Conservative Options Strategy

Y

yucca_mtn

I'm a retired Electrical Engineer learning to dabble in options. My only claim to fame here is taking a 100k portfolio in Jan 2006 to about 200k now (with no withdrawals so far). My goal to not to lose money, and to make as much as I can. So I selected the most conservative strategy I could find that would provide a yield that exceeds inflation risk, allows me to make withdrawals from time to time, and still grow capital. For me that annual yield target is about 35%, after taxes. So I generally shoot for 50% annualized yield on each trade. I will point out that although I consider the strategy to be conservative, my portfolio and management style may not be considered “conservative”.

I use almost exclusively Deep in the money Bull Call Vertical spreads. In a thread I started last year I tried to explain my strategy and seek advice and suggestions from the folks here – turned out to be typical ET bloodletting, but it is there if anybody wants to see it. Just search my name.

In this journal I hope to simply post my trades (I like to think of them as investments since I’m not a “trader”.) I’ll try to add comments on the trades when applicable. I don’t trade every day, but I do trade probably too much.

Methodology: Seek spreads that are 4 to 9 months out. Seek a yield for 50% per year, but take 35% when safety factor seems to warrant the lower yield. Put on a lot of smaller spreads rather than fewer (but larger) positions (the reason for this, aside from diversification, is to lessen exposure to damage from early execution risk). Look for sectors that have the best prospects for longer term growth. Work hard to time the entries into these sectors. Generally, I seek spreads costing $4 and yielding $5 in six months, a 50% annual yield. Generally, I am willing to sacrifice a little more potential yield for a little more safety. More safety = deeper ITM. I try to reduce exposure to risk as the market changes, by reducing or closing out positions, or by extending or rolling the spread. Even with a “consertative” strategy, timing is everything.

I will try to answer responses that I think will benefit this journal, but I have the right to ignore any and all smart-ass comments.

I’ll list my positions here (the good and the bad) and try to attach a .xls file with costs and present values included. Almost everything is energy, metals and commodities. But before you snicker, take a look at the spreads and chart them.

As an example interpretation on my data, lets look at the first position AEM:

I have 4 spreads (8 call contracts) on AEM expiring in Nov08. Long the 50 call and short the 55. AEM right now is 66.20.
For the spread to be successful, the price of AEM must be above 55 on expiration. The P/E is high at 66, so I only have a small position here, but I still consider the sector to be headed higher, and I’m comfortable with the position. The spread cost about 3.85 and will yield 5.0 at expiration. This is a gain of 30% (1.15 return / 3.85 invested) now a little over 5 months away.

Anomalies: My long GLD position is basically a place to store cash long term. My long PMI is the remnant of a trade that I’m down $1500 but cant let go of yet (mentally speaking).




