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Posts Tagged ‘Weekly Options’

Ongoing Spread SVXY Strategy – Week 2

Friday, August 22nd, 2014

Last week we started a $1500 demonstration portfolio using SVXY, and ETP that is destined to move higher over the long run because of the way it is constructed (selling VIX higher-priced futures each day and buying at the spot price of VIX, a condition called contango which exists in about 90% of days).Today we bought back an in-the-money expiring put that we had sold last week and rolled it over to next week.

I hope you find this ongoing demonstration to be a simple way to learn a whole lot about trading options.

Terry

Ongoing Spread SVXY Strategy – Week 2

Last week, we used the following trade to set up this portfolio:

Buy To Open 1 SVXY Jan-15 90 put (SVXY150117P90)
Sell To Open 1 SVXY Aug4-14 87 put (SVXY140822P87) for a debit limit of $12.20  (buying a diagonal)

This executed at this price (90 put bought for $15.02, 87 put sold for $2.82 at a time when SVXY was trading at $85.70.

Our goal is to generate some cash in our portfolio each week.  This should be possible as long as the stock remains below $90 and we have to move that strike price higher.  We will discuss what we need to do later when it becomes an issue. Right now, we are facing a market where the stock is trading lower than it was last week when we bought it.  Now it is about $85, and our goal is to sell a weekly put each week that is about $1 in the money, and do it at a credit.

This is the order we placed (and was executed today):

Buy to close 1 SVXY Aug4-14 87 put (SVXY140822P87)
Sell To Open 1 SVXY Aug5-14 86 put (SVXY140829P86) for a credit limit of $  (selling a diagonal)

When we entered this order, the natural price (buying at the ask price and selling at the bid price) was $.65 and the mid-point price was $.90.  We placed a limit order at $.85, a number which was $.05 below the mid-point price.  It was executed at that limit price.

We paid a commission of $2.50 for this trade, the special rate for Terry’s Tips customers at thinkorswim.  The balance in our account is now $1555 which shows a $55 gain (more than the $45 average weekly gain we are shooting for to make our goal of 3% a week).

Next Friday we will make another similar trade and I will keep you posted on what we do.

The stock has moved up a bit since we made this trade so you might be able to get a better price if you do this on your own.

This is what the risk profile graph looks like for our positions at next Friday’s expiration:

SVXY Risk Profile Graph August 2014

SVXY Risk Profile Graph August 2014

Ongoing Spread SVXY Strategy For You to Follow if You Wish

Monday, August 18th, 2014

A couple of weeks ago, I put $1500 into a separate brokerage account to trade put options on an Exchange Traded Product (ETP) called SVXY.  I placed positions that were betting that SVXY would not fall by more than $6 in a week (it had not fallen by that amount in all of 2014 until that date).  My timing was perfectly awful.  In the next 10 days, the stock fell from $87 to $72, an unprecedented drop of $15.

Bottom line, my account balance fell from $1500 to $1233, I lost $267 in two short weeks when just about the worst possible thing happened to my stock.  Now I want to put $267 back in and start over again with $1500, and make it possible for you to follow if you wish.

This will be an actual portfolio designed to demonstrate one way how you can trade options and hopefully outperform anything you could expect to do in the stock market.  Our goal in this portfolio is to make an average gain of 3% every week between now and when the Jan-15 options expire on January 15, 2015 (22 weeks from now).

That works out to 150% a year annualized.  I think we can do it.  We will start with one trade which we will make today.

I hope you find this ongoing demonstration to be a simple way to learn a whole lot about trading options.

Terry

Ongoing Spread SVXY Strategy For You to Follow if You Wish

Our underlying “stock” is an ETP called SVXY.  It is a complex volatility-related instrument that has some interesting characteristics:

1. It is highly likely to move steadily higher over time.  This is true because it is adjusted each day by buying futures on VIX and selling the spot (current) price of VIX.  Since over 90% of the time, the futures are higher than the spot price (a condition called contango), this adjustment almost always results in a gain.  SVXY gained about 100% in both 2012 and 2013 and is up about 30% this year.

2. SVXY is extremely volatile.  Last Friday, for example, it rose $2 in the morning, fell $6 mid-day, and then reversed direction once again and ended up absolutely flat (+$.02) for the day.  This volatility causes an extremely high implied volatility (IV) number for the options (and very high option prices). IV for SVXY is about 65 compared to the market (SPY) which is about 13.

