The Options Trading and Investing service provides perspective on high quality setups and option trading strategies for the coming week. We carefully select these setups due to their quality and profit potential and we report back on results. This week I review current positions including a new adjustment in the EEM position. Finally, I consider adding new positions in TLT and GLD to take advantage of low implied volatility.
Please refer to our education video HERE for more information in the option strategies used in this post.
A summary of the plan for the week is summarized in the video below. The entries and cost basis will be highlighted on this post and on our private twitter feed.
Overall, the portfolio has a $582 profit since inception. The closed positions have a $1,370 profit and the open positions are now down $787. The open positions have seen a draw down this week due to the underlying instruments moving against our longer term directional positions. A profit/loss curve will always have moves up and down and there is no way to avoid that. However, there is always something to be learned from further examination of the positions. Let’s delve a little deeper into the breakdown of where the profits and losses have occurred. First I would like to look at the adjustment we made this week to a current position in EEM.
The portfolio held a bearish position in EEM going into the week. On Friday I tweeted that I completed the short position by adding 2 new trades. I sold a 10-lot of the Sep15 39/41 vertical call spread for $.98 and I sold 15 of the Sep15 33 puts for $.37. That resulted in the portfolio receiving $1,535 in option premium. Below is the risk profile for the completed position. Notice the upside break even point is 39.58 which is above the current price of 39.39 so while this position benefits from a big move lower, if EEM is at the current price as of Sep15 expiry the position would still be profitable. The biggest profit occurs at the 33 strike at expiry where the profit would be $2,575. Max risk to the upside is $1,425 and risk is undefined to the downside which is why the margin is $5,250. If I wanted to lower the margin requirement I could buy some ‘cheap’ puts. For instance, if I bought 5 of the Sep 28 puts for a total of $60 the margin would be reduced to $3,777. Purchasing 10 for a total of $120 would reduce margin to $2,000. If the account was tight on margin I might consider that but we are not so I didn’t.
I mentioned I would like to look a little closer at where the open profit and loss in the portfolio comes from. Below I have highlighted in yellow all of the short option positions. At the bottom they are totaled and I compare the short option profits to the long option losses. As of Friday, 3/31 the short options have generated $1,456 in profits and the long options have generated $2,343 in losses. Anyone who is primarily a directional buyer of options is familiar with this phenomena. If you are expecting a directional move that takes it time getting started, the losses start to build. Then it becomes a race against time to get to the target price. If, on the other hand, you are a seller of options you are generally happy when a move occurs slowly as you are getting paid for the passage of time. In this portfolio, we utilize both long and short options. The targets are based on price analysis provided by Stan and Jack. While the short options are currently providing the profits, the long options will start to contribute if and when the projected moves begin. Short options generally can’t deliver the same size of gains on a large price move that long options do. We are trying to achieve a balance between the two. Don’t forget, the primary goal of this option education service is to help emphasize the most important concept of Risk Management. Risk management is about both reducing the potential of proportionately large losses as well as reducing cost basis. Anyone who is only a seller of options is reducing cost basis and taking advantage of positive Theta (time decay) but they are exposed to potentially large losses to the portfolio. Option buyers have just the opposite risk profile. We feel the best option portfolio combines effective use of both long and short options to control risk and maximize potential profits.
Now let’s take a look at a potential position that I may initiate this week. Stan is projecting a move higher in TLT that has either begun or should begin Monday or Tuesday. I have missed part of the move up already, is there a way to profit from the rest of the move?
First thing I do is check the Implied Volatility (IV) in TLT to see if there is an edge there. It appears there is as the IV is in the 13th percentile of it’s 1 year range. It is likely that there could be a move higher in IV so I consider what strategy benefits from an increase in rising volatility.
Time Spreads such as Diagonal and Calendar spreads benefit from an increase in IV. I want no potential of a loss if TLT exceeds it’s upside target but I also want the position to be nicely profitable if it falls short of it’s target or if it takes more time than expected to reach the target price. As of Friday’s close, the Jul/Sep 128/127 call Diagonal spread was worth $.71. At that price, I can add a 15-lot for $1,065. That is the maximum loss on the position (not including commissions). In time spreads, you cannot determine the exact maximum profit as that is influenced by the IV of the underlying. However, I can estimate the max profit somewhere in the $3,000 area give or take. I usually only use time spreads if the underlying instrument’s IV rank is less than 25%.
Stan and I will be keeping a close watch on Gold this week also. We could see a turn higher this week so I will be considering several different trade structures. The IV in Gold is relatively low as it was in TLT so that will factor into my analysis as the week progresses. Follow the Twitter feed this week for any developments on this potential position.