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Posts Tagged ‘Calendar Spreads’

Trading Options Can be a Lifetime Learning Experience

Monday, March 23rd, 2015

Last week was a good one for the market.  SPY rose 2.2%, a wonderful week.  The actual options portfolios we carry out at Terry’s Tips had a stellar week as well.  Nine of our ten portfolios gained at least 5%, and 3 of them gained over 33% in a single week.

Nike (NKE) announced blow-out earnings and the stock rose 6.4%.  Our portfolio that trades NKE options gained 13.5%, double the increase in the stock price.  This was far less than we usually do compared to stock price changes, however.

We have proved over and over that if you can find a stock that will increase if value, you can usually make 3 or 4 or more times as much with an options strategy as you could by simply buying the stock.

Of course, buying options is not quite so simple as buying stock.  To do it right requires gaining some understanding that most people just don’t have the energy or willpower to learn.

Terry

Trading Options Can be a Lifetime Learning Experience

If the truth be known, investing in stocks is pretty much like playing checkers.  Any 12-year-old can do it.  You really don’t need much experience or understanding.  If you can read, you can buy stock (and probably do just about as well as anyone else because it’s basically a roulette wheel choice).  Most people reject that idea, of course.  Like the residents of Lake Wobegone, stock buyers believe that they are all above average – they can reliably pick the right ones just about every time.

Trading options is harder, and many people recognize that they probably aren’t above average in that arena.  Buying and selling options is more like playing chess.  It can be (and is, for anyone who is serious about it) a life-time learning experience.

You don’t see columns in the newspaper about interesting checker strategies, but you see a ton of pundits telling you why you should buy particular stocks.  People with little understanding or experience buy stocks every day, and most of their transactions involve buying from professionals with far more resources and brains. Most stock buyers never figure out that when they make their purchase, about 90% of the time, they are buying from professionals who are selling the stock to them rather than buying it at that price.

Option investing takes study and understanding and discipline that the purchase of stock does not require.  Every investor must decide for himself or herself if they are willing to make the time and study commitment necessary to be successful in option trading.  Most people are too lazy.

It is a whole lot easier to play a decent game of checkers than it is to play a decent game of chess.  But for some of us, options investing is a whole lot more challenging, and ultimately more rewarding.  For example, Costco (COST) has had a good year so far, rising from $141.75 to Friday’s close at $152.59, a gain of 7.6%.  The Terry’s Tips  option portfolio that trades COST options (calendar and diagonal spreads) gained 40.4% over this same period, over 5 times as much.  With actual results like this, why wouldn’t any reasonable adult with enough cash to buy stock want to learn how to multiply his or her earnings by learning a little about the wonderful world of options?

Playing checkers (and buying stock) is boring.  Playing chess (and trading options) is far more challenging.  And rewarding, if you do it right.

An Oil Play Designed to Make 25% in One Month

Tuesday, March 3rd, 2015

Bernie Madoff attracted billions of dollars because he said he had a system that would generate gains of 12% a year.  For many investors, 12% must seem like a pretty good return.  Options investors think differently.  They prefer to have at least some of their investment capital in something that could conceivably make a far greater return.Today I would like to discuss an investment I made this week in a demonstration (actual money on the line) portfolio for Terry’s Tips Insiders.  It is designed to make about 25% in the next four weeks.

Terry

An Oil Play Designed to Make 25% in One Month

One of our favorite underlyings these days is USO, an ETP (Exchange Traded Product) which closely tracks the price of oil.  If you have filled your car with gas lately, you know that the price of oil must have been trading lower over the recent past.  In fact, it has.  A barrel of oil has fallen from about $100 to $50, while USO has dropped from about $40 to about $18.

There are a couple of reasons to believe that the downward trend of USO might continue for a while longer.  First, the way this ETP is designed, it suffers from contango (futures prices for further-out months are higher than the spot price of oil).  At the current level of contango, if the price of oil remains the same, USO should lose about 21% of its value over the course of a year due to the influence of contango.

Second, some large investment banks (e.g., Citi) have come out and said that the price of oil is likely to fall in half once again before the current glut is eliminated and oil might start recovering in the third quarter.

With these two reasons suggesting that oil (and USO) might be headed lower, at least  for the next month or so, we looked back at every calendar monthly change in USO for the recent past, and we learned that in the last 25 months, on only two occasions did USO fall by more than 15% in a single month, and only once did it rise by more than 5.6%.

If this historical pattern continues for the next month, the portfolio we set up has an 88% chance of making a gain, and the average gain over most of the possible stock prices is over 25%.

