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Posts Tagged ‘Calls’

Ongoing SVXY Spread Strategy – Week 4

Friday, September 5th, 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.

 

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

 

Terry

 

Ongoing SVXY Spread Strategy – Week 4

 

Near the open today, SVXY was trading about $86.  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 Sep1-14 86.5 put (SVXY140905P86.5)
Sell to Open 1 SVXY Sep2-14 86.5 put (SVXY140912P86.5) for a credit limit of $1.15  (selling a calendar)

 

When we entered this order, the natural price (buying at the ask price and selling at the bid price) was $.85 and the mid-point price was $1.25.  We placed a limit order at $1.15, a number which was $.05 below the mid-point price.  (It executed at $1.16).

 

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 4th 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 ($1400) 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.

 

Let’s bring a couple of other option terms into this conversation.  First, we are bullish on the stock (we are betting that contango will continue to exist and provide more tailwinds for the stock than increasing volatility will hurt the stock).  When you are bullish on a stock, you want to own a portfolio that is delta-positive.  Delta is the measure of how much the option will increase in value if the underlying stock moves $1 higher.

 

Most options traders like to maintain a delta-neutral portfolio condition.  This means they don’t care if the stock goes up or down, at least for small changes.  We want to be a little bullish in our portfolio, so we are aiming for a net-delta-positive condition.

 

Since we are dealing in puts rather than calls, this is extremely 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.

 

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 $1730 which shows a $230 gain over the three weeks we have held the positions.  This is much more than the $45 average weekly gain we are shooting for to make our goal of 3% a week.  We now have $624 in cash in the portfolio.

 

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

 

Ongoing Spread SVXY Strategy – Week 3

Friday, August 29th, 2014

Two weeks ago we started a $1500 demonstration portfolio using SVXY, an 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 about 90% of time).

Today, contango is about 6% (that is how much higher the futures are that this ETP is selling each day when it buys at the spot price of VIX).  In rough terms, this means that SVXY should go up by 6% each month that VIX remains unchanged.  This works out to be about $1.25 per week that SVXY should go up, all other things being equal (which, unfortunately, they usually aren’t).

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

Terry

Ongoing Spread SVXY Strategy – Week 3

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.  The decay of our long 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.

Each Friday we will have to make a decision as to which strike we should sell the following week’s put at.  Our goal is two-fold – sell a put at a strike which is closest to being $1 in the money (i.e., the strike price is about $1 higher than the current price of the stock), and second, it must be sold at a credit so that we add cash to our portfolio each week.

This week, we were a little lucky because the stock is trading today at very near the strike of the 87 put we sold a week ago.  We will buy this put back today and sell a put for next week at the 88 strike and collect cash in doing so.  Here is the trade that we will place today.  If it doesn’t execute after half an hour, we will reduce the credit amount by $.10 (and continue doing this each half hour until we get an execution).

Here is the trade we placed today:

Buy to Close 1 SVXY Aug5-14 86 put (SVXY140829P86)
Sell to Open 1 SVXY Sep1-14 86.5 put (SVXY140905P86.5) for a credit limit of $1.50  (selling a diagonal)

When we entered this order, the natural price (buying at the ask price and selling at the bid price) was $1.25 and the mid-point price was $1.55.  We placed a limit order at $1.50, a number which was $.05 below the mid-point price.  (It executed at $1.50).

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.

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 $1670 which shows a $170 gain over the two weeks we have held the positions.  This is much 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.

3% a Week Possible With This Strategy?

Tuesday, July 29th, 2014

Today I would like to share a strategy with you that seems to make sense to me.  I have not back-tested it, and I am not exactly positive that it will work.  But I think it will.  And I will only need to commit $1500 to test it out (actually, a little less than that as you will see).  I invite you to follow along if you wish.  For the next few weeks, I will send out any trades I make so you can mirror them if you wish.

My gut feeling tells me that this strategy could make 3% each week.  I have set up a separate brokerage account with $1500 to test it out.

Terry

3% a Week Possible With This Strategy?

