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Buy List – Q2 2010 – My Top 20 (Members Only)

OK, now I'm putting pressure on myself

I hate saying top 20 because the top 20 could change next week if the market conditions change but, for now, I did a lot of reading and thinking over the weekend and that led to me writing "The Worst-Case Scenario:  Getting Real With Global GDP!" in which the short story is:  Things are just simply not bad enough to sit on our hands with a big pile of cash

PLEASE keep that in mind at all times - our buying premise is that we have cash (with a target of staying at least 75% cash right now) and we ALREADY have our disaster hedges, which are already in the money.  If we have a 5% hedge in place that pays 25% on a market drop of no more than 20% below where we are now, then we can expect to have 25% of our money from that hedge to pay for any stocks that are put to us and, if we are only allocating 20-25% of our cash to buy round 1 here, then logically, that extra 5% we're putting up as insurance will pay for the rest.  

That means, if we spent $25,000 to buy round 1 of stocks and $5,000 of insurance that pays 500% if we hit our assignment area (down 20%) and we are assigned a basked to stocks, which force us to double down, then the $25,000 we need to double down with will come from our insurance hedge and that means we'll be in 2x the stock for $30,000 with $75,000 more cash on the side (assuming it was a $100K Virtual Portfolio). 

Let's keep this example dead simple and say we buy the SPY for $106.82 and let's say we buy 300 shares for $32,000.  Now we cover that with the sale of the March $103 calls for $12 and the $95 puts for $7 and that nets out to $87.82 ($26,346) and our upside at $103 is $15.18 ($4,554 or 17%).  We are committed to owning 600 shares of SPY at the $87.82 we paid for 300 plus another 300 at $95 for an average of $91.41 on 600 or $54,846

Now comes the hedge.  In order for us to lose money on this SPY trade, SPY has to go down below $87.82, which is our break-even point.  We don't NEED insurance above that spot as we already have it from the puts and calls we sold and REMEMBER, if SPY falls 13.5% to $87.82 we don't make any money for that period but we have a lot of SPY at a price we REALLY wanted it for.  So now we need to pick our insurance based on what makes us comfortable. 

SDS is an ultra-short on the S&P and for the S&P to go down 13.5%, then SDS should go up 27%, from $35.75 to $45.40.  Based on that, all we need to do is take the SDS Jan $37/45 bull call spread for $2 and that will pay $8 on a 13.5% drop in the S&P.  If we risk $1,000 on the insurance, that's all we can lose and our upside is $4,554 on the bull side so net $3,554 if the S&P heads higher.  If we go down, 10 contracts at $1,000 would pay back $4,000 at SPY $86ish and that protects 600 shares (because they will be put to us) with an additional $6.66 each!  So, for $1,000 worth of insurance with NO MARGIN REQUIREMENT, we are able to buy SPY right now for net $87.82 and we are break-even down to $81.16. 

ProRackBanner.jpg image by bridgeydrumsNow, we can get fancier and hedge the hedge with a put sale like the Jan $25 puts for $1 and now the protection costs us nothing and we can buy 20 of the bull call spreads for $2K which pays $8K if the S&P is put to us, giving us an additional $13.33 of downside protection on our SPYs ($74.49) and our risk comes in if the S&P goes up 14% (to 1,200) and drops SDS 28% to $25 and triggers those puts.  We can, of course roll them and we have to figure that, sometime around 1,100 on the S&P, that we would wake up and take some action but it's always good to consider the worst cases

Of course we DON'T play the SPY this way because the payoff is lame but the hedge is nice to protect against a 20% drop in the S&P from here.  I generally prefer hedges that are in the money but one solution is buying the bull call spread for $1 and only selling puts (hopefully better ones) IF the S&P starts going higher AND you still are worried about a pullback.  Othewise, if we rocket back up over 1,100 – you don't need to protect a SPY $103 payout (S&P 1,030) unless the index breaks back below 1,000. 

