Today I would like to share some thoughts I sent out on Saturday to paying subscribers at Terry’s Tips. These thoughts reflected on the recent successes of the nine actual options portfolios we carry out and comment on each week. By the way, all nine portfolios are profitable for 2017 and the composite average gain is currently 28.9% since the beginning of the year. Last week while the market (SPY) fell 0.3%, our portfolios gained an average of 3.2% for the week, demonstrating that we don’t have to rely on a rising market to enjoy portfolio gains.
What Can Be Learned From Successful Option Strategies
If we can identify the strategies that resulted in the extraordinary returns we have enjoyed in the first quarter, maybe we can use those strategies for other underlying stocks or ETPs and time periods.
First, we must admit that we had some good luck. Anyone who makes these kinds of returns must admit that some of it was based on pure luck. Anyone who follows the mutual fund industry knows this intimately. Every year, millions of dollars get plowed into the top-performing funds, and a year or five years later (whichever period the top-rated award covered), those funds almost universally underperform in the subsequent period. As Burton Malkiel explained in the oft-revised book, A Random Walk Down Wall Street, - ”The past history of stock prices cannot be used to predict the future in any meaningful way.” The top stocks (or mutual funds) end up in that position largely on a random basis. (Some of us remember way back when the Wall Street Journal had a column where monkeys throwing darts competed against the top picks of top-rated analysts, and the monkeys won about half the time.)
But luck doesn’t account for it all. Our biggest winner was Wiley Wolf where FB rose 21.6% for the year. Our portfolio is up 117.5%, or 5.4 times greater. This is the only portfolio that uses the 10k Strategy, and we have learned that it will return a multiple of what the stock price does. Unfortunately, that works in both directions, and if the stock had fallen by that amount, our losses would have been proportionately greater. So we can conclude that we were lucky to be playing FB for a period when it was rising nicely, but our strategy had something to do with achieving the exceptional returns.
A less dramatic explanation of the power of an options strategy has taken place in our SPY-based Leaping Leopard portfolio. In this portfolio, we are using the strategy of long-term vertical put credit spreads. This is our favorite way to play underlyings which we believe will at least remain flat, or are likely to rise. The market (SPY) has picked up 4.9% for the year to date, a wonderful record. Our Leaping Leopard portfolio has gained 14.9%, or 3 times the size of the index gain. Even better, our strategy is set up so that if SPY loses as much as 5% or goes up by any amount over the course of the year, we will enjoy a gain of about 40%. The huge difference between what the market does and our portfolio performance is clearly caused by the strategy.
Returning to the being lucky theme, the volatility-related portfolios have prospered because contango has remained at an elevated level for the entire first quarter of the year. With the election of a president whose promises and plans were seen to be unusually volatile and uncertain (which ideas would be proposed, and which might actually become real was a real question), the market expected that in the near future, volatility would be great. Meanwhile, the market racked up small and steady gains, and VIX fell to historic lows and has pretty much remained there. When VIX is low and the futures are predicting high uncertainty for SPY, contango rises to the historic highs we have seen pretty much all year.
This contango condition has been the major contributor to our Contango portfolio gaining 44.6% so far this year, and to a lesser degree, the 29% gain in Vista Valley and the 14.7% gain in Capstone Cascade. In the Capstone Cascade portfolio, SVXY has soared by over 40% for the year, a perfect backdrop for a strategy of selling naked puts on the underlying ETP. At the present level of theta, this portfolio will gain over 100% for the year. We have been selling at strikes which are seriously out-of-the-money, and we would have done just as well if SVXY had not soared like it did. Even worse, we tried to protect against the possibility of a falling SVXY (we bought into the fears that uncertainty would be the predominant condition), and we also sold some well out-of-the-money calls on the ETP. These short calls caused our returns to be lower than if we had not been so worried that volatility would heat up.
It is far more difficult to predict the short-term movements of a stock than the longer-term movements. Short-term fluctuations are often caused by emotionally-driven actions in response to news items such as analysts upgrades or downgrades or quarterly numbers or rumors, while longer-term fluctuations are more likely to be based on the fundamental performance of the underlying company or ETP. In most of our portfolios, we take a longer-term perspective, such as our Boomer’s Revenge portfolio where the shortest-term spread had six months of remaining life when it was placed. This portfolio is our most conservative, and is designed to gain 30% for the year. So far, thanks to the rising market, it is ahead of schedule, picking up 18.2% to date. We are now in the enviable position of being able to look forward to the full 30% annual gains even if the 5 underlying stocks were to fall by 10% between now and the end of the year.
To summarize, the first 11 weeks of 2017 have been good ones for the market. SPY has gained 4.9%. The prudent owner of a large-market-based index fund will have gained this much so far this year. This is about the average 2017 gain initially predicted by the composite of the published analysts we identified at the outset of the year. So the market has achieved in 11 weeks what the analysts expected for the entire year, making it a remarkable year so far.
The difference between this 4.9% market gain and the composite 28.9% of our portfolios is clearly due to the options strategies that we have employed. Options are leveraged investments, and should be expected to perform exponentially better (or worse) than the percentage gains of their underlyings. However, in most of our portfolios, we can look forward to unusually large gains when the underlyings remain absolutely flat or even lose a little over the course of the year. This fact alone is proof that a well-designed and executed options strategy can be expected to outperform the market in general or any mutual fund in particular (where over 80% of the funds have underperformed the market over a multi-decade time period, yet still collect billions of dollars every year in fees for their efforts). We like to think that the performance of our portfolios so far this year is the result of our doing a decent job in the options arena.