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Posts Tagged ‘Credit Spreads’

Using Puts vs. Calls for Calendar Spreads

Monday, April 7th, 2014

I like to trade calendar spreads.  Right now my favorite underlying to use is SVXY, a volatility-related ETP which is essentially the inverse of VXX, another ETP which moves step-in-step with volatility (VIX).  Many people buy VXX as a hedge against a market crash when they are fearful (volatility, and VXX. skyrockets when a crash occurs), but when the market is stable or moves higher, VXX inevitably moves lower.  In fact, since it was created in 2009, VXX has been just about the biggest dog in the entire stock market world.  On three occasions they have had to make 1 – 4 reverse splits just to keep the stock price high enough to matter.

Since VXX is such a dog, I like SVXY which is its inverse.  I expect it will move higher most of the time (it enjoys substantial tailwinds because of something called contango, but that is a topic for another time).  I concentrate in buying calendar spreads on SVXY (buying Jun-14 options and selling weekly options) at strikes which are higher than the current stock price.  Most of these calendar spreads are in puts, and that seems a little weird because I expect that the stock will usually move higher, and puts are what you buy when you expect the stock will fall.  That is the topic of today’s idea of the week.

Terry

Using Puts vs. Calls for Calendar Spreads

It is important to understand that the risk profile of a calendar spread is identical regardless of whether puts or calls are used.  The strike price (rather than the choice of puts or calls) determines whether a spread is bearish or bullish.  A calendar spread at a strike price below the stock price is a bearish because the maximum gain is made if the stock falls exactly to the strike price, and a calendar spread at a strike price above the stock price is bullish.

When people are generally optimistic about the market, call calendar spreads tend to cost more than put calendar spreads.  For most of 2013-14, in spite of a consistently rising market, option buyers have been particularly pessimistic.  They have traded many more puts than calls, and put calendar prices have been more expensive.

Right now, at-the-money put calendar spreads cost more than at-the-money call calendar spreads for most underlyings, including SVXY.  As long as the underlying pessimism continues, they extra cost of the put spreads might be worth the money because when the about-to-expire short options are bought back and rolled over to the next short-term time period, a larger premium can be collected on that sale.  This assumes, of course, that the current pessimism will continue into the future.

If you have a portfolio of exclusively calendar spreads (you don’t anticipate moving to diagonal spreads), it is best to use puts at strikes below the stock price and calls for spreads at strikes which are higher than the stock price.  If you do the reverse, you will own a bunch of well in-the-money short options, and rolling them over to the next week or month is expensive (in-the-money bid-asked spreads are greater than out-of-the-money bid asked spreads so you can collect more cash when rolling over out-of-the-money short options).

Legging Into a Short Iron Condor Spread

Monday, March 3rd, 2014

Today I would like share with you the results of an actual trade recommendations I made for my paying subscribers on January 4th of this year and how subsequent price changes have opened up option possibilities that can further improve possibilities for a first investment.

Please don’t get turned off by what this new spread is called.

Terry

Legging Into a Short Iron Condor Spread

In my weekly Saturday Report that I send to paying subscribers, on January 4, 2014 I set up an actual demonstration portfolio in a separate trading account at thinkorswim in which I made long-term bets that three underlying stocks (GOOG, SPY, and GMCR) would be higher than they currently were at some distant point in the future.  The entire portfolio would make exactly 93% with the three spreads I chose if I were right about the stock prices.

Almost two months later, things are looking pretty good for all three spreads, but that is not as important as what we can learn about option possibilities.

If you recall, early this year I was quite bullish on Green Mountain Coffee Roasters (GMCR) which has recently changed their name to Keurig Green Mountain.  The major reason was that three insiders who had never bought shares before had recently made huge purchases (two of a million dollars each).  I Googled these men and learned that they were mid-level executives who were clearly not high rollers.  I figured that if they were committing this kind of money, they must have had some very good reason(s),  Also, for four solid months, not a single director had sold a single share, something that was an unusual pattern for the company.

My feelings about the company were also boosted when a company writing for Seeking Alpha published an article in which they had selected GMCR as the absolute best company from a fundamental standpoint in a database of some 6000 companies.

