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Back-Testing the 10K Classic Options Strategy

Monday, June 25th, 2012

This week I would like to share a report I sent to paying subscribers this week.  It is a back test of a portfolio we set up just a month ago to carry out the precise strategy outlined in my book, Making 36%: Duffer’s Guide to Breaking Par in the Market Every Year in Good Years and Bad (the revised 2012 edition is the 5th printing).  I believe it gives a definitive answer to the question “Do calendar spreads really work?”

Back-Testing the 10K Classic Options Strategy

The originally-stated goal of the 10K Classic portfolio was to deliver consistent 3% monthly gains and never have a losing month.  This portfolio uses S&P 500 tracking stock (SPY) as the underlying, and uses true deep in-the-money LEAPS as the long side (a full 19 months out to start) and Weekly short calls at several strikes both above the stock price (usually 2 out of 5 to start the week) and below the stock price (usually 3 out of 5 to start the week).  We generally do not make any adjustment trades until Thursday when some calls might be rolled to the next Weekly series at a different strike to make the portfolio more neutral net delta.

I wanted to see what would happen if we made absolutely no adjustments to the 10K Classic during the week based on the risk profile graph of the $9800 portfolio on June 15, 2012 and the weekly price changes for SPY that had taken place over the past 100 weeks.  Here are the results:

This table groups the weekly price changes in dollars into 19 groups and multiplies the number of occurrences in each group by the loss or gain that would have occurred with that price change according to the risk profile graph displayed with the thinkorswim software.  I reduced the indicated gain or loss by $50 each week to account for commission costs and transaction costs (we typically buy back out-of-the-money expiring calls for $3 or so, or pay a small premium when rolling over in-the-money calls).  Of course, VIX was relatively high on this date (about 22), so the gains might be less if VIX were appreciably lower.

In 76% of the weeks, a gain would have been made and in 24% of the weeks, a loss would have resulted. In the gaining weeks, the average gain was $284 and the in the losing weeks, the average loss was $445.   On an average of once a year (1 week out of each 50), a greater-than-15% loss would have occurred if no adjustments were made.

The bottom line is most encouraging.  It says that the portfolio would earn 100% over two years if those positions were in place and no adjustments were made during the week.  In order to carry out a strategy of making no adjustments, however, we would have to be willing to tolerate a weekly loss of about $1400 once every year.  

Since about two weeks a year, very large weekly losses might occur (averaging about $1000), it seems best to slightly alter our goal of never having a losing month.  When we encounter one of these weeks, the other 3 weeks of the month might not always do well enough to cover that large a loss.  Our new goal will to never have a losing month as long as the stock does not fluctuate more than $7 in one week during the month.  The more important 3%-a-month goal will continue to be in place. 

The first month for the portfolio (up 5.1%) is certainly an encouraging start, especially with the volatility that we experienced during that time period. 

The originally-stated goal of the 10K Classic portfolio was to deliver consistent 3% monthly gains and never have a losing month.  This portfolio uses S&P 500 tracking stock (SPY) as the underlying, and uses true deep in-the-money LEAPS as the long side (a full 19 months out to start) and Weekly short calls at several strikes both above the stock price (usually 2 out of 5 to start the week) and below the stock price (usually 3 out of 5 to start the week).  We generally do not make any adjustment trades until Thursday when some calls might be rolled to the next Weekly series at a different strike to make the portfolio more neutral net delta.

I wanted to see what would happen if we made absolutely no adjustments to the 10K Classic during the week based on the risk profile graph of the $9800 portfolio on June 15, 2012 and the weekly price changes for SPY that had taken place over the past 100 weeks.  Here are the results:

This table groups the weekly price changes in dollars into 19 groups and multiplies the number of occurrences in each group by the loss or gain that would have occurred with that price change according to the risk profile graph displayed with the thinkorswim software.  I reduced the indicated gain or loss by $50 each week to account for commission costs and transaction costs (we typically buy back out-of-the-money expiring calls for $3 or so, or pay a small premium when rolling over in-the-money calls).  Of course, VIX was relatively high on this date (about 22), so the gains might be less if VIX were appreciably lower.

