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Posts Tagged ‘Credit Spreads’

How to Set Up a Pre-Earnings Announcement Options Strategy

Monday, November 9th, 2015

One of the best times to set up an options strategy is just before a company announces earnings.  Today I would like to share our experience doing this last month with Facebook (FB) last month.  I hope you will read all the way through – there is some important information there.If you missed them, be sure to check out the short videos which explains why I like calendar spreads , and  How to Make Adjustments to Calendar and Diagonal Spreads.


How to Set Up a Pre-Earnings Announcement Options Strategy

When a company reports results each quarter, the stock price often fluctuates far more than usual, depending on how well the company performs compared both to past performance and to the market’s collective level of expectations.  Anticipating a big move one way or another, just prior to the announcement, option prices skyrocket, both puts and calls.

At Terry’s Tips, our basic strategy involves selling short-term options to others (using longer-term options as collateral for making those sales).  One of the absolute best times for us is the period just before an upcoming earnings announcement. That is when we can collect the most premium.

An at-the-money call (stock price and strike price are the same) for a call with a month of remaining life onFacebook (FB) trades for about $3 ($300 per call).  If that call expires shortly after an earnings announcement, it will trade for about $4.80.  That is a significant difference. In options parlance, option prices are “high” or “low” depending on their implied volatility (IV).  IV is much higher for all options series in the weeks before the announcement.  IV is at its absolute highest in the series that expires just after the announcement.  Usually that is a weekly option series.

Here are IV numbers for FB at-the-money calls before and after the November 4th earnings announcement:

One week option life before, IV = 57  One week option life after, IV = 25
Two week option life before, IV = 47  Two week option life after, IV = 26
One month option life before, IV =38  One month option life after, IV = 26
Four month option life before, IV = 35  Four month option life after, IV = 31

These numbers clearly show that when you are buying a 4-month-out call (March, IV=35) and selling a one-week out call (IV=57), before an announcement, you are buying less expensive options (lower IV) than those which you are selling. After the announcement, this gets reversed.  The short-term options you are selling are relatively less expensive than the ones you are buying.  Bottom line, before the announcement, you are buying low and selling high, and after the announcement, you are buying high and selling low.

You can make a lot of money buying a series of longer-term call options and selling short-term calls at several strike prices in the series that expires shortly after the announcement.  If the long and short sides of your spread are at the same strike price, you call it a calendar spread, and if the strikes are at different prices, it is called a diagonal spread.

Calendar and diagonal spreads essentially work the same, with the important point being the strike price of the short option that you have sold.  The maximum gain for your spread will come if the stock price ends up exactly at that strike price when the option expires.  If you can correctly guess the price of the stock after the announcement, you can make a ton of money.

But as we all know, guessing the short-term price of a stock is a really tough thing to do, especially when you are trying to guess where it might end up shortly after the announcement.  You never know how well the company has done, or more importantly, how the market will react to how the company has performed.  For that reason, we recommend selecting selling short-term options at several different strike prices.  This increases your chances of having one short strike which gains you the maximum amount possible.

Here are the positions held in our actual FB portfolio at Terry’s Tips on Friday, October 30th, one week before the Nov-1 15 calls would expire just after FB announced earnings on November 4th:

Foxy Face Book Positions Nov 2015

Foxy Face Book Positions Nov 2015

We owned calls which expired in March 2016 at 3 different strikes (97.5, 100, and 105) and we were short calls with one week of remaining life at 4 different strikes (103, 105, 106, and 107). There was one calendar spread at the 105 strike and all the others were diagonal spreads.  We owned 2 more calls than we were short.  This is often part of our strategy just before announcement day.  A fairly large percent of the time, the stock moves higher in the day or two before the announcement as anticipation of a positive report kicks in.  We planned to sell another call before the announcement, hopefully getting a higher price than we would have received earlier.  (We sold a Nov1-15 204 call for $2.42 on Monday).  We were feeling pretty positive about the stock, and maintained a more bullish (higher net delta position) than we normally do.

Here is the risk profile graph for the above positions.  It shows our expected gain or loss one week later (after the announcement) when the Nov1-15 calls expired:

Foxy Face Book Rick Profile Graph Nov 2015

Foxy Face Book Rick Profile Graph Nov 2015

When we produced this graph, we instructed the software to assume that IV for the Mar-16 calls would fall from 35 to 30 after the announcement.  If we hadn’t done that, the graph would have displayed unrealistically high possible returns.  You can see with this assumption, a flat stock price should result in a $300 gain, and if the stock rose $2 or higher, the gain would be in the $1000 range (maybe a bit higher if the stock was up just moderately because of the additional $242 we collected from selling another call).

So what happened?  FB announced earnings that the market liked.  The stock soared from about $102 to about $109 after the announcement (but then fell back a bit on Friday, closing at $107.10).  We bought back the expiring Nov1-15 calls (all of which were in the money on Thursday or Friday) and sold further-out calls at several strike prices to get set up for the next week.   The portfolio gained $1301 in value, rising from $7046 to $8347, up 18.5% for the week.  This is just a little better than our graph predicted.  The reason for the small difference is that IV for the March calls fell only to 31, and we had estimated that it would fall to 30.

