You can tell that Stephen Litwok is committed to options. Not only by the excitement in his voice, but by the path that led him to his first job with a brokerage. The starting point of his journey made sense — a 1975 bachelor’s degree in math from the Massachusetts Institute of Technology. But then came the detour. He spent eight years on two different kibbutzim in Israel, joking that his math degree came in handy counting rows of crops. At one point he taught computer science in an Israeli high school. His father, looking to have his son (and now his grandson and daughter-in-law) a little closer to him, suggested that Litwok come back to the United States to get a master’s degree in computer science at Fairleigh Dickinson’s Monmouth County campus.
After he completed the degree in 1989, his father suggested he work for a while and save some money before going back to Israel. Things didn’t work out quite the way he had planned. Finding himself in the middle of a recession, with no computer jobs to be had, he took a path less traveled by computer scientists: “My sister was in the brokerage business,” he says. “She took me in and got me started,” and that was it for Litwok: “I found a niche in selling covered calls.”
Call options and their cohorts, put options, explains Litwok, lend themselves to both simple and more complex strategies, which can protect investors and serve as new ways to earn money. Now a registered options principal for Network One Financial in Red Bank, where he has been since 1997, Litwok is offering a workshop at Mercer County Community College to teach investors how to use stock options to achieve specific goals.
Participants will simulate buying and selling of both puts and calls using the current day’s data and stocks selected by class members. The workshop meets on Monday, July 10, through Monday, July 31, at 7 p.m. If there is sufficient demand Litwok will offer a follow-up class in August on more complex strategies. Cost: $90. For more information, call 609-586-9446 or E-mail ComEdmccc.edu.
Although people are relatively comfortable with stocks and bonds, says Litwok, especially with the opportunities for trading online since the late 1990s, options are another story. “Options are widely misunderstood,” says Litwok, “The typical person thinks: stay away, it’s risky, you’ll lose all your money.” His course is designed to dispel those fallacies.
“Options are a tool designed to manage risk,” says Litwok. “They allow investors to either add risk or eliminate it.” He describes several straightforward strategies available to reach different investment goals:
Making more money on stocks you own. One of the simplest strategies is to use call options — which give you the right to buy shares of a stock at a set price for a limited period of time — to make extra income on stocks you already own. A call takes two players: Let’s say that George owns a stock selling at $22.50 a share and is willing to sell Martha the right to purchase that stock at a higher price, say $25. Martha expects the stock’s price to rise beyond $25, so she is willing to pay George a premium of $1 a share for the right to buy it at $25. In the meantime, George has earned $1 a share, which he keeps no matter what happens to the stock price.
If the stock’s price goes down to $20, Martha is out $1 a share, but she certainly won’t exercise the right to buy the stock for $25. If the stock’s price goes up to $30 a share, however, then Martha exercises the right to buy at $25, and the two people are dividing the profits between them: George gets the $1 per share that Martha paid for the right to buy as well as $2.50 a share because the stock appreciated to $25. Martha buys the stock for $25 a share and can sell it for $30 a share or hold onto it. If Martha sells, then she has earned $5 a share minus the $1 per share premium she paid for the right to purchase at $25.
Litwok explains Martha’s objectives using the metaphor of house-hunting. Suppose Martha comes up to him and says, “I love your house. I want to live in Marlboro, and it’s perfect for me.” Litwok might respond that he is not ready to sell his house — and that would be that. Or would it?
Litwok is thinking to himself that in the next six months or year he may well come up for a transfer. So when Martha pushes him and suggests she would like an option to buy the house at its current worth of, say, $450,000, anytime in the next 12 months, Litwok thinks about it and responds, “O.K., I’ll do it, but only if you pay me a premium of $10,000.” The $10,000 may represent how much he expects his house to appreciate in the near future, but the size of the premium would vary, depending on where the two think real estate prices and interest rates will be moving. Because the agreement is contractual, Litwok can’t sell his house for the next 12 months.
At the end of 12 months, if housing prices go down and the house is only worth $425,000, Martha would not exercise the option to buy and it would expire worthless, because she would be able to buy that house or something else like it on the market at a cheaper price. But if the house’s value went up to $475,000 or a gold mine was discovered on the property, Martha would still have the right to purchase it at $450,000. But whatever happens to the house’s value, Litwok would still get the extra $10,000 premium. When Litwok sold her the option to buy, he had expected the market to go down, and figured the premium might cover part of his loss. Martha, on the other hand, was protecting herself from an extreme rise in price.
Protecting the value of your stock. Put options, which allow a person to sell an asset for a set price for a limited period of time, can serve as an insurance policy on the stocks you own. Back to the housing example (remember, by the way, this is a metaphor only — put options only exist in the world of stocks): Wilma owns a house valued at $500,000 and is considering moving into adult community in the next couple of years. But she is worried that her house’s value may go down by then, so she thinks to herself, “It would be nice if I could guarantee a selling price of $500,000 for two years.”
She could do something just like that with any stocks she owns. The purchaser of a put option pays a premium to the buyer for the right to sell at a specific price during a specified time period. “It’s almost like an insurance policy,” says Litwok. “Put options are a way of buying insurance on your whole portfolio or on large positions you own in particular stocks.”
Generating income. Here’s an example: Say General Motors is selling today at $26, and Alice wants to buy GM stock, but not for more than $20 a share. She could sell Ralph a put option, which says she will take on the obligation to buy GM from him for $20 a share sometime in the next six months.
Ralph pays Alice a premium of $1.80 per share for taking on that obligation. Hence, says Litwok, “Alice will make money while she’s waiting.” If Alice does have to buy the stock (if it goes down to $20 a share), her cost is the $20 minus the $1.80 Ralph has already paid her, a net of $18.20 — an attractive price to Alice. If the stock goes up, Alice still gets to keep the $1.80. Although this strategy seems to have double upsides for Alice, it also has a significant downside. “It is not a right to buy it, but an obligation,” explains Litwok. If it goes down to $20 a share, Alice has to buy it — even if the company has gone bankrupt in the meantime.
Protecting yourself against downside risk. This time we’ll look at the GM stock from Ralph’s perspective. It is selling today at $26 a share, but he wants out if the stock goes below $20. If Ralph buys a put option from Alice, then she has the obligation to buy his stock at $20 a share, no matter how low it goes. In this case Alice is serving as Ralph’s “insurance company,” picking up the premium of $1.80 a share, but insuring him against a catastrophic fall in the stock’s price. “He bought the put,” says Litwok, “as a safety net at $20 a share.” Alice, on the other hand, “can open her own insurance company while picking up stocks at cheaper prices.”
Litwok grew up in Teaneck, where his father was in a general contractor for construction and his mother a homemaker. When Litwok finished Teaneck High School, they moved to a new development his father had helped create in Manalapan.
At Network One Financial, Litwok manages the Disciplined Income Strategy, in which people have to invest at least $100,000. He says he has had reasonable success in the six months he has been using this strategy, with 11 out of 13 accounts outperforming the S&P 500. He also trades options for people, charging a commission. “I listen to what people are saying,” he says, “and convert that into an options strategy.”