This strategy is based on my favorite underlying “stock” (actually an Exchange Traded Product, ETP) called SVXY.  It is the inverse of VXX, a volatility-related ETP which many people buy for protection just in case the market crashes (when that happens, volatility soars, and so does VXX).  The only problem is that volatility has been pretty much tame for quite a while, and VXX has consistently moved lower.

In fact, VXX is just about the worst investment you could have made over the last few years.  Since it was started 7 years ago, it was at a pre-reverse split price of over $3000 and now it is about $28.  It is hard to find anything out there that has been that bad.

SVXY is the inverse of VXX, and that sounds to me like a better investment for the long run.  SVXY has only been around for 2 ½ years, and in each of the first two calendar years, it has about doubled in value.  So far this year it is up about 40%.

Of course, the big risk with owning SVXY is that a crash or correction will come along and the stock will fall by a large amount.  However, over the long run, because of contango (discussed in this newsletter on many occasions), it inevitably will rise.

One possible good investment might be to just buy SVXY. We do essentially this in one of the 10 portfolios we carry out at Terry’s Tips, in fact – it has gained over 40% since we set it up in November 2013 (sometimes we sell shares when we have fears of impending market volatility such as the fiscal cliff scare, and buy shares back when it looks like the possible crisis has blown over).

SVXY is an extremely volatile ETP and option prices are extremely high.  For that reasons, we trade it in several Terry’s Tips portfolios.  The proposed new strategy I am telling you about here will not be traded at Terry’s Tips unless it ends up looking highly likely that we could make the 3% a week that I think is possible.

This strategy is based on my observation that weekly put prices on SVXY are more expensive than weekly call prices, and they also seem to be higher than they should be given what the stock does most of the time.  You can sell someone a weekly put that is $5 out of the money (i.e., $5 less than the current stock price) and collect more than a dollar ($100 per contract) for it.  In other words, if the stock does anything other than fall over $6 in a week, you get to keep the entire option price you collected.  SVXY has only fallen $6 in a single week once in 2014 (although in 2013, it fell considerably more on two occasions).

It is possible to sell puts naked (not in an IRA, however), but that would require a huge maintenance requirement that would reduce your return on investment.  Besides, the risk would just be too great for most of us.  Instead, I will buy a longer-term put at a strike about $6 below the strike of the call I plan to sell.  That will create a maintenance requirement of $600 per trade (less the value of the put that is sold).

To start off, today with SVXY trading about $87, I placed the following spread order:

Buy to Open 1 SVXY Jan-15 75 put (SVXY150117P75)
Sell to Open 1 SVXY Aug-2 81 put (SVXY140808P81) for a debit of $7.20 (buying a diagonal)

The spread executed.  I paid $8.70 for the Jan-15 75 put and received $1.50 for the Aug2-14 81 put that expires in 10 days.  The spread cost me $720 plus a $2.50 commission:

SVXY Diagonal Trade July 2014SVXY Diagonal Trade July 2014

Thinkorswim offers a special commission rate for Terry’s Tips subscribers ($1.25 for a single option trade).  Many people have become Terry’s Tips insiders to qualify for this rate for all their trades.  If you are paying more than this, you might consider it yourself.

My total investment is $720 plus the $600 maintenance requirement, or $1320.  That is the maximum I can lose if SVXY falls below $75 and stays there through next January.  I can live with that unlikely possibility.

A week from Friday when the Aug2-14 81 put expires (most likely worthless), I will either  buy it back for a small amount and sell a new put for the Aug-14 series that expires a week later (at a strike which is about $6 less than the then-current stock price) or do nothing and wait until Monday to sell a new put.

If the Aug2-14 81 put ends up in the money because SVXY has fallen below $81, I will buy it back and sell an Aug-14 81 put as a calendar spread, collecting a credit of some amount.

In any event, as soon as I make a trade, I will tell you about it.  I think this strategy might be a little fun to play, and if it does manage to make 3% a week, I could live with 150% a year on my money.

