Trading ETF Options

Exchange-Traded Funds, or ETFs, are index funds that trade just like stocks on major stock exchanges. All the major stock indexes have ETFs based on them, including: Dow Jones Industrial Average (DIA), Standard & Poor’s 500 Index (SPX), and Nasdaq 100 Composite (QQQQ).

In addition, just about every major industry has an ETF for investors who wish to select an entire industry rather than individual stocks.

ETFs differ fundamentally from traditional mutual funds, which do not trade during the normal trading hours of the day. Traditional mutual funds take orders during Wall Street trading hours, but the transactions actually occur at the close of the market. The price they receive is the sum of the closing day prices of all the stocks contained in the fund. Not so for ETFs, which trade instantaneously all day long (just like ordinary stock).

Since ETFs trade all day, options are available on them. These options provide interesting opportunities for certain strategies, including what I call the 10K Strategy, which is the major strategy offered by Terry’s Tips.

For the most part, at Terry’s Tips, we use broad-based ETFs as underlyings (SPY, DIA) for our option portfolios because they do not fluctuate wildly like individual stocks often do (our strategy works best when the underlying stays flat or moves only slightly in either direction).

We have had good luck with one ETF that is not broad-based, but made up of 84 companies in the banking and financial services area (XLF).

The 15 most important components of the Financial SPDR (XLF) and their weights are:

1 JPMorgan Chase & Co. (JPM) 11.80%

2 Bank of America Corp. (BAC) 8.90%

3 Wells Fargo & Co. (WFC) 8.60%

4 Citigroup Inc.(C) 5.60%

5 U.S. Bancorp (USB) 4.20%

6 Goldman Sachs Group Inc. (GS) 3.10%

7 Bank of New York Mellon Corp. (BK) 2.90%

8 American Express Co. (AXP) 2.60%

9 MetLife Inc. (MET) 2.20%

10 Merrill Lynch & Co. Inc. (MER) 2.20%

11 Travelers Cos. Inc. (TRV) 2.00%

12 PNC Financial Services Group Inc. (PNC) 1.90%

13 AFLAC Inc. (AFL) 1.80%

14 CME Group Inc. (CME) 1.60%

15 Morgan Stanley (MS) 1.60%

A hedged strategy:The options strategy I use with XLF is a hedged strategy. In many respects, this strategy involves taking less risk than if I had just purchased XLF stock. Half the options are “long”, meaning they benefit when XLF moves in one particular direction, while half are “short”, meaning that they benefit if XLF moves in the other direction. No matter which way XLF moves, half the options benefit from the change in stock price.

XLF options can be better than XLF stock. I must admit that I am an options guy, not a stock guy. No matter how much I like XLF (and I do), I know that I can make a whole lot more with the options than I ever can with the stock. And I can do it with a strategy that is “hedged”. I can make money with XLF even if the stock does not go up. Usually, I can even make money when it goes down, (just as long as it doesn’t go down too much, too fast).

If you trade actively in options, and particularly if you are hedged (meaning that you are putting on many different positions rather than speculating with the simple purchase of puts or calls), it is important to look at the options market for the underlying security. Option markets for individual companies, except for a very few extremely active stocks, often have large spreads between the bid and asked price. In many cases, a single market maker sets the prices, and it is difficult to get good executions when you trade.

This means that every time you buy an option, you pay more than you would if the options were more actively traded, and when you sell, you receive less than you would in an active options market. The options market for XLF is liquid. Bid-asked spreads are small, and you can successfully execute spread orders and count on getting decent prices regardless of whether you are buying or selling.

Why is XLF better than trading individual companies?It has nothing to do with the company. Rather, it has to do with the price behavior of most individual companies. The 10K Strategy does best when the stock does not gyrate wildly. At certain times, most individual companies are subject to sudden wide swings in their stock prices. Earnings are announced, and the company either exceeds (or fails to meet) expected results, and the stock moves accordingly. An analyst upgrades (or downgrades) the stock unexpectedly, and the stock makes a big move. Sudden price changes in the stock can result in losses when using the 10K Strategy, so we prefer to trade on a basket of stocks (like XLF) rather than an individual company. That way, if one company has a big swing in stock price, the effect on the total basket of stocks is usually minimal. (If the companies are all in the same industry, sometimes one company’s gain is another’s loss, so the net effect on the basket of stocks is zero).

