Larry -

When the commercials went net long last March, I purchased some shares of the Rydex fund that you told us about, and that has worked out great. I've been able to save up some investment cash over the past couple of months, and I want to invest it in SPY and QQQ options. My questions are 1) How do I calculate the leverage that an option will generate when compared to it's index. I want to know this so that I don't over-leverage myself. And, 2) What would you consider to be a good buy point in the current market? I've heard when the index is within 5% of it's 50-day moving average.

Would you mind posting some specifics of the options you bought when the commercials flipped last March? It would be valuable for me to see what purchase date/price/strike/expiration you bought at so that I can compare to the current info to see the price movement and so forth.

Thanks for all of your great advice on this board, and your weekly report!

Marc,

You’ve brought up a subject that I want to make a focus of a future Smart Money Report, but to answer your questions I will give you a little preview here.

There are no SPY options. However, there are options on the S&P500 index itself – the SPX. I bought a combination of SPX and QQQ options in with various strike prices and various expiration dates. But, for illustration purposes, I’ll give you an example of one.

When the commercials flipped to being net long in late March, the QQQ was trading at about 26. One call that I bought was the Jan ’05 QQQ LEAP with a strike price of 24. I paid an average price of about 5.60 for those options. Since the option was two dollars in-the-money, of that 5.60 premium, 2.00 of it was intrinsic value. The rest was time value. Now QQQ is at about 30 and those options are bid at about 7.80. So QQQ is up about 15%, and the options are up about 40%. So you can see the leverage.

The particular leverage that you’ll experience depends on which option(s) you choose. It’s all in the “greeks.” You will get the most leverage with out-of-the-money options, and the least with in-the-money options. On the other hand, you’re taking more risk with out-of-the-money options in the form of theta (time decay).

Also, you will get more gamma (the change in the delta) with fewer days to expiration, and less with more days to expiration. That will also affect the option price in relation to movements the underlying security. In other words, an option that doesn’t expire for a year and a half, will move slower than an option that will mature in two months even though they may be the same strike price.

For the most part, I tend to be pretty conservative with my options so I tend to emphasize in-the-money options with far out expiration dates.

As I keep emphasizing, options are sophisticated financial instruments and there are a lot of variables to consider.

Larry

I hope I am not duplicating this message. I seem to be having problems with my mouse.

I was following up on Rydexfund.com and read where the starting account is $25K minimum. Isn't that an awful lot of money to tie up?

Kenny

Kenny

I don’t know if it’s a lot of money or not because everybody’s financial situation is different. But the $25,000 minimum is just if you buy directly through Rydex. If you buy through your broker, whatever your broker’s minimum account is should be your minimum.

If you’ll use the “Search” feature at the top of the page and search for “Rydex,” I know there have been some posts on this before. As I recall, Ameritrade for example has something like a $1,000 minimum in an IRA account.

Larry

Marc,

In my haste earlier I didn't answer the second part of your question. For what it's worth, in my trading account I wanted to buy the QQQ today if it had traded a little closer closer to 29 (which is not very far from its 50 dma). And I'll probably be looking to buy weakness again tomorrow.

I don't have a good place to buy SPY yet. But my general view is that the market is setting up for a near term oversold condition in the next few days from which we can get a pretty sharp rally.

I hope that helps.

Larry

does one buy SPX options with a STOCK broker or commodity broker?

ameritrade won't accept options on SPX.

-ja

Joe,

You should be able to trade them through your stock broker. They’re heavily traded options. I’m sure your broker will let you trade options on the even more heavily traded OEX (the S&P 100 index), why not the SPX?

By the way, we haven’t mentioned it before, but the options on the OEX is another good proxy for the S&P.

Larry