Hopefully that clarified more than confused.  The main point is there is a mathematical certainty to hedging SPY with SDS but not so much with others, which is why we choose our Buy List carefully and try to get the best performers which generally have good correlation to the indexes we intend to hedge with.  When the market goes lower, we may take bigger risks but right now we pretty much EXPECT to lose on our bullish plays - this is all about just not wanting to miss out if we do rally higher.  Being able to buy with confidence while other people are panicking is step one to the "Buy Low" part of smart stock trading!

And now, 20 stocks I really like – even if the world ends:

tinman.jpg tin man image by eliahmountjoyAA (6/6 – $10.84) People need tin!  Buying the stock at $10.84 and selling the 2012 $10 puts and calls for $4.70 for net $6.14/8.07.  AA bottomed out at 4.91 when the World was ending last March. 

AET (6/6 – $30.21) Insurance companies are hard to pin down but Aetna has over $20Bn in assets as long as those "Long-Term Investments" aren't in Greece or Spain, or Italy or Ireland or France or…  Anyway, so you never can really tell what the assets are or what the liabilities are but you can tell a company has made steady profits through the crisis and, more importantly, grown revenues, from $27Bn in 2007 to $34Bn last year, yet they trade at almost 1/2 the 2007 highs.  Buying the stock at $30.21 and selling the 2012 $30 puts and calls for $11.60 is net $18.61/24.31 for a nice 20% discount or a 62% upside if the stock just holds $30. 

C (6/6 – $3.79) is a crazy stock.  The only way we like playing them is to hope they don’t go bankrupt and take the 2012 $2.50/4 bull call spread at .75 (no stock) and sell the $2.50 puts for .50 and that’s net .25 on the $1.50 spread so you make 500% if C manages to hold $4 through 2012 or you end up owning C for net $2.75.  You can also play this more aggressively by selling 1 $5 put for $1.85 for each 4 spreads and that would knock out 40% of your margin and raise your cost to .30.  That means if C is at $2 in Jan 2012, you own 100 shares of C at $5.30 with a $3.30 loss vs owning 400 shares of C at $2.75 with a .75 loss but, if they go BK, you lose 1/2 as much with the 100 $5s.

CCJ (6/6 – $23.03) Oil isn't working and whether we build nukes here or Iran is just Christmas shopping, there is bound to be a long-term market for uranium and CCJ is a huge player and, when you think about it – it's in the government's interest not to allow competion in this space for security reasons.  Better to keep control of uranium with people you have a working relationship with.  You can buy the stock for $23.03 and sell the 2012 $22.50 calls for $5 and the $20 puts for $3.20 for net $14.83/17.42 for a very nice 51% if called away .53 below the current price. 

DIG (6/6 – $27.14) Other than the normal oil futures buy above the $70 line, I am liking a Dec bull/call paried with a short put sale but they are very thinly traded.  We should have hurricanes coming off last year’s el nino and, of course, $65 oil isn’t likely to last so the Dec $18/27 bull call spread for $5 (no stock) paired with the sale of the $23 puts at $3 has a nice 350% upside if DIG holds the line and a b/e way down at $22, where DIG has only ever been below for 3 weeks outside of a few quick spikes

GENZ (6/6 – $47.75) We got them on fat-finger day at my target (see older Buy List post) but not too bad here and we can buy the stock at $47.75 and sell the 2012 $45s for $10.40 and the $42.50 puts for $5.30 for net $32.05/37.27 and that's up 40% if called away 5% below the current price

GLW (6/6 – $16.23) Actionable trade on DELL’s new mini-IPad is GLW as I suspect a global glass shortage soon.  We can buy the stock for $16.23 and sell the 2012 $17.50 puts and calls for $7.40 for net $8.94/13.22. 

