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A Possible Great Option Trading Idea

Monday, July 14th, 2014

Just before the close on Friday, we made a strongly bullish trade on our favorite underlying stock in a portfolio at Terry’s Tips.  In my personal account, I bought weekly calls on this same underlying.  As I write this in the pre-market on Monday, it looks like that bet could triple in value this week.

I would like to share with you the thinking behind these trades so next time this opportunity comes up (and it surely will in the near future), you might decide to take advantage of it yourself.

Terry

A Possible Great Option Trading Idea: As we have discussed recently, 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) is hanging out around 12.  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.  One way of doing this would be to buy a straddle (both a put and a call at the same strike price, usually at the market, hoping that the stock will make a decent move in either direction.  In options lingo, you are hoping that actual volatility (IV) is greater than historical volatility.

The biggest problem with buying straddles is that you will lose on one of your purchases while you gain on the other.  It takes a fairly big move in the underlying to cover the loss on your losing position before you can make a profit on the straddle.

A potentially better trade might be to guess which way the market will move in the short term, and then buy just a put or call that will make you money if you are right. The big challenge would be to find a price pattern that could help you choose which direction to bet on?

One historically consistent pattern for most market changes (the law of cycles) is that the direction of the change from one period to the next is about twice as likely to be in the same direction as it was in the previous same time period.  In other words, if the stock went up last week (or month), it is more likely to go up again next week (or month).

We tested this pattern on SPY for several years, and sadly, found that it did not hold up.  The chances were almost 50-50 that it would move in the opposite direction in the second period.

Maybe the pattern would work for our most popular underling, an ETP called SVXY.  You might recall that we love this “stock” because it is extremely volatile and option prices are wonderfully high (great for selling).  In the first 22 weeks of 2014, SVXY fluctuated by at least $3 in one direction or the other in 19 of those weeks.  Maybe we could use the pattern and buy weekly either puts or calls, depending on which way the market had moved in the previous week.

Once again, the historical results did not support the law of cycles pattern.  The stock was almost just as likely to move in the opposite direction as it had in the previous week.  Another good idea dashed by reality.

In making this study, we discovered something interesting, however.  In the first half of 2014, SVXY fell more than $3 in a single week on 5 different occasions.  In 4 of the subsequent weeks, it made a significant move ($3 or more) to the upside.  Buying a slightly out-of-the-money weekly call for about a dollar and a half ($150 per contract) could result in a 100% gain (or more) in the next week in 4 out of 5 weeks.

If this pattern could be counted on to continue, it would be a fantastic trading opportunity.  Yes, you might lose your entire investment in the losing weeks, but if you doubled it in the winning weeks, and there were many more of them than losing weeks, you would do extremely well.

For  those reasons, I bought calls on SVXY on Friday.  The Jul-14 90.5 call that expires this Friday (July 18th) could have been bought for $1.30.  The stock closed at $88.86.  I plan to place an order to sell these calls, half at $2.60, and half at $3.90.  The pre-market prices indicate that one of these orders might exercise sometime today and I will have all my money back and still own half my calls.  It might be a fun week for me.  We’ll see.

On another subject, have you got your free report entitled 12 Important Things Everyone with a 401(K) or IRA Should Know (and Probably Doesn’t).  This report includes some of my recent learnings about popular retirement plans and how you can do better.  Order it here.  You just might learn something (and save thousands of dollars as well).

Vertical Put Credit Spreads Part 2

Monday, July 7th, 2014

Last week I reviewed the performance of the Terry’s Tips options portfolio for the first half of the year.  I should have waited a week because this week was a great one – our composite average gained another 6%, making the year-to-date record 22%, or about 3 times as great as the market (SPY) gain of about 7%.

Last week I also discussed a GOOG vertical put credit spread which is designed to gain 100% in the year if GOOG finished up 2014 at any price higher than where it started, something that it has done in 9 of its 10 years in business.  I want to congratulate those subscribers who read my numbers closely enough to recognize that I had made a mistake.  I reported that we had sold a (pre-split) 1120 – 1100 vertical put credit spread and collected $5.03 which was slightly more than the $500 per spread that I would have at risk. Actually, if the difference between the short and long sides was $20, and the maximum loss would be almost $15 (and the potential return on investment would be 33% rather than 100%).  We actually sold the spread for $10.06, not $5.03, and I mistakenly reported the post-split price.  We are now short 560 puts and long 550 puts, so the difference between the two strikes is $10 and we collected $5.03, or just about half that amount.  Bottom line, if GOOG finishes the year above $560, we will make 100% on our investment.  It closed at $585 Friday, so it can fall by $25 from here and we will still double our money.

