Weekly Stock Options Trading Tips: August 31, 2009

Stock Options Trading Idea of the Week

Reduce Risk by Selecting Different ETFs for Your Underlyings

Last week was an (unexpected) fantastic week for our portfolios, and a reminder of the double-edged sword problem of using an individual stock as the underlying rather than an ETF.  Our 6 portfolios based on an ETF gained an average of 10.7% for the week while markets were essentially flat, while the only portfolio based on an individual stock (MOS) fell 15% when the stock fell 8.5% in a single week (last month, MOS rose 10% and this portfolio gained 60%,  so it is not a portfolio for the faint-hearted).
 
Today, we'll discuss the importance of selecting ETFs rather than individual stocks for option portfolios using a strategy such as ours.

Terry

Reduce Risk by Selecting Different ETFs for Your Underlyings.

The 10K Strategy carried out at Terry's Tips involves buying calendar spreads (usually LEAPS for the long side and selling same-strike current month options, often using puts at strikes below the stock price and calls at strikes above the stock price).  This strategy results in gains if the stock stays flat or moves moderately up or down.  The times when we experience a monthly loss is almost always when the market moves by a large percentage amount in a single month, usually on the downside.
 
Just as important as the strategy itself, it is important to select the right underlyings.  For the most part, we do not use single stocks as the underlyings (although our strategy can be used with individual stocks, but the risks are higher).  We use mostly broad-based ETFs as the underlyings.  This gives us a measure of diversification.  For example, the S&P 500 tracking stock (SPY) is made up of 500 large individual companies so if really bad stuff happens to one or a dozen of them all at the same time, the ETF itself might not move that much. 
 
Another ETF we have had success with is the Dow Jones Industrial tracking stock (DIA) even though it is only based on 30 companies (they are such large companies that the ETF does not fluctuate excessively).
 
Two ETFs that are broad-based but ultimately proved to be too volatile for our strategy to handle are the popular Nasdaq 100 (QQQQ) and the Russell 2000 (small cap, IWM).  At one time, we used both of these ETFs, but came to conclusion that they often fluctuated more like individual companies rather than broad-based indices.
 
While using a broad-based ETF like SPY frees you from the risk of an adverse event hitting a single stock, you can diversify your holdings even more by also choosing an ETF that might move in the opposite direction.  For example, in the past, we have carried out a portfolio based on the Oil Services ETF (OIH).  While this is not broad based index (it is composed of only 18 companies in the oil services industry), it often moves in the opposite direction as the general market.  (We discontinued this portfolio when OIH became too volatile for our strategy to handle.)

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

It was a slow week for the market. Economic and corporate news was essentially nonexistent this past week which led to the doldrums. However, the S&P 500 (SPY) managed to eke out a small 0.4% gain. In addition the Dow, Russell and Nasdaq 100 finished the week higher 2.0%, 3.1% and 1.8% respectively. For the year, the S&P 500 is up 13.9%, the Dow has advanced 8.7% and the Nasdaq is leading the way with a 28.6% gain.

As for the technical picture, I have a few short-term concerns. The S&P (SPY) and Dow (DIA) have both moved into a short-term overbought state. Couple the short-term overbought reading with the upside gap from 8/21 that has yet to close and once again I think we should not be surprised to see a decline over the next week or so. Once the gap closes we can reevaluate the situation.

As I stated before, it was a slow week for the market.  Economic news was few and far between, but the news, what little there was, was better than expected.

New home sales for July rose at a 9.6% annualized rate to 433,000 units, which was well above the 390,000 that economists' anticipated. It was the largest percentage gain since 2005. It was also the fourth consecutive monthly increase in existing home sales. The increase in new home sales came on the heels of several positive reports in the housing market over the past few weeks.

"We might be seeing a broadening-out of the economic recovery," said John Silvia, chief economist at Wells Fargo Securities LLC in Charlotte, North Carolina. "That makes growth more sustainable. The stimulus is providing a floor."

The preliminary Q2 GDP went unchanged. Economists' predicted a drop of 1.5%. It was reported that the reading benefited from a smaller-than-expected drop in consumer spending.

The one negative was the latest weekly jobless claims data. The report continued to reflect a frustrating employment environment.  There were 570,000 new unemployment claims, down 10,000 from the previous week but slightly above expectations. Continuing claims fell by 121,000 to 6.1 million. However, according to Briefing.com "the downward trend of continuing claims should not be confused with a strengthening of the labor market. Jobs are not plentiful and the drop-off is due to workers losing their unemployment benefits."

Consumer Confidence in August advanced to 54.1 from 47.4, which was well above the 47.9 consumer confidence most predicted.  Moreover, the revised University of Michigan Consumer Sentiment Survey for August came in at 65.7, well ahead of the 64.3 consensus.

"Investors still have to be worried about the sustainability of the recovery. It's clear to me that we cannot count on growth through next year as long as consumers are still on the ropes," said Christopher Low, chief economist at FTN Financial in New York, as quoted by Reuters.

All in all it was a slow week. Next week should be interesting given the technical picture I mentioned above.

Overbought/Sold Condition Report

Overbought/Oversold as of August 28, 2009Major Benchmarks

• S&P 500 (SPY) - 73.6 (overbought)
• Dow Jones (DIA) - 71.9 (overbought)
• Russell 2000 (IWM) -  58.8 (neutral)
• NASDAQ 100 (QQQQ) - 69.5 (neutral)

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