HOV (6/6 – $4.90) is a funny one but I think they are one of the best builders and you can get the craziest discounts betting they won't go BK.  I like buying the stock at $4.90 and selling the 2012 $5 puts and calls for $4 for a net .90/2.95 spread with a very nice 455% upside if called away 10 cents above the current price.  I also like the 2012 $2.50/5 bull call spread for $1.25 paired with a 1/2 sale of the Jan (2011) $5 puts at $1.25, which puts you in the $2.50 spread for net .68 and hopefully the puts expire in Jan and we can sell 2012 puts to lower the bais further.  Selling 10 of the puts should not cost you more than $1,250 in net margin ($2,500 for potential assignment less the $1,250 you collect from put sale) and then you can buy 20 of the bull call spreads for $2,500 so you are out of pocket $1,250 of cash and $2,500 in margin but the margin is done in Jan (hopefully) and you are left with $1,250 invested on 20 spreads that return $5,000 in 12 more months if HOV holds $5.

INTC (6/6 – $20.95) is a great, great stock that we'd be happy to own in 2012 so why bother owning it now when we can take the 2012 $10/20 bull call spread for $5 and sell the $17.50 puts for $2.50?  That puts us in the $10 spread for net $2.50 with a break even way down at $13.75 (34% down from here).  This iis what I call an Artificial Buy Write, where we are still happy to have stock put to us but, if it is, it's only 1x and still at a very good discount.  Also note that this play pays off $7.50 if INTC finishes .95 LOWER than it is now while buying the stock outright (which would cost more than this play) would not make you $7.50 unless INTC hit $28.45.  Isn't this stuff great?  What's your worst case?  You own INTC for net $13.75 long term

MON (6/6 – $49.02) Buying the stock at $49.02 (2.2% dividend) and selling the 2012 $47.50 puts and calls for $19.50 is a net $29.52/38.51.

MRK (6/6 – $33.17) Buying the stock at $33.17 (4.6% dividend) and selling the 2012 $35 puts and calls for $11.40 is net $21.77/28.39.  That's a little aggressive but I like the long-term prospects for big Pharma and we want to keep getting that dividend.

MO (6/6 – $20) Pays a 7% dividend so, despite the fact that they are evil, you gotta love the stock!  Buying the stock for $20 and selling the 2012 $17.50 puts and calls for $5.65 is net $14.35/17.18.  I worry about new taxes so a bit of a hedge but you collect $1.40 a year in dividends so figure $2.10 back in the 18 months to expiration gooses your total returns by 14.6%.

OIH (6/6 – $93.40) is another artificial candidate.  The 2012 $94.10/124.10 bull call spread is $9 and you can just go with that with a $30 upside (up 233%) or you can sell the $60 puts for $5.50 to knock the net down to $3.50 on the $30 spread with a put-to price of net $63.50 (down 32%) on an ETF that's very unlikely to be going away












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  1. Phil, (buy list)
    Am still new to this site, but I like the reasoning so far and will slowly get into the flow of things with your reasoning and strategy.
    Of course you are also buying AA here at $10.26 along with the put/ call strategy, right??
    Same for GE puts and calls for Jan 2012……you also have to buy the same number of shares as the call you are selling.
    Please confirm or correct if I am wrong.

  2. Buying/Maya – YES!  These are, unless specifically stated othewise, our Buy/Write plays, which is our core way of buying stocks.  See: "How To Buy A Stock For A 15-20% Discount."

  3. Phil – another newbie here. Great site; love your articles and strategy.
    2 questions here:
    1) For someone starting out now, can you suggest good hedges? I was looking at the BGZ, but Jan ’11 options don’t seem liquid, and I am not sure if I want to go for something shorter term. Would you still recommend TZA (though most stocks being bought might not fall under the small cap category)?
    2) What would you say for a STP trade with selling the 2012 $10 put+call for $6.25 for an effective cost of $2.81 (256% profits if called away for $10, $6.405 average if assigned at $10 – I like the company a lot at that price).

