Performance of our stock tweets

Dear Investor,

since May 11, 2009 Stocksinside has used Twitter to publish some of its research, based upon automated stock market screening. The following table shows the performance of our stock picks so far. The performance values (profit) were calculated regarding the basic financial instruments, but it is worth to mention what profits could have been achieved by using call options leverage.

Rec. Date		Symbol	Name	Buy	Highest	Profit	High Date
11.05.2009		NRG	NRG ENERGY INC	$20,64	$29,19	41,4%	16.09.2009
11.05.2009		APOL	APOLLO GROUP INC	$59,91	$74,74	24,8%	21.09.2009
12.05.2009		ALKS	ALKERMES INC	$8,81	$11,65	32,2%	27.07.2009
12.05.2009		ENDP	ENDO PHARMACEUTICALS	$16,16	$23,07	42,8%	14.09.2009
14.05.2009		VMW	VMWARE INC	$27,03	$41,09	52,0%	22.09.2009
29.05.2009		PNY	PIEDMONT NATURAL GAS CO INC	$22,66	$25,60	13,0%	21.08.2009
30.05.2009		WGL	WGL HOLDINGS INC	$29,72	$34,17	15,0%	27.08.2009
08.06.2009		CBST	CUBIST PHARMACEUTICALS INC	$17,67	$21,97	24,3%	11.09.2009
23.06.2009		HES	HESS CORPORATION	$50,46	$57,29	13,5%	03.08.2009
23.06.2009		MUR	MURPHY OIL CORP	$50,70	$61,79	21,9%	16.09.2009
23.06.2009		MRO	MARATHON OIL CORP	$28,77	$33,88	17,8%	17.09.2009
20.07.2009		RRC	RANGE RESOURCES CORP	$44,42	$52,37	17,9%	22.09.2009
20.07.2009		RIG	TRANSOCEAN INC	$75,45	$87,11	15,5%	22.09.2009
23.07.2009		ENDP	ENDO PHARMACEUTICALS	$17,20	$23,07	34,1%	14.09.2009
04.08.2009		XTO	XTO ENERGY INC	$42,60	$42,88	0,7%	22.09.2009
04.08.2009		CSC	COMPUTER SCIENCES CORP	$48,76	$52,93	8,6%	16.09.2009
04.08.2009		OTEX	OPEN TEXT CORP	$38,64	$39,63	2,6%	13.08.2009
12.08.2009		PCLN	PRICELINE.COM	$148,64	$168,24	13,2%	16.09.2009

How to calculate options leverage?

Financial leverage allows a smaller amount of money to participate in and own profits usually assessable only to a larger amount of money. Leverage is a major benefit of options investing, and when used carefully it can provide significant profits.

Options leverage – also called Lambda in options terminology - is the cash equivalent multiple of one's options position relative to the actual cash (spot) price of the underlying asset.

Stock options produce options leverage as every contract represents 100 shares of the underlying stock while costing only a fraction of the price. This allows option traders to control the profits on the same number of shares at a much lower cost.

To explain how options leverage is calculated, here is an introducing example. Assuming you have $1000 and wish to invest in shares of a certain company, which is currently trading at $20, you can only buy 50 shares. That's further imagine that it's $20 strike price call options are trading at $2.00, which means a single contract costs $200.

Instead of buying the shares you can buy 5 contracts of $20 strike call options to control 500 shares! With the same amount of money, you can control 10 times more shares than you normally can do by buying shares. This gives you a first impression about options leverage in option trading but not unveils the complete story.

The problem with the illustration above is that even though 5 contracts of the $20 strike price call options represents 500 shares, but the option price does not move in exactly the same magnitude as the shares of the company. Stock options move only a fraction of the price of its underlying stock, governed by its “Delta” value. An "at-the-money" option, typically
has a delta value of 0.5. This means that each contract of $20 strike call options moves only $0.50 for every $1 move in the underlying stock. The delta is sometimes also used to describe the probability of the option to end “in-the-money”. The delta of “out-of-the-money” call options is typically between 0 to 0.5, whereas the delta of “in-the-money” call options is above 0.5.

If the stock, in our example, rallies to $24, the $20 strike call options rise $2.00 to $4.00 due to their intrinsic value. In this case the rise in stock price is 20%, whereas the increase in the option price is 100%. This ratio (100% / 20%) is the options leverage.

