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Archive for the ‘Monthly Options’ Category

$20 Spread Investment Idea – a Bet on Oil

Tuesday, April 14th, 2015

This week I would like to share an option spread idea which will cost you only $20 to try (plus commission).  Of course, it you like the idea, you could buy a hundred or more of them like I did, or you could just get your options toe wet at a cost of a decent lunch (skip lunch and take a walk instead – it could improve both your physical and financial health).

The bet requires you to take a stab at what the price of oil might do in the next few weeks.  Your odds of winning are surely better than placing a bet on a fantasy baseball team, and it could be as much fun.  Read on.

Terry

$20 Spread Investment Idea – a Bet on Oil

I continue to investigate investment opportunities in USO, both because there is a large Implied Volatility (IV) advantage to calendar spreads (i.e., longer-term options that you buy are “cheaper” than the shorter-term options that you are selling) and because of the ongoing discussion about which way oil prices are headed (with several investment banks (e.g., Goldman Sachs, Barclays, Citi) telling their clients that oil is headed far lower), and on the other side, other analysts are saying oil is headed higher and hedge funds are covering their shorts.  The Iran nuclear deal, if successful and sanctions are lifted, could lower oil prices by $15 according to industry experts, and every rumor concerning how negotiations are going moves USO in one direction or the other.

Right now, the price of oil is about $59 a barrel (and West Texas Crude is about $5 less).  The price of USO moves roughly in tandem with this price, changing about $1 for every $2 in the change in the barrel price of oil.

We should know something about the Iran deal by the end of June, but its impact on oil prices is likely to occur later (it seems like sanctions will be gradually reduced over time).  The current price of USO has been edging higher in spite of unprecedented supplies, and the possibility of Iran flooding the market even more.   My best guess is that USO might be trading around $20 in June compared to its current $18.80.

That is just my guess.  You may have an entirely different idea of where the price of oil might be headed.  When trading calendar spreads, you want to select a strike price where you believe the stock will be trading when the short options expire.  If you are lucky to be near that strike, those options you sold to someone else will expire worthless (or nearly so) and there will be more time premium in the long options you hold that exists for any other option in that time series.

Yesterday, I bought USO Jul-15 – Jun-15 20 calendar spreads (using calls) and paid only $.20 ($20) per spread. If I am lucky enough for USO to be right at $20 when the June options expire, the July calls should be trading about $.80 and I would make about 3 ½ times on my money after commissions.  If I missed by a dollar (i.e., USO is at $19 or $21), I should double my money.  If I missed by $2 in either direction, I would about break even. More than $2 away from $20, I will probably lose money, but my initial cost was only $20, so how bad can it be?

It seems like a low-cost play that might be fun.  I also bought these same spreads at the 19 strike (paying $.21) to hedge my bet a bit.  If I triple my money on either of the bets, I will be an overall winner.  You may want to bet on lower oil prices in June and buy spreads at a lower strike.

Another way to play this would be to exit early as long as a profit can be assured.  If at any time after a month from now, if USO is trading about where it is now, the calendar spread could be sold for about $.30 or more (a Jun-15 – May-20 calendar could be sold for a natural $.32 today).  If USO were trading nearer to $20, that spread could be sold for $.37 (which would result in a 40% profit after commissions on the spread that I am suggesting).

With a spread costing as little as this, commissions become important.  Terry’s Tips paying subscribers pay $1.25 per option at thinkorswim, even if only one option is bought or sold.  A calendar spread (one long option, one short one) results in a $2.50 per spread commission charge.  This means that you will incur a total commission of $5 on a spread cost of $20 counting both putting it on and closing it out (unless the short options expire worthless and you don’t have to buy them back – if this happens, your total commission cost would be $3.75 per spread).

