from the desk of Dr. Terry F Allen

Skip navigation

Member Login  |  Contact Us  |  Sign Up

1-800-803-4595

Posts Tagged ‘LEAPS’

Trading Options Can be a Lifetime Learning Experience

Monday, March 23rd, 2015

Last week was a good one for the market.  SPY rose 2.2%, a wonderful week.  The actual options portfolios we carry out at Terry’s Tips had a stellar week as well.  Nine of our ten portfolios gained at least 5%, and 3 of them gained over 33% in a single week.

Nike (NKE) announced blow-out earnings and the stock rose 6.4%.  Our portfolio that trades NKE options gained 13.5%, double the increase in the stock price.  This was far less than we usually do compared to stock price changes, however.

We have proved over and over that if you can find a stock that will increase if value, you can usually make 3 or 4 or more times as much with an options strategy as you could by simply buying the stock.

Of course, buying options is not quite so simple as buying stock.  To do it right requires gaining some understanding that most people just don’t have the energy or willpower to learn.

Terry

Trading Options Can be a Lifetime Learning Experience

If the truth be known, investing in stocks is pretty much like playing checkers.  Any 12-year-old can do it.  You really don’t need much experience or understanding.  If you can read, you can buy stock (and probably do just about as well as anyone else because it’s basically a roulette wheel choice).  Most people reject that idea, of course.  Like the residents of Lake Wobegone, stock buyers believe that they are all above average – they can reliably pick the right ones just about every time.

Trading options is harder, and many people recognize that they probably aren’t above average in that arena.  Buying and selling options is more like playing chess.  It can be (and is, for anyone who is serious about it) a life-time learning experience.

You don’t see columns in the newspaper about interesting checker strategies, but you see a ton of pundits telling you why you should buy particular stocks.  People with little understanding or experience buy stocks every day, and most of their transactions involve buying from professionals with far more resources and brains. Most stock buyers never figure out that when they make their purchase, about 90% of the time, they are buying from professionals who are selling the stock to them rather than buying it at that price.

Option investing takes study and understanding and discipline that the purchase of stock does not require.  Every investor must decide for himself or herself if they are willing to make the time and study commitment necessary to be successful in option trading.  Most people are too lazy.

It is a whole lot easier to play a decent game of checkers than it is to play a decent game of chess.  But for some of us, options investing is a whole lot more challenging, and ultimately more rewarding.  For example, Costco (COST) has had a good year so far, rising from $141.75 to Friday’s close at $152.59, a gain of 7.6%.  The Terry’s Tips  option portfolio that trades COST options (calendar and diagonal spreads) gained 40.4% over this same period, over 5 times as much.  With actual results like this, why wouldn’t any reasonable adult with enough cash to buy stock want to learn how to multiply his or her earnings by learning a little about the wonderful world of options?

Playing checkers (and buying stock) is boring.  Playing chess (and trading options) is far more challenging.  And rewarding, if you do it right.

How to Play Oil Prices With Options

Sunday, February 8th, 2015

If you are anything like me, I have enjoyed filling up my car lately.  It almost seems too good to be true. How long do you think gas prices will stay this low?    I figure that the price is more likely to move higher from here than it is to move lower, but I could be wrong.  It seems like a prudent bet would be that it won’t move much lower from here, and that the price of oil is more likely to stay the same or move higher over the next year.  If either scenario (flat or up) is true, you can easily double your money using options.  Today I will show you one way that might be accomplished.

Terry

How to Play Oil Prices With Options

If you want to bet on higher oil prices, you might consider buying the ETF (Exchange Traded Fund) OIL.  This is simply a measure of the price of crude oil.  I don’t like to trade OIL, however, because the price is too low (under $12) to have meaningful option prices (and the options market is not very efficient which means it is hard to get decent prices because bid-ask ranges are too high).

An alternative ETF is OIH.  This covers the oil service companies, like drillers and transporters.  There is an extremely high correlation between the prices of OIL and OIH, and OIH has the advantage of having a higher absolute price ($35.50 at Friday’s close) and a more efficient options market (including weekly options and LEAPS).

Check out the chart for OIH for the last year:

OIH Historical Chart Feb 2015

OIH Historical Chart Feb 2015

If you had been smart (or lucky) enough to buy OIH when it rose above its 30-day moving average a year ago, you might have owned it while it rose from about $46 to about $55 when it fell below its 30-day moving average and then if you sold it short, you might make gains all the way down to $36 (you would have had to resist buying it back when it briefly moved above the moving average a few months ago).

