from the desk of Dr. Terry F Allen

Skip navigation

Member Login  |  Contact Us  |  Sign Up


Posts Tagged ‘Bullish Options strategies’

An Interesting Way to Invest in China Using Options

Monday, November 17th, 2014

A week ago, I reported on a spread I placed in advance of Keurig’s (GMCR) announcement which comes after the market close on Wednesday.  I bought Dec-14 140 puts and sold Nov-14 150 puts for a credit of $1.80 when the stock was trading just under $153.  The spread should make a gain if it ends up Friday at any price higher than $145.  You can still place this trade, but you would only receive about $1.15 at today’s prices.  It still might be a good bet if you are at all bullish on GMCR.Today I would like to discuss a way to invest in China using options.  One of our basic premises at Terry’s Tips is that if you find a company you like, you can make several times as much trading options on that company than you can just buying the stock (and we have proved this premise a number of times with a large number of companies over the years).  If you would like to add an international equity to your investment portfolio, you might enjoy today’s discussion.


An Interesting Way to Invest in China Using Options:

My favorite print publication these days is Bloomberg BusinessWeek which also includes a monthly edition called Bloomberg Markets.  There are times when I find myself at least skimming nearly every article in both publications.  I used to read the Wall Street Journal every day, but it got to be just too much.  Now I only read the Saturday edition along with Barron’s.  This week’s cover story in Bloomberg Markets is entitled “Jack Ma Wants it All.”  It discusses the fascinating story of Ali Baba (BABA) and Ma’s business philosophy which treats customers first, employees second, and stockholders third.  This is precisely Costco’s philosophy, and it has worked wonders for COST, even for stockholders.

Last week was 11/11, a sort of anti-Valentines Day in China called Singles Day (BABA owns the name as well) when unattached people buy something for themselves.  BABA reported online sales of $9 billion on that day.  For comparison, online spending on Black Friday, the hectic U.S. shopping day after Thanksgiving, totaled $1.2 billion in 2013. On Cyber Monday, the top online spending day, sales totaled $1.84 billion, according to research firm comScore.

The only part about Ma’s strategy I didn’t like was his international investments in apparently unrelated businesses.  I generally prefer companies which “stick to their own knitting.”  But BABA might be an interesting way to invest in China, and the option prices are attractive (high IV, relatively small bid-asked ranges, lots of volume, and weekly options are traded).

I tried to get a link to the Bloomberg Markets article, but there doesn’t appear to be one.  It is fascinating, however, and worth a trip to the library or newsstand to read the December issue.

Proposed New Terry’s Tips Portfolio: One of the most successful strategies we have carried out over the years has been using calendar and diagonal spreads on individual companies we like.  If the stock price moves higher (as we expect), we have often gained several times the percentage increase in the stock.  For example, in the 15 months since we started the Vista Valley portfolio which trades NKE call options, the stock has increased by 51% and our portfolio has gained 141%.

BABA would be an interesting company to start a new portfolio to trade.  An at-the-money July-Dec2 calendar spread would cost about $12.  There would be 7 opportunities to sell a one-month-out at-the-money call, and the going price is about $5. If we could do that 3 times we would have all our money back with 4 more chances to take some pure profits.

If we set up a $5000 portfolio using this strategy (owning Jul-15 calls to start, and selling one weekly at each of 4 weeks, from at-the-money to just out-of-the-money, this is what the risk profile graph would look like for the first full month of waiting:

BABA Risk Profile Graph November 2014

BABA Risk Profile Graph November 2014

The break-even range would extend about $5 on the downside and $15 on the upside, a fairly wide range for a $115 stock for one month.  An at-the-money result would cause a better-than-15% return for the month.  It looks like an attractive way to add a little international coverage to our portfolio choices, and to enjoy gains if the stock falls as much as $5 in a month or does any better than that.  If you just bought the stock, it would have to move higher before you made any gains.  With options, you make the highest gain if it just manages to stay flat for the month.  At all times, you enjoy a wider break-even range than you ever could by merely buying a stock that you like.

