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Posts Tagged ‘Bearish Options Strategies’

5 Option Strategies if you Think the Market is Headed Lower

Saturday, June 27th, 2015

A subscriber wrote in and asked what he should do if he thought the market would be 6% lower by the end of September.  I thought about his question a little bit, and decided to share my thoughts with you, just in case you have similar feelings at some time along the way.Terry

5 Option Strategies if you Think the Market is Headed Lower

We will use the S&P 500 tracking stock, SPY, as a proxy for the market.  As I write this, SPY is trading just below $210.  If it were to fall by 6% by the end of September (3 months from now), it would be trading about $197 at that time.  The prices for the possible investments listed below are slightly more costly than the mid-point between the bid and ask prices for the options or the option spreads, and include the commission cost (calculated at $1.25 per contract, the price that Terry’s Tips subscribers pay at thinkorswim).

#1.  Buy an at-the-money put.  One of the most common option purchases is the outright buy of a put option if you feel strongly that the market is crashing.  Today, with SPY trading at $210, a September 2015 put option at the 210 strike would cost you $550.  If SPY is trading at $197 (as the subscriber believed it would be at the end of September), your put would be worth $1300.  You would make a profit of $750, or 136% on your investment.

Buying a put involves an extremely high degree of risk, however. The stock must fall by $5 ½ (about 2.6%) before you make a nickel of profit.  If the market remains flat or goes higher by any amount, you would lose 100% of your investment.  Studies have shown that about 80% of all options eventually expire worthless, so by historical measures, there is a very high likelihood that you will lose everything.  That doesn’t sound like much of a good investment idea to me, even if you feel strongly about the market’s direction.  It is so easy to get it wrong (I know from frequent personal experience).

If you were to buy an out-of-the-money put (i.e., the strike price is below the stock price), the outlook is even worse.  A Sept-15 205 put would cost about $400 to buy.  While that is less than the $550 you would have to shell out for the at-the-money 210 put, the market still has to fall by a considerable amount, $9 (4.3%) before you make a nickel.  In my opinion, you shouldn’t even consider it.

#2.  Buy an in-the-money put.  You might consider buying a put which has a higher strike than the stock price.  While it will cost more (increasing your potential loss if the market goes up), the stock does not need to fall nearly as far before you get into a profit zone.  A Sept-15 215 put would cost you $800, and the stock would only have to fall by $3 (1.4%) before you could start counting some gains.  If the market remains flat, your loss would be $300 (38%).

If the stock does manage to fall to $197, your 215 put would be worth $1800 at expiration, and your gain would be $1000, or 125% on your investment.  In my opinion, buying an in-the-money put is not a good investment idea, either, although it is probably better than buying an at-the-money put, and should only be considered if you are strongly convinced that the stock is headed significantly lower.

#3.  Buy a vertical put spread.  The most popular directional option spread choice is probably a vertical spread.  If you believe the market is headed lower, you buy a put and at the same time, sell a lower-strike put as part of a spread.  You only have to come up with the difference between the cost of the put you buy and what you receive from selling a lower-strike put to someone else.  In our SPY example, you might buy a Sept-15 210 put and sell a Sept-15 200 put.  You would have to pay $300 for this spread.  The stock would only have to fall by $3 before you started collecting a profit.  If it closed at any price below $200, your spread would have an intrinsic value of $1000 and you would make a profit of $700 (230% on your investment), less commissions.

With this spread, however, if the stock remains flat or rises by any amount, you would lose your entire $300 investment.  That is a big cost for being wrong.  But if you believe that the market will fall by 6%, maybe a flat or higher price isn’t in your perceived realm of possible outcomes.

Another (more conservative) vertical put spread would be to buy an in-the-money put and sell an at-the-money put. If you bought a Sept-15 220 put and sold a Sept-15 210 put, your cost would be $600.  If the stock closed at any price below $210, your spread would be worth $1000 and your gain ($400) would work out to be about 64% after commissions. The neat thing about this spread is that if the stock remained flat at $210, you would still gain the 64%.  If there is an equal chance that a stock will go up, go down, or stay flat, you would have two out of the three possible outcomes covered.

