Writing Calls on Volatility
by revtodd64 - October 14th, 2010 8:34 pm
I picked up this idea from Jeff Augen’s book, "Trading Realities: The Truth, the Lies and the Hype In-Between." Augen has written a fine series of books on trading options and I have bought and sampled from all of them. He notes the favorable risk/reward profile on buying VXX, which is a ETN attempting to track the short-term futures on the VIX, and selling at-the-money calls on it while the VIX is low. Augen notes that theoretically you could lower your cost basis in a year’s time to almost zero using this method every month. But it gets even more interesting using weekly options. I bought VXX ETN at $14.92 today and sold the $15 strike on the October 22 weekly options for $.58. That is about 3.8% profit if VXX does not move at all.
That is what I’m trying to average on a trade per month!
Let’s take a look at the one year chart on VXX:
You can see how low VXX has dropped. Unlike a stock you know this chart is not going to drop to zero. Volatility cannot disappear or go bankrupt. There will always be some level of volatility, so there is a limit to downside risk. The VIX, which is a measure of put buying, closed at 21.68 today, which is fairly low volatility. If you had to say which way volatility is moving right now, is it more likely to go up or down in the next month? I’m voting for up, since we have earnings season, elections and a rally that looks like it could roll over at any time. With a low VIX and higher expected volatility events, doesn’t it make sense to sell covered calls on volatility at least until the VIX clears 25.
I’m planning to sell the weekly at-the-money calls up to that point, which may only be one week if the market drops. I’m sure speculators could arrange more profitable trades, but I am looking for income and retirement investments, so I’m not getting greedy and buying calls or some other idea. I am considering selling at-the-money puts in my margin account. Let me know what you think of the idea. The risks I can foresee are poor tracking of the VIX by VXX and that volatility is driven into oblivion. But the VIX rarely drops below 15, which would be a 25%…
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DiggSeptember Expiration Results
by revtodd64 - September 18th, 2010 2:50 pm
I took a conservative approach for September and wrote only deep in-the-money calls on stocks that had the edge I was looking for at entry. Here are the percentage gains for my five trades that are called out today:
TSL – 3.68%
WFR - 3.31%
VMW - 3.10%
CCJ - 2.67%
CMI - 2.2%
Total Average Gain = 2.99%
Since I was not fully invested for September, my actual virtual portfolio gained about 1.2%. I took early positions for October as I found good entry points that worked for my strategy. I am tracking my virtual portfolio compared to the SPY, which moved from 107.53 at August close to 107.88 yesterday, which is a .32% move upward. So even partially invested I beat the S&P 500 by nearly 1 percent.
At some point I will calculate how much I would have made if I had bought the stocks outright and I’m guessing it would have been a very nice number since they all went up and every stock but CCJ was up more than 5 percent. My checkpoints should make for a great stock picking system for straight stock purchases to hold for 3 to 6 weeks. So why don’t I do that instead? My trading style is very cautious. I hate to lose money. I have tried other systems and found myself vulnerable to buying high and selling low, or getting too nervous and shaken out of positions early, when I could have made a profit with patience. This month I would have had a hard time fighting off all the negativity in the market to even enter positions unless I had a hedged entry with a covered call. Since I have a master’s in psychology, my world view is that trading success has as much to do with psychology and emotions as it does fundamental and technical analysis. I have confidence in my system and feel more secure investing when I know I am hedged and can roll into the next month. I feel like I have taken back control from the market manipulators by selling options to give myself flexibility and a cushion against whatever crazy thing happens out there.
Always Trade with Your Edge
by revtodd64 - September 11th, 2010 12:23 pm
Always Trade with Your Edge
Courtesy of Rev Todd
As I near the first option expiration next Friday during my one year plot to make 3% a month for a year, I know I won’t make 3% the first month and I am OK with that. I did not fully invest right away and phased in investments as I found stock patterns that fit my philosophy. After three weeks I am still not fully invested. I will probably make up ground by October because I have put in a number of positions already that will make more than 3%, so I’m not going to go crazy trying to hit my target every month. While I want to make money, I’m going to meet that goal by not losing money and not taking unnecessary risk. I believe I will still meet my overall goal without 3 percent this month by following this simple advice:
Always trade with an edge.
