Weekly Stock Options Trading Tips: August 10, 2009

Stock Options Trading Idea of the Week

Don't Worry About Leap Values

In spite of higher market volatility than we would like, the composite value of our 7 portfolios has gained over 10% in the current expiration month (and the final two weeks are when most of the gains generally come).  Some people would be happy with a 10% gain in their portfolios for an entire year, and we have made that much in 3 weeks.
 
Today we will discuss something which has caused these gains to be less than they might have been in perfect conditions.

Terry

Don't Worry About Leap Values

We call it the 10K Strategy.  It is the basic underlying strategy carried out at Terry's Tips.  The strategy involves buying slower-decaying LEAPS in an underlying ETF and selling faster-decaying short-term options against these LEAPS.
 
When Projected Volatility (IV) of these options changes, their prices change.  Over the last few weeks, IVs have fallen (VIX, the most popular measure of option volatility, fell from the mid 40's to about 25).  This has resulted in lower option prices, both for the LEAPS we own and the short-term options we have sold.
 
Since the absolute value of the LEAPS is greater than that of the short-term options, when IV falls, the LEAPS fall by a greater absolute amount.  The result is that our portfolios suffer a short-term apparent diminution of value.
 
We have been telling subscribers that they shouldn't too upset about the value of the LEAPs.  Their primary function is to provide collateral for our selling short-term options (and collecting the higher time decay they offer).  The only time when we are interested in the value of a LEAP is when it comes time to sell it and replace it with a longer-term LEAP.  At that time, if Projected Volatility (IV) is low and we can't get much for the LEAPS we are selling, we will find that the new LEAPS we are buying will be "cheap" by historical standards as well.
 
The important point to remember is that you shouldn't agonize over the current value of the LEAPS.  They are only there for collateral, not for trading.

Any questions?   I would love to hear from you by email (terry@terrystips.com), or if you would like to talk to our guy Seth, give him a jingle at 800-803-4595 and either ask him your question(s)  or give him your thoughts.
 
You can see every trade made in 7 actual option portfolios portfolios (12 portfolios if you count the Shoot Strategy ones as well) conducted at Terry's Tips and learn all about the wonderful world of options by subscribing here.   Why wait any longer to make this important investment in yourself?
 
I look forward to having you on board, and to prospering with you.
 
Terry 

Andy's Market Report

The market advanced again this past week as the S&P was able to tack on another 2.3%. The push led to another new yearly high as better-than-anticipated economic news in the unemployment and the housing sector spurred more buying interest. For the week the Dow, S&P, Russell and NASDAQ 100 advanced 2.2%, 2.3%, 2.8% and 1.1% respectively.

As I stated over the past few weeks the market has gained over 13% during the past three weeks which has pushed it into a short-term "overbought" state. The probability of at least a short-term pullback looks likely (although I have been stating this for several weeks now). I am still not convinced that buyers have the conviction to continue this latest rally that is, until a short-term reprieve occurs that fills the gap in the S&P 500 (SPY) from 7/30. Once that gap is filled I will then begin to be more confident if the rally is able to snap back from the expected short-term reprieve.

"We've run very fast, very quickly," said Marc Harris, co-head of global research for RBC Capital Markets in New York. "I think we're due to take a breath."

As I stated before economic data stood at the forefront this week as there were quite a few market moving releases this past week.

The week began on a positive note as the ISM Manufacturing Index made its seventh straight increase. The index improved to 48.9, up from 44.8 in July and better that the 46.2 that economists' has anticipated.

Dan Meckstroth, chief economist for Manufacturers Alliance/MAPI, said the figures add "to a growing number of indicators that signal that manufacturing and the general economy is bottoming out and a recovery is coming this summer."

In addition, the National Association of realtors reported that  the Pending Home Sales index increased 3.6% in June. The report also included a 0.8% upwardly revision to the number that came out in May. The overall index is 6.7% above June 2008's level.
"Historically low mortgage interest rates, affordable home prices and large selection are encouraging buyers who've been on the sidelines," said Lawrence Yun, NAR's chief economist, in a statement. "Activity has been consistently much stronger for lower priced homes."

If that wasn't enough to spark buyers' interest, the government said the U.S. unemployment rate unexpectedly fell in July for the first time in 15 months and that employers cut fewer jobs.
The report stated that employers shed 247,000 jobs in July, the fewest in a year. Economists had anticipated the loss of 320,000 jobs. The unemployment rate dropped to 9.4% from 9.5% in June, rather than rising to 9.6% as forecast.

"It really gave the market the proof that it needed to see," said Burt White, chief investment officer at LPL Financial in Boston.
The economic good news pushed the S&P 500 above the 1000 point psychological level for the first time since November.  The S&P 500 is now up 51.5% from its March 6 low, gaining for the fourth consecutive week.

Next week, market participants will be focusing the Fed's two-day interest-rate committee that concludes Wednesday. It is still uncertain if and when policymakers will decide to raise interest rates to keep inflation in check. Investors' will be paying close attention to any insight on whether or not policymakers feel the economy is strong enough to do so.

Overbought/Sold Condition Report

Overbought/Oversold as of August 7, 2009

• S&P 500 (SPY) - 79.1 (overbought)
• Dow Jones (DIA) - 82.7 (very overbought)
• Russell 2000 (IWM) -  69.4 (neutral)
• NASDAQ 100 (QQQQ) - 64.2 (neutral)

Testimonial of the week

"I must say I'm amazed by the quality of your work. The 10k Strategy is absolutely brilliant.  The strategy is both simple and efficient. The expected ROI seems achievable on a regular basis although I have only backtested the strategy on a few months so far.  This puts your strategy apart from the usual crap we can find on the internet."  -- Ron