Now OIH is well above this moving average and this might be a good time to make a bet that it will move higher going forward.  If you wanted to bet that the price of oil (and OIH) will remain flat or move higher, you might consider these trades (with OIH trading at $35.50):

Buy 3 OIH Jan-16 35 calls (OIH160115C35)
Sell 3 OIH Mar-15 36 calls (OIH150320C36) for $3.05 (buying a diagonal)

Buy 1 OIH Jan-16 35 call (OIH160115C35) for $4.45

These prices are at $.05 more than the mid-point between the bid and ask prices for the option or the spread.  You should be able to get those prices – be sure to enter it as a limit order because bid-ask ranges are a little high (although narrower than they are for OIL).

If you got those prices, your total investment would be $915 plus $445 plus $5 commission (Terry’s Tips commission rate at thinkorswim) for a total of $1365.

This is the risk profile graph for these positions when the March calls expire on March 20:

OIH Risk Profile Graph 2015

OIH Risk Profile Graph 2015

The graph shows that if the price of OIH ends up in a range of being flat or moving higher by $3, the portfolio should gain about $300, or about 20% for the six weeks of waiting.  The nice thing about owning options is that you can make this 20% even if the ETF doesn’t go up by a penny.  If you just bought OIH instead of using options, you wouldn’t make anything if the ETF didn’t move higher.

Even better, if OIH falls by a dollar, you still make a profit with the options positions.  If you owned the ETF instead, you would lose money, of course.

Owning an extra uncovered long Jan-16 35 call gives you upside protection in case OIH moves dramatically higher.  It also leaves room to sell another short-term call if OIH drifts lower instead of remaining flat or moving higher. Such a sale would serve to reduce or eliminate a loss if the ETF moves lower.

When the March calls expire, you would buy them back if they are in the money (i.e., the ETF is above $37) and you would sell Apr-15 calls at a strike slightly above the current ETF price.  You should be able to collect a time premium of about $100 for each call you sell.

There will be 10 opportunities to sell one-month-out calls for $100 before the Jan-16 calls expire.  Once you have collected $100 for each of 3 monthly calls you sell, you will have all your original investment back, and further  sales are clear profit.  As long as the Jan-16 calls are in the money when they are about to expire, you would collect additional money from those sales as well.

This strategy involves making trades around the third Friday of each month when the short-term short options are about to expire.  That could be a pain in the neck, but to my way of thinking, it is a small price to pay for the possibility of doubling my money over the course of a year.  There is a variety of other option strategies you might employ, but this one makes good sense to me.

How to Make 20% in one Month on Your Favorite Stock (Using Options)

Thursday, January 22nd, 2015

 

This week I would like to show you the exact positions of one of the 9 portfolios we are currently carrying out for Insiders at Terry’s Tips.  It involves one of my favorite places to shop, Costco, and its stock, COST.  We expect to make just under 20% on this portfolio in the next four weeks, even if the stock does not go up a single penny.  Welcome to the wonderful world of stock options.Terry

How to Make 20% in one Month on Your Favorite Stock (Using Options)

The basic strategy that we carry out at Terry’s Tips is to buy longer-term options on stocks we like and sell shorter-term options against them.  Since the decay rates of the shorter-term options is much higher than the decay rates of the long-term options we own, we hope to make money every day that the stock remains flat or moves in the direction that we expect it will.  In options terms, we have positions that have a positive theta value.

Most of the time, we buy these option spreads on stocks we like, so by selecting strike prices that are higher than the current stock price, we create a portfolio that gains more than the theta value when the stock moves higher.  In options terms, we have a portfolio which is positive net delta.  It gains in value when the stock moves higher, just as owners of the stock enjoy.

Here is the risk profile graph for our actual Costco portfolio.  We have just under $5000 invested in these positions.  The curve shows how much we will make or lose at each of the possible stock prices when the February options expire on February 20, 2015, four weeks from tomorrow.
COST Risk Profile Graph 2015

COST Risk Profile Graph 2015

This graph is created by the free Analyse Tab software that is available at thinkorswim. You can see that if the stock remains flat at today’s price ($139.63 when I created this graph), the portfolio is slated to gain $960.38 when the February options expire.  That is almost 20% on our portfolio value.  If the stock moves higher (as we expect it will most of the time), the gain is just about the same, even if it moves as much as $10 higher in a single month.  (While we love this stock, it is probably unlikely to go that much higher).