You can see why we like earnings announcement time, especially when we are right about the direction the stock moves.  In this case, we would have made a good gain no matter how high the stock might go (because we had one uncovered long call).  Most of the time, we select short strikes which yield a risk profile graph with more downside protection and limited upside potential (a huge price rise would yield a lower gain, and possibly a loss).

One week earlier, in our Starbucks (SBUX) portfolio, we had another earnings week.  SBUX had a positive earnings report, but the market was apparently disappointed with guidance and the level of sales in China, and the stock was pushed down a little after the announcement.  Our portfolio managed to gain 18% for the week.

Many people would be happy with 18% a year on their invested capital, and we have done it in a single week in which an earnings announcement took place.  We look forward to having three more such weeks when reporting season comes around once again over the course of a year, both for these two underlyings and the 4 others we also trade (COST, NKE, JNJ, and SPY).
“I have confidence in your system…I have seen it work very well…currently I have had a first 100% gain, and am now working to diversify into more portfolios.  Goldman/Sachs is also doing well – up about 40%…

The Worst “Stock” You Could Have Owned for the Last 6 Years

Monday, September 14th, 2015

Today I would like to tell you all about the worst “stock” you could have owned for the past 6 years.  It has fallen from $6400 to $26 today.  I will also tell you how you can take advantage of an unusual current market condition and make an options trade which should make a profit of 66% in the next 6 months.  That works out to an annualized gain of 132%.  Not bad by any standards.For the next few days, I am also offering you the lowest price ever to become a Terry’s Tips Insider and get a 14-day options tutorial which could forever change your future investment results.  It is a half-price back-to-school offer – our complete package for only $39.95. Click here, enter Special Code BTS (or BTSP for Premium Service – $79.95).

This could be the best investment decision you ever make – an investment in yourself.

Happy trading.


The Worst “Stock” You Could Have Owned for the Last 6 Years

I have put the word “stock” in quotations because it really isn’t a stock in the normal sense of the word.  Rather, it is an Exchange Traded Product (ETP) created by Barclay’s which involves buying and selling futures on VIX (the so-called “Fear Index” which measures option volatility on the S&P 500 tracking stock, SPY).  It is a derivative of a derivative of a derivative which almost no one fully understands, apparently even the Nobel Prize winners who carried out Long-Term Capital a few years back.

Even though it is pure gobbledygook for most of us, this ETP trades just like a stock.  You can buy it and hope it goes up or sell it short and hope it goes down.  Best of all, for options nuts like me, you can trade options on it.

Let’s check out the 6-year record for this ETP (that time period is its entire life):

VXX Historical Chart 2015

VXX Historical Chart 2015

It is a little difficult to see what this ETP was trading at when it opened for business on January 30, 2009, but its split-adjusted price seems to be over $6000. (Actually, it’s $6400, exactly what you get by starting at $100 and engineering 3 1-for-4 reverse splits).  Friday, it closed at $26.04.  That has to be the dog of all dog instruments that you could possible buy over that time period (if you know of a worse one, please let me know).

This ETP started trading on 1/30/09 at $100.  Less than 2 years later, on 11/19/10, it had fallen to about $12.50, so Barclays engineered a reverse 1-for-4 split which pushed the price back up to about $50.  It then steadily fell in value for another 2 years until it got to about $9 on 10/15/12 and Barclays did the same thing again, temporarily pushing the stock back up to $36.  That lasted only 13 months when they had to do it again on 11/18/13 – this time, the stock had fallen to $12.50 once again, and after the reverse split, was trading about $50.  Since then, it has done relatively better, only falling in about half over almost a two-year span.

Obviously, this “stock” would have been a great thing to sell short just about any time over the 6-year period (if you were willing to hang on for the long run).  There are some problems with selling it short, however.  Many brokers can’t find stock to borrow to cover it, so they can’t take the order.  And if they do, they charge you some healthy interest for borrowing the stock (I don’t quite understand how they can charge you interest because you have the cash in your account, but they do anyway – I guess it’s a rental fee for borrowing the stock, not truly an interest charge).

Buying puts on it might have been a good idea in many of the months, but put prices are quite expensive because the market expects the “stock” to go down, and it will have to fall quite a way just to cover the cost of the put.  I typically don’t like to buy puts or calls all by themselves (about 80% of options people buy are said to expire worthless).  If you straight-out buy puts or calls, every day the underlying stock or ETP stays flat, you lose money. That doesn’t sound like a great deal to me.  I do like to buy and sell both puts and calls as part of a spread, however.  That is another story altogether.

So what else should you know about this ETP? First, it is called VXX.  You can find a host of articles written about it (check out Seeking Alpha) which say it is the best thing to buy (for the short term) if you want protection against a market crash.  While that might be true, are you really smart enough to find a spot on the 6-year chart when you could have bought it and then figured out the perfect time to sell as well?  The great majority of times you would have made your purchase, you would have surely regretted it (unless you were extremely lucky in picking the right day both to buy and sell).

One of the rare times when it would have been a good idea to buy VXX was on August 10, 2015, just over a month ago.  It closed at its all-time low on that day, $15.54.  If you were smart enough to sell it on September 1st when it closed at $30.76, you could have almost doubled your money.  But you have already missed out if you didn’t pull the trigger on that exact day. It has now fallen over 15% in the last two weeks, continuing its long-term trend.

