Low Risk, 77% Annualized Return?

[MJ DeMarco]

Is it possible in this market?

I think it is ...

In the current market we have:

High volatility (this means ... options are loaded with premium which favors sellers of options.)

Here are some short-term investment plays I've been uncovering ...


1) Buy high dividend yielding stocks
2) Sell short term, covered calls on the position.

Here is an example based on current prices (Oct 23rd)

Penn West Energy (PWE)

Price: $16
Dividend Yield: 26%
Nov 17.5 Call Option .75

Here are the numbers:

Buy 2,000 shares of PWE at $16 .... $32,000 total investment.

Dividend (pays monthly) ... $290.00 per 1000 shares

Dividend: $580.00
Sell 20 contracts @ 75 apiece: $1,500

Total income for your $32,000 investment: $2,080

ROI Analysis based on stock price:

PWE Price || ROI || ROI Annualized

• 16.00 - 6.5% -- 77%
• 17.00 - 12.75% -- 153%
• 17.50 - 15.9% -- 190% (Call is exercised)
• 19.00 - 15.9% -- 190% (Call is exercised)

Stock Decline:

• 15.50 - 3.3% -- 40% Gain
• 15.00 - 1/2% - 6% Gain
• 14.50 - (3.1%) - (12%) Loss Annualized
• 14.00 - (6.2%) - (72%) Loss Annualized

The break even on the investment occurs when there is a 6.5% loss in the stock value.

If the stock stays at the same price, you earn 6.5% on your money in 1 month or 77% annualized.

There are deals like this out there ... I'm not saying PWE is the best to do it with, but there are short term opportunities like this that I'd consider low risk. Many of these stocks are so beaten down they can't get lower. Just be careful and consider the ability to pay the dividend for the company bought ... if a dividend is cut on the stock you buy, the stock price will plummet making this analysis all but moot.

 

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[fanocks2003]

Wanna make a sound for currency OTC options. There you have a great return possibilities. Saxobank have a good software for it too. Simple to use.

 

[BryanC]

This is great strategy to play a public market. I would also do it similarly if I had a bigger capital reserve. The DIVI gives you a good cushion against market fluctuation and the ability to sell calls adds even more cashflow.

 

[fanocks2003]

This is great strategy to play a public market. I would also do it similarly if I had a bigger capital reserve. The DIVI gives you a good cushion against market fluctuation and the ability to sell calls adds even more cashflow.

$10,000 and you have a currency OTC option account at Saxobank.

 

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[MJ DeMarco]

The strategy comes with the same caveat as any stock pick ... you have to buy the right stock. If you are buying stock because of the dividend, or solely to sell calls, you increase risk. I wouldn't do this on any stock that I wouldn't want to hold normally as an investment. So what I'm saying is this: Like the stock - not the dividend or call premiums.

 

[BryanC]

Oh yes, I totally agree with you. You should definitely do your due diligence before setting up such a system. I would go based on the Fundamentals, Annual Reports, and SEC filings. Before doing just a rough overview and buying impulsively to sell calls and collect a divi check... However, those same fundamentals do seem to be obsolete at times with the forces of the public market. Really, what I am concerned with right now is preservation of principal. I realize that we are forced to put our currency at the risk of loss to keep up with inflation in our monetary system, but I still need to keep what I got and keep it growing. Once I put a good business system in place, have a few pieces of RE cash flowing, I'll begin taking more risks with my cash. Need more experience and clarity before I jump into the public markets...

 

[BryanC]

$10,000 and you have a currency OTC option account at Saxobank.

While that is a good idea, I still feel I need more experiencing in public market trading.

I learned my lesson with a huge loss on speculating on the USD/EUR... and then I got p*ssed when I lost money speculating and put some money in an FXCM managed account. Those funds dipped on me super bad. I lost a lot of money in currencies and managed accounts.

Haven't been back in since. I will probably get back into it eventually as I learn more.

I am definitely interested in doing something like what MJ has setup here with the interbank rate and currency options. Time will tell.

 

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[DevX]

This strategy based on the VIX is excellent and will likely make a few people (hopefully a few astute readers here) a lot of money in a short time.