I call my system the 10K Strategy. It is somewhere between a boring buy-and-hold strategy and day-trading. It is not a marathon – you do not have to wait forever to see results. Neither is it a sprint, dependent on short-term increases in the price of the stock. Like any race, it takes a little effort to execute. But the extraordinary profit potential makes it all worth while, at least to my way of thinking.

A Simple Options Strategy:The 10K Strategy is based on the simple fact that all options become less valuable every day (if the stock stays flat), but short-term options go down in value (decay) at a faster rate than long-term options. I purchase slower-decaying long-term options and use them as collateral to sell faster-decaying short-term options to someone else. If the stock stays flat, I always win. Guaranteed!

But as we know, all stocks do not stay flat. Some good stocks, like XLF, actually go up much of the time. Having a good feeling about a stock (and being right) makes the 10K Strategy even more profitable than just enjoying the option decay advantage. If the stock goes up, I can make more with the 10K Strategy than I ever could with the stock alone.

If the 10K Strategy is so simple, why doesn’t everybody follow it?First of all, only Terry’s TipsInsiders know about it. That’s a pretty small, but growing, universe. Second, it really isn’t as simple as the basic underlying concept makes it seem. The strategy consists of calendar spreads at several different strike prices (both above and below the stock price), with differing numbers of spreads at different strikes (depending on your personal risk tolerance), often involves puts rather than calls (even if you are bullish on the stock), and is governed by a strict set of Trading Rules that determine when adjustments need to be made.

Does the 10K Strategy make money all the time? I’m afraid that nothing could be quite that good. But it is close. In March 2009, I set up the XLF portfolio using the 10K Strategy (we call it the Marco Polo portfolio). This portfolio was set up in an actual brokerage account all by itself, and the positions (and every trade) updated each week for Terry’s Tips Insiders.

In the first 7 months, the portfolio gained 35% after all commissions (60% annualized) in spite of some extreme mid-month volatility. Several times, the stock fluctuated by over 30% in a single month, something that our strategy has the most trouble handling. To check how the portfolio has performed since that time, go to our Track Record page.

It all sounds too complicated – can you manage the 10K Strategy for me? Unfortunately, I can’t manage your money. I publish an options newsletter, and am not a licensed investment advisor. But through a mechanism called Auto-Trade, you can mirror any of our portfolios, without having to place the trades yourself.

How Much Does It Cost to Learn All About the 10K Strategy? The White Paper (included in our subscription) costs less than a meal for two at a decent restaurant. It gives you all the information you will need to execute the 10K Strategy, and set up, and maintain, a portfolio that matches the degree of risk that you are comfortable taking. Complete Trading Rules for every risk level portfolio are included as well.

And there is more. First, you will receive a free Stock Options Tutorial which will acquaint you with the basics of option trading, including a simple explanation of the often-intimidating “Greeks.” Second, you will receive a membership to our Insiders Newsletter, where you can watch our actual portfolios unfold each week (and receive Trading Alerts whenever a change is made in a portfolio). If you wish, you can mirror one or more of these portfolios in your own account, or sign up for Auto-Trade.

And there is still more, like a list of 20 “Lazy Way” companies which allow you to make two trades at the beginning, and do nothing more for two full years. At the end of this period, you will have earned a minimum 100% on your investment, mathematically guaranteed, if the stock stays flat or goes up by any amount. In most cases, it can even fall by 5% and you make at least 100%, and it can fall by 25% and a small profit still results. (You can figure out all these numbers precisely, before you make the investment.)

Once you have become an Premium Insider, you will have access to several valuable reports on a variety of option strategies, many of which you will not be able to find in any books on options.

All this for less than the cost of a meal for two at a decent restaurant. And once you put the strategy to work, you might well be spending many pleasant evenings at better-than-decent restaurants for the rest of your life. Who knows? In could happen. It did to me, and I want to pass on my learning experiences to you.

