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Archive for the ‘10K Strategies’ Category

How to Play the Upcoming Facebook Earnings Announcement

Wednesday, April 20th, 2016

Over the last 3 weeks, I have suggested a way to leg into calendar spreads at a credit in advance of the earnings announcement for Starbucks (SBUX), Facebook (FB), and Abbvie (ABBV). All three calendars ended up being completed, and all three have already delivered a small profit. Once earnings are announced and the short side of the calendar spread expires, all three spreads are guaranteed to produce a much larger profit as well (depending on how close the stock price is to the strike price).

Today I would like to discuss another Facebook play. While this one does not guarantee profits, I believe it is even more exciting in many ways. It is possible that you could double your money in less than two weeks. I also believe it is extremely unlikely to lose money.

Terry

How to Play the Upcoming Facebook Earnings Announcement

All sorts of articles have been written over the past few weeks about the prospects for FB, some positive and some negative. We will all learn who was right and who was wrong late next week when FB announces earnings on April 27, and the details of the company’s large assortment of new and wondrous initiatives will be disclosed.

The high degree of uncertainty over the announcement has caused implied volatility (IV) of the options to soar, particularly in the series that expires two days after the announcement. Those Apr5-16 options carry an IV of 52. This compares to only 35 for longer-term option series and 32 for the Apr4-16 series which expires this week.

Buying calendar spreads at this time represents one of the best opportunities I have ever seen to buy cheap options and sell expensive options against them. The FB calendar spreads are exceptionally cheap right now, at least to my way of thinking.

I have written an article which was published by TheStreet.com today which describes the actual calendar spreads I have bought yesterday and today (and I have bought a lot of them). The article fully explains my thinking as to which spreads I purchased. Read the full article here.

How to Own 100 Shares of Google (Worth $71,600) for $15,000 or Make 12% a Month With Options

Tuesday, March 8th, 2016

Way back when Google (GOOGL) went public at $80 a share, I decided that I would like to own 100 shares and hang on to it for the long run. Obviously, that was a good idea as the stock is trading today at $716. My $8000 investment would now be worth $144,000 (the stock had a 2-for-1 split in November 2014) if I had been able to keep my original shares. Unfortunately, over the years, an options opportunity inevitably came along that looked more attractive to me than my 100 shares of GOOGL, and I sold my shares to take advantage of the opportunity.

Many times my investment account had compiled a little spare cash, and I went back into the market and bought more shares of GOOGL, always paying a little more to buy it back. At some point it felt like I just had too much money tied up in it. An $8000 commitment is one thing, but $144,000 is a major commitment.

Today I would like to share how I own the equivalent of 100 shares of GOOGL for an investment of less than $15,000, and the neat thing about my investment is that I get expect to get a “dividend” in the next month of about $1700 if the stock just sits there and doesn’t go anywhere.

I own options, of course. Here are two ways you can play it if you like Google.

Terry

How to Own 100 Shares of Google (Worth $71,600) for $15,000 or Make 12% a Month With Options:

You would have to shell out about $71,600 today to buy 100 shares of GOOGL stock. If you bought it on margin, you might have to come up with about half that amount, $35,800, but you have to shell out interest on the margin loan each month. I like money coming in, not going out.

Last week we talked about the Greek measure delta. This is simple the equivalent number of shares of stock that an option has. I own GOOGL 700 calls that expire on the third Friday of January 2017. You could buy one today for $8360. I own 2 of them for a cost of about $16,800

The delta for these Jan-17 700 calls is 60. That means if the stock goes up by a dollar, the value of each of my options will go up by $60. With these 2 options I own the equivalent of 120 shares of stock.

Since all options decline a little bit every day that the stock stays flat (it is called decay), simply owning options is just about as bad as paying margin interest on a stock loan. As I said earlier, I like money coming in rather than going out.

Over the course of the next ten months, the 700 call option will fall in value and end up being worth $1,600 if GOOGL is flat (trading at $716). That works out to an average monthly decay of $666 for each call I own.

One of the things I could do with these calls would be to cover this decay amount by selling two Apr2-16 750 calls for $700 each. The delta on these calls is 26. That means I would own the equivalent of 68 shares of stock worth $48,688 yet I only would have shelled out $16,800 less $1400, or $15,400. In other words, my option investment would cost less than 1/3 of what buying the stock would cost and I would not be paying any interest. Of course, it would take a little work on my part. In one month, if the stock were selling at less than $750, the calls I had sold would expire worthless and I would have to sell more one-month-out calls for at least $666 to cover the average monthly decay of the Jan-17 700 calls I had purchased. It will probably be at a different strike than 750, depending on what the new stock price was at the time.

If the stock were to rise above $750 in one month (I would be delighted because I would make a gain of about $2300 for the month – 68x$34), I would have to buy back the Apr2-16 750 calls just before they expired and sell May2-16 calls at a higher strike price, making sure I collected enough to cover the cost of buying back the Apr2-16 750 calls and the $666 each call will fall on average each month.

Instead of simply using options to own stock with only 1/3 of what it would cost to buy the stock, I chose a different way of trading. Most of the time, I would participate in the higher stock price, but I will make a nice gain every month even if the stock stays flat. Since I own 2 call options at a lower strike price than the market price I am entitled to use them as collateral to sell someone else the opportunity to buy shares of GOOGL. I sold one Apr2-16 725 call, collecting $15.40 ($1540) at today’s price. This option will expire in 30 days (April 8). If the stock is at any price less than $725, this call will expire worthless and I will get to keep the entire $1540.

This Apr2-16 725 call option that I sold carries a delta of 46, making my net option value (120-46) 74 deltas (the equivalent of 74 shares of stock). I also sold a second Apr2-16 call, this one at the 735 strike price, collecting $1150. This call has a delta of 39, giving me a 35 net delta value (60+60-46-39). I won’t own the equivalent of 120 shares of stock that I would have if I hadn’t sold calls against my Jan-17 calls, but I could possibly make even greater gains from option decay.

