How to turn $2,500 into $25,000

 

Sometimes the market has an element of gambling about it, but it is not pure chance, if you understand the trends that are pushing the numbers around better than the market. What exactly is the market? Unfortunately, the average investor is not the same as the market; studies show that the most savvy investors have a disproportionately high degree of influence over a stock's price. This is initially counterintuitive, but it makes sense if you think of stock trades as if they were tweets. Over time, the savviest investors pick up more followers, just as the most popular Twitter accounts do. Active traders tend to jump in the same direction as the savviest investors while ignoring the trades of Joe Nobody, even when the trades are otherwise the same.

The point is that you are always in competition with the market's shrewdest players. If you so much as dip your toe in the market—even in the shallow end—you will soon find you are swimming with the sharks, and the price of every stock has been weighed five times by each of them before you ever see it.

Ah, but have you ever looked at an options chain? A typical stock has dozens, nay, scores of options. Many have hundreds and each of these trades on the open market, just like stock. Each has a bid and an ask, just like stock. But unlike stock, it is impossible for any investor, no matter how shrewd to keep track of all of them at the same time. All we have to do is find the ones that offer the greatest realistically achievable potential gains—and then check to see if the buy price makes the option worth the high risk. In other words, we are looking today at the incredible potential of speculative option trading.

Speculative option trades only have so much upside potential because they are high risk investments. (I know you know that, but you know I have to say it anyway.) It may not seem like there is a unifying theme here, at first, but stay with me.

Orexigen Therapeutics (OREX)

Back in June, Orexigen Therapeutics was awaiting the word from the FDA that its obesity drug Contrave had been approved, but instead, the FDA delayed the decision until September 11. We don't know why the FDA delayed their decision, but there seems little possibility that Contrave will not eventually be approved, for the following reasons:

  1. Contrave is a combination of 2 already-approved drugs, bupropion and naltrexone. Bupropion is an anti-depressant, naltrexone is used to fight alcohol and opioid dependence.
  2. Unlike most weight loss medications, Contrave has little potential for abuse and will not be a controlled substance.
  3. In studies, the group taking Contrave has lost 9% to 10% of their body weight—more than twice as much as the group taking placebo.

The FDA isn't likely to keep us out of our skinny clothes for no good reason, and if they approve the drug, OREX will certainly rise. How much, I can't say, but potentially, it could be a lot—even a double. But why settle for double your money?

Here is the play: OREX is trading at $5.80. Buy 10,000 OREX September 8 calls for twenty cents each. That's a $2,000 investment. If, on September 20, OREX is below 8, you lose the investment. For every dollar OREX is above 8, you make $10,000, minus your original investment, of course. So if OREX were to double, you could sell your options for at least $30,600, for a profit of $28,600. That's a profit of 1,430%.


Chart courtesy of stockcharts.com

Google (GOOGL)

Google continues to dominate the world of online advertising, and though another giant, Facebook, has come on the scene, the companies have staked out very different territories. Google also has a finger in nearly every technology pie ever made, and they continue to innovate in ways that other companies can only envy.

GOOGL stock, at $581.59, is below its March high of $610.42, but you know these tech giants tend to grow in spurts. One of these days investors will decide Apple's (AAPL) spurt is over and head back to Google, but if you had the $58K to buy 100 shares of Google, you wouldn't be reading this article. Also, despite Google's long term potential, no one expects the stock to double this year. $850 to $900 per share would almost certainly be considered a best case scenario.

That doesn't mean you can't more than double your money. Here's the play: buy 1,000 GOOGL December 705 calls for $2.35 each. That's a $2,350 investment. If GOOGL is under $705 on December 20, you lose your investment. For every dollar GOOGL is above $705, you make $1,000. If Google were trading at $850, your options would be worth at least $145,000. That's a 6,000% profit.


Chart courtesy of stockcharts.com

Illumina (ILMN)

Relatively small Illumina is the industry leader in genetic sequencing, a market currently worth $2.3 billion annually, but which is growing very fast (about 50% each year) and which has the potential reach every corner of the globe. ILMN stock got a bit ahead of itself back in March, but the company has continued to do everything right, growing rapidly and making acquisitions. Since 2010, the company's compound annual revenue growth is 16.3% and its compound annual earnings growth is 21%.

I said last year, when ILMN was under $100 per share, that it would hit $200 by the end of the year. I now suspect it will do that by the end of the month. So here's the play: buy 1000 ILMN December 220 calls for $2.50 each, that makes this a $2,500 investment. If ILMN is trading for less than $220 on December 20, you lose your investment. For every dollar over $220, your options are worth $1,000. If ILMN is trading at $280, for example, your options will be worth at least $60,000. That's a profit of $2,300%.