You also might think about compromising between the above two vertical put spreads and buy a Sept-15 215 put and sell a Sept-15 205 put.  It would cost you about $420.  Your maximum gain, if the stock ended up at any price below $205, would be $580, or about 135% on your investment.  If the stock remains flat at $210, your spread would be worth $500 at expiration, and you would make a small gain over your cost of $420.  You would only lose money if the stock were to rise by more than $.80 over the time period.

#4.  Sell a call credit vertical spread.  People with a limited understanding of options (which includes a huge majority of American investors) don’t even think about calls when they believe that the market is headed lower.  However, you can gain all the advantages of the above put vertical spreads, and more, by trading calls instead of puts if you want to gain when the market falls.  When I want to make a directional bet on a lower market, I always use calls rather than puts.

If you would like to replicate the risk-reward numbers of the above compromise vertical put spread, you would buy a Sept-15 215 call and sell a Sept-15 205 call. The higher-strike call that you are buying is much cheaper than the lower-strike call you are selling.  You could collect $600 for the spread.  The broker would place a $1000 maintenance agreement (no interest charge) on your account (this represents the maximum possible loss on the spread if you had not received any credit when placing it, but in our case, you collected $600 so the maximum possible loss is $400 – that is how much you will have to have in your account to sell this spread).  Usually, buying a vertical put spread or selling the same strikes with a credit call vertical spread cost about the same – in this case, the call spread happened to be a better price (an investment of $400 rather than $420).

There are two advantages to selling the call credit spread rather than buying the vertical put spread.  First, if you are successful and the stock ends up below $205 as you expect, both the long and short calls will expire worthless.  There will be no commission to pay on closing out the positions. You don’t have to do anything other than wait a day for the maintenance requirement to disappear and you get to keep the cash you collected when you sold the spread at the outset.

Second, when you try to sell the vertical put spread for $10 (the intrinsic value if the stock is $205 or lower), you will not be able to get the entire $10 because of the bid-ask price situation.  The best you could expect to get is about $9.95 ($995) as a limit order.  You could do nothing and let the broker close it out for you – in that case you would get exactly $1000, but most brokers charge a $35 or higher fee for an automatic closing spread transaction.  It is usually better to accept the $995 and pay the commission (although it is better to use calls and avoid the commissions altogether).

#5.  Buy a calendar spread.  My favorite spreads are calendar spreads so I feel compelled to include them as one of the possibilities. If you think the market is headed lower, all you need to do is buy a calendar spread at a strike price where you think the stock will end up when the short options expire. In our example, the subscriber believed that the stock would fall to $197 when the September options expired.  He could buy an Oct-15 – Sept-15 197 calendar spread (the risk-reward is identical whether you use puts or calls, but I prefer to use calls if you think the market is headed lower because you are closing out an out-of-the-money option which usually has a lower bid-ask range).  The cost of this spread would be about $60.  Here is the risk profile graph which shows the loss or gain from the spread at the various possible stock prices:

Bearish SPY Risk Profile Graph June 2015

Bearish SPY Risk Profile Graph June 2015

You can see that if you are exactly right and the stock ends up at $197, your gain would be about $320, or over 500% on your investment (by the way, I don’t expect the stock will fall this low, but I just went into the market to see if I could get the spread for $60 or better, and my order executed at $57).

What I like about the calendar spread is that the break-even range is a whopping $20.  You can be wrong about your price estimate by almost $10 in either direction and you would make a profit with the spread.  The closer you can guess to where the stock will end up, the greater your potential gain.  Now that I have actually bought a calendar spread at the 197 strike, I will buy another calendar spread at a higher strike so that I have more upside protection (and be more in line with my thinking as to the likely stock price come September).

There are indeed an infinite number of option investments you could make if you have a feeling for which way the market is headed.  We have listed 5 of the more popular strategies if someone believes the market is headed lower.  In future newsletters we will discuss more complicated alternatives such as butterfly spreads and iron condors.