Here's a look at the VIX over the past 20 years or so. Market volatility has never even come close to where it is now, which means as PHXMJ pointed out that option sellers are collecting a very large premium on their contracts.

(I CAN'T POST IMAGES YET! See: chart.finance.yahoo.com/c/my/_/_vix





Another strategy would be to sell put options on QUALITY companies that have been beaten up in the market. Companies that you would love to own for the long term.

Let's take a solid company like Exxon Mobil.

If I were to SELL a put option. I would receive money in my hand today from someone else who thought Exxon Mobil were going to head lower. If Exxon Mobil were to go up in price over the period of the contract, the other guy lost the bet, and I would keep the money he gave me today. THIS IS YOUR IDEAL SITUATION!

If however, the stock were to go down, I'd be forced to buy Exxon Mobil stock at a higher than market price. And yes, you would lose money in this situation. BUT, remember you decided to open up a contract on a stock you'd LOVE to own long term.

Exxon Mobil isn't going anywhere and even with a few % point fluctuation in its stock over the next few weeks, its STILL A CHEAP STOCK HISTORICALLY. So you still preserve the upside run that you expect it to have over the next few months or years.

I think the market today can be a BIG WIN for those who turn off CNBC, don't get caught up in the "sky is falling mentality" and make some astute plays.

 

[BryanC]

This strategy based on the VIX is excellent and will likely make a few people (hopefully a few astute readers here) a lot of money in a short time.

Here's a look at the VIX over the past 20 years or so. Market volatility has never even come close to where it is now, which means as PHXMJ pointed out that option sellers are collecting a very large premium on their contracts.

(I CAN'T POST IMAGES YET! See: chart.finance.yahoo.com/c/my/_/_vix





Another strategy would be to sell put options on QUALITY companies that have been beaten up in the market. Companies that you would love to own for the long term.

Let's take a solid company like Exxon Mobil.

If I were to SELL a put option. I would receive money in my hand today from someone else who thought Exxon Mobil were going to head lower. If Exxon Mobil were to go up in price over the period of the contract, the other guy lost the bet, and I would keep the money he gave me today. THIS IS YOUR IDEAL SITUATION!

If however, the stock were to go down, I'd be forced to buy Exxon Mobil stock at a higher than market price. And yes, you would lose money in this situation. BUT, remember you decided to open up a contract on a stock you'd LOVE to own long term.

Exxon Mobil isn't going anywhere and even with a few % point fluctuation in its stock over the next few weeks, its STILL A CHEAP STOCK HISTORICALLY. So you still preserve the upside run that you expect it to have over the next few months or years.

I think the market today can be a BIG WIN for those who turn off CNBC, don't get caught up in the "sky is falling mentality" and make some astute plays.

Great points. As far as the sky is falling... I believe it is those who do not understand the markets at all but are forced to invest in them as a vehicle for retirement.

 

[fanocks2003]

While that is a good idea, I still feel I need more experiencing in public market trading.

I learned my lesson with a huge loss on speculating on the USD/EUR... and then I got p*ssed when I lost money speculating and put some money in an FXCM managed account. Those funds dipped on me super bad. I lost a lot of money in currencies and managed accounts.

Haven't been back in since. I will probably get back into it eventually as I learn more.

I am definitely interested in doing something like what MJ has setup here with the interbank rate and currency options. Time will tell.

Nah, Saxobank offers you a professional advisor. Comes with the package if you ask for it. No one is an island and shouldn't be. And "later" will never be for most people.

 

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[Edge]

If however, the stock were to go down, I'd be forced to buy Exxon Mobil stock at a higher than market price. And yes, you would lose money in this situation. BUT, remember you decided to open up a contract on a stock you'd LOVE to own long term.

Hey DevX - There is a step 2 that could keep you from losing money even in this scenario. If you get assigned the stock you could immediately sell a call, lowering your cost basis even more and possibly keeping you in the green. You would recieve a very juicy premium for this call, think about it, the VIX would be even higher when you sell your call if the market has just sold all the way down to your naked put.