In 76% of the weeks, a gain would have been made and in 24% of the weeks, a loss would have resulted. In the gaining weeks, the average gain was $284 and the in the losing weeks, the average loss was $445.   On an average of once a year (1 week out of each 50), a greater-than-15% loss would have occurred if no adjustments were made.

The bottom line is most encouraging.  It says that the portfolio would earn 100% over two years if those positions were in place and no adjustments were made during the week.  In order to carry out a strategy of making no adjustments, however, we would have to be willing to tolerate a weekly loss of about $1400 once every year.  

Since about two weeks a year, very large weekly losses might occur (averaging about $1000), it seems best to slightly alter our goal of never having a losing month.  When we encounter one of these weeks, the other 3 weeks of the month might not always do well enough to cover that large a loss.  Our new goal will to never have a losing month as long as the stock does not fluctuate more than $7 in one week during the month.  The more important 3%-a-month goal will continue to be in place. 

The first month for the portfolio (up 5.1%) is certainly an encouraging start, especially with the volatility that we experienced during that time period.

Andy’s Market Report 6/17/12

Sunday, June 17th, 2012

June options expiration is behind us and it ended in the bulls favor. The S&P 500 just came off the best week of 2012, only to have another rally this past week of 1.3%. But, that does not mean we can rest on our laurels because now we have what could be the biggest event of the summer upon us – the Greek elections.

European leaders have basically pleaded with Greece to reject the leftist SYRIZA party as the party promises to reject what would certainly be punishing terms from the 130 billion euro bailout offered by the EU.

The bailout will not be renegotiated, warned German Chancellor Angela Merkel, whose country’s wealth is vital to shoring up its weaker partners in the bloc.

But many in Greece and beyond state that Greece’s lenders are bluffing when they threaten to turn off the funds if Athens reneges on the terms of the bailout – tax hikes, job losses and pay cuts that have helped condemn the country to five years of record-breaking recession.

So, the question is how will the outcome on Sunday affect the U.S. markets? The answer is easy….no one knows.

The only certainty is the gap from 6/6 in the SPDR S&P 500 ETF (SPY) has yet to close. A move back to $129.36 would close the gap.

Moreover, the DOW just pushed above its 50-day moving average. A continuation of that trend has proven positive over the next 6 months, but a failure as seen by an almost immediate push back below the 50-day has been rather volatile for the market.

According to Jason Goepfert of Sentimentrader.com, “when the Dow was lower after it rose above its 50- day moving average, then the next six months were positive 55% of the time”. But the swings ranged from up 22.7% to lower -15.8%. I think we could see much of the same as we enter the summer doldrums. Low- volume allows for widely vacillating markets and that is exactly what we tend to see during the months of July, August and part of September.

As for the short-term direction of the market, most of the major indices are nearing a short-term overbought state. This means that a pullback (1-3 days) is anticipated. Furthermore, the day following options expiration, particularly a triple witching event is historically bearish. However, with the Greece election Sunday I think all of the historical precedents should be tossed aside.

If we do see a push higher at the open Monday I would not be surprised to see an immediate sell-off. Remember, things aren’t so great in the U.S. economy right now. I am amazed how the poor jobs report reported only a few weeks ago has been forgotten.

The best thing you can do right now, stay nimble. Expect volatility and don’t be surprised by a nice “summer doldrums” sell-off.

How to Make a Portfolio of Calendar Spreads Either Bearish or Bullish

Monday, June 11th, 2012

I am pleased to offer the 2012 ebook version of Making 36% for only $2.99. This is your chance to learn everything you need to know about options (ok, maybe almost everything) for a lower price than ever before.  Order here and use the code [this code is no longer valid].  The order form will say that you will receive the 2011 paperback edition but if you use the [this code is no longer valid] code, you will receive the 2012 ebook instead. (The revised 2012 paperback edition will be available in about two weeks if you would prefer to wait and get the hard copy at the regular price).

Even if you have purchased an earlier edition of my book, you might want to see the new version.  Two new important strategies are spelled out for the first time – the 10K STUDD (Short Term Ultra Double Diagonal) and the Calendar Twist (a new approach to placing calendar spreads).  Either strategy might change everything you ever thought about trading options.