Update on the ongoing SVXY put demonstration portfolio.  This sample demonstration portfolio holds a SVXY Mar-15 75, and each week, (almost always on Friday), we buy back an expiring weekly put and sell a one-week put in its place, trying to sell at a strike which is $1 – $2 in the money (i.e., at a strike which is $1 or $2 above the stock price)  Our goal in this portfolio is to make 3% a week.

Last week, SVXY edged up $.70 and we bought back the expiring Nov1-14 73 put  and sold a Nov-14 73 put (selling a calendar), collecting a credit of $1.45 ($143.50 after commissions).

The account value is now $1500, up $55 for the week, and $266 from the starting value of $1234 on October 17th, 4 weeks ago.  This works out to $66 a week, well more than the $37 weekly gain we need to achieve our 3% weekly goal.

I will continue trading this account and let you know from time to time how close I am achieving my goal of 3% a week.  I will follow the guidelines already sent to you for rolling over as outlined above and earlier, so you should be able to do it on your own if you wish.


How to Make 60% to 100% in 2014 if a Single Analyst (Out of 13) is Right – an Update

Friday, October 31st, 2014

Last week we discussed vertical spreads.  This week, I would like to continue that discussion by repeating some of what we reported in late December of last year.  It involves making a relatively long-term (one year) bet on the direction of the entire market.

And again, a brief plug for my step-daughter’s new fitness invention called the Da Vinci BodyBoard – it gives you a full body workout in only 20 minutes a day right in your home.  She has launched a KickStarter campaign to get financing and offer it to the world – check it out:


How to Make 60% to 100% in 2014 if a Single Analyst (Out of 13) is Right – an Update

This is part of we wrote last December – “Now is the time for analysts everywhere to make their predictions of what will happen to the market in 2014.  Last week, the Wall Street Journal published an article entitled Wall Street bulls eye more stock gains in 2014.  Their forecasts – ”The average year-end price target of 13 stock strategists polled by Bloomberg is 1890, a 5.7% gain … (for the S&P 500).  The most bullish call comes from John Stoltzfus, chief investment strategist at Oppenheimer (a prediction of +13%).”

The Journal continues to say “The bad news: Two stock strategists are predicting that the S&P 500 will finish next year below its current level. Barry Bannister, chief equity strategist at Stifel Nicolaus, for example, predicts the index will fall to 1750, which represents a drop of 2% from Tuesday’s close.”

I would like to suggest a strategy that will make 60% to 100% or more (depending on which strike prices you choose to use) if any one of those analysts is right. In other words, if the market goes up by any amount or falls by 2%, you would make those returns with a single options trade that will expire at the end of 2014.

The S&P tracking stock (SPY) is trading around $180.  If it were to fall by 2% in 2014, it would be trading about $176.40.  Let’s use $176 as our downside target to give the pessimistic analyst a little wiggle room.  If we were to sell a Dec-14 176 put and buy a Dec-14 171 put, we could collect $1.87 ($187) per contract.  A maintenance requirement of $500 would be made.  Subtracting the $187 you received, you will have tied up $313 which represents the greatest loss that could come your way (if SPY were to close below $171, a drop of 5% from its present level).  We placed this exact spread in one of the 10 actual portfolios we carry out at Terry’s Tips.

Once you place these trades (called selling a vertical put spread), you sit back and do nothing for an entire year (until these options expire on December 20, 2014). If SPY closes at any price above $176, both puts would expire worthless and you would get to keep $187 per contract, or 60% on your maximum risk.

If you wanted to get a little more aggressive, you could make the assumption that the average estimate of the 13 analysts was on the money, (i.e., the market rises 5.7% in 2014).  That would mean SPY would be at $190 at the end of the year. You could sell a SPY Dec-14 190 put and buy a Dec-14 185 put and collect $2.85 ($285), risking $2.15 ($215) per contract.  If the analysts are right and SPY ends up above $190, you would earn 132% on your investment for the year.

