Wolf Option Tra...'s  Instablog

Gold at $1310, 30-year Treasuries at 3.66% yield and the S&P at $1147.

Seriously can all of these continue to rally?  You betcha.  Can all plummet and wreck your account?  You betcha.

I am going to offer up a KISS concept I often use.  When in doubt, dont trade.  If you must trade, trade small.  If you must "invest" and not sit on cash because its not sexy then KISS.

How can you KISS in this current market?  Define yourself it works wonder like visitng a shrink doctor when you have mental issues. 

What do I mean by defining in terms of investing? 

1st define what your investment style is.

Are you a trader, then trade dont make trades an investment.  Investors, pick your targets based on your fundamentals and stick to them for your tiered entries. 

2nd, once you pick your investment style then define your price targets for your trades or investments both on entries and exits as well as the tier levels for all three.

3rd.  Then trade your plan and stick to it. 

Why did I mention gold, 30-yr and S&P.  All three are broadly tradeable with relatively great liquidity, all feel toppy but can easily continue at warp speed.

So my speciality and fortay is in option trading.  Maybe its not some peoples cup of tea but its a great way to define your risk.  I am going to offer up my opinion on all three on paths they can take by year end.

Gold could easily go to $1500 or $1000.  Yeah broad range right?  At $1310 its getting to the $1500 mark.  Lets use GLD for our example, GLD closed at $127.85.  So lets just say GLD can go to $100 or $150. 

A trader may be defining their risk by having a $2 stop loss or the equivalent of roughly $1250 gold.  Instead of getting bounced around by the stop loss (maybe it hits it by just a penny then sky rocket up) one could simply buy January 2011 $127 calls for $6.10.  Your maximum risk is $6.10 but you dont have to worry about any more.  A simple substitute trade versus being long $128 worth of GLD.  For $6.10 you can participate on an massive upside move in GLD yet face no major downside risk.  Yes there are pitfalls in just buying a call.  Theta will reduce the value to zero if GLD doesnt trade up.  You could consider this a stock substitute trade.  If GLD does trade up to $150, then your returns will be $16.90 / $6.10 or 277% return.  Your maximum risk is the $6.10 you paid or 4.77% of the current stocks value and you dont have to worry about a stop loss getting you out at the wrong point. 

One could also buy a put to guarantee their "exit" point and not have to worry about a stop loss.  Given that put options are relatively cheap on GLD (Jan 2011 $127 puts cost $5.10) it is not a bad way to play it either.  Either way theta will be a problem with either of them.  Plenty of ways to remedy that but all of those remedy make the positions more complex and the concept in KISS.

TLT or 20-year treasury is at $106.02.  How low can interest rates really go?  No one knows, probably really depends on what the government wants them to be.  Yes I know the markets "are" relatively capitalistic but I dont know many firms that will step in front of the government until the rates really reach a level that firms will.  Does 3.66% on the 30-yr represent that?  No.  But I am in the belief that rates will be over 5% on the 30-year Treasury  in the next 30-years but can also see the 30-year Treasury go below a 2.75% yield.

A $105 straddle on TLT on January 2012 options would cost $17.75.  This gives one a dual play on seeing rates continue lower to then "blow" out and go much higher.  My take (I am a trader so I trade short-term but this is a KISS conceptual agrument) is that rates will go lower and then go higher.  One has to actually trade this position.  On a move lower in the rates one should sell out of the $105 calls.  Maybe a move back up to the TLT to the $108-$110 area might be early but could easily occur.  

If this were to occur then sell out of the long $105 calls for a profit and this profit then reduces the costs of the put position.  Then you sit and wait on a move higher in the rates if they do occur.  Either way, given the 52 week range of yield prices, this trade can provide profits on both ends (both profits on teh calls and puts) if properly traded but you have over a year to do so.

SPY is at $114.67.  The market in my opinion can rally back up to this years high around $122.  Not a ton of upside, maybe we could eek out $130.  However the downside is definitely apparent.  Maybe we crack below $100 on the SPY or below $1,000 on the S&P.  I give both ideas even 50% probabilities. 

Call options are rather expensive on SPY.  January 2011 $115 calls cost $5.26.  January $114 puts cost $5.74. 

