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Archive for the ‘10K Strategies’ Category

How to Make Gains in a Down Market With Calendar Spreads

Thursday, May 14th, 2015

This week I came to the conclusion that the market may be in for some trouble over the next few months (or longer).  I am not expecting a crash of any sort, but I think it is highly unlikely that we will see a large upward move anytime soon.

Today, I would like to share my thinking on the market’s direction, and talk a little about how you can use calendar spreads to benefit when the market (for most stocks) doesn’t do much of anything (or goes down moderately).

Terry

How to Make Gains in a Down Market With Calendar Spreads

For several reasons, the bull market we have enjoyed for the last few years seems to be petering out.  First, as Janet Yellen and Robert Shiller, and others, have recently pointed out, the S&P 500 average has a higher P/E, 20.7 now, compared to 19.5 a year ago, or compared to the 16.3 very-long-term average.  An elevated P/E can be expected in a world of zero interest rates, but we all know that world will soon change.  The question is not “if” rates will rise, but “when.”

Second, market tops and bottoms are usually marked by triple-digit moves in the averages, one day up and the next day down, exactly the pattern we have seen for the past few weeks.

Third, it is May.  “Sell in May” is almost a hackneyed mantra by now (and not always the right thing to do), but the advice is soundly supported by the historical patterns.

The market might not tank in the near future, but it seems to me that a big increase is unlikely during this period when we are waiting for the Fed to act.

At Terry’s Tips, we most always create positions that do best if the market is flat or rises moderately.  Based on the above thoughts, we plan to take a different tack for a while.  We will continue to do well if it remains flat, but we will do better with a moderate drop than we would a moderate rise.

As much as you would like to try, it is impossible to create option positions that make gains no matter what the underlying stock does.  The options market is too efficient for such a dream to be possible.  But you can stack the odds dramatically in your favor.

If you want to protect against a down market using calendar spreads, all you have to do is buy spreads which have a lower strike price than the underlying stock.  When the short-term options you have sold expire, the maximum gain comes when the stock is very close to the strike price.  If that strike price is lower than the current price of the stock, that big gain comes after the stock has fallen to that strike price.

If you bought a calendar spread at the market (strike price same as the stock price), you would do best if the underlying stock or ETF remained absolutely flat.  You can reduce your risk a bit by buying another spread or two at different strikes.  That gives you more than one spot where the big gain comes.

At Terry’s Tips, now that we believe the market is more likely to head lower than it is to rise in the near future, we will own at-the-money calendar spreads, and others which are at lower strike prices.  It is possible to create a selection of spreads which will make a gain if the market is flat, rises just a little bit, or falls by more than a little bit, but not a huge amount.  Fortunately, there is software that lets you see in advance the gains or losses that will come at various stock prices with the calendar spreads you select (it’s free at thinkorswim and available at other brokers as well, although I have never seen anything as good as thinkorswim offers).

Owning a well-constructed array of stock option positions, especially calendar spreads, allows you to take profits even when the underlying stock doesn’t move higher.  Just select some spreads which are at strikes below the current stock price.  (It doesn’t matter if you use puts or calls, as counter-intuitive as that seems – with calendar spreads, it is the strike price, not whether you use puts or calls, that determines your gains or losses.)

An Even Better Way to Play Oil With Options

Tuesday, February 10th, 2015

Yesterday I sent you a note describing an interesting way to make some serious money with options, betting that the price of oil will either stabilize or move higher from today’s low levels.  Thanks to subscriber Thomas, there is a better underlying out there.  Just in case you were planning to place the trades, I thought you should check this one out first.

Terry

An Even Better Way to Play Oil With Options

This is a re-write of yesterday’s letter, except the underlying is USO (another ETF) rather than OIH.  The chart for USO is remarkably similar to that of OIH:

The chart for USO is remarkably similar to that of OIH:

USO Historical Chart 2015

USO Historical Chart 2015

There is a distinct advantage to USO, however.  The options are far more liquid and bid-ask spreads are much smaller for USO.  In other words, you can get much better prices when you place orders or roll over your short positions to the next month.

