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How To Juice Your Returns With No Extra Work

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I’m sure you think of option traders and long-term mutual fund investors as being at the opposite ends of the trading spectrum — and they are. But option traders can actually learn a great deal from long-term mutual fund investors.

Because they invest for the long term, mutual fund investors understand the importance of fees.

John Bogle, founder of The Vanguard Group, popularized the low-cost index fund to overcome what he calls “the tyranny of compounding costs.” He even provided a road map to top performance for his competitors, explaining: “The shortest route to top quartile performance is to be in the bottom quartile of expenses.”

Today, I want explain how earning a few extra pennies on a trade can improve your returns.

I recently discussed how a relationship known as put-call parity ensures we can get fair prices for execution of option trades. Based on the math, we know that most options will be trading near their fair price. But when we look at a current price quote we see at least three pricing numbers for the option — the “last” price, the “bid” price and the “ask” price.

Many investors look at the last trade, but that is actually the least meaningful part of a price quote for options traders. That’s because the last trade might have been completed hours or even days before.

Instead, the most important parts of the quote are actually the current bid and ask prices. These are usually just a few cents different than the option’s fair value. The bid will almost always be a few cents below fair value while the ask is usually a few cents above fair value.

By definition, the bid is the price that someone is willing to pay right now to buy the option, and the ask is the price someone will accept to sell the option.

My preferred options strategy is selling options for income, particularly selling put options. There are two main benefits to this strategy: 1. I get to collect income upfront without dishing out any money to buy shares; and 2. I get the opportunity to buy shares if they fall below a level I deem a favorable entry price.

I have used this strategy to close 85 straight winning trades with an average annualized gain of 53%. To help traders understand exactly how this strategy works, I have put together a free step-by-step guide. You can access it here.

Getting back to options pricing, in technical terms, the bid price is offered by a liquidity provider. We are liquidity takers in the market.

When we open a trade with a “sell to open” order, we need a buyer to take the other side of our trade. We know there will be a buyer because potential buyers have placed bid prices into the market. On a “sell to open” order, we should expect to receive the bid price from the buyer of our option.

The difference between the bid and ask can be $0.05 or more and is known as the “spread.” The spread is usually considered to be another cost associated with trading. One way to decrease that expense is to enter our trade using a limit order, which lets us specify the price we’d like to sell our option for. This makes us a liquidity provider.

By setting a price for our “sell to open” order that is a little better than the current bid, we’ll still almost certainly be able to enter our trade and will also snag a few extra cents on each trade. That could increase our total return by more than 1% a year, all by simply using limit orders instead of market orders.

For example, I recently recommended my Income Trader readers sell a $55 strike put on a media company. At the time, the puts were trading with a bid of $0.55 and an ask of $0.60. If we opened the trade with a market order, we should expect to sell the put at $0.55, the bid price. But instead of using a market order, we could open the trade with a limit order that specifies that the lowest price we’ll accept for the trade is $0.58. Because of the way options trade, we are still very likely to get filled at that price, and we’ll increase our income by $3 per contract (each contract controls 100 shares).

The required margin deposit (i.e., the amount your broker makes you set aside as a “down payment” in case you are required to purchase shares) on that particular contract was $1,100, so the extra $3 per contract amounts to an additional 0.27% profit. Since the trade had about 10 weeks until expiration, we could theoretically repeat the trade about five times a year, thereby increasing our income by 1.5% annually.

I realize $3 per contract doesn’t sound like much, but adding more than 1% a year to your returns with no extra work is a no brainer. I recommend using a limit order between the bid and ask prices to maximize the return of every option you sell to improve your returns.

Selling options is an incredibly lucrative strategy. In fact, Brad C. from Memphis, Tenn., said he made over $1 million last year following my recommendations. If you’d like to learn more about how put selling works or get my trades sent directly to your inbox each week, follow this link.

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Options

How to Play Tesla Stock with Options

Once considered a niche segment of the investing world, options trading has now gone mainstream.