On the downside, the stock can fall almost $2 and we will still make a small gain.  How can anybody disagree that these options positions are vastly better than just buying COST stock?  Most months, the stock will remain about flat or edge higher.  In each case, we should pick up almost 20% while stock-buyers gain little or nothing.

In this actual portfolio, we own the following call options:

1 COST Apr-15 145 call (COST150417C145)
4 COST Jul-15 135 calls (COST150717C135)
3 COST Jul-15 140 calls (COST150717C140)
3 COST Jul-15 150 calls (COST150717C150)

These are the calls that we have sold (are short):

6 COST Feb-15 140 calls (COST150220C140)
1 COST Feb-15 145 call (COST150220C145)
3 COST Feb-15 150 calls (COST150220C150)

When we have bought and sold a call at the same strike price, we own what is called a calendar spread (also called a time spread).  When the long and short call are at different strike prices, we own what is called a diagonal spread.  Most of the time, the short call is at a higher strike price than the long call (so we don’t incur a maintenance requirement).

We have one more long call than we have short calls.  We could make a greater gain at a flat stock price if we sold a February call against our extra long call, but we might end up not gaining nearly as much if the stock should move significantly higher in the next four weeks.

We are satisfied with making 20% in the next month in this portfolio.  Most people would be happy gaining that much for an entire year. If you like, COST, NKE, SBUX, GMCR, or SPY (to name a few we are currently trading), you could join us, and have all the trades made for you through Auto-Trade at thinkorswim by becoming a Terry’s Tips Insider.  Why not do it today?  It might be a great way to start out the New Year.

How to Avoid an Option Assignment

Thursday, October 2nd, 2014

This message is coming out a day early because the underlying stock we have been trading options on has fallen quite a bit once again, and the put we sold to someone else is in danger of being exercised, so we will trade a day earlier than usual to avoid that possibility.

I hope you find this ongoing demonstration of a simple options strategy designed to earn 3% a week to be a simple way to learn a whole lot about trading options.

Terry

How to Avoid an Option Assignment

Owning options is a little more complicated than owning stock. When an expiration date of options you have sold to someone else approaches, you need to compare the stock price to the strike price of the option you sold.  If that option is in the money (i.e., if it is put, the stock is trading at a lower price than the strike price, and if it is a call, the stock is trading at a higher price than the strike price), in order to avoid an exercise, you will need to buy back that option.  Usually, you make that trade as part of a spread order when you are selling another option which has a longer life span.

If the new option you are selling is at the same strike price as the option you are buying back, it is called a calendar spread (also called a time spread), and if the strike prices are different, it is called a diagonal spread.

Usually, the owner of any expiring put or call is better off selling their option in the market rather than exercising the option.  The reason is that there is almost always some remaining premium over and above the intrinsic value of the option, and you can almost always do better selling the option rather than exercising your option.  Sometimes, however, on the day or so before an option expires, when the time premium becomes very small (especially for in-the-money options), the bid price may not be great enough for the owner to sell the option on the market and still get the intrinsic value that he could get through exercising.

To avoid that from happening to you when you are short the option, all you need to do is buy it back before it expires, and no harm will be done.  You won’t lose much money even if an exercise takes place, but sometimes commissions are a little greater when there is an exercise.  Not much to worry about, however.

SVXY fell to the $74 level this week after trading about $78 last week.  In our actual demonstration portfolio we had sold an Oct1-14 81 put (using our Jan-15 90 put as security).  When you are short an option (either a put or a call) and it becomes several dollars in the money at a time when expiration is approaching, there is a good chance that it might be exercised.  Although having a short option exercised is sort of a pain in the neck, it usually doesn’t have much of a financial impact on the bottom line.  But it is nice to avoid if possible.