Date: May 12, 2008 8am pst
Description Position

AEM NOV2008 50 C [AEMKJ 100] 4
AEM NOV2008 55 C [AEMKK 100] -4
AEM JAN2009 40 C [ZZJAH 100] 5
AEM JAN2009 45 C [ZZJAI 100] -5
APA OCT2008 110 C [APAJB 100] 4
APA OCT2008 115 C [APAJC 100] -4
BHI OCT2008 50 C [BHIJJ 100] 3
BHI OCT2008 55 C [BHIJK 100] -3
BTU SEP2008 35 C [BTUIG 100] 5
BTU SEP2008 40 C [BTUIH 100] -5
CAM JAN2009 30 C [OKAAF 100] 3
CAM JAN2009 35 C [OKAAG 100] -3
CNX JUL2008 50 C [CNXGJ 100] 7
CNX JUL2008 55 C [CNXGK 100] -7
CNX OCT2008 55 C [CNXJK 100] 8
CNX OCT2008 60 C [CNXJL 100] -8
COP NOV2008 55 C [COPKK 100] 3
COP NOV2008 60 C [COPKL 100] -3
COP JAN2009 60 C [OJPAL 100] 4
COP JAN2009 65 C [OJPAM 100] -4
CVX SEP2008 70 C [CVXIN 100] 3
CVX SEP2008 75 C [CVXIO 100] -3
DBA JUL2008 33 C [DBAGG 100] 3
DBA JUL2008 38 C [DBAGL 100] -3
DBA OCT2008 30 C [DBAJD 100] 5
DBA OCT2008 35 C [DBAJI 100] -5
DBA JAN2009 25 C [DBAAY 100] 7
DBA JAN2009 30 C [DBAAD 100] -4
DBA JAN2009 35 C [DBAAI 100] -3
DO SEP2008 95 C [DO IS 100] 4
DO SEP2008 100 C [DO IT 100] -4
DVN OCT2008 75 C [DVNJO 100] 5
DVN OCT2008 80 C [DVNJP 100] -5
ECA OCT2008 60 C [ECAJL 100] 4
ECA OCT2008 65 C [ECAJM 100] -4
EEM JAN2009 110 C [ZYXAB 100] 10
EEM JAN2009 115 C [ZYXAC 100] -10
ENER JUN2008 17.5 C [EQIFW 100] 5
ENER JUN2008 20 C [EQIFD 100] -5
EOG OCT2008 85 C [EOGJQ 100] 4
EOG OCT2008 90 C [EOGJR 100] -4
EWZ SEP2008 60 C [EWZIL 100] 8
EWZ SEP2008 65 C [EWZIM 100] -8
FWLT MAY2008 47.5 C [UFBET 100] 5
FWLT MAY2008 50 C [UFBEJ 100] 4
FWLT MAY2008 52.5 C [UFBEX 100] -9
FWLT AUG2008 40 C [UFBHH 100] 7
FWLT AUG2008 45 C [UFBHI 100] -7
GDX JUN2008 35 C [GDXFI 100] 5
GDX JUN2008 39 C [GDXFM 100] -5
GDX SEP2008 40 C [GDXIN 100] 5
GDX SEP2008 43 C [GDXIQ 100] -5
GDX DEC2008 35 C [GDXLI 100] 10
GDX DEC2008 40 C [GDXLN 100] -10
GG OCT2008 27.5 C [GG JY 100] 12
GG OCT2008 30 C [GG JF 100] 3
GG OCT2008 32.5 C [GG JZ 100] -12
GG OCT2008 35 C [GG JG 100] -3
GG JAN2009 25 C [GG AE 100] 12
GG JAN2009 30 C [GG AF 100] -12
GLD 700
GRMN OCT2008 35 C [GQRJG 100] 3
GRMN OCT2008 40 C [GQRJH 100] -3
MDR AUG2008 35 C [MDRHG 100] 3
MDR AUG2008 40 C [MDRHH 100] -3
MDR NOV2008 40 C [MDRKH 100] 5
MDR NOV2008 45 C [MDRKI 100] -5
MLM OCT2008 75 C [MLMJO 100] 4
MLM OCT2008 80 C [MLMJP 100] -4
MOS SEP2008 70 C [MOSIN 100] 5
MOS SEP2008 75 C [MOSIO 100] -5
MOS DEC2008 70 C [MOSLN 100] 5
MOS DEC2008 75 C [MOSLO 100] -5
MRO JAN2009 35 C [MROAG 100] 10
MRO JAN2009 40 C [MROAH 100] -10
MTW SEP2008 25 C [MTWIE 100] 4
MTW SEP2008 30 C [MTWIF 100] -4
MW AUG2008 12.5 C [MW HV 100] 4
MW AUG2008 15 C [MW HC 100] -4
MW NOV2008 15 C [MW KC 100] 4
MW NOV2008 20 C [MW KD 100] -4
NOV MAY2008 45 C [NOVEI 100] 4
NOV MAY2008 50 C [NOVEJ 100] 3
NOV MAY2008 55 C [NOVEK 100] -7
NOV AUG2008 45 C [NOVHI 100] 5
NOV AUG2008 50 C [NOVHJ 100] -5
OXY JAN2009 55 C [VXYAK 100] 5
OXY JAN2009 60 C [VXYAL 100] -5
PAAS JUL2008 20 C [USPGD 100] 5
PAAS JUL2008 25 C [USPGE 100] -5
PAAS OCT2008 25 C [USPJE 100] 10
PAAS OCT2008 30 C [USPJF 100] -10
PCU JUN2008 85 C [PCUFQ 100] 3
PCU JUN2008 95 C [PCUFS 100] -3
PCU DEC2008 75 C [PCULO 100] 10
PCU DEC2008 80 C [PCULP 100] -10
PKX NOV2008 80 C [PKXKP 100] 6
PKX NOV2008 85 C [PKXKQ 100] -6
PMI 300
PMI JUN2008 7.5 C [PMIFU 100] -3
POT SEP2008 120 C [PYPID 100] 4
POT SEP2008 125 C [PYPIE 100] -4
PTR DEC2008 105 C [PTRLA 100] 5
PTR DEC2008 110 C [PTRLB 100] -5
RTI JUN2008 35 C [RTIFG 100] 4
RTI JUN2008 40 C [RTIFH 100] -4
RTI SEP2008 30 C [RTIIF 100] 6
RTI SEP2008 35 C [RTIIG 100] -6
SII JUL2008 45 C [SIIGI 100] 4
SII JUL2008 50 C [SIIGJ 100] -4
SLB NOV2008 65 C [SLBKM 100] 5
SLB NOV2008 70 C [SLBKN 100] -5
SU SEP2008 70 C [SU IN 100] 3
SU SEP2008 75 C [SU IO 100] -3
SUN AUG2008 45 C [SUNHI 100] 3
SUN AUG2008 50 C [SUNHJ 100] -3
TDW JUL2008 40 C [TDWGH 100] 3
TDW JUL2008 45 C [TDWGI 100] -3
TDW OCT2008 45 C [TDWJI 100] 5
TDW OCT2008 50 C [TDWJJ 100] -5
TEX JUL2008 45 C [TEXGI 100] 3
TEX JUL2008 50 C [TEXGJ 100] -3
TIE JAN2009 10 C [XJXAB 100] 12
TIE JAN2009 12.5 C [XJXAV 100] -12
UNG OCT2008 35 C [UNEJI 100] 8
UNG OCT2008 40 C [UNGJN 100] -8
UNG OCT2008 42 C [UNGJP 100] 10
UNG OCT2008 47 C [UNGJU 100] -10
USO OCT2008 75 C [UNAJW 100] 5
USO OCT2008 80 C [UNAJB 100] -5
USO JAN2009 70 C [UNAAR 100] 10
USO JAN2009 75 C [UNAAW 100] -10
VIP OCT2008 20 C [VIQJD 100] 8
VIP OCT2008 22.5 C [VIQJJ 100] -8
VLO DEC2008 35 C [VLOLG 100] 4
VLO DEC2008 40 C [VLOLH 100] -4
WFT AUG2008 55 C [WFTHK 100] 3
WFT AUG2008 60 C [WFTHL 100] -3
WY OCT2008 50 C [WY JJ 100] 5
WY OCT2008 55 C [WY JK 100] -5
WYNN SEP2008 70 C [UWYIN 100] 3
WYNN SEP2008 75 C [UWYIO 100] -3
X OCT2008 75 C [X JO 100] 5
X OCT2008 80 C [X JP 100] -5
XLE JUN2008 61 C [GQQFI 100] 2
XLE JUN2008 66 C [GQQFN 100] -2
XLE DEC2008 65 C [XBTLM 100] 10
XLE DEC2008 70 C [XBTLR 100] -10
XOM JUL2008 70 C [XOMGN 100] 5
XOM JUL2008 75 C [XOMGO 100] -5
XOM JAN2009 75 C [XOMAO 100] 5
XOM JAN2009 80 C [XOMAP 100] -5
 

