Today I would like to share an idea that we are using in one of our Terry’s Tips’ portfolios. We started this portfolio on January 4, 2017, and in its first six weeks, the portfolio has gained 30% after commissions. That works out to about 250% for the whole year if we can maintain that average gain (we probably can’t keep it up, but it sure is a good start, and a positive endorsement for the basic idea).
Using Investors Business Daily to Create an Options Strategy
IBD publishes a list which it calls its Top 50. It consists of companies which have a positive momentum. Our idea is to check this list for companies that we particularly like for fundamental reasons besides the momentum factor. Once we have picked a few favorites, we make a bet using options that will make a nice gain if the stock stays at least flat for the next 45 – 60 days. In most cases, the stock can actually fall a little bit and we will still make our maximum gain.
The first 4 companies we selected from IBD’s Top50 list were Nvidia (NVDA), Goldman Sachs (GS), IDCC (IDCC), and HealthEquity (HQY). For each of these companies, we sold a vertical put credit spread which involves selling a put at a strike just below the current stock price and buying a put which is usually $5 lower. When expiration day comes along, we hope the stock will be trading at some price higher than the strike of the puts we sold so that both our long and short puts will expire worthless, and we will be able to keep the cash we collected when we made the sale.
Let’s look at one of the four spreads we placed at the beginning of the year. It involves NVDA, and the options expire this Friday. You can’t sell this spread for this price today, but you could have back on January 4.
With NVDA trading at $99, we placed this trade:
Buy to Open 2 NVDA 17Feb17 95 puts (NVDA170217P95)
Sell to Open 2 NVDA 17Feb17 100 puts (NVDA170217P100) for a credit of $2.00
$400 was placed in our account, less $5 in commissions, or $395. The broker placed a $500 per contract maintenance requirement on the trade ($1000). There is no interest charged on this amount (like there would be on a margin loan), but it is just money that needs to be set aside and can’t be used to buy other stock or options). Subtracting the cash we received from the requirement yields our net investment of $605. This would be our maximum loss if the stock were to fall below $95 when the options expired on February 17, 2017.
NVDA is trading today at $108.50. It looks pretty likely to be above $100 on Friday. If it does, we will not have to make a closing trade, and both options will expire worthless. We will be able to keep the $395 that we collected six weeks ago, and that represents a 65% gain on our investment over 6 weeks (390% annualized). Next Monday, we will go back to the IBD Top 50 list, pick another stock (or maybe NVDA once again – it is their #1 pick), and place a similar trade for an options series that expires about 45 days from then.
We have four stocks in this portfolio, and each week, we sell a new similar spread once we have picked a stock from the Top 50 list. So far, it has been a very profitable strategy.
As with all investments, these kinds of trade should only be made with money that you can afford to lose.