USO closed at $19.60 Friday.  Here are the trades I plan to make today:

Buy 3 USO Jan-16 19 calls (USO160115C19)
Sell 3 USO Mar-15 19.5 calls (USO150320C19.5) for $1.45 (buying a diagonal)

Buy 1 USO Jan-16 19 call (USO160115C19) for $3.35
The spread order is priced at $.02 higher than the mid price between the bid and ask price for the spread, and the single call order is placed at $.05 higher than the mid price between the bid and ask.  You should be able to get those prices.

If you got those prices, your total investment would be $435 plus $335 plus $5 commission (Terry’s Tips commission rate at thinkorswim) for a total of $775.

This is the risk profile graph for these positions when the March calls expire on March 20:

USO Risk Profioe Graph 2015

USO Risk Profile Graph 2015

The graph shows that if the price of USO ends up in a range of being flat or moving higher by $3, the portfolio should gain at least $200, or about 25% for the six weeks of waiting.  The nice thing about owning options is that you can make this 25% even if the ETF doesn’t go up by a penny (in fact, if it actually is flat, your gain should be $327, or over 40%).  If you just bought USO instead of using options, you wouldn’t make anything if the ETF didn’t move higher.

Even better, if USO falls by a dollar, you still make a profit with the options positions.  If you owned the ETF instead, you would lose money, of course.

Owning an extra uncovered long Jan-16 19 call gives you upside protection in case USO moves dramatically higher.  It also leaves room to sell another short-term call if USO drifts lower instead of remaining flat or moving higher. Such a sale would serve to reduce or eliminate a loss if the ETF moves lower.

When the March calls expire, you would buy them back if they are in the money (i.e., the ETF is above $19.50) and you would sell Apr-15 calls at a strike slightly above the current ETF price.  You should be able to collect a time premium of about $100 for each call you sell.

There will be 10 opportunities to sell one-month-out calls for $100 before the Jan-16 calls expire. It is conceivable that you could collect $300 every month and get all your mney back in 3 months, and further  sales would be clear profit.  As long as the Jan-16 calls are in the money when they are about to expire, you would collect additional money from those sales as well.

This strategy involves making trades around the third Friday of each month when the short-term short options are about to expire.  That could be a pain in the neck, but to my way of thinking, it is a small price to pay for the possibility of doubling my money over the course of a year.  There is a variety of other option strategies you might employ, but this one makes good sense to me.

 

How to Play Oil Prices With Options

Sunday, February 8th, 2015

If you are anything like me, I have enjoyed filling up my car lately.  It almost seems too good to be true. How long do you think gas prices will stay this low?    I figure that the price is more likely to move higher from here than it is to move lower, but I could be wrong.  It seems like a prudent bet would be that it won’t move much lower from here, and that the price of oil is more likely to stay the same or move higher over the next year.  If either scenario (flat or up) is true, you can easily double your money using options.  Today I will show you one way that might be accomplished.

Terry

How to Play Oil Prices With Options

If you want to bet on higher oil prices, you might consider buying the ETF (Exchange Traded Fund) OIL.  This is simply a measure of the price of crude oil.  I don’t like to trade OIL, however, because the price is too low (under $12) to have meaningful option prices (and the options market is not very efficient which means it is hard to get decent prices because bid-ask ranges are too high).

An alternative ETF is OIH.  This covers the oil service companies, like drillers and transporters.  There is an extremely high correlation between the prices of OIL and OIH, and OIH has the advantage of having a higher absolute price ($35.50 at Friday’s close) and a more efficient options market (including weekly options and LEAPS).

Check out the chart for OIH for the last year:

OIH Historical Chart Feb 2015

OIH Historical Chart Feb 2015

If you had been smart (or lucky) enough to buy OIH when it rose above its 30-day moving average a year ago, you might have owned it while it rose from about $46 to about $55 when it fell below its 30-day moving average and then if you sold it short, you might make gains all the way down to $36 (you would have had to resist buying it back when it briefly moved above the moving average a few months ago).

Now OIH is well above this moving average and this might be a good time to make a bet that it will move higher going forward.  If you wanted to bet that the price of oil (and OIH) will remain flat or move higher, you might consider these trades (with OIH trading at $35.50):

Buy 3 OIH Jan-16 35 calls (OIH160115C35)
Sell 3 OIH Mar-15 36 calls (OIH150320C36) for $3.05 (buying a diagonal)

Buy 1 OIH Jan-16 35 call (OIH160115C35) for $4.45

These prices are at $.05 more than the mid-point between the bid and ask prices for the option or the spread.  You should be able to get those prices – be sure to enter it as a limit order because bid-ask ranges are a little high (although narrower than they are for OIL).