This is what I wrote in that Saturday Report – “The third spread, on Green Mountain Coffee Roasters (GMCR), is a stronger bullish bet than either of the first two, for two reasons.  The stock is trading about in the middle of the long and short put prices (70 and 80), and the time period is only six months (expiring in June 2014) rather than 11 or 12 months.  I paid $540 for the Jun-14 80 – Jun-14 70 vertical put credit spread.  My maximum loss is $460 per spread if the stock closes below $70, and I will make 115% after commissions in six months if it closes above $80.”

This vertical put credit spread involved selling the Jun-14 80 puts for $13.06 and buying the Jun-70 puts for $7.66, collecting $540 for each spread.  I sold 5 of these spreads, collecting a total of $2700.  There would be a maintenance requirement of $5000 for the spreads (not a margin loan which would have interest charged on it, but an amount that I couldn’t use to buy other stocks or options).  Subtracting what I received in cash from the maintenance requirement, my real cost (and maximum loss) would be $2300.  If GMCR closed at any price above $80 on June 21, 2014, both puts would expire worthless and I could keep my $2700 and make 115% after commissions (there would be no commissions to pay if both puts expired worthless).

An interesting side note to the $2700 cash I received in this transaction.  In the same account, I also owned shares of my favorite underlying stock.  I am so bullish on this other company (which is really not a company at all, but an Exchange Traded Product (ETP)) that I owned some on margin, paying 9% on a margin loan.  The cash I received from the credit spread was applied to my margin loan and reduced the total on which I was paying interest.  In other words, I was enjoying a 9% gain on the spread proceeds while I waited out the six months for the options to expire.

In case you hadn’t heard, GMCR announced on February 5th that they had executed a 10-year contract with Coke to sell individual cups on an exclusive basis.  The stock soared some 50%, from $80 to over $120.  In addition, Coke bought 10% of GMCR for $1.25 billion, and gained over $600 million on their purchase in a single day.  Obviously, those insiders knew what they were doing when they made their big investments last November.

Now I am in an interesting position with this spread.  It looks quite certain that I will make the 115% if I just sit and wait another 4 months.  The stock is highly unlikely to fall back below $80 at this point.  I could but back the spread today for $.64, ($320 for the 5 spreads) and be content with a $2380 gain now rather than $2700 in June.

But instead, I decided to wait it out, and add a twist to my investment.  Since the deal with Coke will not reach the market until at least 2015, it seems to me that we are in for a period of waiting until the chances of success for single servings of Coke are better known.  The stock is probably not going to move by a large amount in either direction between now and June.

With that in mind, I sold another vertical credit spread with June options, this time using calls.  I bought Jun-14 160 calls and sold Jun-14 150 calls and collected $1.45 ($725 less $12.50 commissions).  These options will expire worthless if GMCR is at any price below $150 on June 21, 2014, something that I believe is highly likely.  I think it has already taken the big upward move that it will take this year.

If the stock ends up at any price between $80 and $150, I will make money on both spreads that I sold.  Now the total I can gain is $3400 (after commissions) and my net investment has now been reduced to $1600 and my maximum gain is 212% on my money at risk.

This new spread will not have any maintenance requirement because the broker understands that I can’t lose money on both vertical spreads I have sold.  He will look at the two spreads and notice that the difference between the long and short strike prices is 10 for both spreads.  As long as he is setting aside $5000 in a maintenance requirement on the account, he knows that I can lose that maximum amount on only one of the two spreads.

What I have done is to leg into what is called a short iron condor spread (legging in means you buy one side of a spread to start, and then add the other side at a later time – the normal way to execute a spread is to execute both sides at the same time).  You don’t have to know any more about it than know its name at this time, but I invite you to become a Terry’s Tips Insider and learn all about short iron condors as well as many other interesting options strategies.

Another Interesting Options Bet on Google

Monday, February 24th, 2014

Just over two months ago, shortly before Christmas, I suggested that you might consider making a bet that Google (GOOG) would be higher in one year than it was then.   I figured the chances were pretty good that it might move higher because it had done just that in 9 of its 10 years in existence.

I made this bet in my personal account and also in a real account for Insiders at Terry’s Tips to follow, or mirror in their own accounts.  The stock has moved up by about $90 since then and the bet is looking like it might pay off.

Today I would like to discuss either taking a profit early or doing something else with Google if you feel good about the company as I do.