While we can’t get into the precise specifics of how VXX is valued in the market, we can explain roughly how it is constructed.  Each day, Barclays buys one-month-out futures on VIX in hopes that the market fears will grow and VIX will move higher.  Every day, Barclays sells VIX futures it bought a month ago at the current spot price of VIX.  If VIX had moved higher than the month-ago futures price, a profit is made.

The reason why VXX is destined to move lower over time is that over 90% of the time, the price of VIX futures is higher than the spot price of VIX.  It is a condition called contango.  The average level of contango for VIX is about 5%.  That percentage is how much higher the one-month futures are than the current value of VIX, and is a rough approximation of how much VXX should fall each month.

However, every once in a while, the market gets very worried, and contango disappears.  The last month has been one of those times.  People seem to be concerned that China and the rest of the world is coming on hard times, and our stock markets will be rocked because the Fed is about to raise interest rates.  The stock market has taken a big tumble and market volatility has soared.  This has caused the current value of VIX to become about 23.8 while the one-month futures of VIX are 22.9.  When the futures are less than the spot price of VIX, it is a condition called back-wardation.  It only occurs about 10% of the time.  Right now, backwardation is in effect, (-3.59%), and it has been for about 3 weeks.  This is an exceptionally long time for backwardation to continue to exist.

At some point, investors will come to the realization that the financial world is not about to implode, and that things will pretty much chug along as they have in the past.  When that happens, market volatility will fall back to historical levels.  For most of the past two or three years, VIX has traded in the 12 – 14 range, about half of where it is right now.  When fears subside, as they inevitably will, VIX will fall, the futures will be greater than the current price of VIX, and contango will return.  Even more significant, when VIX falls to 12 or 14 and Barclays is selling (for VXX) at that price, VXX will lose out big-time because a month ago, it bought futures at 22.9.  So VXX will inevitably continue its downward trend.

So how can you make money on VXX with options?  To my way of thinking, today’s situation is a great buying opportunity.  I think it is highly likely that volatility (VIX) will not remain at today’s high level much longer.  When it falls, VXX will tumble, contango will return, and VXX will face new headwinds going forward once again.

Here is a trade I recommended to Terry’s Tips Insiders last Friday:

“If you believe (as I do) that the overwhelming odds are that VXX will be much lower in 6 months than it is now, you might consider buying a Mar-16 26 call (at the money – VXX closed at $26.04 yesteday) and sell a Mar-16 21 call.  You could collect about $2 for this credit spread.  In 6 months, if VXX is at any price below $21, both calls would expire worthless and you would enjoy a gain of 66% on your $3 at risk.  It seems like a pretty good bet to me.”

This spread is called selling a bearish call credit vertical spread.  For each spread you sell, $200 gets put in your account.  Your broker will charge you a maintenance requirement of $500 to protect against your maximum loss if VXX closes above $26 on March 18, 2016.  Since you collect $200 at the beginning, your actual maximum loss is $300 (this is also your net investment in this spread).  There is no interest charged on a maintenance requirement; rather, it is just money in your account that you can’t use to buy other stocks or options.

This may all seem a little confusing if you aren’t up to speed on options trading.  Don’t feel like the Lone Ranger – the great majority of investors know little or nothing about options.  You can fix that by going back to school and taking the 14-day options tutorial that comes with buying the full Terry’s Tips’ package at the lowest price ever – only $39.95 if you buy before Friday, September 23, 2015.

Lowest Subscription Price Ever:  As a back-to-school special, we are offering the lowest subscription price than we have ever offered – our full package, including all the free reports, my White Paper, which explains my favorite option strategies in detail, and shows you exactly how to carry them out on your own, a 14-day options tutorial program which will give you a solid background on option trading, and two months of our weekly newsletter full of tradable option ideas.  All this for a one-time fee of $39.95, less than half the cost of the White Paper alone ($79.95).

For this lowest-price-ever $39.95 offer, click here, enter Special Code BTS (or BTSP for Premium Service – $79.95).

A Low-Risk Trade to Make 62% in 4 Months

Tuesday, September 8th, 2015

Market volatility continues to be high, and the one thing we know from history is that while volatility spikes are quite common, markets eventually settle down.  After enduring a certain amount of psychic pain, investors remember that that the world will probably continue to move along pretty much as it has in the past, and market fears will subside.While this temporary period of high volatility continues to exist, there are some trades to be made that promise extremely high returns in the next few months.  I would like to discuss one today, a trade I just executed in my own personal account so I know it is possible to place.


A Low-Risk Trade to Make 62% in 4 Months

As we have been discussing for several weeks, VIX, the so-called Fear Index, continues to be over 25.  This compares to the 12 – 14 level where it has hung out for the large part of the past two years.  When VIX eventually falls, one thing we know is that SVXY, the ETP that moves in the opposite direction as VIX, will move higher.

