Like Those Stock Buys ? Use Options Instead!

I was called today be a buddy of mine who has a keen eye for stock plays, and is of a conservative bent. We both agree that this stock market is not yet ready to soar, although it has temporarily found a bottom. We both think it’s going to rally a bit on recent government interventions, only to falter a few weeks in as the dismal reality of job layoffs and debt problems really sink in. He thinks it’s going to go into a long, excruciating slow recovery that may stretch over years. I think it’s got another big sharp leg down of around 20% to 25%.

Either way, we both agree that big pharma has taken it on the chin in the last year, and is likely to do well in the eventual recovery. Meanwhile, many of these companies are paying dividends of around 4%. That beats the hell out of bonds while you patiently wait for a recovery.

One of the stocks he likes is LLY. I’m not a gung-ho about that particular stock, but that’s beside the point for this exercise.

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Eli Lilly weekly candles

What I want to demonstrate, is that a careful application of options will give you a far better risk reward relationship than a pure stock play.

Let’s say my friend was happy with the 2.3% return LLY pays around its current price of $139. He himself does not expect the stock to go down much more and he’s betting it will be higher in 2 to 3 years. For the purpose of this example, let’s say he buys 100 shares, for an outlay of $13,930, or a margin requirement of $3497. Here’s the graph of his risk reward profile.

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risk reward of long stock position

risk reward of long stock position

Now fast forward 9 months. Say he’s right and LLY is 10% higher. If he were to liquidate his positions, he’d have a gain of $1390, plus around $240 in dividends, for a total gain of $1630, or an annualized return of 15.61%. If you view it as a percentage of margin required, that’s even more, 62.20%.

Conversely, if he’s wrong and the stock moves down 10% (less likely, he thinks but definitely possible), he’s got a mark to market loss of $1390 less the dividends, so $1150 overall, or 11% annualized in a cash account, or 52.9% annualized based on required margin.

Compare that to a sophisticated calendar play shown below (consisting of selling a lopsisded butterfly expiring in October 2021, and buying a covering lopsided butterfly expiring in January 2022.

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As shown in the graph, although this only requires a $95 outlay, it still requires a margin balance of $4000, similar to the stock only play. In other words, the investor has to maintain at least $4000 in the account, and amount which will not increase over the life of the option trade.

Fast forward 9 months, when the inner options expire, and we would liquidate all positions. On a 10% increase in the stock price, and even using the less favorable assumption that volatility decreases, he would close the trade for a gain of $2000. That’s an annualized gains of 66.60% of margin, about 5% better than a stock only play.

Where the play really shines though, is if LLY slumps down. At any price, the maximum loss is only $108, or 0.36% annualized. Given the huge uncertainty in these markets, and the real potential of unanticipated medical or financial events sending markets careening lower, that limited downside risk will feel like manna from heaven.

If stocks move up 20% or down 20%, the option play advantage is even more crass. The only time the stock play is better, is if stocks rally strongly. At around 25%, the stock play starts being more attractive, and it becomes much more attractive starting at a 50% rally, as the option play loses a total of $1108 while the stock position has gained 50%.

But given this investors assumptions, of a stock that will trend higher but with great pains, and may even take a downturn, the option play shown here is clearly the more attractive position. Yes, it’s complex. If it were not complex, everyone would be doing it and guess what: it would not be as profitable, because the options prices would be different.

Remember, options trading is complicated. Be sure to read our disclaimer. Consult with a professional before attempting such a trade, or your portfolio will suffer.

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How To Play Uncertainty to Goose Your Wallet

As I write this, the corona virus has swept the entire planet, leaving death and economic destruction in its wake.

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corona crash

Think its all over? Well, your a lot braver than I am, and in a few weeks you’ll be a good bit poorer, I fear. I expect a 32% corrective bounce up, than another big leg down, leaving us with a total 50% correction. If you want to start bottom fishing then, you’ve got my blessing.

But there is one way to play this crisis. “Fortunes are made when blood is in the streets”, goes the saying. Well unfortunately, that’s the situation now, and I fear it will get much worse before it improves.

Check out the first graph. It shows you that today’s levels of uncertainty (red line VIX) spiked higher than at any time in the last 20 years, even more than in 2008 when the financial system was teetering. So it could well be that volatility, reflected in the VIX index, is close to its current peak.

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It’s pretty obvious that uncertainty will drop if the market recovers. That’s a no-brainer. But I don’t expect the market to stop dropping. In fact I expect another huge drop. I could short the market with options, which I’ve done and described previously, a trade which has rewarded us handsomely thus far.

But there’s a safer trade, one that makes money regardless of stocks going higher or much lower. A strange thing happens in market crashes: people get used to the pain. Each and every subsequent drop, while just as harmful to the economy and to investors’ portfolios, hurts subjectively just a little bit less, and shocks us less and less as investors.