3. While it is destined to move higher over the long run, SVXY will fall sharply when there is a market correction or crash which results in VIX (market volatility) to increase.  Two weeks ago, we started this demonstration portfolio when SVXY was trading at $87, and it fell to $72 before recovering to its current $83.

4. Put option prices are generally higher than call option prices.  For this reason, we deal entirely in puts.

5. There is a large spread between the bid and ask option prices.  This means that every order we place must be at a limit.  We will never place a market order.  We will choose a price which is $.05 worse for us than the mid-point between the bid and ask prices, and adjust this number (if necessary) if it doesn’t execute in a few minutes.

This is the strategy we will employ:

1. We will own a Jan-15 90 put.  It cost us $15.02 ($1502) to buy (plus $2.50 commission for the spread).  Theta is $4 for this option.  That means that if the stock is flat, the option will fall in value by $4 each day ($28 per week).

This is the trade we made today to get this demonstration portfolio established:

Buy To Open 1 SVXY Jan-15 90 put (SVXY150117P90)
Sell To Open 1 SVXY Aug4-14 87 put (SVXY140822P87) for a debit limit of $12.20  (buying a diagonal)

This executed at this price (90 put bought for $15.02, 87 put sold for $2.82 at a time when SVXY was trading at $85.70.
2. Each week, we will sell a short-term weekly put (using the Jan-15 90 put for collateral).  We will collect as much time premium as we can while selling a slightly in-the-money put.  That means selling a weekly put at the strike which is slightly higher than the stock price.  We hope to collect about $2 ($200) in time premium by selling this put. Theta will start out at about $20 for the first day and increase each day throughout the week.  If the stock stays flat, we would get to keep the entire $200 and make a net gain of $172 for the week because our long put would fall in value by $28.  This is the best-case scenario.  It only has to happen 6 times out of 22 weeks to recover our initial $1200 investment.

3. Each Friday we will need to make a decision, and often a trade. If the put we have sold is in the money (i.e., the stock is trading at a lower price than the strike price), we will have to buy it back to avoid it being exercised.  At the same time, we will sell a new put for the next weekly series.  We will choose the strike price which is closest to $1 in the money.  Our goal is to take some money off the table each and every week. If it is not possible to buy back an expiring weekly put and replace it with the next-week put at the $1 in-the-money strike at a credit we will select the highest-strike option we can sell as long as the spread is made at a credit.  We eventually have to cover the $1220 original spread cost, and collecting about $200 as we will some weeks would recover that amount quite quickly  – we have 22 weeks to collect a credit, so we only need an average of about $45 each week (after commissions).

4. On Friday, if the stock is higher than the strike price, we will not do anything, and let the short put expire worthless.  On the following Monday, we will sell the next-week put at the at-the-money strike price, hopefully collecting another $200.

5. We are starting off by selling a weekly put which has a lower strike price than the long Jan-15 put we own.  In the event that down the line (when the stock price rises as we expect it will), we may want to sell a weekly put at a higher strike price than the 90 put we own.  In that event, we will incur a maintenance requirement of $100 for each dollar of difference between the two numbers.  There is no interest charged on this amount, but we just can’t use it for buying other stocks. For now, we don’t have to worry about a maintenance requirement because our short put is at a lower strike than our long put.  If that changes down the line, we will discuss that in more detail.

This strategy should make a gain every week that the stock moves less than $3 on the downside or $4 on the upside.  Since we are selling a put at a strike which is slightly higher than the stock price, our upside break-even price range is greater. This is appropriate because based solely on contango, the stock should gain about $1.00 each week that VIX remains flat.

I think you will learn a lot by following this portfolio as it unfolds over time.  You might find it to be terribly confusing at first.  Over time, it will end up seeming simple.  Doing it yourself in an actual account will make it more interesting for you, and will insure that you pay close attention.  The learning experience should be valuable, and we just might make some money along the way as well.

3% a Week Possible With This Strategy?

Tuesday, July 29th, 2014

Today I would like to share a strategy with you that seems to make sense to me.  I have not back-tested it, and I am not exactly positive that it will work.  But I think it will.  And I will only need to commit $1500 to test it out (actually, a little less than that as you will see).  I invite you to follow along if you wish.  For the next few weeks, I will send out any trades I make so you can mirror them if you wish.

My gut feeling tells me that this strategy could make 3% each week.  I have set up a separate brokerage account with $1500 to test it out.

Terry

3% a Week Possible With This Strategy?

