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Archive for December, 2013

Google Vertical Put Spread – Corrected Prices

Monday, December 23rd, 2013

Several subscribers wrote in and told me that my numbers were off on the Google spread.  I apologize.  At least I know that some of you read these ideas, so that is encouraging.I have fixed the numbers and repeated the words.  Here is the trade fill:

google trades Google Trades

As you can see, I actually did better than the $10.30 I reported below – I sold it for $10.46.  I had placed a limit order at $10.30 and assumed that was the price I got – it ended up being better than the limit price.

Google Vertical Put Spread – Corrected Prices

To repeat, my 2014 bet on Google is even more interesting, mostly because Google has moved higher over the course of the year 9 times out of 10.  Only in the market melt-down in 2007 did it end up lower than when it started out the year.

GOOG was trading at $1108 today, Monday, I sold a Jan-15 1120 put and bought a Jan-15 1100 put. (You could also trade the minis on GOOG which are one-tenth the value of the regular options).  I collected $10.30 ($1027.50 after paying $2.50 in commissions – the rate that Terry’s Tips subscribers pay at thinkorswim), from selling the vertical put spread and my maximum loss is $972.50.

There will be a $2000 maintenance requirement on this spread, but since I collected $1027.50, my maximum loss and the amount it required to place this trade is $972.50.

(Note: There is a big range between the bid and ask prices – it is important to place a limit order when trading these options rather than a market order.)  I will make over 105% on my investment for the year if the stock is at $1120 or any higher January 17, 2015 (it only needs to go up $12 over the course of a full year and a month).  After note:  GOOG is now trading at $1114 and only needs to go up by $6 for me to make 100%.

If I made this same bet every year for 10 years and Google behaved like it did over the past 10 years, I would collect a total of $9247.50 in the 9 winning years and lose $972.50 once, for a gain of $8275 over the decade, or an average of 85% a year on my money.  Again, this is a pretty good return in today’s market.

Critical to the success with these trades is the assumption that markets in the future will behave like they have in the past.  While that is not always the case, the past is usually a pretty good indicator of what the future might be.  These trades are just an example of how you can make superior returns using options rather than buying stock if you play the odds wisely.

 

Two Interesting Option Bets for 2014 – SPY and Google

Monday, December 23rd, 2013

Today I would like to tell you about two actual option trades that I made just this morning and my reasoning behind them.  They are both long-term bets on what I expect the market to do in 2014.  One of these bets might make an average of 85% every year if the market behaves like it has in the past.

By the way, last week when I salted this newsletter (and my blog) with the keywords “option trading” and “trading options” to see if Google Alerts picked it up, I was not surprised to see that I did not make the cut.  Google seems to have switched what they think is important from keywords to social media traffic, and since Terry’s Tips does not have a Facebook or Twitter account, I am not considered worthy of inclusion in their searches.  Oh well, at least I learned where I stand, right up there with the chopped liver.

I hope you will find these two trades I made interesting enough to consider doing on your own (only with money you can afford to lose) if you agree with my assumptions.

Two Interesting Option Bets for 2014 – SPY and Google

While most stocks go up some months and down others, when you check out how they perform for a whole year, most of the time they manage to move higher between the beginning and end of the year.

The market (using the S&P 500 tracking stock, SPY as the measure) has gone up or fallen by less than 2% in 33 out of 40 years.  A single stock I like, Google (GOOG), has gone up 9 out of the 10 years that it has been publicly traded.

I believe that a year from now, the market in general and GOOG in particular will be higher than it is today.  If I am right, the two trades I made today will make a gain of 53% on the market and 105% on GOOG.

With SPY trading at $182.30 today, allowing for a possible 2% loss in 2014, I decided to sell a Dec-14 180 put and at the same time, buy a Dec-14 170 put.  If SPY is above $180 when these puts expire on the third Friday of December (the 20th) 2014, both of these puts will expire worthless and I will be able to keep any cash I collected when I sold the spread today.