How to Make a Portfolio of Calendar Spreads Either Bearish or Bullish:

At Terry’s Tips, we use an options strategy that consists of owning calendar (or diagonal) spreads at many different strike prices, both above and below the stock price.  Six of the eight actual portfolios we carry out use SPY as the underlying so we are betting on the market as a whole rather than any individual stock.

We typically start out each week or month with a slightly bullish posture since the market has historically moved higher more times than it has fallen.  In option terms, this is called being positive net delta.  Starting in May and extending through August, we usually start out with a slightly bearish posture (negative net delta) in deference to the “sell in May” adage.

Any calendar spread makes its maximum gain if the stock ends up on expiration day exactly at the strike price of the calendar spread.  As the market moves either up or down, adding new spreads at different strikes is essentially placing a new bet at the new strike price.  In other words, you hope the market will move toward that strike.

If the market moves higher, we add new calendar spreads at a strike which is higher than the stock price (and vice versa if the market moves lower).  New spreads at strikes higher than the stock price are bullish bets and new spreads at strikes below the stock price are bearish bets.

If the market moves higher when we are positive net delta, we should make gains because of our positive delta condition (in addition to decay gains that should take place regardless of what the market does).  If the market moves lower when we are positive net delta, we would lose portfolio value because of the bullish delta condition, but some or all of these losses would be offset by the daily gains we enjoy from theta (the net daily decay of all the options).

Another variable affects calendar spread portfolio values.  Option prices (VIX) may rise or fall in general.  VIX typically falls with a rising market and moves higher when the market tanks.  While not as important as the net delta value, lower VIX levels tend to depress calendar spread portfolio values (and rising VIX levels tend to improve calendar spread portfolio values).

Once again, trading options is more complicated than trading stock, but can be considerably more interesting, challenging, and ultimately profitable than the simple purchase of stock or mutual funds.

Option Prices and VIX

Monday, June 4th, 2012

Last week was a bad one for the market.  Friday’s 2.5% drop was the worst day in all of 2012.  Many Terry’s Tips subscribers did just fine because of our 10K Bear portfolio which gained 23.4% for the week.  Over the past five weeks while the market has fallen 8.7%, this bearish options portfolio has gained a whopping 135%.  Once again, options offer opportunities that conventional investments just can’t deliver.

Today I would like to talk about an important options measure called VIX.

Option Prices and VIX

VIX is a measure of the average Implied Volatility of SPY, the tracking stock of the S&P 500.  It is often referred to as the “fear index.”  When investors get scared, they often buy put options and/or sell call options to protect themselves against a big market drop.  When this happens, VIX (and option prices in general) usually moves higher.

VIX almost always moves in the opposite direction of the market.  If the market moves higher, VIX usually moves lower, and vice versa.

On Friday, VIX closed at 26.66, driven higher by the big drop in stock values.  VIX is essentially the percentage change that the market is expected to fluctuate in a year.  The mean average of VIX is about 20, far less than it is today.  Quite often, when there is a sideways market with little volatility, VIX hangs out as low as 16.

Today’s high VIX number means that option prices are high.  It is the perfect situation for our strategy of selling short-term premium.  We love a high VIX.

When VIX moves higher, not only is it possible to collect more premium decay each week or month, but the entire portfolio made up of calendar spreads is likely to move higher as well.  This occurs because the long side of our calendar spreads (the options with more remaining life and therefore the ones with a higher absolute value) increase in value by more than the short-term options that we are short. 

If an option trading at $6.00 goes up 10%, the option will be worth $.60 more, while a short option covered by that longer-term $6.00 option might be trading at $.90, and it might only go up by $.09.  If you had 10 of those spreads in place, your portfolio would increase in value by $510 just because of the higher option prices that result when VIX moves higher.

Trading options is far more complicated than most investments.  If you are just buying stock or mutual funds, you don’t even have to know about VIX.  But we believe that there is a big payoff for making a little effort to learn about the extraordinary possible returns that an options portfolio can deliver if it is properly constructed.

Andy’s Market Report 5/6/12

Sunday, May 6th, 2012

Bears rejoice.

The market experienced its worst week of 2012 on the back of a worse than anticipated unemployment report.

The S&P 500 fell 1.6% to 1,369.10, extending its weekly drop to 2.4%. The Dow slumped 168.32 or 1.3%, to 13,038.27 Friday.