If you got those prices, your total investment would be $915 plus $445 plus $5 commission (Terry’s Tips commission rate at thinkorswim) for a total of $1365.

This is the risk profile graph for these positions when the March calls expire on March 20:

OIH Risk Profile Graph 2015

OIH Risk Profile Graph 2015

The graph shows that if the price of OIH ends up in a range of being flat or moving higher by $3, the portfolio should gain about $300, or about 20% for the six weeks of waiting.  The nice thing about owning options is that you can make this 20% even if the ETF doesn’t go up by a penny.  If you just bought OIH instead of using options, you wouldn’t make anything if the ETF didn’t move higher.

Even better, if OIH falls by a dollar, you still make a profit with the options positions.  If you owned the ETF instead, you would lose money, of course.

Owning an extra uncovered long Jan-16 35 call gives you upside protection in case OIH moves dramatically higher.  It also leaves room to sell another short-term call if OIH drifts lower instead of remaining flat or moving higher. Such a sale would serve to reduce or eliminate a loss if the ETF moves lower.

When the March calls expire, you would buy them back if they are in the money (i.e., the ETF is above $37) and you would sell Apr-15 calls at a strike slightly above the current ETF price.  You should be able to collect a time premium of about $100 for each call you sell.

There will be 10 opportunities to sell one-month-out calls for $100 before the Jan-16 calls expire.  Once you have collected $100 for each of 3 monthly calls you sell, you will have all your original investment back, and further  sales are clear profit.  As long as the Jan-16 calls are in the money when they are about to expire, you would collect additional money from those sales as well.

This strategy involves making trades around the third Friday of each month when the short-term short options are about to expire.  That could be a pain in the neck, but to my way of thinking, it is a small price to pay for the possibility of doubling my money over the course of a year.  There is a variety of other option strategies you might employ, but this one makes good sense to me.

How to Make 20% in one Month on Your Favorite Stock (Using Options)

Thursday, January 22nd, 2015

 

This week I would like to show you the exact positions of one of the 9 portfolios we are currently carrying out for Insiders at Terry’s Tips.  It involves one of my favorite places to shop, Costco, and its stock, COST.  We expect to make just under 20% on this portfolio in the next four weeks, even if the stock does not go up a single penny.  Welcome to the wonderful world of stock options.Terry

How to Make 20% in one Month on Your Favorite Stock (Using Options)

The basic strategy that we carry out at Terry’s Tips is to buy longer-term options on stocks we like and sell shorter-term options against them.  Since the decay rates of the shorter-term options is much higher than the decay rates of the long-term options we own, we hope to make money every day that the stock remains flat or moves in the direction that we expect it will.  In options terms, we have positions that have a positive theta value.

Most of the time, we buy these option spreads on stocks we like, so by selecting strike prices that are higher than the current stock price, we create a portfolio that gains more than the theta value when the stock moves higher.  In options terms, we have a portfolio which is positive net delta.  It gains in value when the stock moves higher, just as owners of the stock enjoy.

Here is the risk profile graph for our actual Costco portfolio.  We have just under $5000 invested in these positions.  The curve shows how much we will make or lose at each of the possible stock prices when the February options expire on February 20, 2015, four weeks from tomorrow.
COST Risk Profile Graph 2015

COST Risk Profile Graph 2015

This graph is created by the free Analyse Tab software that is available at thinkorswim. You can see that if the stock remains flat at today’s price ($139.63 when I created this graph), the portfolio is slated to gain $960.38 when the February options expire.  That is almost 20% on our portfolio value.  If the stock moves higher (as we expect it will most of the time), the gain is just about the same, even if it moves as much as $10 higher in a single month.  (While we love this stock, it is probably unlikely to go that much higher).

On the downside, the stock can fall almost $2 and we will still make a small gain.  How can anybody disagree that these options positions are vastly better than just buying COST stock?  Most months, the stock will remain about flat or edge higher.  In each case, we should pick up almost 20% while stock-buyers gain little or nothing.