So here’s my offer:

Become a Terry’s Tips Insider, pay only $97, and receive my updated 2020 White Paper which describes 4 unique trading strategies with complete Trading Rules for each, including the 10K Strategy that earned an average of 103% for 8 portfolios in 2005, and get all these additional benefits absolutely free:

My Stock Options Tutorial Program service, fourteen separate lessons which provide a sound background for options trading (a $29.90 value).
A list of 20 “Lazy Way” companies which make 100% mathematically guaranteed in 2 years if the stock stays flat, goes up by any amount, or falls by less than 5%. The “Lazy Way” strategy involves making two trades up front, and then sitting back and waiting for 2 years for your 100% to come in.
Updates on all our actual portfolio accounts with every trade ever made in each one. Each account is a real-time unfolding of one of the basic strategies developed in the White Paper. Different underlyings or investment amounts are used for each portfolio.
If you would like, I will email you with every trade I make in each of these accounts, so you can make those same trades yourself if you wish, maybe at even better prices.

Here is the link that could change the way you invest your money for the rest of your life – https://www.terrystips.com/signup.

If you are not convinced that now is the right time to make this investment in yourself, at least sign up for my free newsletter. You will receive my free report, “How to Create an Options Portfolio That Will Outperform a Stock or Mutual Fund Investment”.

For more information about the “Lazy Way” strategy to double your money, click Tip #5.

For more information about how you can use the 10K Strategy in your IRA, click Tip #4.

For more information about options in general, click Tip #1.

But the most important link is right here – https://www.terrystips.com/signup. That is where you can order my White Paper and maybe change how you ever thought about investing for the rest of your life.

October 31, 2023

Dear [[firstname]],

Happy Halloween!

I haven’t written in a couple of weeks since credits weren’t close enough to my target entry prices when I initially sent the trades to my subscribers. However, the credit for last week’s trade on Charles Schwab (SCHW) has come back and now exceeds my initial target.

So, I figured why not send it now since I still like the setup. I’m not changing the initial write-up that I sent to my Saturday Report subscribers on October 21, so it may sound a bit outdated. But the trade is still a good play.

Moreover, this week’s trade credit is a little above my entry level, so it’s good to go as well. So, you’re getting a first this week – two trades. Both bearish call credit spreads on stocks after they reported earnings.

Before I get to the trades, I want to let you know that our Terry’s Tips portfolios have caught fire in the past couple of weeks. We’re up 7% for the past two weeks while the S&P 500 fell nearly 5%. Our recent surge has pushed our overall return to more than triple that of the S&P this year.

I’m also happy to highlight our Microsoft (MSFT) portfolio, which gained 14% just last week alone and 40% over the past four weeks. It’s now up 65% for the year and is challenging our QQQ portfolio, which is up more than 70%!

How long can you afford to miss out on these profits? For our loyal newsletter subscribers (that’s you), I’m of course keeping the sale going that saves you more than 50% on a monthly subscription to Terry’s Tips.

You’ll get …

A month of all trade alerts in our four portfolios, giving detailed instructions for entering and exiting positions. Trade one portfolio or all four. It’s up to you.
Four to five (depending on the month) weekly issues of our Saturday Report, which shows all the trades and positions for our four portfolios, a discussion of the week’s trading activity and early access to our Option Trade of the Week.
Instructions on how to execute the 10K Strategy on your own.
A 14-day options tutorial on the opportunities and risks of trading options.
Our updated 10K Strategy white paper, a thorough discussion of the strategy basics and tactics.
Full-member access to all our premium special reports that can make you a wiser and more profitable options trader.

To become a Terry’s Tips Insider Member, just Click Here, select Sign Up Now and use Coupon Code D21M to start a monthly subscription to Terry’s Tips for half off. You can cancel after a month but, of course, keep all the valuable reports.

