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Posts Tagged ‘Straddles’

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.

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.

Terry
 
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.

Updates on Costco and Joy Global Earnings Plays

Monday, June 3rd, 2013

Last week I wrote two Seeking Alpha articles on earnings plays – How To Play The Costco Earnings Announcement and How To Play Joy Global’s Earnings Announcement.  I expected that Costco would fall after earnings because expectations were unusually high and that JOY would move higher because expectations were quite low.

I was right on with the COST call and our positions gained 16.6% after commissions for the week.  JOY fell marginally, less than $.50 and we gained 7.8%.

Update on the Costco trade (submitted as a comment after the Costco article). Today before the open, Costco announced earnings of $1.04 which beat estimates of $1.02 but fell short of the $1.06 whisper number. The stock is now trading just under $113 compared to just under $115 when I wrote this article so any potential buyer of the stock would have done well to heed my advice and wait until after the announcement to buy shares (Note: a day later fell to below $110).

The diagonal option spread that I suggested was sold in our Terry’s Tips portfolio for a credit of $.84. That meant for anyone buying 5 spreads, your investment would have been the $2500 maintenance requirement less $420 received from the sale, or $2080. Today we sold the spread for a debit of $.10, making $.74 per spread. After paying commissions of $25, the net gain on 5 spreads was $345, or 16.6% on the investment. This was the 11th consecutive successful earnings trade we have made using our Expectation Model.

Note: In the actual Terry’s Tips portfolio where the Costco trade was made, we also placed a calendar spread to reduce our risk (in case we were wrong about Costco falling after the announcement).  This spread lost money and reduced our gain to 9.6% after commissions.

In JOY there were 4 July-13 – May5-13 calendar spreads. In our actual account at thinkorswim, here are the numbers for what we paid for these spreads and what we sold them for: 52.5 strike (cost $1.35 sold for $1.20), 55 strike (cost $1.55 sold for $2.38), 57.5 strike (cost $1.50 sold for $1.61), and 60 strike (cost $1.19 sold for $1.00). We lost money on 2 spreads but gained on 2 others, and enjoyed one big gain. The total cost of our investment was $2236 and our net gain after paying $65 in commissions was $175, or 7.8% on our investment.

While this was quite a bit lower than the returns we made on the earlier 11 investments that resulted in gains averaging about 19% (without a single loss), most people would be happy with 7.8% for a single week after commissions. 

These two profitable earnings trades made it 12 consecutive gainers for this portfolio.
The odds of making 12 successful profitable trades without a single loss is comparable to flipping a coin and getting heads 12 times in a row. The odds of that happening are one out of 4096 times. Either I have been incredibly lucky or maybe there is some merit in the Expectations Model I have developed. The future will tell. 

We are not making any earnings-related trades this week because only one company we are following (they must have weekly options and be trading over $20) reports this week, and our expectations model could not determine whether expectations were unusually high or low.

Eight Consecutive Successful Earnings Plays and What We Learned

Friday, May 17th, 2013

Note: There is a lot of valuable information in this report for anyone who trades stock options.  It will take you about 15 minutes to read, but that investment in your time could be worth thousands of dollars to you down the line.  I hope you will read it thoroughly all the way to the end.

On April’s Fools Day in 2013, we opened a new $5000 portfolio at Terry’s Tips.  We thought that might be a lucky day to start.  For several months we had been studying what happens just before and after a company announces their quarterly earnings, and this portfolio was designed to put our observations to work.

The biggest thing we discovered in our analysis was that the post-announcement change in the stock price was determined more by market expectations prior to the announcement than the actual earnings themselves.  If you have played in the stock market for any length of time, you surely have lived through an earnings announcement when your favorite company exceeded estimates on all scores, and the stock fell on the news.  That really hurts, and I’m sure we all have felt it.

We have concluded that it is all due to what the market was expecting vs. its experience of the actual earnings.

Most of the time, we measured expectations by what the stock had done in the weeks leading up to the announcement and the difference between what analysts predicted earnings would be and the whisper numbers (we also check out RSI numbers to see if the stock is particularly over-sold or over-bought, and recent company performance at earnings time related to results vs. estimates). 

When the stock has had a big run-up before the announcement and whisper numbers were greater than analyst expectations, we concluded that expectations were uncomfortably high, and the least disappointment in the announcement (concerning earnings, revenues, margins, or guidance) might result in the stock trading lower even if the company surpassed earnings by a comfortable margin.

We called it the PEA Picker portfolio (PEA stands for Pre-Earnings Announcement).  We restricted the companies that we would consider to those which traded Weeklys approximately 160).  We eliminated companies trading for less than $20 because option prices were typically not attractive enough for our purposes. We ended up with about 100 companies which are the most actively-traded and have the most liquid option markets (i.e., small bid – ask spreads and the assurance that decent spread prices could be executed). 

Even more important, we could trade out of them on the Friday following the announcement, just a few days after placing our trades.  This eliminated being concerned about the long-run prospects for the company and put us in cash at the end of the week so we could invest in another company in the following week.  We like near-instant gratification on our trades, bad or good, and we like to sleep over the weekend with no positions in place (most of the time).

In addition to checking recent stock price action and whisper numbers, we looked carefully at the last four earnings reports to see what happened, and to the most recent RSI numbers to learn if the stock were unusually over-bought or over-sold.  Some companies consistently exceeded expectations and their stock fell after the announcement while others merely met expectations and the stock moved higher. 

Many times we were able to detect patterns that helped us decide which option spreads we would use.  One pattern was that big moves after announcements tended to be reversed at the next announcement (or more often, big moves were rarely followed by big moves in the same direction at the next announcement).

