Stock Option Trading Idea of the Week
Beware of ETF Expiration Dividends
We call our new portfolio the Weekly Mesa. The Mesa part of the name derives from the shape of the risk profile graph curve that we establish when new positions are place. Here is what the graph looks like for a $10,000 portfolio we set up on Thursday, July 22nd when SPY was trading at $109.50
I must apologize because this graph looks a little more like a mountain than a mesa. Our goal is to set up positions that yield approximately the same gains regardless of whether the stock goes up or down by $3 or less in either direction in one week. (About 2/3rds of the time, SPY moves less than $3 in a 7 day period.) We didn't quite accomplish that goal last week. Our first attempt at this portfolio had a break-even range of that size, but gains would be less if the stock more than $2 ½ in either direction.
We set aside $1700 of the original $10,000 to add new spreads once we had an idea of which direction the stock was headed, and early this week, we will use some of that cash to expand the break-even point in that direction. Although there are several ways we can accomplish this adjustment, one of our favorite methods is to add a new calendar spread at a higher strike price (if the stock seems to be headed higher). Doing so would shift the risk profile graph curve to the right, showing greater gains at higher stock prices and lower gains at lower stock prices.
While most of our portfolios use a series of calendar spreads, with some at strike prices above the stock price and others below the stock price, we did something a little different in the Weekly Mesa portfolio. Some put spreads (called diagonal spreads) had a long side (September expiration month) at a higher strike than the short side (Weeklys expiring July 30th), and some call spreads had a long side at lower strikes than the short Weekly strikes.
While these diagonal spreads tied up more cash than calendar spreads would have, they offer the unique advantage of allowing adjustments (if the price of SPY moved quickly during the week) that could be done for a credit (so no extra cash would be required), and would increase potential profits at the same time.
When we set up the portfolio on Thursday, the graph indicated that we would make about $800 (8%) in a single week if the stock ended up within the $6 range original break-even range. At the end of the day on Friday, the stock had moved up a dollar and the portfolio was worth $10,150 which is a real accomplishment because when new positions are placed, commissions and the bid-ask-spread-penalty usually result in a 3% loss on the first day of trading.
If you are not familiar with options, much of this may seem like mumbo-jumbo right now. A subscription to our service includes an inexpensive and comprehensive options tutorial that will clear up most of your confusion (and if you still have questions, I will be happy to answer them for you).
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 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
Market participants were once again able to push the market back in a position to test the 200-day moving average. The move was admittedly surprising given the news from Big Ben Bernanke Wednesday afternoon. The Fed Chairman stated that the economy faced "unusually uncertain" prospects, suggesting low inflation and low interest rates for a long time.
The Fed Chairman's overly cautious statement came one week after the Fed released its downgraded forecasts on the economy for 2010. Economists in the private sector have also been reducing their growth prediction for 2010 in the wake of disappointing economic reports that point to a broad slowing in the economic recovery.
"Even as the Federal Reserve continues prudent planning for the ultimate withdrawal of monetary policy accommodation, we also recognize that the economic outlook remains unusually uncertain," Bernanke said in a testimony to the Senate Banking Committee.
Yet, the market was able to rally the following day and extend the gains into Friday after the European bank stress tests were reported. Buyers were able to help the market swing from a 1% loss to a 1% gain, as the bears' efforts became somewhat exhausted. The advance Thursday was attributed to better than expected housing data coupled with a strong euro.
Housing starts in June fell 5%, but building permits actually increased 2.1% month-over-month to an annualized rate of 586,000 which is above the 572,000 that economists has predicted. Again, this did not stop the market from rallying hard.
For the week, the blue chip index gained 3.2%, the market benchmark S&P 500 climbed 3.6% and the tech-heavy NASDAQ jumped 4.2%.
At the end of the trading week, the market had once again experienced a widely vacillating market, this time in the bulls favor. The S&P managed to top the 1,100 level on perceived healthy corporate results, GE's improved outlook, and 84 out of 91 European banks passing their so-called stress tests.
So where do go from here? Even with the rally this week the market remains in a neutral state, albeit close to an overbought state. The charts are displaying that we are still in a downtrend. Just look at the one year charts on all of the major indices and it is easy to see with the lower-highs, etc. Furthermore, the major benchmarks are still below the 200-day moving average which also indicates that a downtrend is still in place. However, the S&P (SPY) is right beneath the 200 day at $110.67, so next week could be pivotal to the intermediate-term future of the market. There are still a few bearish indicators that remain in focus for traders, but they seem to be dwindling each time the bears fail to extend a sell-off.
Andy
Overbought/Sold Condition Report
Overbought/Oversold as of July 24, 2010
Major Benchmarks
- S&P 500 (SPY) - 68.2 (neutral)
- Dow Jones (DIA) - 69.4 (neutral)
- Russell 2000 (IWM) - 69.9 (neutral)
- NASDAQ 100 (QQQQ) - 68.7 (neutral)
Testimonial of the week
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