How to Make Gains in a Down Market With Calendar Spreads

Thursday, May 14th, 2015

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

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

Terry

How to Make Gains in a Down Market With Calendar Spreads

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

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

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

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

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

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

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

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

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

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

Why Calendar Spreads Are So Much Better Than Buying Stock

Wednesday, April 22nd, 2015

One of the great mysteries in the investment world (at least to me, an admitted options nut) is why anyone would buy stock in a company they really like when they could dramatically increase their expected returns with a simple stock options strategy instead.  Of course, buying options is a little more complicated and takes a little extra work, but if you could make two or three times (or more) on your investment, wouldn’t that little extra effort be more than worth it?  Apparently not, since most people take the lazy way out and just buy the stock.Today I will try to persuade you to give stock options a try.  I will show you exactly what I am doing in one of my Terry’s Tips portfolios while trading one of my favorite stocks.

Terry

Why Calendar Spreads Are So Much Better Than Buying Stock

I like just about everything about Costco.  I like to shop there.  I buy wine by the case, paying far less than my local wine store (I am not alone – Costco is the largest retailer of wine in the world, selling several billions of dollars’ worth every year).  I like Costco because they treat their employees well, paying them about double what Walmart pays its people.  I like shopping at Costco because I know I am never paying more than I should for anything I buy.  It seems to me that the other customers like it, too.  Everyone seems to be happy while roaming the aisles and enjoying the free samples they offer (I have a skinflint friend who shops at Costco once a week just for the samples – they are his lunch that day).

But most of all, I like the stock (COST).  It has been very nice to me over the years, and I have consistently made a far greater return using options than I would have if I had just gone out and bought the stock.

I recently set up an actual brokerage account to trade COST options for the educational benefit of Terry’s Tips paying subscribers.  I put $5000 in the account.  Today, it is worth $6800.  I started out buying calendar spreads, some at at-the-money strike prices and others at higher strike prices (using calls).  I currently own October 2015 calls at the 145 and 150 strike prices (the stock is trading about $146.50), and I am short (having sold to someone else) May-15 calls at the 145, 147, and 150 strike prices.  These calls will expire in 23 days, on May 15, 2015.  (Technically, the 147 calls I am short are with a diagonal spread rather than a calendar spread because the long side is at the 145 strike.  With calendar spreads, the long and short sides are at the same strike price.)

Here is the risk profile graph for my positions.  It shows how much money I will make (or lose) at the various possible prices where COST might be on May 15th when the short options expire:

COST Risk Profile Graph April 2015

COST Risk Profile Graph April 2015

In the lower right-hand corner, the P/L Day number shows the expected gain or loss if the stock stays flat ($148.54), or is $3 higher, or lower, than the current price.  If the stock stays absolutely flat, I should make about $976, or about 14% on the $6800 I have invested.

I could have bought 46 shares of the stock with $6800 instead of owning these options.   If the stock doesn’t go up any in the next 23 days, I would not gain a penny.  But the options will make a profit of about $976.

If the stock falls $2 by May 15, I would lose $92 with my stock investment, and my options would make a gain of $19. I am still better off owning the options.  Only if the stock falls more than $2 ½ dollars over those three weeks would I be worse off with the options positions.  But I like this stock.  I think it is headed higher.  That’s why I bought COST in the first place.

If I am right, and the stock goes up by $3, I would make $138 if I owned 46 shares of the stock, or I would make $1,700 with my options positions.  That’s more than 10 times as much as I would make by owning the stock.

Can you understand why I am confused why anyone would buy stock rather than trading the options when they find a stock they really like?  It just doesn’t make any sense to me.

Of course, when the options I have sold are set to expire in 23 days, I need to do something.  I will need to buy back the options that are in the money (at a strike which is lower than the stock price), and sell new options (collecting even more money) in a further-out month, presumably June.  The lazy guys who just bought the stock instead of owning stock are lucky in this regard – they don’t have to do anything.  But if the stock had stayed flat or risen moderately over those three weeks, I know that I am way ahead of the stock-owners every time.