In this actual portfolio, we own the following call options:

1 COST Apr-15 145 call (COST150417C145)
4 COST Jul-15 135 calls (COST150717C135)
3 COST Jul-15 140 calls (COST150717C140)
3 COST Jul-15 150 calls (COST150717C150)

These are the calls that we have sold (are short):

6 COST Feb-15 140 calls (COST150220C140)
1 COST Feb-15 145 call (COST150220C145)
3 COST Feb-15 150 calls (COST150220C150)

When we have bought and sold a call at the same strike price, we own what is called a calendar spread (also called a time spread).  When the long and short call are at different strike prices, we own what is called a diagonal spread.  Most of the time, the short call is at a higher strike price than the long call (so we don’t incur a maintenance requirement).

We have one more long call than we have short calls.  We could make a greater gain at a flat stock price if we sold a February call against our extra long call, but we might end up not gaining nearly as much if the stock should move significantly higher in the next four weeks.

We are satisfied with making 20% in the next month in this portfolio.  Most people would be happy gaining that much for an entire year. If you like, COST, NKE, SBUX, GMCR, or SPY (to name a few we are currently trading), you could join us, and have all the trades made for you through Auto-Trade at thinkorswim by becoming a Terry’s Tips Insider.  Why not do it today?  It might be a great way to start out the New Year.

Maybe it’s Time to Buy Options Rather Than Sell Them

Monday, June 23rd, 2014

Last week I recommended buying a calendar spread on SVXY to take advantage of the extremely high option prices for the weekly options (at-the-money option prices had more than doubled over the past two weeks).  The stock managed to skyrocket over 7% for the week and caused the calendar spread to incur a loss.  When you sell a calendar spread, you want the stock to be trading very close to the strike price when the short options expire.  When the underlying stock makes a big move in either direction, you generally lose money on these spreads, just as we did last week.

Ironically, this spread was the only losing portfolio out of the 10 portfolios we carry out at Terry’s Tips (ok, one other portfolio lost a couple of dollars, but 8 others gained an average of almost 5% for the week).  The only losing spread was the one I told the free newsletter subscribers about.  Sorry.  I’ll try to do better next time.

Terry

Maybe it’s Time to Buy Options Rather Than Sell Them:

Option prices are almost ridiculously low.  The most popular measure of option prices is VIX, the so-called “fear index” which measures option prices on SPY (essentially what most people consider “the” market).  Last week VIX fell almost 11% to end up below 11.  The historical mean is over 20, so this is an unprecedented low value.

When we sell calendar or diagonal spreads at Terry’s Tips, we are essentially selling options to take advantage of the short-term faster-decaying options.  Rather than using stock as collateral for selling short-term options we use longer-term options because they tie up less cash.

With option prices currently so low, maybe it is a time to reverse this strategy and buy options rather than selling them.  On Friday, in the portfolio that that lost money on the SVXY calendar spread, we bought at-the-money calls on SPY  for $1.36.  It seems highly likely that  the stock will move higher by $1.50 or more at some point in the next 3 weeks and make this a winning trade (SPY rose $1.81 last week, for example).

With option prices generally low across the board and the stock market chugging consistently higher in spite of the turmoil in Iraq, maybe this would be a good time to buy a call option on your favorite stock.  Just a thought.

Legging Into a Short Iron Condor Spread

Monday, March 3rd, 2014

Today I would like share with you the results of an actual trade recommendations I made for my paying subscribers on January 4th of this year and how subsequent price changes have opened up option possibilities that can further improve possibilities for a first investment.

Please don’t get turned off by what this new spread is called.

Terry

Legging Into a Short Iron Condor Spread

In my weekly Saturday Report that I send to paying subscribers, on January 4, 2014 I set up an actual demonstration portfolio in a separate trading account at thinkorswim in which I made long-term bets that three underlying stocks (GOOG, SPY, and GMCR) would be higher than they currently were at some distant point in the future.  The entire portfolio would make exactly 93% with the three spreads I chose if I were right about the stock prices.

Almost two months later, things are looking pretty good for all three spreads, but that is not as important as what we can learn about option possibilities.

If you recall, early this year I was quite bullish on Green Mountain Coffee Roasters (GMCR) which has recently changed their name to Keurig Green Mountain.  The major reason was that three insiders who had never bought shares before had recently made huge purchases (two of a million dollars each).  I Googled these men and learned that they were mid-level executives who were clearly not high rollers.  I figured that if they were committing this kind of money, they must have had some very good reason(s),  Also, for four solid months, not a single director had sold a single share, something that was an unusual pattern for the company.