The day after the PEA Picker portfolio was set up, we issued the following Trade Alert.  By the way, this portfolio is carried out in an actual TD Ameritrade/thinkorswim portfolio and all commissions are included at the special rate offered to Terry’s Tips Insiders.  All of the Trade Alerts in this report are actual emails that were sent to Terry’s Tips Insiders and to thinkorswim so they could execute trades through Auto-Trade.  Our account is set up through Auto-Trade so every trade reported here was exactly duplicated in the accounts of all our subscribers who set up through Auto-Trade at thinkorswim.

This first trade involved buying a straddle which we bought before the Weeklys which expired on the Friday after the announcement were available.  This not the usual way we set up PEA Plays but we do it sometimes, obviously.

We had decided that expectations were unusually low and the stock would head higher after the announcement, but the first trade was neutral (it would make money if the stock headed either way, just as long as it moved).

April 2, 2013  Trade Alert -  PEA Picker  Portfolio

J.P. Morgan (JPM) announces earnings next week and the Weeklys that become available on Thursday will be the options with the escalated implied volatility (IV).  We will establish some long positions before that time.  The stock is trading very close to $48 right now so the straddle price is at its lowest.  The straddle might gain for two reasons – first, leading up to an announcement the stock quite often moves (usually higher), and second, implied volatility (IV) of the monthly options usually moves higher once the Weeklys become available:

BTO (Buy To Open) 20 JPM Apr-13 48 calls (JPM130420C48)
BTO 20 JPM Apr-13 48 puts (JPM130420P48) for a debit of $1.88  (buying a straddle) 

Two days later, we issued the following:

April 4, 2013  Trade Alert #2 -  PEA Picker  Portfolio

There are many reasons to believe that the stock is headed higher after earnings and we are currently negative net delta.  This trade will make us long:

STO (Sell To Open) 15 JPM Apr2-13 47 puts (JPM130420P47) for $.58

We held these positions (which cost us a net $2041) until shortly before earnings were to be announced after the close on April 10.  The stock had moved about two dollars higher as we had anticipated.  We issued the following:

April 10, 2013  Trade Alert -  PEA Picker  Portfolio

The stock moved up almost $2 and IV also moved up. We have a nice gain here so we might as well take it rather than waiting for more (or maybe less) once earnings are reported:

BTC 15 JPM APR2-13 47 puts (JPM130412P47)
STC 15 JPM Apr-13 48 puts (JPM130420P48) for a credit of $.25  (selling a diagonal)

STC 5 JPM Apr-13 48 puts (JPM130420P48) for $.30

STC 20 JPM Apr-13 48 calls (JPM130420C48) for $1.74

 
This first PEA Play was a little complicated (future ones will make more sense, I promise).  You can see that we sold the original straddle (which had cost us $1.88) for a total of $2.04 ($1.74 + $.30).  It is not so clear to see that the 15 Apr2-13 47 puts we had sold for $.58 were bought back for only $.05 (this was where most of our gain was).  After commissions, we made a profit of $789 on our $2061 investment, or about 38% of the money we had invested.  The portfolio as a whole had gained only 15.8% because we had invested only about 40% of the cash at our disposal.
The next week featured the Google (GOOG) announcement. We noticed that the GOOG options were expecting a move of 12.3% yet the average post-announcement move had historically been only 6.7%.  (You can calculate the percentage change that the options are predicting by adding up the time premium of the at-the-money Weekly put and call and dividing that total by the stock price.)  While we would have liked to sell the straddle short, that is not possible in an IRA account, and we do not make any trades for our subscribers which cannot be executed in an IRA.
Our choice was to buy diagonal spreads at strikes both comfortably above and below the stock price.  We issued the following:

April 15, 2013  Trade Alert -  PEA Picker  Portfolio
This is a small bet that Google will not deviate by more than $40 from its present level of $790 after this week’s announcement:

BTO 1 GOOG May-13 785 put (GOOG130518P785)
STO 1 GOOG Apr-13 765 put (GOOG130420P765) for a debit of $13.51  (buying a diagonal)

BTO 1 GOOG May-13 820 call (GOOG130518C820)
STO 1 GOOG Apr-13 830 call (GOOG130429C830) for a debit of $8.02  (buying a diagonal)

The total amount invested here was $2158 including commissions.

Again, these trades are a little unlike our usual PEA Plays, but the key point is that the stock would have to fall by $25 before the short 765 puts would have any value.  If the stock fell by that much, or more, the May-13 785 put would be worth at least $2000 more than the short put value (and there would still be some value in the May-13 820 call), so there would be a gain no matter how far the stock might fall.

If the stock were to move $40 higher, the 830 call would have some value, but the May-13 820 call will always be worth at least $1000 more than the 830 short call (and actually, quite a bit more because the option would be very close to the money and there would be a full month of time remaining in that option).  In short, it appeared that a gain would come no matter how high the stock might go.  However, while these spreads gave us excellent protection if there was a large move in either direction, if the stock didn’t move much there was the possibility of a loss.  We corrected that three days later when we issued the following Trade Alert:

April 18, 2013  Trade Alert -  PEA Picker  Portfolio

The stock has fallen more than $20 since we placed the first spreads.  This is an indication that expectations have dwindled, and the stock might move higher.  These trades will give us a little more upside protection in case it rallies and also protects the mid-range from the extremes of the diagonal spreads we placed earlier:

BTO 1 GOOG May-13 780 call (GOOG130518C780)
STO 1 GOOG Apr-13 780 call (GOOG130429C780) for a debit of $4.60  (buying a calendar)

BTO 1 GOOG May-13 790 call (GOOG130518C790)
STO 1 GOOG Apr-13 790 call (GOOG130429C790) for a debit of $4.75  (buying a calendar)

The stock ended up trading between $780 and $790, just where these calendar spreads would do best.  We sold them for $11.52 and $11.80, well more than doubling our money on those spreads.  We lost a little money on the original diagonal spreads, closing out the puts for $15.92 and the calls for $3.90 (for a total of $19.82 compared to our cost of $21.53).