By the way, you can do any of the above spreads in an IRA if you choose the right broker.

Note: I prefer using puts rather than calls for these spreads because if you are right, nothing needs to be done at expiration, both options expire worthless, and no commissions are incurred to exit the positions.  Buying a vertical call spread is mathematically identical to selling a vertical put spread at these same strike prices, but it will involve selling the spread at expiration and paying commissions.”

We are now entering November, and SPY is trading around $201.  It could fall by $25 and the 60%-gainer spread listed above would make the maximum gain, or it could fall by $12 and you could make 132% on your money for the year.  Where else can you make these kinds of returns these days?

On a historical basis, for the 40 years of the S&P 500’s existence, the index has fallen by more than 2% in 7 years.  That means if historical patterns continue for 2014, there is a 17.5% chance that you will lose your entire bet and an 83.5% chance that you will make 60% (using the first SPY spread outlined above).  If you had made that same bet every year for the past 40 years, you would have made 60% in 33 years and lost 100% in 7 years.  For the entire time span, you would have enjoyed an average gain of 32% per year.  Not a bad average gain.

Update on the ongoing SVXY put demonstration portfolio.  (We owned one Mar-15 65 put, and each week, we roll over a short put to the next weekly which is about $1 in the money (i.e., at a strike which is $1 higher than the stock price).  SVXY soared higher this week, and we had to make an adjustment.  We wanted to sell a weekly put at the 70 strike since the stock was trading around $68, but that strike is $3 higher than our long put, and we would create a maintenance requirement of $300 to sell that strike put.

Instead, today I sold the Mar-15 65 put and bought a Mar-15 70 put (buying a vertical spread) for $2.43 ($243).  Then I bought back the Oct4-14 65 put for a few pennies and sold a Nov1-14 70 put, collecting $2.94 $294) for the spread.   The account value is at $1324, or $90 higher than $1234 where we started out.  This averages out to $45 per week, slightly above the 3% ($37) average weekly gain we are shooting for.  (Once again, we would have done much better this week if the stock had moved up by only $2 instead of $5).

I will continue trading this account and let you know from time to time how close I am achieving my goal of 3% a week, although I will not report every trade I make each week.  I will follow the guidelines for rolling over as outlined above, so you should be able to do it on your own if you wished.


A Little About Vertical Spreads

Friday, October 24th, 2014

Today we will discuss vertical spreads, and how you can use them when you have a strong feeling about which way a stock is headed.

But first, a brief plug for my step-daughter’s new fitness invention called the Da Vinci BodyBoard – it gives you a full body workout in only 20 minutes a day right in your home.  She has launched a KickStarter campaign to get financing and offer it to the world – check it out:


A Little About Vertical Spreads

Vertical spreads are known as directional spreads.  When you place such a spread, you are betting that the stock will move in a particular direction, either up or down.  If you are right, you can make a nice gain.  Even better, you can usually create a vertical spread that also makes money if the stock doesn’t move in the direction you hoped, but stays absolutely flat instead.

If you have a strong feeling that a particular stock will move higher in the near future, you might be inclined to either buy the stock or buy a call on it.  Both of these choices have disadvantages.  Buying the stock ties up a great deal of money, and even if you are right and the stock moves higher, your return on investment is likely to be quite small.

Buying calls gives you great leverage and a much higher return on investment if you are indeed right and the stock moves higher.  But much of the cost of a call is premium (the extra amount you pay out so that you don’t have to put up so much cash compared to buying the stock).  The stock needs to go up a certain amount just to cover the premium, and you don’t start making money until that premium is covered.  If the stock doesn’t go up (and no matter how great you are at picking winners, you will probably be disappointed many times), you could lose some or all of your investment.  Bottom line, buying calls is a losing proposition much of the time – you have to be really lucky to come out a winner.

