The money in the options
By Chris Rowe —
November 9, 2006
Okay everyone, I’m happy to say that last Thursday's Tycoon report seemed to go over well with a large percentage of our readers.
I decided to make it sort of a Q&A where I answered a bunch of questions that seemed to be popular among our readers. (You can ask questions or post comments by clicking on the "rate this article" link at the bottom.)
This week, I read through most of your questions/comments, and I have some more answers for you, but I don’t want to completely move away from writing articles that you may find useful for trading stocks.
First, I’ll write a very brief article, and then I’ll answer some questions at the bottom of this. Since I see that options trading, as well as options education (Q&A) has caught the interest of so many of you, soon I will also bring in one of my old Wall Street buddies who has options expertise to add some new perspective. At Tycoon Publishing, our goal is to give you what you want!
First a quick article/tip, then the Q&A …
Topic: Stocks trading lower after “secondary offerings.”
One day, there was an 18-year-old rookie stockbroker named Christoph Rhode. He wanted to take over the world, so he was sure to follow his mentor’s advice and be at work (before the other rookies) at 7:00.
He had just finished reading the Wall Street Journal and drinking his coffee (which he had recently acquired a taste for) when he noticed the owners of the firm walking into the back office with the firm’s top two producing brokers (it wasn’t a coincidence that they were there at 7:00, too) and three older men wearing thousand-dollar suits and $30,000.00 watches.
The top two producing brokers at most firms generated about 80-90% of the brokerage firm's commissions, and controlled about 90% of the firm’s money under management. So Christoph knew that there was something big going on, and was dying to know what it was. He knew there was going to be a meeting about a secondary offering a limited number of shares of which the different brokers would be given to sell to their clients. Christoph was trying to figure out if that was just his brokerage firm owner’s pitch to get the firm excited, or if this was really a “hot deal.”
Christoph was immediately motivated to pick up his sales leads and his two telephones and start cold calling his way to the top. At about 8:30 when most of the other brokers made it in to work, the owner of the firm yelled out “Okay, boys, everyone in the conference room.” Everyone brought his pen and pad in and sat down.
The conference room was packed, but it was dead silent. The brokerage firm owner walked in and shut the door. He said “Okay, everyone, these are the guys that I told you about from “Falleron Tech.” As you know, they are here to talk about (pitch us) their secondary offering. Anyone who is late and is not in this room right now, does NOT get any stock.”
There was a knock at the door and a broker who was one minute late poked his head in the conference room. “Nope, turn around and get the heck (only he didn’t say 'heck') outta here!”
Christoph sat anxiously with his pen and pad ready to take down notes (or write bullets) on the secondary offering to talk about with his clients.
Now, for those of you who don’t know, a “secondary offering” refers to the distribution of stock by a company that already has publicly traded securities. Secondary offerings may include newly issued shares sold by the issuing company and/or shares sold by existing shareholders of the issuing company.
There’s a limited number of shares issued, and there was a 5% hidden commission (to the broker) on them which is why the brokerage firm owner said that anyone who was late to the meeting “wouldn’t get any stock.”
Christoph listened closely as the CEO, the CFO, and the President of Falleron Tech spoke about why they were there.
The CEO, David O'Keefe said, “Good morning, ladies and gentlemen. I know that you’re all very busy, so I’ll try to keep this brief so that you can jump back into the action.”
He went on about his great technology, and his cash flow statements, and his future projections. Most of the brokers were thinking about their next cigarette break, the club they went to last weekend, or falling asleep.
When the meeting ended, the majority of the brokers left excited about the commission they would make on this offering and most skipped their cigarette breaks to get on the phone with their clients immediately.
They didn’t know what the company actually did, but they would exchange notes and come up with a great pitch to get their clients as excited about the stock as the brokers were about their commssion.
But after the conference room cleared out, Christoph noticed that the owner of the brokerage firm stayed behind along with the two top producing brokers and the three executives from Falleron Tech. One of the firm owners said, “Kevin, tell these guys what you were telling me about the stock.” Christoph decided to eavesdrop. He peered around the corner and noticed everyone’s eyes light up as the President, Kevin Redington spoke.
“We don’t know whether the stock trades up or down in the short-term. But what I’m about to say stays inside this room.”
“We are going to announce that we will sign three contracts worth over $500,000.00 in sales combined to our company. Keep in mind that we only did $440,000.00 in sales last year. We’re raising this cash right now from your investors because we need the capital, but these contracts will be announced in three months. You can imagine what will happen to the stock when those announcements hit the tape.”
Christoph now knew that he would be staying at work until 12:00 a.m. calling the west coast and Hawaii every night trying to get orders for this stock. He also knew that after the offering took place, he didn’t care whether the stock traded lower before trading higher. That would only give him the chance to buy more stock at a cheaper price.