We decided to roll over the 81 put that expires tomorrow to next week’s option series.  Our goal is to always collect a little cash when we roll over, and that meant this week we could only roll to the 80.5 strike and do the trade at a net credit.  Here is the trade we made today:

Buy To Close 1 SVXY Oct1-14 81 put (SVXY141003P81)
Sell To Open 1 SVXY Oct2-14 80.5 put (SVXY141010P80.5) for a credit of $.20  (selling a diagonal)

Our account value is now $1620 from our starting value of $1500 six weeks ago, and we have $248 in cash as well as the Jan-15 90 put which is trading about $20 ($2000).  We have not quite made 3% a week so far, but we have betting that SVXY will move higher as it does most of the time, but it has fallen from $86 when we started this portfolio to $74 where it is today.  One of the best things about option trading is that you can still make gains when your outlook on the underlying stock is not correct.  It is harder to make gains when you guess wrong on the underlying’s direction, but it is possible as our experiment so far has demonstrated.

 

Legging Into a Short Iron Condor Spread

Monday, March 3rd, 2014

Today I would like share with you the results of an actual trade recommendations I made for my paying subscribers on January 4th of this year and how subsequent price changes have opened up option possibilities that can further improve possibilities for a first investment.

Please don’t get turned off by what this new spread is called.

Terry

Legging Into a Short Iron Condor Spread

In my weekly Saturday Report that I send to paying subscribers, on January 4, 2014 I set up an actual demonstration portfolio in a separate trading account at thinkorswim in which I made long-term bets that three underlying stocks (GOOG, SPY, and GMCR) would be higher than they currently were at some distant point in the future.  The entire portfolio would make exactly 93% with the three spreads I chose if I were right about the stock prices.

Almost two months later, things are looking pretty good for all three spreads, but that is not as important as what we can learn about option possibilities.

If you recall, early this year I was quite bullish on Green Mountain Coffee Roasters (GMCR) which has recently changed their name to Keurig Green Mountain.  The major reason was that three insiders who had never bought shares before had recently made huge purchases (two of a million dollars each).  I Googled these men and learned that they were mid-level executives who were clearly not high rollers.  I figured that if they were committing this kind of money, they must have had some very good reason(s),  Also, for four solid months, not a single director had sold a single share, something that was an unusual pattern for the company.

My feelings about the company were also boosted when a company writing for Seeking Alpha published an article in which they had selected GMCR as the absolute best company from a fundamental standpoint in a database of some 6000 companies.

This is what I wrote in that Saturday Report – “The third spread, on Green Mountain Coffee Roasters (GMCR), is a stronger bullish bet than either of the first two, for two reasons.  The stock is trading about in the middle of the long and short put prices (70 and 80), and the time period is only six months (expiring in June 2014) rather than 11 or 12 months.  I paid $540 for the Jun-14 80 – Jun-14 70 vertical put credit spread.  My maximum loss is $460 per spread if the stock closes below $70, and I will make 115% after commissions in six months if it closes above $80.”

This vertical put credit spread involved selling the Jun-14 80 puts for $13.06 and buying the Jun-70 puts for $7.66, collecting $540 for each spread.  I sold 5 of these spreads, collecting a total of $2700.  There would be a maintenance requirement of $5000 for the spreads (not a margin loan which would have interest charged on it, but an amount that I couldn’t use to buy other stocks or options).  Subtracting what I received in cash from the maintenance requirement, my real cost (and maximum loss) would be $2300.  If GMCR closed at any price above $80 on June 21, 2014, both puts would expire worthless and I could keep my $2700 and make 115% after commissions (there would be no commissions to pay if both puts expired worthless).

An interesting side note to the $2700 cash I received in this transaction.  In the same account, I also owned shares of my favorite underlying stock.  I am so bullish on this other company (which is really not a company at all, but an Exchange Traded Product (ETP)) that I owned some on margin, paying 9% on a margin loan.  The cash I received from the credit spread was applied to my margin loan and reduced the total on which I was paying interest.  In other words, I was enjoying a 9% gain on the spread proceeds while I waited out the six months for the options to expire.

In case you hadn’t heard, GMCR announced on February 5th that they had executed a 10-year contract with Coke to sell individual cups on an exclusive basis.  The stock soared some 50%, from $80 to over $120.  In addition, Coke bought 10% of GMCR for $1.25 billion, and gained over $600 million on their purchase in a single day.  Obviously, those insiders knew what they were doing when they made their big investments last November.

Now I am in an interesting position with this spread.  It looks quite certain that I will make the 115% if I just sit and wait another 4 months.  The stock is highly unlikely to fall back below $80 at this point.  I could but back the spread today for $.64, ($320 for the 5 spreads) and be content with a $2380 gain now rather than $2700 in June.