A KISS concept, a 1:2 put ratio trade on SPY on a strictly Tier 1 of 5 basis.  $114 puts cost $5.74, $107 puts could be sold for $3.38 each.  $5.74 - $3.38 - $3.38 = -$1.02.  The simpliest view of the trade is such.  If the S&P/SPY stays flat or goes up then your profit by year end wold be $1.02.  If the market goes below $107 then your agreeing to be long S&P at $989 or $98.9 SPY.  Remember this is a Tier 1 of 5 entry, your next 4 entries could be at $24 point increments or buys at $74, $50, $26 and $2.  Maximum value at risk would be the $98.9 or your return would be 1.03%.  Better than the 6 month Treasury at .19% yield.  Maximum profitability would be $8.02 ($114-107 @ $107 = $7 + 1.02) / $98.9 = 8.11% return. 

Hopefully this helps to keep people invested in profitable trades or even to initiate new positions.  Profits are never guaranteed but with some hard work and keeping a cool head and KISS positions one can ride out turmoil based on market noise and have defined risk. 










Disclosure: No GLD positions as of writing, no SPY positions as of writing, Butterfly call spreads @ net credit on TLT

With the S&P near 1,130 aka SPY 113 the market is definitely not in a place to be just buying into it.

Caught the bottom?  A myriad of strategies exist, this isnt really focused in your direction.

Want to really get a grasp of driving your portfolio to less volatility and hopefully better profitability. 

Breakout your crayons people. 
INTC: 200 day MA, $20.54, Top of Range $24 bottom range of 16.50 @ 19.01
GE: 200 day MA $16.16, Top of Range $19 bottom range of 13 @ 16.50

Two names, Two cases, dividend yields all above 2%, all in the middle of their ranges based on the past year or so.  Use crayons to establish  the top end of the range and the bottom end of the range. 

Need to have some bullish market exposure but dont want to be buying at the midpoint of the recent ranges in case the market trades back down then look at the following type of strategies.

Buy GE at 16.50, buy GE Dec $16-14 put spread for $0.45, sell a $18 call for $0.29 and collect a $0.12 dividend payment.  Your cost average in GE is $16.54.  You have protection from $16-14, have upside until $18.  If GE trades down by December, your cost average would be at $14.54 but thats also your maximum value at risk (MVAR if GE traded below $14).  If GE trades to $18, your called away and book $1.46 in gains or 10.04% (1.46/14.54).  This gets your some upside profitability and decent gains in % terms before year end if the market decides to rally.  However you dont agree to get long GE in terms of MVAR until 12% lower. 

INTC is a bit easier. Buy INTC @ 19.01, buy $19-16 put spreads for $0.90 and collect at least one $0.16 dividend.  Your effective cost average on INTC would be 19.75.  However you gain the flexibility to sell covered calls in the future to reduce this average or "day trade movements" and have a backstop of protection from $19-16.  The upside is unlimited BUT your MVAR is $16.75 ($19.75-$3) so your not really agreeing to get long INTC until 11.8% lower. 

Overall this type of a strategy can be implented to lower the volatility of your portfolio as your making crayonesque type of lines and dont have to worry or second guess oneself based on market noise when it appears.

Are there risks inherent in this?  Yes, but they are lower than the currently offered by the market if it moves down as your not committed to the stock until a much lower price.  Can you trade out of both the GE and INTC situations along the way if market situations change the effective ranges (say we enter into a depression) you can.  You could then also get "short" via the put spreads and collect profits in the market decline (though you would have some losses on the stock side offsetting these profits but should net out if one can take action in a prudent enough manner).

Be smart out there folks, as nothing is determined and there is no guarantee which direction this market may head.  If your looking to get some more profits out of this market before year end then think about putting on some hedges that also protect you from downside risks that are out there lurking but many appear to be forgetting about.








Disclosure: Long INTC, short INTC calls, long INTC puts, short INTC puts, net bullish, no positions in GE

INTC right now has been beaten up a little bit to much for my liking.  I have been bullish on it but not full delta's.  Primarily covered calls with some put spreads for protection from news event and broad market declines.  Am I slightly down in the position, yup, am I worried nope.  I am merely beginning my second tier of acquisition.  Those who dont have INTC and are looking at acquiring a long-term core position can be a step ahead of me in cost average as they are doing their first tier versus my second tier.

