Stock Options Trading Idea of the Week
Our "Most Conservative" Options Portfolio
The November expiration month was a dreadful one for markets. They fell about 15%. Okay, the DOW only fell 8% (and this resulted in our option portfolio using DIA as the underlying to gain 40% in one month). The S&P 500 (SPY) fell 15% and the Russell 2000 (IWM) fell a whopping 23%. The huge drop in IWM caused both of our IWM portfolios to suffer big losses last month - there is a limit to how far the market can fall without hurting our portfolio values, and it looks like a monthly drop over 15% is where that limit stands. Fortunately, that number has been exceeded only once in over 20 years for SPY, and that was in October.
We have three SPY portfolios, and while the market fell 15%, these three portfolios gained an average of 18% last month. One of these portfolios is set up to do best when markets fall (we call it the Big Bear Mesa) and it understandably did the best, gaining 40% in a single month.
Today I would like to talk about our most conservative portfolio, the Big Dripper. We set this portfolio up on October 23, 2008 with $10,000. Our plan is to withdraw $150 in cash every month from this portfolio forever. That works out to 18% per year, after commissions. The annual goal is 20% - 25%, or less than our other portfolios which are aiming for 36% a year.
In its first month of operation, the market was not kind to the Big Dripper. SPY fell by 15%. Yet the portfolio gained 16.7% in value. In addition to the $150 monthly withdrawal, we took out another $1500 as a "windfall gain" withdrawal. If the market had not fallen so far last month, the Big Dripper would have made much more.
How did we do it? Simple. We established calendar spreads across a wide range of strike prices, going out at least 15% below the stock price and 15% above the stock price. Very few spreads were placed at near-the-money strikes. This is the risk profile graph which shows what these positions will produce in 4 weeks at the various possible stock prices (SPY closed at $79.52 on Friday).
As you can see, the Big Dripper will make a 35% gain if the stock falls by as much as 15% in 4 weeks, a 30% gain if the stock goes up by as much as 15%, or about 45% if the stock ends up about where it is today.
I must add that the above graph assumes that the current option values (IVs) of the long options will continue as they are right now. If VIX falls considerably, the gains projected by the software would be less than the above numbers. For the past two months, we have not seen any diminution of VIX, however.
Give yourself an early Christmas present, and learn exactly how to create the above portfolio in your own account by becoming a Terry's Tips Insider. You could establish these positions in your own account before Thanksgiving, and have something really exciting to look forward to each month from there on.
You can sign up today here. It could be the best Christmas present you ever gave yourself.
Terry
Andy's Market Report
Just when many thought losses would come to a halt (if only temporary) the bear market decided to carve out new lows. The losses experienced this week officially wiped out what little gains were left from the bull market that last from October 2002 to October 2007. At one point this past week the S&P actually hit levels not seen since 1997. Uncertainty is palpable and until the market can show a shimmer of light at the end of tunnel market participants will continue to lack the conviction needed to turn sentiment in a positive direction.The fundamentals continue to display a market that is on slowing at an ever faster rate. Even the news of more rate cuts had no affect on the market. Remember the days, when the news of a rate cut would send the market flying higher. Things certainly have changed as a rate cut in this environment is viewed as just another sign of desperation on the Fed's part. Yes, action is needed, but at this point just is enough? Another rate cut and we are back at levels not seen in over a half a century.
On Wednesday the FOMC minutes from the late October meeting were released and within the report the Fed made it perfectly clear that "unfolding economic developments" would require the FOMC "to further lower its target for the federal funds rate in the future and to review the adequacy of its liquidity facilities".
"In any event, the committee agreed that it would take whatever steps were necessary to support the recovery of the economy," the minutes said.
"The strains from the banking and credit crisis intensified and took on a more global aspect over the intermeeting period," the minutes said. "This development and the related erosion of the economic outlook and reduction in inflationary pressures led many central banks to reduce their policy rates, including in the internationally coordinated action announced on Oct. 8."
The tipping point of the report was the news that the Fed was once again lowering their 2009 growth projection. They slashed the growth rate from the range of 2.0% to 2.8% they announced back in July to a growth rate of -0.2% to 1.1%. This was the catalyst that sent the market into a downward spiral over the next two trading sessions.
As if the economic news was not bad enough, housing starts continued their decline, falling another 4.5% in October. The report showed a 38% decline from October 2007.
Moreover, jobless claims came in with another decline as they surged from 27,000 to 542,000. The report would signal the highest claims in over 16 years and certainly another decline in the nonfarm payroll report due out over the next week or so.
"What worries us is that this will lead to higher defaults on credit cards" and other debt payments, said Arpitha Bykere, an economic analyst at RGE Monitor. That would trigger further losses in the ailing banking sector.
Even more bad news came out of the financial sector as Citigroup, which now trades for a mere $3.77, announced even more balance sheet issues. In the face of announcing layoffs in excess of 52,000 the company decided it was in their best interest to not announce a cut in senior management's bonuses this year. Oh boy!
Of course, I have to also mention the poorly run automobile sector (or the Big 3) and their attempts at salvaging their companies with a $25 billion bailout package. I will not go into the details or my opinion on the automobile sector, but I will say that this group of executives, knowing the dire situation of the economy and the affects it is and will have on the middle class of this country, could not have made a poorer decision when they decided to take three separate jets to Washington that cost well over $20,000. In most cases this may seem petty to some, but when your sole purpose is to come to Washington to ask for a bailout that is funded solely by taxpayers then I think the appropriate PR should be considered. Unfortunately, their pompous decision could potentially cost several million of middle class jobs across the nation. Even though I think a bailout in some fashion is coming for the automobile manufacturers of this country, why would they jeopardize their employees' future by acting in such a disrespecting manner?
On technical basis, the market continues to be oversold on a short-term and intermediate-term basis. The market bounced Friday off of extreme short-term oversold readings and yet the significant bounce could not bring most of the major indices out of even a short-term oversold state. Typically, we would see a continuation of this move going forward (1-3 days) , but we are not in a typical market. I do think if the S&P can somehow manage to get back to the 850 level we could see a rally that carries us into the New Year. We often see sharp rallies in bear markets (as was witnessed in the pre-election rally) and I would not be a bit surprised to see one over the short-term, at least that what the probabilities are saying. Of course, Mr. Probability isn't always correct.
Overbought/Sold Condition Report
Major Benchmarks
- Dow (DIA) - 41.1 (neutral)
- S&P 500 (SPY) - 40.1 (neutral)
- Russell 2000 (IWM) - 38.3 (neutral)
- Nasdaq 100 (QQQQ) - 37.6 (neutral)
- Emerging Markets (EEM) - 43.1 (neutral)