Buying a vertical spread is a safer alternative than either buying stock or calls.  You give up some of the extraordinary gains for a great likelihood of making a more moderate gain, and if you play your cards right, you can also make a gain if the stock stays flat.

Let’s look at an example.  Last week, my favorite underlying, SVXY, had been beaten down because VIX had shot up over 25.  I felt very strongly that the market fears would eventually subside, VIX would fall back to the 15 level, and SVXY (which moves in the opposite direction of VIX) would move higher.

Late last week, when SVXY was trading right at $60, I bought November 55 calls and sold November 60 calls as a vertical spread.  It cost me $3 ($300 per contract).  When these calls expire in about a month, if the stock is any higher than $60, my spread will be worth exactly $5, and I will make about 60% on my investment.  The interesting thing is that it doesn’t have to move any higher than was at the time for me to make that kind of a gain.

In reality, while I did make this vertical spread, I didn’t use calls.  Instead, I sold a vertical spread using puts, buying November 60 puts and selling November 55 puts. I collected $2, an amount which is the exact same risk that I would have taken if I had bought the vertical spread with calls.  The broker will charge a maintenance fee of $5 ($500) on each spread, but since I collected $200 at the outset, my risk, and the amount I had to put up, is only $300.

The risks and rewards are identical if you buy a vertical with calls or sell a vertical with puts (assuming the strike prices are the same), but there is a neat thing about using puts if you believe the stock is headed higher.  In this case, if the stock ends up at the November expiration at any price higher than $60, both the long and short puts will expire worthless (and I get to keep the $200 I got at the beginning).  There is no exit trade to make, and best of all, no commissions to pay.  For this reason, I almost always use puts when I buy a vertical spread betting on a higher stock price rather than calls (the only exceptions come when the spread can be bought for a lower price using calls, something which occurs on occasion).

Update on the ongoing SVXY put demonstration portfolio.  (We own one Mar-15 65 put, and each week, we roll over a short put to the next weekly which is about $1 in the money (i.e., at a strike which is $1 higher than the stock price).

This week, SVXY moved sharply higher, from about $57 to about $62.  Today I bought back the out-of-the-money Oct4-14 59 put for a few cents and sold an Oct5-14 64 put (about $2 in the money) for a credit of $3.65 ($365) on the diagonal spread.  The account value is at $1290, just a little higher than $1234 where we started out (we would have done much better if the stock had moved up by only $2 instead of $5).

I will continue trading this account and let you know from time to time how close I am achieving my goal of 3% a week, although I will not report every trade I make each week.  I will follow the guidelines for rolling over as outlined above, so you should be able to do it on your own if you wished.  This week I sold the next weekly put at a strike which was $2 in the money because I think the stock is headed higher because VIX is still at an elevated level compared to where it has been for the past year or so.

Knowing When to Bite the Bullet

Friday, October 17th, 2014

Sometimes, the market does just the opposite of what you hoped it would, and you are faced with the decision to hang on and hope it will reverse itself, or accept that you guessed wrong, and close out your position and move on to something else.

That will be our subject today.


Knowing When to Bite the Bullet

Kenny Rogers said it well – “You’ve got to know when to walk away and know when to run.”  We set up demonstration portfolio to trade diagonal spreads on an ETP called SVXY.  We were betting that the stock would go up.  In each of the last two years, SVXY had doubled in value.  Its inverse, VXX, had fallen from a split-adjusted $3000+ to under $30 over the past 5 years, making it just about the biggest dog on the entire stock exchange (selling it short would have made anyone a bundle over that time period).  We felt comfortable being long (i.e., the equivalent of owning stock) in something that would do just the opposite of VXX.

In our demonstration portfolio, we decided to trade puts rather than calls because there was a lot more time premium in the weekly puts that we planned to sell to someone else than there was in the calls.  Each Friday, we would buy back the expiring put and replace it by selling another put with a week of remaining life.  This strategy enabled us to be short put options that had extremely high decay.