I know MJs example was a covered call, but there is something you need to keep in mind if you go uncovered (naked) calls when dealing with dividend paying stocks. If you are naked a call and you get assigned before the dividend, this leaves you short the stock at the time of dividend payment. This means the dividend comes out of your account. I'm not saying don't sell naked calls against dividend paying stocks, just keep the dividend date in your mind and watch it if it becomes in the money.

Back to MJ's origional question, "is it possible"? Hell yeah it's possible, I made 23% on a trade this morning on some RUT puts. Was it low risk? That's up for debate, but I do think that when you have your risk identified and a plan for exit, you have risk under control.

How do you annualize pulling in 23% in a little under 4 hours?

 

[fanocks2003]

Hey DevX - There is a step 2 that could keep you from losing money even in this scenario. If you get assigned the stock you could immediately sell a call, lowering your cost basis even more and possibly keeping you in the green. You would recieve a very juicy premium for this call, think about it, the VIX would be even higher when you sell your call if the market has just sold all the way down to your naked put.

I know MJs example was a covered call, but there is something you need to keep in mind if you go uncovered (naked) calls when dealing with dividend paying stocks. If you are naked a call and you get assigned before the dividend, this leaves you short the stock at the time of dividend payment. This means the dividend comes out of your account. I'm not saying don't sell naked calls against dividend paying stocks, just keep the dividend date in your mind and watch it if it becomes in the money.

Back to MJ's origional question, "is it possible"? Hell yeah it's possible, I made 23% on a trade this morning on some RUT puts. Was it low risk? That's up for debate, but I do think that when you have your risk identified and a plan for exit, you have risk under control.

How do you annualize pulling in 23% in a little under 4 hours?

Risk is always subjective.

 

[kidgas]

ROI Analysis based on stock price:

PWE Price || ROI || ROI Annualized

16.00 - 6.5% -- 77%
17.00 - 12.75% -- 153%
17.50 - 15.9% -- 190% (Call is exercised)
19.00 - 15.9% -- 190% (Call is exercised)
Stock Decline:

15.50 - 3.3% -- 40% Gain
15.00 - 1/2% - 6% Gain
14.50 - (3.1%) - (12%) Loss Annualized
14.00 - (6.2%) - (72%) Loss Annualized
The break even on the investment occurs when there is a 6.5% loss in the stock value.

What if you bought the Nov 15 put for $1? What would that do to your risk:reward profile? Just wondering.....

 

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[randallg99]

reference to PWE-

1. there will be some more volatility in the case of a strengthening us$ which will affect the underlying pricing. It was a no-brainer to invest in canadian stocks while US$ was declining but now the tables have reversed
2. this is a trust and the payouts are not dividends but are treated as "distributions" which have different income tax consequences which can alter the rate of return on investment
3. the payouts are subjected to foreign taxes that have caps for foreign tax credits
4. if oil stays sub $70, you can expect distribution cuts from the canroys.
5. check PWE's hedges (i don't know what they are, I haven't invested in them for quite some time)
6. possibility of being called out is very real and so is the fact that oil will bounce back. if so, then the strategy of "rinse & repeat" will probably work effectively

I have to agree (as I mentioned in another thread that divvy paying companies are really the way to go) that the right additions to the portfolio today will be handsomely rewarded and utilizing dividend/distribution paying companies in conjunction with options will maximize returns

 

[fanocks2003]

Actually, by the true definition, risk is *never* subjective...only the potential impact of the risk is subjective...

For each day that goes by I become more and more assured that subjectivity rules the world. What I say, per example, is based on my experience and how I experience things, the same goes for everyone else. If I lose 20% of my money, is that a risk for me? Maybe, maybe not. For others? Maybe, maybe not. But I am sure we do not all agree on one answer in the end. Objectivity would have all of us agree that one answer is right, which rarely is the case.

Yes, many of us would give up our own standpoint just the be friends (or because we are afraid of getting punched in the face), but deep inside our own subjective answer are different for sure.