A Possible Great Option Trading Idea

Monday, July 14th, 2014

Just before the close on Friday, we made a strongly bullish trade on our favorite underlying stock in a portfolio at Terry’s Tips.  In my personal account, I bought weekly calls on this same underlying.  As I write this in the pre-market on Monday, it looks like that bet could triple in value this week.

I would like to share with you the thinking behind these trades so next time this opportunity comes up (and it surely will in the near future), you might decide to take advantage of it yourself.

Terry

A Possible Great Option Trading Idea: As we have discussed recently, option prices are almost ridiculously low.  The most popular measure of option prices is VIX, the so-called “fear index” which measures option prices on SPY (essentially what most people consider “the” market) is hanging out around 12.  The historical mean is over 20, so this is an unprecedented low value.

When we sell calendar or diagonal spreads at Terry’s Tips, we are essentially selling options to take advantage of the short-term faster-decaying options.  Rather than using stock as collateral for selling short-term options we use longer-term options because they tie up less cash.

With option prices currently so low, maybe it is a time to reverse this strategy and buy options rather than selling them.  One way of doing this would be to buy a straddle (both a put and a call at the same strike price, usually at the market, hoping that the stock will make a decent move in either direction.  In options lingo, you are hoping that actual volatility (IV) is greater than historical volatility.

The biggest problem with buying straddles is that you will lose on one of your purchases while you gain on the other.  It takes a fairly big move in the underlying to cover the loss on your losing position before you can make a profit on the straddle.

A potentially better trade might be to guess which way the market will move in the short term, and then buy just a put or call that will make you money if you are right. The big challenge would be to find a price pattern that could help you choose which direction to bet on?

One historically consistent pattern for most market changes (the law of cycles) is that the direction of the change from one period to the next is about twice as likely to be in the same direction as it was in the previous same time period.  In other words, if the stock went up last week (or month), it is more likely to go up again next week (or month).

We tested this pattern on SPY for several years, and sadly, found that it did not hold up.  The chances were almost 50-50 that it would move in the opposite direction in the second period.

Maybe the pattern would work for our most popular underling, an ETP called SVXY.  You might recall that we love this “stock” because it is extremely volatile and option prices are wonderfully high (great for selling).  In the first 22 weeks of 2014, SVXY fluctuated by at least $3 in one direction or the other in 19 of those weeks.  Maybe we could use the pattern and buy weekly either puts or calls, depending on which way the market had moved in the previous week.

Once again, the historical results did not support the law of cycles pattern.  The stock was almost just as likely to move in the opposite direction as it had in the previous week.  Another good idea dashed by reality.

In making this study, we discovered something interesting, however.  In the first half of 2014, SVXY fell more than $3 in a single week on 5 different occasions.  In 4 of the subsequent weeks, it made a significant move ($3 or more) to the upside.  Buying a slightly out-of-the-money weekly call for about a dollar and a half ($150 per contract) could result in a 100% gain (or more) in the next week in 4 out of 5 weeks.

If this pattern could be counted on to continue, it would be a fantastic trading opportunity.  Yes, you might lose your entire investment in the losing weeks, but if you doubled it in the winning weeks, and there were many more of them than losing weeks, you would do extremely well.

For  those reasons, I bought calls on SVXY on Friday.  The Jul-14 90.5 call that expires this Friday (July 18th) could have been bought for $1.30.  The stock closed at $88.86.  I plan to place an order to sell these calls, half at $2.60, and half at $3.90.  The pre-market prices indicate that one of these orders might exercise sometime today and I will have all my money back and still own half my calls.  It might be a fun week for me.  We’ll see.

On another subject, have you got your free report entitled 12 Important Things Everyone with a 401(K) or IRA Should Know (and Probably Doesn’t).  This report includes some of my recent learnings about popular retirement plans and how you can do better.  Order it here.  You just might learn something (and save thousands of dollars as well).

Vertical Put Credit Spreads Part 2

Monday, July 7th, 2014

Last week I reviewed the performance of the Terry’s Tips options portfolio for the first half of the year.  I should have waited a week because this week was a great one – our composite average gained another 6%, making the year-to-date record 22%, or about 3 times as great as the market (SPY) gain of about 7%.