Terry

Another Interesting Options Bet on Google

In my January 4, 2014 Saturday Report sent to Terry’s Tips Insiders, I set up a new demonstration actual portfolio that made long-term bets on three underlying stocks that I believe would be higher well out in the future than they were then.  This is what I said about one of them – “The most interesting one, on Google, will make just over 100% on the money at risk if Google is trading at $1120 or higher on January 17, 2015, a full year and two weeks from now.  It was trading at $1118 when we placed the spread, buying Jan-15 1100 puts and selling Jan-15 1120 puts for a credit of $10.06.  The stock fell to $1105 after we bought the spreads, so you may be able to get a better price if you do this on your own next week.

GOOG has gained in 9 of the 10 years of its existence, only falling in the market-meltdown of 2007.  If you were to make 100% in 9 years and loss 100% in the tenth year, your average gain for the ten-year period would be 80%.  That’s what you would have made over the past 10 years.  If the next 10 years shows the same pattern, you would beat Las Vegas odds by quite a bit, surely better odds than plunking your money down on red or black at the roulette table.

I have told many friends about this bet on Google, and most of them said they would not do it, even if they had faith in the company.  The fear of losing 100% of their investment seemed to be greater than the joy of possibly making an average of 80% a year.  I told them that the trick would be to make the bet every year with the same amount, and not to double down if you won in the first year.  But that did not seem to sway their thinking.  I find their attitude most interesting.  I am looking forward to 10 years of fun with the spread.  It is a shame that it will take so long for the wheel to stop spinning, however.

It is now almost two months later and Google’s latest earnings announcement has suggested that the company has continued to be able to monetize its Internet traffic better than anyone else, especially the social media companies who are drawing most of the market’s attention.  GOOG (at $1204) is trading almost $100 higher than it was when I wrote that report and sold that vertical put credit spread.

In the demonstration portfolio account, I had sold 5 of those vertical put spreads, collecting $10.06 ($5030 for 5 spreads) and there was a $10,000 maintenance requirement charged (no interest like a margin loan, just a claim on cash that can’t be used to buy other stocks or options).  My net investment (and maximum loss would be the maintenance requirement less the amount I received in cash, or $4970).

With the stock trading so much higher, I could now buy the spread back for $7.20 and pick up a gain of $1430.  It is tempting to take a 28% profit after only two months, but I like the idea of hanging on for another 10 months and making the full 100% that is possible.  Now I am in the comfortable position of knowing I can make that 100% even if the stock falls by $84 over that time.

Rather than taking the gain at this time, I am more tempted to buy more of these spreads.  If I could sell them for $7.20 my net investment would be $12.80 and I could make 39% on my money as long as GOOG doesn’t fall by more than $84 in 10 months.  This kind of return is astronomical compared to most investments out there, especially when your stock can fall by so much and you still make that high percentage gain.

Even better, since I continue to like the company, I am planning to sell another vertical put credit spread for the Jan-15 option series.  Today, I will buy Jan-15 1110 puts and sell Jan-15 1140 puts, expecting to receive about $11 ($1100) per spread.  My maximum loss and net investment will be $1900 and if GOOG manages to close above $1140 ($64 below its current level) on January 21, 2015, I will make 57% on my investment after commissions.

I like my odds here, just as I did when I made the earlier investment on Google.  I believe that many investors should put a small amount of their portfolio in an option investment like this, just so they can enjoy an extraordinary percentage gain on some of their money.  And it is sort of fun to own such an investment, especially when it seems to be going your way, or if not exactly going your way, at least not too much in the other direction.

Follow-Up on Green Mountain Coffee Roasters

Monday, February 10th, 2014

Twice in the past three weeks I told everyone why I was bullish on Green Mountain Coffee Roasters (GMCR) and how I was playing the options prior to their earnings announcement last week.

If anyone noticed, the stock is trading about 40% higher now after the company announced a 10-year deal with Coke for selling single portions of Coke.

This was one of those sad times where I was right but didn’t make very much money from the great news, however.  Such is sometimes the plight of owning options.  Almost anything can happen, depending on what kind of a spread you put on.

Enjoy the discussion of three kinds of option spreads.

