Turning $10K into $50K by Jan 21st – Week 12 Update (Members Only)

What an exciting 10 weeks these trades have had!

The most important thing to take away from these hedged play reviews is how important it is NOT TO TOUCH THEM.  We orginated this group on June 11th and the Dow was at 10,200 and it ran up to 10,600 and down to 9,600, back to 10,700, down to 9,800 again and is now back to 10,400.  We could have made some good adjustments and we could have made some bad adjustments but the best move is to do nothing with long-term, hedged positions while the market gyrates UNLESS something fundamentally changes in your range outlook. 

Rather than panic out of positions like these examples, a simple disaster hedge was used in the July 26th update to ride out the dip, while letting time (theta) decay contine to do it’s work on the premiums we sold…

The VIX was at 30 back on June 11th and that, in part, determines the nature of the trade ideas we decide to use.  The higher the VIX, the more we want to sell premium as we simply profit from the declining VIX (now 23.5).  The idea of these picks was to find $10,000 worth of small plays that we thought could gain 500% by Jan 21st as part of a larger virtual portfolio.  If you can do this with just 10% of a $100K virtual portfolio or 5% of a $200K virtual portfolio, that’s plenty of risk for these uncertain times and it’s a nice 25-50% bonus on the entire virtual portfolio if it works out.  Risk can be a component of a conservative virtual portfolio if we wall it off safely.

Our first play was a fundamentals play on YRCW, assuming they wouldn’t go bankrupt.  10,000 shares at .21 was the original entry ($2,100) and I called an audible on this one on 7/7 to add 2x at .11 rather than stop out.  That brought the net down to 0.143 on 30,000 or $4,290 so a bit more than a DD overall and we took 1/2 off the table this week at .29 ($5,850), turning this one into a free play ($1,560 profits in pocket) with 15,000 shares to ride out but we lost our nerve at .41 because we couldn’t get .10 for the Jan $1s so we gave up (and rightly so it turns out) and cashed out for another $6,150 in profits for a total profit of $7,710.  YRCW is once again tempting at .25 but let’s see how next week goes first. 

20 C Dec $3/4 bull call spreads were .62 each ($1,240) and paired with the sale of 10 2012 $4 puts at $1.08 ($1,080) for net $160 investment in the artificial buy/write.  The $3/4s are now .73 ($1,460) and the $4 puts have dropped to .84 ($840) so now net $620 (up 300%), slow but steady progress.  This one is a fine example of Theta decay working on your favor: The 2012 puts do their job by getting cheaper while the spread more or less holds value.  It’s like taking out a loan that asks you for less and less money back as time goes on! 

Do we take this play off the table, up 300%?  Well, our goal is to make a clean $2,000 on the $3/4 spread and we’re nowhere near that but the trade is clearly on target and we got past earnings so no reason not to hang on as long was we hold our major levels (10,200, 1,070 etc.).  Just keep in mind that the focus is on the shorter-term bull call spread and there we have $1,400 to lose if things go badly so pretty much we move a stop up to $1,200 now and push it up another $200, each time we gain $200 more. 

TASR is going nowhere fast.  20 Jan $5/7.50 bull call spreads were .35 each ($700) and are now .20 ($500) so our first loss in the group.  Selling 10 Jan $5 puts to cover at $1.30 ($1,300), on the other hand, is working out well at $1.20 so there’s $100 back already and a net $100 loss to date.  TASR is at $3.99 so on track to expire our putter for a loss of .20 more so let’s say this is one to give up if they fail $4 again as we’d be better off taking a $300 loss and moving on to something more productive but I do love TASR at $4 as a long-term play. 

BP was the riskiest trade we looked at but became a very nice winner. 10 Jan $17.50 puts sold for $2 ($2,000) are already down to .20 ($200) and looking like they will certainly expire worthless, up $1,800 so far.

The other half of that BP trade was the Jan $30/34 bull call spread at $2.20 (10 were $2,400) and those are now $3 ($3,000) so a very dull $800, 36% profit on this leg but up a net $2,600 on $400 committed on the paired trade (650%) is over target for our 500% goal already.  Our max profit is, of course, $3,600 at $34+ in Jan so we have "just" $1,000 more to collect but what is our rule?  If you are up more than 50% with more than 1/3 of the time left to expiration (from where you started) you need to protect that gain so really we will have little tolerance for a pullback in BP.  Keep in mind that these are our gains in 3 out of 7 months – there is no need to be greedy, if we are forced to cash then we can find another set to play.  

