from the desk of Dr. Terry F Allen

Skip navigation

Member Login  |  Contact Us  |  Sign Up


Posts Tagged ‘Market Crash Protection’

A Possible Great Option Trading Idea

Monday, July 14th, 2014

Just before the close on Friday, we made a strongly bullish trade on our favorite underlying stock in a portfolio at Terry’s Tips.  In my personal account, I bought weekly calls on this same underlying.  As I write this in the pre-market on Monday, it looks like that bet could triple in value this week.

I would like to share with you the thinking behind these trades so next time this opportunity comes up (and it surely will in the near future), you might decide to take advantage of it yourself.


A Possible Great Option Trading Idea: As we have discussed recently, option prices are almost ridiculously low.  The most popular measure of option prices is VIX, the so-called “fear index” which measures option prices on SPY (essentially what most people consider “the” market) is hanging out around 12.  The historical mean is over 20, so this is an unprecedented low value.

When we sell calendar or diagonal spreads at Terry’s Tips, we are essentially selling options to take advantage of the short-term faster-decaying options.  Rather than using stock as collateral for selling short-term options we use longer-term options because they tie up less cash.

With option prices currently so low, maybe it is a time to reverse this strategy and buy options rather than selling them.  One way of doing this would be to buy a straddle (both a put and a call at the same strike price, usually at the market, hoping that the stock will make a decent move in either direction.  In options lingo, you are hoping that actual volatility (IV) is greater than historical volatility.

The biggest problem with buying straddles is that you will lose on one of your purchases while you gain on the other.  It takes a fairly big move in the underlying to cover the loss on your losing position before you can make a profit on the straddle.

A potentially better trade might be to guess which way the market will move in the short term, and then buy just a put or call that will make you money if you are right. The big challenge would be to find a price pattern that could help you choose which direction to bet on?

One historically consistent pattern for most market changes (the law of cycles) is that the direction of the change from one period to the next is about twice as likely to be in the same direction as it was in the previous same time period.  In other words, if the stock went up last week (or month), it is more likely to go up again next week (or month).

We tested this pattern on SPY for several years, and sadly, found that it did not hold up.  The chances were almost 50-50 that it would move in the opposite direction in the second period.

Maybe the pattern would work for our most popular underling, an ETP called SVXY.  You might recall that we love this “stock” because it is extremely volatile and option prices are wonderfully high (great for selling).  In the first 22 weeks of 2014, SVXY fluctuated by at least $3 in one direction or the other in 19 of those weeks.  Maybe we could use the pattern and buy weekly either puts or calls, depending on which way the market had moved in the previous week.

Once again, the historical results did not support the law of cycles pattern.  The stock was almost just as likely to move in the opposite direction as it had in the previous week.  Another good idea dashed by reality.

In making this study, we discovered something interesting, however.  In the first half of 2014, SVXY fell more than $3 in a single week on 5 different occasions.  In 4 of the subsequent weeks, it made a significant move ($3 or more) to the upside.  Buying a slightly out-of-the-money weekly call for about a dollar and a half ($150 per contract) could result in a 100% gain (or more) in the next week in 4 out of 5 weeks.

If this pattern could be counted on to continue, it would be a fantastic trading opportunity.  Yes, you might lose your entire investment in the losing weeks, but if you doubled it in the winning weeks, and there were many more of them than losing weeks, you would do extremely well.

For  those reasons, I bought calls on SVXY on Friday.  The Jul-14 90.5 call that expires this Friday (July 18th) could have been bought for $1.30.  The stock closed at $88.86.  I plan to place an order to sell these calls, half at $2.60, and half at $3.90.  The pre-market prices indicate that one of these orders might exercise sometime today and I will have all my money back and still own half my calls.  It might be a fun week for me.  We’ll see.

On another subject, have you got your free report entitled 12 Important Things Everyone with a 401(K) or IRA Should Know (and Probably Doesn’t).  This report includes some of my recent learnings about popular retirement plans and how you can do better.  Order it here.  You just might learn something (and save thousands of dollars as well).