We lost $176 on the diagonal spreads and gained $1392 on the calendar spreads, making the total gain after commissions for the week a healthy $1216 on an investment of $3,098, or 39%.  We plan to make similar investments with Google options in July when the next earnings announcement is scheduled.

Next up was the eBay earnings announcement.  This occurred during the same week as the Google play, and we had spare cash we could put to use:

April 16, 2013  Trade Alert -  PEA Picker  Portfolio

eBay is flirting with a new high and whisper numbers exceed estimates.  This level of expectation usually results in a flat or lower stock price after the announcement, and this spread should make gains if the stock rises moderately or falls by any amount:

BTO 10 EBAY May-13 60 calls (EBAY130518C60)
STO 10 EBAY Apr-13 57.5 calls (EBAY130420C57.5) for a credit of $.16  (buying a diagonal)

This spread required a maintenance requirement of $2500 (less the $160 received).

The stock did manage to fall, and by quite a bit, the Apr-13 57.5 calls expired worthless and we were only able to sell the May-13 60 calls for $.07 ($70) so we managed to make a small gain of $230 less $75 commissions on our eBay play (7%).

The portfolio value had soared to $7,187 in its first two weeks of trading.  We withdrew $2000 from the portfolio so that Terry’s Tips subscribers could follow PEA Picker trades for about $5000 (either through Auto-Trade at thinkorswim where they don’t have to place any trades themselves, or on their own if they preferred another broker).

Next up was Apple (trading at about $405):

April 22, 2013  Trade Alert -  PEA Picker  Portfolio – limit orders

Expectations for Apple seem to be unusually low and when earnings are announced after the close tomorrow there is a good chance that it will trade higher:

BTO 5 AAPL May-13 410 calls (AAPL130518C410)
STO 5 AAPL Apr4-13 410 calls (AAPL130426C410) for a debit limit of $3.85  (buying a calendar)

BTO 5 AAPL May-13 420 calls (AAPL130518C410)
STO 5 AAPL Apr4-13 420 calls (AAPL130426C410) for a debit limit of $3.65  (buying a calendar) 

The stock did move higher and the next day we issued the following:

April 23, 2013  Trade Alert -  PEA Picker  Portfolio

The stock has moved up $15 since we bought our spreads.  We should use our remaining cash to add on another calendar at a higher strike:

BTO 4 AAPL May-13 430 calls (AAPL130518C430)
STO 4 AAPL Apr4-13 430 calls (AAPL130426C430) for a debit limit of $3.16  (buying a calendar) 

The stock closed at $417.20 on Friday.  We sold the 430 spread for $3.14 (incurring a loss of $28 after commissions), the 420 spread for $6.86 and the 410 spread for $4.66, both at nice gains totaling $1960 after commissions.  Net gain for the trades was $1982 on an investment of $5049, or 39%. 

The portfolio value had climbed to $7062 and it was time to withdraw another $2000 from the portfolio to allow new Terry’s Tips subscribers to follow it for about the starting value of $5000.

Next up was Storage Technology (STX):

May 1, 2013  Trade Alert -  PEA Picker  Portfolio

There are a lot of reasons to believe that Seagate (STX) will move higher after today’s announcement following the close.  The company has exceeded expectations every quarter for the last year and sells at a trailing p/e of only 6.4 in spite of consistent growth and a 4.2% dividend.  The company is aggressively buying back shares – in the last six months of 2012, it reduced the outstanding shares by 9.5% and has plans to continue buying back shares.  Whisper numbers are higher than analyst expectations ($1.31 vs. $1.19) but the shares are trading lower than they were three weeks ago which suggests that expectations are not unusually high.  These positions should make gains if the stock falls only a small amount or goes up by any reasonable amount:

BTO 4 STX Jun-13 37 calls (STX130622C37)
STO 4 STX May1-13 36.5 calls (STX130503C36.5) for a debit of $.44  (buying a diagonal)

BTO 4 STX Jun-13 37 calls (STX130622C37) for $1.66

BTO 4 STX Jun-13 37 calls (STX130622C37)
STO 4 STX May1-13 37 calls (STX130503C37) for a debit of $.68  (buying a calendar)
 
BTO 8 STX Jun-13 38 calls (STX130622C38)
STO 8 STX May1-13 38 calls (STX130503C38) for a debit of $.66  (buying a calendar)

BTO 8 STX Jun-13 34 puts (STX130622P34)
STO 8 STX May1-13 34 puts (STX130503P34) for a debit of $.78  (buying a calendar)

The next day the stock moved up over a dollar and we wanted to get a little longer so we placed these trades:

May 2, 2013  Trade Alert -  PEA Picker  Portfolio – limit orders

This trade will pick up a little premium and make us neutral net delta:

BTC 4 STX May1-13 36.5 calls (STX130503C36.5)
STO 4 STX May1-13 39.5 calls (STX130503C39.5) for a debit limit of $2.45  (buying a vertical)

We will take these spreads off:

BTC 4 STX May1-13 37 calls (STX130503C37)
STC 4 STX Jun-13 37 calls (STX130622C37) for a credit limit of $.50  (selling a calendar)

BTC 8 STX May1-13 34 puts (STX130503P34) for a limit of $.01 (no commission)

STC 8 STX Jun-13 34 puts (STX130622P34) for a limit of $.31

Note: thinkorswim does not charge a commission when you buy back short options for $.05 or less.