Our last play on June 11th was selling (we love to sell) 10 XLF Jan $15 puts for $2 ($2,000) and XLF has gone absolutely nowhere (but what a ride!) yet Theta, as always, is our friend and the $15 puts dropped to $1.32 ($1,320) so a quck $680 profit there even though the puts are .49 in the money.  This is a good place to note how totally great it is to sell puts against stocks or ETFs that you REALLY want to buy.  In a $100K+ virtual portfolio, we have no problem owning 1,000 shares of XLF at net $13 ($13,000) – it’s a little heavy but, hey, it’s the financials and they’re all on sale! 

Leg #2 of the XLF play was 10 FAS Jan $21.67/27 bull call spread at $2 ($2,000).  So the worst thing that can happen to us on this whole trade is we own XLF at $15 and we started the trade at $14.60.  If you are a value investor and you don’t mind owning XLF long-term for $15, then selling puts to finance more aggressive spreads has very little downside to a long-term player.  This is not rocket science, folks, just basic common sense buying stocks and selling options. 

In the July 26th update I said: "Now XLF has gone nowhere but FAS has dropped from $22.82 on June 11th to $21.98 on July 23rd.  That’s important to take note of, we lose about $1 per month on FAS in a flatlining XLF.  Fortunately, the Jan $21/27 bull call spread is still $2.20 (up 10% at $2,200) despite the decay.  Why?  Theta is our friend – as the VIX goes down both our $21.67 calls and the $27 callers lose value but our $21.67 calls are still .31 in the money and that helps a lot but not enough to make us very comfortable so we need to see XLF over $15 by the end of the month or we ditch this trade as an underperformer with too much risk."  We didn’t make it so the spead was ditched with a .20 profit, up $200.  The vertical spread is still $2 and still interesting but we’ll look at new combinations next week – the important lesson here is take stops seriously!

So far, In this example, we have laid out net $4,250 on these 5 trades and collected back $5,850 last time on YRCW which left us letting ride a $1,600 cash credit as of July 26th.  We since decided to cash out $7,710 on the YRCW and $200 from the XLF.  That’s a net $9,510 profit and our liquidation value on what remains is $620 on C, – $100 on TASR, $2,600 on BP and $680 on XLF (but, of course, if you do liquidate – it would be less) for a total gain of $13,310 (up 313% from the original allocation) in round one so far.  This is not bad but a long way from $40,000!  Since we had our entire first $4,250 back plus a cash profit was off the virtual table.  On July 26th we initiated a second round of trades despite our less bullish outlook at the time when I said: 

As I noted in our 5% Rule Update, we are now annoyingly right in the middle of our range, which will limit our betting at this stage as we could go either way.  Of course, we could always go either way but, as I explained in that post, it was much easier to take bullish chances coming off a 5% rule floor than it is when we’re back at S&P 1,100, where we could go either way 5% – especially during earnings season!

We ended up falling EXACTLY 5% to EXACTLY the 1,045 line and, sadly, rather than picking more bullish plays for this virtual portfolio, I spent a lot of time (in a tight week, for me) arguing with people who said we were doomed and that I was a fool for daring to be bullish etc., etc.  I have learned my lesson and will focus more on coming up with the trade ideas I feel will work in the future – these are just ideas, and people can choose to follow them or not but I can’t spend my whole day trying to "prove" that we’re at a bottom.  In the end, we all have to go with our gut, right?  Keeping track of virtual portfolios once in a while is the best way to determine whether or not the ideas were good or bad – not who "wins" an economic debate.  That’s not to say I don’t think it’s valid to discuss the economic situation and share ideas or even to debate them – but let’s try to keep it out of market hours, where I’m sure we would all rather concentrate of finding better trade ideas – thanks!

Our first new trade did not work out well as I thought UNG is still very cheap at $7.66 and hurricane season was predicted to be a big one.  Hurricane season runs through November so I chose 30 Jan $7/9 bull call spreads at .85 ($2,550), which are now .40 and down $1,350.  Offsetting that was the sale of 10 2012 $7 puts for $1.35 ($1,350), now $1.65 and down $300.  This is a disastrous loss of 400% on the net $400 play so far but, keep in mind that loss is still mostly premium as the $1,350 loss on the bull call spread can be completely offset if the puts expire worthless in 17 months. 

Still, this is not at all satisfying, is it?  Like YRCW, which fell to .11 before we pulled the trigger and doubled down, we have been waiting for Nat gas to finally finish falling but now comes the very difficult part.  It’s a small virtual portfolio allocation and this is a big loss, despite the offsetting profits.  The conservative play is to just kill the spread and take the $1,350 loss and then hope things work out next year to get us back to even.  I prefer taking advantage of the dip by rolling the 30 $7 calls down to the $6 calls ($1.05) for .47 ($1,410) and paying for most of that by selling 10 Jan $7 puts for $1 ($1,000) so net $400 cash added to the trade and the possibility of getting stuck with 1,000 shares of UNG at $7 at January expiration ($7,000). 