Update on Oil Play Designed to Make 25% in One Month

Friday, April 3rd, 2015

About a month ago I sent out a strategy we were using to capitalize on the price of oil falling further (as many analysts, including those at Goldman, Citi, and Barclays, were predicting).  We set up a small demonstration portfolio which had $2910 to start, and bought calendar spreads at the 18, 17, and 16 strikes when USO was trading at $18.45.When the price of oil did retreat further, USO fell to about $17, and we sold our calendar spreads at the 17 and 18 strikes and replaced them with calendar spreads at the 15 and 14 strikes.  Since the strike prices of calendar spreads is what determines whether you are bullish or bearish on the stock, when we had all our calendar spreads at strikes below the stock price, we were extremely bearish.

Then the stock turned around and headed higher, taking away the gains we had made, and we were right back to where we started.  Today we made a new start, and I would like to share our thinking at this time.

Terry

Update on Oil Play Designed to Make 25% in One Month

USO is an Exchange Traded Product (ETP) which is highly correlated to the price of oil (West Texas Intermediate). But there is another component that is not as easy to contend with, and that is the speculative element.  Oil prices are less than half of what they were a year ago, and in spite of most of the big investment banks warning that even lower prices are coming, there seems to be some people out there who are betting that oil prices will eventually recover, and this may be a good time to get on board.  For example, Robert Shiller, Nobel laureate and Yale University economist  made a strong pitch to “buy oil” this week.  Consequently, over the past few days, USO has inched up a bit in spite of these recent developments:

• The supply of oil is at an 80-year high, and grew at more than 4 million barrels last week in spite of expectations far less than that.
• The rate of oil rigs closing down has fallen drastically (and it appears that the rigs that have been closed down so far were the lowest-producing ones so the supply of oil gets higher each week)
• There appears to be an accord with Iran which could flood the market with new oil from Iran if sanctions are removed.

We are siding with the investment banks’ predictions instead of Mr. Shiller’s (who is likely to be thinking longer-term). While we believe the short-term price of USO is headed lower (for the above reasons and the headwinds caused by contango), we hedged our bet a little, and established new positions in our demonstration portfolio.  We own puts expiring in Jan-16 and we have sold Apr-4 15 puts which expire in 3 weeks (on April 24th).  We have 8 calendar spreads at the 15 strike, 8 at the 16 strike, and 5 at the 17 strike at a time when the stock is trading at $17.45.  Our portfolio is worth $2910 today.

This is the risk profile graph for these calendar spread positions for April 24th:

USO Risk Profile Graph April 2015

USO Risk Profile Graph April 2015

The graph shows that if USO doesn’t change one cent in value for the next three weeks, we will make about 20% with our positions.  If it falls by about a dollar (or more) as we expect, we could make double that amount.  If we are wrong, and it goes higher by a dollar in three weeks, we will break even.

We like our chances with these positions, and they demonstrate how you can make extraordinary gains with options, even if you are not quite right in guessing which way a stock price is headed.  I always like the feeling that if the stock doesn’t change at all (which is so often the case), I will still make a nice gain when the short options expire.

Trading Options Can be a Lifetime Learning Experience

Monday, March 23rd, 2015

Last week was a good one for the market.  SPY rose 2.2%, a wonderful week.  The actual options portfolios we carry out at Terry’s Tips had a stellar week as well.  Nine of our ten portfolios gained at least 5%, and 3 of them gained over 33% in a single week.

Nike (NKE) announced blow-out earnings and the stock rose 6.4%.  Our portfolio that trades NKE options gained 13.5%, double the increase in the stock price.  This was far less than we usually do compared to stock price changes, however.

We have proved over and over that if you can find a stock that will increase if value, you can usually make 3 or 4 or more times as much with an options strategy as you could by simply buying the stock.

Of course, buying options is not quite so simple as buying stock.  To do it right requires gaining some understanding that most people just don’t have the energy or willpower to learn.

Terry

Trading Options Can be a Lifetime Learning Experience

If the truth be known, investing in stocks is pretty much like playing checkers.  Any 12-year-old can do it.  You really don’t need much experience or understanding.  If you can read, you can buy stock (and probably do just about as well as anyone else because it’s basically a roulette wheel choice).  Most people reject that idea, of course.  Like the residents of Lake Wobegone, stock buyers believe that they are all above average – they can reliably pick the right ones just about every time.