Here are the calendar spreads we placed in a portfolio that could be set up for no more than $2900 at today’s prices with USO trading about $18.45:

Buy to Open 8 USO Jan-16 16 puts (USO160115P16)
Sell to Open 8 USO Mar4-15 16 puts (USO150327P16) for a debit of $1.26  (buying a calendar)

Buy to Open 8 USO Jan-16 17 puts (USO160115P17)
Sell to Open 8 USO Mar4-15 17 puts (USO150327P17) for a debit of $1.42  (buying a calendar)

Buy to Open 4 USO Jan-16 18 puts (USO160115P18)
Sell to Open 4 USO Mar4-15 18 puts (USO150327P18) for a debit of $1.58  (buying a calendar)

Here is the risk profile graph for these spreads for March 27th when the short puts expire:

USO Risk Profile Graph March 2015

USO Risk Profile Graph March 2015

The vertical red lines on the graph are set at -15% on the downside and +5% on the upside, and roughly indicate the break-even range for the positions.  Over the past 25 months, USO has fluctuated inside this range in 22 of the 25 months.  You can eyeball the potential gain and see that across a very large portion of the possible prices within this range, the indicated gain is close to $1000, or about 33% on your investment.

We like our chances with these positions.  It seems like a much higher chance of making double what Mr. Madoff was promising, and in only one month rather than a full year.  Option investors think differently than stock buyers.  I will report back on how well we do.

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

Thursday, January 22nd, 2015

 

This week I would like to show you the exact positions of one of the 9 portfolios we are currently carrying out for Insiders at Terry’s Tips.  It involves one of my favorite places to shop, Costco, and its stock, COST.  We expect to make just under 20% on this portfolio in the next four weeks, even if the stock does not go up a single penny.  Welcome to the wonderful world of stock options.Terry

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

The basic strategy that we carry out at Terry’s Tips is to buy longer-term options on stocks we like and sell shorter-term options against them.  Since the decay rates of the shorter-term options is much higher than the decay rates of the long-term options we own, we hope to make money every day that the stock remains flat or moves in the direction that we expect it will.  In options terms, we have positions that have a positive theta value.

Most of the time, we buy these option spreads on stocks we like, so by selecting strike prices that are higher than the current stock price, we create a portfolio that gains more than the theta value when the stock moves higher.  In options terms, we have a portfolio which is positive net delta.  It gains in value when the stock moves higher, just as owners of the stock enjoy.

Here is the risk profile graph for our actual Costco portfolio.  We have just under $5000 invested in these positions.  The curve shows how much we will make or lose at each of the possible stock prices when the February options expire on February 20, 2015, four weeks from tomorrow.
COST Risk Profile Graph 2015

COST Risk Profile Graph 2015

This graph is created by the free Analyse Tab software that is available at thinkorswim. You can see that if the stock remains flat at today’s price ($139.63 when I created this graph), the portfolio is slated to gain $960.38 when the February options expire.  That is almost 20% on our portfolio value.  If the stock moves higher (as we expect it will most of the time), the gain is just about the same, even if it moves as much as $10 higher in a single month.  (While we love this stock, it is probably unlikely to go that much higher).

On the downside, the stock can fall almost $2 and we will still make a small gain.  How can anybody disagree that these options positions are vastly better than just buying COST stock?  Most months, the stock will remain about flat or edge higher.  In each case, we should pick up almost 20% while stock-buyers gain little or nothing.

In this actual portfolio, we own the following call options:

1 COST Apr-15 145 call (COST150417C145)
4 COST Jul-15 135 calls (COST150717C135)
3 COST Jul-15 140 calls (COST150717C140)
3 COST Jul-15 150 calls (COST150717C150)

These are the calls that we have sold (are short):

6 COST Feb-15 140 calls (COST150220C140)
1 COST Feb-15 145 call (COST150220C145)
3 COST Feb-15 150 calls (COST150220C150)

When we have bought and sold a call at the same strike price, we own what is called a calendar spread (also called a time spread).  When the long and short call are at different strike prices, we own what is called a diagonal spread.  Most of the time, the short call is at a higher strike price than the long call (so we don’t incur a maintenance requirement).

We have one more long call than we have short calls.  We could make a greater gain at a flat stock price if we sold a February call against our extra long call, but we might end up not gaining nearly as much if the stock should move significantly higher in the next four weeks.

We are satisfied with making 20% in the next month in this portfolio.  Most people would be happy gaining that much for an entire year. If you like, COST, NKE, SBUX, GMCR, or SPY (to name a few we are currently trading), you could join us, and have all the trades made for you through Auto-Trade at thinkorswim by becoming a Terry’s Tips Insider.  Why not do it today?  It might be a great way to start out the New Year.