I’m going to cut this story short since it’s supposed to be a short story. Excuse me for ending so abruptly, but I’ve already made my point.
First of all, this type of thing happens all the time. A company’s management comes to a brokerage firm. They want to raise money for a project that will increase the value of the company, so they offer new shares of stock to increase their working capital. While it doesn’t always go down exactly like this, the management usually gives the brokerage firm a good reason to put their clients at risk by taking all of that stock.
Now you may consider a few things here:
First of all, the publicly traded company might have conned the brokerage firm into thinking that big things were on the horizon. So don’t think that just because the company recently did a secondary offering, that the stock will definitely trade higher.
But when you see that a stock which has recently traded lower had a secondary offering of stock, there may be some big things to come. If a brokerage firm “knows” that a stock will trade higher, they would rather let the stock trade lower first so that they can buy cheap stock.
Even if the company and the brokerage firm weren’t comfortable enough to share inside information (which is common, believe it or not,) you should remember that although the existing shareholders may be diluted by the new stock coming to market, the company has just raised cash, which if the company is honest, is probably going to be used for the benefit if the company and the stock.
Another thing that you may consider doing, (which surprisingly, most investors don’t do) is calling the company (their phone number is usually on any financial website, or on the company’s website,) and asking for the prospectus for the secondary offering. There you will be able to see what the secondary was all about. In the story above, the cash is raised by issuing additional shares. But you should be careful to be extra cautious about a company who did the secondary offering for the purpose of getting insiders out of their stock (insiders who are selling their existing shares to the new investor, the broker's clients.)
It’s like I always say, there is no “holy grail” to investing, but you should know that the publicly traded company giving the investment bank (stock brokers) a “heads up” on the future of the company is a common occurrence.
It’s just something that most people don’t think about, so it’s something that you should keep in mind.
OKAY – IT’S Q&A TIME!
This question came from Art R.
QUESTION: How do you find out where the options are listed on-line?
You should click on the following link and once you are on the webpage, you should add it to your favorites or bookmark it. http://www.cboe.com/DelayedQuote/QuoteTable.aspx
This is just the options delayed quotes page at www.cboe.com .
Don’t know who this came from, but thank you for the heads up.
COMMENTS: Proof read your stuff before posting. Puts and Calls are erroneously intermixed in your response.
I made a couple of mistakes last week. I was talking about a strategy using puts, and I accidentally typed the work “call” a couple of times. Sorry for any confusion, but you can find the corrected article by clicking HERE .
Last week, I asked for the help of our readers. One of our readers asked me where they can find something (I guess a book or something) to help them with staying disciplined with their trading. I didn’t have an answer except that discipline can’t be learned in a book. But I wondered if our readers had any advice. I had a million suggestions of services to sign up for. But here are two answers from our readers.
SUGGESTION #1) Being basically a conservative (from a banking family, father was pres. of a small town bank for many years), I agree wholeheartedly with the concept of "keep 1/2 of your investing funds in cash at all times." This is what keeps me sane while playing the options market
SUGGESTION #2) Trading Ideas: 1) Prior to making a trade, (a purchase, figure what your acceptable loss would be, such as a dollar figure, or a percentage. Stocks do go down.) 2) Place a Stop Loss order with a Good 'Til Cancelled order in, at the acceptable loss that was predetermined in #1, above. 3) Do your homework!!! I like reading Investors Business Daily.
Here’s a comment about an article two weeks ago. Actually it’s a general question, but you should all know the answer ...
Your abuse article was both witty and informative. Keep it up. Also, I would like to suggest that you send all Trend Rider articles and reports as an attachment. Not in the body of the email. The way it is now, when I want to print and save the article/report for future reference (I have your options report in a binder) the last 2 words of each sentence is cut off. Every word is critical when one is trying to understand technical advice. Thank you for reading this. DM
This only tends to happen when you copy something from the internet. There is a way to make sure that doesn’t happen.
You can copy the article, and paste it on to a Word document. Then print it. Be sure, however, not to copy the whole page, i.e. don’t highlight the whole page including the logos, and don’t hit “control A” which copies the whole page.
If you want it to look nice, put your curser on the first letter on the first word in the article, and then left click your mouse (and hold down the clicker) while you drag it down to the last letter in the last paragraph of the article so that only the text on the page is highlighted.
Then right click and choose "copy" (or you can hold down “control” and click the “C” if using windows,) and then paste it into a Word document by right clicking on the Word doc., and choosing paste (or just hold control and click the “V”.)
Once the article is on the Word doc., you should then print the Word document, and you will not have any part of it cut off.
I hope that I have helped someone today, and if you like my article, please rate it below, and feel free to add comments.