I look forward to having you join in the fun and profits! Now on to the trades, starting with the previous week’s trade …

Avast Ye Schwabs

Two call spreads in Estee Lauder (EL) and the SPDR Healthcare ETF (XLV) expired worthless yesterday for gains of 25% apiece. To be fair, our bullish spread on Lululemon Athletica (LULU) expired in the money a week earlier for a larger loss. But the LULU misstep interrupted a string of seven straight winners. A large part of this success has been due to taking a more bearish stance toward the market. In fact, today’s trade marks the fifth straight bearish call spread and eighth of the past 11. And with good reason, as our only losses of the past two months have been bullish positions. We’re on a solid roll. I hope you’re banking some winners.

With earnings season hitting full stride this week, there’s no end to the trade possibilities. Of course, there were the spotlight names, such as Tesla (TSLA) and Netflix (NFLX), whose large post-earnings moves grabbed headlines. But I prefer stocks that have smaller, off-the-radar moves that have a lower likelihood of reversing. One such stock is Charles Schwab (SCHW), which is no stranger to these pages (you may recall I had a few issues with the TD transition in September).

SCHW reported before the open on Monday, so we had a whole week’s worth of post-earnings price action to digest. The numbers were mixed, with net income coming in slightly ahead of expectations while revenue fell a bit short. However, both numbers fell far short of last year’s figures. I won’t bore you by parsing through all the individual data points (bank deposits, net interest revenue, TD migration, new brokerage accounts, etc.). Analysts seem to feel that SCHW still faces several short-term hurdles that have buffeted it all year, though the longer-term prospects are encouraging.

Speaking of analysts, their reaction was much like SCHW’s earnings … mixed. There were no ratings changes while target price changes went both ways. But analysts are clearly bullish on SCHW, giving it a solid buy rating on average. The average target price is near $70, which is around 35% above Friday’s close. This fits into the struggle now, prosper later narrative I mentioned above. But since we’re looking ahead only a few weeks, the bearish case makes more sense.

On the chart, the stock reacted positively to earnings, popping 6% in Monday’s trading before settling for a 4.7% gain. But that was the high close of the week, as the shares tumbled more than 5% after Monday. It’s notable that the 20-day moving average provided staunch resistance throughout the week, containing the initial Monday burst and then sending the stock lower through the week’s end. The 20-day has done a solid job keeping the current decline intact since it rolled over in May. I’ll also note that the stock enjoyed a massive 12.6% spike after its previous earnings report in July, only to give it all back during the subsequent month.

If you agree that the stock will continue its downtrend based on the resistance from its 20-day moving average, consider the following credit spread trade that relies on SCHW staying below $53 through expiration in 6 weeks:

Buy to Open the SCHW 1 Dec 56 call (SCHW231201C56)
Sell to Open the SCHW 1 Dec 53 call (SCHW231201C53) for a credit of $0.75 (selling a vertical)

This credit is $0.09 less than the mid-point price of the spread at Friday’s $50.87 close. Note that I’m giving a little extra room on the entry credit. Unless SCHW falls sharply at the open on Monday, you should be able to get close to that price.

The commission on this trade should be no more than $1.30 per spread. Each spread would then yield $73.70. This trade reduces your buying power by $300, making your net investment $226.30 per spread ($300 – $73.70). If SCHW closes below $53 on Dec. 1, the options will expire worthless and your return on the spread would be 33% ($73.70/$226.30).

Here’s this week’s trade …

Low Voltage

We had another spread expire worthless on Friday, but it made us sweat. Adobe (ADBE) was looking great, which was saying something as our only open bullish position. It hit an annual high on Oct. 12, putting the short put nearly 15% out of the money. Then the falling market tide grabbed the stock and pulled it down to within eight points of the short strike at Friday’s close. Another day and it might have moved into the money. But it didn’t and we bagged a gain of over 30% for our eighth winner of the past nine closeouts. That leaves us with five open positions, all bearish call spreads.

I’d love to add a put spread this week, but I can’t make a case for fighting the bearish tape. Maybe next week. For this week, I had way too many earnings plays to choose from, as this was the busiest week of the season. Frankly, I stopped looking after an hour, realizing that I could have spent all day analyzing dozens and dozens of top names.