These were our closing transactions:

May 3, 2013  Trade Alert -  PEA Picker  Portfolio – limit orders

We need to close these out today:

BTC 8 STX May1-13 38 calls (STX130503C38)
STC 8 STX Jun-13 38 calls (STX130622C38) for a credit limit of $.37  (selling a calendar)

BTC 4 STX May1-13 39.5 calls (STX130503C39.5)
STC 4 STX Jun-13 37 calls (STX130622C37) for a credit limit of $2.68  (selling a diagonal)

STC 4 STX Jun-13 37 calls (STX130622C37) for $4.45

The stock had shot up 11% after announcing earnings.  While we correctly guessed the direction of the change, we didn’t quite expect it would be that large.  We lost money on all the spreads we had placed, but the four extra uncovered Jun-13 37 calls rose enough to cover all the losses.  It was our worst week so far.  We gained only $161 which worked out to be 6.4% on our investment and 3.2% on the portfolio value.

Next up was Green Mountain Coffee Roasters (GMCR), a company I have followed since its founding since I live in Vermont and have played tennis regularly with the founder (now ex-chairman) of the company (no, he never gives me any tips, darn it).  I have made a great deal of money betting on the company this year (while it has risen nearly four-fold from its low).  I wrote a Seeking Alpha article outlining why I believed that the company would exceed estimates on earnings but the stock might be flat or fall a little after the announcement – How To Play The Green Mountain Coffee Roaster…

This is the trade I recommended in that article:

May 6, 2013  Trade Alert -  PEA Picker  Portfolio

As we indicated in the Saturday Report, we will make this trade:

BTO 12 GMCR Jun-13 52.5 calls (GMCR130622C52.5)
STO 12 GMCR May2-13 57 calls (GMCR130510C57) for a debit of $3.78 (buying a diagonal) 

Two days later, my prognosis of the earnings was right on the money, but the company unexpectedly announced a new five-year deal with Starbucks which removed much of the uncertainty about the company.  The stock soared by 25%!

If this announcement had not been made I feel certain that our spread would have gained about 50%, but with such a huge gain in the stock, we had to settle for less:

May 9, 2013  Trade Alert -  PEA Picker  Portfolio – limit order

The stock has gone up so far that we can expect to collect little more than the intrinsic value of this spread:

BTC 12 GMCR May2-13 57 calls (GMCR130510C57)
STC 12 GMCR Jun-13 52.5 calls (GMCR130622C52.5) for a credit limit of $4.53  (selling a diagonal)

We “only” made 18.5% after commissions for the trades.  The wonderful thing about options is that you can be wrong and still make a gain much of the time, as we managed to do this time around.

The PEA Picker portfolio was now all in cash and was worth $6,065.  It was time to withdraw another $1000.  Subscribers who followed our trades or participated in Auto-Trade now had all $5000 they originally invested back, and the portfolio was still worth over $5000, It had only been 38 days since our first trade.

Next week we made two PEA Plays, one on Deere & Company and the other on Sina Corporation (SINA).  I wrote Seeking Alpha articles in advance of both plays -How To Play The Deere & Company Earnings Anno… and How To Play The Sina Corporation Earnings Ann…

May 14, 2013  Trade Alert -  PEA Picker  Portfolio – limit orders

We will invest about half our cash in this play as described in the Saturday Report:

BTO 8 DE Jun-13 95 puts (DE130622P95)
STO 8 DE May-13 92.5 puts (DE130518P92.5) for a debit limit of $2.35  (buying a diagonal)

BTO 4 DE Jun-13 90 puts (DE130622P90)
STO 4 DE May-13 90 puts (DE130518P90) for a debit limit of $.93  (buying a calendar)

We thought expectations were running high (whisper numbers well above analyst expectations and the stock had traded higher going into the announcement) so we were betting on a flat or down market after the announcement.  In addition, for the prior four quarters, Deere had traded lower (by about 4%) after earnings, even though they exceeded estimates most of the time.

We were not disappointed.  Even though the company announced earnings that were above estimates, their guidance was tepid.  The stock fell about $4 after the announcement.  We took off our diagonal spread the same day:

May 15, 2013  Trade Alert -  PEA Picker  Portfolio – LIMIT ORDER

We will take off this spread if can get this price:

BTC 8 DE May-13 92.5 puts (DE130518P92.5)
STC 8 DE Jun-13 95 puts (DE130622P95) for a credit limit of $2.72  (selling a diagonal)

We closed out the calendar spread on Friday, selling it for $1.42.  Our gain on the trades was $176 for each spread after commissions, or $352 total on an investment of $2282, or 15%.