Employers added 115,000 jobs in April, the Labor Department stated on Friday. It was the third straight month in which hiring had slowed, intensifying fears the U.S. recovery is truly losing momentum.

In addition, even a slight drop in the unemployment rate to 8.1% had a dark tone because the fall was due entirely to people dropping out of the workforce.

“The bottom line is you don’t have evidence that this economy has reached escape velocity,” said Robert Tipp, an investment strategist at Prudential Fixed Income.

Analysts had expected 170,000 new jobs in April, and the shortfall could open the door a bit wider for the Federal Reserve to step up efforts to help the economy with another round of quantitative easing.
The employment report included another ominous numbers. The participation rate, a measure of how many Americans are looking for work, fell to a 30-year low at 63.6% of the population.

But kicking the can down the road once again isn’t the ultimate answer. The economy is not growing as fast as needed and with continued woes in Europe there could be another rough road ahead. This of course is just speculation, but when stripped down to its core the economy does not look promising over the coming months.

Technical Mumbo Jumbo

The S&P pushed through 1370 and is now on track to hit 1350. If the major market index is able to push through that level I would expect to see a test of the 1290 area. However, I do expect to see a short-term bounce over the near-term only because of the oversold nature of the market. But, once that kicks back into a neutral state which might only take half a trading day, I expect the selling to start back up.

Remember, sell in May is upon us and I expect to see the historical norms to once again play out this year. One of the perks is that volatility as see by the VIX, VXX and VXN should increase which should afford some great opportunities to sell premium.

The economic calendar is light next week, but elections in Europe should stir the market pot during the early part of the week. One thing is certain next week should be very interesting…possibly the most interesting week of the year.

Stay tuned!

Using Puts vs. Calls for Calendar Spreads

Monday, April 16th, 2012

Over the last two weeks, the market (SPY) has fallen about 3%, the first two down weeks of 2012.  At Terry’s Tips, we carry out a bearish portfolio called 10K Bear which subscribers mirror if they want some protection against these kinds of weeks.  They were rewarded this time, as usual, when the market turned south.  They gained 45% on their money while SPY fell 3%.

10K Bear is down slightly for all of 2012 because up until the last two weeks, the market has been quite strong.  If someone invested in all eight of our portfolios, however, their net gain so far in 2012 would be greater than 50%.  How many investments out there do you suppose are doing that well?

10K Bear predominantly uses calendar spreads (puts) at strike prices which are lower than the current price of the stock.  Today I would like to discuss a little about the choice of using puts or calls for calendar spreads.

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 2012, 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.  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).

The choice of using puts or calls for a calendar spread is most relevant when considering at-the-money spreads.  When buying at-the-money calendar spreads, the least expensive choice (puts or calls) should usually be made. An exception to this rule comes when one of the quarterly SPY dividends is about to come due.  On the day the dividend is payable (always on expiration Friday), the stock is expected to fall by the amount of the dividend (usually about $.60).  Since the market anticipates this drop in the stock (and knowing the specific day that the stock will fall), put prices are generally bid higher in the weeks before that dividend date.

This bottom line is that put calendar spreads are preferable to call calendar spreads for at-the-money strikes (or even at strikes slightly higher than the stock price) coming into a SPY dividend date. Even though the put spreads cost more, the Weekly options that can be sold for enough extra to cover the higher cost.  You do not want to own SPY call calendar spreads which might become in the money on the third Friday of March, June, September, or December because you will have to buy them back on Thursday to avoid paying the dividend, and you may not want to make that purchase to keep your entire portfolio balanced.

How to Contend With Historically Low Option Prices

Monday, March 19th, 2012

Option prices for the market in general (SPY) are lower than they have been for five years.  Maybe it is time to change from a strategy of selling short-term options (the strategy carried out at Terry’s Tips) to one of buying those options and hoping the market is more volatile than those low option prices would expect.

We will discuss that possibility today.

How to Contend With Historically Low Option Prices

Before discussing the situation of low option prices for most equities, I should comment on the continuing high option prices for Apple.  Implied Volatility (IV – the most important determinate of whether option prices are “high” or “low”) is about 40 for AAPL.  This means the market is expecting AAPL to fluctuate about 40% over the course of a year.

