from the desk of Dr. Terry F Allen

Skip navigation

Member Login  |  Contact Us  |  Sign Up

1-800-803-4595

Archive for August, 2014

Ongoing Spread SVXY Strategy – Week 3

Friday, August 29th, 2014

Two weeks ago we started a $1500 demonstration portfolio using SVXY, an ETP that is destined to move higher over the long run because of the way it is constructed (selling VIX higher-priced futures each day and buying at the spot price of VIX, a condition called contango which exists about 90% of time).

Today, contango is about 6% (that is how much higher the futures are that this ETP is selling each day when it buys at the spot price of VIX).  In rough terms, this means that SVXY should go up by 6% each month that VIX remains unchanged.  This works out to be about $1.25 per week that SVXY should go up, all other things being equal (which, unfortunately, they usually aren’t).

I hope you find this ongoing demonstration to be a simple way to learn a whole lot about trading options.

Terry

Ongoing Spread SVXY Strategy – Week 3

In this simple portfolio, we own an SVXY Jan-15 90 put.  We will use this as collateral for selling a put each week in the weekly series that expires a week later than the current short put that we sold a week ago.  The decay of our long put (theta) is $4 (this means that if SVXY remains unchanged, the put will fall in value by $4 each day.  The decay of our short put is $13 (and will increase every day until next Friday).  This means that all other things being equal, we should gain $9 in portfolio value every day at the beginning of the week and about double that amount later in the week.

Each Friday we will have to make a decision as to which strike we should sell the following week’s put at.  Our goal is two-fold – sell a put at a strike which is closest to being $1 in the money (i.e., the strike price is about $1 higher than the current price of the stock), and second, it must be sold at a credit so that we add cash to our portfolio each week.

This week, we were a little lucky because the stock is trading today at very near the strike of the 87 put we sold a week ago.  We will buy this put back today and sell a put for next week at the 88 strike and collect cash in doing so.  Here is the trade that we will place today.  If it doesn’t execute after half an hour, we will reduce the credit amount by $.10 (and continue doing this each half hour until we get an execution).

Here is the trade we placed today:

Buy to Close 1 SVXY Aug5-14 86 put (SVXY140829P86)
Sell to Open 1 SVXY Sep1-14 86.5 put (SVXY140905P86.5) for a credit limit of $1.50  (selling a diagonal)

When we entered this order, the natural price (buying at the ask price and selling at the bid price) was $1.25 and the mid-point price was $1.55.  We placed a limit order at $1.50, a number which was $.05 below the mid-point price.  (It executed at $1.50).

Our goal is to generate some cash in our portfolio each week.  This should be possible as long as the stock remains below $90 and we have to move that strike price higher.  We will discuss what we need to do later when it becomes an issue.

We paid a commission of $2.50 for this trade, the special rate for Terry’s Tips customers at thinkorswim.  The balance in our account is now $1670 which shows a $170 gain over the two weeks we have held the positions.  This is much more than the $45 average weekly gain we are shooting for to make our goal of 3% a week.

Next Friday we will make another similar trade and I will keep you posted on what we do.

Ongoing Spread SVXY Strategy – Week 2

Friday, August 22nd, 2014

Last week we started a $1500 demonstration portfolio using SVXY, and ETP that is destined to move higher over the long run because of the way it is constructed (selling VIX higher-priced futures each day and buying at the spot price of VIX, a condition called contango which exists in about 90% of days).Today we bought back an in-the-money expiring put that we had sold last week and rolled it over to next week.

I hope you find this ongoing demonstration to be a simple way to learn a whole lot about trading options.

Terry

Ongoing Spread SVXY Strategy – Week 2

Last week, we used the following trade to set up this portfolio:

Buy To Open 1 SVXY Jan-15 90 put (SVXY150117P90)
Sell To Open 1 SVXY Aug4-14 87 put (SVXY140822P87) for a debit limit of $12.20  (buying a diagonal)

This executed at this price (90 put bought for $15.02, 87 put sold for $2.82 at a time when SVXY was trading at $85.70.

Our goal is to generate some cash in our portfolio each week.  This should be possible as long as the stock remains below $90 and we have to move that strike price higher.  We will discuss what we need to do later when it becomes an issue. Right now, we are facing a market where the stock is trading lower than it was last week when we bought it.  Now it is about $85, and our goal is to sell a weekly put each week that is about $1 in the money, and do it at a credit.

