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Posts Tagged ‘Auto-Trade’

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.

An Interesting Trade to Make on Monday

Monday, June 16th, 2014

The recent developments in Iraq have nudged options volatility higher, but for one underlying, SVXY, it has apparently pushed IV through the roof.  This development has brought about some potentially profitable option spread possibilities.Terry

An Interesting Trade to Make on Monday

In case you don’t know what SVXY is, you might check out the chart of its volatility-related inverse, VXX.  This is the ETP many investors use as a protection against a market crash.  If a crash comes along, options volatility skyrockets, taking VXX right along with it.  The only problem with VXX is that over time, it is just about the worst investment you could imagine making.  Three times in the last five years they have had to engineer 1 – for – 4  reverse splits to keep the price higher enough to bother with buying.  Over the past 7 years, VXX has fallen from a split-adjusted price over $2000 to its current $32.

Wouldn’t you like to buy the inverse of VXX?  You can.  It’s called SVXY  (XIV is also its inverse, but you can’t trade options on XIV).

Last week I talked about buying short-term (weekly) call options on SVXY because in exactly half the weeks so far in 2014, the stock had moved $4 higher at least once during the week.  I also advised waiting until option prices were lower before taking this action.  Now that option prices have escalated, the best thing seems to be selling option premium rather than buying it.

Two weeks ago, a slightly out-of-the-money weekly SVXY option had a bid price of $1.05.  Friday, that same option had a bid price of $2.30, more than double that amount.

All other things being equal, SVXY should move higher each month at the current level of Contango (6.49%).  That works out to about $1.20 each week.  I would like to place a bet that SVXY moves higher by about that amount and sell a calendar spread at a strike price about that much above Friday’s close ($79.91).

Below I have displayed the risk profile graph  for a July-June 81 calendar put spread (I used puts rather than calls because if the stock does move higher, the June puts will expire worthless and I will save a commission by not buying them back.

This would be the risk profile graph if we were to buy 5 Jul-14 – Jun-14 put calendar spreads at the 81 strike price at a cost of $3.00 (or less).  You would have $1500 at risk and could make over 50% on your investment if the stock goes up by amount that contango would suggest.  Actually, as I write this Monday morning, it looks like SVXY will open up about a dollar lower, and the spread might better be placed at the 80 strike instead of the 81.

SVXY Risk Profile Graph June 2014
SVXY Risk Profile Graph June 2014

A break-even range of $3 to the downside and about $5 on the upside looks quite comfortable.  If you had a little more money to invest, you might try buying September puts rather than July – this would allow more time for SVXY to recover if it does fall this week on scary developments in Iraq (or somewhere else in the world).

I have personally placed a large number of Sep-Jun calendar spreads on SVXY at strike prices both above and below the current stock price in an effort to take advantage of the unusually higher weekly option prices that exist  right now.

That’s enough about SVXY for today, but 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).  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).

Check Out the Volatility in SVXY

Monday, June 9th, 2014

This week is a further discussion of my favorite ETP (Exchange Traded Product), SVXY.  We have already discussed this unusual equity.  Because of contango, it is destined to move higher every week that there is not a market crash or correction.  It has doubled in value in each of the last two years.  If you have an idea of which way an underlying is headed, there are extremely attractive option strategies that you might use.  I will talk about one such strategy this week.Terry

Check Out the Volatility in SVXY

Every week for the past four weeks in my personal account, I have bought at least 200 out-of-the-money weekly call options on SVXY, paying $.20 ($20) for each option.  In every single instance, I was able to sell those options for at least $1.00 ($100), and sometimes much more.  That works out to 500% a week for 4 weeks in a row.  I could make that same bet every week for the next 16 weeks and lose every time and still be ahead.  (As we will see below, in half the weeks in 2014 so far, my bet would have been a winner, however).

Last week I was delighted to unload t hese calls because I figured that after moving higher for 6 consecutive weeks, it might be in for some weakness.  Not so.  The options I sold for $100 each could have been sold later in the week for $550.  I left a lot of money on the table.

I shared these trades with Terry’s Tips subscribers, by the way.  They were an insurance purchase as part of a larger portfolio of long and short options on SVXY.  Usually insurance costs money. I expected to lose money on it.  Over the past few weeks, it paid off nicely.