Last week I also discussed a GOOG vertical put credit spread which is designed to gain 100% in the year if GOOG finished up 2014 at any price higher than where it started, something that it has done in 9 of its 10 years in business.  I want to congratulate those subscribers who read my numbers closely enough to recognize that I had made a mistake.  I reported that we had sold a (pre-split) 1120 – 1100 vertical put credit spread and collected $5.03 which was slightly more than the $500 per spread that I would have at risk. Actually, if the difference between the short and long sides was $20, and the maximum loss would be almost $15 (and the potential return on investment would be 33% rather than 100%).  We actually sold the spread for $10.06, not $5.03, and I mistakenly reported the post-split price.  We are now short 560 puts and long 550 puts, so the difference between the two strikes is $10 and we collected $5.03, or just about half that amount.  Bottom line, if GOOG finishes the year above $560, we will make 100% on our investment.  It closed at $585 Friday, so it can fall by $25 from here and we will still double our money.

Today we will discuss two other spreads we placed at the beginning of 2014 in one of the 10 portfolios we conduct for all to see at Terry’s Tips.

Terry

Vertical Put Credit Spreads Part 2:

We have a portfolio we call Better Odds Than Vegas.  In January, we picked three companies which we felt confident would be higher at the end of the year than they were at the beginning of the year.  If we were right, we would make 100% on our money.  We believed our odds were better than plunking the money down on red or black at the roulette table.

Late in 2013, the Wall Street Journal interviewed 13 prominent analysts and asked them what they expected the market would do in 2014.  The average projection was that it would gain slightly more than 5%.  The lowest guess was that it would fall by 2%.  We decided to make a trade that would make a nice gain if any one of the 13 analysts were correct.  In other words, if SPY did anything better than falling by 2%, our spread would make money.

In January, when SPY was trading about $184, we sold a vertical credit put spread for December, buying 177 puts and selling 182 puts.  We collected $2.00 at that time.  If the stock manages to close at any price higher than $182 on the third Friday in December, we will get to keep our entire $200 (per spread – we sold 8 spreads, collecting $1600).  The maintenance requirement would be $500 per spread less the $200 we collected, or $300 per spread ($2400, our maximum loss which would come if SPY closed below $177 in December).  Our potential profit would be about 66% on the investment, and this would come if the market was absolutely flat (or even fell a little bit) over the course of the year.  The stock closed Friday at $198.20, so it could fall by $16.20 between now and December and we would still make 66%.

The third company we bet on in this portfolio in January was Green Mountain Coffee Roasters (GMCR), now called Keurig Coffee Roasters.  This was a company with high option premiums that we have followed closely over the years (being in my home state of Vermont).  We have made some extraordinary gains with options on several occasions with GMCR.  Two directors (who were not billionaires) had bought a million dollars each of company stock, and we believed that something big might be coming their way.

With the stock trading about $75, we made an aggressive bet, both in our selection of strike prices and expiration month. Rather than giving the stock a whole year to move higher, we picked June, and gave it only 6 months to do something good.  We sold Jun-14 80 puts and bought Jun-14 70 puts, and collected $5.40.  If the stock stayed at $75, we would make only a small profit on the third Friday in June, but if it rose above $80 by that time, we would make $5.40 on an investment of $4.60, or 117%.

The good news that we anticipated came true – Coke came along and bought 10% of the company for $1 billion and signed a 10-year licensing agreement with GMCR.  The stock shot up to $120 overnight (giving Coke a $500 million windfall gain, by the way).  At that point, we picked up a little extra from the original spread.  We sold a vertical call credit spread for the June expiration month, buying the 160 calls and selling 150 calls, collecting an extra $1.45 per spread.  This did not increase our maintenance requirement because we had, in effect, legged into a short iron condor spread. It would be impossible for us to lose money on both our spreads, so the broker only charged the maintenance requirement on one of them.

Selling the call spread meant that our total gain for the six months would amount to almost 150% if GMCR ended up at any price between $80 and $150.  It ended up at about $122 and we enjoyed this entire gain.