This strategy is based on my favorite underlying “stock” (actually an Exchange Traded Product, ETP) called SVXY.  It is the inverse of VXX, a volatility-related ETP which many people buy for protection just in case the market crashes (when that happens, volatility soars, and so does VXX).  The only problem is that volatility has been pretty much tame for quite a while, and VXX has consistently moved lower.

In fact, VXX is just about the worst investment you could have made over the last few years.  Since it was started 7 years ago, it was at a pre-reverse split price of over $3000 and now it is about $28.  It is hard to find anything out there that has been that bad.

SVXY is the inverse of VXX, and that sounds to me like a better investment for the long run.  SVXY has only been around for 2 ½ years, and in each of the first two calendar years, it has about doubled in value.  So far this year it is up about 40%.

Of course, the big risk with owning SVXY is that a crash or correction will come along and the stock will fall by a large amount.  However, over the long run, because of contango (discussed in this newsletter on many occasions), it inevitably will rise.

One possible good investment might be to just buy SVXY. We do essentially this in one of the 10 portfolios we carry out at Terry’s Tips, in fact – it has gained over 40% since we set it up in November 2013 (sometimes we sell shares when we have fears of impending market volatility such as the fiscal cliff scare, and buy shares back when it looks like the possible crisis has blown over).

SVXY is an extremely volatile ETP and option prices are extremely high.  For that reasons, we trade it in several Terry’s Tips portfolios.  The proposed new strategy I am telling you about here will not be traded at Terry’s Tips unless it ends up looking highly likely that we could make the 3% a week that I think is possible.

This strategy is based on my observation that weekly put prices on SVXY are more expensive than weekly call prices, and they also seem to be higher than they should be given what the stock does most of the time.  You can sell someone a weekly put that is $5 out of the money (i.e., $5 less than the current stock price) and collect more than a dollar ($100 per contract) for it.  In other words, if the stock does anything other than fall over $6 in a week, you get to keep the entire option price you collected.  SVXY has only fallen $6 in a single week once in 2014 (although in 2013, it fell considerably more on two occasions).

It is possible to sell puts naked (not in an IRA, however), but that would require a huge maintenance requirement that would reduce your return on investment.  Besides, the risk would just be too great for most of us.  Instead, I will buy a longer-term put at a strike about $6 below the strike of the call I plan to sell.  That will create a maintenance requirement of $600 per trade (less the value of the put that is sold).

To start off, today with SVXY trading about $87, I placed the following spread order:

Buy to Open 1 SVXY Jan-15 75 put (SVXY150117P75)
Sell to Open 1 SVXY Aug-2 81 put (SVXY140808P81) for a debit of $7.20 (buying a diagonal)

The spread executed.  I paid $8.70 for the Jan-15 75 put and received $1.50 for the Aug2-14 81 put that expires in 10 days.  The spread cost me $720 plus a $2.50 commission:

SVXY Diagonal Trade July 2014SVXY Diagonal Trade July 2014

Thinkorswim offers a special commission rate for Terry’s Tips subscribers ($1.25 for a single option trade).  Many people have become Terry’s Tips insiders to qualify for this rate for all their trades.  If you are paying more than this, you might consider it yourself.

My total investment is $720 plus the $600 maintenance requirement, or $1320.  That is the maximum I can lose if SVXY falls below $75 and stays there through next January.  I can live with that unlikely possibility.

A week from Friday when the Aug2-14 81 put expires (most likely worthless), I will either  buy it back for a small amount and sell a new put for the Aug-14 series that expires a week later (at a strike which is about $6 less than the then-current stock price) or do nothing and wait until Monday to sell a new put.

If the Aug2-14 81 put ends up in the money because SVXY has fallen below $81, I will buy it back and sell an Aug-14 81 put as a calendar spread, collecting a credit of some amount.

In any event, as soon as I make a trade, I will tell you about it.  I think this strategy might be a little fun to play, and if it does manage to make 3% a week, I could live with 150% a year on my money.

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.

Terry

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).

Maybe it’s Time to Buy Options Rather Than Sell Them

Monday, June 23rd, 2014

Last week I recommended buying a calendar spread on SVXY to take advantage of the extremely high option prices for the weekly options (at-the-money option prices had more than doubled over the past two weeks).  The stock managed to skyrocket over 7% for the week and caused the calendar spread to incur a loss.  When you sell a calendar spread, you want the stock to be trading very close to the strike price when the short options expire.  When the underlying stock makes a big move in either direction, you generally lose money on these spreads, just as we did last week.

