I
bought DNDN shares last month at about $4.00 and less than a month later, I
sold it for $21. Yes, that’s 425 percent profit in less than a month. Was that
pure luck? How often has that happened to you? What if I told you that luck has
nothing to do with this and that I bought DNDN shares knowing that it will
break out strongly very soon?
Yes, I did
know for a high level of probability that DNDN was going to stage a big rally
soon and I didn’t even look at their news or their earnings nor financial
statements in order to do that. In fact, it took me only about 1 minute to spot
this great trade. What? Just one minute without even looking at the charts?
That’s
right and here’s how I did it:
Every day,
I simply look for stocks with unusually high extrinsic value on their out of
the money call options. I usually look for extrinsic values that are over 20
percent of the price of the underlying stock itself.
Why do
stocks with unusually high extrinsic value
signal a rally?
What is
extrinsic value ( http://www.optiontradingpedia.com/extrinsic_value.htm )?
Extrinsic value is the part of the price of an option which goes down to zero when
the option expires. It is the extra money you pay to market makers for selling
the options to you. It is like insurance premium which goes to zero when the
insurance expires. Of course, a lot of factors go into determining fair
extrinsic value and one of the biggest determinant is implied volatility or how
volatile market makers think the stock is going to be in the near future.
Market makers
are members of the exchange and are who you are buying and selling options with
when you trade options. Market makers control the extrinsic value of options
through adjusting the implied volatility of options in response to news,
sentiment or trading activities. Market makers are the “insiders” of
the market and they know when something is brewing and then raise the extrinsic
value of options on those stocks so that nobody can reap a free lunch through
purchasing those options. Sad, but true. Somehow, these market makers are
extremely accurate and stocks do rally, most of the time.
With this
information, one could either do a covered call options trading strategy on these
stocks ( http://www.optiontradingpedia.com/free_covered_call.htm ) or they can
simply hold on to the stocks itself to speculate the stock going higher. How
about buying call options instead? Yes, if you buy deep in the money call
options with little extrinsic value. At the money call options and out of the
money call options are out of the question since the extrinsic value would have
been high enough to significantly reduce any potential profits, if any remains.
Yes, this
is no rocket science and you can easily set up a screener for such stocks using
most of the online options trading accounts. Have fun, good luck and remember
to obtain professional advise before acting on any of the above suggestions.