Interesting SPY Straddle Purchase Strategy

Monday, November 18th, 2013

Interesting SPY Straddle Purchase Strategy:

In case you are new to options or have been living under a rock for the past few months, you know that option prices are at historic lows.  The average volatility of SPY options (VIX) has been just over 20 over the years.  This means that option prices are expecting the stock (S&P 500) will fluctuate about 20% over the course of a year.

Right now, VIX is hanging out at less than 13.  Option buyers are not expecting SPY to fluctuate very much with a reading this low.   Since in reality, SPY jumps around quite a bit every time the word “tapering” appears in print, or the government appears to be unwilling to extend the debt limit, there is a big temptation to buy options rather than selling them.

Today I would like to share with you an idea we have developed at Terry’s Tips that has been quite successful in the short time that we have been watching it.

Interesting SPY Straddle Purchase Strategy:

For many years, Terry’s Tips has advocated buying calendar spreads.  These involve selling short-term options and benefitting from the fact that these options deteriorate in value faster than the longer-term options that we own as collateral.  However, when option prices are as low as they are right now, this strategy has difficulty making gains if the stock fluctuates more than just a little in either direction.  Volatility has always been the Darth Vader of calendar spreads, and with option prices as low as they are right now, it only takes a little volatility to turn a promising spread into a losing one.

If you could get a handle on when the market might be a little more volatile than it is at other times, buying options might be a better idea than selling them.  At Terry’s Tips, we admit that we have no idea which way the market is headed in the short run (we have tried to guess a number of times, or used technical indicators to give us clues, but our batting average has been pretty close to 50% – we could have done just about as well by flipping a coin).

With that in mind, when we buy options, we usually buy both a put and a call. If those options have the same strike price and expiration day, the simultaneous purchase of a put and call is called a straddle.

If you had a good feeling that the market would soon make a big move and you also had no strong feeling which direction that move might take, you might consider buying a straddle.

We did a backtest of SPY price changes and discovered that in the final week of an expiration month for the normal monthly options, SPY tended to fluctuate more than it did in the other three or four weeks of the expiration month.

Three months ago, we decided to buy an at-the-money SPY straddle on the Friday before the week when the monthly options would expire.  We hoped to buy this straddle for just over $2.  If SPY moved more than $2 in either direction at some point in the next week we would be guaranteed to be able to sell either the put or call for a profit (our backtest showed that SPY moved by more than $2 on many occasions on a single day).

On Friday, September 13th, we discovered that at-the-money the straddle was trading  about $2.50, more than we wanted to pay.  There was a reason for it.  SPY pays a dividend four times a year, and the ex-dividend date is the Thursday before the monthly options expire.  When a dividend is paid, the stock usually falls by the amount of the dividend (about $.80) for SPY on the day after it goes ex-dividend (all other things being equal).  For this reason, in the days before that happens, the put prices move much higher in anticipation of the stock falling on Friday.  This pushed the straddle price higher than we wanted to pay.

We decided not to buy the September at-the-money straddle on Friday the 13th (maybe it would be bad luck anyway).  But we should have coughed up the extra amount.  The stock rose more than $3 during the next week, and we could have collected a nice gain.

When the October expiration came around, we could have bought an at-the-money straddle on Friday, October 11 for just over $2, but the portfolio that we set up to buy straddles had all its money tied up in straddles on individual companies. So we didn’t make the purchase. Too bad, for in the next week, SPY rose by over $4.  We could have almost doubled our money.

Finally, on November 9, we finally got our act together.  It was the Friday before the regular monthly options were to expire on November 15.  When the stock was trading very near $176.50, we bought the 176.5 straddle which was due to expire in one week. We paid $2.16 for it. 