The biggest challenge was to decide which strikes to sell new puts at.  We selected a strike that was about $1 in-the-money (i.e., about a dollar higher than the stock price), or if the put we were buying back was well into the money so that the trade could not be made at a credit, we would select the highest strike we could take that could yield us a credit on the spread.  This meant that when the stock tumbled, the best we could do would be to sell a calendar spread at a very small credit.

In a six-week period, the stock managed to fall by over 30%.  Not such good news when we were betting that it would go up.  The biggest problem with a drop of this magnitude was that our short put was so far in the money that we risked an execution.  This would mean that the stock would be put to us (i.e., we would be forced to buy it at the strike price).  With that risk hanging over our head, the time has come to recognize our loss.

Admitting that you were wrong, at least for a certain time period, and closing out your trade, is sometimes the best thing you could do.  Many people hang on to their losing investments and sell the winners (usually for a smaller profit than they could have made by hanging on).  In the long run, this strategy leaves you with a portfolio of losing stocks that you are hoping will go higher (and probably never will).  Better to sell your losers and move on to something more promising.

Today we placed the following trade which closed out our spread:

Buy to Close 1 SVXY Oct4-14 80.5 put (SVXY141024P80.5)
Sell to Close 1 SVXY Jan-15 90 put (SVXY150117P90) for a credit of $9.71  (selling a diagonal)

When the trade was executed at this price, we were left with $1,234 in the account after paying commissions.  Since we started with $1500, we were faced with a loss of $266, or a little less than 18%.  This was over a period in which the stock we were betting on lost over 30%.  This is another example of how options can protect you better than merely buying stock.

We expected to make 150% a year on this portfolio, many times greater than the 18% we lost in the couple of months we operated it.  If the stock had remained flat or moved higher as we expected, we could have expected to gain the 3% a week we were hoping for.

Today, in the special account I set up this portfolio with $1500 (and now is down to $1234), I am trying again, this time at lower strike prices which are more appropriate to the current level of the stock.

This was the trade I executed today when the stock was trading about $57:

Buy To Open 1 SVXY Mar-15 65 put (SVXY150320P65)
Sell To Open 1 SVXY Oct4-14 59 put (SVXY141025P59) for a debit of $12.07 (buying a diagonal)

I will continue trading this account and let you know from time to time how close I am achieving my goal of 3% a week, although I will not report every trade I make each week.  I will follow the guidelines for rolling over as outlined above, so you should be able to do it on your own if you wished.

Handling an Adverse Price Change

Friday, October 10th, 2014

Our SVXY demonstration hit a real snag this week, as the volatility index (VIX) soared to over 20 and SVXY got hammered, falling from the mid-$80’s level when we started the portfolio to about $65 while we were betting that it would move higher.

I hope you find this ongoing demonstration of a simple options strategy designed to earn 3% a week to be a simple way to learn a whole lot about trading options.


Handling an Adverse Price Change

There wasn’t much we could do today.  The short 80.5 SVXY put that we had sold was expiring about $15 in the money, a situation that makes it quite difficult to roll it over to next week as a calendar and still enjoy a credit on the trade.  Instead, we chose to go out two weeks and sell an Oct4-14 80.5.  This is the trade we executed:
Buy to Close 1 SVXY Oct2-14 80.5 put (SVXY141010P80.5)
Sell to Open 1 SVXY Oct4-14 80.5 put (SVXY141024P80.5) for a credit of $.20  (selling a calendar)

Hot tip of the week.  With SVXY trading below $66 and VIX over 20, buying any call on SVXY is probably an excellent speculative purchase (go out a couple of months to give the stock some time to recover, as it surely will).  As usual, only invest money in options that you can truly afford to lose.  I am buying Dec-14 66 calls, paying $8.50 ($850) per contract with an idea to sell shorter-term calls against them at a later time once the stock has recovered some.