I sold the SPY vertical spread for $3.57 ($354.50 after commissions).  The maximum loss I can have from the spread will come about if SPY closes below $170 when the options expire.  Subtracting the $$354.50 I received from selling the spread from the $1000 maximum loss means that I will have risked $645.50 to possibly collect a possible $354.50.  This works out to a 53% return on my maximum loss.

My broker will post a maintenance requirement on my account for $1000 while we wait for the options to expire.  This is not a loan like a margin loan and no interest is charged.  It is just money cash in my account that I can’t use of other purposes for the year.  The actual amount of cash I have tied up in the spread is only $645.50 , however, since I collected $354.50 in cash when I sold the spread today.

If I made $354.5 in each of the 33 years when the market rose or fell by less than 2% and lost the entire $645.50 at risk in the 7 years when the market fell over the last 40 years, my average gain for the 40 years would be $179.50 per year, or 27% per year.  That beats most investments today by a huge margin.  (The actual average gain would be higher than this because in some of those 7 losing years the loss would not be a total one).

My 2014 bet on Google is even more interesting, mostly because Google has moved higher over the course of the year 9 times out of 10.  Only in the market melt-down in 2007 did it end up lower than when it started out the year.

GOOG was trading at $1008 today, Monday, I sold a Jan-15 1020 put and bought a Jan-15 1010 put. (You could also trade the minis on GOOG which are one-tenth the value of the regular options).  I collected $10.30 ($1027.50 after paying $2.50 in commissions – the rate that Terry’s Tips subscribers pay at thinkorswim), from selling the vertical put spread and my maximum loss is $972.50. (Note: There is a big range between the bid and ask prices – it is important to place a limit order when trading these options rather than a market order.)  I will make over 105% on my investment for the year if the stock is at $1020 or any higher January 17, 2015 (it only needs to go up $12 over the course of a full year and a month).

If I made this same bet every year for 10 years and Google behaved like it did over the past 10 years, I would collect a total of $9247.50 in the 9 winning years and lose $972.50 once, for a gain of $8275 over the decade, or an average of 85% a year on my money.  Again, this is a pretty good return in today’s market.

Critical to the success with these trades is the assumption that markets in the future will behave like they have in the past.  While that is not always the case, the past is usually a pretty good indicator of what the future might be.  These trades are just an example of how you can make superior returns using options rather than buying stock if you play the odds wisely.

 

 

 

A “Conservative” Options Strategy for 2014

Monday, December 16th, 2013

Every day, I get a Google alert for the words “options trading” so that I can keep up with what others, particularly those with blogs, are saying about options trading.  I always wondered why my blogs have never appeared on the list I get each day.  Maybe it’s because I don’t use the exact words “option trading” like some of the blogs do.

Here is an example of how one company loaded up their first paragraph with these key words (I have changed a few words so Google doesn’t think I am just copying it) – “Some experts will try to explain the right way to trade options by a number of steps.  For example, you may see ‘Trading Options in 6 Steps’ or ’12 Easy Steps for Trading Options.’  This overly simplistic approach can often send the novice option trading investor down the wrong path and not teach the investor a solid methodology for options trading. (my emphasis)”  The key words “options trading” appeared 5 times in 3 sentences.  Now that they are in my blog I will see if my blog gets picked up by Google.

Today I would like to share my thoughts on what 2014 might have in store for us, and offer an options strategy designed to capitalize on the year unfolding as I expect.

Terry

A “Conservative” Options Strategy for 2014

What’s in store for 2014?  Most companies seem to be doing pretty well, although the market’s P/E of 17 is a little higher than the historical average.  Warren Buffett recently said that he felt it was fairly valued.  Thirteen analysts surveyed by Forbes projected an average 2014 gain of just over 5% while two expected a loss of about 2%, as we discussed a couple of weeks ago. With interest rates so dreadfully low, there are not many places to put your money except in the stock market. CD’s are yielding less than 1%.  Bonds are scary to buy because when interest rates inevitably rise, bond prices will collapse.  The Fed’s QE program is surely propping up the market, and some tapering will likely to take place in 2014.  This week’s market drop was attributed to fears that tapering will come sooner than later.