Today we will discuss two other spreads we placed at the beginning of 2014 in one of the 10 portfolios we conduct for all to see at Terry’s Tips.

Terry

Vertical Put Credit Spreads Part 2:

We have a portfolio we call Better Odds Than Vegas.  In January, we picked three companies which we felt confident would be higher at the end of the year than they were at the beginning of the year.  If we were right, we would make 100% on our money.  We believed our odds were better than plunking the money down on red or black at the roulette table.

Late in 2013, the Wall Street Journal interviewed 13 prominent analysts and asked them what they expected the market would do in 2014.  The average projection was that it would gain slightly more than 5%.  The lowest guess was that it would fall by 2%.  We decided to make a trade that would make a nice gain if any one of the 13 analysts were correct.  In other words, if SPY did anything better than falling by 2%, our spread would make money.

In January, when SPY was trading about $184, we sold a vertical credit put spread for December, buying 177 puts and selling 182 puts.  We collected $2.00 at that time.  If the stock manages to close at any price higher than $182 on the third Friday in December, we will get to keep our entire $200 (per spread – we sold 8 spreads, collecting $1600).  The maintenance requirement would be $500 per spread less the $200 we collected, or $300 per spread ($2400, our maximum loss which would come if SPY closed below $177 in December).  Our potential profit would be about 66% on the investment, and this would come if the market was absolutely flat (or even fell a little bit) over the course of the year.  The stock closed Friday at $198.20, so it could fall by $16.20 between now and December and we would still make 66%.

The third company we bet on in this portfolio in January was Green Mountain Coffee Roasters (GMCR), now called Keurig Coffee Roasters.  This was a company with high option premiums that we have followed closely over the years (being in my home state of Vermont).  We have made some extraordinary gains with options on several occasions with GMCR.  Two directors (who were not billionaires) had bought a million dollars each of company stock, and we believed that something big might be coming their way.

With the stock trading about $75, we made an aggressive bet, both in our selection of strike prices and expiration month. Rather than giving the stock a whole year to move higher, we picked June, and gave it only 6 months to do something good.  We sold Jun-14 80 puts and bought Jun-14 70 puts, and collected $5.40.  If the stock stayed at $75, we would make only a small profit on the third Friday in June, but if it rose above $80 by that time, we would make $5.40 on an investment of $4.60, or 117%.

The good news that we anticipated came true – Coke came along and bought 10% of the company for $1 billion and signed a 10-year licensing agreement with GMCR.  The stock shot up to $120 overnight (giving Coke a $500 million windfall gain, by the way).  At that point, we picked up a little extra from the original spread.  We sold a vertical call credit spread for the June expiration month, buying the 160 calls and selling 150 calls, collecting an extra $1.45 per spread.  This did not increase our maintenance requirement because we had, in effect, legged into a short iron condor spread. It would be impossible for us to lose money on both our spreads, so the broker only charged the maintenance requirement on one of them.

Selling the call spread meant that our total gain for the six months would amount to almost 150% if GMCR ended up at any price between $80 and $150.  It ended up at about $122 and we enjoyed this entire gain.

We have since sold another GMCR vertical credit put spread for Jan-15, buying 90 puts and selling 100 puts for a credit of $3.45.  Our maximum loss is $6.55, and this would come if the stock closed below $90 on the third Friday in January.  The potential maximum gain would amount to 52% for the six months.  This amount was far less than the first spread because we selected strikes which were well below the then-current price of the stock (GMCR is now $125, well above our $100 target).  This makes our potential gain for this stock for the year a very nice 200%.

We advocate making these kinds of long-term options bet when you feel confident that a company will somehow be the same or higher than it is at the beginning. If you are right, extraordinary gains are possible. In our case, our portfolio has gained 41% for the year so far, and the three stocks can all fall by a fair amount and we will still make 100% on our starting investment when these options expire (hopefully worthless so we can keep all the cash we collected at the outset) on January 17, 2015.

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.

Contango, Backwardation, and SVXY

Monday, May 19th, 2014

This week I would like to introduce you to a thing called contango.  This is relevant today because contango just got higher than I have seen it in many years – over 10% while most of the time, it hangs out in the 3% – 4% range.  This measure becomes important when you are trading in my favorite ETP (Exchange Traded Product), SVXY.  If your eyes haven’t glazed over yet, read on.
Terry

Contango, Backwardation, and SVXY

There seems to be a widespread need for a definition of contango.   I figure that about 99% of investors have no idea of what contango or backwardation are.  That’s a shame, because they are important concepts which can be precisely measured and they strongly influence whether certain investment instruments will move higher (or lower).  Understanding contango and backwardation can seriously improve your chances of making profitable investments.

