An Option Play Designed to Make 68% in One Month
Last week, VIX, the so-called “fear index” rose 65% to close at 24.39. It was the 10th time that it moved over 20 in the last 3 years. In 9 of those 10 occasions, VIX fell back below 20 in less than 10 days, and in the other instance (August 21, 2015), it took 40 days to fall back below 20. Today I would like to tell you about a trade I am making today that will make 68% in one month if that pattern continues this time around.
An Option Play Designed to Make 68% in One Month
Last week was a bad one for the market. The S&P 500 tracking stock (SPY) fell $7.74 to close at $201.88, down 3.7% for the week. SPY closed out 2014 at $205.54 and started out 2015 at $206.38, so if last week’s close holds up for two more weeks, the market will record a calendar year loss for the first time since 2008.
Apparently, the reason for the big drop centered around the Fed’s likely move to raise interest rates on Wednesday, the first time it has done so in a decade. I believe that the institutions (who control over 90% of the trading volume) were carrying out a last-ditch effort to discourage this move. After all, does the Fed want to be the bad guys who are responsible for the worst yearly market in 7 years? Would raising rates be a good idea at a time when the market is lower than it was a year ago? (We should remember that the Fed is composed of big banks who make greater profits when interest rates are higher, so raising rates may seem to be self-serving).
I have no idea if the Fed will raise rates in two days as Janet Yellen has indicated they plan to. If they do, I suspect it will be a small start, maybe 0.25%, and they will also report that they intend to be slow to make further increases. In either case, no rate increase or a small one, the big change will be that the uncertainty over the timing of the increase will cease to exist. Either choice should result in a higher market and more importantly for option traders, a lower VIX.
As I have written about extensively, an Exchange Traded Product (ETP) called SVXY varies inversely with VIX. When VIX moves higher, SVXY crashes, and vice versa. Last week, SVXY fell $14.27, from $59.41 to $45.14, (24%) when VIX rose 65%.
When VIX falls back below 20, as it has done every single time it rose over 20 for the past 3 years, SVXY will be trading higher than it is today. Here is the trade that will make 68% if SVXY is trading any higher than it closed on Friday in 32 days (on January 15, 2016).
Buy To Open 1 SVXY Jan-16 40 put (SVXY160115P40)
Sell To Open 1 SVXY Jan-16 45 put (SVXY160115P45) for a credit of $2.05 (selling a vertical)
This trade will put $205 in your account (less $2.50 commissions at the rate Terry’s Tips subscribers pay at thinkorswim), or $202.50. The broker will place a maintenance requirement on your account of $500, but your maximum amount at risk is $500 less the $202.50 you collected, or $297.50) – this loss would occur if SVXY closed at any price below $40 at the January expiration. The break-even price for you would be $43.00 – any price above this would be profitable and any price below it would incur a loss. There is no interest charge on the maintenance requirement, but that much in your account will be set aside so that you can’t buy other stocks or options with it.
At the close of trading on January 15, 2016, if SVXY is at any price above $45, both these puts options will expire worthless and you will keep the $202.50 you collected when you made the trade. This works out to be a 68% gain on your investment at risk. You will not have to make a trade at that time, but just wait until the end of the day to see the maintenance requirement disappear.
Of course, there are other ways you could make a similar bet that SVXY will head higher as soon as some of the market uncertainty dissipates. You could sell the same spread at any weekly option series for the next 5 weeks and receive approximately the same credit price. For shorter time periods, you don’t have to wait so long to pocket your profit, but there is less time for uncertainty to settle down and SVXY move higher.
Actually, VIX does not have to fall for SVXY to at least remain flat. It should trade at least at $45 as long as VIX does not rise appreciably between now and when the options expire.
A more aggressive trade would be to bet that SVXY rises to at least $50 in 33 days. In this trade, you would buy Jan-16 45 puts and sell Jan-16 50 puts. You should collect at least $2.80 ($277.50 after commissions) and make 124% on your maximum risk of $222.50 if SVXY closed at any price above $50 on January 15, 2016.
The last time that VIX closed above 20 was on November 13, 2016. On that day, SVXY closed at $50.96. On the very next day, VIX fell below 20 and SVXY rose to $56.16. It never traded below the $50.96 number until last Friday when VIX once again moved above 20.
I think this is an opportune time to make a profitable trade which is essentially a bet that the current market uncertainty will be temporary, and might be over as soon as Wednesday when the Fed makes its decision concerning interest rates. Of course, a serious terrorist action or other calamity might spook markets as well, and the uncertainty will continue.