I now own the equivalent of 35 shares of GOOGL at a cost of $16,800 less the $2690 I collected from selling the two calls, or $14,110.

The neat thing about my option positions is that if the stock doesn’t go up (as I hope it will), my disappointment will be soothed a bit because I will gain about $1700 over the next month. Here is the risk profile graph for my positions:

GOOG Risk Profile Graph March 2016

GOOG Risk Profile Graph March 2016

 

The P/L Day column in the lower right-hand corner shows what the gain or loss will be at the price in the first column on the left. It shows that when the Apr2-16 calls expire on April 8, my positions will have a $1,742 gain in value (12% for the month on my investment of $14,110). If the stock were to gain just a little, I could make as much as $3000. If it went up 5% (about $35) I would make about the same amount as if it remained unchanged.

While a possible 12% gain every month sounds a little too good to be true, if you do it right, the actual gain would be greater. For the first few months, the Jan-17 700 calls I bought will decay less than the average $666 monthly amount. Theta (decay for a single day) is $12, or about $360 for the first month. For the last month just before it expires, the Jan-17 700 calls would decay about $1250. The best way to play this strategy would be to put some money back in (using cash you have taken out every month) when there is about 3 or 4 remaining months to the Jan-17 calls and sell those calls and replace them with calls expiring at a more distant-out month, such as July 2017 or January 2018.

There are disadvantages to owing the options I do rather than the stock. The biggest problem comes when the stock fluctuates by large numbers in either direction. If the stock falls 5% ($36), my options would lose about $2196. If I owned 68 shares of stock, I would lose $2448, about 11% more than the options loss. However, if the stock were to tumble significantly more than 5% in one month, the option loss would be considerably greater than the loss of share value. If the stock goes up by 5% in the next month, I would gain $2448 if I owned 68 shares of stock, and only $1884 with the options, or about $564 (23%) less than the stock would have gained. Using options rather than stock, I give up a little potential gain if the stock picks up 5% in one month but make a much greater gain if the stock is flat or moves moderately higher.

The major advantage to my options positions comes when the stock fluctuates well less than 5% in a month. As we showed earlier, an absolutely flat stock will result in a 12% gain while owning the stock would not make a penny.

I have just outlined two possible ways that you can invest in a company you like with options rather than buying the stock. One strategy allows you to have the equivalent of owning stock while having to come up with only one-third of the cash. A second strategy is designed to make about 12% in every month when the stock is flat or rises moderately. Either way seems smarter to me than just buying the stock.

 

Make 40% in One Month With This Costco Trade

Friday, February 19th, 2016

Make 40% in One Month With This Costco Trade

Two weeks ago, LinkedIn (LNKD) issued poor guidance while at the same time announced higher than expected earnings. Investors clobbered the stock, focusing on the guidance rather than the earnings. At the same time, as is often the case, another company in the same industry, Facebook (FB) was also traded down. With FB falling to $98, I reported to you on a trade that would make 66% after commissions if the company closed at any price above $97.50 on March 18, 2016. FB has now recovered and is well over $104 and this spread looks like it will be a winner. All we have to do is wait out the remaining 4 weeks (no closing trade will be necessary as long as the stock is at any price above $97.50).

Today, a similar thing took place. Walmart (WMT) announced earnings which narrowly beat estimates, but missed top line revenue by a bit. However, they projected that next quarterly earnings (starting now) would be flat. This announcement was a big disappointment because they had earlier projected growth of 3% – 4%. The stock fell 4.5% on that news.

Costco (COST) is also a retailer, and many investors believe that as Walmart goes, so will Costco. They sold COST down on WMT’s news by the same percentage, 4.5%. This how the lemmings do it, time and time again.

That seemed to be an over-reaction to me. COST is a much different company than WMT. COST is adding on new stores every month while WMT is in the process of closing 200 stores, for example. WMT has a much greater international exposure than COST, and the strong dollar is hurting them far more.

I expect cooler heads will soon prevail and COST will recover. Today, with COST trading at $147.20, I made a bet that 4 weeks from now, COST will be at least $145. If it is, I will make 40% after commissions on this spread trade. The stock can fall by $2.20 by that time and I will still make 40%.

Here is what I did for each contract:

Buy to Open 1 COST Mar-16 140 put (COST160318P140)
Sell to Open 1 COST Mar-16 145 put (COST160318P145) for a credit of $1.45 (selling a vertical)

This is called selling a bull put credit spread. When the trade is made, your broker will deposit the proceeds ($145) in your account (less the commission of $2.50 which Terry’s Tips subscribers pay at thinkorswim), or a net of $142.50). The broker will make a maintenance requirement of $500 (the difference between the two strike prices). There is no interest on this requirement (like a margin loan), but it just means that $500 in your account can’t be used to buy other stock or options.

Since you received $142.50 when you sold the spread, your net investment is $357.50 (the difference between $500 and $142.50). This is your maximum loss if COST were to end up at any price lower than $140 when the puts expire. The break-even price is $143.57. Any ending price above this will be profitable and any ending price below this will result in a loss. (If the stock ends up at any price between $140 and $145, you will have to repurchase the 145 put that you originally sold, and the 140 put you bought will expire worthless.)

Since I expect the stock will recover, I don’t expect to incur a loss. It is comforting to know that the stock can fall by $2.20 and I will still make my 40%.

If you wanted to be more aggressive and bet the stock will move higher, back above the $150 where it was before today’s sell-off, you could buy March puts at the 145 strike and sell them at the 150 strike. You could collect at least $2.00 for that spread, and you would gain 65% if COST ended up above $150. Higher risk and higher reward. The stock needs to move a bit higher for you to make the maximum gain. I feel more comfortable knowing it can fall a little and still give me a seriously nice gain for a single month.

By the way, these trades can be made in an IRA (if you have a broker like thinkorswim which allows options spread trading in an IRA).