This is not such a terrible thing.  In a $100K virtual portfolio, the fallback of an unsuccessful short-term trade is to turn it into a long-term hold.  Currently, the 2012 $6 puts and calls can be sold for $2.65 so that $7,000 assignment can be reduced to a $4.35/5.18 buy/write.  If you don’t REALLY WANT to own 2,000 shares of UNG at $5.18 plus the possibility of another 1,000 shares at $7 in Jan 2012 ($17,360) for an average of $5.79 on 3,000 shares – then take the $1,350 loss now and be done with it.  Of course, if that is how you feel, it would have been better to get out with a $350 loss because this was the inevitable conclusion to riding it out. 

If you look ahead on these trades and plan out your next 3 or 4 possible moves, you will get a much better idea of where to stop out.  Of course, that’s a worst-case scenario and not likely to happen but, what if it does?  Well, at $5.79 (and UNG is $6.54 now), even if we can sell $6 calls for JUST .10 JUST 6 times a year, that’s a 10% ROI.  Since the Jan $8 calls are $1.50 out of the money and selling for .30, there’s .30 in 5 months right there which means the premise is sound, probably down to $4.50.  We still believe in our premise and we will pull the plug if we’re wrong but $3.75 has been a strong floor on natural gas and we’re coming to the end of the Summer storage cycle.  So doing the roll and setting a $700 stop loss on the new set, keeps this trade alive ratther than taking a loss on something we feel is way oversold.  Last year, Nat gas flew from $9 to $12 after bottoming on Sept 3rd – if we don’t get a good pop by the 17th, it might be time to pack it in. 

VLO was too close to our $16.50 buy-in to ignore at $17.09.  We liked selling 10 Jan $16 puts for $1.50 ($1,500) and those are now $1.18 ($1,180) despite the fact that VLO is LOWER at $16.94.  This is why we ALWAYS sell into the initial excitement.  The putter who bought the $16 puts for $1.50 was betting VLO would keep falling to $14.50 or less by January 21st.  Since VLO has stopped falling, those puts look less and less attractive every day and the bet loses it’s value.  Keep in mind that even IF VLO falls to $14.50 by Jan 21, all that happens is the putter gets his money back and you had a free loan for 6 months!  That loan was used to partially fund 20 Jan $15/17.50 bull call spreads at $1.45 ($2,900) and that spread is still $1.45 so a a net $320 profit (22%) on the $1,400 cash outlay so far DESPITE VLO GOING LOWER! 

I really liked 10 XLF Jan $13/15 bull call spreads at $1.22 ($1,220) and XLF has gone nowhere, but buying a spread that’s in the money is SMART and we’re still $1.52  and the spread is now $1.27 (up $50) and looking good.  We paired that with the sale of 10 Jan $14 puts for $1.12 ($1,120) and, again, despite XLF losing ground, the puts dropped all the way to .85 for another $270 gain so $320 gained off a net $100 cash commitment there so far but we’re still $1.52 in the money so no reason to give up on this one just yet. 

The most brilliant thing I did on July 26th was to add a disaster hedge to this set.  We went with 15 FAZ Sept $11/14 bull call spreads at $1.70 ($2,550), selling 10 Oct $12 puts for $1.15 ($1,150) for net $1,400 for $4,500 in downside protection.  The Oct $12 puts bottomed out at .19 when we flipped bullish last week but let’s call it the 50% stop I set when we made the trade for .30 as an exit (up $850) and the spread was interesting as the $11s topped out at $6.60 on the 25th while the $14s were $3.95 so that’s $2.65 realized on a $3 spread and, even though I was away, I certainly hope Members do follow our core strategy and TAKE THE MONEY AND RUN when you go up 50% on the vertical and you are now risking $2.65 just to make .35 more with 3 weeks to go. 

Of course, my favorite way to play these is to sell the calls (the Sept $11s) into the excitement and leave the naked callers (the Sept $14s) for a retrace but that’s more dangerous.  Even if you rode this vertical out, it’s still $2.15 so we’ll split the difference and call this exit at $2.45, which would be up $1,125.

So, not a total disaster in the second set (down $1,650 on UNG, up $320 on VLO, up $320 on XLF and up $1,975 on FAZ for net up $965 and a grand total of up $14,275 overall).  This is all the more reason to kill the UNG trade if you don’t REALLY like the potential risk of ownership.  We WILL find more trades for this virtual portfolio next week but I want to see what happens when the volume comes back first.  While we set out to make $40,000 and are currently "behind schedule" that’s no reason to take more risk – $14,000 is still a 140% profit on the allocated cash and is 14% of a $100K virtual portfolio – that is not something to be taken lighly and CERTAINLY not something you want to be giving back!