Because of the persistence of contango, SVXY is destined to move higher even if VIX stays flat.  Let’s check out the 5-year chart of this interesting ETP:

5 Year Chart SVXY September 2015

5 Year Chart SVXY September 2015

Note that while the general trend for SVXY is to the upside, every once in a while it takes a big drop.  But the big drops don’t last very long.  The stock recovers quickly once fears subside.  The recent drop is by far the largest one in the history of SVXY.

As I write this, SVXY is trading about $47, up $2 ½ for the day. I believe it is destined to move quite a bit higher, and soon.  But with the trade I made today, a 62% profit (after commissions) can be made in the next 4 months even if the stock were to fall by $7 (almost 15%) from where it is today.

This is what I did:

Buy to Open 1 SVXY Jan-16 35 put (SVXY160115P35)
Sell to Open 1 SVXY Jan-16 40 put (SVXY160115P40) for a credit of $1.95  (selling a vertical)

When this trade was executed, $192.50 (after a $2.50 commission) went into my account. If on January 15, 2016, SVXY is at any price higher than $40, both of these puts will expire worthless, and for every vertical spread I sold, I won’t have to make a closing trade, and I will make a profit of exactly $192.50.

So how much do I have to put up to place this trade?  The broker looks at these positions and calculates that the maximum loss that could occur on them would be $500 ($100 for every dollar of stock price below $40).  For that to happen, SVXY would have to close below $35 on January 15th.  Since I am quite certain that it is headed higher, not lower, a drop of this magnitude seems highly unlikely to me.

The broker will place a $500 maintenance requirement on my account.  This is not a loan where interest is charged, but merely cash I can’t use to buy shares of stock.  However, since I have collected $192.50, I can’t lose the entire $500. My maximum loss is the difference between the maintenance requirement and what I collected, or $307.50.

If SVXY closes at any price above $40 on January 15, both puts will expire worthless and the maintenance requirement disappears.  I don’t have to do anything except think of how I will spend my profit of $192.50.  I will have made 62% on my investment.  Where else can you make this kind of return for as little risk as this trade entails?

Of course, as with all investments, you should only risk what you can afford to lose.  But I believe the likelihood of losing on this investment is extremely low.  The stock is destined to move higher, not lower, as soon as the current turbulent market settles down.

If you wanted to take a little more risk, you might buy the 45 put and sell a 50 put in the Jan-15 series.  You would be betting that the stock manages to move a little higher over the next 4 months. You could collect about $260 per spread and your risk would be $240.  If SVXY closed any higher than $50 (which history says that it should), your profit would be greater than 100%.  I have also placed this spread trade in my personal account (and my charitable trust account as well).

How to Fine-Tune Market Risk With Weekly Options

Monday, August 17th, 2015

This week I would like to share an article word-for-word which I sent to Insiders this week.  It is a mega-view commentary on the basic options strategy we conduct at Terry’s Tips.  The report includes two tactics that we have been using quite successfully to adjust our risk level each week using weekly options.

If you are already trading options, these tactic ideas might make a huge difference to your results.  If you are not currently trading options, the ideas will probably not make much sense, but you might enjoy seeing the results we are having with the actual portfolios we are carrying out for our subscribers.


How to Fine-Tune Market Risk With Weekly Options

“Bernie Madoff attracted hundreds of millions of dollars by promising investors 12% a year (consistently, year after year). Most of our portfolios achieve triple that number and hardly anyone knows about us.  Even more significant, our returns are actual – Madoff never delivered gains of any sort. There seems to be something wrong here.

Our Capstone Cascade portfolio is designed to spin off (in cash) 36% a year, and it has done so for 10 consecutive months and is looking more and more likely that we will be able to do that for the long run (as long as we care to carry it out).  Actually, at today’s buy-in value (about $8300), the $3600 we withdraw each year works out to be 43%.  Theta in this portfolio has consistently added up to double what we need to make the monthly withdrawal, and we gain even more from delta when SVXY moves higher.

Other portfolios are doing even better.  Rising Tide has gained 140% in just over two years while the underlying Costco has moved up 23.8% (about what Madoff promised).   Black Gold appears to be doing even better than that (having gained an average of 3% a week since it was started).

A key part of our current strategy, and a big change from how we operated in the past, is having short options in each of several weekly series, with some rolling over (usually about a month out) each week.  This enables us to tweak the risk profile every Friday without making big adjustments that involve selling some of the long positions.  If the stock falls during a week, we will find ourselves with previously-sold short options that  are at higher strikes than the stock price, and we will collect the  maximum time premium in a month-out series by selling an at-the-money (usually call) option.

If the stock rises during the week, we may find that we have more in-the-money calls than we would normally carry, so we will sell new month-out calls which are out of the money.  Usually, we can buy back in-the-money calls and replace them with out-of-the-money calls and do it at a credit, again avoiding adjustment trades which might cause losses when the underlying displays whip-saw price action.

For the past several weeks, we have not suffered through a huge drop in our underlyings, but earlier this year, we incurred one in SVXY.  We now have a way of contending with that kind of price action when it comes along.  If a big drop occurs, we can buy a vertical call spread in our long calls and sell a one-month-out at-the-money call for enough cash to cover the cost of rolling the long side down to a lower strike.  As long as we don’t have to come up with extra cash to make the adjustment, we can keep the same number of long calls in place and continue to sell at-the-money calls each week when we replace expiring short call positions.  This tactic avoids the inevitable losses involved in closing out an out-of-the-money call calendar spread and replacing it with an at-the-money calendar spread which always costs more than the spread we sold.