The formula to calculate options leverage is defined as:

Options Leverage (or Lambda) = Delta x Stock price (S) / Option price (V)

with

Delta = dV / dS = Change of option price / Change of stock price

In our example:

Options Leverage = 0.5 x $20 / $2.0 = 5

As you can see, the calculation of options leverage is quite easy if you know the Delta value, but it is hard business, if Delta is not yet available. Especially, if the option is far “out-of-the-money” or deep “in-the-money”. Several financial models - like the Black-Scholes model - provide equations to calculate Delta and other options related numbers approximately, but due to their complex mathematical expressions they are not feasible by the usual options investor.

Usually, your brokerage system should provide option parameters like the Delta. If not, we have developed a proprietary approach to determine Delta from option prices. If you want to determine the Delta parameter of a particular call option, you can do so by exercising the following formula:

Delta = (price of next expensive option – price of target option) / (strike of target option – strike of next expensive option)

Example with call options:
Spot price of underlying security: $41.00
Price of target option: $2.30, strike price: $46.00
Price of next expensive option: $2.63, strike price: $45.00

Delta = ($2.63 - $2.30) / ($46.00 - $45.00) = $0.33 / $1.00 = 0.33

Please, be aware that the result of this calculation is not precise and contains certain amount of inaccuracy. But nevertheless, it’s a feasible approach to calculate Delta in line with the mathematical definition.

How to invest middle-term?

Today, the most important question for you, as an investor is: Should I cash in profits now, stay in the market or even expand positions? This is finally not easy to be answered. If you take a look at the S&P 500 of the last 10 years, you can simply discover that after reaching the lows in 2002 and early 2003 the recovery took place without significant decline in prices.


When the S&P 500 had been returned to 1000 points in summer 2003, no W-pattern had been formed and the lows were not reached again. Everybody had fear after 3 years of bear market, but nobody wanted to sell out. And while leading indicators continued to improve, it was the right choice to bet on further market improvement.

Today, the situation feels pretty much the same. After emerging from the lows and reaching the level of 1000 points, nobody wants to stand at the sideline.
Short-term we expect some range-trading – most investors want to see lower prices to load up on the buy side. As long as worldwide policy remain loose, and yields remain low, declines in prices are used to expand positions and there is still a lot of money out there. This can be seen as a healthy correction. At the end of 2003 the S&P was above 1100.

However the big challenge in the future will be, how central banks around the world, solve the situation with the easing and the flood of cheap money. No doubt, the economy will have to digest rising interest rates in the future. But this situation should not arise before second half of 2010.

As a mid-term investor you have to keep your focus on the following questions:

• When will policymakers withdraw the stimulus and how much?
  We expect a first increase in interest rates by the FED in the 2nd quarter 2010, but it will be moderate and should not make markets shy.
  
  
• Will the leading indicators continue to improve?
  We think yes, because any fiscal actions always show signs with some delay. Although, unemployment rates are on the maximum right now, the situation will improve within the next 9 to 12 month.
  
  
• Will Chinese import growth continue to accelerate relative to exports and what will tighter financial conditions in China do to growth?
  Even, within the worst times of recession, China showed a positive growth domestic product (GDP) development and is likely to return to old performance. The more interesting question is – when will China going to be overheated?
  
  
• Will inflation continue to be under control despite improving growth and accommodative policies?
  We expect yes - the centrals banks will take care about this more than ever.
  
  
• Are the better signs in the US housing market likely to persist and how will the job market develop?
  
  
• Was the recent positive surprise in the Euro-area a one-off, or is it set to continue?
  The economy in Europe should improve with lower pace than in Asia, but exports into this region would help to further improve the local situation.

So, what’s the conclusion of the story?
As many others, we expect a further market improvement in the mid-term, not without some declines in the short-term. But this can be opportunities to expand your long positions, not without hedging against set-backs.

Therefore you should buy put options with enough leverage to secure your long positions. For example – if you like to invest $10,000 on the buy side and like to assure against a 30% decline – which equates to $3,000 - you should spend $300 into put options with a tenfold leverage.

Next time we'll explain the calculation of options leverage in detail.