Ironically, this spread was the only losing portfolio out of the 10 portfolios we carry out at Terry’s Tips (ok, one other portfolio lost a couple of dollars, but 8 others gained an average of almost 5% for the week).  The only losing spread was the one I told the free newsletter subscribers about.  Sorry.  I’ll try to do better next time.

Terry

Maybe it’s Time to Buy Options Rather Than Sell Them:

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).  Last week VIX fell almost 11% to end up below 11.  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.  On Friday, in the portfolio that that lost money on the SVXY calendar spread, we bought at-the-money calls on SPY  for $1.36.  It seems highly likely that  the stock will move higher by $1.50 or more at some point in the next 3 weeks and make this a winning trade (SPY rose $1.81 last week, for example).

With option prices generally low across the board and the stock market chugging consistently higher in spite of the turmoil in Iraq, maybe this would be a good time to buy a call option on your favorite stock.  Just a thought.

An Interesting Trade to Make on Monday

Monday, June 16th, 2014

The recent developments in Iraq have nudged options volatility higher, but for one underlying, SVXY, it has apparently pushed IV through the roof.  This development has brought about some potentially profitable option spread possibilities.Terry

An Interesting Trade to Make on Monday

In case you don’t know what SVXY is, you might check out the chart of its volatility-related inverse, VXX.  This is the ETP many investors use as a protection against a market crash.  If a crash comes along, options volatility skyrockets, taking VXX right along with it.  The only problem with VXX is that over time, it is just about the worst investment you could imagine making.  Three times in the last five years they have had to engineer 1 – for – 4  reverse splits to keep the price higher enough to bother with buying.  Over the past 7 years, VXX has fallen from a split-adjusted price over $2000 to its current $32.

Wouldn’t you like to buy the inverse of VXX?  You can.  It’s called SVXY  (XIV is also its inverse, but you can’t trade options on XIV).

Last week I talked about buying short-term (weekly) call options on SVXY because in exactly half the weeks so far in 2014, the stock had moved $4 higher at least once during the week.  I also advised waiting until option prices were lower before taking this action.  Now that option prices have escalated, the best thing seems to be selling option premium rather than buying it.

Two weeks ago, a slightly out-of-the-money weekly SVXY option had a bid price of $1.05.  Friday, that same option had a bid price of $2.30, more than double that amount.

All other things being equal, SVXY should move higher each month at the current level of Contango (6.49%).  That works out to about $1.20 each week.  I would like to place a bet that SVXY moves higher by about that amount and sell a calendar spread at a strike price about that much above Friday’s close ($79.91).

Below I have displayed the risk profile graph  for a July-June 81 calendar put spread (I used puts rather than calls because if the stock does move higher, the June puts will expire worthless and I will save a commission by not buying them back.

This would be the risk profile graph if we were to buy 5 Jul-14 – Jun-14 put calendar spreads at the 81 strike price at a cost of $3.00 (or less).  You would have $1500 at risk and could make over 50% on your investment if the stock goes up by amount that contango would suggest.  Actually, as I write this Monday morning, it looks like SVXY will open up about a dollar lower, and the spread might better be placed at the 80 strike instead of the 81.

SVXY Risk Profile Graph June 2014
SVXY Risk Profile Graph June 2014

A break-even range of $3 to the downside and about $5 on the upside looks quite comfortable.  If you had a little more money to invest, you might try buying September puts rather than July – this would allow more time for SVXY to recover if it does fall this week on scary developments in Iraq (or somewhere else in the world).

I have personally placed a large number of Sep-Jun calendar spreads on SVXY at strike prices both above and below the current stock price in an effort to take advantage of the unusually higher weekly option prices that exist  right now.

That’s enough about SVXY for today, but I would like to offer you a 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).

Check Out the Volatility in SVXY

Monday, June 9th, 2014

This week is a further discussion of my favorite ETP (Exchange Traded Product), SVXY.  We have already discussed this unusual equity.  Because of contango, it is destined to move higher every week that there is not a market crash or correction.  It has doubled in value in each of the last two years.  If you have an idea of which way an underlying is headed, there are extremely attractive option strategies that you might use.  I will talk about one such strategy this week.Terry

Check Out the Volatility in SVXY

Every week for the past four weeks in my personal account, I have bought at least 200 out-of-the-money weekly call options on SVXY, paying $.20 ($20) for each option.  In every single instance, I was able to sell those options for at least $1.00 ($100), and sometimes much more.  That works out to 500% a week for 4 weeks in a row.  I could make that same bet every week for the next 16 weeks and lose every time and still be ahead.  (As we will see below, in half the weeks in 2014 so far, my bet would have been a winner, however).