I settled on General Electric (GE), which may seem like an odd choice given that it had a blowout report and had its best post-earnings day in years. The company easily beat earnings and revenue estimates and raised earnings and revenue growth guidance for 2023. The stock responded with a 6.5% pop on Tuesday, its largest gain after earnings since Jan. 2020. What’s not to like, right?

Well, analysts didn’t seem overly excited. In fact, only two weighed in with target price increases of $1 and $2. That’s it. The average target sits near $126, which is around 19% above Friday’s close. I’ll also point out the last time GE saw $126 was six years ago. There were no ratings changes, which were already heavily slanted toward the buy level. This does not seem like a hearty endorsement of a stock that just had as good an earnings report as you’ll see.

While the shares enjoyed a big gain on Tuesday, the rest of the week didn’t go well. In fact, the stock closed out the week below the pre-earnings close. The dual resistance of the 20-day and 50-day moving averages were in play, as the stock closed the week below both. These trendlines have rolled over into declines, a bad sign given that the stock doesn’t stray far from either. Another factor to note: GE had a big pop of more than 6% after the previous earnings release, but the stock drifted lower after that first day and has never closed a day higher since.

It seems that the earnings effect lasted all of one day and the stock has resumed its downtrend that’s been in place for six weeks. This trade is a bet that the trend will continue, especially in light of the broader market’s weakness. Note that the short call strike sits above Tuesday’s close and the mid-October peak.

If you agree that the stock will continue its downtrend based on the resistance from its 20-day (blue line) and 50-day (red line) moving averages, consider the following credit spread trade that relies on GE staying below $114 (green line) through expiration in 6 weeks:

Buy to Open the GE 8 Dec 116 call (GE231208C116)
Sell to Open the GE 8 Dec 114 call (GE231208C114) for a credit of $0.40 (selling a vertical)

This credit is $0.05 less than the mid-point price of the spread at Friday’s $106.35 close. Note that I’m giving a little extra room on the entry credit. Unless GE falls sharply at the open on Monday, you should be able to get close to that price.

The commission on this trade should be no more than $1.30 per spread. Each spread would then yield $38.70. This trade reduces your buying power by $200, making your net investment $161.30 per spread ($200 – $38.70). If GE closes below $114 on Dec. 8, the options will expire worthless and your return on the spread would be 24% ($38.70/$161.30).

Good luck with these trades,

Remember to click here, select Sign Up Now and use Coupon Code D21M to start a monthly subscription to Terry’s Tips for half off.

Any questions? Email Jon@terrystips.com. Thank you again for being a part of the Terry’s Tips newsletter.

Happy trading,

Jon

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October 9, 2023

October 10, 2023

With earnings reports virtually dried up this week and wanting to stay on the bearish side, I had to go back a few weeks to find reports that failed to impress the Street. One name that popped up was a stock that we successfully played (28% profit) for a bullish winner back in March – Darden Restaurants (DRI), the sit-down restaurant chain conglomerate that includes Olive Garden, LongHorn Steakhouse, Capital Grille, and the recently acquired Ruth’s Chris Steak House.

DRI reported earnings a couple of weeks ago. The numbers were solid, as the company beat estimates on both the top and bottom lines. Same-restaurant sales also handily beat expectations. Moreover, sales and profits were higher than a year earlier. The only negatives were slowing growth in its fine-dining holdings and some concern over its aggressive expansion plans amid a potential recessionary environment.

Analysts seemed unmoved by the seemingly positive news. The report was met with a mix of target price upgrades and more numerous downgrades. This left the average target in the $160-170 range, well above Friday’s $137 close. With no ratings changes, analysts remain firmly in the buy/outperform camp.

Perhaps analysts should take closer note of DRI’s stock chart and post-earnings performance. After hitting an all-time high in late July, the stock is down 21% and logged its lowest close in nearly a year on Friday. I’ll point out that the S&P 500 is down just 5% over the same time frame. This slump has been perfectly guided by the 20-day moving average, a trendline the stock hasn’t closed above in more than two months. Also, for technical wonks, the 50-day moving average is crossing below the 200-day moving average, also known as the “death cross.”