One way of proving it: Why do people eat chocolate when they know that chocolate makes them fat? Why do people not excercise even though it is said to reduce weight and better their health? If we where objective, we would all be excercising, we would all stop working for money and even stop eating fattening chocolate, but we do this all day long. Objective people do not do that. Hence, we are subjective beings and objectivity is an illusion that is fun to play with.

Logical conclusion.

 

[Edge]

Is it possible in this market?


Buy 2,000 shares of PWE at $16 .... $32,000 total investment.

Here's a way to have even more fun by getting the same exposure of 2,000 shares for only 11,800 instead of $32,000.

Instead of buying the underlying to write calls against, you buy the equivalent of +2000 deltas of the underlying by purchasing 40 contracts of the JUN09 15 strike call. Now you write near month calls against that position.

The NOV 08 15 strike is currently trading for 1.75, so you immediately knock $7000 off of that 11,800. Your basis cost is now only $4,800 and you can write calls for another 7 months!

 

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[fanocks2003]

If you lost 20% of your money, then yes, apparently it was a risk prior to you losing it. The is nothing subjective about it.

Whether that 20% loss hurts you is subjective, but whether it was a risk or not is absolutely quantifiable and non-subjective.



Ask a first grader what 2+2 equals, and he might tell you that it equals 5. Does that mean that the question I asked what subjective? Or perhaps does that mean that the question was perfectly quantifiable and knowable (objective), but the perhaps I asked wasn't well-enough informed to know or espouse the right answer.

There's a difference between a question being subjective, and a person knowing (or doing) the correct response.

I won't claim logical conclusion from that argument, but hopefully my point was made...

Hehe...I win the war you win the battle (In my mind of course, because I am subjective). My view is still the same though (subjectively mine).

And 2+2 could very well equal a million if you divide it in many tiny parts..hehe. You see everything is subjective and we only create this illusion of us being in alignment on stuff just to avoid ripping each others head off (subjectively a good thing for all of us. It serves our basic survival instincts). That is what peace is all about, avoiding being different on issues (due to it leading to war and massacres). We agree to one thing even though we know subjectively that it is pure BS in the first place.

 

[randallg99]

Here's a way to have even more fun by getting the same exposure of 2,000 shares for only 11,800 instead of $32,000.

Instead of buying the underlying to write calls against, you buy the equivalent of +2000 deltas of the underlying by purchasing 40 contracts of the JUN09 15 strike call. Now you write near month calls against that position.

The NOV 08 15 strike is currently trading for 1.75, so you immediately knock $7000 off of that 11,800. Your basis cost is now only $4,800 and you can write calls for another 7 months!

it traded as low as 14.35. opened 14.48.... how does the strategy change? rebuy the call at lower premiums and then resell next month out on future strength?

currently trading at 15.40 ...looking very tempting but everything is getting thrown out despite fundamentals....

 

[Edge]

it traded as low as 14.35. opened 14.48.... how does the strategy change? rebuy the call at lower premiums and then resell next month out on future strength?

currently trading at 15.40 ...looking very tempting but everything is getting thrown out despite fundamentals....

Are you asking me how the strategy would change if I put on that trade this morning and I wanted to adjust? I personally wouldn't adjust anything if I put it on at the prices quoted above. I'd let the position mature and time do its thing. You've got 7 months of call writing to make a mint on this one.

Once the Nov contract expires, if it is out of the money, let it expire worthless and sell a Dec call to knock down your deltas and bring in a little more theta. I wouldn't adjust a thing based on one days action.

 

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[randallg99]

http://online.wsj.com/article/SB122525416172779449.html?mod=todays_us_marketplace

this article confirmed my concern that we are in a rapidly depleting yield enviornment .... in times of deflationary fears, apparently debt will be paid off before dividend income will be passed on to the shareholders.

in linked article a large company stated that they cut their divvy to attract more buyers (oh, the irony!) but if one were to rip apart their balance sheet and interview their lenders, we would probably find other reasons.

I read (and posted) in other threads/posts about some dividends being at much higher yields now as a result of some stocks being battered but now reality is setting in and dividends are being cut ferociously across the board to adjust to the declining cash flow and profits.

selling calls on holdings is a preferred method of mine.... selling insurance is a money maker, but the big variable in this market is how well the dividends will hold up. A couple of my stocks I have my eyes have already chopped divvies or are in position to do so.