Last week I was delighted to unload t hese calls because I figured that after moving higher for 6 consecutive weeks, it might be in for some weakness.  Not so.  The options I sold for $100 each could have been sold later in the week for $550.  I left a lot of money on the table.

I shared these trades with Terry’s Tips subscribers, by the way.  They were an insurance purchase as part of a larger portfolio of long and short options on SVXY.  Usually insurance costs money. I expected to lose money on it.  Over the past few weeks, it paid off nicely.

An interesting feature of SVXY price changes is the weekly volatility numbers.  This is an extremely volatile stock. The following table shows the biggest up and down changes in 2014 from the previous Friday’s close for SVXY.

This stock is unbelievably volatile.  In 19 of the 22 weeks, it either rose or fell by more than $3 (highlighted weeks). It rose over $3 in exactly half the weeks and if fell by more than $3 in 8 of the weeks.

SPXY Changes Newsletter June 2014

SPXY Changes Newsletter June 2014
With this kind of volatility, maybe buying a straddle each week at the close on Friday would be a good idea. The cheapest straddle last Friday would have been at the 84 strike (SVXY closed at $84.11) and would have cost about $3.35 (in most previous weeks, this straddle could have been bought for about $1 less – this week’s 10% rise in the stock price pushed IV much higher).

The biggest challenge with buying straddles is to figure out when to sell.  If you waited until the stock had moved by $4 to sell, you could have made a gain in 14 if the 22 weeks (64% of the time) but you would be only making about 20% at this week’s straddle cost and possibly losing almost everything in the remaining weeks. Not a good prospect, except maybe if you had bought at earlier-week prices.

A better idea would have been to buy a slightly out-of-the-money weekly call, paying about $.80 for it, and selling it when you have tripled your money.  You could have done that in half the weeks in 2014, insuring a great profit no matter what happened in the other half the weeks.

After SVXY rose $3 or more at some point in 7 of the last 8 weeks, however, call prices have moved higher this week (for the first time, surprisingly).  It would now cost about $1.20 to buy a weekly 85 call with the stock closing at $84.11.  A week ago, that same call would have cost about half as much.
This week I am not making an insurance purchase of out-of-the-money calls on SVXY.  The call option prices have become too rich for my taste. I suspect that a week from now, they might be back to a more reasonable level.

For several months, the call options have been much less expensive that the put options, but they are about the same right now.  In the past, traders were buying puts as a hedge against a market crash (when the market tanks, SVXY falls by a much greater percentage than the market).  This phenonemon will probably return soon, and make buying out-of-the-money calls a good strategy.

I suspect that SVXY might take a breather here for a week or two, so I will be sitting on the sidelines.  When call prices retreat a bit, I plan to start buying cheap out-of-the-money weekly calls once again.

That’s enough about SVXY for today, but I would like to offer you a 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).

A Look at the Downsides of Option Investing

Monday, May 12th, 2014

Most of the time we talk about how wonderful it is to be trading options.  In the interests of fair play, today I will point out the downsides of options as an investment alternative.

Terry

A Look at the Downsides of Option Investing

1. Taxes.  Except in very rare circumstances, all gains are taxed as short-term capital gains.  This is essentially the same as ordinary income.  The rates are as high as your individual personal income tax rates. Because of this tax situation, we encourage subscribers to carry out option strategies in an IRA or other tax-deferred account, but this is not possible for everyone.  (Maybe you have some capital loss carry-forwards that you can use to offset the short-term capital gains made in your option trading).

2. Commissions.  Compared to stock investing, commission rates for options, particularly for the Weekly options that we trade in many of our portfolios, are horrendously high.  It is not uncommon for commissions for a year to exceed 30% of the amount you have invested.  Because of this huge cost, all of our published results include all commissions.  Be wary of any newsletter that does not include commissions in their results – they are misleading you big time.

Speaking of commissions, if you become a Terry’s Tips subscriber, you may be eligible to pay only $1.25 for a single option trade at thinkorswim.  This low rate applies to all your option trading at thinkorswim, not merely those trades made mirroring our portfolios (or Auto-Trading).

