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
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.