One month has passed since we dramatically changed our investment philosophy, and the early returns are most encouraging.

On July 10, 2008, we established an entirely new philosophy and investment strategy at Terry’s Tips.  Rather than setting up portfolios that sought 50% or so, or even 36% annual gains, we decided to become more conservative.  We established 6 new portfolios (using 5 popular indexes as the underlying stock), and each portfolio is designed to never lose money no matter what the market does.

First Month Results of the New Conservative Options Strategy

All Six Portfolios Made Great Gains!  The first expiration month using our modified 10K Strategy was a resounding success.  In spite of devoting up to half of the entire portfolio value to an exotic butterfly spread that only provided insurance against a big market drop, substantial gains resulted in every portfolio.

The portfolios gained an average of 4.5% after commissions for the expiration month.  That works out to be 54% annualized, far more than we expected.  We had hoped for a 4% gain in those months where no adjustments were necessary.  This month our gains exceeded this goal, and adjustments were made in every portfolio because it was a volatile month, with several market swings in both directions. 

The Oil Services portfolio was the best example of the value of butterfly spreads.  The underlying OIH fell by 11.3% for the month.  In the past, this kind of volatility almost always resulted in large losses.  This month, after the addition of a large number of butterfly spreads on the downside, the portfolio managed to gain of 6.4% in spite of the strong slide in the stock price.

Maybe we have indeed created an options strategy that never loses money.  That is the ultimate goal of our modified strategy, and the first month’s record was most encouraging.

The portfolios that had the greatest gains were the two that had been established before July – Mini-Russell (up 12% for the month) and Oil Services (up 6.4%).  The four portfolios that were started in July had to cover the bid-asked spread penalty of a new portfolio, and the final results understate how well they did.  Three of these portfolios were in existence for only 23 days, hardly enough to qualify for a month’s results.

The lowest-gaining portfolio for the month, Mighty Stalagmite (up 2.6%) would cost about $10,560 to replicate now.  This means that a fairer estimate of the gain was probably closer to 5%, and this was our worst-performer (largely because we made several adjustments that were later reversed). 

Annualized Portfolio Gains for the August Expiration Month:

Mini-Russell (IWM) – up 144%

Oil Services (OIH) – up 77%

Durable Diamond* (DIA) - up 92%

Building BRIC* (EEM)  - up 62%

Rising Russell* (IWM) - up 37%

Mighty Stalagmite (SPY) – up 31%

     *Based on three week’s results averaged over a year

You can see every position and every trade we made in each of these portfolios by becoming a Terry’s Tips Insider – sign up HERE.

Actually, before we made this change in our investment philosophy, our track record for the past two years was not so shabby.  From the beginning of 2005 until late in 2007, our portfolios had earned an average of over 50% each year.  But when the market fell nearly 15% in a single expiration month ending in January 2008 (a drop equaled only once before in over 20 years), much of the 2007 gains were erased.

In January, we dropped all our portfolios which were based on individual stocks (we had made over 100% on Apple options for two years running but lost nearly 80% when the stock dropped from $180 to $120 in a very short time).  We also set our annual sights at the 36% target rather than a higher number, and created some portfolios that leaned to the bearish side for those subscribers who expected lower markets.

Many subscribers paired a bearish portfolio with the a bullish portfolio using the same underlying as a way to hedge their investment bets.

For several months, the portfolios earned at better than the 36% annualized target, and then the June 2008 saw another big drop in the markets.  Our portfolios lost an average of 15%.  The losses in the bullish portfolios was not enough to cover the gains in the bearish portfolios.

This unhappy experience made it clear that we had a strategy that made good money in most months but then gave up much or all of those gains when things went badly.  We concluded that this was ultimately not a very sound long-term investment strategy.

On July 10, 2008, we amended our strategy to include exotic butterfly spreads to provide downside protection for the higher-strike calendar spreads which had proved to be so profitable in most of the months, sacrificing some potential gains for the security of having a portfolio that might never go down in value.

A 10-year backtest showed that 32% annual gains were possible with hardly any months that showed even negligible losses.

For the record, here are the 6 portfolios we are now carrying out at Terry’s Tips, ranked from lowest to highest risk.  Speaking of risk, your entire investment is at risk, just like it would be if you purchased a portfolio of stocks. However, since the long positions generally have several months of remaining value, they should always be more valuable than the short positions regardless of what the market does.  This means that theoretically, you could never lose the entire investment.

Loss Conditions:  All 6 portfolios use exotic butterfly spreads for downside protection and have higher-strike calendar spreads to generate decay revenue.  Monthly losses might result when the stock falls so fast that an adjustment cannot be made (such as what happened on 9/11) or when two adjustment trades need to be made during a single expiration month.  Spare cash is retained at the beginning of the month so that the first adjustment can be made to expand the break-even point in the direction the stock has moved.  Usually adjustments are triggered when the stock has moved about 5% in either direction.  In those months when a single adjustment trade needs to be made, a small profit is expected.