This is the order we placed (and was executed today):

Buy to close 1 SVXY Aug4-14 87 put (SVXY140822P87)
Sell To Open 1 SVXY Aug5-14 86 put (SVXY140829P86) for a credit limit of $  (selling a diagonal)

When we entered this order, the natural price (buying at the ask price and selling at the bid price) was $.65 and the mid-point price was $.90.  We placed a limit order at $.85, a number which was $.05 below the mid-point price.  It was executed at that limit price.

We paid a commission of $2.50 for this trade, the special rate for Terry’s Tips customers at thinkorswim.  The balance in our account is now $1555 which shows a $55 gain (more than the $45 average weekly gain we are shooting for to make our goal of 3% a week).

Next Friday we will make another similar trade and I will keep you posted on what we do.

The stock has moved up a bit since we made this trade so you might be able to get a better price if you do this on your own.

This is what the risk profile graph looks like for our positions at next Friday’s expiration:

SVXY Risk Profile Graph August 2014

SVXY Risk Profile Graph August 2014

Ongoing Spread SVXY Strategy For You to Follow if You Wish

Monday, August 18th, 2014

A couple of weeks ago, I put $1500 into a separate brokerage account to trade put options on an Exchange Traded Product (ETP) called SVXY.  I placed positions that were betting that SVXY would not fall by more than $6 in a week (it had not fallen by that amount in all of 2014 until that date).  My timing was perfectly awful.  In the next 10 days, the stock fell from $87 to $72, an unprecedented drop of $15.

Bottom line, my account balance fell from $1500 to $1233, I lost $267 in two short weeks when just about the worst possible thing happened to my stock.  Now I want to put $267 back in and start over again with $1500, and make it possible for you to follow if you wish.

This will be an actual portfolio designed to demonstrate one way how you can trade options and hopefully outperform anything you could expect to do in the stock market.  Our goal in this portfolio is to make an average gain of 3% every week between now and when the Jan-15 options expire on January 15, 2015 (22 weeks from now).

That works out to 150% a year annualized.  I think we can do it.  We will start with one trade which we will make today.

I hope you find this ongoing demonstration to be a simple way to learn a whole lot about trading options.

Terry

Ongoing Spread SVXY Strategy For You to Follow if You Wish

Our underlying “stock” is an ETP called SVXY.  It is a complex volatility-related instrument that has some interesting characteristics:

1. It is highly likely to move steadily higher over time.  This is true because it is adjusted each day by buying futures on VIX and selling the spot (current) price of VIX.  Since over 90% of the time, the futures are higher than the spot price (a condition called contango), this adjustment almost always results in a gain.  SVXY gained about 100% in both 2012 and 2013 and is up about 30% this year.

2. SVXY is extremely volatile.  Last Friday, for example, it rose $2 in the morning, fell $6 mid-day, and then reversed direction once again and ended up absolutely flat (+$.02) for the day.  This volatility causes an extremely high implied volatility (IV) number for the options (and very high option prices). IV for SVXY is about 65 compared to the market (SPY) which is about 13.

3. While it is destined to move higher over the long run, SVXY will fall sharply when there is a market correction or crash which results in VIX (market volatility) to increase.  Two weeks ago, we started this demonstration portfolio when SVXY was trading at $87, and it fell to $72 before recovering to its current $83.

4. Put option prices are generally higher than call option prices.  For this reason, we deal entirely in puts.

5. There is a large spread between the bid and ask option prices.  This means that every order we place must be at a limit.  We will never place a market order.  We will choose a price which is $.05 worse for us than the mid-point between the bid and ask prices, and adjust this number (if necessary) if it doesn’t execute in a few minutes.

This is the strategy we will employ:

1. We will own a Jan-15 90 put.  It cost us $15.02 ($1502) to buy (plus $2.50 commission for the spread).  Theta is $4 for this option.  That means that if the stock is flat, the option will fall in value by $4 each day ($28 per week).