My feelings about the company were also boosted when a company writing for Seeking Alpha published an article in which they had selected GMCR as the absolute best company from a fundamental standpoint in a database of some 6000 companies.

This is what I wrote in that Saturday Report – “The third spread, on Green Mountain Coffee Roasters (GMCR), is a stronger bullish bet than either of the first two, for two reasons.  The stock is trading about in the middle of the long and short put prices (70 and 80), and the time period is only six months (expiring in June 2014) rather than 11 or 12 months.  I paid $540 for the Jun-14 80 – Jun-14 70 vertical put credit spread.  My maximum loss is $460 per spread if the stock closes below $70, and I will make 115% after commissions in six months if it closes above $80.”

This vertical put credit spread involved selling the Jun-14 80 puts for $13.06 and buying the Jun-70 puts for $7.66, collecting $540 for each spread.  I sold 5 of these spreads, collecting a total of $2700.  There would be a maintenance requirement of $5000 for the spreads (not a margin loan which would have interest charged on it, but an amount that I couldn’t use to buy other stocks or options).  Subtracting what I received in cash from the maintenance requirement, my real cost (and maximum loss) would be $2300.  If GMCR closed at any price above $80 on June 21, 2014, both puts would expire worthless and I could keep my $2700 and make 115% after commissions (there would be no commissions to pay if both puts expired worthless).

An interesting side note to the $2700 cash I received in this transaction.  In the same account, I also owned shares of my favorite underlying stock.  I am so bullish on this other company (which is really not a company at all, but an Exchange Traded Product (ETP)) that I owned some on margin, paying 9% on a margin loan.  The cash I received from the credit spread was applied to my margin loan and reduced the total on which I was paying interest.  In other words, I was enjoying a 9% gain on the spread proceeds while I waited out the six months for the options to expire.

In case you hadn’t heard, GMCR announced on February 5th that they had executed a 10-year contract with Coke to sell individual cups on an exclusive basis.  The stock soared some 50%, from $80 to over $120.  In addition, Coke bought 10% of GMCR for $1.25 billion, and gained over $600 million on their purchase in a single day.  Obviously, those insiders knew what they were doing when they made their big investments last November.

Now I am in an interesting position with this spread.  It looks quite certain that I will make the 115% if I just sit and wait another 4 months.  The stock is highly unlikely to fall back below $80 at this point.  I could but back the spread today for $.64, ($320 for the 5 spreads) and be content with a $2380 gain now rather than $2700 in June.

But instead, I decided to wait it out, and add a twist to my investment.  Since the deal with Coke will not reach the market until at least 2015, it seems to me that we are in for a period of waiting until the chances of success for single servings of Coke are better known.  The stock is probably not going to move by a large amount in either direction between now and June.

With that in mind, I sold another vertical credit spread with June options, this time using calls.  I bought Jun-14 160 calls and sold Jun-14 150 calls and collected $1.45 ($725 less $12.50 commissions).  These options will expire worthless if GMCR is at any price below $150 on June 21, 2014, something that I believe is highly likely.  I think it has already taken the big upward move that it will take this year.

If the stock ends up at any price between $80 and $150, I will make money on both spreads that I sold.  Now the total I can gain is $3400 (after commissions) and my net investment has now been reduced to $1600 and my maximum gain is 212% on my money at risk.

This new spread will not have any maintenance requirement because the broker understands that I can’t lose money on both vertical spreads I have sold.  He will look at the two spreads and notice that the difference between the long and short strike prices is 10 for both spreads.  As long as he is setting aside $5000 in a maintenance requirement on the account, he knows that I can lose that maximum amount on only one of the two spreads.

What I have done is to leg into what is called a short iron condor spread (legging in means you buy one side of a spread to start, and then add the other side at a later time – the normal way to execute a spread is to execute both sides at the same time).  You don’t have to know any more about it than know its name at this time, but I invite you to become a Terry’s Tips Insider and learn all about short iron condors as well as many other interesting options strategies.

Another Interesting Options Bet on Google

Monday, February 24th, 2014

Just over two months ago, shortly before Christmas, I suggested that you might consider making a bet that Google (GOOG) would be higher in one year than it was then.   I figured the chances were pretty good that it might move higher because it had done just that in 9 of its 10 years in existence.