We had to wait until Thursday before it moved very much, but on that day when we could claim a 20% gain after commissions, we sold it (for $2.64).  The stock moved even higher on Friday (up $3.50 over our strike price), so we could have made more by waiting a day, but taking a sure 20% seemed like the best move to make.  We plan to make a similar purchase on Friday, December 13th, at least those of us who are not spooked by superstitions.

For three consecutive months, buying an at-the-money SPY straddle on the Friday before the monthly options expire has proved to be a profitable purchase.  Of course, we have no certainty that this pattern will continue into the future.  But these months did confirm what we had noticed in our backtest.

A Strategy of Buying Weekly SPY Straddles

Wednesday, August 28th, 2013

I performed a back-test of weekly SPY volatility for the past year and discovered that in just about half the weeks, the stock fluctuated at some point during the week by $3 either up or down (actual number 27 of 52 weeks).  That means if you could have bought an at-the-money straddle for $2 (both an at-the-money call and put), about half the time you could sell it for a 50% gain if you placed a limit order to sell the straddle for $3.  As long as the stock moves at least $3 either up or down at some point during the week you can be assured that the straddle can be sold for $3.

Here are the numbers for SPY for the past six months:


SPY Straddle Chart

SPY Straddle Chart

The weekly changes (highlighted in yellow) are the ones where SPY fluctuated more than $3 so that a 50% gain was possible (by the way this week is not over yet, and the stock fell over $3 at one point yesterday).

An interesting strategy for these months would be to buy 10 at-the-money SPY straddles on Friday (or whatever your budget is – each straddle will cost about $200). With today’s low VIX, an at-the-money straddle last Friday cost $1.92 to buy (one week of remaining life),  In the weeks when VIX was higher, this spread cost in the neighborhood of $2.35  (but actual volatility was higher, and almost all of the weeks showed a $3.50 change at some point during the week).

Over the past year, in the half of the weeks when the stock moved by at least $3, your gain on 10 straddles would be $1000 on the original straddle cost $2.  If the change took place early in the week, there would be time premium remaining and the stock would not have to fluctuate by quite $3 for the straddle to be sold for that amount.

The average loss in the other weeks would be about $700, maybe less.  On Friday morning, the worst-case scenario would be that you could sell the 70 straddles for $700 (causing a loss of $1300). This would occur if the stock were trading exactly at the strike price of the straddle – on Friday morning it could be sold for about $.70 because there would be some time premium remaining for both the puts and calls.  The maximum loss that occurred in about a third of the losing weeks was about $.70 but another third of the weeks when the 50% gain was not triggered, you could have broken even (on average) by selling the straddle at the close on Friday.  I calculated that the average loss for all of the last 12 months would be about $700 in those weeks when the 50% gain was not triggered.

This means an average investment of $2000 (10 straddles) would make an average gain of $150 per week. While that might be considered to be a decent gain by most standards, it could be dramatically improved if you varied the amount that you invested each week by following the volatility patterns.

There was a remarkable tendency for high-volatility weeks to occur together.  In the above table you can see that at one point there was a string of 14 weeks when 12 times a 50% gain was possible (high-lighted in yellow) and two weeks (high-lighted in red) when a small gain was possible because the closing price was greater than $2 away from the starting price.  Only one week out of the 14, 5/28/13 would a loss have occurred, and that would have been negligible because the stock closed $1.86 lower, almost covering the $2 initial cost of the straddle.

The same went for low-volatility weeks – there were strings of them as well. At one point early in 2013 the strategy would have incurred a string of seven consecutive weeks when no 50% was possible, and in the last six months pictured above, there were two four-week strings when SPY fluctuated by less than $3 in either direction.

If you invested $4000 in weeks after you made a gain and $2000 in weeks after a 50% gain was not possible, your net gains would be much higher.  This is the most promising part of the strategy.

Another way of playing this strategy would be to invest only in those weeks when a 50% gain would have been possible in the previous week, and sit on the sidelines for the other weeks.  Of course, since the average gain for all weeks was positive (but small), you would be giving up a little by not investing each week.