Another change we have added is to make some long-term credit put spreads as a small part of an overall 10K Strategy portfolio, betting that the underlying will at least be flat in a year or so from when we placed the spread.  These bets can return exceptional returns while in many respects being less risky than our basic calendar and diagonal spread strategies.  The longer time period allows for a big drop in stock price to take place as long as it is offset by a price gain in another part of the long-term time frame.  Our Better Odds Than Vegas II portfolio trades these types of spreads exclusively, and is on target to gain 91% this year, while the Retirement Trip Fund II portfolio is on target to gain 52% this year (and the stock can fall a full 50% and that gain will still come about).

The trick to having portfolios with these kinds of extraordinary gains is to select underlying stocks or ETPs which you feel strongly will move higher.  We have managed to do this with our selections of COST, NKE, SVXY, SBUX, and more recently, FB, while we have  failed to do it (and faced huge losses) in our single failing portfolio, BABA Black Sheep where Alibaba has plummeted to an all-time low since we started the portfolio when it was near its all-time high.  Our one Asian diversification effort has served to remind us that it is far more important to find an underlying that you can count on moving higher, or at least staying flat (when we usually do even better than when it moves higher).

Bottom line, I think we are on to something big in the way we are managing our investments these days.  Once you have discovered something that is working, it is important to stick with it rather than trying to improve your strategy even more.  Of course, if the market lets us know that the strategy is no longer working, changes would be in order.  So far, that has not been the case.  The recent past has included a great many weeks when we enjoyed 10 of our 11 portfolios gaining in value, while only BABA lost money as the stock continued to tumble. We will soon find another underlying to replace BABA (or conduct a different strategy in that single losing portfolio).”

3 Options Strategies for a Flat Market

Thursday, August 6th, 2015

Before I delve into this week’s option idea I would like to tell you a little bit about the actual option portfolios that are carried out for Insiders at Terry’s Tips.  We have 11 different portfolios which use a variety of underlying stocks or ETPs (Exchange Traded Products).  Eight of the 11 portfolios can be traded through Auto-Trade at thinkorswim (so you can follow a portfolio and never have to make a trade on your own).  The 3 portfolios that cannot be Auto-Traded are simple to do on your own (usually only one trade needs to be made for an entire year).

Ten of our 11 portfolios are ahead of their starting investment, some dramatically ahead.  The only losing portfolio is based on Alibaba (BABA) – it was a bet on the Chinese market and the stock is down over 30% since we started the portfolio at the beginning of this year (our loss is much greater).  The best portfolio for 2015 is up 55% so far and will make exactly 91% if the three underlyings (AAPL, SPY, and GOOG) remain where they presently are (or move higher).  GOOG could fall by $150 and that spread would still make 100% for the year.

Another portfolio is up 44% for 2015 and is guaranteed to make 52% for the year even if the underlying (SVXY) falls by 50% between now and the end of the year.  A portfolio based on Costco (COST) was started 25 months ago and is ahead more than 100% while the stock rose 23% – our portfolio outperformed the stock by better than 4 times.  This is a typical ratio –  portfolios based on Nike (NKE) and Starbucks (SBUX) have performed similarly.

We are proud of our portfolio performance and hope you will consider taking a look at how they are set up and perform in the future.


3 Options Strategies for a Flat Market

“Thinking is the hardest work there is, which is probably the reason why so few engage in it.” – Henry Ford

If you think the market will be flat for the next month, there are several options strategies you might employ.  In each of the following three strategies, I will show how you could invest $1000 and what the risk/reward ratio would be with each strategy.  As a proxy for “the market,” we will use SPY as the underlying (this is the tracking stock for the S&P 500 index).  Today, SPY is trading at $210 and we will be trading options that expire in just about a month (30 days from when I wrote this).

Strategy #1 – Calendar Spread.  With SPY trading at $210, we will buy calls which expire on the third Friday in October and we will sell calls which expire in 30 days (on September 4, 2015).  Both options will be at the 210 strike.  We will have to spend $156 per spread (plus $2.50 commissions at the thinkorswim rate for Terry’s Tips subscribers).  We will be able to buy 6 spreads for our $1000 budget. The total investment will be $951.   Here is what the risk profile graph looks like when the short options expire on September 4th:

SPY Calendar Spread Risk Profile Graph August 2015

SPY Calendar Spread Risk Profile Graph August 2015

On these graphs, the column under P/L Day shows the gain (or loss) when the short options expire at the stock price in the left-hand column.  You can see that if you are absolutely right and the market is absolutely flat ($210), you will double your money in 30 days.  The 210 calls you sold will expire worthless (or nearly so) and you will own October 210 calls which will be worth about $325 each since they have 5 weeks of remaining life.

The stock can fluctuate by $4 in either direction and you will make a profit of some sort.  However, if it fluctuates by much more than $4 you will incur a loss.  One interesting thing about calendar spreads (in contrast to the other 2 strategies we discuss below) is that no matter how much the stock deviates in either direction, you will never lose absolutely all of your investment.  Since your long positions have an additional 35 days of life, you will always have some value over and above the options you have.  That is one of the important reasons that I prefer calendar spreads to the other strategies.