While stock owners sit around and do nothing, my job on May 15 will be to roll over the short calls to the next month (and use the cash that is generated to buy new spreads to increase future returns even more).  I show my subscribers exactly what and how to make those trades each month (in both the COST portfolio and 9 other portfolios which use different underlying stocks).  Hopefully, eventually, they won’t need me any longer, but they will have discovered how to use stock options to dramatically increase their investment returns on their own.

$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).

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).

A “Conservative” Options Strategy for 2014

Monday, December 16th, 2013

Every day, I get a Google alert for the words “options trading” so that I can keep up with what others, particularly those with blogs, are saying about options trading.  I always wondered why my blogs have never appeared on the list I get each day.  Maybe it’s because I don’t use the exact words “option trading” like some of the blogs do.

Here is an example of how one company loaded up their first paragraph with these key words (I have changed a few words so Google doesn’t think I am just copying it) – “Some experts will try to explain the right way to trade options by a number of steps.  For example, you may see ‘Trading Options in 6 Steps’ or ’12 Easy Steps for Trading Options.’  This overly simplistic approach can often send the novice option trading investor down the wrong path and not teach the investor a solid methodology for options trading. (my emphasis)”  The key words “options trading” appeared 5 times in 3 sentences.  Now that they are in my blog I will see if my blog gets picked up by Google.

Today I would like to share my thoughts on what 2014 might have in store for us, and offer an options strategy designed to capitalize on the year unfolding as I expect.

Terry

A “Conservative” Options Strategy for 2014

What’s in store for 2014?  Most companies seem to be doing pretty well, although the market’s P/E of 17 is a little higher than the historical average.  Warren Buffett recently said that he felt it was fairly valued.  Thirteen analysts surveyed by Forbes projected an average 2014 gain of just over 5% while two expected a loss of about 2%, as we discussed a couple of weeks ago. With interest rates so dreadfully low, there are not many places to put your money except in the stock market. CD’s are yielding less than 1%.  Bonds are scary to buy because when interest rates inevitably rise, bond prices will collapse.  The Fed’s QE program is surely propping up the market, and some tapering will likely to take place in 2014.  This week’s market drop was attributed to fears that tapering will come sooner than later.

When all these factors are considered, the best prognosis for 2014 seems to be that there will not be a huge move in the market in either direction.  If economic indicators such as employment numbers, corporate profits and consumer spending improve, the market might be pushed higher except that tapering will then become more likely, and that possibility will push the market lower.  The two might offset one another.

This kind of a market is ideal for a strategy of multiple calendar spreads, of course, the kind that we advocate at Terry’s Tips.  One portfolio I will set up for next year will use a Jan-16 at-the-money straddle as the long side (buying both a put and a call at the 180 strike price).  Against those positions we will sell out-of-the-money monthly puts and calls which have a month of remaining life. The straddle will cost about $36 and in one year, will fall to about $24 if the stock doesn’t move very much (if it does move a lot in either direction, the straddle will gain in value and may be worth more than $24 in one year).  Since the average monthly decay of the straddle is about $1 per month,  that is how much monthly premium needs to be collected to break even on theta.  I would like to provide for a greater move on the downside just in case that tapering fears prevail (I do not expect that euphoria will propel the market unusually higher, but tapering fears might push it down quite a bit at some point).  By selling puts which are further out of the money, we would enjoy more downside protection.

Here is the risk profile graph for my proposed portfolio with 3 straddles (portfolio value $10,000), selling out-of-the-money January-14 puts and calls. Over most of the curve there is a gain approaching 4% for the first month (a five-week period ending January 19, 2014).   Probably a 3% gain would be a better expectation for a typical month.  A gain over these 5 weeks should come about if SPY falls by $8 or less or moves higher by $5 or less.  This seems like a fairly generous range.