What is the trading edge when writing monthly covered calls? I am trying to take advantage of one of the three certainties in life – death, taxes and premium decay on options. I don’t know what the stock market or the company I invest in will do. I do know with certainty that when I sell an option I will get paid and the premium will drain to zero by the third Friday of the next month. I sell monthly options because the premium is compressed to a greater degree than LEAPS (long-term) options. My first edge is very simple, sell premium that allows for 3 percent in profit per month. Since my current bias is that the market is ranging, I’m playing it safe and writing in-the-money calls that allow for a 5 to 10 percent downside protection, which seems reasonably safe for now.
I never write a covered call on a stock just because of a compelling premium. My goal is to make a stable income on the stock every month, not to speculate. High premiums are a sign of high volatility in the stock, which makes the investment more speculative. I want a high degree of certainty, so I follow some basic rules, which you can see in every trade alert I post.…
Week 4: How do you make your IRA safe?
by revtodd64 - September 6th, 2010 5:16 pm
Courtesy of Rev Todd
What is the safest way to invest with an IRA? The housing bubble (which should really be called an avalanche, since bubbles don’t sound dangerous) challenged traditional notions of safety. I remember reading several articles in 2007 about how safe REITs were, and they paid double digit dividends at the time. “Everyone pays their mortgage, right? It’s like investing in the American Dream!” Financial planners focused on asset allocation strategies, blending domestic and international stocks, bonds, and advocating that being spread out everywhere insured that you would gain in some places and lose in others, but over time you should make 10 percent a year.
Then we find out that the first decade of the 21st century was a complete wash in the stock market. In September of 2008, do you know how many of the several thousand mutual funds were beating the market? 17! And five of those funds were run by the same woman! Wish I could remember where I read that. So I could have put all my money in a couple of ETFs and done better than a mutual fund and avoided all the fees. So much for safety.
Where do you feel most safe investing now – stocks, government or corporate bonds, gold, real estate, commodities? Wrong on all the above. Chocolate is the best performing asset over time. Do you think Warren Buffett invests in Hershey and Cadbury because he has a sweet tooth? You could have skipped the dot.com and housing avalanches and retired with a pile of Hershey’s kisses, which taste much better than gold.
Here’s my answer the question of safety. Invest with options! People forget that options are designed to hedge against risk, not as speculation tools. My Grandfather ran a farm, feed store and trucking business in a tiny Iowa town. When I was 13 years old, he taught me about corn and soybean futures. He left me in charge of the feed store and a telephone number in Chicago to call if any farmers came in to hedge their crops for the fall. I drew up three contracts that afternoon for small farmers looking to lock in their grain prices while the market was high and…
Three Styles of Buy-Writes in an IRA
by revtodd64 - August 29th, 2010 1:52 pm
A whipsawing market can disturb your sleep to the point where you feel like you spent the night sailing around the Cape of Good Hope in a hurricane rather than dreaming about how you will spend your retirement. I batten down the hatches by writing covered calls in my IRA virtual portfolio. Covered calls enhance returns in a range-bound market and make the IRA ship sail a little smoother in choppy wakes caused by the latest CNBC “USS Dome and Gloom” and “USS BuyBuyBuy” sail at your stern. The Education section at Phil’s Stock World (PSW) gives three great strategies on how to buy-write your way to a more peaceful retirement. I suggest you read the details of each of these strategies as you get the chance, but I will provide a brief summary and what I see as the strengths of each style of writing covered calls.
XOM is a good inflation hedge and so beaten down (back to Sept 2008 spike lows, when oil was $40) that I have to include it. They have a 3.1% dividend of $1.76 with the stock at $57.46 and we can sell the 2012 $55 calls for $9.20 and the 2012 $52.50 puts for $7.35 for a net $40.91/46.71. That brings the dividend up to 4.3% and you make another 34% if called away at $55 with your worst case being owning 2x XOM at an 18.7% discount to today’s price.