Terry

Follow-Up on Green Mountain Coffee Roasters

This is what I wrote two weeks ago – “I bought a diagonal call spread, buying GMCR Jun-14 70 calls and selling Feb1-14 80 calls.  The spread cost me $9.80 at a time when the stock was trading at just below $80.  If the stock moves higher, no matter how high it goes, this spread will be worth at least $10 plus the value of the time premium for the 70 call with about 5 months of remaining value, no matter how much IV might fall for the June options. The higher the stock might soar, the less I would make, but I expect I should make at least 20% on my money (if the stock moves higher) in 17 days.”

While the spread could not lose money no matter how high the stock might go, this was not a great investment to make if you were as bullish on the company as I was.  The more it rose above $80, the less it would make.  A 40% move on an earnings announcement is highly unusual, but that is what happened.

When the stock traded down a bit last Friday, I sold that spread for $11.00, making $1.20 less commissions of $.05, or $1.15 ($115 per spread).  That worked out to about 12%.  I will never complain about making a gain, but this was a major disappointment when I was so right about how the stock would move after the announcement.  It just moved a whole lot more than I expected.

Last week I told you about another spread I placed on GMCR before earnings.  This was a calendar spread (same strike, buy one further-out month and sell a shorter-term option).  The trick was to pick the strike price you believed the stock would end up after the announcement.  With the stock trading at $80 before the announcement, I suggested to pick the 85 strike (buying April calls and selling March calls for about $.80 per contract).

The further away from $85 the stock traded after the announcement, the less well the calendar spread would do.  On the other hand, if you correctly picked the price, you could make 200% or more on your money.  When the stock soared $30 and was trading around $110, this spread lost about half its value (I actually bought 100 of these spreads at the 90 strike instead of the 85 strike, but this spread did not do much better – I am hanging on to most of the contracts just in case it reverses direction over the next 6 weeks).

Another spread which I did not report to everyone (except my paying subscribers) was a vertical put credit spread, selling 85 puts and buying 75 puts in the same month.  I placed these trades for June, collecting a credit of $5.20, making my investment $480 per spread (this is the amount that would be my maximum loss if GMCR closes below $75 in June).  If the stock closes above $85 (which it looks highly likely to do), I will make 108% on my investment.  (I also sold similar vertical put credit spreads for both March and June at others strikes, and every spread appears that it will make 70% or better at expiration).

This time around, the calendar spreads didn’t fare well because the stock skyrocketed so high.  It is really necessary to guess where the stock will end up with that kind of spread.  I was too conservative in my bullishness. Who would have ever guessed that the stock would soar by 40%?  Certainly not me.  But I was happy that I also bought some other directional spreads that profited from the upward move (these spreads would have done just as well, or better, if the upward stock price move had been smaller).

A Post-Earnings Play on Starbucks

Monday, January 27th, 2014

I am a coffee lover, and not only am I adding to my Green Mountain Coffee Roasters (GMRC) spreads discussed last week, I am adding two new spreads this week in Starbucks (SBUX).  By betting on both these coffee companies, I end up not caring whether everyone is drinking coffee at home or at their favorite Starbucks café, just as long as they continue to enjoy the java.And as I sip away at my 4+ cup daily coffee allotment, I can feel I am helping my investments just a tiny little bit.  I will feel so righteous.  The coffee can only taste better.

Terry

A Post-Earnings Play on Starbucks

SBUX announced earnings last week, and they were pretty much in line with expectations.  The stock moved a little higher and then fell back a bit along with everything else on Friday.

The company is doing quite well.  Total sales rose almost 12%, same-store sales rose 5%, earnings were up 25%, and they were opening new stores at the rate of nearly 5 per day (417 for the quarter).

While all those numbers are impressive, the market seems a little concerned over the valuation.  It is selling at 28 times earnings (23 times forward earnings).  The stock has fallen nearly 10% from its high reached just after the last earnings announcement.

The stock has displayed a pattern of being fairly flat between announcement dates.  With that in mind, it might be a good idea to buy some calendar spreads, some at a strike price just above its current stock price ($74.39) and some at a lower strike.

I will be buying SBUX 10 Apr-14 – Mar-14 75 call calendar spreads (natural price $.60, or $625 including commissions) and 5 Apr-14 – Mar-14 72.5 put calendar spreads (natural price $.53, or $278 including commissions) for a total investment of $903.