This is the trade we made today to get this demonstration portfolio established:

Buy To Open 1 SVXY Jan-15 90 put (SVXY150117P90)
Sell To Open 1 SVXY Aug4-14 87 put (SVXY140822P87) for a debit limit of $12.20  (buying a diagonal)

This executed at this price (90 put bought for $15.02, 87 put sold for $2.82 at a time when SVXY was trading at $85.70.
2. Each week, we will sell a short-term weekly put (using the Jan-15 90 put for collateral).  We will collect as much time premium as we can while selling a slightly in-the-money put.  That means selling a weekly put at the strike which is slightly higher than the stock price.  We hope to collect about $2 ($200) in time premium by selling this put. Theta will start out at about $20 for the first day and increase each day throughout the week.  If the stock stays flat, we would get to keep the entire $200 and make a net gain of $172 for the week because our long put would fall in value by $28.  This is the best-case scenario.  It only has to happen 6 times out of 22 weeks to recover our initial $1200 investment.

3. Each Friday we will need to make a decision, and often a trade. If the put we have sold is in the money (i.e., the stock is trading at a lower price than the strike price), we will have to buy it back to avoid it being exercised.  At the same time, we will sell a new put for the next weekly series.  We will choose the strike price which is closest to $1 in the money.  Our goal is to take some money off the table each and every week. If it is not possible to buy back an expiring weekly put and replace it with the next-week put at the $1 in-the-money strike at a credit we will select the highest-strike option we can sell as long as the spread is made at a credit.  We eventually have to cover the $1220 original spread cost, and collecting about $200 as we will some weeks would recover that amount quite quickly  – we have 22 weeks to collect a credit, so we only need an average of about $45 each week (after commissions).

4. On Friday, if the stock is higher than the strike price, we will not do anything, and let the short put expire worthless.  On the following Monday, we will sell the next-week put at the at-the-money strike price, hopefully collecting another $200.

5. We are starting off by selling a weekly put which has a lower strike price than the long Jan-15 put we own.  In the event that down the line (when the stock price rises as we expect it will), we may want to sell a weekly put at a higher strike price than the 90 put we own.  In that event, we will incur a maintenance requirement of $100 for each dollar of difference between the two numbers.  There is no interest charged on this amount, but we just can’t use it for buying other stocks. For now, we don’t have to worry about a maintenance requirement because our short put is at a lower strike than our long put.  If that changes down the line, we will discuss that in more detail.

This strategy should make a gain every week that the stock moves less than $3 on the downside or $4 on the upside.  Since we are selling a put at a strike which is slightly higher than the stock price, our upside break-even price range is greater. This is appropriate because based solely on contango, the stock should gain about $1.00 each week that VIX remains flat.

I think you will learn a lot by following this portfolio as it unfolds over time.  You might find it to be terribly confusing at first.  Over time, it will end up seeming simple.  Doing it yourself in an actual account will make it more interesting for you, and will insure that you pay close attention.  The learning experience should be valuable, and we just might make some money along the way as well.

How to Pick the Best Mutual Fund for Your IRA or 401(K)

Monday, August 11th, 2014

How to Pick the Best Mutual Fund for Your IRA or 401(K)

If you are a participant in a typical 401(k) plan, you face a list of 18 mutual funds to choose from.   If you set up your own IRA plan, the list grows to over 4000 funds in the universe.  Most people don’t have the foggiest notion of which fund choice is the best for them.  The answer is actually quite simple, if you understand a few essential truths.

Before you get to the mutual fund choice, you may have an even more important decision to make. It involves the kind of IRA you pick.  The Roth IRA is an infinitely better choice than the traditional IRA.  You forego a tax deduction in year one but you avoid paying ordinary income taxes every year you withdraw money during your retirement years when the amounts you withdraw are greater and the tax rate you pay is likely to be higher than during that first year (the government ultimately will be forced to raise rates to pay for social security and the interest on the federal debt).

The Roth IRA is such a good deal for you and such a bad deal for the government that they severely limit how much you can contribute ($5500 a year or $6500 if you are over 50), and if you make over $127,000 as a single or $188,000 as a couple, you can’t contribute at all.  If you qualify, choosing a Roth IRA over a traditional IRA is a no-brainer.  After five years and you reach 59 ½, there are no restrictions when (and if) you withdraw money while your nest egg continues to grow tax-free, including the dividends.