Strategy #2 – Butterfly Spread:  A typical butterfly spread in involves selling 2 options at the strike where you expect the stock to end up when the options expire (either puts or calls will do – the strike price is the important thing) and buying one option an equidistant number of strikes above and below the strike price of the 2 options you sold.  You make these trades all at the same time as part of a butterfly spread.

You can toy around with different strike prices to create a risk profile graph which will provide you with a break-even range which you will be comfortable with.  In order to keep the 3 spread strategies similar, I set up strikes which would yield a break-even range which extended about $4 above and below the $210 current strike.  This ended up involving selling 2 Sept-1 2015 calls at the 210 strike, and buying a call in the same series at the 202.5 strike and the 217.5 strike.  The cost per spread would be $319 plus $5 commission per spread, or $324 per spread.  We could buy 3 butterfly spreads with our $1000 budget, shelling out $972.

Here is the risk profile graph for that butterfly spread when all the options expire on September 4, 2015:

SPY Butterfly Spread Risk Profile Graph August 2015

SPY Butterfly Spread Risk Profile Graph August 2015

You can see that the total gain if the stock ends up precisely at the $210 price is even greater ($1287) than it is with the butterfly spread above ($1038).  However, if the stock moves either higher or lower by $8, you will lose 100% of your investment.  That’s a pretty scary alternative, but this is a strategy that does best when the market is flat, and you would only buy a butterfly spread if you had a strong feeling of where you think the price of the underlying stock will be on the day when all the options expire.

Strategy #3 – Short Iron Condor Spread.  This spread is a little more complicated (and is explained more fully in my White Paper).  It involves buying (and selling) both puts and calls all in the same expiration series (as above, that series will be the Sept1-15 options expiring on September 4, 2015).  In order to create a risk profile graph which showed a break-even range which extended $4 in both directions from $210, we bought calls at the 214 strike, sold calls at the 217 strike and bought puts at the 203 strike while selling puts at the 206 strike.  A short iron condor spread is sold at a credit (you collect money by selling it).  In this case, each spread would collect $121 less $5 commission, or $116.  Since there is a $3 difference between each of the strikes, it is possible to lose $300 per spread if the stock ends up higher than $217 or lower than $203.  We can’t lose the entire $300, however, because we collected $116 per spread at the outset.  The broker will put a hold on $300 per spread (it’s called a maintenance requirement and does not accrue interest like a margin loan does), less the $116 we collected.  That works out to a total net investment of $184 per spread (which is the maximum loss we could possibly incur).  With our $1000 budget, you could sell 5 spreads, risking $920.

Here is the risk profile graph for this short iron condor spread:

SPY Short Iron Condor Spread Risk Profile Graph August 2015

SPY Short Iron Condor Spread Risk Profile Graph August 2015

You can see the total potential gain for the short iron condor spread is about half what it was for either of the earlier spreads, but it has the wonderful feature of coming your way at any possible ending stock price between $206 and $214.  Both the calendar spread and the butterfly spread required the stock to be extremely near $210 to make the maximum gain, and the potential gains dropped quickly as the stock moved in any direction from that single important stock price.  The short iron condor spread has a lower maximum gain but it comes your way over a much larger range of possible ending stock prices.

Another advantage of the short iron condor is that if the stock ends up at any price in the profit range, all the options expire worthless, and you don’t have to execute a trade to close out the positions.  Both the other strategies require closing trades.

This is clearly not a complete discussion of these option strategies.  Instead, it is just a graphic display of the risk/reward possibilities when you expect a flat market.  Maybe this short report will pique your interest so that you will consider subscribing to our service where I think you will get a thorough understanding of these, and other, options strategies that might generate far greater returns than conventional investments can offer.

Long-Term Options Strategies For Companies You Like

Thursday, July 30th, 2015

Today I would like to share an article I sent to paying subscribers two months ago.  It describes an 8-month options play on Facebook (FB), a company that seems to be doing quite well these days.  The spread is a vertical credit put spread which I like because once you place it, you don’t have to make any closing trades (both options hopefully expire worthless, all automatically) as long as the stock is any higher than a pre-determined price.  It is actually quite simple to do, so please don’t tune out because its name sounds so confusing.Terry

Here is the exact article sent out on April 24, 2015:

“A Long-Term Play on Facebook (FB):  Last week in my charitable trust account I made a long-term bet that FB would not fall dramatically from here during the balance of 2015.  It seems to be a good company that is figuring out how to monetize its traffic.  I checked out the 5-year chart:

Face Book Chart July 2015

Face Book Chart July 2015

While there were times when the stock made serious drops, if you check full-year time periods, there do not seem to be any that show a cumulative loss.  Selling long-term
vertical put credit spreads allows you to tolerate short-term losses if your time period is long enough for a recovery to take place.