But instead, I decided to wait it out, and add a twist to my investment.  Since the deal with Coke will not reach the market until at least 2015, it seems to me that we are in for a period of waiting until the chances of success for single servings of Coke are better known.  The stock is probably not going to move by a large amount in either direction between now and June.

With that in mind, I sold another vertical credit spread with June options, this time using calls.  I bought Jun-14 160 calls and sold Jun-14 150 calls and collected $1.45 ($725 less $12.50 commissions).  These options will expire worthless if GMCR is at any price below $150 on June 21, 2014, something that I believe is highly likely.  I think it has already taken the big upward move that it will take this year.

If the stock ends up at any price between $80 and $150, I will make money on both spreads that I sold.  Now the total I can gain is $3400 (after commissions) and my net investment has now been reduced to $1600 and my maximum gain is 212% on my money at risk.

This new spread will not have any maintenance requirement because the broker understands that I can’t lose money on both vertical spreads I have sold.  He will look at the two spreads and notice that the difference between the long and short strike prices is 10 for both spreads.  As long as he is setting aside $5000 in a maintenance requirement on the account, he knows that I can lose that maximum amount on only one of the two spreads.

What I have done is to leg into what is called a short iron condor spread (legging in means you buy one side of a spread to start, and then add the other side at a later time – the normal way to execute a spread is to execute both sides at the same time).  You don’t have to know any more about it than know its name at this time, but I invite you to become a Terry’s Tips Insider and learn all about short iron condors as well as many other interesting options strategies.

Google Vertical Put Spread – Corrected Prices

Monday, December 23rd, 2013

Several subscribers wrote in and told me that my numbers were off on the Google spread.  I apologize.  At least I know that some of you read these ideas, so that is encouraging.I have fixed the numbers and repeated the words.  Here is the trade fill:

google trades Google Trades

As you can see, I actually did better than the $10.30 I reported below – I sold it for $10.46.  I had placed a limit order at $10.30 and assumed that was the price I got – it ended up being better than the limit price.

Google Vertical Put Spread – Corrected Prices

To repeat, 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 $1108 today, Monday, I sold a Jan-15 1120 put and bought a Jan-15 1100 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.

There will be a $2000 maintenance requirement on this spread, but since I collected $1027.50, my maximum loss and the amount it required to place this trade 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 $1120 or any higher January 17, 2015 (it only needs to go up $12 over the course of a full year and a month).  After note:  GOOG is now trading at $1114 and only needs to go up by $6 for me to make 100%.

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.

 

Two Interesting Option Bets for 2014 – SPY and Google

Monday, December 23rd, 2013

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.

 

 

 

A “Conservative” Options Strategy for 2014

Monday, December 16th, 2013

Every day, I get a Google alert for the words “options trading” so that I can keep up with what others, particularly those with blogs, are saying about options trading.  I always wondered why my blogs have never appeared on the list I get each day.  Maybe it’s because I don’t use the exact words “option trading” like some of the blogs do.

Here is an example of how one company loaded up their first paragraph with these key words (I have changed a few words so Google doesn’t think I am just copying it) – “Some experts will try to explain the right way to trade options by a number of steps.  For example, you may see ‘Trading Options in 6 Steps’ or ’12 Easy Steps for Trading Options.’  This overly simplistic approach can often send the novice option trading investor down the wrong path and not teach the investor a solid methodology for options trading. (my emphasis)”  The key words “options trading” appeared 5 times in 3 sentences.  Now that they are in my blog I will see if my blog gets picked up by Google.

Today I would like to share my thoughts on what 2014 might have in store for us, and offer an options strategy designed to capitalize on the year unfolding as I expect.

Terry

A “Conservative” Options Strategy for 2014

What’s in store for 2014?  Most companies seem to be doing pretty well, although the market’s P/E of 17 is a little higher than the historical average.  Warren Buffett recently said that he felt it was fairly valued.  Thirteen analysts surveyed by Forbes projected an average 2014 gain of just over 5% while two expected a loss of about 2%, as we discussed a couple of weeks ago. With interest rates so dreadfully low, there are not many places to put your money except in the stock market. CD’s are yielding less than 1%.  Bonds are scary to buy because when interest rates inevitably rise, bond prices will collapse.  The Fed’s QE program is surely propping up the market, and some tapering will likely to take place in 2014.  This week’s market drop was attributed to fears that tapering will come sooner than later.

