Hobofinance.com

Case Study Entry 3
Can a Hobo go from 0 to financially independent in 6 months?

Plan your trade and trade your plan they always say. And that’s what I’m doing here for all to see. It’s not that I want to expose my personal finances but I have a problem with the pool of experts and trading websites out there that only recommend trades. Now some of these experts may be very experienced and educated, but I don’t believe you can trust someone that makes their money giving advice, and is not also putting their own money at risk at the same time. And if you read the small print at the bottom of the page you’ll usually find something like, ‘trade at your own risk’ and ‘past performance is not indicative of future success’.

I have the greatest respect for people who disclose their positions, and as such, I ought to follow suit if I don’t want to be grouped with the rest. And it doesn’t hurt that hoboes have a proclivity for exposing themselves, usually on trains to stowaways for petty cash. So here we begin a 6 to 8 month case study on wealth creation via the principles of Hobofinance and putting my own credit and livelihood at risk. With any luck this case study will serve as a model for penniless hoboes everywhere.

The Plan:
1. Research a Market

Summarized in Superstition and the Coffee Baptism.

2. Secure Finances

In keeping with the theme of this site, I’ll trade as a hobo should, with money that isn’t mine and highly leveraged. The content of this site is geared toward those hungry for freedom, financial and otherwise, and who are unwilling to sacrifice the present for freedom in the distant future. Most of us don’t have a million dollars in the bank and we certainly don’t want to spend our time working for it. So, in accordance with our Hobofinance philosophy we’ll procure the funds we need by using OPM, other people’s money. Most hoboes don’t cavort with the wealthy however, so I’m going to plan this trade with money accessible to all; namely credit card loans via balance transfer checks. I’m using the methods described in Using Credit Card Debt to Make Money to secure $60,000 dollars. This is near the upper limit of my accumulated credit dispersed over 4 credit cards. We hoboes play for glory or for prison, and nothing in between.

3. Trading Strategy

A. Position and Money Management: I’m going to establish my position in two tiers of call options, with the intention of liquidating most of the first tier once I’ve doubled my money. (This happens quickly in commodities trading if you’re playing the right side of the market due to extremely high leverage). The first tier will be 5 to 15 cents in the money and priced around $6,000 each. The second tier will be out of the money 20 to 40 cents and cost around $1,000 to $3,000. The reason for trading this way is that if, on the rare chance coffee doesn’t move in 6 months, the ‘in the money’ call options will retain most of their value because a good portion of the premium is equity, providing a margin of safety for the account as a whole. The reason for the out of the money calls is simply that they’re cheaper, and I can hold a larger position than if I’d stuck only with the deep in the money calls.

Every ten cent rise or fall in coffee means a $3,750.00 profit or loss, so a twenty five to 35 cent rise in price at these options prices would mean 100 percent profit. A twenty cent rise would not even bring prices to their February highs, a price that seems to me easily surpassable given current fundamentals. Once my positions double I will liquidate the first round, which means I will have $60,000 in cash which I can use to pay off my loan or reinvest on a correction or both, and another $60,000 in call options, which are now all ‘at the money’ after the 20 cent price rise. These I will ride out through at least March of next year and possibly into May as the market factors in next year’s deficit crop.

B. Time Horizon: Futures, as the name suggests, are commodities contracts that have a specified time for delivery at some point in the future. Options, because they are based on the underlying futures contracts, also have a limited life, and expire just before the futures contracts come due. So an important element of options trading is identifying your time horizon. I’m basing things particular trade on the 2004-2005 coffee season, where market fundamentals were very similar to the current ones (though not as bullish), and where prices ran up over 70 cents from Sept. 04 to March 05. The strongest seasonal in coffee occurs in June at the onset of the Brazilian harvest and drags prices down sharply. So I am anticipating the coming supply deficit to be factored into prices by May of 09. Therefore I’ll be looking to purchase March, May and perhaps July 09 call options.

Why I’ve borrowed so much:
With this trading strategy, an account with less than $15,000 dollars would be too risky to trade. Trading with a larger sum using this two tier strategy will both give me more staying power over the long run, and allow me to pay off my debt without quitting the trade. I’m trading options here rather than futures because options require a lot less savvy, timing, and capital. One can trade a much larger position than would be prudent with futures, and one can wait until the market proves them right without having to meet a margin call. All that, and I’d like to retire by my 30th birthday.

A note to those with a broker or a futures account:
This trade is sound until prices have risen heavily, at which time one can’t take a profit without diminishing the position. The way to work around this, and the strategy I’ll be using with the other accounts I manage are as follows:

If the ‘out of the money’ calls wind up being 40 to 50 cents in the money (approximately $20,000 of equity per contract), they can be converted to the underlying futures contracts. I’ll do this because it will allow me to place a stop loss under certain floors in the market. If the market runs out of gas it will stop me out at a profit. If the market still has legs I can continue to raise the stop loss following the market higher securing more and more profit per contract.

The other benefit to converting options to futures is that the equity is no longer trapped in a single options contract but can actually be reinvested. This technique is called pyramiding, and although it is dangerous, it is how a great many fortunes have been made. The key is to make sure your reinvestment does look like a pyramid, with a narrow top supported by a larger base. So if you’ve got 10 contracts to start, you may want to increase your position by only 3 to 5, and again later by only 1 if the market is still on fire. At this stage stop losses are vital. If/when the market declines you’ll be loosing money on many more contracts than you had making money for you on the way up. Profits can disappear quickly.