In the same week we made a second PEA Play, this one on Sina:
 
May 14, 2013  Trade Alert  #2 -  PEA Picker  Portfolio – limit orders

We will invest about half our cash in this play:

BTO 7 SINA Jun-13 55 puts (SINA130622P55)
STO 7 SINA May-13 55 puts (SINA130518P55) for a debit limit of $1.17  (buying a calendar)

BTO 7 SINA Jun-13 57.5 puts (SINA130622P57.5)
STO 7 SINA May-13 57.5 puts (SINA130518P57.5) for a debit limit of $1.28  (buying a calendar)

BTO 7 SINA Jun-13 60 calls (SINA130622C60)
STO 7 SINA May-13 60 calls (SINA130518C60) for a debit limit of $1.30  (buying a calendar)

On the day before earnings were announced, we added another spread:

May 16, 2013  Trade Alert -  PEA Picker  Portfolio – limit order

If Sina stock rallies more than 5% we will lose money on our spreads.  This trade will expand our upside protection a little and still give us coverage for almost a 10% drop on the downside:

BTO 4 SINA Jun-13 57.5 puts (SINA130622P57.5)
STO 4 SINA May-13 60 puts (SINA130518P60) for a debit of $.10  (buying a diagonal)

We had expected Sina to fall after the earnings announcement because expectations were so high, but we left ourselves with a little room for the stock to move higher in case we were wrong.  The extra trade ended up being a good one because the stock opened up almost $2 higher but then fell back over a dollar mid-day.  We sold the 4 diagonal put spread for $.93, making $352 after commissions.  The 55 put calendar spread was sold for a loss ($.70), the 57.5 put calendar spread for a small gain ($1.35), and the 60 call calendar was sold for a nice gain ($2.05).  After commissions, the Sina options were closed out for a $525 gain, or 19% on our $2727 investment (we had a $1250 maintenance requirement for one day because of the put diagonal, but since we had closed out the Deere positions we had plenty of spare cash in the account).

So there we are.  Eight consecutive profitable option spreads on earnings announcements.  The original $5000 investment had been entirely withdrawn in cash and the account was worth $5862 and sitting in cash awaiting the next week’s trades.

Here are the net results:
JPM  38%
GOOG  39%
EBAY   7%
AAPL  39%
STX   6%
GMCR 18%
DE  15%
SINA  19%

The average gain for the eight successful plays was 22.6%.  Most of the time we only put about half our money at risk so the portfolio increased in value by less than 8 x 22.6%.

What We Have Learned:   We have identified the following characteristics of earnings-announcement-related price action based on our experience over the past several months:

1. It is possible to construct a combination of option spreads which creates a profit if the stock moves less than 10% in one direction or 5% in the other.  Most of the time, the level of pre-announcement expectation determines the direction you want to establish the 10% coverage.

2. It is possible to create unlimited coverage in one direction or the other with diagonal spreads but the potential gains are diminished.

3. Big (over 10%) price moves are almost always in the opposite direction of these last 10% earnings-related move.

4. Downside 10% moves are about twice as likely as upside 10% moves.

5. Big downside price moves are much more likely when expectations are high (some small part of the announcement often disappoints).  High expectations can be measured by a strong upward move in the stock price in the month or two prior to the announcement, a high RSI, and whisper numbers exceeding analyst expectations – all three numbers should be checked prior to making PEA Play).  Low expectations (and a possible 10%+ upward post-earnings move) have the opposite numbers.

6. When risk profile graphs are created prior to making a PEA Play, it is important to change the Implied Volatility (IV) of the long options to account for the expected implosion of all option prices after the announcement has been made.  Check back to see what IV of the one-month options fell to after the last earnings announcement as a guide. If the month of the long options is greater than three months more than the short-term options which are being sold (usually Weeklys), IV will not fall as much as shorter-term long options (because a second earnings-announcement day will occur before they expire).

7. It is usually possible to create a risk profile graph which shows a break-even range which extends about 10% in one direction (usually on the downside) and 5% in the other (usually the upside) by selecting the strike prices of the calendar spreads.

8. When selecting the best month for the long side of the calendar spreads, check out the bid-ask ranges of the options to learn if decent executions are likely.  The further out you go, the more conservative your positions will be (more of the option’s value is due to its long life than its IV) but the greater the bid-ask range might be.

9. Restrict PEA Play companies to those which have Weekly options available.  These are the most actively-traded option markets and decent executions are generally available (which is often not the case with companies which trade only monthly options).  Selling Weeklys also means that you can exit the positions in just a few days rather than waiting until the month expires before the short-term options fall to their intrinsic value.

10. In about a third of the weeks, there will not be a viable PEA Play available, especially if Weekly options are to be sold.  Earnings announcements tend to lump together in a distinct season starting about the middle of January and extending for about six weeks (and then moving 90 days forward to the next quarterly reports).

11. While losses are possible with PEA Plays, the entire amount of the investment can never be lost because there will always be more value to the long side of the calendar spreads than the short value because of the additional time value to those options.

12. More conservative (with lower potential gains) PEA Plays can be made by choosing a wider range of strike prices for the calendar spreads.

13. We checked to see if hedge funds had recently bought (or sold) shares in the company, and concluded that such information was valuable in deciding whether to bet on a higher (or lower) stock price.  While hedge funds aren’t always right, they surely do intensive due diligence before investing or divesting, and they have far more resources to do this that any individual has.

14. A statistic that will need more study is the short interest ratio.  When an unusually high percentage of shares have been sold short, a short squeeze is possible that could result in a large upward move after the announcement, but except for the GMCR case (huge short interest, huge gain after the announcement), the short interest level did not seem to be a significant factor. 

.  Will we be able to continue making profitable PEA Plays every week for the next six weeks?  Probably not.  But it’s possible.  We plan to invest only about half our portfolio value in any given earnings play (and sometimes two in a week) so that if there is a 10% move in the opposite direction we expect, we won’t be left with no money to work with.  (If we feel really strongly about a trade, like we did in Green Mountain Coffee Roasters, we will invest more than half the portfolio value.)

So far, playing the earnings announcements has been fun, and profitable.  After reading this, I hope you decide that it would be a lot easier to become a Terry’s Tips Insider, sign up for Auto-Trade at thinkorswim, and let us make all the investment decisions.  You could also follow our Trade Alerts and place the trades at another broker if you prefer.