When all these factors are considered, the best prognosis for 2014 seems to be that there will not be a huge move in the market in either direction.  If economic indicators such as employment numbers, corporate profits and consumer spending improve, the market might be pushed higher except that tapering will then become more likely, and that possibility will push the market lower.  The two might offset one another.

This kind of a market is ideal for a strategy of multiple calendar spreads, of course, the kind that we advocate at Terry’s Tips.  One portfolio I will set up for next year will use a Jan-16 at-the-money straddle as the long side (buying both a put and a call at the 180 strike price).  Against those positions we will sell out-of-the-money monthly puts and calls which have a month of remaining life. The straddle will cost about $36 and in one year, will fall to about $24 if the stock doesn’t move very much (if it does move a lot in either direction, the straddle will gain in value and may be worth more than $24 in one year).  Since the average monthly decay of the straddle is about $1 per month,  that is how much monthly premium needs to be collected to break even on theta.  I would like to provide for a greater move on the downside just in case that tapering fears prevail (I do not expect that euphoria will propel the market unusually higher, but tapering fears might push it down quite a bit at some point).  By selling puts which are further out of the money, we would enjoy more downside protection.

Here is the risk profile graph for my proposed portfolio with 3 straddles (portfolio value $10,000), selling out-of-the-money January-14 puts and calls. Over most of the curve there is a gain approaching 4% for the first month (a five-week period ending January 19, 2014).   Probably a 3% gain would be a better expectation for a typical month.  A gain over these 5 weeks should come about if SPY falls by $8 or less or moves higher by $5 or less.  This seems like a fairly generous range.

Spy Straddle Risk Profile For 2014

Spy Straddle Risk Profile For 2014

For those of you who are not familiar with these risk profile graphs (generated by thinkorswim’s free software), the P/L Day column shows the gain or loss expected if the stock were to close on January 19, 2014 at the price listed in the Stk Price column, or you can estimate the gain or loss by looking at the graph line over the various possible stock prices.  I personally feel comfortable owning SPY positions which will make money each month over such a broad range of possible stock prices, and there is the possibility of changing that break-even range with mid-month adjustments should the market move more than moderately in either direction.

The word “conservative” is usually not used as an adjective in front of “options strategy,” but I believe this is a fair use of the word for this actual portfolio I will carry out at Terry’s Tips for my paying subscribers to follow if they wish (or have trades automatically executed for them in their accounts through the Auto-Trade program at thinkorswim).

There aren’t many ways that you can expect to make 3% a month in today’s market environment.  This options strategy might be an exception.

How to Make 60% to 100% in 2014 if a Single Analyst (Out of 13) is Right

Monday, November 25th, 2013

Today we are going to look at what the analysts are forecasting for 2014 and suggest some option strategies that will make 60% or more if any one of the analysts interviewed by the Wall Street Journal are correct. They don’t all have to be correct, just one of the 13 they talked to.

Please continue reading down so you can see how you can come on board as a Terry’s Tips subscriber for no cost at all while enjoying all the benefits that thinkorswim by TD Ameritrade offers to anyone who opens an account with them.

Terry
 
How to Make 60% to 100% in 2014 if a Single Analyst (Out of 13) is Right 

 
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% (depending on which underlying 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). 
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. 
You could make 100% on your investment with a similar play using Apple as the underlying.  You would have to make the assumption that Apple will fluctuate in 2014 about as much as the S&P.  For most of the past few years, Apple has done much better than the general market, so it is not so much of a stretch to bet that it will keep up with the S&P in 2014.
Apple is currently trading about $520.  You could sell at vertical put spread for the January 2015 series, selling the 510 put and buying the 480 put and collect a credit of $15.  If Apple closes at any price above $510 on January 17, 2015, both puts would expire worthless and you would make 100% on your investment.  You would receive $1500 for each of these spreads you placed and there would be a $1500 maintenance requirement (the maximum loss if Apple closes below $480).
Apple is trading at about 10 times earnings on a cash-adjusted basis, is paying a 2.3% dividend, and is continuing an aggressive stock buy-back campaign, three indications that make a big stock price drop less likely to come about in 2014.
A similar spread could be made with Google puts, but the market is betting that Google is less likely to fall than Apple, and your return on investment would be about 75% if Google fell 2% or went up by any amount.  You could sell Jan-15 1020 puts and buy Jan-15 990 puts and collect about $1300 and incur a net maintenance requirement of $1700 (your maximum loss amount).
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 put SPY 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.  I would advise against it, however, because your gains will eventually be taxed at ordinary income rates (at a time when your tax rate is likely to be higher) rather than capital gains rates.
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.
What are the chances that every single analyst was wrong?  Someone should do a study on earlier projections and give us an answer to that question.  We all know that a market tumble could come our way if the Fed begins to taper, but does that mean the market as a whole would drop for the entire year?  Another unanswerable question, at least at this time.
On a historical basis, for the 40 years of the S&P 500’s existence (counting 2013 which will surely be a gaining year), 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.