We have since sold another GMCR vertical credit put spread for Jan-15, buying 90 puts and selling 100 puts for a credit of $3.45.  Our maximum loss is $6.55, and this would come if the stock closed below $90 on the third Friday in January.  The potential maximum gain would amount to 52% for the six months.  This amount was far less than the first spread because we selected strikes which were well below the then-current price of the stock (GMCR is now $125, well above our $100 target).  This makes our potential gain for this stock for the year a very nice 200%.

We advocate making these kinds of long-term options bet when you feel confident that a company will somehow be the same or higher than it is at the beginning. If you are right, extraordinary gains are possible. In our case, our portfolio has gained 41% for the year so far, and the three stocks can all fall by a fair amount and we will still make 100% on our starting investment when these options expire (hopefully worthless so we can keep all the cash we collected at the outset) on January 17, 2015.

An Interesting Trade to Make on Monday

Monday, June 16th, 2014

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

An Interesting Trade to Make on Monday

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

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

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

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

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

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

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

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

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

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

That’s enough about SVXY for today, but I would like to offer you a free report entitled 12 Important Things Everyone with a 401(K) or IRA Should Know (and Probably Doesn’t).  This report includes some of my recent learnings about popular retirement plans and how you can do better.  Order it here.  You just might learn something (and save thousands of dollars as well).

Check Out the Volatility in SVXY

Monday, June 9th, 2014

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

Check Out the Volatility in SVXY

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

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

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

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

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

SPXY Changes Newsletter June 2014

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

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

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

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

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

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

That’s enough about SVXY for today, but I would like to offer you a free report entitled 12 Important Things Everyone with a 401(K) or IRA Should Know (and Probably Doesn’t). This report includes some of my recent learnings about popular retirement plans and how you can do better.  Order it here.  You just might learn something (and save thousands of dollars as well).

Contango, Backwardation, and SVXY

Monday, May 19th, 2014

This week I would like to introduce you to a thing called contango.  This is relevant today because contango just got higher than I have seen it in many years – over 10% while most of the time, it hangs out in the 3% – 4% range.  This measure becomes important when you are trading in my favorite ETP (Exchange Traded Product), SVXY.  If your eyes haven’t glazed over yet, read on.
Terry

Contango, Backwardation, and SVXY

There seems to be a widespread need for a definition of contango.   I figure that about 99% of investors have no idea of what contango or backwardation are.  That’s a shame, because they are important concepts which can be precisely measured and they strongly influence whether certain investment instruments will move higher (or lower).  Understanding contango and backwardation can seriously improve your chances of making profitable investments.

Contango sounds like it might be some sort of exotic dance that you do against (con) someone, and maybe the definition of backwardation is what your partner does, just the opposite (indeed, it is, but we’re getting a little ahead of ourselves because we haven’t defined contango is yet).

If you have an idea (in advance) which way a stock or other investment instrument is headed, you have a real edge in deciding what to do.  Contango can give you that edge.

So here’s the definition of contango – it is simply that the prices of futures are upward sloping over time, (second month more expensive than front month, third month more expensive than second, etc.), Usually, the further out in the future you look, the less certain you are about what will happen, and the more uncertainty there is, the higher the futures prices are.  For this reason, contango is the case about 75 – 90% of the time.

Sometimes, when a market crash has occurred or Greece seems to be on the brink of imploding, the short-term outlook is more uncertain than the longer-term outlook (people expect that things will settle down eventually).  When this happens, backwardation is the case – a downward-sloping curve over time.

So what’s the big deal about the shape of the price curve?  In itself, it doesn’t mean much, but when it gets involved in the construction of some investment instruments, it does become a big deal.

A Little About VXX (and its Inverse, SVXY)

One of the most frequent times that contango appears in the financial press is when VXX is discussed. VXX is an ETP which trades very much like any stock.  You can buy (or sell) shares in it, just like you can IBM.  You can also buy or sell options using VXX as the underlying. VXX was created by Barclay’s on January 29, 2009 and it will be closed out with a cash settlement on January 30, 2019 (so we have a few years remaining to play with it).

