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.