You can become a Terry’s Tips Insider, and receive all our educational reports and materials absolutely free by opening a new account (even if you already have another account) at the best options broker around – thinkorswim. You must use this link to sign up – open thinkorswim account– and once you have funded your account with at least $3500, email Seth@TerrysTips.com and let him know that you have done it, and this is what he will do – sign you for our Premium Service package ($119.95 value plus an extra 4 months of our Premium Service, valued at another $190.80).  You get $300.65 worth of services without paying us one penny, and your service will extend for five full months after which you can decide on whether to continue or not.

I look forward to prospering with you.

Terry
Terry@TerrysTips.com

How to Use Expectations to Prosper With Earnings Announcements

Monday, April 15th, 2013

This week I will offer a simple spread idea that could make 50% in a couple of days next week.  It will cost about $170 per spread to put on. 

Also, if you read down further, there is information on how you can become a Terry’s Tips Insider absolutely free! 

How to Use Expectations to Prosper With Earnings Announcements 

The earnings season started just last week.  In my last Idea of the Week I recommended buying a straddle on JPMorgan (JPM), the first big company to announce this time around.  We made that trade in an actual portfolio for Terry’s Tips subscribers and closed it out for a 15%+ gain after commissions. 

I also suggested an options strategy for JPM in a Seeking Alpha article – How To Play The JPMorgan Earnings Announcement.  In another Terry’s Tips portfolio  we placed calendar spreads as outlined in this article and closed them out for a gain of 15% after commissions even though the stock fell a little after the announcement while we were betting that it would go higher. 

A wonderful thing about options is that you can be wrong and still make profits as we did last week in our JPM trades.  Terry’s Tips subscribers who followed both portfolios made over 30% last week, more than most people make in an entire year of stock market investing. 

This week I wrote another Seeking Alpha article which checks out seven big companies which announce this week – How To Play The First Week Of The April Earnings Season.  

The major message of this article is that the price of the stock after the announcement is more dependent on pre-announcement market expectations than the actual numbers that the company releases.  If expectations are too high, the stock will fall no matter how much the company beats the analysts’ projections. 

Of the seven companies reviewed, SanDisk (SNDK) seemed to have the highest level of expectations.  Whisper numbers were 18.6% higher than analyst projections, the stock had shot up over 10% to a new high over the last week, and had moved 5% higher in the last week alone.  We believe that it is highly likely that some investors will “sell on the news” no matter how good it is, and the stock will either stay flat or fall after the announcement. 

With the stock trading about $57.70, I am buying May 57.5 puts and selling April 55 puts. Implied volatility (IV) of the May options is 37 while the April options carry an IV of 70, nearly double the May number (this means you are buying “cheap” and selling “expensive” options).  Each diagonal spread would cost $163 to place at the natural option prices at the close on Friday. 

Here is the risk profile graph for these spreads if you bought 20 of them, investing about $3400 after commissions (of course, you could buy fewer, or more, if you wished): 

SNDK Risk Profile Graph

SNDK Risk Profile Graph

This graph assumes that after the announcement, implied volatility (IV) of the May options will fall from its current 37 to 30 which is more likely in a non-announcement time period.  The graph shows that when you close the positions on Friday, April 19th, a double-digit gain could be made if the stock holds steady, and could nearly double your investment if it fell about $2 ½ after the announcement.  A profit would result no matter how far the stock might fall in value. 

We think the stock is likely to fall after the announcement because expectations are so unusually high.  If it moves higher, however, a loss could very well result.  Even in the world of options, there is no free lunch.  You need to take a risk.  We like our chances here.

An Interesting Straddle Purchase Opportunity in J.P. Morgan (JPM)

Monday, April 1st, 2013

Most of the time I prefer to sell options with just a few days or weeks of remaining life and collect the premium that is decaying at a higher rate than ever before.  However, this policy is not always the most profitable alternative out there.  Today I would like to discuss one of those situations where buying options rather than selling them might be the better bet. 

If you read down further, there is information on how you can become a Terry’s Tips Insider absolutely free! 

An Interesting Straddle Purchase Opportunity in J.P. Morgan (JPM)

 Implied Volatility (IV) of an option price is supposed to measure the market’s expectation of how much the underlying security will fluctuate in one year.  If an options series has an IV of 20, the market expects the stock will move either up or down by 20% over the course of a year. 

Sometimes there is a huge difference between IV of the options and the actual price behavior of the stock.  For example, check out J P Morgan (JPM).  The April options have an IV of 24 with three weeks of remaining life, and this IV is unusually high because an earnings announcement is due on April 12 (before the open), and volatility is usually higher than normal after announcements. 

So how much did JPM fluctuate over the past year?  On June 4, 2013 it hit a low of $30.83 and on March 15, 2013 it hit a high of $51.00. This is a 64% change, more than triple the IV of the options.  In other words, options are relatively inexpensive compared to the actual volatility of the stock. 

When you see a situation like this, the best options play might be to buy a straddle (both a put and a call) at an at-the-money strike and hope that the stock fluctuates as it has in the past. 

Right now, with JPM trading at $47.50, you could either buy an April 47 or 48 straddle for about $2.00 (if you think JPM is headed higher, you would select the 47 strike, and if you think JPM is more likely to fall, you would choose the 48 strike).  If the stock fluctuates more than $3.00 in the next three weeks, you could sell your straddle for a 50% gain.  (The nice thing about straddles is that you don’t care whether the stock goes up or down, just as long as it moves.) 