Spy Straddle Risk Profile For 2014

Spy Straddle Risk Profile For 2014

For those of you who are not familiar with these risk profile graphs (generated by thinkorswim’s free software), the P/L Day column shows the gain or loss expected if the stock were to close on January 19, 2014 at the price listed in the Stk Price column, or you can estimate the gain or loss by looking at the graph line over the various possible stock prices.  I personally feel comfortable owning SPY positions which will make money each month over such a broad range of possible stock prices, and there is the possibility of changing that break-even range with mid-month adjustments should the market move more than moderately in either direction.

The word “conservative” is usually not used as an adjective in front of “options strategy,” but I believe this is a fair use of the word for this actual portfolio I will carry out at Terry’s Tips for my paying subscribers to follow if they wish (or have trades automatically executed for them in their accounts through the Auto-Trade program at thinkorswim).

There aren’t many ways that you can expect to make 3% a month in today’s market environment.  This options strategy might be an exception.

How to Make a Portfolio of Calendar Spreads Either Bearish or Bullish

Monday, June 17th, 2013

Last week our string of 12 consecutive winning PEA Plays (Pre-Earnings Announcement) was broken, not because our model guessed wrong on where the stock (LULU) would go after the announcement (down, as it did), but because the CEO announced her retirement and the stock fell almost 20% on that news (the company actually exceeded estimates on earnings, revenues, and guidance but the retirement news overshadowed that good news).  Our option positions were set up to handle a 7% drop and still make a gain, but we could not handle a 20% drop.

Interestingly, our loss came about not from our basic diagonal spread (where we would have made money in spite of the huge drop) but from the insurance calendar spreads we placed “just in case we were wrong” about the direction the stock would take.  If we had had more faith in our model, we would not have made the insurance purchase, and we would not have suffered a loss.

Our loss on LULU was slightly greater than the average gain we made on the 12 previous PEA Plays, so while it was an unpleasant setback, it was not devastating.

Terry

How to Make a Portfolio of Calendar Spreads Either Bearish or Bullish: 

At Terry’s Tips, we use an options strategy that consists of owning calendar (aka time) spreads at many different strike prices, both above and below the stock price. A calendar spread is created when you buy an option with a longer lifespan than the short option that you sell against your long position with both options at the same strike price. We also use diagonal spreads which are similar to calendar spreads (except that the strike prices of the long and short sides are different). 

We typically start out each week or month with a slightly bullish posture since the market has historically moved higher more times than it has fallen.  In option terms, this is called being positive net delta.  Starting in May and extending through August, we usually start out with a slightly bearish posture (negative net delta) in deference to the “sell in May” adage. 

Any calendar spread makes its maximum gain if the stock ends up on expiration day exactly at the strike price of the calendar spread.  As the market moves either up or down, adding new spreads at different strikes is essentially placing a new bet at the new strike price.  In other words, you hope the market will move toward that strike.

If the market moves higher, we add new calendar spreads at a strike which is higher than the stock price (and vice versa if the market moves lower).  New spreads at strikes higher than the stock price are bullish bets and new spreads at strikes below the stock price are bearish bets.

It does not make any difference whether puts or calls are used for a calendar spread – the risk profile is identical for both.  The key variable for calendar spreads is the strike price rather than whether puts or calls.  In spite of that truth, we prefer to use puts when buying calendar spreads at strikes below the stock price and calls when buying calendar spreads at strikes above the stock price because it is easier to trade out of out-of-the-money options when the short options expire.

If the market moves higher when we are positive net delta, we should make gains because of our positive delta condition (in addition to decay gains that should take place regardless of what the market does).  If the market moves lower when we are positive net delta, we would lose portfolio value because of the bullish delta condition, but some or all of these losses would be offset by the daily gains we enjoy from theta (the net daily decay of all the options).

Another variable affects calendar spread portfolio values.  Option prices (VIX) may rise or fall in general.  VIX typically falls with a rising market and moves higher when the market tanks.  While not as important as the net delta value, lower VIX levels tend to depress calendar spread portfolio values (and rising VIX levels tend to improve calendar spread portfolio values).  