If you make either of these trades, please be sure you do it with money you can truly afford to lose. Options are leveraged instruments and often have high-percentage gains and losses. With spreads like the above, at least you know precisely what the maximum loss could be. You can’t lose more than you risk.

Making a Long-Term Options Bet on Oil

Sunday, January 17th, 2016

 

The market is closed for the Marin Luther King holiday today, and maybe you have a little time to see how we plan to make some exceptional returns by playing what might happen with oil prices.

I would like to share with you details on a new portfolio we have set up at Terry’s Tips. It is a long-term bet that the price of oil will eventually recover from its recent 12-year lows, but maybe it will get even worse in the short run before an eventual recovery takes place. In the wonderful world of stock options, you can bet on both possibilities at once, and possibly make double-digit monthly gains while you wait for the future to unfold.

I hope you enjoy my thinking about an option strategy based on the future of oil prices. Maybe you might like to emulate these positions in your own account or become a Terry’s Tips Insider and watch them evolve over time.

Terry

Making a Long-Term Options Bet on Oil

Nobel Laureate Yale University professor Robert Shiller was interviewed by Alex Rosenberg of CNBC on July 6, 2015. He delivered his oft-repeated message that he believed that both stocks and bonds were overvalued and likely to fall. The last couple of weeks in the market makes his forecast seem pretty accurate. And then he continued on to say that he thought that oil would be a good investment, and that he was putting some of his own money on a bet that oil prices would move higher in the long run.
“One should have a wide variety of assets in one’s portfolio. And oil, by the way, is a particularly important asset to have in one’s portfolio, because we need it, and the economy thrives on it,” he said.

“So yeah, prices have come down a lot, partly because of the invention of fracking,” which has increased supply levels. “Will that reverse and go up smartly? I don’t know. But I’m just thinking—historically, commodities have been a good part of a portfolio, and they’re not pricey, so why not?”

So how has his advice turned out? On the day that Shiller suggested buying oil, USO (the most popular ETP that tracks the price of oil) was trading at $19. It is almost exactly half of that amount today.

We might wonder how Mr. Shiller feels about losing half his money in six months. If he hasn’t sold it yet, he really hasn’t lost it of course, but his account value is surely a whole lot less than it was.

I like the idea of getting into oil at a price which is half of what this apparently brilliant man bought it for, and also would like to benefit if the steady drop in the price of oil might continue a bit longer in the short run. Iran is scheduled to start dumping lots of its oil on the world market as the sanctions are removed, and OPEC has shown no inclination to reduce production (in its effort to discourage American frackers who have a higher cost of production). If the supply of oil continues to grow at a faster rate than demand, lower prices will probably continue to be the dominant trend, at least until a major war or terrorist action breaks out, or OPEC changes its tune and cuts back on production. If oil costs more to produce than it can be sold for (as OPEC asserts), then eventually supply must shrink to such a point that oil prices will improve.

Intuition would tell us that lower gas prices in the U.S. should help our economy (except for oil producers). Instead of paying $4 per gallon of gas, American drivers can pay about half that amount and have lots of money left over to buy other things. One would think that this would stimulate the economy and be good for the stock market. Apparently, it has not worked out that way. The recent drop in the stock market was supposedly due to fears of weakness in international economies. Many of them are dependent on oil revenues, and they are in bad shape with oil so cheap. Sometimes what seems intuitively true doesn’t work out in the real world.

It makes sense to me that at some point, supply and demand must even out, and a price achieved that is at least as high as the average cost of getting oil out of the ground. On a 60 Minutes episode on the subject of oil drilling in Saudi Arabia, the minister cited $60 per barrel as that number. This is more than double the current selling price of oil. It seems logical to believe that sometime in the future, this number will once again be reached. If that is the case, USO should be double what it is now.

The portfolio we created at Terry’s Tips (aptly called Black Gold) involves buying call LEAPS on USO which expire in 2018 so we have two years to wait for a rebound in oil.

Here are the two spreads we placed in this portfolio which was set up with $3500 (the actual cost of these spreads, including commissions, was $3186)

Buy To Open 7 USO Jan-18 8 calls (USO180119C8)
Sell To Open 7 USO Mar-16 10.5 calls (USO160318C10.5) for a debit of $2.32 (buying a diagonal)

Buy To Open 10 USO Jan-18 8 calls (USO180119C8)
Sell To Open 10 USO Feb-16 8 calls (USO160229C8) for a debit of $1.52 (buying a calendar)

The first spread (the diagonal) is set up to provide upside protection. The intrinsic value of this spread is $2.50 (the difference between the strike prices of the long and short sides). No matter how high the stock moves, this spread can never trade for less than $2.50. Actually, since there are 22 more months of life to the long Jan-18 calls, they will always have an additional time premium value that will keep the spread value well over $2.50. Since we paid only $2.32 for the spread, we can never lose money on it if the stock were to move higher.

The second spread, the calendar which is slightly in the money (at the 8 strike while the stock is trading about $8.75) is designed to provide downside protection in case the price of oil moves lower. Ideally, we would like the stock to fall about $.75 to end up exactly at $8 in 5 weeks when the Feb-16 calls expire. If that happens, those calls we sold will expire worthless and we will be in a position to sell new calls that expire a month later at the same strike. We should be able to collect about $500 from that sale, well over 10% of the initial cost of all the positions). No matter where the stock ends up, we will sell new calls at the February expiration, most likely in the March-16 series at the 8 strike price. If that is near the money, we should be able to collect about $.50 for each option, and it won’t take too many monthly sales at that level to completely cover our initial $1.52 cost of the spread. We will have 21 opportunities to sell new monthly premium to cover the original cost.

The long side of the calendar spread (the Jan-18 calls) will always have a value which is greater than the short-term calls that we sell at the 8 strike price. It is not always certain that they will be worth $1.32 more than the short-term calls like they are at the beginning, however. If the stock stays within a few dollars of $8, the long side should be worth at least $1.32 higher than the short side. If the stock makes a very large move in either direction, the long side might not be worth $1.32 more than the short side. Hopefully, we will collect new premium each month early on so that the original $1.32 cost has been returned to us and we are then playing with the house’s money for all the remaining months.

