological or English reasons of his own, the translator who came up with the King James chose to make it ‘You shall not kill’ (in the English of his days, which actually has nothing inherently Biblical about it) but this is very clearly not what the original Hebrew means.

“Your reproachful second reader might want to get his facts straight, language-wise, before he uses wrong arguments to hurl insults at the previous reader, who was language-wise absolutely correct. The accumulation of errors made by your reproachful second reader actually makes him look rather ridiculous and weakens his political case considerably.

“I hope that this does not spoil your nice day.”

*** This week marks the 60th anniversary of the liberation of Auschwitz. There, the Nazis put millions of people to death. The victims were surely killed. But were they “murdered” or “assassinated?” We pause to admire the suppleness of the language and the human brain. Can a legitimate government – especially one of the world’s most advanced and supposedly civilized nations – “murder” someone? Is it murder when a government hangs a criminal? Is it murder when the government bombs a city of a nation that never attacked it and with which it is not at war? What if the killing is part of a government program intended to improve the world?

We don’t know.

For our own part, we will take the King James Version the way we learned it as a child. If we are going to kill someone, we will need a damned good reason. And even then…may we roast in Hell if we did the wrong thing.

Superleverage originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.