Trading options is harder, and many people recognize that they probably aren’t above average in that arena.  Buying and selling options is more like playing chess.  It can be (and is, for anyone who is serious about it) a life-time learning experience.

You don’t see columns in the newspaper about interesting checker strategies, but you see a ton of pundits telling you why you should buy particular stocks.  People with little understanding or experience buy stocks every day, and most of their transactions involve buying from professionals with far more resources and brains. Most stock buyers never figure out that when they make their purchase, about 90% of the time, they are buying from professionals who are selling the stock to them rather than buying it at that price.

Option investing takes study and understanding and discipline that the purchase of stock does not require.  Every investor must decide for himself or herself if they are willing to make the time and study commitment necessary to be successful in option trading.  Most people are too lazy.

It is a whole lot easier to play a decent game of checkers than it is to play a decent game of chess.  But for some of us, options investing is a whole lot more challenging, and ultimately more rewarding.  For example, Costco (COST) has had a good year so far, rising from $141.75 to Friday’s close at $152.59, a gain of 7.6%.  The Terry’s Tips  option portfolio that trades COST options (calendar and diagonal spreads) gained 40.4% over this same period, over 5 times as much.  With actual results like this, why wouldn’t any reasonable adult with enough cash to buy stock want to learn how to multiply his or her earnings by learning a little about the wonderful world of options?

Playing checkers (and buying stock) is boring.  Playing chess (and trading options) is far more challenging.  And rewarding, if you do it right.

An Oil Play Designed to Make 25% in One Month

Tuesday, March 3rd, 2015

Bernie Madoff attracted billions of dollars because he said he had a system that would generate gains of 12% a year.  For many investors, 12% must seem like a pretty good return.  Options investors think differently.  They prefer to have at least some of their investment capital in something that could conceivably make a far greater return.Today I would like to discuss an investment I made this week in a demonstration (actual money on the line) portfolio for Terry’s Tips Insiders.  It is designed to make about 25% in the next four weeks.

Terry

An Oil Play Designed to Make 25% in One Month

One of our favorite underlyings these days is USO, an ETP (Exchange Traded Product) which closely tracks the price of oil.  If you have filled your car with gas lately, you know that the price of oil must have been trading lower over the recent past.  In fact, it has.  A barrel of oil has fallen from about $100 to $50, while USO has dropped from about $40 to about $18.

There are a couple of reasons to believe that the downward trend of USO might continue for a while longer.  First, the way this ETP is designed, it suffers from contango (futures prices for further-out months are higher than the spot price of oil).  At the current level of contango, if the price of oil remains the same, USO should lose about 21% of its value over the course of a year due to the influence of contango.

Second, some large investment banks (e.g., Citi) have come out and said that the price of oil is likely to fall in half once again before the current glut is eliminated and oil might start recovering in the third quarter.

With these two reasons suggesting that oil (and USO) might be headed lower, at least  for the next month or so, we looked back at every calendar monthly change in USO for the recent past, and we learned that in the last 25 months, on only two occasions did USO fall by more than 15% in a single month, and only once did it rise by more than 5.6%.

If this historical pattern continues for the next month, the portfolio we set up has an 88% chance of making a gain, and the average gain over most of the possible stock prices is over 25%.

Here are the calendar spreads we placed in a portfolio that could be set up for no more than $2900 at today’s prices with USO trading about $18.45:

Buy to Open 8 USO Jan-16 16 puts (USO160115P16)
Sell to Open 8 USO Mar4-15 16 puts (USO150327P16) for a debit of $1.26  (buying a calendar)

Buy to Open 8 USO Jan-16 17 puts (USO160115P17)
Sell to Open 8 USO Mar4-15 17 puts (USO150327P17) for a debit of $1.42  (buying a calendar)

Buy to Open 4 USO Jan-16 18 puts (USO160115P18)
Sell to Open 4 USO Mar4-15 18 puts (USO150327P18) for a debit of $1.58  (buying a calendar)

Here is the risk profile graph for these spreads for March 27th when the short puts expire:

USO Risk Profile Graph March 2015

USO Risk Profile Graph March 2015

The vertical red lines on the graph are set at -15% on the downside and +5% on the upside, and roughly indicate the break-even range for the positions.  Over the past 25 months, USO has fluctuated inside this range in 22 of the 25 months.  You can eyeball the potential gain and see that across a very large portion of the possible prices within this range, the indicated gain is close to $1000, or about 33% on your investment.

