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Tom Armistead
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I'm a well-informed retail investor and post on SA in order to expose my thought process to critical examination and comment from readers. It makes me a better investor. I'm particularly proud of bullish macro articles posted in 2009 and later, in which I presented ideas that encouraged me to... More
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Tom Armistead's Instablog
  • Opening A Speculative Account 3 comments
    Dec 28, 2013 8:26 AM

    Please don't stone me for mentioning Jim Cramer. I don't watch him on TV (anymore): but I did read his book when I started investing, and I like his advice about speculation. The point is, it's a natural human activity, you're going to do it anyway, so just limit it to a certain size (20% per Jim) and then go out and have your fun.

    After returning from my hiking sabbatical and reopening my discretionary account, I re-entered the market cautiously and restricted myself to dividend growth stocks, somewhat overvalued, but unlikely to do lasting harm. Long term they'll do fine. The problem is, it's like watching paint dry: investment's too slow.

    Of course funds invested in the Vanguard S&P 500 Index performed wondrously, up 30%, who's counting? That's embarrassing, why not just leave your money with Bogle's boys and go fishing (or hiking)? permanently.

    Recently I set up a Chinese firewall and dedicated somewhat less than 10% of my investable assets to a speculative account. If the money was left in the bank, the rates on CD's are insulting. If you buy treasuries, the return is trivial, and you're bearing interest rate risk. Meanwhile, I can have some fun and make some money. Wall Street is the only casino on earth where you can leave your money on the table for ten years and still have something left.

    After what we went through in 2008 and 2009, it's hard to remember or believe that the stock market has a profound upward bias. The most likely 90 day return, based on history from 1950 to 2010, is 2.43%. Short-sellers and doomsayers will be correct from time to time, and amply rewarded, but the fact remains: the bias is up.

    What I've Done So Far

    Tech companies frequently have strong balance sheets, and many of them trade at conservative valuations. Implied volatility at times is high. There are stocks that have good downside support from excess cash, strong cash flow, etc., but sport low PE multiples and attractive premiums for selling options. I've been doing option trades that bet these situations will not go much lower, and receiving net time premium for doing so.

    Seeking Alpha is not looking for articles on options. With that in mind I plan to do brief write-ups of my trades in my instablog.

    Recent positions include Jabil (JBL), Intel (INTC) and Harmonic (HLIT), written up in the instablog, as well as Vishay (VSH) and Xyratex (XRTX), which popped shortly after I went long.

    The Jabil trade was a catch the falling dagger ploy, by means of a vertical call spread, with both legs in the money. A similar trade was done on Cirrus (CRUS), and noted in a comment to another contributor's article. For Intel, the speculative trade is a bullish reversal, based on the idea that the market doesn't appreciate the upside potential there.

    Portfolio Objective

    The immediate motivation for most of the trades is to sell calls and collect time premium. When a vertical call spread is used in an effort to catch a falling dagger, some of the temporarily high volatility premium can be captured. If the stock then goes up, while volatility goes down, the investor can sit and wait for a fine profit at expiration.

    If the stock continues down, the lower leg can be rolled down, in effect collecting additional time premium. If there is some sort of floor due to excess cash, strong cash flow, etc., from there it's a game of patience, keep betting it goes up and collecting time premium.

    Holding a good amount of cash, I'm prepared to actually buy the stocks involved if they stay down. The vertical call spread is being used similar to selling just out of the money puts, but in a format that I find easier to deal with if the situation develops unfavorably.

    I'm looking to generate about 15% per year by these tactics, more if the market will provide better opportunities. That would mean a nice correction with an increase in overall volatility.

    Disclosure: I am long INTC, JBL, VSH, XRTX, CRUS, HLIT.

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Comments (3)
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  • Greg_Maryland
    , contributor
    Comments (133) | Send Message
     
    Hi Tom,

     

    Always enjoy your articles and comments on the Instablog.

     

    I'm curious how you choose to use vertical call spreads vs diagonal call spreads. I've noticed that your speculative account is using the verticals and the synthetic account is using diagonal call spreads.

     

    What's the thought process in choosing one strategy over the other?

     

    I've been using options as a stock replacement strategy for stocks with low or no dividends. My typical trade is a diagonal call spread that looks a lot like a covered call where I'm using Leaps instead of stock ownership.

     

    Thanks in advance.
    29 Dec 2013, 02:36 PM Reply Like
  • Tom Armistead
    , contributor
    Comments (5164) | Send Message
     
    Author’s reply » Greg, my thought process for the diagonal is pretty much the same as if I bought the stock and sold a covered call. I like LEAPS for that purpose, it frees up capital and limits downside risk. I don't have any real concern with volatility in these cases.

     

    The vertical call spreads I'm doing in situations where I would previously have sold a put just out of the money. The stocks involved are unlikely to go very much lower, in my opinion. Typically they have more volatility, at least on a temporary basis.

     

    For example KLIC which I wrote up I used the 9/11 vertical call spread when I could just as easily have sold a put at 11. The stock stood at 11.xx when I did that. If I used the diagonal the lower leg would have too much time value. So if the stock made a large move and the time value went away, there wouldn't be very much profit in the trade.

     

    I've had good luck trying to catch the falling dagger with vertical call spreads, I usually roll the lower leg down if the stock keeps sinking.

     

    Another thing is, Interactive Brokers doesn't make it easy to do diagonals as a spread, so I leg into them. That's OK if the stock is just sitting there and you take your time.

     

    But when a stock is moving around a lot I prefer to place my order as a spread so I don't have to worry about doing one leg and then the stock moves before I get the price I want on the other.

     

    29 Dec 2013, 05:04 PM Reply Like
  • Tom Armistead
    , contributor
    Comments (5164) | Send Message
     
    Author’s reply » PS I'm glad you like the instablog, and thanks for your comment. They don't give us a count of page views so unless somebody comments I don't know if anyone even read it.

     

    29 Dec 2013, 05:08 PM Reply Like
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