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Originally published by Cabot Wealth on September 27th

As I shared after-hours cocktails with Cabot Wealth Summit attendees two weeks ago, a large table of us shared our big-picture stock ideas. On the subject of Tesla stock, my thesis, after a couple bourbons, was that because of the innovations in self-driving cars made by Tesla (TSLA) and Uber, my young kids may never get a driver’s license.

Countless neighborhood friends of mine, who have older kids who are of age to get their licenses, have told me that their kids have no interest. “Why would I want a car? I can just Uber” is what one neighbor’s son told his dad. And the research trends back up this lack of interest.

As noted in Money Magazine and Business Insider, Researchers Michael Sivak and Brandon Schoettle from the Transportation Research Institute at the University of Michigan compared the percentage of people of different age groups with drivers’ licenses in the United States in 1983, 2008, 2011 and 2014. The study found that in every year examined, there has been a decrease in the percentage of 16- to 44-year-olds with drivers’ licenses in the U.S.

Once considered a niche segment of the investing world, options trading has now gone mainstream.

From 1983 to 2014, there’s been a drop of 47 percentage points in 16-year-olds with drivers’ licenses. For people ages 20 to 24, there’s been a 16 percentage point decrease over the same time span.

This chart of the decline of young licensed drivers is a sign of the times, and could bode well for Tesla stock.And much of this data was compiled before Uber and Tesla began to really shake up the automotive world!

In 2015, these same researchers noted, “In the most extreme scenario, self-driving vehicles could cut average ownership rates of vehicles by 43 percent—from an average of 2.1 vehicles to 1.2 vehicles per household”.

And as we know, the range of opinions on Tesla and Uber is wide ranging. For example, earlier this year, China’s Tencent Holdings (TCEHY) bought a 5% stake in TSLA.

“Tesla is a global pioneer at the forefront of new technologies,” a Tencent spokesperson said. “Tencent’s success is partly due to our record of backing entrepreneurs with capital; Elon Musk is the archetype for entrepreneurship, combining vision, ambition, and execution.”

That said, there are no shortage of critics of the company, including Bob Lutz, an auto industry legend who held top positions at Ford (F), Chrysler, General Motors (GM) and BMW throughout his career. In a Los Angeles Times article Lutz had plenty to say about TSLA. Here are some excerpts:

What’s your take on Elon Musk and Tesla?

“I don’t know why it is that otherwise intelligent people can’t see what’s going on there. They lose money on every car, they have a constant cash drain, and yet everybody talks as if this is the most miraculous automobile company of all time.”

What do you think will happen with Tesla down the line? Bought by a traditional auto company?

“Maybe, but who needs it? [Musk] has no technology that’s not available to anybody else. It’s lithium-ion cobalt batteries. Every carmaker on the planet has electric vehicles in the works with a 200-300-mile range.

“Raising capital is not going to help, because fundamentally the business equation on electric cars is wrong. They cost more to build than what the public is willing to pay. That’s the bottom line.”

What about the design?

“The one advantage [Musk] has is that the Model S is a gorgeous car. It’s one of the best-looking full-size sedans ever. The Model X? It looks like a loaf of bread. There’s no arguing the Model 3 is nice-looking but it doesn’t break any new ground aesthetically.

“Don’t get me wrong, what Musk has achieved, whether it is profitable or not, is incredible. He’s created an automobile company based solely on electric vehicles, and they have pretty good, not yet completely reliable, autonomous capability.”

What Wall Street Thinks of Tesla Stock (This was

Wall Street is also divided on Tesla stock, as traders position for the stock to crash, or explode to new highs.

So with TSLA trading at 345, how might I bet on, or against, Tesla stock trading options?

If I believed in Elon Musk, and the future of Telsa, I might execute the following trade:

Buy to Open the TSLA December 355 Calls for $22.

The most you can lose on this trade is $2,200 per call purchased, if Tesla stock were to close below 355 on December 15, 2017.

However, this trade has unlimited upside potential, just like a stock purchase, but at a fraction of the cost ($2,200 vs. $34,500)

If I wanted to bet against TSLA stock, I might execute the following trade:

Buy to Open the TSLA December 330 Puts for $16.