That’s why you got the following behaviour in 2008:

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volatility drops as market continues to crash

Notice how volatility skyrocketed on the first big drop in SPY (S&P ETF)? Volatility rose 280% on a 23% drop in stocks. But what happened afterwards? Stocks continued there drop, losing another 7-10%. But instead of risking, volatility dropped by almost 100%!

If stocks had risen, volatility would have dropped even more! The lesson here, is if you can short volatility without betting the ranch, you’ve got a dream stock play. That’s just what we’ll do.

Our wager? That between now and January 2021, the stock market is likely to be much lower. (I actually expect the big drop by September-October, just in time to mess up the elections, but that not germane here.) But we’ll have gotten used to the dismal state of affairs, so volatilty will drop down to the 20’s or 20’s. And if things improve and God-willing we get a handle on this nasty disease, all the better. Volatility will drop even more.

I don’t expect it to reach the artificially low levels of 10 or 12 which we had previously, a gift from the free spending FED from its unlimited (imaginary ? ) reserves of money fresh off the printing press. My best guess is it will settle into the 30 to 40 range.

So I’ll use a calendar spread, selling UVXY (a volatility driven ETF) put options that expire in January of 2021, and buying covering puts that expire a few months later.

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UVXY bearish calendar

For this play to lose money, volatility must remain higher than 70, or drop lower than 10 by January of next year. I cannot imagine either scenario occurring in 10 months time. If they do occur, I lose the entire amount spent on the position. For 1 set of each calendar option, this is around $115. The reward is maximized if volatility ends at around 30 points, in which case the position can be closed at a profit of around $750. If it drops back down as low as $20, the gains are around $500, or 4 times what I’ve spent.

Remember, options trading can be risky. Be sure to consult our disclaimer page.

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The Corona Virus May Kill You or Make You Money

The world is being ravaged by the corona virus. As I write this it has spread to 56 countries in two months, sickening more than 90,000 people and causing over 3000 deaths. Though as many people die from influenza, corona has been demonstrated to have about 1000 times the infectiousness. It has already humbled China’s economy, forcing 10% of humanity into a quarantine.

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Scientists are racing to find a vaccine, but possible vaccines are about 1 year away. Currently, only a handful of treatments show any sign of allowing doctors to treat the severe pneumonia that results from the disease, though nothing it for sure yet.

The leading candidate for an effective treatment (not a vaccine) is Remdesivir, a product under development by Gilead Sciences. I don’t know if Remdesivir will perform well, but early indications are that it will. I prefer to buy the rumor. If I wait for proof, from a stock perspective it will be too late.

Readers may want to refer to the following article (and the comments) on Seeking Alpha for the background on the drug. Gilead: Remdesivir’s Potential Most Dependent On COVID-19 Spread I’m focusing here on a bullish play, betting that the stock will rise sharply over the next weeks and months.

I have developed a speculative play using what I call a “lopsided butterfly” option play. This is like a traditionial butterfly, but I stack it in favor of the direction I expect the stock to move. This allows me to benefit from the passage of time, disregard volatility calculations – as it is neutral to volatility fluctuations (always a tricky area with options), and requires little margin.

If properly executed the following option has a defined risk for around $57 per position. If I’m correct in my fibonacci/elliot wave calculations and time projections, the stock should reach $82 by the end of this week or the middle of next week. This option expires worthless if the stock does not move by the 13 th of March. Watch out! That’s a Friday for those among you who are superstitious…

So if I’m correct, I could make between $300 and $450. If I’m wrong, I lose $57. I like those odds.

If you believe the mathematical probability statistics (the yellow lines) I’ve got only about a 10% chance of ending up in the money,and making a profit. Obviously, those are poor odds, if they were correct. But those lines and prices represent GILD’s price movements in the past. They know nothing of the unique situation that has evolved since the corona outbreak. I’ve learned to trust my technical calculations more than the options’ software. I think I have better than even chances of being right. Time will tell.

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Bullish short term option play on GILD

As always, please read our disclaimer. Options trading is very risky if performed by the inexpert. Consult with a professional before investing, or you could lose everything.

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Hedging Your Portfolio Against A Big Market Meltdown

Markets are just recovering from the biggest 1 week drop in market history, as the corona virus sends economies and markets reeling.

Here’s what my technical analysis of the SPY (S&P 500 proxy) reveals.

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Given that opinion, here’s one way you could create a very effective downside hedge to protect other positions you might have that have presumably already lost a lost of value (12-20 percent) off of their peaks, but which you are unwilling to sell at this time.

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Please note. This should only be done if you have experience trading options. You should only place trades like these after consulting with an experienced financial advisor. Please read our disclaimer. Investing in options is very tricky and can lead to loss of your entire portfolio if improperly performed.


