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Why Owning Options Beats Owning Stock

Two weeks ago, Apple announced blow-out earnings that pleased just about everyone who follows the stock.  Since that time, AAPL has soared by 9.2%.  Owners of the stock are celebrating.

Meanwhile, the actual options portfolio we carry out at Terry’s Tips increased in value by 42.5% over this same time period.  Options outperformed the stock by more than 4 times.

Today I will share with you the actual option positions we hold in this portfolio, and show the potential gains (or losses) that lie ahead.  This is an important report that I hope you will read carefully

Why Owning Options Beats Owning Stock

In April, 2010, we set up a $5000 portfolio to demonstrate that a well-designed options portfolio could substantially outperform the outright purchase of stock.  We selected AAPL as the underlying, a company we thought had a good future.

We never imagined that future would be quite as spectacular as it has been so far.  The stock has skyrocketed by 72% since then.  Meanwhile, our options portfolio has gone up by 263%.  Our subscribers who mirrored our portfolio from the very beginning have gained over 3.5 times as much as they would have if they had merely purchased shares of AAPL.

We withdrew $3000 of the original $5000 so new subscribers could mirror the portfolio with a smaller investment.  The original investment, now $2000, as grown to its present value of $12,141 in 21 months.  Not bad by any standards, if we do say so ourselves.

How did we do it?   Quite simply, we bought call options with a few months of remaining life and sold call options with only one month of remaining life against these positions. The shorter-term calls we sold to someone else decay at a faster rate than the longer-term calls that we own.  This gives us a major advantage over anyone who has just gone out and bought shares of stock.

In options terminology, we created a portfolio that maximized net delta (the equivalent number of shares of stock we own) as long as there was positive theta (which means that the portfolio would make a small gain every day that the stock remained absolutely flat).

Here are the actual positions of this report from our weekly report sent to paying subscribers:

If you spent $12,141 (the portfolio value) to buy stock, you could purchase 26 shares.  The net delta of this portfolio (117) means that we own the equivalent of 117 shares, or over 4 times as many as the stock owners control.  Meanwhile, theta ($32) means that we are collecting a sort of dividend of $32 every day that the stock remains flat.  We don’t actually get a check for that amount, but that is how much the portfolio should gain from the different decay rates of the long and short options in the portfolio.

Here is the risk profile graph which shows the gains (or losses) that this portfolio should experience when the current short options (Feb-12) expire on February 17, 2012 at the various possible stock prices.  (Note: If the stock moves sharply from its present level, we would make adjustments to the portfolio that would shift the curve in the direction the stock had moved.)

The graph shows that the portfolio should gain over 15% in two weeks if the stock remains absolutely flat or goes up by about $10.  Surely, this is a better place to be compared to what the stockholders have.  If the stock stays flat, they will not make anything.

If the stock falls about $5 in two weeks, the owners of stock would lose that amount while the portfolio should break even. If the stock falls about $10 in two weeks, the options portfolio would do just about the same as the owners of stock would do.  If it falls more than $10, the options portfolio would suffer a greater loss than the stock would, but we would have made an adjustment to reduce or eliminate that possible loss (by rolling down short calls to lower strike prices).

This may sound confusing, or maybe even too good to be true, but Terry’s Tips Insiders are generally not confused, and they know full well from experience that these results are real.   We feel that we have definitively proved that an options portfolio can significantly outperform the outright purchase of stock if you pick a stock that goes up.

Actually, we are a little confused why anyone who really believes in a particular stock would buy shares in it rather than setting up an options portfolio like this one.  Do you understand why?  Other than it taking a little more work?  Surely, learning a little about options is something that could pay off every year for the rest of your life.  Why not start off right now by clicking here?

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