The high option prices for AAPL has meant that our calendar spread strategies has been quite successful of late (we move our calendar spreads to new strike prices as the stock moves higher).  We carry out two AAPL portfolios at Terry’s Tips – one gained 8% last week and the other gained over 20%.  The one that gained 8% has been operating for one month less than two years and is now ahead by 642%.  It is our most profitable portfolio by a large margin. 

Compare this 40 IV number for AAPL to IV of the S&P 500 tracking stock, SPY, which is called VIX.  It is less than 15, and briefly fell below 14 last week for the first time since I can remember.  This is extreme low territory (the mean average is about 20).

The IV picture for SPY gets even more interesting when you check out the Weekly options.  When VIX is calculated, the Weekly option prices are not included (only options with 8 or more days of remaining life or included).  IV for the SPY Weeklys is only 12.47.

Last week SPY rose $2.70 and the week before, moved by $3 in both directions during the week.  If you bought an at-the-money straddle or strangle using SPY Weeklys at today’s prices in either of those weeks, you would surely have doubled your money in a single week.

With SPY closing at $140.30 last Friday, you could have bought a 140 Weekly straddle (both a put and call at the 140 strike) for $1.80 or a strangle (the 141 call and the 140 put) for $1.33.  If the stock moved by at least $1.50 in either direction next week, either of those purchases should result in a gain.  SPY moves by that much in just about every week, even in quiet markets like we have been having so far this year.

_ _ _

It is an interesting trade to try.  I plan to buy a few this week (in both my personal account and in one of the Terry’s Tips portfolios), just to test it out.  Of course, you should never risk money that you can’t afford to lose.

We have made 3 short videos which explain the 3-week results of our AAPL trading. The original positions were set out in an actual account carried out at Terry’s Tips.  The YouTube link is http://youtu.be/6J9KPuimyXk

The portfolio was updated in the Week 2 video -
http://youtu.be/e0B7_6e_5AE 

And finally, adjustment trades we made were displayed in this little video –
http://youtu.be/YC3d2NuX2MI  Be sure to enlarge it to full-screen mode so you can see the numbers. 
_ _ _
Any questions?   I would love to hear from you by email (terry@terrystips.com), or if you would like to talk to our guy Seth, give him a jingle at 800-803-4595 and either ask him your question(s) or give him your thoughts.

You can see every trade made in 8 actual option portfolios conducted at Terry’s Tips (including the two AAPL-based portfolios) and learn all about the wonderful world of options by subscribing here.   Why wait any longer to make this important investment in yourself? 

I look forward to having you on board, and to prospering with you.

Terry

Andy’s Market Report – 1/31/12

Tuesday, January 31st, 2012

January’s rally was admirable. Its perseverance frustrated bears. The infrequent single day declines maxed out at -0.6%.

And the last nine days of the month were more than mind-numbing for most traders as the market traded in a very tight range.

There’s no doubt the bears are ready. Almost every technical and sentiment measure I follow has pushed into a bearish state. Typically, I am ecstatic by the weight of the bearish measures, but it seems everyone is aware of the measures and have joined my short-term bearish camp. And when the herd is anticipating something a bearish move might have a hard time coming to fruition.

That was certainly the case last month.
We must remember that January is one of the strongest month of the year for the market. February not so strong with a historical return of 0.0%.

February swoon? Not yet.

After Friday’s unemployment report, the bulls managed to push the indices, particularly the Dow to highs not seen since before the financial crisis in 2008. A drop in the unemployment rate to its lowest level in three years (8.3%) propelled stocks.

“In this economy only one variable matters right now and that variable is employment,” said Lawrence Creatura, an equity portfolio manager at Federated Investors.

“This report was great news. It was beyond all expectations, literally. The number was higher than even the highest forecast.”

After three months of gains a decline seems the likely scenario. Again, almost all technical and sentiment measures have reached short to intermediate-term extremes, but will they win out for the bears or will the mighty power of the bulls push through the consolidation that has lasted nine long trading days?

Talented analyst Jason Goepfert of Sentimentrader.com recently stated that when “the S&P 500 closed at a six-month high with volume 10% off its low from the past month (as it did on Thursday), then the next two days were positive only 12 out of 46 times.”