3. Wide Fluctuations in Portfolio Value.   Options are leveraged instruments.  Portfolio values typically experience wide swings in value in both directions.

Many people do not have the stomach for such volatility, just as some people are more concerned with the commissions they pay than they are with the bottom line results (both groups of people probably should not be trading options).

4. Uncertainty of Gains. In carrying out our option strategies, we depend on risk profile graphs which show the expected gains or losses at the next options expiration at the various possible prices for the underlying.  We publish these graphs for each portfolio every week for subscribers and consult them hourly during the week.

Oftentimes, when the options expire, the expected gains do not materialize.  The reason is usually because option prices (implied volatilities) fall.   (The risk profile graph software assumes that implied volatilities will remain unchanged.).   Of course, there are many weeks when VIX rises and we do better than the risk profile graph had projected.   But the bottom line is that there are times when the stock does exactly as you had hoped (usually, we like it best when it doesn’t do much of anything) and you still don’t make the gains you originally expected.

With all these negatives, is option investing worth the bother?  We think it is.  Where else is the chance of 50% or 100% annual gains a realistic possibility?  We believe that at least a small portion of many people’s investment portfolio should be in something that at least has the possibility of making extraordinary returns.

With CD’s and bonds yielding ridiculously low returns (and the stock market not really showing any gains for quite a while – adjusted for inflation, the market is 10% lower than it was in March,  2000,), the options alternative has become more attractive for many investors, in spite of all the problems we have outlined above.

How Option Prices are Determined

Monday, April 21st, 2014

Last week was one of the best for the market in about two years.  Our option portfolios at Terry’s Tips made great gains across the board as well.  One portfolio gained 55% for the week, in fact.  It is fun to have a little money tied up in an investment that can deliver those kinds of returns every once in a while.

This week I would like to discuss a little about what goes into an option price – what makes them what they are?

Terry

How Option Prices are Determined

Of course, the market ultimately determines the price of any option as buyers bid and sellers ask at various prices.  Usually, they meet somewhere in the middle and a price is determined.  This buying and selling action is generally not based on some pie-in-the-sky notion of value, but is soundly grounded on some mathematical considerations.

There are 5 components that determine the value of an option:

1. The price of the underlying stock

2. The strike price of the option

3. The time until the option expires

4. The cost of money (interest rates less dividends, if any)

5. The volatility of the underlying stock

The first four components are easy to figure out.  Each can precisely be measured.  If they were the only components necessary, option pricing would be a no-brainer.  Anyone who could add and subtract could figure it out to the penny.

The fifth component – volatility – is the wild card.  It is where all the fun starts.  Options on two different companies could have absolutely identical numbers for all of the first four components and the option for one company could cost double what the same option would cost for the other company.  Volatility is absolutely the most important (and elusive) ingredient of option prices.

Volatility is simply a measure of how much the stock fluctuates.  So shouldn’t it be easy to figure out?   It actually is easy to calculate, if you are content with looking backwards.  The amount of fluctuation in the past is called historical volatility.  It can be precisely measured, but of course it might be a little different each year.

So historical volatility gives market professionals an idea of what the volatility number should be.  However, what the market believes will happen next year or next month is far more important than what happened in the past, so the volatility figure (and the option price) fluctuates all over the place based on the current emotional state of the market.

Using Puts vs. Calls for Calendar Spreads

Monday, April 7th, 2014

I like to trade calendar spreads.  Right now my favorite underlying to use is SVXY, a volatility-related ETP which is essentially the inverse of VXX, another ETP which moves step-in-step with volatility (VIX).  Many people buy VXX as a hedge against a market crash when they are fearful (volatility, and VXX. skyrockets when a crash occurs), but when the market is stable or moves higher, VXX inevitably moves lower.  In fact, since it was created in 2009, VXX has been just about the biggest dog in the entire stock market world.  On three occasions they have had to make 1 – 4 reverse splits just to keep the stock price high enough to matter.

Since VXX is such a dog, I like SVXY which is its inverse.  I expect it will move higher most of the time (it enjoys substantial tailwinds because of something called contango, but that is a topic for another time).  I concentrate in buying calendar spreads on SVXY (buying Jun-14 options and selling weekly options) at strikes which are higher than the current stock price.  Most of these calendar spreads are in puts, and that seems a little weird because I expect that the stock will usually move higher, and puts are what you buy when you expect the stock will fall.  That is the topic of today’s idea of the week.

Terry

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 2013-14, 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 for most underlyings, including SVXY.  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).

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