Contango sounds like it might be some sort of exotic dance that you do against (con) someone, and maybe the definition of backwardation is what your partner does, just the opposite (indeed, it is, but we’re getting a little ahead of ourselves because we haven’t defined contango is yet).

If you have an idea (in advance) which way a stock or other investment instrument is headed, you have a real edge in deciding what to do.  Contango can give you that edge.

So here’s the definition of contango – it is simply that the prices of futures are upward sloping over time, (second month more expensive than front month, third month more expensive than second, etc.), Usually, the further out in the future you look, the less certain you are about what will happen, and the more uncertainty there is, the higher the futures prices are.  For this reason, contango is the case about 75 – 90% of the time.

Sometimes, when a market crash has occurred or Greece seems to be on the brink of imploding, the short-term outlook is more uncertain than the longer-term outlook (people expect that things will settle down eventually).  When this happens, backwardation is the case – a downward-sloping curve over time.

So what’s the big deal about the shape of the price curve?  In itself, it doesn’t mean much, but when it gets involved in the construction of some investment instruments, it does become a big deal.

A Little About VXX (and its Inverse, SVXY)

One of the most frequent times that contango appears in the financial press is when VXX is discussed. VXX is an ETP which trades very much like any stock.  You can buy (or sell) shares in it, just like you can IBM.  You can also buy or sell options using VXX as the underlying. VXX was created by Barclay’s on January 29, 2009 and it will be closed out with a cash settlement on January 30, 2019 (so we have a few years remaining to play with it).

VXX is an equity that people purchase as protection against a market crash.  It is based on the short-term futures of VIX, the so-called “fear index” which is a measure of the implied volatility of options on SPY, the tracking stock for the S&P 500.  When the market crashes, VIX usually soars, the futures for VIX move higher as well, pushing up the price of VXX.

In August of 2011 when the market (SPY) fell by 10%, VXX rose from $21 to $42, a 100% gain.  Backwardation set in and VXX remained above $40 for several months.  VXX had performed exactly as it was intended to.  Pundits have argued that a $10,000 investment in VXX protects a $100,000 portfolio of stocks against loss in case of a market crash.  No wonder it is so popular.  Investors buy about $3 billion worth of VXX every month as crash protection against their other investments in stocks or mutual funds.

There is only one small bad thing about VXX.  Over the long term, it is just about the worst stock you could ever buy. Over the last three years, they have had to have 3 reverse 1 – 4 stock splits just to keep the price of VXX high enough to bother with trading.  Every time it gets down to about $12, they engineer a reverse split and the stock is suddenly trading at $48.  Over time, it goes back to $12 and they do it again (at least that is how it has worked ever since it was created).

VXX is adjusted every day by buying VIX futures and selling VIX at its spot price.  (This is not exactly what happens, but conceptually it is accurate.)  As long as contango is in effect, they are essentially buying high (because future prices are higher than the spot price) and selling low (the current spot price).  The actual contango number represents an approximation of how much VXX will fall in one month if a market correction or crash doesn’t take place.

So it’s a sort of big deal when contango gets over 10% as it is today.  VXX is bound to tumble, all other things being equal.  On the other hand, SVXY is likely to go up by that much in a month since it is the inverse of VXX.  SVXY has had a nice run lately, moving up an average of 4.5% in each of the last three weeks, in fact.  You can see why it is my favorite ETP (I trade puts and calls on it in large quantities every week, usually betting that it will move higher).

That’s enough about contango for today, but if you are one of the few people who have read down this far, I would like to offer you a free report entitled 12 Important Things Everyone with a 401(K) or IRA Should Know (and Probably Doesn’t).  I want to share some of my recent learnings about popular retirement plans but I don’t want to be overwhelmed by too much traffic while I get a new website set up.  Order it here.  You just might learn something (and save thousands of dollars as well).

 

A Look at the Downsides of Option Investing

Monday, May 12th, 2014

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

Terry

A Look at the Downsides of Option Investing

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

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

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

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

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

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

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

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

With CD’s and bonds yielding ridiculously low returns (and the stock market not really showing any gains for quite a while – adjusted for inflation, the market is 10% lower than it was in March,  2000,), the options alternative has become more attractive for many investors, in spite of all the problems we have outlined above.