When the Mar-16 10.5 calls expire, we will sell new calls with about a month or two of life, choosing strike prices that are appropriate at the time, being careful not to choose a strike which is too low to insure we have at least some spreads which will not lose money no matter how high the stock price moves over the next two years. Presumably, we will be selling short term (one or two month) calls at increasingly higher strike prices as the stock moves higher in the long run, collecting new premium and watching the value of our long Jan-18 8 calls increase substantially in value as they become more and more in the money.

This is the risk profile graph which shows what we should make or lose at various possible stock prices in 5 weeks when the Feb-16 calls expire:

USO Risk Profile Graph Jan 2016
USO Risk Profile Graph Jan 2016

The stock can fall about 9% in 5 weeks before a loss occurs on the downside, or it can go up by any reasonable amount and a double-digit gain should be made on the original cost of the spreads. Each month, we plan to sell enough short-term premium to give us a 10% gain as long as the stock does not fluctuate outside a range of about 10% in either direction. Most months, this should be possible.

This explanation may be a little confusing to anyone who is not familiar with stock options. It would all make total sense if you became a Terry’s Tips Insider and read our 14-day tutorial. It takes a little effort, but it could change your investment returns for the rest of your life.

Portfolios Gain an Average of 10% for the Month

Monday, December 7th, 2015

This week we are reporting the results for the actual portfolios we carry out at Terry’s Tips. Many of our subscribers mirror our trades in their own accounts or have thinkorswim execute trades automatically for them through their free Auto-Trade program. In addition, we are showing the actual positions we currently hold in one of these portfolios so you can get a better idea of how we carry out the 10K Strategy.

Enjoy the full report.

Terry

Portfolios Gain an Average of 10% for the Month

The market (SPY) edged up 0.8% in November. In spite of mid-month relatively high volatility, things ended up just about where they started. The 6 actual portfolios carried out at Terry’s Tips outperformed the market by a factor of 12, gaining an average of 10.0%.

This 10% was less than October’s 14.2% average gain for the portfolios. The big reason why November lagged behind October was that we had one big losing portfolio this month (more on that later). Here are the results for each portfolio:

First Saturday Report Chart November 2015

First Saturday Report Chart November 2015
 * After doubling in value, portfolio had 2-for-1 split in October 2015

** After doubling in value, portfolio had 2-for-1 split in September 2015.
***Portfolio started with $4000 and $5600 withdrawn in December 2014.

S&P 500 Price Change for November = +0.8%
Average Portfolio Company Price Change for November = +1.8%
Average Portfolio Value Change for November = +10.0%

Further Comments: We have now recorded a 24.2% gain for the first two months of our First Saturday Reports. This is surely a remarkable result, 4 times better than the 5.4% that the market gained over those two months. Our results work out to an annualized rate of 145%, a level that we are surely not going to be able to maintain forever. But is has been fun so far.

All of the underlying stock prices did not gain in November. SBUX fell 1.3%, yet the Java Jive portfolio picked up 13.6%, proving once again that a lower stock price can still yield good gains, just as long as the drop is not too great.

Only one of our underlying stocks had an earnings announcement this month. Facebook (FB) announced and the stock edged higher, causing our Foxy Facebook to be our greatest gainer (up 22.1%) for November. We will have two earnings announcements in December – COST on the 8th and NKE which reports on the 20th or 21st. NKE also will have a 2-for-1 stock split on December 23rd. History shows that stocks which have a split tend to move higher after the split is announced, but then they move lower after the split has taken place. We will keep that in mind when we establish option positions later this month.

New Portfolio JNJ Jamboree Starts off With a Nice Gain: In its first month of operation, our newest portfolio gained 14.3% while the stock closely mirrored the market’s gain, picking up 0.9% compared to the market’s 0.8% gain. JNJ pays a healthy dividend which reduces volatility a bit, but the portfolio’s early performance demonstrates that the 10K Strategy can make good gains even when the options carry a low Implied Volatility (IV).

What Happened in Vista Valley, our big Loser This Month? NKE experienced extreme volatility, first dropping when Dick’s had a dismal earnings announcement, and then recovering when reports indicated that NKE was doing much better than most of the retailers. In the second week of November, NKE crashed $9.92 (7.5%). This is a truly unusual drop, and immediately forced us to make a decision. Do we lower the strike prices of our options to protect ourselves against a further drop, or do we hang on and wait for a recovery?

We were a little concerned by some analyst reports which argued that while NKE was a great company, its current valuation was extremely high (and probably unsustainable). So we lowered the strike prices from the 130–135 range to the 120-125 range. This ended up being a big mistake, because in the subsequent week, the stock rose $10.79, totally reversing the week-earlier drop. This forced us to sell off the lower-strike spreads and start over again with the higher strikes we had at the beginning of the month. If we had done nothing, the portfolio would have made a large gain for the month. Since we have selected underlyings that we believe are headed higher, in the future we should be slow to adjust to the downside unless there is strong evidence to refute our initial positive take on the company. This experience is another reminder that high volatility is the Darth Vader of the 10K Strategy world.

Here are the actual positions we held in one of the 6 Terry’s Tips portfolios. This portfolio uses the S&P 500 tracking stock (SPY) as the underlying. We have been running this portfolio for only two months. These positions are typical of how we carry out the 10K Strategy for all the portfolios.
_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _
Summary of Spy 10K Classic Portfolio. This $5000 portfolio was set up on October 6, 2015. It uses the 10K Strategy with short calls in several weekly series, some of which expire each week and is counted as one of our stock-based portfolios (even though it is not technically a stock, but an ETP).

First Saturday Report November 2015 10K Spy Positions

First Saturday Report November 2015 10K Spy Positions
 Results for the week: With SPY up $1.69 (0.8%) for the 5-week month, the portfolio gained $491 or 8.6%. This is about what we should expect when the market is ultimately flat, but with high volatility inside the month. We dodged a bullet by refraining from adjusting last week when the stock tanked on Thursday because it recovered that entire loss on Friday.

