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

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

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.