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Brent Leonard
Send Message Retired options and stockbroker, ROP, RIA Retired Adjunct Professor of Finance at Golden Gate Univ. Editor, TSAASF Review Private Investor Author: Zero (IN)Tolerance, blogs: More
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  • Leaping Ahead

    Leaping Ahead

    Recently Stephen Todd pointed out that since 1900 there have only been three times that the stock market has risen five consecutive years up until now: the '20s, '40s, and '80s, which did not end well! A fourth time it rose 9 years - 1990s (say no more). For this reason it seems logical to assume a sideways to down market-strategy would be prudent. I also thought this in May 2009, when I started testing my DITM (deep-in-the-money covered call) hedging strategy, which happened to coincide with the recent 4th five-year up market, although my test account actually rose 11% per year for 4 years, then flatlined due to poor/early sector selection and low option Volatility caused by the Up market. It also increased the cushion from being 5 to 10% in the money protection, to much higher, for which I am now thankful.

    With a higher likelihood of stocks now moving sideways to down for the near future, an even more prudent strategy is being tested - one that a client successfully employed several years ago when I was a senior option trader (NYSE:ROP) with Charles Schwab. This client would turn the tables, so to speak, from being the "patsy" in the game to being the House, or casino - by selling options rather than speculating on potential direction. The concept is to buy a quality stock in the $5 to 20 range that has LEAP options and sell a covered call (never a "naked" one), and simultaneously selling the same year Leap put- both slightly out of the money.

    Normally one can immediately bring between 1/3 and 1/2 of the funds spent on buying the stock, providing a better cushion than the above DITM plan; although being similar to it, the Safety and Reward are both considerably higher, and the monitoring is almost negligible for about two years- at which time the options expire. Although potential annual double-digit profits are likely, direction is not important, but being called away at expiry does increase the return.

    Since one year ago I have amassed a Leap portfolio of 20 positions, mostly done recently.

    As with any investing strategy there are Risks attached:

    Below is the logic of the strategy with a theoretical example, and the "Visible Hand" of five fingers ( A through E) of what can happen over time.

    As with "E", more stock can be put to the investor - so they must want to own the stock.


    **Worst case:

    Stock gets taken over or involved in merger - adjusted options


    gets complicated, but no loss involved; XYZ goes bankrupt: 1 in 1,000


    Profits on other 15-20 stocks make up for loss.


    ***commissions not included; stocks bought in IRAs, etc. must sequester Max Loss(e.g.$700)


    In IRAs, profits become 8%: and 11% annualized (if called away)


    If repeated every two years, no stock cost - profits much higher.


    A Strangle is just a Straddle with different prices for calls and puts













    Buy 100 shares of XYZ at $9.00




    Sell 1 LEAP covered call -

    Jan.2016 10-strike price @ $1.20




    Sell 1 LEAP put-Jan. 2016 7-strike price @ $.80




    4% Dividend; 9 quarters @ $9/Q=








    % Profit:






    (over 12 months, not 26)




    If stock called away at $10 in Jan.2016



    % Profit:







    Stock settles at $10 on expiry-

    Maximum profit, repeat NEXT two years

    raise option strike prices.






    Stock stays the same: $9

    Maximum profit, repeat for two years


    * If stock falls to $7 ON Jan.21, 2016 - Keep $281, resell 2 more years out (loss of $200 on XYZ).



    Sell $6 put; sell $8 call (2018)

    No cost for stock this time!!



    *Worse Case: Stock falls BELOW $7 put strike price ON Jan.21 2016:


    100 shares of XYZ are "put" to you; repeat D

    Feb 07 3:50 PM | Link | Comment!

    As another year comes to a close, it is prudent to reassess one's fiscal condition, and consider future adjustments to their investments. Previous columns have delineated an investment strategy - one that is by definition defensive, conservative, and yet, optimal when comparing it to other strategies currently in use. Noting anecdotal reports of not only mutual funds barely breaking even, but also the average hedge fund only slightly on the plus side, this strategy consistently over time should outperform most others, as well as providing a partial safety net in case of another Flash Crash.

    Having extensively tested this strategy over nearly four years in several brokerage accounts, with the purest microcosm in a small five-figure IRA (no contributions or withdrawals allowed) which is actually currently making new highs despite a choppy market, it has been found to require little monitoring time or activity. Time-wise, it is somewhere between less effectual day-trading and obsolete buy-and-hold (NASDAQ:FOLD).

    So what is this strategy, you ask? Nicknamed DITM, for deep-in-the-money covered call writing, it is a seldom used variation on the normal covered call plan, but "pre-sells" the stock 5-6 months out at a 5 to 10% lower price (providing the safety net of someone else's money) to move around in its sinusoidal motion until expiry. Screening for a stock or ETF with at least a 3% dividend that also has enough "extrinsic" option value, if called prematurely, one is less pressured to get whipsawed out of the stock- usually at the low. Even if the stock (and/or the overall market) drops precipitously, as has happened over the past 4 years at least a dozen times, one is consoled with the fact that it they are receiving yet a higher dividend percent - even if the stock temporarily goes below the pre-sold price- and that they are also milking the call option premium each day (theta).

    Consider this hypothetical example: Stock XYZ is currently at $50 a share;

    it goes ex-dividend on December 2 with a quarterly dividend of $.50 per share.. One buys 100 shares on November 30 to get the nearby dividend;

    simultaneously, they sell a covered call (a Buy/Write) - the June $45 strike price- for $6. $5 makes up for the loss from 50 to 45, where XYZ should be called away; the $1 is extrinsic call time premium. $2 per year in dividends would be 4%; based on a $45 stock price, the dividend rate is now 4.44% instead. Counting on two dividends ($1), plus the $1 from the call, total return for 6 months would be 4.44%; annualized (done twice in 12 months) the return becomes 8.89%. Note: if the stock remains at 50, one can merely roll out the June call to December, keeping the stock.