The most you can lose on this trade is $1,600 per put purchased, if TSLA were to close above 330 on December 15, 2017.

The advantage to buying puts is that most brokerage companies don’t allow average investors to short stocks. However, they do all allow you to buy puts, which is a bearish position, because your potential loss is limited to the price you paid for the put ($1,600).

For more information on how to trade options, consider taking a trial subscription to Cabot Options Trader

Free "dummies guide" to trading options

Did you know trading options can actually be safer and more profitable than buying and selling stocks? Video and plain English training guide reveals how to get started tonight. 100% free.

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Options

Stocks Stall After Posting Record Highs

The EPA has announced plans to begin rolling back major Obama-era legislation

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Originally published at SchaefferResearch.com

The Dow Jones Industrial Average (DJIA) and Nasdaq Composite (IXIC) both hit record highs this morning, but gains have so far been limited. The S&P 500 Index (SPX), in fact, has spent most of the day below breakeven, as traders take a wait-and-see approach ahead of third-quarter earnings season.

Among individual equities, Dow stock General Electric (GE) is sharply lower today, continuing its descent into multi-year-low territory. The energy sector also remains in focus; not only are hurricane-affected oil facilities in the Gulf of Mexico reopening, but Environmental Protection Agency (EPA) leader Scott Pruitt said he’ll be signing a rule to roll back the Obama-era Clean Power Plan tomorrow.

Continue reading for more on today’s market, including:

  • The healthcare stock crushed by Hurricane Maria — and analysts.
  • Inside today’s Tesla stock pullback.
  • Plus, puts popular on Kellogg; the Nasdaq stock that’s doubled; and AMC stock gets slammed.

Midday stock market stats October 9

Among the stocks with unusual options volume is cereal and food company Kellogg Company (NYSE:K), with roughly 14,000 puts traded — 20 times the average intraday norm, and already at the highest percentile of its annual range. The October 60 put is most popular, with almost 12,200 contracts exchanged in what looks to be bearish, buy-to-open activity. At last check, K was trading down 2% at $61.41, and earlier hit a nearly three-year low of $61.08.

One of the best stocks on the Nasdaq is textile dyeing company Cleantech Solutions International Inc (NASDAQ:CLNT). The shares of CLNT are soaring after the company entered into an agreement to purchase no less than 51% of Inspirit Studio. The stock was last seen trading up 115% at $7.14, on pace for its highest close since late 2015.

One of the worst stocks on the New York Stock Exchange (NYSE) today is movie theater entertainment company AMC Entertainment Holdings Inc (NYSE:AMC), with the shares down more than 6% at $14.27, following a price-target cut by Wedbush to $20.50 from $22.75. The shares have dropped more than 56% over the past year, and touched a record low of $12.05 on Aug. 18, not long after a post-earnings bear gap.

Daily Chart of AMC Since Jan 2017

Free "dummies guide" to trading options

Did you know trading options can actually be safer and more profitable than buying and selling stocks? Video and plain English training guide reveals how to get started tonight. 100% free.

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Options

Why Should I Sell Puts in a Low-Volatility Environment

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WisdomTree believes this strategy can help reduce portfolio beta and potentially provide higher risk-adjusted returns over the long run.

Since the cost of protection–option premiums–tends to decline during periods of low volatility, one question often comes up: Is now the right time to be collecting premiums by selling puts, when volatility is so low?

My analysis below will show why sticking to the basics of investing can answer this question and help investors with the risk mitigation they look for.

Investing 101–Sell Overpriced Assets

In 2017, the S&P 500 Index is into its eighth consecutive positive year, without a negative year since 2009. Historically, a consecutive-year bull run as long as this is rare and has happened only two other times since the 1950s: 1983-1989 and 1991-1999. A sense of complacency among the investment community is natural after such long bull runs. As a result, the CBOE Volatility Index® (VIX®), a gauge of investor fear that tracks 30-day implied volatility (or markets’ expectation of the next 30-day volatility), is at its all-time low.