Attachments

todays activity:
COST Net Profit
(commisions included)
sold: 7 CNX JUL 50/55 @ 4.85 3.8 $744
5 ENER JUN 17.5/20 @ 2.45 2.0 $211
4 SII JUL 45/50 @ 4.85 3.35 $589



Following commentary for any novices who might be reading this.

Explanation of first sale:
sold 7 spreads on CNX for $485 X 7 = $3395 cost was 380 X 7 = 2660 (not countng commissions)
BTC (Buy to Close) 7call contracts CNX JUL08 55 (short leg)
STC (Sell to Close) 7 call contracts CNX JUL08 50 (long leg)
yield was 744 profit / 2660 cost = 28% (bought spreads in Jan held for 5 months so annualized yield 67%)

I sold these spreads early cause risk/reward changes - Very little time value left, and increasing risk of early execution. Could have made .15 more for waiting 2 more months, for an extra 3.1% (annualized 18%) is not worth the risk.

Comments:
Want another position in SII, will wait for better entry.

I still have a few May spreads expiring Friday (FWLT and NOV), so will get more cash from them.

I could close out SU and WFT now (way early), but have no better place right now to put the money to work.
It might as well sit there earning something (still pays more than my margin interest).

There are some really good larger companies I would like to have a position in, but volatility is low (beta is not so low however) and I can't get deep enough spreads to justify the risk. IMO anyway.