  4. Welcome RN!  I’m not very into new hedges this morning as I think we’re due for a run up but feel free to keep asking until I relent because we should take at least one new one into the run-up.  I like TZA because it’s an ultra near the bottom.  In other words, you can’t lose more than $7 or whatever your net is while other ultra-hedges can really burn you and we really don’t expect the RUT to go up 30% (90% drop on TZA) so we don’t really expect it to drop below about $4 at worst, which makes it fairly easy to manage.    As to STP, as long as you REALLY want to own 2x at the net, then yes – that’s the whole idea to this strategy.  Buy long-term positions you like now at a great discount and your worst case is you own even more for, in this case, about a 30% discount.  They key is to make sure you love the stock and, at least once a month, make sure you still love them after reading up again. 

  5. Phil,
    What do you make of the news this morning that the majority of options are short sided?
    Do you ever trade VXX? 

  6. Phil, As the Top 20 (positions/stocks)change from week to week or month to month, what are you recommending we do with the positions that are locked in with Jan 2012 sold puts /calls.  (as some of the recommendations are with 2012 options). For example, if they are no longer on the top 20 are you recommending we close them?
    Also, DO you ever provide what your specific portfolio looks like in terms of positions (which stocks and spreads) not dollar amount or contract size?

  7. Phil,
    BRAND new to this site and options as well, although I have been studying them over the past couple of weeks prior to signing up for this site. Looking at your idea for DIG and trying to figure out if I should pay the market price for the options or limit to the range you suggested. But if I set a limit and only some of the deal goes through, doesn’t that put me in a bad position? Sorry to be so green.

  8. Phil,
    Will you clarify the following?
    When you say we should be 75% cash, does this include any put reserve requirement cash held in the account or does the 25% deployed include the put reserve? This is an IRA.
    I am 24% long in stocks with buy/writes on most (no position over 5% of the account) still well inside any cushions even with recent selloffs. (I really like that strategy) and some naked puts sold that will likely expire or may be rolled if we start to fall into the black hole, but the long positions on the stocks are 24% of my account without the put reserve? Is this a problem?  Put reserve is about another 25%. Pure old cash about 50%. I want to begin the correction process now if this is wrong.
    You have help me a bunch…Thanks.

  9. Short sided/Exec – To me it just means we’re oversold.  It also means it’s probably a good time to sell puts.

    Ch ch ch changes/Dean – I think I answered this in a post but the buy list is updated and changed on a regular basis.  Go check the Portfolio tab for old buy lists and you’ll see how we track and change them over time.  These very long trades are a little different as there will not likely be any reason to touch them for a year but the next Buy List we have will be a more aggressive set (once we feel secure about this batch) and we are ready to move on.  As to size, it is pointless to specify size as there are people with $10,000 and people with $10M trading and if you have $10M, then buying 100 shares of AAPL for $250 is not big deal but if you have 10,000, you will probably be more interested in buying 100 shares of C or WFR as it’s more within your budget.  As a rule of thumb (and our Portfolio Section also has 3 fairly recent articles on "Smart Portfolio Management") you should never allocate more than 10% of your portflio to any single positions, preferably 5% so, if you have $100K, your max allocation is $10,000 and you would rather keep it at $5,000.  Since we are scaling into buy/writes with 1x and then if put to us 2x and then if we decide to go again, possibly 4x, that means you don’t want to take a 1x entry that’s more than about $1,500 (rounds 2 and 3 are cheaper) and absolutely no more than $3,000.  That means you are limited to taking net entries of $15 to AT MOST $30 stocks since you must buy 100 shares in order to do anything.  

    Market prices/Mill – That one is easy.  NEVER pay market prices.  One of the biggest failings of new options traders is they don’t realize how much a nickel is.  If you pay "just" .05 extra on the way in and .05 extra on the way out that’s .10 per trade and if you make 10 trades, you’ve already lost $1 and if those trades are generally $1 contracts, then you turn a 60:40 winning percentage into 50:50.  That’s another thing about trade ideas and portfolios – just because we like a trade idea, doesn’t mean we absoulutely take it.  If it doesn’t hit our offer, WE DON’T WANT IT! 