Either way lets ponder some negative scenarios for INTC as well frankly its always good to have a "bad fundamental outcome view" to know what your getting into.

Lets call future earnings of INTC down from $2.00 (consensus the last time I looked for next years earnings) down to an even $1.25.  This should encapsulate a flat to weakening economy and a slowdown in "pc demand".  For a company like INTC I would apply a 8 PE multiple for recessionary times, 11 flatish times and 16 for bullish times.  Target prices then go out to $10, $13.75, $20 of a $1.25 earnings per share.  I think I am pretty conservative in these estimates and marks.  All the better.

So given my view of flattish Japan style economy $13.75 would be my "first entry".  But what if I am wrong about the earnings estimates and they do come in at $2.00.  Then INTC target would be at $22 well above the $13.75.  This presents a quandry of taking action now versus sticking to you targets.  Well lets have our cake and eat it too.

Acquiring INTC through a ladder of time and option trades will allow one to provide better entries than currently while providing upside gains. 

Scenario assumption assumes Investor A wants around 1,000 shares in the end but at lower market prices but wants upside potential.
Trades
Sell 1 October $17 put for a $0.38 net credit.
Sell 2 January 2011 $16 put for a $0.69 net credit per option
Sell 2 April 2011 $14 put for a $0.57 net credit per option.
Buy 5 January 2011 $20 calls for a $0.50 net debit per option
Sell 5 January 2011 $22.50 calls for a $0..13 net credit per option.

The total net credits for the 5 option components would be $1.05.  Margin requirements will vary but lets just assume its on average $500 per put sold to start out.  So you have $2,500 in margin requirements at initiation less $105 or $23.95 up front.  Worst case is someone can only do cash secured puts and be at $7,700 (1700+3,200+2800) - $105 = $7,595. 

All of the put sales would average out to owning INTC stock (assumption all puts assigned) at $15.19 per share.  With the ability of adding the "remaining 500 shares Investor A wanted" at lower levels. 

Investor A however gets bullish participation if INTC earnings are better than the $1.25 or the market decines to award higher PE multiples. 

In a bullish scenario (assumption you acquire no stock) the stock trades up to $23 per share by January expiration.  The total trade at expiration would have profits of $1.05 (original net credit) + $12.50 (5* $2.50 call spreads) = $13.55 or $1,355 (less the cost of closing out the April $14 puts which is impossible to predict but should be relatively minimal).  $1,355 / $2395 = 56.58%.  INTC stock at $17.90 up to $23 would be a return of 28.49%. 

The punch in the gut scenario is by January 2011 expiration INTC is at $20, and your returns are looking like just the $1.05 original net credit less the cost of closing out the Apr $14 puts sold (just to close out the trade).  $105 / $2395 = 4.38% return versus INTC gain of $2.10 / $17.90 = 11.73%. 

This structure is able to vastly outperform INTC stock in a variety of scenarios without taking on the risk of purchasing INTC right now.  

The scenarios can break down in a wide variety of manners other than outlined above and there could be better option structures out there.

In summary, the trade outlined above allows one to acquire INTC roughly 15% lower (if assigned on all put options) while allowing one to collect between 4.38%-56.58% returns if INTC stays between $17-23 price per share at January option expiration (less the cost of those Apr $14 puts sold in order to close out the trade).

The trade of course can be exited out early if INTC moves up but the returns will vary depending upon the time frame and as well as how each individual option component is being traded.  

For full disclosure, I am long INTC stock, short Sept INTC calls with a 1:1:1 put ratio trade in Oct put options ($18-17-16 strikes).  I am looking at adding to the positions via a similiar structured trade (selling additional puts and purchasing call spreads).


 

Disclosure: I am long INTC stock, short Sept INTC calls with a 1:1:1 put ratio trade in Oct put options ($18-17-16 strikes). I am looking at adding to the positions via a similiar structured trade (selling additional puts and purchasing call spreads).

Disclosure: I am long INTC stock, short Sept INTC calls with a 1:1:1 put ratio trade in Oct put options ($18-17-16 strikes). I am looking at adding to the positions via a similiar structured trade (selling additional puts and purchasing call spreads).