Volatility’s Impact on Option Prices

Monday, April 28th, 2014

Today I would like to talk a little about an important measure in the options world – volatility, and how it affects how much you pay for an option (either put or call).

Terry

Volatility’s Impact on Option Prices

Volatility is the sole variable that can only be measured after the option prices are known.  All the other variables have precise mathematical measurements, but volatility has an essentially emotional component that defies easy understanding.  If option trading were a poker game, volatility would be the wild card.

Volatility is the most exciting measure of stock options.  Quite simply, option volatility means how much you expect the stock to vary in price. The term “volatility” is a little confusing because it may refer to historical volatility (how much the company stock actually fluctuated in the past) or implied volatility (how much the market expects the stock will fluctuate in the future).

When an options trader says “IBM’s at 20” he is referring to the implied volatility of the front-month at-the-money puts and calls.  Some people use the term “projected volatility” rather than “implied volatility.”  They mean the same thing.

A staid old stock like Procter & Gamble would not be expected to vary in price much over the course of a year, and its options would carry a low volatility number.  For P & G, this number currently is 12%.  That is how much the market expects the stock might vary in price, either up or down, over the course of a year.

Here are some volatility numbers for other popular companies:

IBM  – 16%
Apple Computer – 23%
GE – 14%
Johnson and Johnson – 14%
Goldman Sachs – 21%
Amazon – 47%
eBay – 51%
SVXY – 41% (our current favorite underlying)

You can see that the degree of stability of the company is reflected in its volatility number.  IBM has been around forever and is a large company that is not expected to fluctuate in price very much, while Apple Computer has exciting new products that might be great successes (or flops) which cause might wide swings in the stock price as news reports or rumors are circulated.

Volatility numbers are typically much lower for Exchange Traded Funds (ETFs) than for individual stocks.  Since ETFs are made up of many companies, good (or bad) news about a single company will usually not significantly affect the entire batch of companies in the index.  An ETF such as OIH which is influenced by changes in the price of oil would logically carry a higher volatility number.

Here are some volatility numbers for the options of some popular ETFs:

Dow Jones Industrial (Tracking Stock – DIA) – 13%
S&P 500 (Tracking Stock – SPY) –14%
Nasdaq (Tracking Stock – QQQ) – 21%
Russell 2000 (Small Cap – IWM) – 26%

Since all the input variables that determine an option price in the Black-Scholes model (strike price, stock price, time to expiration, interest and dividend rates) can be measured precisely, only volatility is the wild card.   It is the most important variable of all.

If implied volatility is high, the option prices are high.  If expectations of fluctuation in the company stock are low, implied volatility and option prices are low.  For example, a one-month at-the-money option on Johnson & Johnson would cost about $1.30 (stock price $100) vs. $2.00 for eBay (stock price $53).  On a per-dollar basis, the eBay option trades for about three times as much as the JNJ option.

Of course, since only historical volatility can be measured with certainty, and no one knows for sure what the stock will do in the future, implied volatility is where all the fun starts and ends in the option trading game.

Using Puts vs. Calls for Calendar Spreads

Monday, April 7th, 2014

I like to trade calendar spreads.  Right now my favorite underlying to use is SVXY, a volatility-related ETP which is essentially the inverse of VXX, another ETP which moves step-in-step with volatility (VIX).  Many people buy VXX as a hedge against a market crash when they are fearful (volatility, and VXX. skyrockets when a crash occurs), but when the market is stable or moves higher, VXX inevitably moves lower.  In fact, since it was created in 2009, VXX has been just about the biggest dog in the entire stock market world.  On three occasions they have had to make 1 – 4 reverse splits just to keep the stock price high enough to matter.

Since VXX is such a dog, I like SVXY which is its inverse.  I expect it will move higher most of the time (it enjoys substantial tailwinds because of something called contango, but that is a topic for another time).  I concentrate in buying calendar spreads on SVXY (buying Jun-14 options and selling weekly options) at strikes which are higher than the current stock price.  Most of these calendar spreads are in puts, and that seems a little weird because I expect that the stock will usually move higher, and puts are what you buy when you expect the stock will fall.  That is the topic of today’s idea of the week.

Terry

Using Puts vs. Calls for Calendar Spreads

It is important to understand that the risk profile of a calendar spread is identical regardless of whether puts or calls are used.  The strike price (rather than the choice of puts or calls) determines whether a spread is bearish or bullish.  A calendar spread at a strike price below the stock price is a bearish because the maximum gain is made if the stock falls exactly to the strike price, and a calendar spread at a strike price above the stock price is bullish.