An interesting feature of SVXY price changes is the weekly volatility numbers.  This is an extremely volatile stock. The following table shows the biggest up and down changes in 2014 from the previous Friday’s close for SVXY.

This stock is unbelievably volatile.  In 19 of the 22 weeks, it either rose or fell by more than $3 (highlighted weeks). It rose over $3 in exactly half the weeks and if fell by more than $3 in 8 of the weeks.

SPXY Changes Newsletter June 2014

SPXY Changes Newsletter June 2014
With this kind of volatility, maybe buying a straddle each week at the close on Friday would be a good idea. The cheapest straddle last Friday would have been at the 84 strike (SVXY closed at $84.11) and would have cost about $3.35 (in most previous weeks, this straddle could have been bought for about $1 less – this week’s 10% rise in the stock price pushed IV much higher).

The biggest challenge with buying straddles is to figure out when to sell.  If you waited until the stock had moved by $4 to sell, you could have made a gain in 14 if the 22 weeks (64% of the time) but you would be only making about 20% at this week’s straddle cost and possibly losing almost everything in the remaining weeks. Not a good prospect, except maybe if you had bought at earlier-week prices.

A better idea would have been to buy a slightly out-of-the-money weekly call, paying about $.80 for it, and selling it when you have tripled your money.  You could have done that in half the weeks in 2014, insuring a great profit no matter what happened in the other half the weeks.

After SVXY rose $3 or more at some point in 7 of the last 8 weeks, however, call prices have moved higher this week (for the first time, surprisingly).  It would now cost about $1.20 to buy a weekly 85 call with the stock closing at $84.11.  A week ago, that same call would have cost about half as much.
This week I am not making an insurance purchase of out-of-the-money calls on SVXY.  The call option prices have become too rich for my taste. I suspect that a week from now, they might be back to a more reasonable level.

For several months, the call options have been much less expensive that the put options, but they are about the same right now.  In the past, traders were buying puts as a hedge against a market crash (when the market tanks, SVXY falls by a much greater percentage than the market).  This phenonemon will probably return soon, and make buying out-of-the-money calls a good strategy.

I suspect that SVXY might take a breather here for a week or two, so I will be sitting on the sidelines.  When call prices retreat a bit, I plan to start buying cheap out-of-the-money weekly calls once again.

That’s enough about SVXY for today, but 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). 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).

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.

How Option Prices are Determined

Monday, April 21st, 2014

Last week was one of the best for the market in about two years.  Our option portfolios at Terry’s Tips made great gains across the board as well.  One portfolio gained 55% for the week, in fact.  It is fun to have a little money tied up in an investment that can deliver those kinds of returns every once in a while.

This week I would like to discuss a little about what goes into an option price – what makes them what they are?

Terry

How Option Prices are Determined

Of course, the market ultimately determines the price of any option as buyers bid and sellers ask at various prices.  Usually, they meet somewhere in the middle and a price is determined.  This buying and selling action is generally not based on some pie-in-the-sky notion of value, but is soundly grounded on some mathematical considerations.

There are 5 components that determine the value of an option:

1. The price of the underlying stock

2. The strike price of the option

3. The time until the option expires

4. The cost of money (interest rates less dividends, if any)

5. The volatility of the underlying stock

The first four components are easy to figure out.  Each can precisely be measured.  If they were the only components necessary, option pricing would be a no-brainer.  Anyone who could add and subtract could figure it out to the penny.

The fifth component – volatility – is the wild card.  It is where all the fun starts.  Options on two different companies could have absolutely identical numbers for all of the first four components and the option for one company could cost double what the same option would cost for the other company.  Volatility is absolutely the most important (and elusive) ingredient of option prices.

Volatility is simply a measure of how much the stock fluctuates.  So shouldn’t it be easy to figure out?   It actually is easy to calculate, if you are content with looking backwards.  The amount of fluctuation in the past is called historical volatility.  It can be precisely measured, but of course it might be a little different each year.

So historical volatility gives market professionals an idea of what the volatility number should be.  However, what the market believes will happen next year or next month is far more important than what happened in the past, so the volatility figure (and the option price) fluctuates all over the place based on the current emotional state of the market.

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.

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