Our positions right now are a little unusual for us because we only have short calls in the next two weekly option series. Usually, we have 3 or 4 short series in place. The reason we ended up where we are right now is that when we buy back expiring calls each Friday, if the market that week has been flat or down, we sell next-week at-the-money calls. If the market has moved higher, we go to further-out series and sell at strikes which are higher than the stock price. Most weeks in November were flat or down, so we did not move out to further-out option series.

Looking forward to next week, the risk profile graph shows that our break-even range extends from about $2 on the downside to $3 on the upside. An absolutely flat market should result in a much greater weekly gain than we experienced last month because we have an unusually high number of near-the-money calls expiring next week.

First Saturday Report November 2015 10K Spy Risk Profile
First Saturday Report November 2015 10K Spy Risk Profile

As we approach the regular monthly option series for December (they expire on the third Friday, the 18th), we need to remember that a dividend is payable to holders of SPY on December 17. If we have short in-the-money calls on that date, we risk having them exercised and leaving us with the obligation to pay that dividend. For that reason, we will roll out of any in-the-money short calls a day earlier than usual to avoid this possibility.

How to Make Extraordinary Returns with Semi-Long Option Plays

Friday, November 27th, 2015

One of my favorite stock option plays is to make a bet that sometime in the future, a particular stock will be no lower than it is today. If you are right, you can make 50% – 100% without doing anything other than making a single option trade and waiting out the time period. Ten weeks ago, I made two specific recommendations (see my September 8, 2015 blog) for making this kind of bet, one which would make 62% in 4 months and the other 100% in that same time period. Today I would like to update those suggestions and discuss a little about how you set up the option trade if you know of a company you feel good about.

If you missed them, be sure to check out the short videos which explains why I like calendar spreads, and How to Make Adjustments to Calendar and Diagonal Spreads.

Terry

How to Make Extraordinary Returns with Semi-Long Option Plays

What is a long-term bet in the options world? A month? A week? I spend most of my time selling options that have only a week of remaining life. Sometimes they only have a day of life before they expire (hopefully worthless). So I don’t deal with long-term options, at least most of the time.

Most options plays are short-term plays. People who trade options tend to have short-term time horizons. Maybe they have ADHD and can’t handle long waits to learn whether they made a gain or not. But there are all sorts of different ways you can structure options plays. While most of my activity involves extremely short-term bets, I also have quite a bit of money devoted to longer-term bets which take 4 months to a year before the pay-day comes along.

One of my favorite semi-long (if there is such a word) option plays involves picking a stock which I particularly like for the long run, or one which has been beaten down for some reason which doesn’t seem quite right. When I find such a stock, I place a bet that sometime in the future, it will be at least as high as it is now. If I am right, I can usually make 50% – 100% on the bet, and I know in advance exactly what the maximum possible gain or loss will be, right to the penny.

Ten weeks ago, I liked where the price of SVXY was. This ETP is inversely correlated with option volatility. When volatility moves higher, SVXY falls, and vice versa. At the time, fears of a world-wide slowdown were emerging. Markets fell and volatility soared. VIX, the so-called “fear index” rose from the 12 – 14 range it had maintained for a couple of years to over 20. SVXY tanked to $45, and had edged up to $47 when I recommended placing a bet that in 4 months (on January 15, 2016), SVXY would be $40 or higher.

This trade would make the maximum gain even if SVXY fell by $7 and remained above $40 on that date:

Buy to Open 1 SVXY Jan-16 35 put (SVXY160115P35)
Sell to Open 1 SVXY Jan-16 40 put (SVXY160115P40) for a credit of $1.95 (selling a vertical)

Quoting from my September 8th blog, “When this trade was executed, $192.50 (after a $2.50 commission) went into my account. If on January 15, 2016, SVXY is at any price higher than $40, both of these puts will expire worthless, and for every vertical spread I sold, I won’t have to make a closing trade, and I will make a profit of exactly $192.50.

So how much do I have to put up to place this trade? The broker looks at these positions and calculates that the maximum loss that could occur on them would be $500 ($100 for every dollar of stock price below $40). For that to happen, SVXY would have to close below $35 on January 15th. Since I am quite certain that it is headed higher, not lower, a drop of this magnitude seems highly unlikely to me.

The broker will place a $500 maintenance requirement on my account. This is not a loan where interest is charged, but merely cash I can’t use to buy shares of stock. However, since I have collected $192.50, I can’t lose the entire $500. My maximum loss is the difference between the maintenance requirement and what I collected, or $307.50.

If SVXY closes at any price above $40 on January 15, both puts will expire worthless and the maintenance requirement disappears. I don’t have to do anything except think of how I will spend my profit of $192.50. I will have made 62% on my investment. Where else can you make this kind of return for as little risk as this trade entails?

Of course, as with all investments, you should only risk what you can afford to lose. But I believe the likelihood of losing on this investment is extremely low. The stock is destined to move higher, not lower, as soon as the current turbulent market settles down.

If you wanted to take a little more risk, you might buy the 45 put and sell a 50 put in the Jan-15 series. You would be betting that the stock manages to move a little higher over the next 4 months. You could collect about $260 per spread and your risk would be $240. If SVXY closed any higher than $50 (which history says that it should), your profit would be greater than 100%. I have also placed this spread trade in my personal account (and my charitable trust account as well).”

It is now 10 weeks later. SVXY is trading at $58 ½. I could buy back the first spread for $.45 ($47.50 after commissions). That would give me a $145 profit on my maximum risk of $307.50. That works out to a 47% gain for 10 weeks. That was easy money for me.

The other spread I suggested, raising the strikes of both the long and short sides by $10, could have been sold for $260. You could buy back the spread for $102.50 including commissions, giving you a profit of $157.50 on a maximum risk of $240, or 65%. Or you could just wait it out and enjoy the full 108% gain if SVXY closes no lower than $50 on the third Friday in January. I am hanging on to both my original bets and not selling now unless something better comes along.

