Last week we discussed vertical spreads. This week, I would like to continue that discussion by repeating some of what we reported in late December of last year. It involves making a relatively long-term (one year) bet on the direction of the entire market.
And again, a brief plug for my step-daughter’s new fitness invention called the Da Vinci BodyBoard – it gives you a full body workout in only 20 minutes a day right in your home. She has launched a KickStarter campaign to get financing and offer it to the world – check it out: https://www.kickstarter.com/projects/412276080/da-vinci-bodyboard
How to Make 60% to 100% in 2014 if a Single Analyst (Out of 13) is Right – an Update
This is part of we wrote last December – “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% or more (depending on which strike prices 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). We placed this exact spread in one of the 10 actual portfolios we carry out at Terry’s Tips.
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.
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 mean SPY would be 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.
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.”
We are now entering November, and SPY is trading around $201. It could fall by $25 and the 60%-gainer spread listed above would make the maximum gain, or it could fall by $12 and you could make 132% on your money for the year. Where else can you make these kinds of returns these days?
On a historical basis, for the 40 years of the S&P 500’s existence, 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.
Update on the ongoing SVXY put demonstration portfolio. (We owned one Mar-15 65 put, and each week, we roll over a short put to the next weekly which is about $1 in the money (i.e., at a strike which is $1 higher than the stock price). SVXY soared higher this week, and we had to make an adjustment. We wanted to sell a weekly put at the 70 strike since the stock was trading around $68, but that strike is $3 higher than our long put, and we would create a maintenance requirement of $300 to sell that strike put.
Instead, today I sold the Mar-15 65 put and bought a Mar-15 70 put (buying a vertical spread) for $2.43 ($243). Then I bought back the Oct4-14 65 put for a few pennies and sold a Nov1-14 70 put, collecting $2.94 $294) for the spread. The account value is at $1324, or $90 higher than $1234 where we started out. This averages out to $45 per week, slightly above the 3% ($37) average weekly gain we are shooting for. (Once again, we would have done much better this week if the stock had moved up by only $2 instead of $5).
I will continue trading this account and let you know from time to time how close I am achieving my goal of 3% a week, although I will not report every trade I make each week. I will follow the guidelines for rolling over as outlined above, so you should be able to do it on your own if you wished.