I made this bet in my personal account and also in a real account for Insiders at Terry’s Tips to follow, or mirror in their own accounts.  The stock has moved up by about $90 since then and the bet is looking like it might pay off.

Today I would like to discuss either taking a profit early or doing something else with Google if you feel good about the company as I do.

Terry

Another Interesting Options Bet on Google

In my January 4, 2014 Saturday Report sent to Terry’s Tips Insiders, I set up a new demonstration actual portfolio that made long-term bets on three underlying stocks that I believe would be higher well out in the future than they were then.  This is what I said about one of them – “The most interesting one, on Google, will make just over 100% on the money at risk if Google is trading at $1120 or higher on January 17, 2015, a full year and two weeks from now.  It was trading at $1118 when we placed the spread, buying Jan-15 1100 puts and selling Jan-15 1120 puts for a credit of $10.06.  The stock fell to $1105 after we bought the spreads, so you may be able to get a better price if you do this on your own next week.

GOOG has gained in 9 of the 10 years of its existence, only falling in the market-meltdown of 2007.  If you were to make 100% in 9 years and loss 100% in the tenth year, your average gain for the ten-year period would be 80%.  That’s what you would have made over the past 10 years.  If the next 10 years shows the same pattern, you would beat Las Vegas odds by quite a bit, surely better odds than plunking your money down on red or black at the roulette table.

I have told many friends about this bet on Google, and most of them said they would not do it, even if they had faith in the company.  The fear of losing 100% of their investment seemed to be greater than the joy of possibly making an average of 80% a year.  I told them that the trick would be to make the bet every year with the same amount, and not to double down if you won in the first year.  But that did not seem to sway their thinking.  I find their attitude most interesting.  I am looking forward to 10 years of fun with the spread.  It is a shame that it will take so long for the wheel to stop spinning, however.

It is now almost two months later and Google’s latest earnings announcement has suggested that the company has continued to be able to monetize its Internet traffic better than anyone else, especially the social media companies who are drawing most of the market’s attention.  GOOG (at $1204) is trading almost $100 higher than it was when I wrote that report and sold that vertical put credit spread.

In the demonstration portfolio account, I had sold 5 of those vertical put spreads, collecting $10.06 ($5030 for 5 spreads) and there was a $10,000 maintenance requirement charged (no interest like a margin loan, just a claim on cash that can’t be used to buy other stocks or options).  My net investment (and maximum loss would be the maintenance requirement less the amount I received in cash, or $4970).

With the stock trading so much higher, I could now buy the spread back for $7.20 and pick up a gain of $1430.  It is tempting to take a 28% profit after only two months, but I like the idea of hanging on for another 10 months and making the full 100% that is possible.  Now I am in the comfortable position of knowing I can make that 100% even if the stock falls by $84 over that time.

Rather than taking the gain at this time, I am more tempted to buy more of these spreads.  If I could sell them for $7.20 my net investment would be $12.80 and I could make 39% on my money as long as GOOG doesn’t fall by more than $84 in 10 months.  This kind of return is astronomical compared to most investments out there, especially when your stock can fall by so much and you still make that high percentage gain.

Even better, since I continue to like the company, I am planning to sell another vertical put credit spread for the Jan-15 option series.  Today, I will buy Jan-15 1110 puts and sell Jan-15 1140 puts, expecting to receive about $11 ($1100) per spread.  My maximum loss and net investment will be $1900 and if GOOG manages to close above $1140 ($64 below its current level) on January 21, 2015, I will make 57% on my investment after commissions.

I like my odds here, just as I did when I made the earlier investment on Google.  I believe that many investors should put a small amount of their portfolio in an option investment like this, just so they can enjoy an extraordinary percentage gain on some of their money.  And it is sort of fun to own such an investment, especially when it seems to be going your way, or if not exactly going your way, at least not too much in the other direction.

An Earnings Play on Green Mountain Coffee Roasters

Wednesday, January 22nd, 2014

Today I would like to tell you about an actual trade I made today in my personal account  as well as two Terry’s Tips portfolios.  The underlying is Green Mountain Coffee Roasters (GMCR) which is located in my home state of Vermont and is one of my favorite companies.This trade will make a nice gain if the stock stays flat or moves higher by any amount between now and 17 days from now, just after earnings are announced.

If the company disappoints in any way and the stock falls, I will have plenty of time to recover by selling new calls against my long positions over the next five months.