When people are generally optimistic about the market, call calendar spreads tend to cost more than put calendar spreads.  For most of 2013-14, in spite of a consistently rising market, option buyers have been particularly pessimistic.  They have traded many more puts than calls, and put calendar prices have been more expensive.

Right now, at-the-money put calendar spreads cost more than at-the-money call calendar spreads for most underlyings, including SVXY.  As long as the underlying pessimism continues, they extra cost of the put spreads might be worth the money because when the about-to-expire short options are bought back and rolled over to the next short-term time period, a larger premium can be collected on that sale.  This assumes, of course, that the current pessimism will continue into the future.

If you have a portfolio of exclusively calendar spreads (you don’t anticipate moving to diagonal spreads), it is best to use puts at strikes below the stock price and calls for spreads at strikes which are higher than the stock price.  If you do the reverse, you will own a bunch of well in-the-money short options, and rolling them over to the next week or month is expensive (in-the-money bid-asked spreads are greater than out-of-the-money bid asked spreads so you can collect more cash when rolling over out-of-the-money short options).

How to Play War Rumors

Monday, March 10th, 2014

Last week, on Monday, there were rumors of a possible war with Russia.  The market opened down by a good margin and presented an excellent opportunity to make a short-term gain.  Today I would like to discuss how we did it at Terry’s Tips and how you can do it next time something like this comes along.

Terry

How to Play War Rumors

When the market opens up at a higher price than the previous day’s highest price or lower than the previous day’s lowest price, it is said to have a gap opening.  Gap openings unusually occur when unusually good (or bad) news has occurred.  Since there are two days over which such events might occur on weekends, most gap openings happen on Mondays.

A popular trading strategy is to bet that a gap opening will quickly reverse itself in the hour or two after the open, and day-trade the gap opening.  While this is usually a profitable play even if it doesn’t involve the possibility of a war, when rumors of a war prompted the lower opening price, it is a particularly good opportunity.

Over time, rumors of a new war (or some other economic calamity) have popped up on several occasions, and just about every time, there is a gap (down) opening. This time, the situation in Ukraine flared, even though any reasonable person would have figured out that we were highly unlikely to start a real war with Russia.

When war rumors hit the news wires, there is a consistent pattern of what happens in the market.  First, it gaps down, just like it did on Monday.  Invariably, it recovers after that big drop, usually within a few days.  Either the war possibilities are dismissed or the market comes to its senses and realizes that just about all wars are good for the economy and the market.  It is a pattern that I have encountered and bet on several times over the years and have never lost my bet.

On Monday, when the market gapped down at the open (SPY fell from $186.29 to $184.85, and later in the day, as low as $183.75), we took action in one of the 10 actual portfolios we carry out for Terry’s Tips paying subscribers (who either watch, mirror, or have trades automatically placed in their accounts for them through Auto-Trade).

One of these portfolios is called Terry’s Trades.  It usually is just sitting on cash.  When a short-term opportunity comes along that I would do in my personal account, I often place it in this portfolio as well.  On Monday, shortly after the open, we bought Mar2-14 weekly 184 calls on SPY (essentially “the market”), paying $1.88 ($1880 plus $12.50 commissions, or $1900.50) for 10 contracts.  When the market came to its senses on Tuesday, we sold those calls for $3.23 ($3230 less $12.50 commission, or $3217.50), for a gain of $1317, or about 70% on our investment.  We left a lot of money on the table when SPY rose even higher later in the week, but 70% seemed like a decent enough gain to take for the day.

War rumors are even more detrimental to volatility-related stocks.  Uncertainty soars, as does VXX (the only time this ETP goes up) while XIV and SVXY get crushed.  In my personal account, I bought SVXY and sold at-the-money weekly calls against it.  When the stock ticked higher on Friday, my stock was exercised away from me but I enjoyed wonderful gains from the call premium I had sold on Monday.

Whether you want to bet on the market reversing or volatility receding, when rumors of a war come along (accompanied by a gap opening), it might be time to act with the purchase of some short-term near-the-money calls.  Happy trading.

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.

Two Interesting Option Bets for 2014 – SPY and Google

Monday, December 23rd, 2013

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

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

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

Two Interesting Option Bets for 2014 – SPY and Google

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

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

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

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

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

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

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

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

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

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

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

 

 

 

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