In this world of low option prices (VIX is at historical lows) and relatively high volatility, this might be an exceptionally profitable strategy to follow.  We plan to carry it out in one of the portfolios we run at Terry’s Tips.

Invest in Yourself in 2013 (at the Lowest Rate Ever)

Monday, December 31st, 2012

To celebrate the coming of the New Year I am making the best offer to come on board that I have ever offered.  It is time limited.  Don’t miss out.

Invest in Yourself in 2013 (at the Lowest Rate Ever)

The presents are unwrapped.  The New Year is upon us.  Start it out right by doing something really good for yourself, and your loved ones. 

The beginning of the year is a traditional time for resolutions and goal-setting.  It is a perfect time to do some serious thinking about your financial future.

I believe that the best investment you can ever make is to invest in yourself, no matter what your financial situation might be.  Learning a stock option investment strategy is a low-cost way to do just that.

As our New Year’s gift to you, we are offering our service at the lowest price in the history of our company.      If you ever considered becoming a Terry’s Tips Insider, this would be the absolutely best time to do it.  Read on…

Don’t you owe it to yourself to learn a system that carries a very low risk and could gain 36% a year as many of our portfolios have done?

So what’s the investment?  I’m suggesting that you spend a small amount to get a copy of my 70-page (electronic) White Paper, and devote some serious early-2013 hours studying the material. 

And now for the Special Offer – If you make this investment in yourself by midnight, January 9, 2013, this is what happens:

For a one-time fee of only $39.95, you receive the White Paper (which normally costs $79.95 by itself), which explains my two favorite option strategies in detail, 20 “Lazy Way” companies with a minimum 100% gain in 2 years, mathematically guaranteed, if the stock stays flat or goes up, plus the following services :

1) Two free months of the Terry’s Tips Stock Options Tutorial Program, (a $49.90 value).  This consists of 14 individual electronic tutorials delivered one each day for two weeks, and weekly Saturday Reports which provide timely Market Reports, discussion of option strategies, updates and commentaries on 8 different actual option portfolios, and much more. 

2) Emailed Trade Alerts.  I will email you with any trades I make at the end of each trading day, so you can mirror them if you wish (or with our Premium Service, you will receive real-time Trade Alerts as they are made for even faster order placement or Auto-Trading with a broker).  These Trade Alerts cover all 8 portfolios we conduct.

3) If you choose to continue after two free months of the Options Tutorial Program, do nothing, and you’ll be billed at our discounted rate of $19.95 per month (rather than the regular $24.95 rate).

4) Access to the Insider’s Section of Terry’s Tips, where you will find many valuable articles about option trading, and several months of recent Saturday Reports and Trade Alerts.

5) A FREE special report “How We Made 100% on Apple in 2010-11 While AAPL Rose Only 25%”. This report is a good example of how our Shoot Strategy works for individual companies that you believe are headed higher.

With this one-time offer, you will receive all of these benefits for only $39.95, less than the price of the White Paper alone. I have never made an offer better than this in the twelve years I have published Terry’s Tips.  But you must order by midnight on January 9, 2013.  Click here, choose “White Paper with Insider Membership”, and enter Special Code 2013 (or 2013P for Premium Service – $79.95).

Investing in yourself is the most responsible New Year’s Resolution you could make for 2013.  I feel confident that this offer could be the best investment you ever make in yourself.

Happy New Year!  I hope 2013 is your most prosperous ever.  I look forward to helping you get 2013 started right by sharing this valuable investment information with you. 

P.S.  If you would have any questions about this offer or Terry’s Tips, please call Seth Allen, our Senior Vice President at 800-803-4595.  Or make this investment in yourself at the lowest price ever offered in our 8 years of publication – only $39.95 for our entire package - using Special Code 2013 (or 2013P for Premium Service – $79.95).