In my charitable trust account, I give away most of donations in December, so I like to have some positions expire in that month.  Last week, with FB trading about $82, I was willing to bet that it would end up no lower than $75 on the third Friday in December.  I sold Dec-15 75 puts and bought Dec-15 70 puts and collected $130 per spread.  My risk (and the total possible loss) would be $370 per contract if the stock fell over $12 (15%) over those 9 months.  If the 5-year chart is indicative of how things are going for FB, there should be no concern about a possible loss.  If the company manages to end up over $75 at the December expiration, the spread would gain 35% on the investment.  Where else can you make those kind of returns and still sleep comfortably?” (End of article.)

Fast forward two months until today and we see that FB has gained about $14 and is trading about $94.  Now I am in a position where the stock can fall $19, a full 20%, and I will still gain 35% for the 8-month period. That works out to over 50% a year on my investment with an extremely high likelihood of making it.

I could buy back the spread today for $58 per contract (including commissions) and make 19% for the two months I have owned it, but I intend to wait it out until December and take the full 35%.

In one of our actual portfolios at Terry’s Tips, in January we made full-year similar trades to this FB trade using GOOG, AAPL, and SPY as underlyings, and the portfolio is on target to gain 91% for the year.  It could be closed out today for a 63% gain for the first seven months (thanks to GOOG’s big up move after announcing earnings last week).

Vertical credit put spreads are just one way you can use options to maximize gains for a company you feel positive about, and the potential gains can be several times as great as the percentage gains in the underlying stock.














5 Option Strategies if you Think the Market is Headed Lower

Saturday, June 27th, 2015

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

5 Option Strategies if you Think the Market is Headed Lower

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Bearish SPY Risk Profile Graph June 2015

Bearish SPY Risk Profile Graph June 2015

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

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

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

How to Make 80% a Year With Long-Term Option Bets

Thursday, May 28th, 2015

One of my favorite options plays is a long-term bet that a particular stock will be equal to or higher than it is today at some future date.  Right now might be a perfect time to make that kind of a bet with one of my favorite stocks, Apple (AAPL).Each January, I pick several stocks I feel really positive about and buy a spread that will make an extraordinary gain if the stock is flat or any higher when the options expire one year out.  Today I would like to tell you about one of these spreads we placed in one of the Terry’s Tips portfolios we carry out, and how you can place a similar spread right now.  If AAPL is only slightly higher than it is today a year from now, you would make 100% on your investment.


How to Make 80% a Year With Long-Term Option Bets

I totally understand that it may seem preposterous to think that over the long run, 80% a year is a possible expectation to have for a stock market investment.  But if the AAPL fluctuates in the future as it has in the past, it will absolutely come about. It can be done with a simple option spread that can be placed right now, and you don’t have to do anything else but wait out a year. If the stock is any higher at the end of the year, the options expire worthless and you don’t even have to close out the spread.  You just get to keep the money you got at the beginning.

Let’s check out the 10-year chart for Apple:

10 Year Apple Chart May 2015

10 Year Apple Chart May 2015

In 9 of the last 10 years, AAPL has been higher at the end of the calendar year than it was at the beginning.  Only in the market-meltdown of 2008-2009 was the stock at a lower price at the end of the year than it was at the beginning.

In January of this year, in one of our Terry’s Tips portfolios, we placed the following trade when AAPL was trading at $112.  We felt confident that the stock would be at least a little higher a year from then.  The precise date would be January 15, 2016, the third Friday of the month when monthly options expire.  This is the trade we made:

Buy To Open 7 AAPL Jan-16 105 puts (AAPL160115P105)
Sell To Open 7 AAPL Jan-16 115 puts (AAPL160115P115) for a credit of $5.25 (selling a vertical)

For each spread, we collected $525 less $2.50 in commissions, or $522.50.  For 7 spreads, we collected $3657.50 after commissions.  The amount at risk per spread was $1000 – $522.50, or $477.50.  For all 7, that worked out to $3342.50.

The proceeds from selling the spread, $3657.50, was placed in our account when the sale was made.  The broker placed a maintenance requirement on us for $7000 (the maximum we could lose if the stock ended up below $105 at expiration.  Our actual risk if this happened would be $7000 less the $3657.50 we received, or $3342.50.  If AAPL ends up at any price above $115 on January 15, 2016, both options will expire worthless and we will make a gain of 109% on our investment.

Since we placed that spread, AAPL has moved up nicely, and it is now at $132.  If you did not want to wait another six months to collect the 109%, you could buy back the spread today for $2.67 ($269.50 per spread after commissions).  Buying back all 7 spreads would cost $1886.50, resulting in a profit of $1771.  This works out to be a 53% gain for the 4 months.  We are waiting it out rather than taking a gain right now, knowing that 109% will come our way even if the stock falls about $17 from here.

AAPL might not be headed to $240 as Carl Ichan (net worth, $23 billion) believes it is, but it seems likely that it might be higher a year from now than it is today.  Options for June, 2016 have just become available for trading.  As I write this today, AAPL is trading at $132.  If you were willing to bet that over the next 12 months, the stock might edge up by $3 or more, you could sell the following spread (in my personal account, I made this exact trade today):

Buy To Open (pick a number) AAPL Jun-16 125 puts (AAPL160617P125)
Sell To Open ((pick a number) AAPL Jun-16 135 puts (AAPL160617P135) for a credit of $5.10  (selling a vertical)

Each contract will cost you about $500 to place, after commissions. This spread will make a 100% profit after commissions if AAPL ends up at any price above $135 on June 17, 2016.

