Stock Option Trading Idea of the Week
Why You Should Drop Everything and Check Out the New Weekly Options
"Weekly Mesa Gains 20% (After Commissions) for the Week: It was first-time ever event for a 10K Strategy portfolio based on SPY. Gold Bug also gained 20% last week, and William Tell has done it when AAPL has moved up, but this was a first time for a Weekly SPY portfolio to break the 20% barrier. It was actually a good week all around. Seven of the 8 portfolios made gains - only William Tell fell because AAPL lost a couple of points. Even Big Bear enjoyed a double-digit gain while SPY edged up a penny.
The 20% gain in Weekly Mesa came our way because the market was essentially flat and VIX rose at the same time (VIX went up 12.9% last week, probably propelled by the uncertainty of next week's election). Usually, when the market is flat or goes higher, VIX falls or holds steady, but this was not the case this week. However, we do not need a rising VIX for high weekly gains to continue. We just need a quiet market.
As good as last week was, next week could conceivably be just as good, even if VIX falls once the election results are known. When we rolled to the new Weekly options on Friday, we collected about $1.05 for the at-the-money call spreads. This compares to about $.85 that we collected on the previous Friday. The risk profile graphs show that exceptional gains could be made next week because of these very high premiums that we have collected.
Here is what the risk profile graph looks like for next week in the Weekly Mesa portfolio:
How Long Can It Last? The short answer is that we can expect double-digit weekly gains as long as the market remains quiet. A range-bound market like we have experienced for the last 6 weeks or so can extend for quite a long time. In fact, we enjoyed this kind of a market for about 3 ½ years from 2005 until late 2008. During this time, our portfolios averaged over a 50% annual gain. Now that Weekly options are available, there are 52 expirations a year rather than 12, and we should be able to do double or triple those kinds of annual gains if the market doesn't fluctuate too much.
Actual volatility if far more important to our success than Implied Volatility (IV). Last summer, IV was about 10% higher than it is now but we lost money almost every week because actual volatility was too high. In the 3 ½ year span when actual volatility was low and we did so well, IV was almost always below 20 (it is 21.2 today).
Actual volatility is almost impossible to predict. Last summer we expected the doldrums to set in and cause a flat market, yet it fluctuated wildly on low volume. In October, historically one of the most volatile months, it settled down and we averaged double digit portfolio gains every week.
Weekly options do provide us with an opportunity to adjust more frequently to protect against high actual volatility. We generally set cash aside to expand the break-even range in either direction if the market moves too much on Monday, Tuesday, or Wednesday. On Thursday and Friday, new Weekly options are a source of new cash that can be used to balance the risk curve on those days.
Have You Ever Made 3% a Day? The 3 Weekly SPY portfolios have an average theta which is about 3% of portfolio value. That means that if the stock stays flat, the portfolio should gain 3% a day. I have never seen it that high before, ever, with a full week to go until expiration. And the number should get even larger each day next week. Thanks to a higher VIX, our break-even range extends more than $3 in both directions, something that has not been possible for the last couple of months. If the market doesn't go crazy next week, it should be fun."
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 8 actual option portfolios (including our Weekly Mesa that gained 20% just last week) 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
For the last three weeks the S&P 500 (SPY) has finished mostly flat. Ahead of what could arguably be the biggest week of the year the major market benchmark closed the week up 0.18 points or 0.0%.
However, even though the last three weeks were stagnant, the market still had its best October in four years. Every major market index closed the month up more than 3% and the tech-heavy Nasdaq ended the month up 5.9%.
It was the first time since April that the market was able to finish higher for two consecutive months. Since September, the S&P has shot higher an amazing 12.9%. As a result, the S&P, Dow, Russell 2000 and the tech-heavy Nasdaq are all higher year-to-date 6.1%, 6.6%, 12.5% and 10.5%, respectively.
The focus has moved away from earnings and arguably the economy and is now looking towards the upcoming elections Tuesday and the FOMC meeting that concludes Wednesday.
The Fed meeting is expected to include the announcement of more quantitative easing. So basically, they want to pump more money in the economy by announcing hundreds of billions of new asset purchases, particularly long-term Treasuries, in an attempt to revitalize the struggling U.S. economy.
The theory is that quantitative easing will drive down interest rates even further which will in turn, encourage business and consumers to borrow and spend more. The plan will be unveiled at the conclusion of the two-day meeting Wednesday.
The question is will the next round of easing have a positive effect on the economy?
Rates are already at historical lows and there really isn't much room to go lower. Even with rates at historical lows, borrowing and spending have been rather lackluster as a lack of confidence in the economy continues amongst U.S. citizens (according to consumer sentiment reports).
Currently, personal savings rates are significantly higher and corporations are sitting on record levels of cash. Moreover, banks have reported extremely weak demand for loans.
"I think people are wasting time talking about monetary policy," said Richard Koo, chief economist with the Nomura Research Institute in Tokyo and an expert on the massive quantitative easing efforts by Japan during the past two decades. "No one is borrowing money, even with rates near zero. So the economy has little reason to respond to QE2."
His sentiment has been echoed by two of the top economists in the world, Nobel Prize winning economist Joseph Steiglitz and PIMCO bond manager, Bill Gross. Both have stated that the U.S. could be facing a "liquidity trap" in which lower interest rates are no longer able to spur borrowing and spending.
One thing Is certain, we will all see how this plays out. I for one, have my doubts, but then again, I have been wrong numerous times before and will continue to be in the future.
Technically Speaking
Currently, only the tech-heavy Nasdaq 100 (QQQQ) sits in a "very overbought" state. Yes, the Q's typically lead the way when it comes to market direction so I would expect to see a short-term decline as we head into next week, but I truly think will see an enormous amount of volatility enter the market Tuesday, which should carry into the final tick at the close Friday.
As I stated before, this could arguably be the most important week for the market. We are sitting near highs and the market seems to be sitting idly waiting for a catalyst. One thing is certain next week will provide the catalyst. The question is where will the market go? If I only knew the answer to that question I would be more than happy to provide you the answer.
I guess we will all have to anxiously wait for the results. I can't wait!
Andy
Overbought/Sold Condition Report
Overbought/Oversold as of October 30, 2010
- S&P 500 (SPY) - 61.7 (neutral)
- Dow Jones (DIA) - 55.0 (neutral)
- Russell 2000 (IWM) - 51.9 (neutral)
- NASDAQ 100 (QQQQ) - 75.4 (overbought)
Testimonial of the week
"You're a class act and it's obvious to me why you have become so successful. Keep up the good work. I look forward to staying with you for a long time." - Tim