All About Back Spreads

Sunday, December 9th, 2012

Back spreads and ratio spreads are usually discussed together because they are simply the mirror image of each other. Back spreads and ratio spreads are comprised of either both calls or both puts at two different strike prices in the same expiration month. If the spread has more long contracts than short contracts, it is a Back Spread. If there are more short contracts, it is a Ratio Spread.
Since ratio spreads involve selling “naked” (i.e., uncovered by another long option) they can’t be used in an IRA.  For that reason, and because we like to sleep better at night knowing that we are not naked short and could possibly lose more than our original investment, we do not trade ratio spreads at Terry’s Tips.

Back spreads involve selling one option and buying a greater quantity of an option with a more out-of-the-money strike. The options are either both calls or both puts.
A typical back spread using calls might consist of buying 10 at-the-money calls and selling 5 in-the-money calls at a strike low enough to buy the entire back spread at a credit. 
Ideally, you collect a credit when you set up a back spread.  Since the option you are buying is less expensive than the one you are buying, it is always possible to set up the back spread at a credit.  You would like as many extra long positions as possible to maximize your gains if the underlying makes a big move in the direction you are betting. 
If you are wrong and the underlying moves in the opposite direction that you originally hoped, if you had set up the back spread at a net credit at the beginning, all of your options will expire worthless and you will be able to keep the original credit as pure profit (after paying commissions on the original trades, of course).
Call back spreads work best when the stock price makes a large move up; put back spreads work best when the stock price makes a large move down.
One of the easiest ways to think about a back spread is as a vertical with some extra long options. A call back spread is a bear vertical (typically a short call vertical) plus extra long call options at the higher of the two strikes. A put back spread is a bull vertical (typically a short put vertical) plus extra long put options at the lower of the two strikes.
The purpose of a back spread is to profit on a quick extended move toward, through and beyond the long strike. The purchase of a quantity of more long options is financed by the sale of fewer short options. The danger is that because the short options are usually in the money, they might grow faster than the long out-of-the-money options if the stock price moves more slowly or with less magnitude than expected. This happens even faster as expiration approaches. The long out-of-the-money options may lose value despite a favorable move in the stock price, and that same move in the stock price may increase the value of the short options. This is when the back spread loses value most quickly. This is depicted in the “valley” of the risk profile graphs. The greatest loss in the graph occurs at exactly the strike price of the long options.

There are two reasons that I personally don’t like back spreads.  First, they are negative theta.  That means you lose money on your positions every day that nothing much happens to the underlying strike price. 

Second, and more importantly, the gains you make in the good time periods are inconsequential compared to the large losses you could incur in the other time periods.  If the stock moves in the opposite way you are hoping, you end up making a very small gain (the initial credit you collected when the positions were originally placed).  If the underlying doesn’t move much, your losses could be huge.  On the other hand, in order for you to make large gains when the market moves in the direction you hope it will, the move must be very large before significant gains come about.

Here is the risk profile graph for a back spread on SPY (buying 10 Dec-12 142 calls for $1.55 and selling 6 Dec-12 140 calls for $2.78 when SPY was trading at $142.20 and there were two weeks until expiration):

You have about $1100 at risk (the $1200 maintenance requirement less the $115 credit (after commissions) you collected at the outset.  If the stock falls by more than $2.20 so that all the calls expire worthless, you would gain the $115 credit.  If the stock moves higher by $2, you would lose just about that same amount.  It would have to move $2.20 higher before a gain could be expected on the upside, and every dollar the stock moved higher from there would result in a $400 gain (the number of extra calls you own).

The big problem is that if the stock doesn’t do much of anything, you stand to lose about $1000, a far greater loss than most of the scenarios when a gain could be expected.  In order for you to make $1000 with these positions, the stock would have to go up by $5 in the two-week period.  Of course, that happens once in a great while, but probably less than 10% of the time.  There there is a much greater likelihood of its moving less than $2 in either direction (and a loss would occur at any point within that range).

Bottom line, back spreads might be considered if you have a strong feeling that the underlying stock might move strongly in one direction or another, but I believe that there are other more promising directional strategies such as vertical spreads, calendar or diagonal spreads, or even straddles or strangles that make more sense to me.