We like our chances with these positions.  It seems like a much higher chance of making double what Mr. Madoff was promising, and in only one month rather than a full year.  Option investors think differently than stock buyers.  I will report back on how well we do.

List of Options Which Trade After Hours (Until 4:15)

Friday, February 27th, 2015

I noticed that the value of some of our portfolios was changing after the market for the underlying stock had closed.  Clearly, the value of the options was changing after the 4:00 EST close of trading.  I did a Google search to find a list of options that traded after hours, and came up pretty empty.  But now I have found the list, and will share it with you just in case you want to play for an extra 15 minutes after the close of trading each day.

Terry

List of Options Which Trade After Hours (Until 4:15)

Since option values are derived from the price of the underlying stock or ETP (Exchange Traded Product), once the underlying stops trading, there should be no reason for options to continue trading.  However, more and more underlyings are now being traded in after-hours, and for a very few, the options continue trading as well, at least until 4:15 EST.

Options for the following symbols trade an extra 15 minutes after the close of trading – DBA, DBB, DBC, DBO, DIA, EFA, EEM, GAZ, IWM, IWN, IWO, IWV, JJC, KBE, KRE, MDY, MLPN, MOO, NDX, OEF, OIL, QQQ, SLX, SPY, SVXY, UNG, UUP, UVXY, VIIX, VIXY, VXX, VXZ, XHB, XLB, XLE, XLF, XLI, XLK, XLP, XLU, XLV, XLY, XME, XRT.

Most of these symbols are (often erroneously) called ETFs (Exchange Traded Funds).  While many are ETFs, many are not – the popular volatility-related market-crash-protection vehicle – VXX is actually an ETN (Exchange Traded Note).  A better way of referring to this list is to call them ETPs.

Caution should be used when trading in these options after 4:00.  From my experience, many market makers exit the floor exactly at 4:00 (volume is generally low after that time and not always worth hanging around).  Consequently, the bid-ask ranges of options tend to expand considerably.  This means that you are less likely to be able to get decent prices when you trade after 4:00.  Sometimes it might be necessary, however, if you feel you are more exposed to a gap opening the next day than you would like to be.

I would like to tell you about one of our portfolios that might interest you.  At the beginning of the year, we picked three underlyings that we felt would be at least the same at the end of 2015 as they were at the beginning.  They were SPY (S&P 500 tracking stock), AAPL, and GOOG.  If we are right, and they are the same or any higher in price when the Jan-16 options expire (on January 15, 2016), we will make exactly 52% on our investment.  We made a single credit spread trade for each of these stocks, and if all goes well, the options will expire worthless and we won’t have to do another thing (except collect our 52% profit on that date).  At this point in time, all three underlyings are trading quite a bit higher than where they were when we started, so they could actually fall quite a ways from here and we will still collect those same gains. This is just one of 10 portfolios that we carry out for Terry’s Tips subscribers.  Each carries out a different strategy, and we update how each is doing every week in our Saturday Report.  We welcome you to come on board and check them all out.

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.

Try a Vertical Put Credit Spread on a Stock That You Like

Thursday, January 8th, 2015

This week I would like to share my thoughts about the market for 2015, and also one of my favorite option strategies when I find a stock I really like. Whenever I find a stock I particularly like for one reason or another, rather than buy the stock outright, I use options to dramatically increase the returns I enjoy if I am right (and the stock goes up, or at least stays flat).

Today I would like to share a trade that I made today in my personal account.  Maybe you would like to do something similar with a company you particularly like.

And Happy New Year – I hope that 2015 will by your best year ever for investments (even if the market falls a bit).