If the stock moves more than moderately during a single expiration month, a second adjustment trade may need to be made.  Since the extra cash has already been spent, the second adjustment would involve taking off some positions at strikes the furthest away from the stock price, and replacing them with spreads at the other end of the range of strike prices.  In those months where this second adjustment is necessary, little or no profit (or a small loss) is to be expected.

10K Strategies

Basic Strategy for all 6 Portfolios: Calendar spreads are set up at several strikes near and above the stock price.  The long side of these spreads is typically 4-6 months out and the short side is in the current expiration month.  A strong premium decay advantage exists with these spreads.  In addition, an exotic butterfly spread employing puts is added to provide downside protection.  The butterfly spread usually involves a small negative premium decay and expires worthless in most months.

Market Direction Desired for all 6 Portfolios: Each month the portfolio starts out in an essentially neutral position, meaning we don’t much care whether the market goes up or down as long as the change is moderate.

Mighty Stalagmite
Underlying: SPY (S&P 500 Tracking Stock)
"Starting" Value: $10,000
Gains Sought: 36% a year
Risk Level: This is our most "conservative" portfolio because the underlying S&P 500 is one of the most stable of the indexes. Most people consider the S&P 500 to be "the market".
Note: Options on SPY are available at increments of one dollar which allows for precise configuring of a balanced portfolio.

Rising Russell
Underlying: Russell 2000 (small-cap) - IWM
"Starting" Value: $10,000
Gains Sought: 36% a year
Risk Level: This is our second most "conservative" portfolio because the underlying Russell 2000 is a broad-based index and therefore not subject to the whims of a single company or small group of companies. In spite of being composed of mostly small companies (average market cap is about $1 billion), it is a fairly stable index.
Note: Options on IWM are available at increments of one dollar which allows for precise configuring of a balanced portfolio.

Durable Diamond
Underlying: Dow Jones Industrial Average tracking stock - DIA
"Starting" Value: $10,000
Gains Sought: 36% a year
Risk Level: This is our third most "conservative" portfolio. Historically, the Dow was one of the most stable of all indexes, composed of 30 of the largest Blue Chip companies. Recently, however, because of problems in the banking and automobile industries, the Dow has fallen by a greater percentage loss than most of the other market indexes.
Note: Options on DIA are available at increments of one dollar which allows for precise configuring of a balanced portfolio.

Building BRIC
Underlying: Emerging Markets (EEM) is made up of companies in over 20 "emerging" countries with a concentration in BRIC (Brazil, Russia, India and China) but also Indonesia, South Korea and South Africa.
"Starting" Value: $10,000
Gains Sought: 36% a year
Risk Level: This is our fourth most "conservative" portfolio because this index has historically been more volatile than most domestic indexes.
Note: EEM was split 3-for-1 two days after we set up our portfolio and we encountered large transaction costs to trade out of the pre-split options into the post-split ones (the portfolio managed to gain value in spite of these trades).  One advantage of the lower stock price is that options are available at increments of one dollar instead of the larger $5 increments of the pre-split shares.

Mini-Russell
Underlying: Russell 2000 (small-cap) - IWM
"Starting" Value: $5,000
Gains Sought: 36% a year
Risk Level: This portfolio is a little more risky than the Rising Russell because with a smaller amount available for investment it may not be possible to fine-tune the positions as precisely as we can with the larger investment amount in the Rising Russell portfolio.
Note: Options on IWM are available at increments of one dollar which allows for precise configuring of a balanced portfolio.

Oil Services
Underlying: OIH (Oil Services ETF - 18 companies in the Oil Services industry).
"Starting" Value: $10,000
Gains Sought: 50% a year
Risk Level: This portfolio is our most risky portfolio because the Oil Services ETF is made up of only 18 companies, all of which are in the same industry. Consequently, the stock often is as volatile as an individual company might be.
Note: Options on OIH are available at increments of five dollars up to $200 and $10 increments at strikes above $200. This does not allow as precise configuring of a balanced portfolio as the other indexes provide. On the other hand, since OIH is so volatile, option prices are quite high, and substantial premium decay is generally available.

Cash Withdrawal Policy: For all 6 portfolios, the goal is to maintain the portfolios near their "starting" values so that new subscribers can mirror the portfolio at nearly the same initial cost.  The "starting" values are $10,000 for all the portfolios except Mini-Russell ($5,000). Cash withdrawals will be made from portfolios in increments of 3% of starting portfolio value.  For example, for the 5 $10,000 portfolios, on the Monday following each monthly expiration, $300 will be taken out of the account if the account balance is over $10,300.  If a gain of over $600 is made in a month and the portfolio balance is over $10,600, $600 will be removed that month.  The goal is to remove $3600 from the account over the course of a year (and $1800 from the Mini-Russell since it started with $5000) and continue to maintain the original starting value.

Please check back on this Track Record page frequently. It will be updated on Monday following each monthly Friday expiration.

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