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TJX – 28 August

As anticipated, TJX has moved to first level. Now further move up looks likely. We are adjusting
our position to be more bullish over next three weeks. The anticipated upside is around $1800.
So far with these trades we have gained $143 to date.

Status before adjustment:


Status after adjustment:

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TJX moved up according to our expectations.
We now expect a continue move up over the next week, so we will play to upside. We bought back our 67.50 short puts and sold short 70.00 puts, collecting $76 in premium. Do not consider this positive cash flow a gain! Our gain loss so far reflects a $34 loss, the difference in the transaction costs of our $67.50 put.

Our new risk profile looks like this:


We now have positive theta (0.74), positive delta (14.24) and positive vega (6.88). This benefits from the passage of time and a rise in the stock price, but will suffer a bit if volatility decreases a lot. We don’t expect much of a drop in volatility, so this is acceptable.

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TJX Industries (TJX)

On August 15th, TJX companies announced slightly disappointing earnings, with earnings growth under 2% and sales growth of 6% projected for the next year. However, management announced slightly better prospects, as same day sales growth turned around and its full year outlook improved. The stock moved up a few points in heavy trading.

Here’s my technical read:


Today, on August 16th, volatility has already plunged, and is unlikely to fall much lower. Looking at the monthly and daily technical charts above, I foresee a temporary rise to between $75 and $77 over the next 2 weeks, then a move lower down to around $62 within 6 months.

My bet will be to the downside, despite the management prognosis. I don’t think the fundamentals are strong enough to reflect an already high p/e ratio and I expect technicals to overcome fundamentals. However, I will scale into the trade as I expect a temporary rise.

Ultimately I want to end up with a “married call” , namely shorting the shares and buying a deep in the money call as my insurance policy. If I were to do that immediately, it would provide me a credit of $6127. My call option is in the money by $8.28, so my time cost is only $1.43. My maximum loss in this scenario is $143.

If I am right, and the price moves down to $62, say by December, I’ll only be making around $240 or about 1/2 more than what I could lose. However there’s a possibility the price will move all the way down to $50, and this position would be worth about $1100 if that happened.

In and of itself, I usually like to target trades with a better than 1:3 risk reward ratio, which this one does not feature unless we have a large move downwards, which I do not expect either. However ,over the course of the next few weeks I will execute a series of trades around this “base” scenario that hopefully will bring my “risk” portion of the portfolio down to nothing, “bulletproofing” the trade.


One of these I’ll take right now. Since I first expect a short quick move up, I’m going to sell volatility and time short. Usually volatility remains low and sometimes drifts a bit lower after an earnings report’s initial volatility plunge. I’m going to collect about $1.13 cents per share by selling a short term $70 put, and collecting $113 right away.


I am now making money to a price rise all the way to $82.50, and will make money if the price drops moderately to the $70/$69 range at which time the sold call would get exercised. If that happened I would make about $100.

Of course, options trades always have their trade-offs. If the price moves down fast and quickly below the level of the $70 put, this setup does open me up to a bigger loss (around $750). But that is unlikely, and besides it has a simple solution. If the put is exercised and you are no long short the shares, short the shares again or sell your long call, whichever is more profitable. If it is not exercised, take steps to extract yourself from this position with minimum cost, probably by buying back the put with a loss of $30-#50.

Chances are, we won’t have this concern, but if it does, I need to be aware. I will set up an alert if the price drops to $70.

If the stock moves in the $70-$75 range over the next month, which I expect, I will reap that $113 premium,
lowering my overall risk to $30 maximum loss, while keeping my downside gains potential.

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This is a position origally entered into as a calendar spread after earnings


As you can see, I expected to make money anywhere between 37.50 and 47.50, with a 95% statistical probability of being the price range.

Unfortunately, volatility dropped far beyong what I expected, diminishing the values of my still active long calls and puts. Rather than close them at a small loss, I decided to adjust the trade, giving it a bullish bias.
The $37 profit I already booked is reflected in this graph by modifying the cost basis of the 45 calls we sold.

Here was my prognosis for the stock


So in my adjustment, I kept the long puts for safety until I saw a breakout or volume confirming my upside bias.I converted the long call into a ratio spread, buying 1x 18sep 43 call selling 2x my position of 45 calls, and buying 1x of SEP 45 calls. This is long delta, benefitting from a price rise, and will only slightly lose from the passage of time and expected decrease in volatility.

My maintenance margin, per position is zero dollars, requiring no extra outlay, and my maximum loss per position is $38. At the price I reasonable expect the stock to reach by the expiry of the near term options, I stand to make about $100/position. This is a risk reward of about 1:3.


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Summer Doldrums 2015

The last few weeks have seen the market give back all of its gains for 2015, causing a number of our clients to ask if this was “the big one”. My belief in short, is no, but I do expect a “normal” correction after 6 years of a steadily rising bull market.