How to Avoid an Option Assignment

Thursday, October 2nd, 2014

This message is coming out a day early because the underlying stock we have been trading options on has fallen quite a bit once again, and the put we sold to someone else is in danger of being exercised, so we will trade a day earlier than usual to avoid that possibility.

I hope you find this ongoing demonstration of a simple options strategy designed to earn 3% a week to be a simple way to learn a whole lot about trading options.


How to Avoid an Option Assignment

Owning options is a little more complicated than owning stock. When an expiration date of options you have sold to someone else approaches, you need to compare the stock price to the strike price of the option you sold.  If that option is in the money (i.e., if it is put, the stock is trading at a lower price than the strike price, and if it is a call, the stock is trading at a higher price than the strike price), in order to avoid an exercise, you will need to buy back that option.  Usually, you make that trade as part of a spread order when you are selling another option which has a longer life span.

If the new option you are selling is at the same strike price as the option you are buying back, it is called a calendar spread (also called a time spread), and if the strike prices are different, it is called a diagonal spread.

Usually, the owner of any expiring put or call is better off selling their option in the market rather than exercising the option.  The reason is that there is almost always some remaining premium over and above the intrinsic value of the option, and you can almost always do better selling the option rather than exercising your option.  Sometimes, however, on the day or so before an option expires, when the time premium becomes very small (especially for in-the-money options), the bid price may not be great enough for the owner to sell the option on the market and still get the intrinsic value that he could get through exercising.

To avoid that from happening to you when you are short the option, all you need to do is buy it back before it expires, and no harm will be done.  You won’t lose much money even if an exercise takes place, but sometimes commissions are a little greater when there is an exercise.  Not much to worry about, however.

SVXY fell to the $74 level this week after trading about $78 last week.  In our actual demonstration portfolio we had sold an Oct1-14 81 put (using our Jan-15 90 put as security).  When you are short an option (either a put or a call) and it becomes several dollars in the money at a time when expiration is approaching, there is a good chance that it might be exercised.  Although having a short option exercised is sort of a pain in the neck, it usually doesn’t have much of a financial impact on the bottom line.  But it is nice to avoid if possible.

We decided to roll over the 81 put that expires tomorrow to next week’s option series.  Our goal is to always collect a little cash when we roll over, and that meant this week we could only roll to the 80.5 strike and do the trade at a net credit.  Here is the trade we made today:

Buy To Close 1 SVXY Oct1-14 81 put (SVXY141003P81)
Sell To Open 1 SVXY Oct2-14 80.5 put (SVXY141010P80.5) for a credit of $.20  (selling a diagonal)

Our account value is now $1620 from our starting value of $1500 six weeks ago, and we have $248 in cash as well as the Jan-15 90 put which is trading about $20 ($2000).  We have not quite made 3% a week so far, but we have betting that SVXY will move higher as it does most of the time, but it has fallen from $86 when we started this portfolio to $74 where it is today.  One of the best things about option trading is that you can still make gains when your outlook on the underlying stock is not correct.  It is harder to make gains when you guess wrong on the underlying’s direction, but it is possible as our experiment so far has demonstrated.


Ongoing Spread SVXY Strategy – Week 2

Friday, August 22nd, 2014

Last week we started a $1500 demonstration portfolio using SVXY, and ETP that is destined to move higher over the long run because of the way it is constructed (selling VIX higher-priced futures each day and buying at the spot price of VIX, a condition called contango which exists in about 90% of days).Today we bought back an in-the-money expiring put that we had sold last week and rolled it over to next week.

I hope you find this ongoing demonstration to be a simple way to learn a whole lot about trading options.


Ongoing Spread SVXY Strategy – Week 2

Last week, we used the following trade to set up this portfolio:

Buy To Open 1 SVXY Jan-15 90 put (SVXY150117P90)
Sell To Open 1 SVXY Aug4-14 87 put (SVXY140822P87) for a debit limit of $12.20  (buying a diagonal)

This executed at this price (90 put bought for $15.02, 87 put sold for $2.82 at a time when SVXY was trading at $85.70.