In some Terry’s Tips, we make similar investments like this each January, betting that one year later, stocks we like will be at least where they were at the time. The portfolio we set up this year made those kinds of bets on GOOG, AAPL, and SPY. It will make 92% on the maximum amount at risk in 6 weeks if these three stocks are where they are today or any higher when the January 2016 puts expire. In fact, GOOG could fall by $155 and we would still make over 100% on that spread we had sold in January 2015. We could close out all three spreads today and make a gain of 68% on our maximum risk.

These are just some examples of how you can make longer-term bets on your favorite stocks with options, and making extraordinary gains even if the stock doesn’t do much of anything.

 

First Saturday Report with October 2015 Results

Monday, November 2nd, 2015

This week I would like to share with you (for the first time ever) every option position we hold in every stock-based actual portfolio we carry out at Terry’s Tips.  You can access this report here.If you missed it last week, be sure to check out the short videos which explains why I like calendar spreads, and  How to Make Adjustments to Calendar and Diagonal Spreads.

There is a lot of material to cover in the report and videos, but I hope you will be willing to make the effort to learn a little about a non-traditional way to make greater investment returns than just about anything out there.

Terry

First Saturday Report with October 2015 Results

Here is a summary of how well our 5 stock-based portfolios using our 10K Strategy performed last month as well as for their entire lifetime:

First Saturday Report October Results 2015

First Saturday Report October Results 2015

 

While it was a good month for the market, the best in 4 years, our 5 portfolios outperformed the market by 166% in October.

Enjoy the full report here.

Making Adjustments to Calendar and Diagonal Spreads

Thursday, October 29th, 2015

If you missed it last week, be sure to check out the short video which explains why I like calendar spreads.  This week I have followed it up with a second video entitled How to Make Adjustments to Calendar and Diagonal Spreads.

I hope you will enjoy both videos.  I also hope you will sign up for a Terry’s Tips insider subscription and start enjoying exceptional investment returns along with us (through the Auto-Trade program at thinkorswim).

Terry

Making Adjustments to Calendar and Diagonal Spreads

When we set up a portfolio using calendar spreads, we create a risk profile graph using the Analyze Tab on the free thinkorswim trading platform.  The most important part of this graph is the break-even range for the stock price for the day when the shortest option series expires.  If the actual stock price fluctuates dangerously close to either end of the break-even range, action is usually required.

The simple explanation of what adjustments need to be made is that if the stock has risen and is threatening to move beyond the upside limit of the break-even range, we need to replace the short calls with calls at a higher strike price.  If the stock falls so that the lower end of the break-even range is threatened to be breached, we need to replace the short calls with calls at a lower strike.

There are several ways in which you can make these adjustments if the stock has moved uncomfortably higher:

1. Sell the lowest-strike calendar spread and buy a new calendar spread at a higher strike price, again checking with the risk profile graph to see if you are comfortable with the new break-even range that will be created.  The calendar spread you are buying will most likely cost more than the calendar spread you are selling, so a small amount of new capital will be required to make this adjustment.
2. Buy a vertical call spread, buying the lowest-strike short call and selling a higher-strike call in the same options series (weekly or monthly).  This will require a much greater additional investment.
3. Sell a diagonal spread, buying the lowest-strike short call and selling a higher-strike call at a further-out option series.  This will require putting in much less new money than buying a vertical spread.
4. If you have a fixed amount of money to work with, as we do in the Terry’s Tips portfolios, you may have to reduce the number of calendar spreads you own in order to come up with the necessary cash to make the required investment to maintain a satisfactory risk profile graph.

There are similar ways in which you can make these adjustments if the stock has moved uncomfortably lower.  However, the adjustment choices are more complicated because if you try to sell calls at a lower strike price than the long positions you hold, a maintenance requirement comes into play.  Here are the options you might consider when the stock has fallen:

1. Sell the highest-strike calendar spread and buy a new calendar spread at a lower strike price, again checking with the risk profile graph to see if you are comfortable with the new break-even range that will be created.  The calendar spread you are buying will most likely cost more than the calendar spread you are selling, so a small amount of new capital will be required to make this adjustment.
2. Sell a vertical call spread, buying the highest-strike short call and selling a lower-strike call in the same options series (weekly or monthly).  This will require a much greater additional investment.  Since the long call is at a higher strike price than the new lower-strike call you sell, there will be a $100 maintenance requirement per contract per dollar of difference between the strike price of the long and short calls.  This requirement is reduced by the amount of cash you collect from selling the vertical spread.
3. Sell a diagonal spread, buying the highest-strike short call and selling a lower-strike call at a further-out option series.  This will require putting in much less new money than selling a vertical spread.

Why I Like Calendar Spreads

Wednesday, October 21st, 2015

I have created a short video which explains why I like calendar spreads.  It also shows the exact positions we hold in 3 Terry’s Tips actual portfolios so you can get a better idea of how we use calendar spreads.

 

I hope you will enjoy the video, and I welcome your comments.

 

Terry

 

Why I Like Calendar Spreads

 

The basic reason I like calendar spreads (aka time spreads) is that they allow you to make extraordinary gains compared to owning the stock if you are lucky enough to trade in a stock that stays flat or moves moderately higher.

 

I get a real kick out of making serious gains when the stock just sits there and doesn’t do anything.  Calendar spreads almost always do extremely well when nothing much happens in the market.

 

While I call them calendar spreads, if you look at the actual positions that we hold in our portfolios, you will see that the long calls we own are not always at the same strike prices as the short calls we have sold to someone else.  That makes them diagonal spreads rather than calendar spreads, but they operate exactly the same as calendar spreads.

 

With both calendar and diagonal spreads, the long calls you own decay at a slower rate than the short calls that you have sold to someone else, and you benefit from the differences in decay rates.  Both spreads do best when the stock ends up precisely at the strike price of an expiring option.  At that point, the short options expire worthless and new options can be sold at a further-out time series at the maximum time premium of any option in that series.