Here is what the risk profile graph looks like for when the March options expire on the 21st:

SBUX risk profile graph

SBUX risk profile graph

If the stock stays flat, these spreads could just about double the investment in the 52 days I will have to wait.  My break-even range extends about $3 in either direction.  Any change less than $3 in either direction should result in a profit.

Since the stock has fallen so far from its high even though it seems to be doing very well, I don’t expect that any further weakness will be substantial.  On the other hand, the valuation continues to be relatively high so I don’t see it moving dramatically higher either.  It looks to me like a quiet period is the most likely scenario, and that is the ideal thing for a strategy of calendar spreads.

I will report back on the success of these spreads after the March expiration.  I like my chances here.

An Earnings Play on Green Mountain Coffee Roasters

Wednesday, January 22nd, 2014

Today I would like to tell you about an actual trade I made today in my personal account  as well as two Terry’s Tips portfolios.  The underlying is Green Mountain Coffee Roasters (GMCR) which is located in my home state of Vermont and is one of my favorite companies.This trade will make a nice gain if the stock stays flat or moves higher by any amount between now and 17 days from now, just after earnings are announced.

If the company disappoints in any way and the stock falls, I will have plenty of time to recover by selling new calls against my long positions over the next five months.

I believe this spread has an excellent chance of making a nice gain and there seems to be almost no chance that I will lose money on it even though it might take a little time to at least break even.

An Earnings Play on Green Mountain Coffee Roasters

GMCR announces earnings after the close on February 5, 2013.  The weekly options that expire a couple of days later, on February 7 are trading at extremely high valuations (implied volatility (IV) is 65).  I would like to sell some of that premium.

I am bullish on this company.  Two insider directors recently bought over a million dollars each of the stock (and they aren’t billionaires).  The company is buying back shares every quarter, so they must believe it is a good purchase.

One company wrote a Seeking Alpha article in which they picked GMCR as the absolute best company out of their database of over 7000 companies. Only a handful of other companies have met this criterion in the past, and on average, their stock has outperformed the S&P 500 by a factor of three. Check it out – Green Mountain Coffee Roasters: The Fundamental King.

I bought a diagonal call spread, buying GMCR Jun-14 70 calls and selling Feb1-14 80 calls.  The spread cost me $9.80 at a time when the stock was trading at just below $80.  If the stock moves higher, no matter how high it goes, this spread will be worth at least $10 plus the value of the time premium for the 70 call with about 5 months of remaining value, no matter how much IV might fall for the June options. The higher the stock might soar, the less I would make, but I expect I should make at least 20% on my money (if the stock moves a lot higher) in 17 days.

This is what the risk profile graph looked like at the end of the day today.  (In this portfolio, one of the 10 we conduct for Terry’s Tips subscribers to  follow), I bought 6 spreads which just under $6000.  Commissions were $15.  It shows the expected loss or gain on the investment on February 7th when the short calls expire:

gmcr risk profile graph jan 2014

gmcr risk profile graph jan 2014

If it stays flat I should make about 40% (the graph shows more, but IV for the June calls will most likely fall).  If it falls more than $5, I will be looking at a paper loss, but will still own 70 calls with 5 months of remaining life.  I should be able to sell weekly calls against these June 70 calls and recoup any paper losses that might come my way if the company disappoints on announcement day.

I believe this is a very safe bet that is highly unlikely to result in a loss, although I may have some money tied up for a while if the stock does tank after announcing.   But as usual, I hope that no one will take the risk with money that they can’t afford to lose.

 

 

 

 

Google Vertical Put Spread – Corrected Prices

Monday, December 23rd, 2013

Several subscribers wrote in and told me that my numbers were off on the Google spread.  I apologize.  At least I know that some of you read these ideas, so that is encouraging.I have fixed the numbers and repeated the words.  Here is the trade fill:

google trades Google Trades

As you can see, I actually did better than the $10.30 I reported below – I sold it for $10.46.  I had placed a limit order at $10.30 and assumed that was the price I got – it ended up being better than the limit price.

Google Vertical Put Spread – Corrected Prices

To repeat, my 2014 bet on Google is even more interesting, mostly because Google has moved higher over the course of the year 9 times out of 10.  Only in the market melt-down in 2007 did it end up lower than when it started out the year.