Concerns:
Keeping a close eye on:
3 DBA JUL 33/38
5 GDX SEPT 40/43
3 GRMN 35/40
3 SUN AUG 45/50

Worried about early Execution:
5 MOS SEPT 70/75
5 X OCT 75/80 (THIS IS US STEEL stock at 172. I'm very friggin deep,
but earnings day just passed (so I think I'm safe till next earning date) and I am greedy enough to want more profit from the
spreads before I close out. I consider this to be one of my most risky positions.
If the owner of the 80 calls wants to exercise early, I will be short 500 shares of
stock at 170 bucks each. That's 45K drain on my margin ((170 - 80)X500) ,
and my margin is not that big.
I will have 15 minutes the next day to exercise my 75 calls or a BIG DUMB Interactive Brokers computer will randomly demolish my account.
 
today's activity:

buys (no sells today): all buys are bull call debit spreads unless noted

5 CNX JAN09 65/70 @ 3.7
cost = 1850 + 7 commision
expected return 650
STOCK AT 93.96 (at time of buy)

5 SII OCT08 60/65 @ 4.0
COST = 2007
expected return 500
stock at 80.8

5 SWN JAN08 27.5/32.5 @ 3.95
cost = 1982
expected return 525
stock at 44.3

Not a great day for entries, but I have no strong feelings entries will get better on these stocks in the near future. I take what I can get sometimes, but I have sufficient reserves to take advantage if a good buying opportunity comes about.
 
I would think the main worry about early exercise is when the stock goes ex-dividend. Why not just do the same spread with puts if you don't want to worry about early exercise?
 
todays activity:

sold:
3 TDW JUL 40/45 @ 4.87
cost was 3.7 net profit (after commissions in & out) 342.6

5 X OCT 75/80 @ 4.74
cost was 3.7 net profit 506.00
I said I was worried about this position. Tickled to death to close this at 4.74.

8 EWZ SEPT 60/65 @ 4.8
cost was 3.9 net profit was 731.84 Another gift.

bought:
5 PBR JAN09 50/55 @ 3.8 +7comm
cost 1907 expected gross profit 600
stock at 67.25


positions (expected) to be exercised this weekend :

5 FWLT MAY 47.5/52.5
4 FWLT MAY 50/52.5
Note: this position entered on 2 dates - gross profit on all spreads is 485. No commissions on exercise.

4 NOV MAY 45/55
3 NOV MAY 50/55
Note: this position started as 7 nov may 50/55 @ 3.8 later bought 4 nov may 45/50 @ 3.6
total gross profit 1400. A rather wild ride that worked out OK.



comments:
You may notice that spreads rarely last till the expiration day. Things happen, both good and bad, to
justify or require early closure of positions. Mostly good, or I wouldn't be writting this.

Looking at some notes:
I had 48 May spreads on Jan 31, a higher number before that.
I had 36 May spreads on March 27
I had 18 May spreads on April 30
and I have 16 May spreads now that will be exercised this weekend, and that's an unusually high number.

As of April 30, my number of spreads were distributed in time as:
May 18
June 29
July 56
Aug 25
Sept 54
Oct 97
Nov 23
Dec 25
Jan 69
total number of spreads: 395

I'll do another summary next week. I'm traveling tonight and won't trade tomorrow, although I have a few GTC orders in place.


Reply to Art - my purely personal preference is debit spreads - I'm willing to deal with the occasional migrain from early exercise. This works for me and EVERYTIME I try bear spreads or credit spreads or other strategies, I seem to get bit. I don't claim to be a great options guru. Just an average guy trying to survive retirement with a fairly simple investment plan that seems to work.
 
Friday's activity:

sold: 7 FWLT AUG 40/45 @ 4.85 on a GTC order
cost was 3.8 gross profit = 735.00
stock price closed friday @ 79.6

Today's activity:

SOLD:

5 BTU SEP 35/40 @ 4.85
cost was 3.75 net profit = 536.00
stock at 78.9

3 DBA JUL 33/38 @ 2.75
cost was 3.9 NET LOSS = 344.40
This position never went the way I hoped so I decided to take a loss now rather than
speculate upon the future. Not everyone would agree with my decision, but I ask myself
would I want to buy this spread at 2.75 with 2 months remaining and stock at 36.10 and answer is NO!
It doesn't fit my investment strategy. DBA was supposed to be an ETF commodity play,
but it didn't work out as I hoped. I still have other DBA spreads to worry about, but they are a little deeper ITM.
 
Today's activity:

BUYS:

10 UNG JAN09 40/45
bought 6 spreads @ 3.4 +10.56 commission
bought 4 spreads @ 3.35 + 7.04 comm.
cost: (6 X 340 + 4 X 335 + 17.6) = 3397.60
stock @ 53.40 expected gross profit 1500.00 (44% yield)
comment: Hope this is deep enough, don't usually chase such a strong trend, but
DITM helps mitigate the risk. Sector still looks strong.
Would have prefered deeper ITM for less yield and less risk, but strikes not offered.

5 TRA DEC 25/30 @ 3.75 + 7 comm.
stock @ 41.92 expected gross profit = 625

5 AGU JAN09 60/65 @ 3.7 + 7 COMM.
stock @ 87.55 expected gross profit = 650

nice charts and P/E ratios on the above 2 stocks. Good depth, I think.