Our goal is to generate some cash in our portfolio each week.  This should be possible as long as the stock remains below $90 and we have to move that strike price higher.  We will discuss what we need to do later when it becomes an issue. Right now, we are facing a market where the stock is trading lower than it was last week when we bought it.  Now it is about $85, and our goal is to sell a weekly put each week that is about $1 in the money, and do it at a credit.

This is the order we placed (and was executed today):

Buy to close 1 SVXY Aug4-14 87 put (SVXY140822P87)
Sell To Open 1 SVXY Aug5-14 86 put (SVXY140829P86) for a credit limit of $  (selling a diagonal)

When we entered this order, the natural price (buying at the ask price and selling at the bid price) was $.65 and the mid-point price was $.90.  We placed a limit order at $.85, a number which was $.05 below the mid-point price.  It was executed at that limit price.

We paid a commission of $2.50 for this trade, the special rate for Terry’s Tips customers at thinkorswim.  The balance in our account is now $1555 which shows a $55 gain (more than the $45 average weekly gain we are shooting for to make our goal of 3% a week).

Next Friday we will make another similar trade and I will keep you posted on what we do.

The stock has moved up a bit since we made this trade so you might be able to get a better price if you do this on your own.

This is what the risk profile graph looks like for our positions at next Friday’s expiration:

SVXY Risk Profile Graph August 2014

SVXY Risk Profile Graph August 2014

Ongoing Spread SVXY Strategy For You to Follow if You Wish

Monday, August 18th, 2014

A couple of weeks ago, I put $1500 into a separate brokerage account to trade put options on an Exchange Traded Product (ETP) called SVXY.  I placed positions that were betting that SVXY would not fall by more than $6 in a week (it had not fallen by that amount in all of 2014 until that date).  My timing was perfectly awful.  In the next 10 days, the stock fell from $87 to $72, an unprecedented drop of $15.

Bottom line, my account balance fell from $1500 to $1233, I lost $267 in two short weeks when just about the worst possible thing happened to my stock.  Now I want to put $267 back in and start over again with $1500, and make it possible for you to follow if you wish.

This will be an actual portfolio designed to demonstrate one way how you can trade options and hopefully outperform anything you could expect to do in the stock market.  Our goal in this portfolio is to make an average gain of 3% every week between now and when the Jan-15 options expire on January 15, 2015 (22 weeks from now).

That works out to 150% a year annualized.  I think we can do it.  We will start with one trade which we will make today.

I hope you find this ongoing demonstration to be a simple way to learn a whole lot about trading options.


Ongoing Spread SVXY Strategy For You to Follow if You Wish

Our underlying “stock” is an ETP called SVXY.  It is a complex volatility-related instrument that has some interesting characteristics:

1. It is highly likely to move steadily higher over time.  This is true because it is adjusted each day by buying futures on VIX and selling the spot (current) price of VIX.  Since over 90% of the time, the futures are higher than the spot price (a condition called contango), this adjustment almost always results in a gain.  SVXY gained about 100% in both 2012 and 2013 and is up about 30% this year.

2. SVXY is extremely volatile.  Last Friday, for example, it rose $2 in the morning, fell $6 mid-day, and then reversed direction once again and ended up absolutely flat (+$.02) for the day.  This volatility causes an extremely high implied volatility (IV) number for the options (and very high option prices). IV for SVXY is about 65 compared to the market (SPY) which is about 13.

3. While it is destined to move higher over the long run, SVXY will fall sharply when there is a market correction or crash which results in VIX (market volatility) to increase.  Two weeks ago, we started this demonstration portfolio when SVXY was trading at $87, and it fell to $72 before recovering to its current $83.