Black Swan Insurance

Monday, December 3rd, 2012

This week I wrote an article for Seeking Alpha which describes an option portfolio that bets on VIX moving higher as uncertainty grows over the looming fiscal cliff.  The best part of the deal is that the options will make about a 50% gain even if VIX doesn’t go up a bit over the next three weeks until the options expire.
Please read this important article as it could show you a way to provide extremely good protection against you other investments should the market take a big dive this month.

Black Swan Insurance
Here’s the link:

Black Swan Insurance That Might Pay Off Even If There Is No Crash

This is a very simple strategy that involvBlack Swan Insurance That Might Pay Off Even If There Is No Crashes buying in-the-money Dec-12 13 calls and selling a smaller number of Dec-12 16 calls.  You are setting up a vertical spread for some of the calls and holding several calls uncovered long.  The 13 calls have essentially no time premium in them and the 16 calls have a lot of time premium since they are very close to the money.

The only scenario where these positions lose money is if VIX falls much below 15 when the options expire on December 19.  For its entire history, VIX has traded below 15 on only a few rare occasions, and it always moved higher shortly thereafter.

If VIX does get down close to 15 as expiration nears, additional calls might be sold against the uncovered long calls you own, maybe at the 15 strike..  This would expand the downside break-even range about a half a dollar.

There are a few things that you should know about trading VIX options. Weekly options are not available.  You are restricted to the regular monthly option series.  Even more restricting, calendar spreads and diagonal spreads are not allowed in VIX options because the underlying entity is a derivative rather than an actual stock.  You are pretty much restricted to vertical or back spreads unless you want to post a large maintenance requirement.

In spite of these limitations, VIX options are a lot better than VXX if you want to buy portfolio insurance.  VXX suffers from contango dilution most of the time while VIX fluctuates independent of any such headwinds.


Contango, Backwardation, and VXX

Monday, November 26th, 2012

This week we will discuss three investment concepts that you probably never heard of. If you understood them, they might just change your investment returns for the rest of your life.  Surely, it will be worth your time to read about them. 

Contango, Backwardation, and VXX

There seems to be a widespread need for a definition of contango.   I figure that about 99% of investors have no idea of what contango or backwardation are.  That’s a shame, because they are important concepts which can be precisely measured and they strongly influence whether certain investment instruments will move higher (or lower).  Understanding contango and backwardation can seriously improve your chances of making profitable investments.

Contango sounds like it might be some sort of exotic dance that you do against (con) someone, and maybe the definition of backwardation is what your partner does, just the opposite (indeed, it is, but we’re getting a little ahead of ourselves because we haven’t defined contango as yet). 

If you have an idea (in advance) which way a stock or other investment instrument is headed, you have a real edge in deciding what to do.  Contango can give you that edge.

So here’s the definition of contango – it is simply that the prices of futures are upward sloping over time, (second month more expensive than front month, third month more expensive than second, etc.), Usually, the further out in the future you look, the less certain you are about what will happen, and the more uncertainty there is, the higher the futures prices are.  For this reason, contango is the case about 75 – 90% of the time.

Sometimes, when a market crash has occurred or Greece seems to be on the brink of imploding, the short-term outlook is more uncertain than the longer-term outlook (people expect that things will settle down eventually).  When this happens, backwardation is the case – a downward-sloping curve over time. 

So what’s the big deal about the shape of the price curve?  In itself, it doesn’t mean much, but when it gets involved in the construction of some investment instruments, it does become a big deal.

All about VXX

One of the most frequent times that contango appears in the financial press is when VXX is discussed. VXX is an ETN (Exchange Traded Note) which trades very much like any stock.  You can buy (or sell) shares in it, just like you can IBM.  You can also buy or sell options using VXX as the underlying (that’s why it important at Terry’s Tips). 
VXX was created by Barclay’s on January 29, 2009 and it will be closed out with a cash settlement on January 30, 2019 (so we have a few years remaining to play with it).

