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Case Study of a Costco Options Portfolio:
Costco (COST) started out 2015 trading at $141.61 while the Terry’s Tips portfolio which uses COST as the underlying was worth $6223. With this amount invested, you could have purchased 43.95 shares of the stock (we’ll round it off and say you could have bought 44 shares).
Here is how the price of COST fluctuated during the first nine months of 2015:
The stock rose steadily early in the year, but fell from a high of about $153 to as low as $135 in the first week of September. In the middle of September, it was trading slightly below where it started out the year. Let’s compare the prices for 44 shares of COST with the value of our Rising Tide portfolio during this same time period:
In late January when the stock fell a bit, the portfolio value fell by a greater amount, but when the stock recovered, the portfolio outperformed on the upside as well. Two other times during the year, the stock took a sudden drop and the portfolio value fell below the equivalent investment in the stock, but when the stock moved higher in July, the portfolio shot by a considerably higher percentage.
Over the nine months, an investment in the stock would have gained $1.20 per share from dividends you would have received on 44 shares, or $52.80. The stock actually had declined $.55 over these months, so the shares were worth $24.20 less than they were at the beginning, reducing the dividend gain to a net $28.60. This compares to $6376 that the portfolio value gained over the same period.
Let’s check the actual positions in this portfolio at the beginning of the year (from our January 3, 2015 Saturday Report):
We owned 7 calls which expired in April and 2 which would extend until July, and we had sold a total of 8 Jan-15 calls, 3 of which were at a strike just below the stock price and 5 which were slightly out of the money. We had one long uncovered call which we could have sold a short-term call against, but we wanted to maintain a higher net delta. The option positions were the equivalent of owning 218 shares of stock (the net delta figure). That explains why the portfolio value gains or loses at almost 5 times the rate of owning 44 shares of stock.
Here is what the risk profile graph looked like at this time. It shows the likely loss or gain in the portfolio value when the Jan-15 calls expired in two weeks:
You can see that about a 9% gain could be expected in two weeks if the stock remained flat, and greater gains would come if the stock were to move higher. On the downside, If the stock fell by about $1.50, a loss would result for the portfolio.
These are the positions we held after the close on the third Friday of January when the Jan-15 calls expired:
The stock had fallen almost $2, and a $1000 portfolio loss was incurred. Some of this loss was due to what we call the bid-ask-spread-penalty when the expiring Jan-15 calls were bought back and new Feb-15 calls were sold to replace them. In addition, with the cash created from selling Feb-15 calls, we pushed out all the long calls (except one) to Jul-15 from Apr-15, and these trades also involved buying new calls at the ask price while selling Apr-15 calls at the bid price. It usually takes a few days for the portfolio to recover from the bid-ask-spread-penalty when most of the positions are rolled over to new time periods.
Now let’s fast forward to what the portfolio looked like at the close of business on September 11, 2015. Here are the positions that we held:
You can see many differences between these positions and what we held back in January. First, the long calls are mostly all the way out to 2016 (Jan-16 and Apr-16), with a single long call in the October expiration month. Second, there are some put positions. In May, when COST was trading about $144, we sold a bullish credit put spread (buying Oct-15 135 puts and selling Oct-15 140 puts). If COST is at any price above $140 when those puts expire on October 16th, both puts will expire worthless, and we will have made 51% on the amount we risked when we sold the spread in May. Third, the short calls are in several weekly series rather than in a single (monthly) options series.
About half-way through 2015, we changed the way we trade this portfolio. We are now short weekly options in several different series. Each week, some calls expire, and we buy them back (usually on Friday) and sell new ones which expire about 4 weeks later. We select strikes which will balance out the risk profile for the portfolio. This allows us to tweak the profile each week rather than making wholesale adjustments at the end of the expiration month. We believe that the superior performance we have enjoyed over the past few months has been due to this new way of trading.
We are using this new way of adjusting in other portfolios which use FB, NKE, and SBUX as underlyings, and we are having similar good results in those portfolios as well.
To sum it up, over the 8 ½ months of trading, our portfolio gained $6376. This works out to be 102% of the starting value of $6223. Someone who had spent the same amount of money buying shares of COST would have picked up about $29, mostly from the dividend. Our portfolio performed over 200 times greater than the stock owners made out.
We believe that this experience establishes beyond all doubt that a properly-executed options strategy can out-perform the outright purchase of the shares many times over. Of course, it is a lot easier just to buy the stock. Trading options takes time and attention, but surely, isn’t it worth it when you can do 200 times better?
If you don’t want to bother with all the trading, you could open an account at thinkorswim and sign up for their free Auto-Trade service, and not only enjoy their $1.25 commission rate for a single option purchase or sale, but all the trades will be automatically made for you in your account.
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Any questions? I would love to hear from you by email (terry@terrystips.com), or if you would like to talk to our guy Seth, give him a jingle at 800-803-4595 and either ask him your question(s) or give him your thoughts. seth@terrystips.com
You can see every trade made in 8 - 10 actual option portfolios conducted at Terry’s Tips and learn all about the wonderful world of options by subscribing here. Why wait any longer to make this important investment in yourself?
Even better, you can become a Terry’s Tips Insider, and receive all our educational reports and materials absolutely free by opening a new account at the best options broker around - thinkorswim. If you open an account with our link, they will give you 60 days of free trading or up to $600, the same deals they give to everyone who opens an account with them. You must use this link to sign up - open thinkorswim account – and once you have funded your account with at least $3500, email Seth@TerrysTips.com and let him know that you have done it, and this is what he will do – sign you for our Premium Service package ($119.95 value plus an extra 4 months of our Premium Service, valued at another $190.80). You get $300.65 worth of services without paying us one penny.
I look forward to having you on board, and to prospering with you.
Terry
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