A Trading Plan For A $10,000 Summer Portfolio Using Options

Includes: SPY, TEF
by: Ricardo Espinosa

The Fundamental View

We live in interesting times, watching historic events unfold around the world. Wars are terrible, but currency wars are a more subtle way of financial fighting between Europe, US, China and Japan.

The fundamental view shared by many regarding US markets is that they are now decoupling from European markets, leaving them with great daily swings around rumors from the "Grexit", which would be good or bad depending on how you look at it.

Pros and cons of the Grexit

The Greek exit would be good because it eliminates the weakest link from the Euro, thereby strengthening it against all other currencies. Greece would be left with the drachma, slowly recovering from its depression by making its exports and travel industry cheaper, and it looks now like it´s the best for both Greece and Europe.

The bad news regarding the Grexit is that it creates uncertainty around "who´s next" to exit the European Union, and the credit markets point to both Italy and Spain, the remaining PIIGS, by making its debt more expensive and unsustainable.

As economics turn to politics, and politicians control the economy (and know very little about it), they are stuck between a rock and a hard place between choosing either option, so they will let it play out until they are forced to make a decision. A proposed "austerity" solution with over 25% unemployment makes a recipe for disaster (look at Greece, the bailouts and further bankruptcy); Keynesians do have a point there.

We all know about Europe´s woes, but more importantly, we know ECB will be pressured into once again firing up the printing press in order to "save the economy."

I will use options as a flexible and cheaper way to trade/invest instead of stocks or futures, and this article will be the first in a series which will show you a simple way to trade options and profit from almost any market conditions, and however the market reacts to a "Grexit," be it by tanking or by rallying on the news.

The only market condition that I am discounting as impossible is that the US market continues rallying and Europe continues falling, because this time, it´s not different.

How to trade it

So what we will be focused on our first trade will be a kind of "calendar pairs" trade, going long and short at the same time on different expirations and securities.

Let´s examine the long trade first, which will give us exposure into Europe in a solid company that derives most of its revenues from Latin America, which is in a healthy growth environment: Telefonica Movistar (NYSE:TEF), which also has a dividend yield of 17.08%.

Panic selling disregarding fundamental value has reached TEF, just because it´s a Spanish company, and when there´s blood on the streets, it´s time to buy.

The Long Trade

We will start the trade by buying 40 TEF 12.5 calls @1.10 each, which is the ask price, more than 1k open interest and over 200 days to expiration is well worth the risk, and the option pricer gives these calls a 2.13 theoretical value (using Black-Scholes model), with transaction costs of $60 (via OptionsXpress, my broker), the total cost is $4,460.

We will give this play almost 7 months to bounce up to around $16-18, by then we will know if Greece exited and how much Spanish debt will the ECB buy (or not).

And now for the Short Trade

As European stocks have been falling for more than 6 months now, the U.S. market will need to feel the pain too, because this time it´s not different.

That´s why I chose to sell some calls on (NYSEARCA:SPY), which is showing signs of weakness, closing in the red for 10 out of the last 14 sessions. The trade is selling 30 contracts of SPY August 125 calls and buying 30 contracts on SPY August 130 calls, effectively creating a short call spread; the trade will look like this at expiration [click to enlarge]:

As you can see, 128.33 on the SPY is the breakeven point for this trade, and we´re not very far away from these levels. This hedge will be made for a credit of $3.33 ($3,330) per contract (price as of May 23rd, 2012). Maximum loss will be $1.67, so $1.50 potential reward for every $1 risk looks great, even if it´s just a hedge.




Option Requirement


Total Requirements


Estimated Commission


This trade costs $5,010 to initiate, so as of today, we have these 2 positions:

  • Long 30 TEF Dec 12.5 calls @1.10
  • Short 30 SPY Aug 125/130 call spread @3.33 credit

Total cost including commissions is now $9,470, so that leaves us $530 in cash.

I will be updating this portfolio every few weeks to update any change in it, in the meantime, grab some popcorn and watch headlines from European leaders make this summer a very interesting one.

Disclosure: I am long TEF, short SPY call spreads.