Try a Vertical Put Credit Spread on a Stock That You Like

Thursday, January 8th, 2015

This week I would like to share my thoughts about the market for 2015, and also one of my favorite option strategies when I find a stock I really like. Whenever I find a stock I particularly like for one reason or another, rather than buy the stock outright, I use options to dramatically increase the returns I enjoy if I am right (and the stock goes up, or at least stays flat).

Today I would like to share a trade that I made today in my personal account.  Maybe you would like to do something similar with a company you particularly like.

And Happy New Year – I hope that 2015 will by your best year ever for investments (even if the market falls a bit).

Terry

Try a Vertical Put Credit Spread on a Stock That You Like

First, a few thoughts about the market for 2015.  The Barron’s Roundtable (made up of 10 mostly large investment bank analysts) predicted an average 10% market gain for 2015.  None of the analysts predicted a market loss for the year.  Others have suggested that the year should be approached with more caution, however. The whopping gain in VIX in the last week of 2014 is a clear indication that investors have become more fearful of what’s ahead. The market has gained about 40% over the past two years.  The bull market has continued for 90 months, a near-record–breaking string.

The forward P/E for the market has expanded to 19, several points higher than the historical average, and 2 points above where it was a year ago.  The trailing market P/E is 22.7x compared to 14x for the 125-year average.  Maybe such high valuations are appropriate for a zero-interest environment, but that is about to change. For the first time since 2007, the Fed will not be propping up the market with their Quantitative Easing purchases. The Fed has essentially promised that they will raise interest rates in 2015.  The only question is when it will happen.

There is an old adage that says “don’t fight the Fed.”  Not only have they stopped pumping billions into the economy every month, they plan to raise interest rates this year.  Like it or not, stock market investments made in 2015 are tantamount to picking a fight with the Fed.

While the U.S. economy is strong (and apparently growing), a great number of U.S. companies depend on foreign sales for a significant share of their business, and the foreign prospects aren’t so great for a number of countries. This situation could cause domestic company earnings to disappoint, and stock prices could fall.  At the very best, 2015 seems like a good time to take a cautious approach to investing.

Even if the market is not great for 2015, surely some shares will move higher. Barron’s chose General Motors (GM) as one of its best 10 picks for 2015 and made a compelling argument for the company’s prospects.  The 3.27% dividend should insulate the company from a big down-draft if the market as a whole has a correction in 2015.

I was convinced by their analysis that GM was highly likely to move higher in 2015.  Today, with GM trading at $35.70, I placed the following trade:

Buy To Open 10 GM Jun-15 32 puts (GM150619P32)

Sell To Open 10 GM Jun-15 37 puts (GM150619P37) for a credit of $2.20  (selling a vertical)

I like to go out about six months with spreads like this to give the stock a little time to move higher.  The above trade put $2200 in my account.  There will be a $5000 maintenance requirement which is reduced to $2800 when you subtract out the amount of cash I received.  This means that my maximum loss would be $2800, and this would come about if the stock closes below $32 on June 19, 2015.

If the stock closes at any price above $37, both the long and short puts will expire worthless and I will not have to make any more trades.  If this happens, I will make a profit of $2200 (less $25 commission, or $2175) on an investment of $2800.  This works out to a gain of 77%.

In order for me to make 77% on this investment, GM only needs to go up by $1.50 (4.2%).  If it stays exactly the same on June 19th ($35.70), I will have to buy back the 37 put for a cost of $1.30 ($1300 for 10 contracts).  That would leave me with a gain of $862.50, or 30.8%.

If I had purchased shares of GM with the $2800 I had at risk, I could have bought 78 shares.  I I might have collected a dividend of $91 over the 6 months.  With my options investment, I would have gained nearly 10 times that much if the stock did not move up at all.

Bottom line, even though I am taking a greater risk with options, the upside potential is so much greater than merely buying the stock that it seems to be a better move when you find a company that looks like it will be a winner.

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.

Terry

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.

 

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: https://www.kickstarter.com/projects/412276080/da-vinci-bodyboard

Terry

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.

Terry

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.

Terry

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.

Terry

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 SVXY Spread Strategy – Week 6

Friday, September 19th, 2014

Today we will continue our discussion of both SVXY and the actual portfolio we are carrying out with only two positions.  Every Friday, we will make a trade in this portfolio and tell you about it here.

Our goal is to earn an average gain of 3% a week in this portfolio after commissions.  So far, we are well ahead of this goal.

