Stock or Option

Posted by: Dr. Ge on October 8, 2005 2:14 pm | In Long Ideas, Stock Options | No Comments | E-Mail This Post/Page

I added 200 more shares of OVTI at $12.27. My price target of OVTI in the next 6 months remains $20.

Today I am going to talk about what investment vehicles you should use after you spot a good investment opportunity. In my posts, investment mostly means staying long in a security. In my opinion, shorting is a much tougher game to play. It’s not because you have difficulties to spot something overvalued (we all know TASR, SHLD, MSO, BIDU etc. are (or were) overvalued), but because you have trouble to figure out how much it’s overvalued and when the bubble will burst. A lot of people got burned on the short side because of bad timing.

My investment strategy is almost identical to John Neff’s – buy bad stock of a good company. Sometimes I choose long term out-of-money call options when the stock is really bad because the call options are so dirty cheap (like my play with NOK and OVTI last year). But sometimes I buy out-of-money short-term calls to play an event such as a court decision or an earning report. You spend a small amount of money but if things go well, the return will be incredibly lofty. Basically you are playing the leverage game – but with some extremely undervalued stocks and good timing, you have a better chance to win.

My play with the court decision of LEXR (LEXAR MEDIA INC, Lexar VS. Toshiba ) in March, 2005 yields a 1200% return in 7 days. It’s very tough to play with the stock because if the court decision had been against LEXR, you would have lost a lot of money.

Bought 20 LEXR APRIL 2005 $5 call options on 3/17/2005 @$0.1
Sold on 03/24/2005 @$1.53. Total return: 1,221.5%

Similar play with PAYX (Paychex Inc.) on earning report yields a 663.4% gain in a month.

Bought 30 PAYX JULY 2005 $32.5 call options on 5/31/2005 @$0.1
Sold on 06/28/2005 @$0.9. Total return: 663.40%

But the ultimate problem with stock option is the timing. You are losing money everyday on your options as time flows. So generally I buy stocks and long term call options (to play the leverage game thus beef up my total return) but once in a while, play some special events with dirty cheap short-term out-of-money options. It’s all about how much risk you can bear with.