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Dear Friend,
For most of the last year, the market (SPY) and many individual stocks have fluctuated more than the implied volatility of the options would predict. This situation has made it quite difficult to make gains with the calendar spread strategy that we have long advocated.
Now we are experimenting with buying straddles as an alternative to our basic strategy. This represents a total reversal from hoping for a flat market to betting on a fluctuating one.
Today I would like to report on a straddle purchase I made last week.
Terry
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| Option Tip of the Week |
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Another Buying Straddles Story
I selected the Russell 2000 (Small-Cap) Index (IWM) as the underlying. For many years, this equity seems to fluctuate in the same direction and by about the same amount as the market in general (SPY) although it is trading for far less ($80 vs. $134) so the percentage fluctuations are greater.
On Monday morning, IWM was trading right about $80. I bought an 80 straddle using IWM (Jul2-12 puts and calls), paying $1.53 for the pair. If IWM moved by $1.53 in either direction, the intrinsic value of either the puts or calls would be $1.53, and there would be some time premium remaining so that either the puts or calls could be sold for a profit.
How likely was IWM to move by more than $1.53 in either direction in only one week? Looking back at weekly price behavior for IWM, I found that in 62 of the past 66 weeks, IWM had fluctuated at least $1.60 during the week in one direction or another. That is the key number I needed to make the purchase. That meant that if the historical pattern repeated itself, I could count on making a profit in 94% of the weeks. I would be quite happy with anything near that result.
Buying a straddle fits my temperament because I was not choosing which way the market might be headed (something I know from experience that I can’t do very well, at least in the short term), and I knew that I could not lose 100% of my investment (even on Friday and the stock had not moved, there would still be some time premium remaining in the options that could be sold for something).
One on the biggest problems with trading straddles is the decision on when to sell one or both sides of the trade. We’ll discuss some of the choices next week. What I did was place a limit order to take a reasonable profit if it came along. When IWM had fallen about $1.75, I sold my puts for $1.85 on Thursday. On Friday the stock reversed itself, and I was able to collect $.17 by selling the calls, making a total 20% after commissions for the week. Not a bad result, I figured.
At some point during the week, there were opportunities to sell both the puts and calls for more than I sold them for, but I was delighted with taking a reasonable profit. You can’t look back when trading straddles. If I had not sold the calls but waited until the end of the week, I would have lost about 70% of my original purchase. So selling when you have a small profit is clearly the way to go.
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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.
You can see every trade made in 8 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?
I look forward to having you on board, and to prospering with you.
Terry
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| Andy's Market Report |
The market is one month into the notoriously slow “summer doldrums”.
So far the S&P has made a remarkable 0.20%.
I expect to see more of the same going forward.
The well-defined range has been established over the past three months. Until SPY can muster the strength or lack thereof to break the $141-$127 range, expect to see a continuation of the low volatility, range-bound market environment. Trade accordingly.
Moreover, SPY currently sits smack dab in the middle of the range with a solid short-term neutral reading. So, as it stands neither the bulls nor bears have a short-term advantage, at least technically.
But, if you look at seasonality, the market is moving into a short-term bearish environment.
And if that wasn’t enough traders/investors who play in the world of Rydex mutual funds are getting extremely comfortable with their equity investments. Several weeks ago money market assets as a percentage of total assets were 60%, over the past few days they have fallen to a dismal 39%. While this doesn’t seem like a huge decline it is actually a key level in what has been a very reliable indicator in the past.
As Jason Goepfert of sentimentrader.com points out, “this is unusual because the market was dropping during that time - normally these traders move into the money market, and not out of it, when the market drops”.
Basically, when this figure has dipped below 40%, the market moved lower over the short to intermediate-term. I expect to see history repeat itself once again and if it actually does expect to see another test of the lower end of the range In SPY.
Earnings season is also upon us.
Next week, Bank of America, Goldman Sachs, Citigroup and Johnson & Johnson are just a few of the S&P companies scheduled to report.
"Expectations have been beaten down a lot," said Robbert Van Batenburg, head of equity research at Louis Capital in New York. "The problem is we're dealing with a global slowdown, and I'm sure that's going to be reflected in some of the comments you're going to be hearing."
But if that wasn’t enough action for the week Helicopter Ben is set to speak.
That’s right, Bernanke is due to deliver his semiannual monetary policy report to Senate and House committees on Tuesday and Wednesday.
"I don't think he's going to allude to any quantitative easing, so I don't think you'll get any solace from that," Van Batenburg said.
"I would expect him to try to bring the message home to policymakers to address the fiscal cliff. Fiscal tightening flies in the face of any effort to dodge deflation."
That’s right, the fiscal cliff.
Get ready for a few market fireworks over the next few weeks. |
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| Overbought/Sold Condition Report |
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Overbought/Oversold as of July 14, 2012
• S&P 500 (SPY) – 60.8 (neutral)
• Dow Jones (DIA) – 59.8 (neutral)
• Russell 2000 (IWM) – 56.0 (neutral)
• NASDAQ 100 (QQQ) – 49.4 (neutral)
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| Testimonial of the Week |
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"I have learned more than I ever expected from your tips and want to thank you for starting an educational journey I value more than my MBA." ~ Mark
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Thank you again for being a part of the Terry's Tips newsletter. If you are interested in signing up as an Insider, visit Terry's Tips today for details.
Sincerely,
Dr. Terry Allen
Terry's Tips
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