Terry

Try a Vertical Put Credit Spread on a Stock That You Like

First, a few thoughts about the market for 2015.  The Barron’s Roundtable (made up of 10 mostly large investment bank analysts) predicted an average 10% market gain for 2015.  None of the analysts predicted a market loss for the year.  Others have suggested that the year should be approached with more caution, however. The whopping gain in VIX in the last week of 2014 is a clear indication that investors have become more fearful of what’s ahead. The market has gained about 40% over the past two years.  The bull market has continued for 90 months, a near-record–breaking string.

The forward P/E for the market has expanded to 19, several points higher than the historical average, and 2 points above where it was a year ago.  The trailing market P/E is 22.7x compared to 14x for the 125-year average.  Maybe such high valuations are appropriate for a zero-interest environment, but that is about to change. For the first time since 2007, the Fed will not be propping up the market with their Quantitative Easing purchases. The Fed has essentially promised that they will raise interest rates in 2015.  The only question is when it will happen.

There is an old adage that says “don’t fight the Fed.”  Not only have they stopped pumping billions into the economy every month, they plan to raise interest rates this year.  Like it or not, stock market investments made in 2015 are tantamount to picking a fight with the Fed.

While the U.S. economy is strong (and apparently growing), a great number of U.S. companies depend on foreign sales for a significant share of their business, and the foreign prospects aren’t so great for a number of countries. This situation could cause domestic company earnings to disappoint, and stock prices could fall.  At the very best, 2015 seems like a good time to take a cautious approach to investing.

Even if the market is not great for 2015, surely some shares will move higher. Barron’s chose General Motors (GM) as one of its best 10 picks for 2015 and made a compelling argument for the company’s prospects.  The 3.27% dividend should insulate the company from a big down-draft if the market as a whole has a correction in 2015.

I was convinced by their analysis that GM was highly likely to move higher in 2015.  Today, with GM trading at $35.70, I placed the following trade:

Buy To Open 10 GM Jun-15 32 puts (GM150619P32)

Sell To Open 10 GM Jun-15 37 puts (GM150619P37) for a credit of $2.20  (selling a vertical)

I like to go out about six months with spreads like this to give the stock a little time to move higher.  The above trade put $2200 in my account.  There will be a $5000 maintenance requirement which is reduced to $2800 when you subtract out the amount of cash I received.  This means that my maximum loss would be $2800, and this would come about if the stock closes below $32 on June 19, 2015.

If the stock closes at any price above $37, both the long and short puts will expire worthless and I will not have to make any more trades.  If this happens, I will make a profit of $2200 (less $25 commission, or $2175) on an investment of $2800.  This works out to a gain of 77%.

In order for me to make 77% on this investment, GM only needs to go up by $1.50 (4.2%).  If it stays exactly the same on June 19th ($35.70), I will have to buy back the 37 put for a cost of $1.30 ($1300 for 10 contracts).  That would leave me with a gain of $862.50, or 30.8%.

If I had purchased shares of GM with the $2800 I had at risk, I could have bought 78 shares.  I I might have collected a dividend of $91 over the 6 months.  With my options investment, I would have gained nearly 10 times that much if the stock did not move up at all.

Bottom line, even though I am taking a greater risk with options, the upside potential is so much greater than merely buying the stock that it seems to be a better move when you find a company that looks like it will be a winner.

Further Discussion on an Options Strategy Designed to Make 40% a Month

Thursday, December 4th, 2014

Last week we outlined an options play based on the historical fluctuation pattern for our favorite ETP called SVXY.  This week we will compare those fluctuations to the market in general (using the S&P 500 tracking stock, SPY, as the market definition). We proposed buying a vertical call spread for a one-month-out expiration date with the lower strike about 6% above the starting stock price.

The results were a little unbelievable, possibly gaining an average of 65% a month (assuming the fluctuation pattern continued into the future). If you used an outside indicator to determine which months were more likely to end up with a winning result, you would invest in just under half the months, but when you did invest, your average gain might be in the neighborhood of 152%.  Your average monthly gain would be approximately the same if you only invested half the time or all the time, but some people like to increase the percentage of months when they make gains (the pain of losing always seems to be worse than the pleasure of winning).