4. Put option prices are generally higher than call option prices.  For this reason, we deal entirely in puts.

5. There is a large spread between the bid and ask option prices.  This means that every order we place must be at a limit.  We will never place a market order.  We will choose a price which is $.05 worse for us than the mid-point between the bid and ask prices, and adjust this number (if necessary) if it doesn’t execute in a few minutes.

This is the strategy we will employ:

1. We will own a Jan-15 90 put.  It cost us $15.02 ($1502) to buy (plus $2.50 commission for the spread).  Theta is $4 for this option.  That means that if the stock is flat, the option will fall in value by $4 each day ($28 per week).

This is the trade we made today to get this demonstration portfolio established:

Buy To Open 1 SVXY Jan-15 90 put (SVXY150117P90)
Sell To Open 1 SVXY Aug4-14 87 put (SVXY140822P87) for a debit limit of $12.20  (buying a diagonal)

This executed at this price (90 put bought for $15.02, 87 put sold for $2.82 at a time when SVXY was trading at $85.70.
2. Each week, we will sell a short-term weekly put (using the Jan-15 90 put for collateral).  We will collect as much time premium as we can while selling a slightly in-the-money put.  That means selling a weekly put at the strike which is slightly higher than the stock price.  We hope to collect about $2 ($200) in time premium by selling this put. Theta will start out at about $20 for the first day and increase each day throughout the week.  If the stock stays flat, we would get to keep the entire $200 and make a net gain of $172 for the week because our long put would fall in value by $28.  This is the best-case scenario.  It only has to happen 6 times out of 22 weeks to recover our initial $1200 investment.

3. Each Friday we will need to make a decision, and often a trade. If the put we have sold is in the money (i.e., the stock is trading at a lower price than the strike price), we will have to buy it back to avoid it being exercised.  At the same time, we will sell a new put for the next weekly series.  We will choose the strike price which is closest to $1 in the money.  Our goal is to take some money off the table each and every week. If it is not possible to buy back an expiring weekly put and replace it with the next-week put at the $1 in-the-money strike at a credit we will select the highest-strike option we can sell as long as the spread is made at a credit.  We eventually have to cover the $1220 original spread cost, and collecting about $200 as we will some weeks would recover that amount quite quickly  – we have 22 weeks to collect a credit, so we only need an average of about $45 each week (after commissions).

4. On Friday, if the stock is higher than the strike price, we will not do anything, and let the short put expire worthless.  On the following Monday, we will sell the next-week put at the at-the-money strike price, hopefully collecting another $200.

5. We are starting off by selling a weekly put which has a lower strike price than the long Jan-15 put we own.  In the event that down the line (when the stock price rises as we expect it will), we may want to sell a weekly put at a higher strike price than the 90 put we own.  In that event, we will incur a maintenance requirement of $100 for each dollar of difference between the two numbers.  There is no interest charged on this amount, but we just can’t use it for buying other stocks. For now, we don’t have to worry about a maintenance requirement because our short put is at a lower strike than our long put.  If that changes down the line, we will discuss that in more detail.

This strategy should make a gain every week that the stock moves less than $3 on the downside or $4 on the upside.  Since we are selling a put at a strike which is slightly higher than the stock price, our upside break-even price range is greater. This is appropriate because based solely on contango, the stock should gain about $1.00 each week that VIX remains flat.

I think you will learn a lot by following this portfolio as it unfolds over time.  You might find it to be terribly confusing at first.  Over time, it will end up seeming simple.  Doing it yourself in an actual account will make it more interesting for you, and will insure that you pay close attention.  The learning experience should be valuable, and we just might make some money along the way as well.

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.


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.


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.

Making 36%

Making 36% — A Duffer's Guide to Breaking Par in the Market Every Year in Good Years and Bad

This book may not improve your golf game, but it might change your financial situation so that you will have more time for the greens and fairways (and sometimes the woods).

Learn why Dr. Allen believes that the 10K Strategy is less risky than owning stocks or mutual funds, and why it is especially appropriate for your IRA.

Order Now

Success Stories

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.

~ John Collins