GOOG was trading at $1108 today, Monday, I sold a Jan-15 1120 put and bought a Jan-15 1100 put. (You could also trade the minis on GOOG which are one-tenth the value of the regular options).  I collected $10.30 ($1027.50 after paying $2.50 in commissions – the rate that Terry’s Tips subscribers pay at thinkorswim), from selling the vertical put spread and my maximum loss is $972.50.

There will be a $2000 maintenance requirement on this spread, but since I collected $1027.50, my maximum loss and the amount it required to place this trade is $972.50.

(Note: There is a big range between the bid and ask prices – it is important to place a limit order when trading these options rather than a market order.)  I will make over 105% on my investment for the year if the stock is at $1120 or any higher January 17, 2015 (it only needs to go up $12 over the course of a full year and a month).  After note:  GOOG is now trading at $1114 and only needs to go up by $6 for me to make 100%.

If I made this same bet every year for 10 years and Google behaved like it did over the past 10 years, I would collect a total of $9247.50 in the 9 winning years and lose $972.50 once, for a gain of $8275 over the decade, or an average of 85% a year on my money.  Again, this is a pretty good return in today’s market.

Critical to the success with these trades is the assumption that markets in the future will behave like they have in the past.  While that is not always the case, the past is usually a pretty good indicator of what the future might be.  These trades are just an example of how you can make superior returns using options rather than buying stock if you play the odds wisely.

 

Two Interesting Option Bets for 2014 – SPY and Google

Monday, December 23rd, 2013

Today I would like to tell you about two actual option trades that I made just this morning and my reasoning behind them.  They are both long-term bets on what I expect the market to do in 2014.  One of these bets might make an average of 85% every year if the market behaves like it has in the past.

By the way, last week when I salted this newsletter (and my blog) with the keywords “option trading” and “trading options” to see if Google Alerts picked it up, I was not surprised to see that I did not make the cut.  Google seems to have switched what they think is important from keywords to social media traffic, and since Terry’s Tips does not have a Facebook or Twitter account, I am not considered worthy of inclusion in their searches.  Oh well, at least I learned where I stand, right up there with the chopped liver.

I hope you will find these two trades I made interesting enough to consider doing on your own (only with money you can afford to lose) if you agree with my assumptions.

Two Interesting Option Bets for 2014 – SPY and Google

While most stocks go up some months and down others, when you check out how they perform for a whole year, most of the time they manage to move higher between the beginning and end of the year.

The market (using the S&P 500 tracking stock, SPY as the measure) has gone up or fallen by less than 2% in 33 out of 40 years.  A single stock I like, Google (GOOG), has gone up 9 out of the 10 years that it has been publicly traded.

I believe that a year from now, the market in general and GOOG in particular will be higher than it is today.  If I am right, the two trades I made today will make a gain of 53% on the market and 105% on GOOG.

With SPY trading at $182.30 today, allowing for a possible 2% loss in 2014, I decided to sell a Dec-14 180 put and at the same time, buy a Dec-14 170 put.  If SPY is above $180 when these puts expire on the third Friday of December (the 20th) 2014, both of these puts will expire worthless and I will be able to keep any cash I collected when I sold the spread today.

I sold the SPY vertical spread for $3.57 ($354.50 after commissions).  The maximum loss I can have from the spread will come about if SPY closes below $170 when the options expire.  Subtracting the $$354.50 I received from selling the spread from the $1000 maximum loss means that I will have risked $645.50 to possibly collect a possible $354.50.  This works out to a 53% return on my maximum loss.

My broker will post a maintenance requirement on my account for $1000 while we wait for the options to expire.  This is not a loan like a margin loan and no interest is charged.  It is just money cash in my account that I can’t use of other purposes for the year.  The actual amount of cash I have tied up in the spread is only $645.50 , however, since I collected $354.50 in cash when I sold the spread today.

If I made $354.5 in each of the 33 years when the market rose or fell by less than 2% and lost the entire $645.50 at risk in the 7 years when the market fell over the last 40 years, my average gain for the 40 years would be $179.50 per year, or 27% per year.  That beats most investments today by a huge margin.  (The actual average gain would be higher than this because in some of those 7 losing years the loss would not be a total one).