    If you go to buy a $30,000 car and you shop around and decide you like it but you go into the dealer and he says "Oops, I need $35,000 today" do you still buy it?  Hopefully not.  You have a VALUE you are willing to pay for the car and you know that if you shop around some more you will eithe find the care for $30,000 or, if the price doesn’t come back – you will find another car you like for the money.  Similarly, if you wanted to buy the car for $30,000 but you see it on sale for $24,000 – you don’t avoid it because it got cheaper – you don’t worry that tomorrow it will be $18,000 or maybe $12,000 in a month.  IT’S THE CAR YOU WANTED FOR $30,000 and you are glad to pay $24,000.  Why do people understand this about buying cars but not about buying stocks?

    There are two parts to entering a buy/write.  We have a covered call on the stock and we have a naked put sale or you can look at it as buying a stock and selling a short straddle/strangle.  You can try to time it as best you can but always be aware of the net price you want to pay for the set.  This morning, for example, GE is about $15.50 so I may say to myself "I absolutely want to own 100 shares of GE for net $10.45 in 2012 so I will sell the 2012 $12.50 puts for $2.10.  If those fill, then I have pressure on me to sell the calls but I still may decide we are at a bottom and buy the GE stock for $15.40 and then I look at the 2012 $15s I want to sell, which are now $3.10 and would give me a net $10.20/11.35 BUT I didn’t sell the calls yet and I have to think of what I’m willing to risk.  Let’s say I’m willing to have GE put to me at $11.50 so that gives me .30 of tolerance on the call sale so I put in a "sell stop" at $2.80 which would make my net $10.50/11.50 as a "worst case."  Anything I can sell those $15 calls for over $3.10 is a bonus to the position…

    The more money you have, the more you can play with these entries and, if you are scaling in with 1,000 shares in the first round, you can always sell 5 puts, buy 500 shares and then wait to EITHER sell calls if we go higher or sell more puts and buy more stock if we go lower and then wait for a bounce but now we’re into day-trading and not buying hedged entries so be careful with this if you don’t have lots of experience in momentum trading.

    Cash/BPS – The 25% we are allocating for long-term positions is roughly 23% for the buy/writes and 2% for hedges that pay at least 5x on a 20% drop.  We expect that, if the 23% is put to us, we will have 12% back on our hedge and that means that, of the 75% sidelined cash, we will need to pull another 11% off the sides to fullfill our obligation to the putter.  That will put us in $46,000 worth of stock positions with $64,000 on the sides (in a $100K Portfolio), so up 10%, which means we are break even until we lose over 20% of the put-to value of our positions.  See, it’s all just math!  

    Our $46,000 in positions can then be protected with $4,000 worth of Disaster Hedges, which will pay another $20,000 if we drop another 20% and that will allow us to get brave and sell about $10,000 worth of puts and calls and that will leave us with $70,000 in cash, the $4,000 Disaster Hedge and $36,000 in positions (after the hedges).

    That brings us out to about Jan 2014, where we are either called away with nice profits or we are forced to double up into $72,000 worth of stocks (with the Dow down around 6,000) using $24,000 from our hedge and $12,000 of our cash leaving us with $72,000 worth of stocks and $58,000 in cash.  If we think the Dow is going down to 4,000, we probably, at that point, want to cash out and move to Bali or something but, otherwise, we may just sit on our $72,000 worth of stock that was, in 2010, when we started, worth about $125,000 if the market ever comes back.

    That plan requires a grand total of 2 adjustments between now and 2014 – simple enough?

  10. Phil, I think your artificial buy/write technique is great! I was wondering about the break even calculation – perhaps you already have this explained in some article?