I believe this spread has an excellent chance of making a nice gain and there seems to be almost no chance that I will lose money on it even though it might take a little time to at least break even.

An Earnings Play on Green Mountain Coffee Roasters

GMCR announces earnings after the close on February 5, 2013.  The weekly options that expire a couple of days later, on February 7 are trading at extremely high valuations (implied volatility (IV) is 65).  I would like to sell some of that premium.

I am bullish on this company.  Two insider directors recently bought over a million dollars each of the stock (and they aren’t billionaires).  The company is buying back shares every quarter, so they must believe it is a good purchase.

One company wrote a Seeking Alpha article in which they picked GMCR as the absolute best company out of their database of over 7000 companies. Only a handful of other companies have met this criterion in the past, and on average, their stock has outperformed the S&P 500 by a factor of three. Check it out – Green Mountain Coffee Roasters: The Fundamental King.

I bought a diagonal call spread, buying GMCR Jun-14 70 calls and selling Feb1-14 80 calls.  The spread cost me $9.80 at a time when the stock was trading at just below $80.  If the stock moves higher, no matter how high it goes, this spread will be worth at least $10 plus the value of the time premium for the 70 call with about 5 months of remaining value, no matter how much IV might fall for the June options. The higher the stock might soar, the less I would make, but I expect I should make at least 20% on my money (if the stock moves a lot higher) in 17 days.

This is what the risk profile graph looked like at the end of the day today.  (In this portfolio, one of the 10 we conduct for Terry’s Tips subscribers to  follow), I bought 6 spreads which just under $6000.  Commissions were $15.  It shows the expected loss or gain on the investment on February 7th when the short calls expire:

gmcr risk profile graph jan 2014

gmcr risk profile graph jan 2014

If it stays flat I should make about 40% (the graph shows more, but IV for the June calls will most likely fall).  If it falls more than $5, I will be looking at a paper loss, but will still own 70 calls with 5 months of remaining life.  I should be able to sell weekly calls against these June 70 calls and recoup any paper losses that might come my way if the company disappoints on announcement day.

I believe this is a very safe bet that is highly unlikely to result in a loss, although I may have some money tied up for a while if the stock does tank after announcing.   But as usual, I hope that no one will take the risk with money that they can’t afford to lose.

 

 

 

 

How to Use Options to Invest in Nike

Tuesday, September 24th, 2013

Today I would like to share an options strategy that we are carrying out in an actual portfolio at Terry’s Tips. It is based on the underlying stock Nike (NKE), and is set up to show how an options portfolio can make far greater gains than you could expect if you bought shares of the stock instead.The options portfolio should make a double-digit gain in the next four weeks even if the stock falls by $3 or so. If you like Nike, you will have to like this options portfolio even more.

Read to the bottom of this letter to learn how you can become a Terry’s Tips Insider for absolutely no cost.

Terry 

How to Use Options to Invest in Nike: Please spend a few minutes studying this risk profile graph carefully. It shows the expected return you would make on an investment of about $4000 in NKE call options in the next 25 days:

NKE Risk Profile Graph

NKE Risk Profile Graph

If the stock ends up at about where it is right now ($69) when the October call options expire on Friday, October 19, 2013, the graph shows that you could expect to make almost $1000 on your $4000 investment. That is almost 25% and the stock doesn’t have to go up one nickel.

People who buy shares of NKE instead of setting up a simple options portfolio like this one will not make any gains at all while we make over 20% in a single month. Of course, stockholders get to keep the 1.5% dividend that the company pays (regardless of which way the stock price might move). We have to give up that reward in exchange for the possibility of making over 20% in the next month, and presumably, in every subsequent month as well.

Admittedly, this sounds a little too good to be true. But the graph does not lie. Those are the numbers.

The graph shows that if the stock manages to move higher by about $3 over the next 25 days, less money would come our way. Only about 13% (after commissions) on our $4000 investment. But that is still a whole lot better than the stockholders would gain. They would pick up about 4.3% (a $3 gain on a $69 stock), less than half of what we expect.

The biggest advantage to our options portfolio actually comes about in the event that the stock falls moderately over the next month. If it should fall about $3 to the $66 area, the graph shows that we would make a profit of about 11% on our investment. Of course, if that happens, the owners of the stock would all lose money while we are re-investing some nice gains, or taking a little vacation in Provence, or whatever we want to do with those winnings.