My 2014 bet on Google is even more interesting, mostly because Google has moved higher over the course of the year 9 times out of 10.  Only in the market melt-down in 2007 did it end up lower than when it started out the year.

GOOG was trading at $1008 today, Monday, I sold a Jan-15 1020 put and bought a Jan-15 1010 put. (You could also trade the minis on GOOG which are one-tenth the value of the regular options).  I collected $10.30 ($1027.50 after paying $2.50 in commissions – the rate that Terry’s Tips subscribers pay at thinkorswim), from selling the vertical put spread and my maximum loss is $972.50. (Note: There is a big range between the bid and ask prices – it is important to place a limit order when trading these options rather than a market order.)  I will make over 105% on my investment for the year if the stock is at $1020 or any higher January 17, 2015 (it only needs to go up $12 over the course of a full year and a month).

If I made this same bet every year for 10 years and Google behaved like it did over the past 10 years, I would collect a total of $9247.50 in the 9 winning years and lose $972.50 once, for a gain of $8275 over the decade, or an average of 85% a year on my money.  Again, this is a pretty good return in today’s market.

Critical to the success with these trades is the assumption that markets in the future will behave like they have in the past.  While that is not always the case, the past is usually a pretty good indicator of what the future might be.  These trades are just an example of how you can make superior returns using options rather than buying stock if you play the odds wisely.

 

 

 

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

Monday, November 25th, 2013

Today we are going to look at what the analysts are forecasting for 2014 and suggest some option strategies that will make 60% or more if any one of the analysts interviewed by the Wall Street Journal are correct. They don’t all have to be correct, just one of the 13 they talked to.

Please continue reading down so you can see how you can come on board as a Terry’s Tips subscriber for no cost at all while enjoying all the benefits that thinkorswim by TD Ameritrade offers to anyone who opens an account with them.

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

 
Now is the time for analysts everywhere to make their predictions of what will happen to the market in 2014.  Last week, the Wall Street Journal published an article entitled Wall Street bulls eye more stock gains in 2014.  Their forecasts – ”The average year-end price target of 13 stock strategists polled by Bloomberg is 1890, a 5.7% gain … (for the S&P 500).  The most bullish call comes from John Stoltzfus, chief investment strategist at Oppenheimer (a prediction of +13%).”
The Journal continues to say “The bad news: Two stock strategists are predicting that the S&P 500 will finish next year below its current level. Barry Bannister, chief equity strategist at Stifel Nicolaus, for example, predicts the index will fall to 1750, which represents a drop of 2% from Tuesday’s close.”
I would like to suggest a strategy that will make 60% to 100% (depending on which underlying you choose to use) if any one of those analysts is right. In other words, if the market goes up by any amount or falls by 2%, you would make those returns with a single options trade that will expire at the end of 2014.
The S&P tracking stock (SPY) is trading around $180.  If it were to fall by 2% in 2014, it would be trading about $176.40.  Let’s use $176 as our downside target to give the pessimistic analyst a little wiggle room.  If we were to sell a Dec-14 176 put and buy a Dec-14 171 put, we could collect $1.87 ($187) per contract.  A maintenance requirement of $500 would be made.  Subtracting the $187 you received, you will have tied up $313 which represents the greatest loss that could come your way (if SPY were to close below $171, a drop of 5% from its present level). 
Once you place these trades (called selling a vertical put spread), you sit back and do nothing for an entire year (until these options expire on December 20, 2014). If SPY closes at any price above $176, both puts would expire worthless and you would get to keep $187 per contract, or 60% on your maximum risk. 
You could make 100% on your investment with a similar play using Apple as the underlying.  You would have to make the assumption that Apple will fluctuate in 2014 about as much as the S&P.  For most of the past few years, Apple has done much better than the general market, so it is not so much of a stretch to bet that it will keep up with the S&P in 2014.
Apple is currently trading about $520.  You could sell at vertical put spread for the January 2015 series, selling the 510 put and buying the 480 put and collect a credit of $15.  If Apple closes at any price above $510 on January 17, 2015, both puts would expire worthless and you would make 100% on your investment.  You would receive $1500 for each of these spreads you placed and there would be a $1500 maintenance requirement (the maximum loss if Apple closes below $480).
Apple is trading at about 10 times earnings on a cash-adjusted basis, is paying a 2.3% dividend, and is continuing an aggressive stock buy-back campaign, three indications that make a big stock price drop less likely to come about in 2014.
A similar spread could be made with Google puts, but the market is betting that Google is less likely to fall than Apple, and your return on investment would be about 75% if Google fell 2% or went up by any amount.  You could sell Jan-15 1020 puts and buy Jan-15 990 puts and collect about $1300 and incur a net maintenance requirement of $1700 (your maximum loss amount).
If you wanted to get a little more aggressive, you could make the assumption that the average estimate of the 13 analysts was on the money, (i.e., the market rises 5.7% in 2014).  That would put SPY at $190 at the end of the year. You could sell a SPY Dec-14 190 put and buy a Dec-14 185 put and collect $2.85 ($285), risking $2.15 ($215) per contract.  If the analysts are right and SPY ends up above $190, you would earn 132% on your investment for the year.
By the way, you can do any of the above spreads in an IRA if you choose the right broker.  I would advise against it, however, because your gains will eventually be taxed at ordinary income rates (at a time when your tax rate is likely to be higher) rather than capital gains rates.
Note: I prefer using puts rather than calls for these spreads because if you are right, nothing needs to be done at expiration, both options expire worthless, and no commissions are incurred to exit the positions.  Buying a vertical call spread is mathematically identical to selling a vertical put spread at these same strike prices, but it will involve selling the spread at expiration and paying commissions.
What are the chances that every single analyst was wrong?  Someone should do a study on earlier projections and give us an answer to that question.  We all know that a market tumble could come our way if the Fed begins to taper, but does that mean the market as a whole would drop for the entire year?  Another unanswerable question, at least at this time.
On a historical basis, for the 40 years of the S&P 500’s existence (counting 2013 which will surely be a gaining year), the index has fallen by more than 2% in 7 years.  That means if historical patterns continue for 2014, there is a 17.5% chance that you will lose your entire bet and an 83.5% chance that you will make 60% (using the first SPY spread outlined above).  If you had made that same bet every year for the past 40 years, you would have made 60% in 33 years and lost 100% in 7 years.  For the entire time span, you would have enjoyed an average gain of 32% per year.  Not a bad average gain.