You might wonder why the title of this blog mentioned 80% as a long-term annual gain possibility.  If AAPL behaves in the next 10 years as it has in the last 10 years, and makes a gain in 9 of those years, over the course of a decade, you would gain 100% in 9 years and lose 100% (although the actual loss might be less) in one year, for an average gain of 80% a year.

For sure, you would not want to place all, or even a large part, of your investment portfolio in long-term spreads like this.  But it seems to me that a small amount, something that you can afford to lose, is something that you might consider, if only for the fun of doubling your money in a single year.

Check Out a Long-Term Bet on FaceBook (FB)

Wednesday, April 29th, 2015

In the family charitable trust I set up many years ago, I trade options to maximize the amounts I can give away each year.  In this portfolio, I prefer not to actively trade short-term options, but each year, I make selected bets on companies I feel good about and I expect they won’t tank in price over the long run.  Last week, I made such a bet on FaceBook (FB) that I would like to tell you about today.  The spread will make over 40% in the next 8 months even if the stock were to fall $5 over that time.Terry

Check Out a Long-Term Bet on FaceBook (FB)

When most people think about trading options, they are thinking short-term.  If they are buying calls in hopes that the stock will skyrocket, they usually by the cheapest call they can find.  These are the ones which return the greatest percentage gain if you are right and the stock manages to make a big upward move.  The cheapest calls are the shortest term ones, maybe with only a week of remaining life.  Of course, about 80% of the time, these options expire worthless and you lose your entire bet, but hopes of a windfall gain keep people playing the short-term option-buying game.

Other people (including me) prefer to sell these short-term options, using longer-term options as collateral.  Instead of buying stock and writing calls against it, longer-term options require far less capital and allow for a potentially higher return on investment if the stock stays flat or moves higher.  This kind of trading requires short-term thinking, and action, as well.  When the short-term options expire, they must be replaced by further-out short options, and if they are in the money, they must be bought back before they expire, allowing you to sell new ones in their place.

Most of the strategies we advocate at Terry’s Tips involve this kind of short-term thinking (and adjusting each week or month when options expire).  For this reason, many subscribers sign up for Auto-Trade at thinkorswim (it’s free) and have trades executed automatically for them, following one or more of our 10 actual portfolios.

Some portfolios make longer-term bets, and since they do not require active trading, they are not offered through Auto-Trade.  With these bets, you place the trade once and then just wait for time to expire.  If you are right, and the stock falls a little, stays flat, or goes up by any amount, the options you started with all expire worthless, and you end up with a nice gain without making a single extra trade.

In one of our Terry’s Tips demonstration portfolios, in January of this year, we placed long-term bets that AAPL, SPY, and GOOG would move higher during 2015, and when the January 2016 options expired, we would make a nice gain.  In fact, we knew precisely that we would make 91% on our investment for that one-year period.  At this point in time, all three of these stocks have done well and are ahead of where they need to be for us to make our 91% gain for the year.  We could close out these positions right now and take a 44% gain for the 3 months we have owned these options.  Many subscribers have done just that.

Let’s look at FaceBook and the long-term trade I just made in it.  I like the company (even though I don’t use their product).  They seem to have figured out how to monetize the extraordinary traffic they enjoy.  I looked at the chart for their 3 years of existence:

FaceBook FB Chart 2015

FaceBook FB Chart 2015

Note that while there have been times when the stock tanked temporarily, if you look at any eight-month period, there was never a stretch when it was lower at the end of 8 months than at the beginning.  Making a bet on the longer-term trend is often a much safer bet, especially when you pick a company you feel good about.

With the stock trading about $80, in my charitable trust, I made a bet that in 8 months, it would be trading at some price which was $75 or higher on the third Friday of December, 2015.  I make most of my donations in December, so like to be in cash at that time.

This is the trade I placed:

Buy to open FB Dec-15 70 puts (FB151219P70)
Sell to open FB Dec-15 75 puts (FB151219P75) for a credit of $1.52  (selling a vertical)

For every contract I sold, I collected $152 which immediately went into my account.  The puts I sold were at a higher strike than the puts I bought, so they commanded a higher price.  The broker placed a maintenance requirement on me of $5 ($500 per contract) which would be reduced by the $152 I collected.  This left me with a net investment of $348.  This would be my maximum loss if FB ended up below $70 on December 19, 2015.

A maintenance requirement is not like a margin loan.  No interest is charged.  It just means that I must leave $348 in cash in the account until the puts expire (or I close out the positions).  I can’t use this money to buy other options or stock.

If the stock ended up at $74 in December, I would have to buy back the 75 put I had sold for $1.  This would reduce my profit to $52 (less commissions of $3.75 – 3 commissions of $1.25  on the initial trades as well as the closing one).

If the stock ends up at any price above $75 (which I feel confident that it will), all my puts will expire worthless, the $348 maintenance requirement will disappear, and I get to keep the $152 (less $2.50 commission).  That works out to a 43% gain for the 8 months.

Where else can you find a return like this when the stock can fall by $5 and you still make the gain?  It is a bet that I don’t expect to lose any sleep over.

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).


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.

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

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