Once again, trading options is more complicated than trading stock, but can be considerably more interesting, challenging, and ultimately profitable than the simple purchase of stock or mutual funds.

Using Puts vs. Calls for Calendar Spreads

Tuesday, March 12th, 2013

A lot of our discussion lately has focused on pre-earnings-announcement strategies (we call them PEA Plays).  This has been brought about by lower option prices (VIX) than we have seen since 2007, a full six years ago.  With option prices this low it has been difficult to depend on collecting premium as our primary source of income with our basic option strategies. 

But the earnings season has now quieted down and will not start up again for several weeks, so we will return to discussing more conventional option issues. 

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 2012 and into 2013, 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.  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). 

The choice of using puts or calls for a calendar spread is most relevant when considering at-the-money spreads.  When buying at-the-money calendar spreads, the least expensive choice (puts or calls) should usually be made. An exception to this rule comes when one of the quarterly SPY dividends is about to come due.  On the day the dividend is payable (always on expiration Friday), the stock is expected to fall by the amount of the dividend (usually about $.60).  Since the market anticipates this drop in the stock (and knowing the specific day that the stock will fall), put prices are generally bid higher in the weeks before that dividend date. 

The bottom line is that put calendar spreads are preferable to call calendar spreads for at-the-money strikes (or even at strikes slightly higher than the stock price) coming into a SPY dividend date.   Even though the put spreads cost more, the Weekly options that can be sold for enough extra to cover the higher cost.  You do not want to own SPY call calendar spreads which might become in the money on the third Friday of March, June, September, or December because you will have to buy them back on Thursday to avoid paying the dividend, and you may not want to make that purchase to keep your entire portfolio balanced.

Six consecutive successful Apple option plays, and more still to come?

Wednesday, January 2nd, 2013

Three weeks ago I wrote an article about how to play the unusual stock action pattern of Apple (AAPL). – Play Apple Volatility With A Unique Weekly Options Strategy

For some unclear reason (most likely options-related, at least to my way of thinking), AAPL tends to fall on Fridays, often quite dramatically, and to move higher on Mondays.

At that time, I suggested that buying at-the-money puts Thursday near the close (or shortly after the open on Friday) would often result in extraordinary gains if you sold the puts near the close on Friday.  For the past three weeks, this pattern has continued in spades.

The stock fell on Friday in those three weeks by $19.90, $2.40, and $5.47.  Since at at-the-money put with a single day of remaining life would cost about $4, your average gain over these three weeks works out to more than 150% per week.  During these three weeks, greater gains were possible by buying the puts before the close on Thursday rather than after the open on Friday (in the prior 12-week test, the stock often opened up a bit higher on Friday, suggesting that might be a better entry point).

The results for Mondays were not as dramatic, but still quite impressive.  Of course, buying an at-the-money call either Friday near the close or near the open on Monday would cost closer to $10 because there would be five trading days remaining rather than only one, so the initial cost of the option would be about double the amount required to buy puts in anticipation of the Friday drop.

Over the last three weeks, on Mondays, AAPL has moved higher by $9.04, $.84, and $22.58.  Substantial gains would have come your way in two of the three weeks with probably a break-even in the week when the stock budged up only $.84.

Will this Friday-Monday pattern continue?  No one knows, for sure.  My experience is that trading patterns identified by back-testing do not always hold up going forward.  But somehow this one seems different.  Until the pattern is broken, at least buying puts near the close on Thursday seems like a good bet.  Even if you lose the entire bet on occasion, there have been so many Fridays when the drop has been substantial, over time, the returns could have been extraordinary.

At heart, I am not an option buyer.  I prefer collecting decay from selling short-term options (using longer-term options as collateral rather than stock).  But for many months now, the daily and weekly fluctuations in AAPL have been considerably higher than the implied volatilities of the options would suggest.  As long as this pattern persists, buying AAPL options rather than selling them seems be in order, especially when there us some reason to believe that buying a put or call (rather than a straddle or strangle) gives you an edge.  The Friday-Monday phenomenon might just be the edge you need.