Barron’s Article Creates Great Buying Opportunity For Green Mountain Coffee Roasters

Monday, August 5th, 2013

This morning Green Mountain Coffee Roasters (GMCR) fell more than $2, apparently because of a negative article about the company published by Barron’s on Saturday.  I submitted an article to Seeking Alpha in which I argued that Barron’s had inappropriately used some statistics and made some faulty comparisons of GMCR’s p/e ratios and their competitors.

I’m not sure if my article really turned the market around, but in the first two hours after it was published, the stock went from being down $2 to being up $2.50, a swing of over $4.50  or well over 5%.

In this article I recommended buying a diagonal call spread which I will discuss today.

Read to the bottom of this letter to learn how you can become a Terry’s Tips Insider for absolutely no cost.

Terry

Barron’s Article Creates Great Buying Opportunity For Green Mountain Coffee Roasters

In this article I made a case that GMCR would move higher and that the Barron’s article had temporarily unfairly pushed the stock lower.   In a Terry’s Tips portfolio, we purchased the spread I recommended in the article for $10.93.  The natural price is now $12.15 so we have a paper profit of about 10% for the day.

I recommended making a fairly conservative options investment, buying Dec-13 well in-the-money calls at the 67.5 strike when the stock was trading about $78 and selling Aug2-13 weekly calls at the 77.5 strike.  I selected the Dec-13 series because implied volatility of those options (55) was lower than any other weekly or monthly series, and since the December expiration comes well after the next earnings announcement in late October or early November, IV is not likely to plummet after Wednesday’s announcement like the August, September, and October options will probably do.

IV of the Aug2-13 weeklies is a whopping 137, just the kind of options that we like to sell.

This diagonal spread should make an average of about 25% this week if the stock stays flat or goes up by any reasonable amount, and should only lose money if the stock falls by more than 7%.  This seems like a pretty good bet to me, and I have bought a large number of these spreads in my personal account.

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