So how likely is JPM to fluctuate by at least $3.00 in a month?  Here are the biggest and smallest moves it has made over the past 25 months: 

Month

Open

High

Low

Close

Big Up

Big Down

3/1/2013

48.6

51

47.28

47.46

2.08

1.64

2/1/2013

47.4

49.68

46.85

48.92

2.63

0.20

1/2/2013

44.98

47.35

44.2

47.05

3.38

-0.23

12/3/2012

41.27

44.54

40.2

43.97

3.46

0.88

11/1/2012

41.7

43.07

38.83

41.08

1.39

2.85

10/1/2012

40.88

43.54

40.42

41.68

3.06

0.06

9/4/2012

36.98

42.09

36.78

40.48

4.95

0.36

8/1/2012

36.19

38.86

34.76

37.14

2.86

1.24

7/2/2012

36.27

37.2

33.1

36

1.47

2.63

6/1/2012

32.41

37.03

30.83

35.73

3.88

2.32

5/1/2012

43

44.24

32.26

33.15

1.26

10.72

4/2/2012

45.75

46.35

41.8

42.98

0.37

4.18

3/1/2012

39.51

46.49

39.12

45.98

7.25

0.12

2/1/2012

37.89

39.94

37.05

39.24

2.64

0.25

1/3/2012

34.06

38.1

34.01

37.3

4.85

0.05

12/1/2011

30.86

34.19

30.03

33.25

3.22

0.94

11/1/2011

32.47

35.18

28.28

30.97

0.42

6.48

10/3/2011

30.03

37.54

27.85

34.76

7.42

2.27

9/1/2011

37.62

37.82

28.53

30.12

0.26

9.03

8/1/2011

41.16

41.37

32.31

37.56

0.92

8.14

7/1/2011

40.81

42.55

38.93

40.45

1.61

2.01

6/1/2011

42.87

42.99

39.24

40.94

0.12

4.00

5/2/2011

45.94

46.07

41.69

43.24

0.44

3.94

4/1/2011

46.55

47.8

43.53

45.63

1.70

2.57

3/1/2011

46.47

47.1

43.4

46.1

0.41

3.29

 I have highlighted the months in which the stock fluctuated at least $3.00 in either direction (enough for you to make a 50% gain on a $2.00 straddle purchase).  For those months, a 50% gain would be possible in 17 out of 25 months (68% of the time).

 Admittedly, in this example with April options, there are only three weeks rather than four for the stock to fluctuate by this much, but since this time period includes an earnings announcement, greater volatility can be expected in this three-week period than a normal (no earnings announcement) month. 

If you were to buy an April straddle on JPM for $2.00 and place a good-til-cancelled order to sell it if it hit $3.00, you would gain 50% on your investment (less commissions).  If it did not execute in the next two weeks, I would recommend selling it when there was one week remaining for the April options.  If the stock is trading exactly at the strike price of your straddle, you would probably get back half of your $2.00 cost, losing 50%.  If the stock is at any other price than exactly at your strike price, you should be able to sell the straddle for more than $1.00.  If the stock is as little as $1.00 higher or lower than your strike price, you should be able to get back $1.50 of your original $2.00 cost by exiting (selling) the position with a week of life remaining in the option.  If the stock is $2.00 away from the strike price, you should be able to sell the straddle at a profit. 

The stock does not have to fluctuate by $3.00 for you to sell an at-the-money straddle for $3.00 since there will always be some time value to the options (over and above the intrinsic value) right up until the options expire. 

I like the odds of this straddle purchase and plan to do it both in my personal account and in one of my portfolios that I conduct at Terry’s Tips

Buying a Straddle on Oracle

Monday, March 25th, 2013

Last week I told you about a pre-earnings announcement on Nike.  With the stock trading around $65, we bought calendar spreads at the 62.5, 65, and 67.5 strikes for an average of $.33 each, guessing that if the stock ended up near any one of these strikes, that spread would be worth over a dollar and cover all three spreads. The stock shot up more than 11% after the announcement, and was closest to the 70 strike.  The calendar spread at that  strike was worth $1.20, so we were right on that score.  But we didn’t have any spreads at that strike, and we lost money for the day.  In future calls in companies like Nike which have a history of big moves after announcements, we will add extra out-of-the-money calls and/or puts to provide insurance against huge moves of this size. 

If you read down further, there is information on how you can become a Terry’s Tips Insider absolutely free! 

Buying a Straddle on Oracle 

On Friday, with Oracle (ORCL) trading at $32, I bought an April straddle (both a put and a call) at the 32 strike.  The straddle cost me $1.40.  The stock will have to move in either direction at least $1.40 for the intrinsic value of my straddle to be at break-even (although it will not have to move that much for the straddle to be able to be sold for a gain as there will always be some extra premium value in the options I own).

 Let’s look at how much Oracle has fluctuated each month for the past two years:  

Oracle Monthly Price Changes Last Two Years

Oracle Chart March 25 2013

Oracle Chart March 25 2013

Only two times in the last two years has Oracle failed to move at least $1.40 in one direction or another in a single month.  That means that an at-the-money straddle purchased for $1.40 at the beginning of the month could have been sold for a profit at some point during that month 22 out of 24 times. 

Many times, there would have been an opportunity to more than double your money, and while the maximum loss is theoreticlly $1.40 per spread, last week, with a week of remaining life, the 32 at-the-money straddle could have been sold for $.72 which means that if you closed out the spread with a week remaining, the worst you could do would be to recover half your initial investment.  (If the stock were at any price higher or lower than $32, the straddle would be worth more than $.72 with a week remaining). 