When all these factors are considered, the best prognosis for 2014 seems to be that there will not be a huge move in the market in either direction.  If economic indicators such as employment numbers, corporate profits and consumer spending improve, the market might be pushed higher except that tapering will then become more likely, and that possibility will push the market lower.  The two might offset one another.

This kind of a market is ideal for a strategy of multiple calendar spreads, of course, the kind that we advocate at Terry’s Tips.  One portfolio I will set up for next year will use a Jan-16 at-the-money straddle as the long side (buying both a put and a call at the 180 strike price).  Against those positions we will sell out-of-the-money monthly puts and calls which have a month of remaining life. The straddle will cost about $36 and in one year, will fall to about $24 if the stock doesn’t move very much (if it does move a lot in either direction, the straddle will gain in value and may be worth more than $24 in one year).  Since the average monthly decay of the straddle is about $1 per month,  that is how much monthly premium needs to be collected to break even on theta.  I would like to provide for a greater move on the downside just in case that tapering fears prevail (I do not expect that euphoria will propel the market unusually higher, but tapering fears might push it down quite a bit at some point).  By selling puts which are further out of the money, we would enjoy more downside protection.

Here is the risk profile graph for my proposed portfolio with 3 straddles (portfolio value $10,000), selling out-of-the-money January-14 puts and calls. Over most of the curve there is a gain approaching 4% for the first month (a five-week period ending January 19, 2014).   Probably a 3% gain would be a better expectation for a typical month.  A gain over these 5 weeks should come about if SPY falls by $8 or less or moves higher by $5 or less.  This seems like a fairly generous range.

Spy Straddle Risk Profile For 2014

Spy Straddle Risk Profile For 2014

For those of you who are not familiar with these risk profile graphs (generated by thinkorswim’s free software), the P/L Day column shows the gain or loss expected if the stock were to close on January 19, 2014 at the price listed in the Stk Price column, or you can estimate the gain or loss by looking at the graph line over the various possible stock prices.  I personally feel comfortable owning SPY positions which will make money each month over such a broad range of possible stock prices, and there is the possibility of changing that break-even range with mid-month adjustments should the market move more than moderately in either direction.

The word “conservative” is usually not used as an adjective in front of “options strategy,” but I believe this is a fair use of the word for this actual portfolio I will carry out at Terry’s Tips for my paying subscribers to follow if they wish (or have trades automatically executed for them in their accounts through the Auto-Trade program at thinkorswim).

There aren’t many ways that you can expect to make 3% a month in today’s market environment.  This options strategy might be an exception.

A Look at the Downsides of Option Investing

Tuesday, December 10th, 2013

Most of the time we talk about how wonderful it is to be trading options.  In the interests of fair play, today I will point out the downsides of options as an investment alternative.

Terry

A Look at the Downsides of Option Investing

1. Taxes.  Except in very rare circumstances, all gains are taxed as short-term capital gains.  This is essentially the same as ordinary income.  The rates are as high as your individual personal income tax rates. Because of this tax situation, we encourage subscribers to carry out option strategies in an IRA or other tax-deferred account, but this is not possible for everyone.  (Maybe you have some capital loss carry-forwards that you can use to offset the short-term capital gains made in your option trading).

2. Commissions.  Compared to stock investing, commission rates for options, particularly for the Weekly options that we trade in many of our portfolios, are horrendously high.  It is not uncommon for commissions for a year to exceed 30% of the amount you have invested.  Because of this huge cost, all of our published results include all commissions.  Be wary of any newsletter that does not include commissions in their results – they are misleading you big time.