VXX is an equity that people purchase as protection against a market crash.  It is based on the short-term futures of VIX, the so-called “fear index” which is a measure of the implied volatility of options on SPY, the tracking stock for the S&P 500.  When the market crashes, VIX usually soars, the futures for VIX move higher as well, pushing up the price of VXX.

In August of 2011 when the market (SPY) fell by 10%, VXX rose from $21 to $42, a 100% gain.  Backwardation set in and VXX remained above $40 for several months.  VXX had performed exactly as it was intended to.  Pundits have argued that a $10,000 investment in VXX protects a $100,000 portfolio of stocks against loss in case of a market crash.  No wonder it is so popular.  Investors buy about $3 billion worth of VXX every month as crash protection against their other investments in stocks or mutual funds.

There is only one small bad thing about VXX.  Over the long term, it is just about the worst stock you could ever buy.  Check out its graph since it was first created in January of 2009.


Have you ever seen such a dog?  (Maybe you bought stock in one or two of these, but I suspect no matter how bad they were, they couldn’t match VXX’s performance). On two occasions (November 9, 2010 and October 5, 2012) they had to make 1 – 4 reverse splits to make the stock have a reasonable value.  It never really traded at $2000 as the graph suggests, but two reverse splits will make it seem that way.
VXX is designed to mimic a 30 day futures contract on the VIX spot index (note: the VIX “spot” index is not directly tradable, so short term futures are the nearest proxy). Every day, Barclays VXX “sells” 1/30th of its assets in front month VIX futures contracts and buys second month contracts which are almost always more costly. This is where contango becomes important.
 It’s the old story of “buy high” and “sell low” that so many of us have  done with their stock investments, but Barclays does it every day (don’t feel sorry for them – they are selling VXX, not buying it, and they are making a fortune every month).
There are two other reasons besides contango that VXX is destined to move lower over time. First, when the value of an instrument is based on changes in the value of another measure, a mathematical glitch always occurs.  When VIX is at 20 and increases by 10%, it goes up by 2, and the tracking instrument (VXX) is likely to move by about that percentage in the same direction. If the next day, VIX falls by 10%, it goes down by 2.20 (10% of 22).  At the end of the two-day period, VXX will end up $.20 lower than where it started.

This is the same thing that happens if you lose 50% of the value of a stock investment.  The stock has to go up by 100% for you to get your money back.  In the day-by-day adjusting of the value of VXX based on changes in VIX, the value of VXX gets pushed lower by a tiny amount every day because of the mathematical adjustment mechanism.

A third reason that VXX gets lower in the long run is that Barclay’s charges a 0.89% fee each year to maintain the ETN. 

In summary, because of the predominant condition of contango as well as the way VXX is constructed, it is destined to go down consistently every month.  Coming soon, we will discuss option strategies that can prosper from this phenomenon.

A Timely Test of the Ultimate Hedge Against a Market Crash

Monday, November 12th, 2012

A week ago I gave you details on how to use stock options to create the perfect hedge against a market crash.  Last Monday, a mini-crash took place.  It was the worst day for the market all year. While the market (SPY) fell 2.3%, VXX rose 7.6%.  The Crash Control portfolio I set up as a hedge against a crash gained 18%, and is poised to gain at an accelerated rate if the market continues to fall. 

The market totally vindicated my analysis.

First, the high inverse correlation between VXX and the market came true, and the options strategy we set up using VXX as the underlying had a high correlation with the price of VXX.  So when the market tanked, the Crash Control portfolio prospered.

The great thing about this market-hedge options portfolio is that it is designed to make a small profit even if the market doesn’t crash.  It’s like buying insurance and getting a settlement even though the bad event that you bought insurance for didn’t actually happen.