It is natural that in such a low-volatility environment, the cost of insuring downside–put premiums–would go down. That is what the red line in the figure below shows. However, while VIX itself may be low, 30-day realized volatilities are even lower. In fact, the spread of VIX over trailing 30-day realized volatility has not been higher in the last 10 years.

Rising Spreads of Implied Vol Over Realized Vol Making a Case for Selling Implied Vol

VIX Index Avg

This means that implied volatility (i.e., market expectation for the next 30-day volatility) is much more richly priced than realized volatility (i.e., trailing 30-day volatility). Just as buying downside protection is a bet that realized volatility would increase more than current implied volatility, selling an option is a reverse of this.

To put it simply, as long as implied volatility stays above realized volatility, people buying protection are overpaying, while people selling protection are collecting rich premiums. What matters for a strategy like PUTW, which collects put premiums every month, is for implied volatility to stay above realized volatility, making premiums that it collects richer than they ought to be.

With this logic in mind, I believe selling put options and collecting premiums in the current environment is akin to sticking to the fundamentals of investing: selling expensive, richly priced assets.

 

Downside Protection through Option Premiums

 

The CBOE S&P 500 PutWrite Index (PUT), whose performance PUTW seeks to track, before fees and expenses, has a track record of more than 10 years, and we can compared actual day-to-day returns of PUT with the S&P 500 Index. One way of doing this is bucketing returns of two indexes in various return slots and counting the number of observations corresponding to each bucket or slot. 

If a strategy is less volatile, most of its returns should be concentrated in buckets closer to zero, while a more volatile strategy would see a higher number of observations in return buckets that are more extreme or far away from zero. Risk managers call this chart the distribution of returns.

Less Wide Tails of PUT Index (Historically) – Implying Better Protection for Investors
PUT Index Performance

What is immediately obvious in the figure above is that:

1. PUT distribution concentrated in middle–a daily return profile that stays closer to the mean (i.e., 0)

2. S&P distribution spread out–a daily return profile that swings much more away from the mean (i.e., 0 and with fatter tails)

3. Slight right tilt of PUT distribution–a return profile with higher density of daily returns in positive territory

Conclusion

Two things to take away from the above charts:

1. Collecting premiums makes sense at a time when implied volatility is as richly priced compared to realized volatility as it has ever been.

2. Long-term distribution of PUT also indicates a return profile that was much less volatile compared to traditional index equities.

As nobody can claim to know the future, and the S&P 500 may very well continue its bull run for years to come, I do not think investors should migrate away from equities. I think investors who blend their equity holdings with PUTW can potentially not just collect income from options but reduce volatility of daily returns in their portfolios.

Read more about blending equity position with PUTW.


Important Risks Related to this Article

There are risks associated with investing, including possible loss of principal. The Fund will invest in derivatives, including S&P 500 Index put options (“SPX Puts”). Derivative investments can be volatile, and these investments may be less liquid than securities, and more sensitive to the effects of varied economic conditions. The value of the SPX Puts in which the Fund invests is partly based on the volatility used by market participants to price such options (i.e., implied volatility). The options values are partly based on the volatility used by dealers to price such options, so increases in the implied volatility of such options will cause the value of such options to increase, which will result in a corresponding increase in the liabilities of the Fund and a decrease in the Fund’s NAV. Options may be subject to volatile swings in price influenced by changes in the value of the underlying instrument. The potential return to the Fund is limited to the amount of option premiums it receives; however, the Fund can potentially lose up to the entire strike price of each option it sells. Due to the investment strategy of the Fund, it may make higher capital gain distributions than other ETFs. Please read the Fund’s prospectus for specific details regarding the Fund’s risk profile.


The WisdomTree CBOE S&P 500 PutWrite Strategy Fund (PUTW) was unchanged in premarket trading Monday. Year-to-date, PUTW has gained 7.87%, versus a 13.56% rise in the benchmark S&P 500 index during the same period.

Free "dummies guide" to trading options

Did you know trading options can actually be safer and more profitable than buying and selling stocks? Video and plain English training guide reveals how to get started tonight. 100% free.

Download now.

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