Chart courtesy of stockcharts.com

Tesla (TSLA)

Remarkable Tesla has proven to be the little engine that could, despite their cars lacking anything recognizable as an engine, though today, many analysts are as excited about Tesla's entry into the domestic solar battery market as they are about Tesla's cars. If you looked away, back in the Spring, when Tesla was being beaten up for foolish reasons, you may not have noticed that the stock is back at a new all-time high of $260 per share. Perhaps you believe in Tesla's potential but don't like the idea of buying stock at a high. Fair enough.

So here's the play: buy 500 TSLA January 350 calls for $5 each. Again, that's a $2,500 investment. If, on January 17, 2015, TSLA trades for less than $350 ($350 is Morgan Stanley's target price for the stock, as it happens), you lose your investment. For every dollar above $350 TSLA trades, your options will be worth another $500. If TSLA trades for $420 in January, your investment will be worth at least $35,000. That's a 1,300% profit.


Chart courtesy of stockcharts.com

Noodles & Company (NDLS)

This company has never been a favorite of mine, but there must be some contrarians out there who think the stock's recent 16% drop (following a bad earnings report) was too much, and who want to play it on the rebound. Well, if there is one thing I can't resist, it's giving the people what they want.

Be additionally warned that while all of these trades are high risk, this one is particularly high risk, because the options in question expire in less than five weeks. Still, if play you will, here's the play: Buy 10,000 NDLS September 25 calls for twenty-five cents each. That's a $2,500 investment. If NDLS trades for less than $25 per share September 19, you lose your investment. For every dollar above 25 that NDLS trades, your investment will be worth another $10,000. If NDLS bounces back, over the next month, to $30, (which is where it was trading one month ago) your options will be worth at least $50,000. That's a 1,900% return.


Chart courtesy of stockcharts.com

Final thoughts

As you know, the chance of losing your money in these trades is higher than the chance of achieving the target profit. By perfect market theory, the risk and return should rise with each other in a predictable way, e.g., in the Illumina trade, the target profit is 23 times the initial investment, meaning (roughly) that you should expect to win on a trade like this only about 1 time in 23 and lose your money the rest of the time. Now take into account the large bid-ask spreads on options. One must always trade options using limit orders, and while I have suggested prices I think you will most likely be able to get, there is no guarantee. Factoring in the spread, you would most likely win on a trade like this only about one time in 30.

Now let me say that I think perfect market theory seems to be a touch imperfect in some of these cases. I can almost surely pick more than one stock that will double by the end of the year if I'm given 30 guesses. By that logic, there may be some virtue (if not much wisdom) in doing all these trades instead of just one. You will have five times the chance of winning, and if you hit a single one of these trades, you'll still make back many times what you invested.

Of course, now I'm talking about a $12,500 investment, and the odds say you'll likely never see any of it again. I doubt if anyone is tempted, but as it happens, if you were to do such a thing, this would be the perfect time. Why? Because of the historically low VIX. The VIX, used a measure of market volatility, is actually a measure of the relative premiums being charged for options. The (nearly) historically low VIX means that you would pay less for these options today than you would have on (nearly) any other day.

I was going to give you one more warning against this kind of trading here, but I've made the risks abundantly clear, so I'll go the other way. Remember that the odds only matter if things are random. If you think you know, or at least understand something  the market doesn’t about the way things are going, trust yourself—making money is fun, but making it by out-sharking the sharks? Well, that's beautiful beyond description.

Julian Close has been a business writer since the first day of the twenty-first century, having written for PRA International and the United Nations Department of Peacekeeping. He graduated from Davidson College in 1993 and received a Master of Arts in Teaching from Mary Baldwin College in 2011. He became a stockbroker in 1993, but now works for Fresh Brewed Media and uses his powers only for good. You can see closing trades for all Julian's long and short positions and track his long term performance via twitter: @JulianClose_MIC.

Julian Close

Julian Close

Julian Close became a stockbroker in 1995. In his 20 years of market experience, he has seen all market conditions and written about every aspect of investing. Julian has also written extensively on corporate best practices and even written reports for the United Nations. He graduated from Davidson College in 1993 and received a Master of Arts in Teaching from Mary Baldwin College in 2011. You can see closing trades for all Julian's long and short positions and track his long term performance via twitter: @JulianClose_MIC.

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