Stock Options Trading Idea of the Week
The Big Dripper - A Conservative Options Strategy
Subscribers have been clamoring for a super-conservative portfolio that will make less money than our other portfolios but will never lose money except perhaps in market crashes like this one (and losses will be considerably less if such a crash ever occurs again in our lifetimes). This will be our most conservative portfolio.The Big Dripper will start next Thursday (October 23rd) with $10,000, will use SPY as the underlying, and each month, $150 (1 ½%) will be withdrawn (hence, the name "dripper") regardless of the gain or loss for the portfolio that month. If a windfall gain comes along (which might be possible given the current option prices), larger chunks will be withdrawn to allow new subscribers to mirror the portfolio for approximately $10,000.
Here are the Basic Trading Rules for the Big Dripper portfolio:
Calendar spreads will be bought over a larger range of strike prices than our other portfolios. At first, we will use a range of 15% both below and above the stock price. This number will be reduced to approximately 10% when the market settles down to more normal times.
A minimum of 10% will be set aside for adjustments in case they are necessary.
Rather than waiting until expiration week to roll out short options to the next month, the roll-out will normally occur earlier than expiration week. This will reduce the potential gain but also reduce risk considerably.
In spite of the conservative nature of this portfolio, here is what the risk profile graph looks like right now. (It might not look quite this attractive next Thursday when we set it up, but it should be similar.)
If you study this graph carefully, you can see that a greater profit potential exists over a wider range of possible stock prices than ever before in any of our portfolios. The stock can go up $28 before a loss would result (SPY has never gone up by half that amount in any expiration month). On the downside, it could fall by 18% before a loss would occur (with no adjustments) - over 50 years, it has fallen only once by that amount (in October 2008, of course).
We would be holding at least $1000 to extend the lower break-even price in the event that the stock fell by 10%, so it is unlikely that we would encounter a loss even if the October crash repeated itself in November.
The Big Dripper is likely to be a dull portfolio that delivers 1 ½% in hard cash every month for decades to come. Except in unusual months like this one when short-term options are so much more expensive than long-term ones - we very well might make a windfall gain this month. The risk profile graph shows that truly unusual profits might be possible in these unusual market times.
Happy trading.
Andy's Market Report
It was another historical week for the market. Monday was witness to the largest one-day point gain in market history followed two days later by the second-worst point loss in market history. Three-hundred point moves in five minutes were the norm for the Dow. One thousand point trading ranges were commonplace. The S&P moved 9.5% on Thursday. The major market index gained only 3.5% all of last year.The VIX (investors fear gauge) moved to an all-time intraday high of 81.17 and closed the week over 70. To put the enormous amount of volatility into perspective, 30 was considered to be the height of great uncertainty and fear which typically have contrarians salivating. Why?
Short-term periods of high volatility often signal that a reversal is in the making. Another positive for the bullish camp is the double-bottom that occurred over the past five trading days. Could this indeed be the intermediate-term low we have all been anxiously awaiting? While I would not be surprised to see another test of the recent lows I do think that the lows will hold and should act as a springboard for a decent fourth quarter rally. Historically, the fourth quarter is the best for the market. Hopefully, history will repeat itself. First we need a few bulls with conviction to lead the way.
The following paragraph depicts in greater detail the type of volatility we witnessed last week.
As I stated earlier, Monday saw a huge rally. The S&P rallied from one of the deepest oversold conditions in market history. It advanced 11.7% on the day. Over the next two days it would lose 17.4% only to finish the week higher 4.6%.
This past week kicked off third quarter earnings season, but like the economics report this past week, the fundamentals of the market do not seem to matte at the moment. The market knows that right now emotions, due to the uncertainty surrounding the credit market, have a stranglehold on everything sane.
However, towards the end of the week the credit markets were moving in the right direction. The Libor rate moved from over 5% to just over 1.6%. Most of the credit indicators moved lower this past week, but some, like the 3-month Libor, remained at levels that have market participants still uncertain about the pace of a recovery.
If confidence continues to move back into the credit markets I would expect to see the move off the lows continue into the New Year. I will discuss this further in the technical section below.
Technical Mumbo Jumbo
Last week I stated the following:
"I do think when the rally occurs that it will be sharp and violent. Once the shorts start to feel the pain on the upside we should see hordes of sellers hit the button. I would not be surprised to see the move close the enormous gap from 10/6. However, I think that is where the selling could once again move back into the market. So, keep a close eye on how the market reacts once it reaches that level."
Well, I do not think that I could have called it any better. Hopefully, my good fortune will continue into the New Year. Anyway, the market is currently nearing a short-term overbought state, so I would not be surprised to see some of the typical post-expiration weakness early in the week.
I do think that we could be carving out an intermediate-term low here which could be the beginning of a nice fourth quarter rally (it is historically the best performing quarter) before the New Year tumble that has plagued the market more often than not the last ten years.
Overbought/Sold Condition Report
Overbought/Oversold for October 17, 2008
Major Benchmarks- Dow (DIA) - 52.3 (neutral)
- S&P 500 (SPY) - 42.6 (neutral)
- Russell 2000 (IWM) - 46.2 (neutral)
- Nasdaq 100 (QQQQ) - 44.1 (neutral)
- Emerging Markets (EEM) - 52.4 (neutral)