VXX is an equity that people purchase as protection against a market crash.  It is based on the short-term futures of VIX, the so-called “fear index” which is a measure of the implied volatility of options on SPY, the tracking stock for the S&P 500.  When the market crashes, VIX usually soars, the futures for VIX move higher as well, pushing up the price of VXX.

In August of 2011 when the market (SPY) fell by 10%, VXX rose from $21 to $42, a 100% gain.  Backwardation set in and VXX remained above $40 for several months.  VXX had performed exactly as it was intended to.  Pundits have argued that a $10,000 investment in VXX protects a $100,000 portfolio of stocks against loss in case of a market crash.  No wonder it is so popular.  Investors buy about $3 billion worth of VXX every month as crash protection against their other investments in stocks or mutual funds.

There is only one small bad thing about VXX.  Over the long term, it is just about the worst stock you could ever buy. Over the last three years, they have had to have 3 reverse 1 – 4 stock splits just to keep the price of VXX high enough to bother with trading.  Every time it gets down to about $12, they engineer a reverse split and the stock is suddenly trading at $48.  Over time, it goes back to $12 and they do it again (at least that is how it has worked ever since it was created).

VXX is adjusted every day by buying VIX futures and selling VIX at its spot price.  (This is not exactly what happens, but conceptually it is accurate.)  As long as contango is in effect, they are essentially buying high (because future prices are higher than the spot price) and selling low (the current spot price).  The actual contango number represents an approximation of how much VXX will fall in one month if a market correction or crash doesn’t take place.

So it’s a sort of big deal when contango gets over 10% as it is today.  VXX is bound to tumble, all other things being equal.  On the other hand, SVXY is likely to go up by that much in a month since it is the inverse of VXX.  SVXY has had a nice run lately, moving up an average of 4.5% in each of the last three weeks, in fact.  You can see why it is my favorite ETP (I trade puts and calls on it in large quantities every week, usually betting that it will move higher).

That’s enough about contango for today, but if you are one of the few people who have read down this far, I would like to offer you a free report entitled 12 Important Things Everyone with a 401(K) or IRA Should Know (and Probably Doesn’t).  I want to share some of my recent learnings about popular retirement plans but I don’t want to be overwhelmed by too much traffic while I get a new website set up.  Order it here.  You just might learn something (and save thousands of dollars as well).

 

A Look at the Downsides of Option Investing

Monday, May 12th, 2014

Most of the time we talk about how wonderful it is to be trading options.  In the interests of fair play, today I will point out the downsides of options as an investment alternative.

Terry

A Look at the Downsides of Option Investing

1. Taxes.  Except in very rare circumstances, all gains are taxed as short-term capital gains.  This is essentially the same as ordinary income.  The rates are as high as your individual personal income tax rates. Because of this tax situation, we encourage subscribers to carry out option strategies in an IRA or other tax-deferred account, but this is not possible for everyone.  (Maybe you have some capital loss carry-forwards that you can use to offset the short-term capital gains made in your option trading).

2. Commissions.  Compared to stock investing, commission rates for options, particularly for the Weekly options that we trade in many of our portfolios, are horrendously high.  It is not uncommon for commissions for a year to exceed 30% of the amount you have invested.  Because of this huge cost, all of our published results include all commissions.  Be wary of any newsletter that does not include commissions in their results – they are misleading you big time.

Speaking of commissions, if you become a Terry’s Tips subscriber, you may be eligible to pay only $1.25 for a single option trade at thinkorswim.  This low rate applies to all your option trading at thinkorswim, not merely those trades made mirroring our portfolios (or Auto-Trading).

3. Wide Fluctuations in Portfolio Value.   Options are leveraged instruments.  Portfolio values typically experience wide swings in value in both directions.

Many people do not have the stomach for such volatility, just as some people are more concerned with the commissions they pay than they are with the bottom line results (both groups of people probably should not be trading options).

4. Uncertainty of Gains. In carrying out our option strategies, we depend on risk profile graphs which show the expected gains or losses at the next options expiration at the various possible prices for the underlying.  We publish these graphs for each portfolio every week for subscribers and consult them hourly during the week.