No option trades are sure bets, even if the last 10 times a certain indicator flashed and a 68% profit could have been made every time. As with all investments, you should never risk any money that you truly can’t afford to lose. However, I feel pretty good about the two investments outlined above, and will be making them today, shortly after you receive this letter.
Portfolios Gain an Average of 10% for the Month
This week we are reporting the results for the actual portfolios we carry out at Terry’s Tips. Many of our subscribers mirror our trades in their own accounts or have thinkorswim execute trades automatically for them through their free Auto-Trade program. In addition, we are showing the actual positions we currently hold in one of these portfolios so you can get a better idea of how we carry out the 10K Strategy.
Enjoy the full report.
Portfolios Gain an Average of 10% for the Month
The market (SPY) edged up 0.8% in November. In spite of mid-month relatively high volatility, things ended up just about where they started. The 6 actual portfolios carried out at Terry’s Tips outperformed the market by a factor of 12, gaining an average of 10.0%.
This 10% was less than October’s 14.2% average gain for the portfolios. The big reason why November lagged behind October was that we had one big losing portfolio this month (more on that later). Here are the results for each portfolio:
- First Saturday Report Chart November 2015
** After doubling in value, portfolio had 2-for-1 split in September 2015.
***Portfolio started with $4000 and $5600 withdrawn in December 2014.
S&P 500 Price Change for November = +0.8%
Average Portfolio Company Price Change for November = +1.8%
Average Portfolio Value Change for November = +10.0%
Further Comments: We have now recorded a 24.2% gain for the first two months of our First Saturday Reports. This is surely a remarkable result, 4 times better than the 5.4% that the market gained over those two months. Our results work out to an annualized rate of 145%, a level that we are surely not going to be able to maintain forever. But is has been fun so far.
All of the underlying stock prices did not gain in November. SBUX fell 1.3%, yet the Java Jive portfolio picked up 13.6%, proving once again that a lower stock price can still yield good gains, just as long as the drop is not too great.
Only one of our underlying stocks had an earnings announcement this month. Facebook (FB) announced and the stock edged higher, causing our Foxy Facebook to be our greatest gainer (up 22.1%) for November. We will have two earnings announcements in December – COST on the 8th and NKE which reports on the 20th or 21st. NKE also will have a 2-for-1 stock split on December 23rd. History shows that stocks which have a split tend to move higher after the split is announced, but then they move lower after the split has taken place. We will keep that in mind when we establish option positions later this month.
New Portfolio JNJ Jamboree Starts off With a Nice Gain: In its first month of operation, our newest portfolio gained 14.3% while the stock closely mirrored the market’s gain, picking up 0.9% compared to the market’s 0.8% gain. JNJ pays a healthy dividend which reduces volatility a bit, but the portfolio’s early performance demonstrates that the 10K Strategy can make good gains even when the options carry a low Implied Volatility (IV).
What Happened in Vista Valley, our big Loser This Month? NKE experienced extreme volatility, first dropping when Dick’s had a dismal earnings announcement, and then recovering when reports indicated that NKE was doing much better than most of the retailers. In the second week of November, NKE crashed $9.92 (7.5%). This is a truly unusual drop, and immediately forced us to make a decision. Do we lower the strike prices of our options to protect ourselves against a further drop, or do we hang on and wait for a recovery?
We were a little concerned by some analyst reports which argued that while NKE was a great company, its current valuation was extremely high (and probably unsustainable). So we lowered the strike prices from the 130–135 range to the 120-125 range. This ended up being a big mistake, because in the subsequent week, the stock rose $10.79, totally reversing the week-earlier drop. This forced us to sell off the lower-strike spreads and start over again with the higher strikes we had at the beginning of the month. If we had done nothing, the portfolio would have made a large gain for the month. Since we have selected underlyings that we believe are headed higher, in the future we should be slow to adjust to the downside unless there is strong evidence to refute our initial positive take on the company. This experience is another reminder that high volatility is the Darth Vader of the 10K Strategy world.
Here are the actual positions we held in one of the 6 Terry’s Tips portfolios. This portfolio uses the S&P 500 tracking stock (SPY) as the underlying. We have been running this portfolio for only two months. These positions are typical of how we carry out the 10K Strategy for all the portfolios.
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Summary of Spy 10K Classic Portfolio. This $5000 portfolio was set up on October 6, 2015. It uses the 10K Strategy with short calls in several weekly series, some of which expire each week and is counted as one of our stock-based portfolios (even though it is not technically a stock, but an ETP).