R

 

[Edge]

Here's a way to have even more fun by getting the same exposure of 2,000 shares for only 11,800 instead of $32,000.

Instead of buying the underlying to write calls against, you buy the equivalent of +2000 deltas of the underlying by purchasing 40 contracts of the JUN09 15 strike call. Now you write near month calls against that position.

The NOV 08 15 strike is currently trading for 1.75, so you immediately knock $7000 off of that 11,800. Your basis cost is now only $4,800 and you can write calls for another 7 months!

It's not a dividend paying stock, but this is exactly the type of position I just opened on SLW. I am looking for returns consistent with the title of this thread.

More specifically, I bought some March09/Nov08 call calendar spreads for the $5 strike. I paid $0.68/spread.

I've got 4 opportunities to roll this this position or close early. If there is interest in following along, i'll update as I make adjustments.

 

[Jill]

...If there is interest in following along, i'll update as I make adjustments.

YES! I'm not sure I'll understand (I only have a degree in Finance and 3 securities licenses!! Embarrassing!) But I'd love to at least TRY.

 

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[NerdSmasher]

Yes, Edge, it would be wonderful if you would allow us to follow along as you play this - and perhaps even give us an idea of what you plan to do with it as time progresses, whether it goes up or down.

I know how calendar spreads work technically, but I've never done one - and of course there are always a few little differences with the actual practice of anything... things that I would like to avoid, if I do decide to attempt them sometime.

Thanks!

 

[randallg99]

a lot of are companies suspending or decreasing dividends right now and there doesn't seem to be any one single sector right now that's immune to with the only exception being MBS Reits.

 

[zaiteku]

Hi Edge,

could you go into a little more detail into one aspect of the Calendar Spread? Im wondering how you manage risk using Gamma? Do you have a Gamma number that represents too much risk for you? How do you use Gamma in evaluating calendars?

Any info would be great! thanks!

 

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[Edge]

Hi Edge,

could you go into a little more detail into one aspect of the Calendar Spread? Im wondering how you manage risk using Gamma? Do you have a Gamma number that represents too much risk for you? How do you use Gamma in evaluating calendars?

Any info would be great! thanks!

You talk about Gamma like it is a bad thing. LOL.

No, I don't have a hard Gamma number that I use, I use more of a "gamma comfortable" number, and that range is dependent on Theta. Remember, Gamma has an inverse relationship to Theta, so this is really a matter of trade off. When I do these multi-month calendars in a high vol environment, these are primarily vol skew (Vega) trades for me and Gamma is a secondary concern.

Here’s my rule of thumb with managing Gamma:

1) If I have a strong directional bias towards my short strike, I’ll assume the Gamma risk and keep my short strike in the near month. You have a directional bias and you have turned this into a directional (Delta) play by assuming the Gamma risk.

2) If I don’t have a strong directional bias and my negative Gamma gets out of my comfort range, I take a look at the overall position and…

--2a) if the credit for rolling is greater than my monthly cost of owning the spread, I’ll roll the short strike to the next month. This will bring Gamma back in your comfort range, but the cost is reflected in the lower Theta. For example, the trade above cost me a debit of $0.68/spread. It is a Nov/March calendar, so I have 4 rolling opportunities, that makes my cost/month $0.17/spread ($0.68/4).

--2b) if the credit for rolling isn’t greater than the monthly cost of owning the spread, it’s time to think about closing the spread out for a loss. You don’t have a strong directional bias and the reason you got in the trade (vol skew) probably doesn’t make sense anymore, so it’s time to cut it and move on.

I'm reallly liking these calendar spreads right now. When I get the time, i'll start another thread on calendar spreads and stop cluttering up MJs dividend thread.

 

[zaiteku]

that was a great explanation thanks! Sorry, I dont think Gamma is a bad thing! :smxB: I was just trying to figure out how to explain what I was thinking, and that was the closest I got!:smx4:

 

[Edge]

It's not a dividend paying stock, but this is exactly the type of position I just opened on SLW. I am looking for returns consistent with the title of this thread.

