Today we will continue our discussion of both SVXY and the actual portfolio we are carrying out with only two positions. Every Friday, we will make a trade in this portfolio and tell you about it here.

Our goal is to earn an average gain of 3% a week in this portfolio after commissions.

I hope you find this ongoing demonstration to be a simple way to learn a whole lot about trading options.

Terry

**Ongoing SVXY Spread Strategy – Week 4**

Near the open today, SVXY was trading about $86. We want to sell a put that is about $1 in the money (i.e., at a strike one dollar higher than the current stock price). Our maximum gain each week will come if we are right, and the stock ends the week very close to the strike of our short put.

Here is the trade we placed today:

Buy to Close 1 SVXY Sep1-14 86.5 put (SVXY140905P86.5)

Sell to Open 1 SVXY Sep2-14 86.5 put (SVXY140912P86.5) for a credit limit of $1.15 (selling a calendar)

When we entered this order, the natural price (buying at the ask price and selling at the bid price) was $.85 and the mid-point price was $1.25. We placed a limit order at $1.15, a number which was $.05 below the mid-point price. (It executed at $1.16).

If it hadn’t executed after half an hour, we would have reduced the credit amount by $.10 (and continue doing this each half hour until we got an execution).

Each week, we will make a trade that puts cash in our account (in other words, each trade will be for a credit). Our goal is to accumulate enough cash in the portfolio between now and January 17, 2015 when our long put expires so that we have much more than the $1500 we started with. Our Jan-15 may still have some remaining value as well.

This is the 4th week of carrying out our little options portfolio using SVXY as the underlying. SVXY is constructed to move up or down in the opposite directions as changes in volatility of stock option prices (using VIX, the measure of option volatility for the S&P 500 tracking stock, SPY). SVXY is a derivative of a derivative of a derivative, so it is really, really complex. Right now, option prices are trading at historic lows, and lots of people believe that they will move higher. If they are right, SVXY will fall in value, but if option prices (i.e., volatility) don’t rise, SVXY will increase in value. In our demonstration portfolio, we are assuming that option prices will not rise dramatically and that SVXY will move higher, on average, about a dollar a week.

In this simple portfolio, we own an SVXY Jan-15 90 put. We will use this as collateral for selling a put each week in the weekly series that expires a week later than the current short put that we sold a week ago. Today’s value of our long put is about $14 ($1400) and decay of this put (theta) is $4 (this means that if SVXY remains unchanged, the put will fall in value by $4 each day). The decay of our short put is $13 (and will increase every day until next Friday). This means that all other things being equal, we should gain $9 in portfolio value every day at the beginning of the week and about double that amount later in the week.

Let’s bring a couple of other option terms into this conversation. First, we are bullish on the stock (we are betting that contango will continue to exist and provide more tailwinds for the stock than increasing volatility will hurt the stock). When you are bullish on a stock, you want to own a portfolio that is delta-positive. Delta is the measure of how much the option will increase in value if the underlying stock moves $1 higher.

Most options traders like to maintain a delta-neutral portfolio condition. This means they don’t care if the stock goes up or down, at least for small changes. We want to be a little bullish in our portfolio, so we are aiming for a net-delta-positive condition.

Since we are dealing in puts rather than calls, this is extremely complicated. I hope you won’t give up. Delta for our Jan-15 90 put is minus 50. This means that if the stock goes up a dollar, our long put option will lose about $.50 ($50) in value. The weekly option that we have sold to someone else has a delta value of about 75 (since we sold it, it is a positive number). If the stock goes up by a dollar, this option will go down by about $.75 ($75) which will be a gain for us because we sold that to someone else.

Our net delta value in the portfolio is +25. If the stock goes up by a dollar, the portfolio should go up about $25 in value because of delta. (Unfortunately, this gets more confusing when you understand that delta values will be quite different once the stock has moved in either direction, but we will discuss that issue later).

If the stock behaves as we hope, and it goes up by about a dollar in a week, we will gain about $25 from the positive delta value, and about $100 from net theta (the difference between the slower-decaying option we own and the faster-decaying weekly option that we have sold to someone else.

Our goal is to generate some cash in our portfolio each week. This should be possible as long as the stock remains below $90. We will discuss what we need to do later if the stock moves higher than $90.

We paid a commission of $2.50 for this trade, the special rate for Terry’s Tips customers at thinkorswim. The balance in our account is now $1730 which shows a $230 gain over the three weeks we have held the positions. This is much more than the $45 average weekly gain we are shooting for to make our goal of 3% a week. We now have $624 in cash in the portfolio.

Next Friday we will make another similar trade and I will keep you posted on what we do.

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