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Dear Friend,
This week I would like to share a report I sent to paying subscribers this week. It is a back test of a portfolio we set up just a month ago to carry out the precise strategy outlined in my book, Making 36%: Duffer’s Guide to Breaking Par in the Market Every Year in Good Years and Bad (the revised 2012 edition is the 5th printing). I believe it gives a definitive answer to the question “Do calendar spreads really work?”
Terry
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| Option Tip of the Week |
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Back-Testing the 10K Classic Options Strategy
The originally-stated goal of the 10K Classic portfolio was to deliver consistent 3% monthly gains and never have a losing month. This portfolio uses S&P 500 tracking stock (SPY) as the underlying, and uses true deep in-the-money LEAPS as the long side (a full 19 months out to start) and Weekly short calls at several strikes both above the stock price (usually 2 out of 5 to start the week) and below the stock price (usually 3 out of 5 to start the week). We generally do not make any adjustment trades until Thursday when some calls might be rolled to the next Weekly series at a different strike to make the portfolio more neutral net delta.
I wanted to see what would happen if we made absolutely no adjustments to the 10K Classic during the week based on the risk profile graph of the $9800 portfolio on June 15, 2012 and the weekly price changes for SPY that had taken place over the past 100 weeks. Here are the results:
This table groups the weekly price changes in dollars into 19 groups and multiplies the number of occurrences in each group by the loss or gain that would have occurred with that price change according to the risk profile graph displayed with the thinkorswim software. I reduced the indicated gain or loss by $50 each week to account for commission costs and transaction costs (we typically buy back out-of-the-money expiring calls for $3 or so, or pay a small premium when rolling over in-the-money calls). Of course, VIX was relatively high on this date (about 22), so the gains might be less if VIX were appreciably lower.
In 76% of the weeks, a gain would have been made and in 24% of the weeks, a loss would have resulted. In the gaining weeks, the average gain was $284 and the in the losing weeks, the average loss was $445. On an average of once a year (1 week out of each 50), a greater-than-15% loss would have occurred if no adjustments were made.
The bottom line is most encouraging. It says that the portfolio would earn 100% over two years if those positions were in place and no adjustments were made during the week. In order to carry out a strategy of making no adjustments, however, we would have to be willing to tolerate a weekly loss of about $1400 once every year.
Since about two weeks a year, very large weekly losses might occur (averaging about $1000), it seems best to slightly alter our goal of never having a losing month. When we encounter one of these weeks, the other 3 weeks of the month might not always do well enough to cover that large a loss. Our new goal will to never have a losing month as long as the stock does not fluctuate more than $7 in one week during the month. The more important 3%-a-month goal will continue to be in place.
The first month for the portfolio (up 5.1%) is certainly an encouraging start, especially with the volatility that we experienced during that time period.
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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. Wouldn’t it be a good idea to have some of your retirement money in a strategy that is designed to earn 36% every year? (At 3% a month, with compounding, $10,000 would double in 25 months and be worth $390,000 in 10 years).
I look forward to having you on board, and to prospering with you.
Terry
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| Andy's Market Report |
After a few weeks of gains the market finally decided to pull back this week. The talking heads would have you believe the decline was caused by the ongoing woes in Europe and the struggling U.S. economy, but heading into Thursday’s trading day the market had reached a short-term ‘very overbought’ state. Typically this type of reading leads to a short-term reprieve and that is exactly what occurred this past Thursday as the S&P 500 lost 2.2%.
The loss led to the overall declines for the week as the S&P fell 0.6%. The Dow lost 0.9%. However, the tech heavy Nasdaq actually managed to push higher 0.7%.
The reason the Nasdaq escaped the declines: the index wasn’t affected by Moody’s big banks downgrade.
Late in the trading week Moody's announced credit downgrades for 15 of the world's largest banks. The downgrades had been expected, but some were less severe than feared, which helped boost those shares on Friday.
But as we head into the second half of 2012 the major concerns remain the same. Uncertainty still surrounds Europe, Asia, and the upcoming U.S. presidential election.
“We are in a low-growth environment,” David Pearl, who oversees $21 billion in assets as co-chief investment officer at New York-based Epoch Investment Partners, said in a phone interview. “If the economy around the world is slow, corporate profitability is going to be slow, so the return will be mild.”
The market retreated even as the Big Ben Bernanke said the Fed will extend its stimulus program known as Operation Twist, disappointing investors anticipating a more aggressive approach.
“The Fed is doing whatever it can and be extraordinarily accommodative,” Dean Junkans, chief investment officer for the wealth management, brokerage and retirement units of Wells Fargo. “It’s important for them to do something to show support for the market, but I don’t think it will have a material impact on the economy.”
Expectations for further policy action gave stocks their first back-to-back weekly gain since April on June 15. The S&P 500 earlier this month was on the brink of a so-called correction, or a 10 percent drop from a recent peak, on concern about a global slowdown and a worsening of Europe’s crisis. It was a textbook case of buy the rumor, sell the news.
The question now is how long will the sell-off from Thursday last. Was it just a one-time ordeal or was it the first of many sharp declines to come?
Until the S&P can break out of its months-long trading range I expect to see more range-bound trading ahead. Keep watching the 1350-1310 area in the S&P. Once that breaks we could see a test of the 1380 or 1290 levels. Once those are broken, well, I think that is when we will see some conviction in the direction of the market. |
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| Overbought/Sold Condition Report |
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Overbought/Oversold as of June 16, 2012
• S&P 500 (SPY) – 59.6 (neutral)
• Dow Jones (DIA) – 57.3 (neutral)
• Russell 2000 (IWM) – 58.2 (neutral)
• NASDAQ 100 (QQQ) – 68.2 (neutral)
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| Testimonial of the Week |
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I have been auto trading your service since Oct 2011 and am pleased with the results. ~ David (received June 2012)
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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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