How to Own 100 Shares of Google for $16,000

Monday, October 7th, 2013

Way back when Google (GOOG) went public at $80 a share, I decided that I would like to own 100 shares and hang on to it for the long run. Obviously, that was a good idea as the stock is trading today at $870. My $8000 investment would now be worth $87,000 if I had been able to keep my original shares. Unfortunately, over the years, an options opportunity inevitably came along that looked more attractive to me than my 100 shares of GOOG, and I sold my shares to take advantage of the opportunity.

Many times my investment account had compiled a little spare cash, and I went back into the market and bought more shares of GOOG, always paying a little more to buy it back. At some point it felt like I just had too much money tied up in it. An $8000 commitment is one thing, but $87,000 is real money.

Today I would like to share how I own the equivalent of 100 shares of GOOG for an investment of only $17,000, and the neat thing about my investment is that I get expect to get a “dividend” in the next two weeks of about $1300 if the stock just sits there and doesn’t go anywhere.

I own options, of course. Here is what I own.

Terry

 How to Own 100 Shares of Google for $16,000:  You would have to shell out about $87,000 today to buy 100 shares of GOOG stock. If you bought it on margin, you might have to come up with about half that amount, $43,500, but you have to shell out interest on the margin loan each month. I like money coming in, not going out.

A couple of weeks in this newsletter we talked about the Greek measure delta. This is simple the equivalent number of shares of stock that an option has. I own GOOG 800 calls that expire on the third Friday of January 2014. You could buy one today for $8600. I own 2 of them for a cost of about $17,200.

The delta for these Jan-14 800 calls is 75. That means if the stock goes up by a dollar, the value of each of my options will go up by $75. With these 2 options I own the equivalent of 150 shares of stock.

Since all options decline a little bit every day that the stock stays flat (it is called decay), simply owning options is just about as bad as paying margin interest on a stock loan. As I said earlier, I like money coming in rather than going out.

Since I own 2 call options at a lower strike price that the market price I am entitled to use them as collateral to sell someone else the opportunity to buy shares of GOOG at a higher price. I sold one Oct-13 890 call, collecting $13.50 ($1350) at today’s price. This option will expire in two weeks (October 18). If the stock is at any price less than $890, this call will expire worthless and I will get to keep the entire $1350.

This Oct-13 890 call option that I sold carries a delta of 38, making my net option value 112 deltas (the equivalent of 112 shares of stock).

Since I am aiming to own 100 shares of GOOG, I sold another Oct-13 call, this one at the 935 strike. At today’s prices, this one would go for $3.50 ($350). The delta on this call is 13, reducing my net delta value to exactly 100.

I now own the equivalent of 100 shares of GOOG at a cost of $17,200 less the $1700 I collected from selling the two calls, or $15,500.

The neat thing about my option positions is that if the stock doesn’t go up (as I hope it will), my disappointment will be soothed a bit because I will gain about $1300 over the next two weeks. Here is the risk profile graph for my positions:

Google Risk Profile Graph

Google Risk Profile Graph

The P/L Day column in the lower right-hand corner shows what the gain or loss will be at the price in the first column on the left. (The stock popped up about $3 while I was writing this Monday morning so it is no longer trading at $870 as it was when I started).

There are two disadvantages to owing the options I do rather than the stock. If the stock falls 10%, I will lose about $9800. If I owned 100 shares of stock, I would lose only $8700. On the other hand, if the stock goes up by 10% in the next two weeks, I would only gain $7100 vs. the $8700 I would make if I owned the stock. I don’t think the stock will move by anywhere near these amounts in the next two weeks, so I am content to live with the slightly less I might gain (or the slightly more I would lose) at these extremes.

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.

Order Now

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