TWO SPREADS EXPLAINED

November 23rd, 2010

Some members have asked for clarification of the two spreads I wrote recently.

The first is the same SPY spread I’ve been writing over and over for many months.  As the market has been going up I have had to roll it up several times.  As a result the option position has not been as profitable as in prior periods, but this is compensated for by the rise in portfolio value.  Still, it’s been mildly profitable and continues to be.

In this latest write, I sold 10 calls of the January 123 SPY and took in $1,515.  At the same time I bought 15 calls of the June 135 and paid $1,465 for it.  So I’m only $50 ahead at this point in time, from a cash point of view.

The reason for this trade was to capture the June 135 position without having to pay for it.  If the market does not go over 123 between now and January 22, the short position will expire worthless, and I will already own the long hedge.  So then I can write a new short position at hopefully keep all of the premium.  I might even due it two or three times,  in Feb, March, April or May, but that’s a decision I will make in late January, depending on where the market is at that time and what I think about it.

And since there is so much spread between 123 and 135, if the market is very strong in December and January, and goes over 123, I have plenty of room to buy back the 123 and sell a new position higher.

Note that this SPY spread is effectively a bearish posture.  In that respect it acts as a hedge against my equity portfolio: if my portfolio goes down in value I make some of it back with this spread.  If my portfolio goes up in value I give some of it back here.  Maybe, and maybe not.

The second spread is a “bull put spread” on Apple.  The premise in writing this is that I do not think Apple will go below $300 a share between now and January 22.  Even though I am bullish on apple, however, I do not want to put up the cash necessary to own a significant amount of the stock.  Hence the put spread.

Here I sold 10 puts on the January 300 and took in $14,400.  To protect myself against a catastrophe and limit my risk to $10,000 less premiums collected, I bought the January 290’s and paid $10,800.  So I have $3,600 in my pocket, and I get to keep it forever if I am right and Apple stays over $300 for the next 60 days.

Questions?

Merv, Nov 22

UPDATE NOV 16

November 17th, 2010

The “merv’s trades” portfolio is not current, but the positions are similar.

I bought back the 120 SPY and sold the 124’s when the market was strong.  Since it has weakened since then the position is profitable so far.  I have the 125’s long as a hedge.

As WAG goes up I keep rolling up with it, trying to save my original premium.  I value the stock at about $38, and when it gets there I will probably let it be called away.  Meanwhile I bought back the 35 short calls and sold the April 37 calls for a loss of $900, but of course the stock can go up 2 points ( $2,000) now before it’s called away, so I’m in a better position.

I continue to hold NUAN (voice recognition) by virtue of puts at 16.  The stock has stayed over 16, so –so far so good.

I continue to hold RIG, and will roll up again if it goes above my covered call with a strike price of 70.  I believe the stock will hit 80 eventually.

To capture some losses in stocks that have declined (but have been a good base for covered call writing over the years) I’ve sold out of C, PL, and GE.  Because I still think GE has a future up to around 20, I sold the 18 puts, an in the money put, which is a bullish position.  I think the stock has an upside potential of $20, so by selling the 18 puts I am betting on the stock going at least to $18.  If it sinks I will lose $1,000 for each point it sinks below about $16.

I’m slowing getting out of MDT.  I’ve been writing calls against the stock for several years, and have made thousands of dollars in premiums.  But I only like to write calls against well run companies, and my friend Ralph Weil, a very successful stock analyst, says that the company is not now well run.

I’m still sitting short the 14 puts on BAC, which have not performed well.  I predicted that the stock would slowly go up to 14 or 15, but the stock has continued to decline.  So far this has not been a good prediction, but I stick by it.

I made a few more trades which I will cover on another blog in the near future.  Be sure to feel free to email me with questions, comments, and your suggestions.  I hope this site will become a place for trading option information and strategies.

Merv

A BUSY WEEK AFTER ALL

November 7th, 2010

I thought it would be a slow, relaxing week but it wasn’t.  First of all, as you might recall, I recommended Enbridge Energy (EEP) and Altria (MO) as good short term purchases for income.  I bought MO at $22.77 and EEP at $55.22.  Each was paying a dividend over 7% which was my attraction.  I sold calls on both of them, thinking that there wasn’t much upside to the stock, just a nice yield coupled with a call premium.

MO went quickly from $22.77 to almost 26, and EEP went from $55.22 to $61.50.  The EEP was just called away, and of course the MO will also be called away.  It didn’t turn out as well as I had hoped, with a long term holding earning 7% plus premium.  But I can’t complain.  For the short time I did own the stock I did get what I expected.  Writing calls doesn’t always work out well, and you sometimes miss the big upside.

Walgreen has continued to rise in price, and I continue to roll up.  Now I’m at 38 and if the stock goes over that strike I will let it be called away.  I will have made a very nice return over a long period of time.

The other excitement has been on the Spider (SPY).  As you might recall I was short the Dec. 120’s and long the March 125’s to hedge.  The stock hit 120 so I bought it back and sold the March 125.  I broke even on this trade, so I was able to keep the premium from the earlier trade.  This spread has not been very profitable, but that just means that my underlying portfolio has gone way up!

mlh

WATCHING AND WAITING

November 4th, 2010

The election didn’t seem to have much affect on the market.  I’m still “watching and waiting.”  The one position that has occupied my attention is Medtronic, MDT.  Medtronic has been strong, and I rolled up the Feb 36 calls to the May 38 calls, losing about $150 on the trade (but of course that’s a lot less than the original premium taken in).  Normally I don’t go out that far, but 38 is my read on upper value for the stock, so if it goes above 38 I will let it be called away.  So for me, letting calls ride at 38 forever is OK.  Note that in late Oct I had rolled up the Nov 34 calls and sold the Feb 36 calls for about a break even.  So I’m well ahead on this covered call strategy, even though the stock has continued to go up strongly.

The S&P has been dangerously close to my 120 strike price, at which I will have to roll up, but not yet.  You must be careful not to prematurely ejaculate when writing covered calls.

Merv