It’s particularly pleasing to rack up a nice gain for the month when the stock we picked actually fell in value. We call it the “options kicker” and we really get a kick out of it.

So what does this portfolio consist of, and why can we expect to make money if the stock stays flat or moves moderately either up or down? It all comes about from the decay rate of the options that we own and the options that we have sold to someone else.

This portfolio owns call options with strike prices of 62.5 and 65, and most of these calls are LEAPS expiring in January, 2015. All options fall in value every day (assuming that the stock stays flat), but the rate of decay is much lower for longer-term options like the ones we own. Every day, our call LEAPS fall in value by about $1 each (in the options world, this is called theta). Since we own 7 LEAPS, we lose about $7 a day in decay.

Using these LEAPS as collateral, we have sold October, 2013 calls at the 70 and 72.5 strikes to someone else. These calls decay at the rate of $4 a day, and the 7 we have sold short collectively go down in value by $28 every day. Since our long positions are decaying by $7 a day and the ones we sold to someone else are falling by $28, the portfolio is gaining $21 every day that the stock is flat. This number will grow larger as the October 19th expiration is approached. In the last few days, those options will fall by $15 or so (each) while our LEAPS will continue to fall by only about $1 each.

When the October expiration day comes around, we will buy back the expiring short calls if they are in the money (i.e., the strike price is lower than the stock price) and we will sell November calls in their place. If our short calls are out of the money (i.e., the strike price is higher than the current stock price), they will expire worthless and we will be able to keep 100% of what we sold those calls for. At that point we will sell new calls expiring in November.

This is a simplistic explanation of the strategy. It gets a little more complicated when you have to decide which strike prices to sell calls at each month. Since we are bullish on NKE, we usually sell calls that are mostly at out-of-the-money strike prices so that we will gain both from the increase in the stock price and the decay of the calls that we have sold. The above risk profile graph is typical of what we normally have in place because a bigger gain will come our way if the stock gains $3 compared to what we would make if it fell by $3.

You can use this same strategy on just about any stock. It doesn’t have to be Nike. We also have a portfolio that uses the same strategy with one of my favorite companies, Costco. While the strategy may look a little confusing to someone who is not familiar with stock options, it is actually quite simple. I invite you to become a Terry’s Tips Insider and watch how this strategy (and others) are carried out over time.

Once you learn how to do it, you won’t need us any longer. My goal is for every person who subscribes to my service to learn enough in a few months to be able to quit and do it on their own. But first you need to come on board. It only costs a total of $79.95, or you can get it free if you open an account with our link at thinkorswim.

A Useful Way to Think About Delta

Monday, September 9th, 2013

This week we will start a discussion about the “Greeks” – the measures designed to predict how option prices will change when underlying stock prices change or time elapses. It is important to have a basic understanding of some of these measures before embarking on trading options.

I hope you enjoy this short discussion.

Terry 

A Useful Way to Think About Delta: The first “Greek” that most people learn about when they get involved in options is Delta. This important measure tells us how much the price of the option will change if the underlying stock or ETF changes by $1.00.

If you own a call option that carries a delta of 50, that means that if the stock goes up by $1.00, your option will increase in value by $.50 (if the stock falls by $1.00, your option will fall by a little less than $.50).

The useful way to think about delta is to consider it the probability of that option finishing up (on expiration day) in the money. If you own a call option at a strike price of 60 and the underlying stock is selling at $60, you have an at-the-money option, and the delta will likely be about 50. In other words, the market is saying that your option has a 50-50 chance of expiring in the money (i.e., the stock is above $60 so your option would have some intrinsic value).

If your option were at the 55 strike, it would have a much higher delta value because the likelihood of its finishing up in the money (i.e., higher than $55) would be much higher. The stock could fall by $4.90 or go up by any amount and it would end up being in the money, so the delta value would be quite high, maybe 70 or 75. The market would be saying that there is a 70% or 75% chance of the stock ending up above $55 at expiration.

On the other hand, if your call option were at the 65 strike while the stock was selling at $60, it would carry a much lower delta because there would be a much lower likelihood of the stock going up $5 so that your option would expire in the money.

Of course, the amount of remaining life also has an effect on the delta value of an option. We will talk about that phenomenon next week.

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