More specifically, I bought some March09/Nov08 call calendar spreads for the $5 strike. I paid $0.68/spread.

I've got 4 opportunities to roll this this position or close early. If there is interest in following along, i'll update as I make adjustments.

We've gone from Nov08 option expiry to Dec08 option expiry so it's probably time for an update.

First of all, I broke one of my rules getting into this position, and felt some pain becuase of it. I like to trade options on issues where the underlying is priced above $40/share and very liquid (meaning lots of volume in the underlying and option contracts). I felt some pain becuause there were times where I wanted to roll my short strike for between $0.30 and $0.40, but because of lack of volume I couldn't get filled. So there is a real example of why you hear me talking about trading liquid products.

What I ended up doing is rolling half of my position on 11/13 for $0.20, and I let the other half expire worthless and sold the Dec08 for $0.20. So the net of that is I rolled my Nov08 to Dec08 for $0.20.

My net risk in the position has decreased from $0.68/share to $0.48/share and I still have 3 more rolling opportunities. I still think this position has the potential to be a big winner (consistent with the title of this thread) and plan on riding it out through March. However, if SLW trades below the recent lows of $2.50/share, i'll take another hard look at this position and consider closing it out.

 

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[AroundTheWorld]

Here's a way to have even more fun by getting the same exposure of 2,000 shares for only 11,800 instead of $32,000.

Instead of buying the underlying to write calls against, you buy the equivalent of +2000 deltas of the underlying by purchasing 40 contracts of the JUN09 15 strike call. Now you write near month calls against that position.

The NOV 08 15 strike is currently trading for 1.75, so you immediately knock $7000 off of that 11,800. Your basis cost is now only $4,800 and you can write calls for another 7 months!

Can you say this again.... but speak slowly for the... uhhh... slow people?

I'm having fun learning about options - totally new area for me - - - but I'm at a loss on calendar spreads.

 

[Edge]

Can you say this again.... but speak slowly for the... uhhh... slow people?

I'm having fun learning about options - totally new area for me - - - but I'm at a loss on calendar spreads.

Keep in mind that this is in reference to MJs PWE example, and the price quotes were from that day.

Delta is an indicator that tells you how much your option position gains if the value of the underlying goes up by $1. So, by definition, it can also be looked at as the number of shares your option position simulates. If you have an option position in PWE that has a delta of +2000, your position is synthetically equivalent to owning 2000 shares of PWE at that point in time. For each $1 that PWE goes up in price, your position goes up $2000.

So, instead of buying 2,000 shares which would cost $32,000, I’m attempting to show you could get the synthetic equivalent for much less. You could have the exposure of 2,000 shares by buying 40 call contracts of the PWE JUN09 15 strike. Those contracts would only cost you $11,800. You get the exposure of 2,000 shares, for about 1/3 the cost.

Next, you could’ve turned this into a calendar spread by selling 40 contracts of the NOV08 15 strike call. At the time, the credit for selling 40 of those calls was $7,000.

Now your net cost is $11,800 – $7,000 = $4,800.

After NOV options expire, you could sell DEC calls for another credit, this is called rolling. You have 7 opportunities (Dec08, Jan09, Feb09, Mar09, Apr09, May09, & June09) to roll this position. Ideally, each time you roll, you get back another portion of the initial cost of the position.

Now that a month has gone by, and Nov expiration is over, let’s see where we’d be. Nov options expired on 11/21, so on 11/24 you could’ve (rolled) sold 40 Dec contracts. On 11/24, that contract was trading for $0.55, so you could’ve collected $2,200 for that roll. ($0.55/share * 100 shares/contract * 40 contracts = $2,200.)

Now your net cost would be $4,800 - $2,200 = $2,600.

If at the end of Dec08 expiration, you have an opportunity to roll for another $2,200, you pretty much guaranteed yourself a profit and you still have 6 more rolling opportunities.

Not sure if this is getting to your question or not. You’ve seen first hand that i’m not a real good teacher. If you can point out where I’m rambling, I’ll narrow down and give the explanation another shot.