Invest in Yourself in 2013 (at the Lowest Rate Ever)

Monday, December 31st, 2012

To celebrate the coming of the New Year I am making the best offer to come on board that I have ever offered.  It is time limited.  Don’t miss out.

Invest in Yourself in 2013 (at the Lowest Rate Ever)

The presents are unwrapped.  The New Year is upon us.  Start it out right by doing something really good for yourself, and your loved ones. 

The beginning of the year is a traditional time for resolutions and goal-setting.  It is a perfect time to do some serious thinking about your financial future.

I believe that the best investment you can ever make is to invest in yourself, no matter what your financial situation might be.  Learning a stock option investment strategy is a low-cost way to do just that.

As our New Year’s gift to you, we are offering our service at the lowest price in the history of our company.      If you ever considered becoming a Terry’s Tips Insider, this would be the absolutely best time to do it.  Read on…

Don’t you owe it to yourself to learn a system that carries a very low risk and could gain 36% a year as many of our portfolios have done?

So what’s the investment?  I’m suggesting that you spend a small amount to get a copy of my 70-page (electronic) White Paper, and devote some serious early-2013 hours studying the material. 

And now for the Special Offer – If you make this investment in yourself by midnight, January 9, 2013, this is what happens:

For a one-time fee of only $39.95, you receive the White Paper (which normally costs $79.95 by itself), which explains my two favorite option strategies in detail, 20 “Lazy Way” companies with a minimum 100% gain in 2 years, mathematically guaranteed, if the stock stays flat or goes up, plus the following services :

1) Two free months of the Terry’s Tips Stock Options Tutorial Program, (a $49.90 value).  This consists of 14 individual electronic tutorials delivered one each day for two weeks, and weekly Saturday Reports which provide timely Market Reports, discussion of option strategies, updates and commentaries on 8 different actual option portfolios, and much more. 

2) Emailed Trade Alerts.  I will email you with any trades I make at the end of each trading day, so you can mirror them if you wish (or with our Premium Service, you will receive real-time Trade Alerts as they are made for even faster order placement or Auto-Trading with a broker).  These Trade Alerts cover all 8 portfolios we conduct.

3) If you choose to continue after two free months of the Options Tutorial Program, do nothing, and you’ll be billed at our discounted rate of $19.95 per month (rather than the regular $24.95 rate).

4) Access to the Insider’s Section of Terry’s Tips, where you will find many valuable articles about option trading, and several months of recent Saturday Reports and Trade Alerts.

5) A FREE special report “How We Made 100% on Apple in 2010-11 While AAPL Rose Only 25%”. This report is a good example of how our Shoot Strategy works for individual companies that you believe are headed higher.

With this one-time offer, you will receive all of these benefits for only $39.95, less than the price of the White Paper alone. I have never made an offer better than this in the twelve years I have published Terry’s Tips.  But you must order by midnight on January 9, 2013.  Click here, choose “White Paper with Insider Membership”, and enter Special Code 2013 (or 2013P for Premium Service – $79.95).

Investing in yourself is the most responsible New Year’s Resolution you could make for 2013.  I feel confident that this offer could be the best investment you ever make in yourself.

Happy New Year!  I hope 2013 is your most prosperous ever.  I look forward to helping you get 2013 started right by sharing this valuable investment information with you. 
Terry

P.S.  If you would have any questions about this offer or Terry’s Tips, please call Seth Allen, our Senior Vice President at 800-803-4595.  Or make this investment in yourself at the lowest price ever offered in our 8 years of publication – only $39.95 for our entire package - using Special Code 2013 (or 2013P for Premium Service – $79.95).

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I have been trading the equity markets with many different strategies for over 40 years. Terry Allen's strategies have been the most consistent money makers for me. I used them during the 2008 melt-down, to earn over 50% annualized return, while all my neighbors were crying about their losses.

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