This week we will offer a second way to bet that the stock will rise by 12.5% in about 38% of the months (as it has in the past).  It involves buying a calendar spread rather than a vertical call spread (and sort of legging into a long call position as an alternative to the simple purchase of a call).

Terry

Further Discussion on an Options Strategy Designed to Make 40% a Month

First. Let’s compare the monthly price fluctuations of SPY and SVXY.  You will see that they are totally different.

Here is a graph showing how much SPY has fluctuated each month over the past 38 months:

Over the 38 months of the time period, SPY rose in 28 months and fell in 10 months.  By far, the most popular monthly change was in the zero to +2.5% range.  Note that in less than 8% of the months (3 out of 38) SPY fluctuated by more than 5%, while in over 92% of the months, the fluctuation was less than 5%.

Compare the monthly fluctuations of SPY with those for SVXY over the same time period:

SVXY rose in 28 of the 38 months, exactly the same number as SPY. However, the absolute percentage price changes are far higher for SVXY.  In nearly half the months, SVXY fluctuated by more than 10% either way (18 of 38 months).  In 24 of the 38 months (63%), SVXY changed by more than 5% in either direction compared to less than 8% of the months for SPY.  In 21 of the 38 months (55%)  SVXY gained over 5%.

Bottom line, monthly fluctuations for SVXY are considerably greater than they are for SPY.  In most months, the price change for SPY is relatively insignificant and for SVXY, the price is rarely anywhere near where it started out each expiration month.

Buying Vertical Spreads:

If you were to buy a one-month vertical spread on SPY, buying the at-the-money strike price and selling at a strike $5 higher, the spread would cost about $1.65 ($165) and you could sell it for $5.00 ($500) if the stock rose about 2 1/2% or more.  However, if the historical pattern persisted, you would make the maximum gain in only 13 of 38 months, or 34% of the time.

The same 5-point spread in SVXY would cost far more ($2.50) but you could look forward to making the maximum gain in 21 of 38 months (55% of the time).  While buying this spread would give you a statistical edge, it probably is not the best spread to purchase.  A more profitable spread would be at higher strike prices – betting that the stock would increase by 12.5% or more (which it has 38% of the time).  Since this higher-strike price would cost far less, your statistical edge would be much greater as would your gains in those months when a big increase took place.

A second alternative would be to simply buy a call which was about 6% above the purchase price.  Last week, in a demonstration portfolio at Terry’s Tips, with SVXY trading at $75, we bought a one-month-out 80 call.  It cost $1.40.  If the stock rose by 12.5% from $75, it would be trading around $84 ½ and you could sell the call for about 3 times what you paid for it.

We also bought some SVXY Dec4-14 – Dec2-14 80 calendar call spreads for $1.14.  This is a way of buying a 5-week call at the 80 strike, paying less than a 4-week call which cost $1.40.  When the Dec2-14 short calls expire in two weeks, we would not replace them, and stick with uncovered long calls that expires a week later than the Dec-14 call.  The only extra risk we are taking here is that the stock skyrockets 12.5% in the very first two weeks so that the Dec2-14 80 call finishes in the money (something that seems unlikely to happen his month since VIX is so low so that most of the increase in SVXY should come from the contango component).  This spread seems to be a better alternative than just buying the Dec-14 80 call, but we will see how it works out. Of course, I’ll report back to you.

So far, the stock has edged up to close today about 5% higher than it started out last week (after recovering from a big drop on Monday).  Contango is above 10%, unusually high, but not so unusual for the month of December because of the “holiday effect” (December is often characterized by low volume and higher stock prices, and VIX futures for this month are typically lower than any other month).  The contango number is a rough approximation of how much SVXY should increase in one month from the daily adjustment which is made (selling the one-month-out futures and buying at the spot price of VIX).  Of course, if VIX fluctuates, SVXY will move in the opposite direction.  If VIX moves higher, SVXY might move lower even if it is helped by the contango tailwinds.

 

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