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IRA Plot Week II: Why Margin is the Suspected IRA Killer
by revtodd64 - August 23rd, 2010 6:59 am
Courtesy of Rev. Todd, Rev Todd’s IRA Plot, PSW member
I love the way Phil does buy-writes that leads to buying stocks at a 20 percent discount and a nice long-term, no stress profit. Add in some debit spreads on TZA, SDS or whatever else to protect and I sleep very well at night. I am quick to load up on buy-writes whenever Phil gives the word. But a silent killer lurks in the shadows when I walk the dark alleys of my IRA account – margin requirements. (Cue the scary organ music.)
To illustrate the dilemma, look at CSCO on Phil’s buy list. He recommends buying Cisco and selling the $20 strike on calls and puts. If I go into that trade today, CSCO is at $22.23, and I would sell the Jan. 2012 call at $4.90 and the put for $2.55 for a great entry and a break even point that is 22% down. If Cisco holds above $20, the profit is $529 on 100 shares. Since the margin requirement (buying power in TOS) is only $1316, that makes for a 40% profit in 16 months, about 2.5% a month. Very nice!
So I move to my IRA account to do the same trade, set things up very quickly and get ready to pull the trigger and look at the margin requirement, which is now $3471! I would still make $529 profit, but gain is only 15% or just under 1% a month. What happened? In a margin account I only have to put up half of the $2223 to buy the 100 shares of CSCO, minus $$490 for selling the call, plus about $590 in margin to sell the put, which comes to only $1316. In my IRA I have to put down $1745 to sell a cash secured put ($20 put strike minus the $2.55 sale = $17.45 per share). Plus I have to put up all the purchase cost of the stock minus the cash I get for selling the call which is a whopping $3471.
There is absolutely nothing wrong with making the trade in my IRA account. I want security in my retirement, and 1% a month profit with downside protection is certainly better than the bobble-headed shark working for DaBoyz while taking 2% in yearly fees out of my account is going to make for me. But I would like to do…
IRA Plot Week I: Some checkpoints for monthly covered calls
by revtodd64 - August 20th, 2010 7:23 am
CCJ trade: Some checkpoints for monthly covered calls
Courtesy of Rev. Todd, Rev Todd’s IRA Plot
- CCJ is above the 50 day moving average (50 MA) and just regained the 20 SMA. I like to write on stocks moving back upward.
- There is support at the 50 SMA, which is at $24 pre-market. Remember the cost basis is at $24.09
- Volume just moved up nicely yesterday. I like to buy things as others are buying it, instead of selling it.
- Open interest on the option is 3244. I like it to be over 2500 so there is plenty of liquidity. If I have to kill this trade or roll it down, I want to be able to move in and out of it easily.
- CCJ will not report earnings before Sept expiration. I do not like to write calls with earning ahead of expiration because it is hard to say what will happen to the price. Phil has some nice trades to take advantage of the volatility at earning, which I do in my margin account, but with covered calls I want predictability and as much safety as possible. I want to hit a very high percentage of these trades, say 90 percent or better.
- I also like to look at the sector and see how it is doing. Phil has already done the fundamentals on this, but right now uranium miners seem to be doing well with a lot of demand out there.
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What “the plot” is all about
by revtodd64 - August 19th, 2010 2:40 pm
What “the plot” is all about
Courtesy of Rev. Todd, Rev Todd’s IRA Plot
For several years I have been a wandering stock market pilgrim seeking the holy grail of trading. I started with $2500 from a tax rebate and started climbing the volatile active volcano of penny stocks. I barely escaped the lava and moved through a series of gurus. I journeyed through the lands that were infested with gold bugs; flew (and crashed) with the iron condors, traveled with a trading tribe of “turtle traders” until whipsawed unconscious; and flew too near the sun with Icarus-like option traders. None of these proved to be the holy grail, since I either had too little cash, too little time or too little patience since I work full-time and cannot devote myself to day trading.
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Philip R. Davis is a founder Phil's Stock World, a stock and options trading site that teaches the art of options trading to newcomers and devises advanced strategies for expert traders...
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