 

If you have sold short options at a variety of strike prices you can make gains over a wider range of possible stock prices.  We use the analyze tab on the free thinkorswim software to select calendar and diagonal spreads which create a risk profile graph which provides a break-even range that lets us sleep at night and will yield a profit if the stock ends up within that range.  I encourage you to try that software and create your own risk profile for your favorite stock, and create a break-even range which you are comfortable with.

Two 2015 Case Studies of Options Portfolios

Wednesday, October 14th, 2015

Got an extra five minutes of time to change your thinking about investing forever?  I invite you to read the following report and see why.  You could get a clear understanding of how an options strategy can be used to dramatically improve your investment results for any stock you feel good about (good enough to buy shares in that company).   For two companies we picked at the beginning of 2015, we have made over 100% on our money in the first nine months, and you could have done it as well, even if you knew absolutely nothing about options (read on and see how).

 

These case studies were actual portfolios carried out during the first nine months of 2015 in separate brokerage accounts at thinkorswim for Terry’s Tips subscribers (many of whom mirrored these trades in their own accounts or had trades executed automatically in their accounts by the (free) Auto-Trade service at that brokerage firm.  The results include commissions on all the trades.

 

The first nine months of 2015 were not good ones for the market.  The S&P 500 fell 6.7%, from 2059 to 1920. 

 

The two individual stocks covered in this report, Costco (COST) and Starbucks (SBUX) outperformed the overall market during this time period.  COST rose from $141.87 to $144.57, a gain of $2.70, or 1.9%.  SBUX soared from $82.05 to $113.68 (pre 2-for-1 split), or 38.5%.

 

As you will soon see, while the gains in COST and SBUX were most impressive compared to the overall market, they did not do nearly as well as our two actual portfolios which traded options on these underlyings.

 

The strategy used in these portfolios is a lot like buying stock and writing calls against the stock.  However, there is a big difference in the options portfolios.  Instead of buying stock, longer-term call options (and sometimes, LEAPS) are used as collateral against which to sell short-term call options.  The return on investment from writing calls against longer-term options that might cost one-tenth the value of the stock is why the options portfolio comes out well ahead of buying stock and writing calls against those shares. 

 

Extreme leverage can be your friend if the stock holds steady or moves higher.  On the other hand, if the underlying stock falls more than moderately, the options portfolio might lose more than you would lose you had bought stock instead.  So it’s important to select a stock you feel comfortable about.  The stock doesn’t have to move higher for this options strategy to prosper, but it can’t fall a lot and still expect to produce extraordinary gains.

 

Case Study #1 – Costco Options Portfolio

 

Costco (COST) started out 2015 trading at $141.87 while the Terry’s Tips portfolio which uses COST as the underlying was worth $6223.  With this amount invested, you could have purchased 43.8 shares of the stock (we’ll round it off and say you could have bought 44 shares).

 

Here is how the price of COST fluctuated during the first nine months of 2015:

 2015 Stock Price Of COST

2015 Stock Price Of COST

 

 

 

 

 

 

The stock rose steadily early in the year, but fell from a high of about $153  to as low as $135 in the first week of September. At the end of September, it was trading about $3 higher than where it started out the year. Let’s compare the prices for 44 shares of COST with the value of the actual Terry’s Tips portfolio trading COST options during this same time period:

COST Stock vs Portfolio 2015 

COST Stock vs Portfolio 2015

 

 

 

In late January when the stock fell a bit, the portfolio value fell by a greater amount, but when the stock recovered, the portfolio outperformed on the upside as well.  Two other times during the year, the stock took a sudden drop and the portfolio value fell below the equivalent investment in the stock, but when the stock moved higher in July, the portfolio shot by a considerably higher percentage.

 

Over the nine months, an investment in the stock would have gained $1.20 per share from dividends you would have received on 44 shares, or $52.80.  The stock gained $2.70 over these months, so the 44 shares were worth $118.80 more than they were at the beginning, for a net gain of $171.60 including the dividends. This total works out to a 1.2% gain on the stock purchase for the nine months.

 

Over this same period, the actual COST options portfolio (we call it the Rising Tide portfolio) rose from $6223 to $12,900, for a gain of $6667, or 107%.

 

Let’s check the actual positions in this portfolio at the beginning of the year (from our January 3, 2015 Terry’s Tips Saturday Report):

 

  

Rising Tide

     Price:

$141.61

     

 

 

 Option

Strike

Symbol

Price

    Total

Delta

Gamma

 Theta

-3

Jan-15

C

140

COST150117C140

$2.92

($876)

-3

Jan-15

C

143

COST150117C143

$1.23

($368)

-2

Jan-15

C

145

COST150117C145

$0.57

($113)

6

Apr-15

C

135

COST150417C135

$9.25

$5,550

1

Apr-15

C

145

COST150417C145

$3.43

$343

2

Jul-15

C

140

COST150717C140

$7.68

$1,535

 

Cash

$152

218

-37

$26

    Total Account Value

$6,223

3.5%

1

Annualized ROI at today’s net Theta:

152%

 

We owned 7 calls which expired in April and 2 which would extend until July, and we had sold a total of 8 Jan-15 calls, 3 of which were at a strike just below the stock price and 5 which were slightly out of the money.  We had one long uncovered call which we could have sold a short-term call against, but we wanted to maintain a higher net delta.  The option positions were the equivalent of owning 218 shares of stock (the net delta figure).  That explains why the portfolio value gains or loses at almost 5 times the rate of owning 44 shares of stock.