Speaking of commissions, if you become a Terry’s Tips subscriber, you may be eligible to pay only $1.25 for a single option trade at thinkorswim.  This low rate applies to all your option trading at thinkorswim, not merely those trades made mirroring our portfolios (or Auto-Trading).

3. Wide Fluctuations in Portfolio Value.   Options are leveraged instruments.  Portfolio values typically experience wide swings in value in both directions.

Many people do not have the stomach for such volatility, just as some people are more concerned with the commissions they pay than they are with the bottom line results (both groups of people probably should not be trading options).

4. Uncertainty of Gains. In carrying out our option strategies, we depend on risk profile graphs which show the expected gains or losses at the next options expiration at the various possible prices for the underlying.  We publish these graphs for each portfolio every week for subscribers and consult them hourly during the week.

Oftentimes, when the options expire, the expected gains do not materialize.  The reason is usually because option prices (implied volatilities, VIX, -  for those of you who are more familiar with how options work) fall.   (The risk profile graph software assumes that implied volatilities will remain unchanged.).   Of course, there are many weeks when VIX rises and we do better than the risk profile graph had projected.   But the bottom line is that there are times when the stock does exactly as you had hoped (usually, we like it best when it doesn’t do much of anything) and you still don’t make the gains you originally expected.

With all these negatives, is option investing worth the bother?  We think it is.  Where else is the chance of 50% or 100% annual gains a realistic possibility?  We believe that at least a small portion of many people’s investment portfolio should be in something that at least has the possibility of making extraordinary returns.

With CD’s and bonds yielding ridiculously low returns (and the stock market not really showing any gains for quite a while – adjusted for inflation, the market is 12% lower than it was in March,  2000,), the options alternative has become more attractive for many investors, in spite of all the problems we have outlined above.

If the market knocks you down, try laughing instead of crying – some market definitions

Tuesday, December 3rd, 2013

This week is a good time to take a little break from the market (it’s the holiday season and volatility usually slows to a crawl and edges a little higher – it’s called the Santa Claus rally).  It is a great time to own calendar spreads or my favorite ETNs (ZIV and XIV, two equities that have nearly doubled in each of the last two years).
Check out below how you can become a Terry’s Trades Insider, receive two month of free service plus several valuable reports, all for absolutely no cost while you enjoy all the benefits of a new account at thinkorswim by TD Ameritrade (including no commissions for two months of trading).

Terry
 
If the market knocks you down,  try laughing instead of crying –

Some Market Definitions:

CEO –Chief Embezzlement Officer.

CFO– Corporate Fraud Officer.

BULL MARKET — A random market movement causing an investor to mistake himself for a financial genius.

BEAR MARKET — A 6 to 18 month period when the kids get no allowance, the wife gets no jewellery, and the husband gets no sex.

VALUE INVESTING — The art of buying low and selling lower.

P/E RATIO — The percentage of investors wetting their pants as the market keeps crashing.

STANDARD & POOR — Your life in a nutshell.

STOCK ANALYST — Idiot who just downgraded your stock.

STOCK SPLIT — When your ex-wife and her lawyer split your assets equally between themselves.

FINANCIAL PLANNER — A guy whose phone has been disconnected.

MARKET CORRECTION — The day after you buy stocks.

OUT OF THE MONEY –   When your checking account’s overdraft hits bottom.

CASH FLOW– The movement your money makes as it disappears down the toilet.

YAHOO — What you yell after selling it to some poor sucker for $240 per share.

WINDOWS — What you jump out of when you’re the sucker who bought Yahoo @ $240 per share.

INSTITUTIONAL INVESTOR — Past year investor who’s now locked up in a nuthouse.

PROFIT — An archaic word no longer in use.

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Success Stories

I have been trading the equity markets with many different strategies for over 40 years. Terry Allen's strategies have been the most consistent money makers for me. I used them during the 2008 melt-down, to earn over 50% annualized return, while all my neighbors were crying about their losses.

~ John Collins