Astonishingly, in spite of the considerable advantages of Roth IRA’s, only 2% of all IRA investments are in Roth IRAs.  That is an unbelievable number to me. I just don’t understand how so many millions of Americans have made the absolutely wrong choice for themselves.  Of course, they also drop millions of dollars every day at the casinos, knowing full well that the house will win every time over the long run.  So I guess we should not expect them to be very smart about their IRA choice, either.  But it is a sad fact for me.

If your company’s 401(k) plan does not offer a Roth IRA alternative, speak to HR and ask them to get it in there.  Your fellow employees, and you, deserve it.

Once you have selected the Roth IRA alternative (if it indeed is a choice for you), you face the mutual fund choice challenge.  Why do you suppose that the average 401(k) plan has 18 choices?  That seems to be a fairly large number to choose from.  Surely, your company could figure out the three or four best choices out there and restrict your choices to those.  That would be offering a real service to anyone who lacks the financial education or experience to make that kind of important choice for their future livelihood.

Sadly, apparently the biggest reason that many companies offer a large number of mutual fund choices in their 401(k) plan is to avoid a lawsuit.  Class action suits have (successfully) been brought by employees of many companies against their employees because mutual fund choices were more beneficial to the mutual fund companies and just awful for the employees.  The courts have sided with the companies when a large number of mutual fund choices were offered (“it was the employees who decided to pick those bad ones – they had a better choice but did not take it” was the reasoning).

In a perfectly just world, the companies would also be required to provide more information to employees as to which the best choices would be for their employees. But as we all know, our world is far from perfect.

Fortunately, there is a best choice, and it is definitely not the most popular one.  The most popular choice is the target-date funds.  They make intuitively good sense.  You know the approximate year when you expect to retire, and you just select that date fund.  More than 40% of 401(k) participants make that choice (and that number is projected to grow to 50% by 2020). 

The sad fact is that there is not a single 5-year period ever when target-date funds have outperformed a low-cost broad-based index fund.  The only time when they have come close is when the stock market has crashed (since some of the target-date money is in fixed-income instruments, they do not fall quite as much as the overall market in market-crash years).  Over the last 5 years, target-date funds have lagged behind the market by 22% – 47% depending on the target date – truly monumental losses for all target-date fund owners.

Target-date funds underperform for two important reasons.  First, expense ratios (management fees) are higher, usually about three times as much as most index funds.  It doesn’t take a smart Wall Street MBA to pick the stocks in an index fund (rather, a fixed selection of stocks is blindly followed).  Consequently, the management fee can be much less for the index fund.

 Second, trading costs are usually two or three times as great in equity funds (especially target-date funds) compared to passive index funds.  The turnover rate can be 50% to 100% for many equity funds, running up considerable commission and trading costs that are passed on to participants (and generally not revealed to them). 

Even worse, this excessive turnover is subject to the completely hidden costs of high frequency trading which skims off millions of dollars for Wall Street every single trading day.  The big losers from high frequency trading are the owners of non-index equity mutual funds.

I have written a Kindle book that explores this entire issue in far more detail and tells you specifically exactly which fund you should choose for your 401(k) plan.  It is designed to be read in an hour (although two hours is probably a better time to allot).  I have immodestly called the book The Best Little Book on investing in an IRA or 401(k), Period! It is yours for only $5.99.  It could change everything you ever knew or were told about retirement investing.  If you have a single target-date or other non-index mutual fund in your investment portfolio, this small investment of your time and money could save you thousands of dollars over your lifetime.  Get it now, here.

The book includes one suggestion that is highly unlikely to have been disclosed to you by HR and is almost guaranteed to save you thousands in tax savings when you retire.  Why would any rational 401(k) participant not plunk down $5.99 to discover it?  Maybe because they are at the casino where they think they are more likely to come home with more money than they started out with.

Making 36%

Making 36% — A Duffer's Guide to Breaking Par in the Market Every Year in Good Years and Bad

This book may not improve your golf game, but it might change your financial situation so that you will have more time for the greens and fairways (and sometimes the woods).

Learn why Dr. Allen believes that the 10K Strategy is less risky than owning stocks or mutual funds, and why it is especially appropriate for your IRA.

Order Now

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