A Timely Test of the Ultimate Hedge Against a Market Crash

The link to the follow-up on the options market hedge strategy is:

A Timely Test of the Ultimate Hedge Against a Market Crash

I suspect you will find this market-crash options strategy is so complex that you would be happier just subscribing to Terry’s Tips, sign up for Auto-Trade, and have thinkorswim execute the trades for you in your account.

Last Week’s Trade – Buying Straddles With Weekly Options

Monday, July 9th, 2012

Last Friday was the government’s monthly jobs report.  Historically, the market has been unusually volatile on those Fridays when the actual numbers either exceed expectations or are disappointing.  Last week we gave the results of a strangle trade we made a year ago which resulted in a gain of 67% for the day.

Last Thursday we made a similar bet, this time using a straddle.  Here is how it worked out for us.

Last Week’s Trade – Buying Straddles With Weekly Options

Near the close on Friday, the stock (SPY) was trading right around $137 and it was possible to buy both a Jul2-12 137 put and a 137 call which would expire one day later for $1.18 ($118 per spread plus $2.50 commissions).  We bought 7 spreads, paying $843.50 including commissions.  

This is called buying a straddle.  If at any point on Friday, SPY changed in value by more than $1.00 in either direction, we could sell those options at a profit.  (At any price above $138, the calls could be sold for more than we paid for the straddle, and at any price below $136, the puts could be sold for more than we paid for the straddle.)

The market expected that 100,000 new jobs would be created, but the actual results were lower – about 80,000.  When the market opened up just over a dollar lower, it seemed not to be going anywhere so we took a profit, selling the puts for $155 each, collecting $1076.25 after commissions (the calls expired worthless and no commission was involved).  Our net gain on the trade was $235, or 27.8% on the initial investment.

We were hoping that the stock would reverse itself after the early drop so that we could sell the calls later in the day and add to our gain, but that never happened.

If we had waited until later in the day the profit could have been more than double this amount but if we had waited until the end of the day it would have been less.  There is no easy answer as to when to sell a straddle, but we will probably continue our strategy of taking a moderate profit when it comes along.  Another way to play it would have been to sell enough of the spreads to break even and let the others ride in hopes of a windfall gain.

Straddle buyers like volatility as much as we don’t like it in our other portfolios.  What they like best is a whip-saw market where the market moves sharply higher (and they sell their calls) and then down (when they unload their puts).   There are many ways to profit with options. Buying straddles when option prices are low and volatility is high is one very good way to make extraordinary gains.

The downside to buying straddles is that if the market doesn’t fluctuate much, you could lose every penny of your investment.  This makes it a much riskier investment than the other option strategies we recommend at Terry’s Tips.  

However, straddle-buying can be quite profitable if the current market patterns persist.  Right now, VIX (the so-called “fear index” that measures how high option prices are for SPY options) is at 17.10 compared to its mean average of 20.54.  This means that option prices are relatively low right now.  Last December, for example, when VIX was about 25, the same straddle we bought last week for $118 would have cost over $200.

On Friday, a SPY 137 at-the-money straddle with one week of remaining life (expiring July 13, 2012) could have been bought for $1.99 ($199 each).  If at any time during the next week, if SPY fluctuated more than $2, the straddle should be trading for more than $2.  Over the past 13 weeks, SPY has moved in one direction or another by at least $2 in 11 of those weeks, and in one week it fell by $1.94 at one point.

Straddle buyers like volatility as much as we don’t like it in our other portfolios.   There are many ways to profit with options. It is best to remain flexible, and use the option strategy that best matches current market conditions. Buying straddles or strangles when option prices are low and volatility is high is one very good way to make extraordinary gains, as we happily did last week.

The downside to buying straddles or strangles is that if the market doesn’t fluctuate much, you could lose every penny of your investment (although if you don’t wait too much longer than mid-day on the day options expire, even out-of-the-money options retain some value and should be able to be sold for something).  This makes it a much riskier investment than the other option strategies we recommend at Terry’s Tips.  However, straddle- or strangle-buying can be quite profitable if the current market patterns persist.

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.

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