The big challenge with these kinds of spreads is deciding when to sell.  One way is to place a limit order when the spread reaches a certain profit level, say 50%, and take that gain whenever it comes.  In our example, that would mean placing an order to sell the straddle at $2.10.  The above table shows that in more than half the months (13 out of 24), you could have sold the straddle for at least a 50% gain.  I like those odds. 

The stock does not have to fluctuate the full $2.10 in order for the straddle to be sold at that price.  As long as there is time remaining in the options you hold, they will be worth more than the intrinsic value.  The $2.10 price might be hit if the stock only fluctuates $1.80 or so if it does it early in month. 

Another way of selling the spread is to place limit orders at slightly more than what you paid for the straddle if either the put or call reaches that price.  You might place a limit order to sell the puts at $1.43 and another order to sell the calls if they reach $1.43.  In either case, you get all your money back (plus the commission) and you have either puts or calls remaining that might be worth a great deal if the stock reverses itself and moves in the opposite direction.  The stock might have to move only about $1.20 in either direction for one of these trades to execute. 

We typically place orders to sell half of our original spreads if either the puts or calls can be sold for the original cost of the straddle.  That way we get half our money back (almost assuming that we will not lose money for the month) and if the stock continues in the direction it has started, a huge gain might be made on those remaining options, and if the stock reverses, you have twice as many of the other options that might grow in value. 

Most of our investments at Terry’s Tips involves selling premium and waiting over time for decay to set in, all the time hoping that the stock does not fluctuate too much (as that hurts calendar spreads).  It is fun to have at least one investment play that does best if the market does fluctuate, and the more the better.  Buying a straddle on Oracle gives us that opportunity, and the history of the stock’s fluctuations shows that it is a pretty good bet.

 

Closing out the APPLE Pre-Earnings Spreads

Friday, January 25th, 2013

The AAPL crash after the earnings announcement surely hurt a lot of people big-time (several people had commented that just buying calls was the smart way to approach the announcement, and others said they were selling out-of-the-money puts to be more “conservative” – they are the ones who got hurt the most – at least the call buyers only lost their entire investment).

 If you recall, in my Seeking Alpha article entitled A Remarkably Safe Way To Play The Apple Earni…  I recommended buying one AAPL Apr-13 500 straddle and selling one Jan4-13 500 straddle to take advantage of the huge difference in IV between them (April = 34, Jan4-13 = 76).  In addition, I said to buy two Apr-13 500 straddles to protect against a large move in AAPL in either direction. 

The difference between the first two straddles came up to $2900, and the extra two straddles cost $6500 each (I actually got better prices than these, but let’s go with the numbers I used in the article). 

I waited until Friday about noon to close out the positions.  AAPL had fallen all the way to $440, down about $60 since I placed the spreads, and $75 from where it had closed just before the announcement. 

I closed out the long and short straddles by selling both the  puts and calls as a calendar spread, collecting $570 for the calls and $750 for the puts.  So I lost money on those spreads (cost $2900, sold for $1320, lost $1580). 

The extra two straddles were sold for $7350 each ($14,700 total) compared to the $13,000 cost for a gain of $1700.  Bottom line, after paying $15 in commissions, I eked out a gain of $105 for the day. 

I consider myself lucky, especially waiting until Friday to close it out (the stock fell another $10 by the time I sold so I did better with the extra straddles than I would have done closing out on Thursday).  

I suspect that my small gain was a whole lot better than most option-players experienced this earnings week (I surely did a whole lot worse in many of my other spreads, most calendars at higher strike prices than $500 – all of which lost big time).

It ended up being one of the worst weeks ever for me, in fact. 

The biggest reason that the “remarkably safe” positions I  recommended  did not do anywhere near what the risk profile graph had suggested the spreads might gain was because IV of the April options fell far more than I expected.  Before the announcement, IV was 34, lower than any other option month.  After the announcement, IV tumbled to 29.  The at-the-money straddle would cost $4900 to buy compared to the almost $6500 that I paid for the April at-the-money straddle a couple of days earlier. 

The at-the-money Feb1-13 440 straddle with a week to go until expiration (as I write this with AAPL at $440) could be sold for $1730 or just about half what the at-the-money straddle with a week of remaining life could be been sold for prior to  the announcement. 

In conclusion, it is important not to get too excited about the risk profile graphs that get created before an earnings announcement (unless your software allows you to set an expected IV of the longer-term options). 

The inevitability of all option prices falling dramatically after the earnings announcement makes calendar and diagonal spreads difficult to execute profitably at the time.

A Remarkably Safe Way To Play The Apple Earnings Announcement

Tuesday, January 22nd, 2013

Apple announces earnings Wednesday after the close and I have come up with a strategy that looks like it can make a decent gain for the week (ranging from 5% to 15%) with almost no chance of incurring a loss. 

The big downside of the strategy is that it requires an investment of about $16,000.  I understand that many subscribers are looking for less costly option investments.

 However, if you can afford an investment of this size, check out the Seeking Alpha article I wrote just yesterday. 

Terry 

Here is the link – A Remarkably Safe Way To Play The Apple Earnings Announcement 

This is the third week in a row that I have offered a strategy centering on the unusually-high option prices in the series that expires just after an earnings announcement. 

The first play was for Wells Fargo – How to Play the Wells Fargo Earnings Announcement for Tomorrow.  This one gained 44% after commissions. 

The second play involved eBay – How to Play the EBAY Earnings Announcement.  I waited too long to close out my spreads this time around (many subscribers gained 24% or more).  But I did manage to make 11.6% after commissions, still not a bad week. 

I think this week’s earnings-announcement play is the safest one yet in spite of the high cost  requirement.  I am also sharing with paid subscribers a most promising play in Starbucks (SBUX).

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