I hope you find this ongoing demonstration to be a simple way to learn a whole lot about trading options.  We will also discuss another Greek measure today – gamma.

Terry

Ongoing SVXY Spread Strategy – Week 6

Near the open today, SVXY was trading about $89.00.  We want to sell a put that is about $1 in the money (i.e., at a strike one dollar higher than the current stock price).  Our maximum gain each week will come if we are right, and the stock ends the week very close to the strike of our short put.

Here is the trade we placed today:

Buy to Close 1 SVXY Sep-14 86.5 put (SVXY140920P86.5)
Sell to Open 1 SVXY) Sep4-14 90 put (SVXY140926P90 for a credit limit of $2.70  (selling a diagonal)

Each week, we try to sell a weekly put which is at a strike about $1 in the money (i.e., the strike price is about a dollar higher than the stock price) as long as selling a diagonal (or calendar) spread can be done for a credit.

When we entered this order, the natural price (buying at the ask price and selling at the bid price) was $2.50 and the mid-point price was $2.75.  We placed a limit order at $2.70, a number which was $.05 below the mid-point price.  (It executed at $2.70).

If it hadn’t executed after half an hour, we would have reduced the credit amount by $.10 (and continue doing this each half hour until we got an execution).

Each week, we will make a trade that puts cash in our account (in other words, each trade will be for a credit).  Our goal is to accumulate enough cash in the portfolio between now and January 17, 2015 when our long put expires so that we have much more than the $1500 we started with.  Our Jan-15 may still have some remaining value as well.

This is the 6th week of carrying out our little options portfolio using SVXY as the underlying.  SVXY is constructed to move up or down in the opposite directions as changes in volatility of stock option prices (using VIX, the measure of option volatility for the S&P 500 tracking stock, SPY). SVXY is a derivative of a derivative of a derivative, so it is really, really complex.  Right now, option prices are trading at historic lows, and lots of people believe that they will move higher.  If they are right, SVXY will fall in value, but if option prices (i.e., volatility) don’t rise, SVXY will increase in value.  In our demonstration portfolio, we are assuming that option prices will not rise dramatically and that SVXY will move higher, on average, about a dollar a week.

In this simple portfolio, we own an SVXY Jan-15 90 put.   We will use this as collateral for selling a put each week in the weekly series that expires a week later than the current short put that we sold a week ago.  Today’s value of our long put is about $14 ($1200) and decay of this put (theta) is $4 (this means that if SVXY remains unchanged, the put will fall in value by $4 each day).  The decay of our short put is $13 (and will increase every day until next Friday).  This means that all other things being equal, we should gain $9 in portfolio value every day at the beginning of the week and about double that amount later in the week.

Last week we spoke a little about delta.  As you may recall, delta is the equivalent number of shares your option represents.  If an option has a delta of 70, it should gain $70 in value if the stock goes up by one dollar.  Today we will briefly introduce another options “Greek” called gamma.  Gamma is simply the amount that delta will change if the underlying stock goes up by one dollar.

If your option has a delta of 70 and a gamma of 5, if the underlying stock goes up by a dollar, your option would then have a delta of 75.  Gamma becomes more important for out-of-the-money options because delta tends to increase or decrease at faster rates when the stock moves in the direction of an out-of-the-money option.

To repeat what we covered last week, since we are dealing in puts rather than calls, the delta calculation is a little complicated.  I hope you won’t give up.  Delta for our Jan-15 90 put is minus 50.  This means that if the stock goes up a dollar, our long put option will lose about $.50 ($50) in value.  The weekly option that we have sold to someone else has a delta value of about 75 (since we sold it, it is a positive number).  If the stock goes up by a dollar, this option will go down by about $.75 ($75) which will be a gain for us because we sold that to someone else.

Our net delta value in the portfolio is +25.  If the stock goes up by a dollar, the portfolio should go up about $25 in value because of delta.  (Unfortunately, this gets more confusing when you understand that delta values will be quite different once the stock has moved in either direction, but we will discuss that issue later).

If the stock behaves as we hope, and it goes up by about a dollar in a week, we will gain about $25 from the positive delta value, and about $100 from net theta (the difference between the slower-decaying option we own and the faster-decaying weekly option that we have sold to someone else.

Our goal is to generate some cash in our portfolio each week.  This should be possible as long as the stock remains below $90. We will discuss what we need to do later if the stock moves higher than $90.

To update our progress to date, the balance in our account is now $1870 which shows a $370 gain over the 5 weeks we have held the positions.  This is well more than the $45 average weekly gain we are shooting for to make our goal of 3% a week.  We now have $1009 in cash in the portfolio.

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