The fundamental reasons are numerous:

  • China’s growth is lagging seriously, down from levels in the mid teens to levels of around 7%
  • China’s recent devalution is likely to set off a beggar-thy-neighbor currency war among raw-materials exporters in the emerging world, to the detriment of all.
  • 6 years of slow, painful recovery have still not brought US employment levels back to pre-recession levels, and the average middle class consumer is still “tapped out”.
  • Corporate profits among US companies are starting to decline. Most corporations prefer to invest cash in share buybacks and mergers and acquisitions, instead of investments in capital and technology. This is a sure sign of a lack of confidence in the robustness of consumer spending.
  • The glut of oil in the world has sent oil prices down 50%. While good for consumers, it has provoked a serious macro-economic and geopolitical re-shuffling of the deck, increasing market uncertainty.
  • The FED is considering raising interest rates to dampen hidden inflation, and this is scaring both bond and stock markets. Will they end up raising rates? The majority of economists think yes, but for me, the verdict is still out. I believe we will see a further dramatic decline in oil prices, which will lessen the risks of inflation.

So there are numerous real world reasons for this stock market to correct down.

But let’s also look at technical factors. Stocks do move on fundamental intrinsic values in the long run, but they move on mass psychology in the short term. This mass psychology tends to move in wave patterns that correspond eerily closely to the mathematics developed by 12th century mathematician Leonardo Bonacci, known more commonly as Fibonacci numbers.

So back in August I was expecting the SPY to peak at 197.08. The actual peak was 4 points higher at 201.90, or off by 2 percent. From there, a retracement of 23.6% occurs over 90 percent of the time, and a retracement of at least 38.2% occurs around 80% of the time. Stocks can drop lower than that but those are the most common levels.

Take a look at the following 2 graphs, one showing a monthly view (each candle represents one month), the other a weekly view, for more detail.

spy technical prognosis
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This graph shows that I’ve been expecting a correction for almost a year now, and in fact the peak on SPY extended 10% more than I expected. Now, however, I believe the bullish three year upwave is finally ending.

spy technical prognosis
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Elliot wave technicians will tell you that after the 5th Elliot wave pattern peaks, in this case at $217.92 , it is common to see a downward retracement in a zigzag formation (ABC pattern) that retraces down 61.8%. This would take us all the way down to a level of around $120.

That dramatic drop is certainly possible, but I do not believe it is likely to happen. Note how our price and RSI slopes only diverge on the short term but on the longer term (30 period) RSI chart they are both sloping upwards, in a pattern of bullish convergence. This leads me to conclude that the market will find ultimate support at $185 level. That would only be a retracement of about 18% off of the highs, which is very rare in Elliot wave patterns. Elliot wave theory would ascribe a minimum drop of 23.6% or around $175.

As we get closer to those levels, we will need to take a look at volume and rsi measurements, and make a new determination. And of course technical waves just measure probabilities, not certainties. But when bother the fundamentals and the technicals point down, the wise investor will take defensive measures.

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Power Up Your Portfolio with A Quick QQQ Scalp

At market close the POWERSHARES ETF (QQQ) was trending in a narrow range, having found support and bounced off the 99.68 level. My prognosis is that we will see QQQ bounce up to test the resistance at $103, then from there a move down over the next week to prices below $99.

qqq status
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Here’s a wonderful way to play that, using the banker’s money to finance a credit spread. If it never happens, and the stock stays stagnant, there is only a miniscule loss of about $5, and at bigger drops there is even a small maximum gain of $40. For every position you commit to this trade, you must have $2000 in margin. You have about a 1% chance of losing $5 and and 95% chance of making between $1 and $500. Those are odds anyone would like.

The Opportunity

  • Probability of success : greater than 95%
  • Risk : Reward : around 1 to 50
  • Duration: 2 day trade
  • Minimum Investment: -$40 (credit)
  • Maximum Investment: none
  • Margin Requirement: $2k per contract
  • Maximum Probable Loss : $5
  • Maximum Probable Gain : $250
  • Maximum Possible Loss : $5

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Disclosure: Options investing is inherently risky. This is not a solicitation to buy or sell. Please read our full disclosure on this site.

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Disclosure:This web site discusses exchange-traded options issued by The Options Clearing Corporation. Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options. Copies of this document may be obtained from your broker, from any exchange on which options are traded or by contacting The Options Clearing Corporation, One North Wacker Dr., Suite 500 Chicago, IL 60606 is not a registered investment advisor or broker-dealer. We do not make recommendations as to particular securities or derivative instruments, and do not advocate the purchase or sale of any security or investment by you or any other individual. By continuing to use this site, you agree to read and abide by the full disclaimer.