- First Saturday Report November 2015 10K Spy Positions
Our positions right now are a little unusual for us because we only have short calls in the next two weekly option series. Usually, we have 3 or 4 short series in place. The reason we ended up where we are right now is that when we buy back expiring calls each Friday, if the market that week has been flat or down, we sell next-week at-the-money calls. If the market has moved higher, we go to further-out series and sell at strikes which are higher than the stock price. Most weeks in November were flat or down, so we did not move out to further-out option series.
Looking forward to next week, the risk profile graph shows that our break-even range extends from about $2 on the downside to $3 on the upside. An absolutely flat market should result in a much greater weekly gain than we experienced last month because we have an unusually high number of near-the-money calls expiring next week.
As we approach the regular monthly option series for December (they expire on the third Friday, the 18th), we need to remember that a dividend is payable to holders of SPY on December 17. If we have short in-the-money calls on that date, we risk having them exercised and leaving us with the obligation to pay that dividend. For that reason, we will roll out of any in-the-money short calls a day earlier than usual to avoid this possibility.
A $350 Investment on Apple Could Double in 2 Months
On January 27, 2016, at 4:30 EST, Apple (AAPL) will announce earnings for 2015. This has always been an exciting time for investors, and this year should not be any different from years past.
Today, I made a $350 bet on AAPL’s earnings. I feel confident that I will double my money in 2 months on this wager, even if the stock does not do much between now and then. I would like to share my thinking with you, and maybe you will like to do something similar yourself.
A $350 Investment on Apple Could Double in 2 Months
AAPL is trading today about $116, only $5 higher than it was a year ago at this time.
Over that year, earnings have grown about 30% and sales have increased 20%, and the stock has gone up less than 5%. The world’s most valuable company sells at only 11 times earnings while it is growing nearly double that percentage, and even the 11 number should be adjusted to a lower figure because of the large stash of cash they are sitting on.
By any fundamental valuation standards, AAPL is a screaming bargain. Yet it has been in this same position for years, often held down because of tepid guidance it invariably puts out while announcing sales and earnings which are considerably above the guidance they gave last time around. The company seems to enjoy setting a low expectation bar and then crushing it with stellar earnings.
While Black Friday was a disappointment for most retailers, AAPL apparently had its best day ever. One analyst reported “the iPhone and Apple Watch were the most popular, with the Watch likely the number seller online. IPads are emerging as the first computing device for kids, with the iPad Air 2 the hottest gift item for kids eight and older, the Mini for those younger.” It sounds like it might be a good Christmas selling season for the company.
Two things almost always occur in the week or weeks leading up to AAPL’s January earnings announcement. First, the stock usually moves up $5 or so in anticipation of a positive announcement. Second, option prices skyrocket because there is often a big move in the stock after the announcement, either up or down.
With these thoughts in mind, I bought calendar spreads on AAPL today with the stock about $116. I chose the 120 strike price because I think at some point in the next few weeks, the stock will edge up to that price. I bought Feb-16 120 calls and sold Dec-16 120 calls as a calendar spread, paying $347 plus $2.50 commission per spread (the commission rate paid by Terry’s Tips subscribers at thinkorswim).
Just before the Dec-16 calls expire, I will buy them back and sell a further-out weekly option at a strike price which will hopefully net me at least $100. I expect to repeat this once or twice in the subsequent weeks, hopefully reducing my initial $350 cost to about $150 when I can sell the calls I am most looking forward to.
Those calls will be the Jan5-16 calls which will expire on January 29, just after the earnings announcement. They are not yet available for sale, but will be offered in a couple of weeks. These are the calls which will be juiced up by the uncertainty of the coming announcement. Looking back to January 2015 when there were two weeks to the post-announcement, these are thebif prices for those calls:
At-the-money – $4.00
$1 away-from-the-money – $3.50
$1 away-from-the-money – $3.05
$1 away-from-the-money – $2.66
$1 away-from-the-money – $2.28
If I am successful in getting my cost down to $150 by that time, I should be able to sell Jan5-16 calls for more than my net investment, therefore guaranteeing me a profit no matter what the stock price does after the announcement. Of course, the closer to $120 it is, the more profitable it will be for me when I close out the Feb-16 – Jan5-16 spread on Friday, January 29, 2016.
As with most option investments, this obviously will take a little work to carry out. But I sort of like that kind of work when it might result in my doubling my money in a two-month time period. It seems like a low-risk, high potential gain to me, and I look forward to having a little fun with it.
Of course, you should only make option investments with money you can truly afford to lose. Profits are not guaranteed, no matter how promising they might appear when you first set up your positions.