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Little Book but Big Gains

Published on February 4, 2007

Little Book but Big Gains

February 4, 2007

The little book that beats the market.

I first mentioned about this book in my posting here on Jan 20, 2007. Let me briefly talk about why I think this is a great book and how I would like to use it for option trading. As per the screening on Feb 3, for >100million market cap, Fording Canadian Coal Trust (FDG) is amongst one of the TOP 25 companies. Here are the key points about FDG:

  • Market Cap > $3.3 billion
  • Pre-Tax Earnings Yield : 20%
  • Return on Capital (ROC) > 100%

    I didn’t penetrate into further details on how these numbers are calculated but I am assuming that system works and it’s correct. Though past performance is not indicative of future, just look at the past 5yr chart of the company. fdg-feb-1-2007.png

     

    Let’s dive in how to use it- According to Magic formula investing (The little book that beats the market) I shall assume that over a period of time, the price should go up assuming fundamentals, yields remains same. If I buy either diagonal leaps spread or calendars, I should be able to create something that will give me gains from Theta or delta. So Here I created 3 calendar spreads of $20/$22.5/$25 for $270 investment. fdg-feb-2-2007.png

    And Look at the beauty of this trade, depending upon where FDG is by Feb expiration your returns may vary from $40 to $98 on $270 investment. And mind it, this is only 1 month. You can continue to benefit from this till next year. fdg-feb-2007.png

    Simple concept, difficult to manage. One need to understands Option greeks and adjustments to manage the trade. Those are the key points that one needs to understand thoroughly before enjoying this so that you don’t lose money. However, my point here was to show how this book can be used. One needs to read through it to understand better the foundation of “stock screen” for this strategy.

    Enjoy experimenting,

    Profitable trading,
    OptionPundit

5 Comments

  • Avatar Simon says:

    Optionpundit . This stock to me looks overbought looking at the RSI. It has been on a downtrend for quite some time.
    The positive is its not a big mover an is not very volatile. Are you bullish or non directional here?

  • Avatar optionpundit says:

    Simon- Though I like technical indicators to determine entry and exits, but in this particular strategy I am not looking for technical indicators that much. I want to benefit from theta decay and long term bullishness on the stock. My way to go is to keep my delta as close to neutral as possible while maximize theta so that I am not too much carried away by the fall.

    You are right that this has been on a downfall for past 1 year or so, but I think if I would have managed my delta well on the downfall, I could have still benefited from theta decay. And I think that’s where trade management skills will come into play. I have experienced this with XOM for the past 2 months, it’s been enriching experience. I shall share that at some later date.

    Hope that helps,
    OptionPundit

  • Avatar matpos says:

    Hi OP, could you post more about the diagonal leaps spread or calendars? And how you analysed the theta or delta? Could you recommend a book or a website which cover the greeks well?

    Thanks. All the best for your trading.

  • Avatar OptionPundit says:

    Matops, I have recommended only 2 books so far. One “The little book that beats the market” but that is not about options. I have recommended “Options Trading : The Hidden reality”, for options trading and all the nuts and bolts of options trading. PLs check out my post for details and know about the book …..it is in the right side column in “reading spotlight”…

  • Avatar matpos says:

    Thanks OP, I’ve got the ‘Little Book’, am reading it now. Will take a look at the ‘Hidden Reality’ after that.

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