5 EWZ JAN09 75/80 @ 3.81 + 8.8 comm.
stock @ 98.57 expected gross profit = 595
replacing a position I just closed successfully

5 BTU JAN09 50/55 @ 3.85 + 7 comm.
stock @ 77.5 expected gross profit = 575
replacing a position I just closed successfully


5 CNX JAN09 65/70 @ 3.75 + 7 COMM
stock @ 97.7 expected gross profit = 625
added to position. Already had 5 spreads here. Sector play again.

8 CF NOV 85/90 @ 3.95 +11.2comm.
stock @ 135.5 expected gross profit = 840
Are you kidding me? P/E @ 16.3 33% DITM 26.6% profit in 6 months.
Strong trending up. Decently rated. Great sector.
Everything except perfect timing. Oh well...


No SELLS today.

My account hovering around 209K, a new high, last couple of days, but leveraged accounts like this fluctuate a lot and I would not be alarmed if the liquidation value went down to 185K temporarily.

*******************************
FROM MY POST 5/15:
As of April 30, my number of spreads were distributed in time as:
May 18
June 29
July 56
Aug 25
Sept 54
Oct 97
Nov 23
Dec 25
Jan 69
total number of spreads: 395
*************************

TODAYS spread distribution @closing:

June 14
July 13
Aug 18
Sept 37
Oct 117
Nov 32
Dec 49
Jan09 131 (I'm partial to Jan spreads to optionally delay taxes on gains till next year, market conditions permitting.)

total number of spreads: 411
 
Today's activity:

Buy: 5 X OCT 135/140 @ 3.9 + $7 comm.
stock at 184.7, expected gross profit = 550.
Not great timing since it dropped $7 a share later. But the spread price only dropped about 10 cents or so.

Screwed up yesterday buying too many spreads in one day. Should have limited my buys per day more. Over-trading, my weakness. Could have gotten better fills today, but that's hindsight, and I like the positions I got yesterday - just too many of them.



Following comments and observations directed to those 3 readers with less experience than me:

This is one of those days (oil hitting 133, gold at 930, DOW down 450 pts in 2 days) that I could look back on, several months from now, and think, "Wow, my account was at an all time high, why didn't I liquidate everything and just sit in cash and wait for a day like today when everything is cheap?" I've had that thought before. Like the time my account went from 165k to 135k, and the time it dropped from 193k to 164K. I still do not have a real good answer to that question, but I know i won't liquidate my account.

The bull market in commodities and energy can't last forever, but fear of the unknowable "when" shouldn't force us (conservatives?) out of the game. My entire portfolio is aboard this commodity boat, swept along by an increasingly faster current towards the inevitable cliff. So why am I happy? Because I have a bigger liferaft than most others on the boat, and I have an anchor.

There are many fine qualities inherent in the DITM bull spread. Not least is that the strategy can handle 15% market (sector) corrections pretty well. I also learned some lessons from those previous cliffs, and I hope I can avoid some of the mistakes I made before. We shall see. When markets get extended like this, volatility in general naturally goes up; and the opposit is also true, that as markets drop, volatility (risk) declines also.

So, think about this: my methodology advocates a constant controlled quantity of risk in an environment where risk fluctuates. Like driving a car at a constant speed - going up and down hills you must shift gears. That's sort of what happens with my trades. As volatility increases (in an extended market) I can get DEEPER ITM trades than I can get in a falling market, while aiming for the SAME 50% annual yield. The trade today in US Steel (X) illustrates that point. The trade can withstand a 24% [(184-140)/184] drop in X stock and be successful. Other times I tried to put on an X spread, I could only get 10 to 15% deep for the same yield. This characteristic tends to lessen the headpain of investing in this extended market. That does not mean that you can invest in extended markets with total abandon, but it means (in my opinion) that (all other fundamental factors being favorable) one can still participate in these markets with a degree of safety that is far superior to the risk/reward realities of the guys who are long the stocks, and the guys who hold mutual funds. This comment is as "technical" as I get.

The other side of the coin is the fact that these "corrections" can be so fast and hard (in leveraged accounts) that they leave you breathless, and you need guts, confidence in the fundamentals of your positions, and good judgement in risk management to withstand them.
These modest skills are acquired with experience, which is why we start small in any new strategy.

Final thought for the day: When these market corrections happen and you think it's buying frenzy time cause everything is so cheap - this is the time it's almost impossible to get the same depth ITM that would make you feel comfortable. And these new positions you just bought are more vulnerable than usual to losses if the "bottom" continues to drop. So there is never a time to abandon caution. Bummer. I said my plan was "simple", did not say "easy".
 
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