Out of the 12 positive occurrences, only twice did it advance more than 1%. Thirteen times it closed with a loss greater than 1%.

Another interesting stat provided by Mr. Goepfert is “the last 8 Fridays when the Nonfarm Payroll report was released” all have closed lower than the prior trading day.

In fact, if you went back to September 2009 and purchased shares of the S&P and sold at the close of the trading day you would have only made a paltry 1%.

Couple the aforementioned studies with short-term overbought readings in three out of the four major indices and I expect to see a short-term pullback over the next 1-5 days.

The two best performing days (on a historical basis) in February are now behind us and now we are entering into a period of bearish seasonality.
Just more food for thought.

Andy’s Market Report – January 30, 2012

Tuesday, January 31st, 2012

Have you seen the VIX lately?

18.53? Seriously?

Well, some of you asked for it and now look what you get in return – low options premium. Sellers of options need volatility, we thrive on volatility. Volatility is our friend.

But volatility is at a six-month low, which raises hopes that a calmer market will bring in more investors. There is certainly no doubt that most risk is tied up in bonds right now, but once investors are willing to take on more risk they will move back into the stock market. The question is when.

“Lower volatility is like a security blanket for retail investors. It allows them to invest for the long term,” said Ben Schwartz, chief market strategist at Lightspeed Financial, the retail broker. “Investors remain nervous about the eurozone crisis, but money is beginning to trickle back.”

Although investment banks and their institutional clients are not convinced that volatility will remain low. Because, low volatility equates to a low-price hedge against a sharp market decline.

“With Vix levels so low, this is a good time for investors to put on hedge positions,” said Pankaj Khandelwal, a senior Vix trader at Barclays Capital. “Even if you have a bullish view on the market, you can buy downside protection for your portfolio at low prices right now,” said Pankaj Khandelwal, a senior Vix trader at Barclays Capital.

And the smart money or commercial hedgers (among the largest traders in the market) have gone net short on Nasdaq, Dow and Russell 2000 futures.

This is telling.

Because when commercial hedgers move net short the market typically witnesses a correction shortly thereafter.

Whether or not we see a decline soon is THE hot question right now.

For the last three weeks it’s been like the movie Groundhog Day. Every day I wake up and market moves higher.

But the bearish indicators are piling up. But the tower of stacked pennies inevitably falls when it does – it typically comes crashing down.

Unless, we have truly entered into a market environment where investors are moving money off the sidelines and into the market then this bull run could continue. But the numbers just aren’t there. Volume is incredibly low and has been throughout the majority of this bull rally.

Has it been a bear trap all along?

Maybe so, maybe not, but one thing IS for certain, with the market at these elevated levels the risk is to the upside. Trade accordingly.

A Look at the Downsides of Option Investing

Monday, January 9th, 2012

Most of the time, we talk about the wonderful aspects of investing in options. I am proud that the new strategy we set up five weeks ago has now had five consecutive weeks of gains (averaging over 5% a week), but today I would like to discuss some of the negatives in trading options.  Unfortunately, there are a few.

A Look at the Downsides of Option Investing

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

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

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

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

One of our most popular portfolio (we call it the 10K Bear) has gained nearly 70% (after commissions, of course) in the last six months.  The underlying stock for the 10K Bear is the S&P 500 tracking stock, SPY, one of the most stable of all indexes.  Yet our weekly results included a loss of 34.7% in the last week of November when SPY rose $8.52 in a single week (a highly-unusual upside move).  Many times over the past six months, our weekly gains were above 20%, however, when SPY fell in value during the week.

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

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

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

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

With CD’s and bonds yielding ridiculously low returns (and the stock market not really showing any gains for the past 4 years), the options alternative has become more attractive for many investors, in spite of all the problems we have outlined above.

Making 36%

Making 36% — A Duffer's Guide to Breaking Par in the Market Every Year in Good Years and Bad

This book may not improve your golf game, but it might change your financial situation so that you will have more time for the greens and fairways (and sometimes the woods).

Learn why Dr. Allen believes that the 10K Strategy is less risky than owning stocks or mutual funds, and why it is especially appropriate for your IRA.

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Success Stories

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

~ John Collins