After the Fall

May 10th, 2010

Today is May 9th.  It’s been an exciting week.  As I predicted, the market pulled back.  Back a lot further and faster than I predicted.  The SPY today is just under 112.  That was quite profitable for me.  As I said I would do, I bought back the Sep 124 SPY calls at a nice profit (see Merv’s Trades) and sold the July 120 calls for $2.32, putting another $2,325 in my pocket for the moment.  If the SPY doesn’t go over 120 between now and the third Friday of July, I will come out way ahead.  I’ll post a summary of the trades in this SPY sequence next week, but meanwhile here is what’s happened on this sequence to date:

sold May 121 calls and took in $1,144

Bought back the May 121 calls for $1,905, for a loss of about $740.

At the same time sold the Sep 124 calls and took in $3,556

When the market dropped, to shorten the time on the short calls, bought back the Sept 124 calls for $2,700, taking a profit there of about $850.  Net position at this time is plus $100, but I have paid for the long position in September, so although I have an asset that can create more profit for me, it is losing value as we get toward September.

At the same time as I bought back the Sept 124 calls, I wold the July 120 calls, taking in $2,325.  So now I am ahead (so far) about $2,400 plus whatever value my long position still has.

Keep watching

.   mlh

FOLLOW UP ON THE INDEX SPREAD

May 3rd, 2010

It’s my birthday, April 24th.  Yesterday the market was strong and the S&P got up to 121.  So to protect my position I bought back the May 121 call for $1,85 ($1,850) taking a loss of $650, for a net loss so far of just under $700.

At the same time I sold the September 124 calls for $3.65 and took in about $3,650.  So at this point I’m about $3,000 ahead.  I’m still at risk for as much as $5,000 (the five points between 124 and 129) less the $3,000 in my pocket, if the market keeps going up and goes to 129.

Why did I change philosophy and sell September calls instead of July calls?  Because I’m predicting a significant pull back in the market.  If I am right and the market goes back down to about 118, I can buy back my 124 Sept calls at a nice profit (taxable) and sell the July 122 calls for more profit.

So now we wait again and see what happens.  Isn’t this fun?

THE INDEX SPREAD

May 3rd, 2010

Our first trade was to write a covered call.  We did that on Medtronic stock, and you can see the status of the position in Merv’s Trades.

For our second activity now that April is here, we will write an index call spread.  The call spread is similar in principal to the covered call write, but instead of buying and owning the stock, we buy and own an option.  That’s somewhat like owning the stock for a limited period of time. Since we only “own” the stock for a limited period of time, we don’t have to pay much for it, so we don’t have much money tied up.  Many investors prefer this method of writing options because it’s a “higher leverage” play.

In this particular scenario, instead of “buying” an ordinary stock like Medtronic, we buy a security that is a “derivative” called an “index option.”  This particular index option is called the SPY, short for “spider” and it is designed so that it exactly tracks the S&P 500 index.  That index is one of the best to track the large company stocks.

So as you can see from looking at Merv’s trades, we buy 10 positions (controlling 1000 shares) of the September 129 spy and pay $1,255 net after commissions.  This is our “long” position that takes the place of owning the stock.  In effect this position protects us from any loss if the S&P 500 index goes over 129, because for every dollar it goes over 129 we make a dollar on this position.  As you will see, if the S&P 500 goes up beyond our expectations, we will begin to lose $1,000 on every point it goes up.  So that loss will stop at 129.

Now, to begin the trades that will create a profit, if all goes well, we SELL the May 121 call and take in a net premium of $1,220.  That puts us almost even in cash.

We are now at risk if the S&P goes up above 121.  We will lose $1,000 per point on each point over 121.  Why do we take that risk just to break even on cash?  Note that the “long position” is for September, and the short position is for May.  So if the S&P doesn’t go over 121 before the third Friday of May (the option expiration date) we can rewrite the position (maybe again in July) and the premium from those sales will be our profit. In other words, the first trade is designed to pay for our long position.

So now we wait and see what happens.

How are we doing on the January MDT trade?

May 1st, 2010

In January we bought 1000 shares of Medtronic stock at 45.60 and sold a covered call against it with a strike price of 49 with an expiration on the third Friday of May.  Right now the stock is down about $2.  So what does that mean?

First of all, if we look only at the stock we are down about $2,000.  Of course, as we said, this is an option writing test and in theory we would have bought the stock anyway because we believe it’s a good company.  I still think so.

Unless the stock rebounds very substantially before May 21, it looks like we will be allowed to just keep the $1,225 premium we received from the sale of the call.  In addition, since the stock pays a dividend of just under 2%, we will have accrued about $300 in dividends.  So we are way ahead by having sold the call.  At the end of May we should be able to sell another call and take in another $1,000 or so.  That will put us ahead even if the stock does not rebound.  that’s the power of options.

Overall, for the first 6 months of the year, if we take in two premiums and 6 months worth of dividend we should be earning at least 6% on our investment.  That’s better than I can currently do on real estate, and my funds are liquid.  And I’m still optimistic on the stock.  We will look in again on this trade next month.    mlh