This bearish trade is based on the stock’s continued slump even after the good earnings results. With analysts perhaps too optimistic, it’s reasonable to expect some target price reductions, if not some ratings downgrades that could further pressure the share price.

Finally, the 20-day resistance is hard to ignore, which is why we’re playing a call spread with the short call strike sitting just above this trendline. Note that this trade has a smaller return than most because I wanted the short strike to be above the 20-day. Thus, we have a larger cushion of safety and greater probability of profit.

If you agree that the stock will continue its downtrend based on the resistance from its 20-day moving average (blue line), consider the following credit spread trade that relies on DRI staying below $145 (red line) through expiration in 6 weeks:

Buy to Open the DRI 17 Nov 150 call (DRI231117C150)
Sell to Open the DRI 17 Nov 145 call (DRI231117C145) for a credit of $0.85 (selling a vertical)

This credit is $0.02 less than the mid-point price of the spread at Friday’s $136.94 close. Unless DRI falls sharply at the open on Monday, you should be able to get close to that price.

The commission on this trade should be no more than $1.30 per spread. Each spread would then yield $83.70. This trade reduces your buying power by $500, making your net investment $416.30 per spread ($500 – $83.70). If DRI closes below $145 on Nov. 17, the options will expire worthless and your return on the spread would be 20% ($83.70/$416.30).

Happy trading,

Jon L

**Our QQQ portfolio is up more than 70% in 2023! Our MSFT portfolio is up around 30%! Overall, we’re beating the S&P. Don’t be left behind … now you can save more than 50% on a monthly subscription to Terry’s Tips. Just Click Here, select Sign Up Now and use Coupon Code D21M to start a monthly subscription to Terry’s Tips for half off.**

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September 25, 2023

Cold and Soggy

There were a few interesting earnings announcements this week, even though we’re in the quiet period for earnings reports (things start to ramp up again in three weeks). In fact, I had three bearish plays to choose from. That’s a good thing since we currently have three bullish and three bearish trades open, and I feel like the bears need a little more weight after the past week’s Fed-infected price action.

The trade this week is on prepared-food giant General Mills (GIS), which owns several iconic cereal brands along with such names as Betty Crocker, Blue Buffalo, Pillsbury, Progresso, Green Giant and Yoplait. GIS reported earnings numbers on Wednesday before the open that were filled with a lot of “buts.” Sales increased 4% due to higher prices, but volume was lower. Net income beat the consensus expectation but fell 18% from a year ago. GIS executives are bullish on their pet food segment but sales for the quarter were flat. Moreover, some analysts feel that consumers are reaching their limit on rising food costs. And GIS’s CFO said that the company’s operating profit margin will not improve this year.

All in all, it was not a great report, which is perhaps why the stock was hit with a few price target cuts. At least there were no ratings downgrades. Analysts on the whole are neutral toward the stock, while the average target price is in the $70-75 range compared to Friday’s close near $65.

Perhaps analysts would be a bit more skeptical if they took a quick glance at GIS’s chart, which shows the stock plunging 30% in the past four months. This descent has been expertly guided by the 20-day moving average, a trendline the stock has closed above just four times since mid-May. This resistance was evident the two days after earnings this week, when the shares failed to pierce the 20-day with early rallies. Note that the short call strike of our spread sits above this trendline.

If you agree that the stock will continue its downtrend after an uninspiring earnings report and remain below its 20-day moving average (blue line), consider the following credit spread trade that relies on GIS staying below $67.50 (red line) through expiration in 8 weeks:

Buy to Open the GIS 17 Nov 70 call (GIS231117C70)
Sell to Open the GIS 17 Nov 67.5 call (GIS231117C67.5) for a credit of $0.45 (selling a vertical)

This credit is $0.05 less than the mid-point price of the spread at Friday’s $64.82 close. Unless GIS falls sharply at the open on Monday, you should be able to get close to that price.

The commission on this trade should be no more than $1.30 per spread. Each spread would then yield $43.70. This trade reduces your buying power by $200, making your net investment $156.30 per spread ($200 – $43.70). If GIS closes below $67.50 on Nov. 17, the options will expire worthless and your return on the spread would be 28% ($43.70/$156.30).

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