    With nearly thirty years experience as a professional senior options trader for a major firm, as well as money manager and individual investor, this columnist has see about every type of market. After the mother of all Bull markets from the 1980s, an extended period of consolidation, compounded by the Fed's current protracted zero rate policy, is ideal for this strategy. Admittedly there have been a handful of plungers, such as British Petroleum (NYSE:BP), Cliff Resources (NYSE:CLF),, but these are equally offset with stocks that are prematurely called away early - 1 or 2 months before option expiry - which compresses the holding time, making an annualized return (as if done multiple times in 12 months) 30-40%.

    The only flaw in this plan is in a case of another Black Swan which does not recover for a long time. Studies by both University of Chicago and Standard and Poor's show at least one, but no more than two Bear markets per decade since 1900. The previous decade had two, and although both were around an uncharacteristically deep 50% drop, they were both V-Spikes, recovering quickly behind their electronic drivers. Unlike a "collar" strategy, where a covered call produces the funds for a protective put, but lowers the return if not needed, DITM does need to be hedged. With the safety net, some warning is given, and even if a loss is incurred, it is much less than with an Index fund or unhedged portfolio.

    Despite writing a book on DITM - Zero (NYSE:IN)Tolerance from Amazon- and giving several talks in the San Francisco Bay Area, it has few adherents that consistently follow it. Ideal for retirees and prudent investors searching for alternatives to punitive interest rates without the higher risk, it is prudent for at least a portion of one's assets. There is also a blog: which can be researched, with Older Posts showing actual trading results over several time frames, all returning high single-digit results.

    More information on DITM is also available at this columnists website:

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

    Additional disclosure: The concept of this article was accepted previously by SA - it is also published under the populist site with minimal viewers

    Nov 30 9:26 AM | Link | Comment!
  • Safe SPX

    On my way home from dinner last night I ran into an old acquaintance who voiced a common complaint these days: losing purchasing power on their money from zero interest rates of safe investments; yet they also did not want to risk the loss from the other less safe investments.

    My obvious answer was explaining the strategy that I write about in my weekly blog: It is something that I have been testing with most of my family money for over three years, and based on thirty years of professional trading and money management. A variation on the common covered call writing theme, it caps the "hoped for" appreciation in this lost decade, in favor of a predictable fixed income from combined dividends of 3% or more, and selling in-the-money call option premium for a certain length of time.

    With a little study and effort one can phase into this plan, bearing in mind that a plunging stock and/or market is always possible, although the risk - based on my experience of well over a hundred trades and just a handful of losses- is estimated at less than two standard deviations, or 5%. I've found that even the most recommended stocks- British Petroleum (BP, Super Value Stores (NYSE:SVU), and Cliffs Resources (NYSE:CLF) - can drop precipitously. However, by selling a safety net call 5 to 10% below the buy price, one should have adequate warning of weakness and be able to contain losses by hedging or exiting the position.

    In what I call a "hummingbird" approach, one can implement a buy/write on a quality stock that is about to go ex-dividend, writing (or selling) the call 5 or 6 months hence; this ensures at least one dividend and receives the decaying time premium from the call - the extrinsic value. Some of these, especially tech stocks and recent fallen ones that usually increase volatility, can provide a large amount of this.

    In this strategy, which I call DITM (deep-in-the-money) covered calls, the profit is a known amount in almost all cases, since it derives from the dividend and call option sold. It works in an up market, sideways or down market - only a Bear market (20% or more in the market or individual stock) has risk. Bear markets have occurred only once or twice per decade since 1900, according to both Standard and Poor's and the University of Chicago studies.

    Here are some examples of upcoming stocks going ex-dividend this month that being fully invested I can only hope to own if available cash appears:

    Golar LNG (NASDAQ:GLNG) - $39.50 goes ex-dividend on September 11 for $.40 (3.51%). Although the bid/ask spread is wider than desired, one could sell the December35 call for $5.35, rendering an extrinsic value of $.85, combined with the two dividends ($.80) for 4.18% for three months, or 16.7% annualized (if extended to twelve months in the same or like trade. It is rated Outperform by Reuters and recent earnings were quite good.

    Garmin Ltd. (NASDAQ:GRMN), a navigation company $39.85 goes ex-D September12 with $.45 for a 4.46% yield. Wells Fargo initiated an Outperform with 3 stars by S&P, although with the safety net, the best stocks are not always necessary, especially in today's high correlation markets where basket trading dominates. Combining two dividends of $.45 plus the $.80 possible extrinsic call price (theoretical between bid and ask), one gets 4,27% for 4 months, or 12.8% annualized. If the price of the stock remains the same, it is possible to "roll out" the call another 5-6 months, saving stock commission.

    For the newbie, one could try the Dow 30 DIA ETF, which pays just under 3%, but every month is different due to the 30 stocks going ex-D that month - one can cherry pick November, December, February, for highest yields within the timeframe. With the DIA at 130, one sells the January 121 call at $11.35 ($2.35 extrinsic) plus @ $1.00 dividends, for 7.73% annualized with the 4 months. The DJIA would have to fall below 12,100 for the DIA to not be called away. If so, one could again roll out the call or sell it above the price in the normal fashion.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

    Sep 07 1:41 PM | Link | Comment!
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