Oftentimes, when the options expire, the expected gains do not materialize.  The reason is usually because option prices (implied volatilities) fall.   (The risk profile graph software assumes that implied volatilities will remain unchanged.).   Of course, there are many weeks when VIX rises and we do better than the risk profile graph had projected.   But the bottom line is that there are times when the stock does exactly as you had hoped (usually, we like it best when it doesn’t do much of anything) and you still don’t make the gains you originally expected.

With all these negatives, is option investing worth the bother?  We think it is.  Where else is the chance of 50% or 100% annual gains a realistic possibility?  We believe that at least a small portion of many people’s investment portfolio should be in something that at least has the possibility of making extraordinary returns.

With CD’s and bonds yielding ridiculously low returns (and the stock market not really showing any gains for quite a while – adjusted for inflation, the market is 10% lower than it was in March,  2000,), the options alternative has become more attractive for many investors, in spite of all the problems we have outlined above.

Volatility’s Impact on Option Prices

Monday, April 28th, 2014

Today I would like to talk a little about an important measure in the options world – volatility, and how it affects how much you pay for an option (either put or call).

Terry

Volatility’s Impact on Option Prices

Volatility is the sole variable that can only be measured after the option prices are known.  All the other variables have precise mathematical measurements, but volatility has an essentially emotional component that defies easy understanding.  If option trading were a poker game, volatility would be the wild card.

Volatility is the most exciting measure of stock options.  Quite simply, option volatility means how much you expect the stock to vary in price. The term “volatility” is a little confusing because it may refer to historical volatility (how much the company stock actually fluctuated in the past) or implied volatility (how much the market expects the stock will fluctuate in the future).

When an options trader says “IBM’s at 20” he is referring to the implied volatility of the front-month at-the-money puts and calls.  Some people use the term “projected volatility” rather than “implied volatility.”  They mean the same thing.

A staid old stock like Procter & Gamble would not be expected to vary in price much over the course of a year, and its options would carry a low volatility number.  For P & G, this number currently is 12%.  That is how much the market expects the stock might vary in price, either up or down, over the course of a year.

Here are some volatility numbers for other popular companies:

IBM  – 16%
Apple Computer – 23%
GE – 14%
Johnson and Johnson – 14%
Goldman Sachs – 21%
Amazon – 47%
eBay – 51%
SVXY – 41% (our current favorite underlying)

You can see that the degree of stability of the company is reflected in its volatility number.  IBM has been around forever and is a large company that is not expected to fluctuate in price very much, while Apple Computer has exciting new products that might be great successes (or flops) which cause might wide swings in the stock price as news reports or rumors are circulated.

Volatility numbers are typically much lower for Exchange Traded Funds (ETFs) than for individual stocks.  Since ETFs are made up of many companies, good (or bad) news about a single company will usually not significantly affect the entire batch of companies in the index.  An ETF such as OIH which is influenced by changes in the price of oil would logically carry a higher volatility number.

Here are some volatility numbers for the options of some popular ETFs:

Dow Jones Industrial (Tracking Stock – DIA) – 13%
S&P 500 (Tracking Stock – SPY) –14%
Nasdaq (Tracking Stock – QQQ) – 21%
Russell 2000 (Small Cap – IWM) – 26%

Since all the input variables that determine an option price in the Black-Scholes model (strike price, stock price, time to expiration, interest and dividend rates) can be measured precisely, only volatility is the wild card.   It is the most important variable of all.

If implied volatility is high, the option prices are high.  If expectations of fluctuation in the company stock are low, implied volatility and option prices are low.  For example, a one-month at-the-money option on Johnson & Johnson would cost about $1.30 (stock price $100) vs. $2.00 for eBay (stock price $53).  On a per-dollar basis, the eBay option trades for about three times as much as the JNJ option.

Of course, since only historical volatility can be measured with certainty, and no one knows for sure what the stock will do in the future, implied volatility is where all the fun starts and ends in the option trading game.

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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.

~ John Collins