 

Now let’s fast forward to what the portfolio looked like at the close of business on September 25, 2015.  Here are the positions that we held:

 Rising Tide Positions Oct 2015

 Rising Tide Positions Oct 2015

 

You can see many differences between these positions and what we held back in January.  First, the long calls are all the way out to 2016 (Jan-16 and Apr-16).  Second, there are some put positions.  In May, when COST was trading about $144, we sold a bullish credit put spread (buying Oct-15 135 puts and selling Oct-15 140 puts).  If COST is at any price above $140 when those puts expire on October 16th, both puts will expire worthless, and we will have made 51% on the amount we risked when we sold the spread in May. Third, the short calls are in several weekly series rather than in a single (monthly) options series. 

 

About half-way through 2015, we changed the way we trade this portfolio. We are now short weekly options in several different series.  Each week, some calls expire, and we buy them back (usually on Friday) and sell new ones which expire about 4 weeks later.  We select strikes which will balance out the risk profile for the portfolio.  This allows us to tweak the profile each week rather than making wholesale adjustments at the end of the expiration month.  We believe that the superior performance we have enjoyed over the past few months in all of our stock-based portfolios has been due to this new way of trading which was not possible before the advent of weekly options.

 

Every Friday, we create a risk profile graph to help us decide which strike prices to use when we buy back the expiring weekly options and replace them with further-out new short calls.  Here is the graph we created on October 2, 2015 which shows the expected gain or loss in portfolio value when the short options expire on the next Friday, October 9th:

Rising Tide Risk Profile Graph Oct 2015 

Rising Tide Risk Profile Graph Oct 2015

 

This graph shows that if the stock is absolutely flat ($143.21) a week from now, the portfolio will gain $735, about 5% of the portfolio value.  If It moves about $3 higher, the portfolio would gain about double that amount.  A gain should result even if the stock falls by about a dollar during the next week.  It can move higher by about $6 before a loss would occur on the upside.  You can see how most weeks, this collection of long and short calls will result in a gain as long as the stock moves only moderately.  (Actually, in most weeks, we end up with positions that allow for the stock to fall by $2 before a loss would be incurred – this week was unusually bullish for us.)

 

To sum it up, over the 9 months of trading, our portfolio gained $6376.  This works out to be 107% of the starting value of $6223.  Someone who had spent the same amount of money buying shares of COST would have picked up about $172, or 1.2%..  Our portfolio outperformed by more than 30 times what the owners of the stock gained.

 

We believe that this experience establishes beyond all doubt that a properly-executed options strategy can out-perform the outright purchase of the shares many times over.  Of course, it is a lot easier just to buy the stock.  Trading options takes time and attention, but surely, isn’t it worth it when you might do about 30 times better?

 

If you don’t want to bother with all the trading, you could open an account at thinkorswim and sign up for their free Auto-Trade service, and not only enjoy their $1.25 (normally $3.90) commission rate for a single option purchase or sale, but all the trades will be automatically made for you in your account.  By the way, this lower commission rate made available to Terry’s Tips subscribers will apply to all your trades, not just those you make through Auto-Trade.  Many subscribers cover their entire subscription cost by their commission cost savings.

 

We recommend setting up a self-directed IRA account for trading options (especially a Roth IRA if you are eligible for one).  Gains from option trading are short-term capital gains taxed pretty much like ordinary income, and you don’t have to itemize individual trades when you file your tax return for an IRA account.

 

By the way, you may wonder about my options-trading experience.  Way back in 1980, I had a seat on the C.B.O.E. and traded as a market maker on the floor.  Ever since then, for 35 years, I have traded options essentially every day the market has been open.  I graduated from the Harvard Business School and earned a Doctorate in Business Administration from the University of Virginia, but my most valuable credentials came from trading options nearly every day for all those years.  My options trading has enabled me to give away over $2 million to charities in my home state of Vermont.  I was especially proud to build a large swimming pool for the Burlington Boys and Girls Club, and give dozens of college  scholarships to single-parent and first-in-family-to-attend-college Vermonters.

 

Case Study #2 – Starbucks (SBUX) Options Portfolio

 

The first nine months of 2015 were pretty good months for owners of Starbucks (SBUX).  The stock started out the year trading at $81.44 and steadily rose to a high of about $98, and then in early April, they had a 2-for-1 stock split.  By the end of September, the stock traded at $57.99 which works out to a pre-split price of $115.98.  There were 3 dividends of $.16 paid, adding another $.48 to the total, making it a total gain of $35.02, or 43% for the 9 months.

 

Our Java Jive  portfolio started out the year with $6032 invested in SBUX.  At $81.44 per share, you could have purchased 74 shares of stock.  Over the nine months, the portfolio gained $11,768 in value, making 195%.

 

Here is a graphic comparison of how a $6032 investment in the options portfolio compared to the purchase of 74 shares of stock:

 SBUX Stock vs Portfolio 2015

SBUX Stock vs Portfolio 2015

 

 

 

Unfortunately, the actual portfolio did not gain that much because we also had about half the money invested in Keurig Green Mountain (GMCR), a different kind of coffee company.  The GMCR portion of the portfolio lost $8905 over the period as the stock fell from over $130 to the low $50’s.  In August, GMCR was dropped and FB added to the portfolio, and FB about broke even for the next six weeks (we are now trading both SBUX and FB in separate portfolios).  The portfolio started out the year being worth $10,604 and at the end of September, was worth $12.786, up $2182, or 20.5%.  Not a bad gain over a period when the market fell 6.7%, but not quite the 195% it would have made if only SBUX had been traded.

 

We believe that the above two case studies establish beyond all doubt that a properly-executed options strategy can out-perform the outright purchase of the shares many times over.  Of course, it is a lot easier just to buy the stock.  Trading options takes time and attention, but surely, isn’t it worth it when you can make 107% with options rather than 1.2% owning the same stock, (as we did with COST), or 195% with options instead of 43% owning the same stock (as we did with SBUX)?

 

If you don’t want to bother with all the trading, you could open an account at thinkorswim and sign up for their free Auto-Trade service, and not only enjoy their $1.25 commission rate for a single option purchase or sale, but all the trades will be automatically made for you in your account (this same lower Terry’s Tips commission will apply to all your trades, not just those in Auto-Trade).

Making 36%

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

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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.

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