LEAPS PP

[Storm]

At the risk of sound paternalistic, keep in mind that options trading is hard.  You don't just have to be right about direction.  You have to be right about direction and timing. 

In the end, I have a feeling that these strategies you and I are discussing will turn out to be highly volatile, and will probably not yield much more than the good ol' PP in the end...maybe even less after taxes and commissions. 

Having said that, it is a lot of fun...

I'm with you there - any one of us I'm sure would love to sell the options now and pocket the cool 25% in 1 week return.  Of course if you did that you'd probably leave money on the table - or maybe not.

I was trying to make a system out of it (similar to the PP) where you could take market timing out of the equation, by treating it like an "options" ladder, although you are completely correct in that timing is difficult and may not be able to be made into a system.

[AdamA]

I was trying to make a system out of it (similar to the PP) where you could take market timing out of the equation, by treating it like an "options" ladder, although you are completely correct in that timing is difficult and may not be able to be made into a system.

I think that the best way to do this is to sell the options a reasonable amount of time before expiration.  The 3 month mark is where they really start to lose their time value. 

Another idea to keep the volatility low is to buy deep in the money options...of course, this gives you less leverage. 

[Storm]

$10K worth of at the money GLD/SPY/TLT Nov/11 calls is up 32.05% since Monday.

[AdamA]

$10K worth of at the money GLD/SPY/TLT Nov/11 calls is up 32.05% since Monday.

Wow.  Keep us updated.  I'm very curious about this. 

I've been thinking about it, and I think that MT is absolutely correct.  The problems will occur when the market is relatively flat.  My bet is that the strategy makes you a fortune once every few years, and then slowly loses it for during sideways markets, when all of your options expire worthless.

Probably a good idea to keep some portion of this money in cash.  If you have your money tied up in calls, and they all expire out of the money, it might not be too much fun. 

[Storm]

$10K worth of at the money GLD/SPY/TLT Nov/11 calls is up 32.05% since Monday.

34.55% up at close Wednesday.

I think you're right, Adam and MT, about during periods of sideways markets having terrible returns, but have you ever known a period in time when all 3 assets did almost nothing?  I guess the last couple of weeks have given us much greater volatility than most time periods, so I may be getting extremely biased results, but I'm wishing I had real money on the line right now...

[AdamA]

Have you ever known a period in time when all 3 assets did almost nothing? 

So, that's the part I'm not sure about. 

They don't have to do nothing for you to lose money.  Just close enough to nothing so that your options expire. 

There could be big moves in between, but if your underlying security goes way up and then comes right back down at
about expiration time, then you'll lose.  What the chances are of this happening to all 3 assets are I'm not sure, but 2/3, probably pretty high. 

Still...if you buy a little deeper into the money and sell while there's still some time value left, you could probably tweak it enough so that you'd live to roll the dice a few more times.

[Storm]

I'm going to try tweaking my test options strategy to include the following:

40% GLD
40% SPY
20% EDV

The reason for the difference is that we're only using TLT/EDV as a hedge against SPY tanking, and EDV gives larger price moves.  Options holders aren't entitled to any dividends anyway, so perhaps it makes more sense to use EDV or zero coupon bonds for this purpose.  MT previously determined EDV has roughly 3/2 the price fluctuation as TLT, so it seems like changing the allocation from 33% to 20% might give you enough protection while allowing you to juice the returns from SPY/GLD a little more.

Any thoughts, Adam?

[AdamA]

Any thoughts, Adam?

Sounds like a good idea except...you can't buy options on EDV, as far as I know...

[Storm]

That I didn't know...  I am probably going to pass on trying this with real money as my $10K Nov11 options have pared some of their gains and are now back at 19.3% as of writing this.

I also started a test of Dec11 options that are currently underwater 2.04%.

It seems way too volatile and requires too much market timing.  Buying in on the wrong day you can end up with options that will never be in the black.  But, it was fun to watch especially during a market meltdown.

I think one way you could play options well in a VP is like MediumTex did - if you know some big event is going to happen like on August 2nd, just make a bet the week before.

[AdamA]

I think one way you could play options well in a VP is like MediumTex did - if you know some big event is going to happen like on August 2nd, just make a bet the week before.

...or, if you know the market is going to go up, buy a call.  Then, right before it goes down, sell the call and buy a put. 

I don't blame you for passing on the options thing with real money.  If it can go up 19% in a week, it can come down just as fast.  Definitely involves some degree of timing.  I will not be using this strategy either.

Fun to think about, though. 

[AdamA]

Are you guys fans of the Dogs of the Dow?

How do you think a LEAPS strategy would work with them?

[AdamA]

I just setup a virtual trading account at OptionsExpress.com with the following positions

1/3 SPY Jan 2013 Call
1/3 GLD Jan 2013 Call
1/3 TLT Jan 2013 Call

(all at the money options).

My plan would be to rebalance in one year, selling losers with one day left in the year, and winners the next day for tax reasons.  I'd then rebuy the options with later expiration dates.

Does anyone think that such a plan could work?

Note, this is a virtual account and contains no real money. 

I didn't use a cash ETF b/c none of them have LEAPS as far as I can tell.

It's up 88% since Aug 1st, for anyone interested.

[clacy]

Interesting, thanks for the update.  I think using LEAPS for your variable portion would be an interesting way to stay within the framework of the HBPP (all 4 asset classes represented equally) but yet levered up for more significant returns.

Sounds like a great way to put your 10% variable portfolio to work.

[AdamA]

I suspect it will go down as fast as it goes up...if not faster.

[clacy]

Possibly.  But if the principles of the HBPP continue to hold, more times than not, there will a positive lift in the portfolio as a whole and some price movement.  The time decay and so forth of options might very well eat up any gains as fast as they come however.

[Storm]

It's up 88% since Aug 1st, for anyone interested.

Awesome!

Nov11 GLD/SPY/TLT options - up 79.6%

Dec11 GLD/SPY/TLT options - up 40.3%

Jan13 GLD/SPY/TLT options - up 41.6%

[Storm]

It's up 88% since Aug 1st, for anyone interested.

Jan13 GLD/SPY/TLT options - up 41.6%

One thing to note - the returns are highly volatile depending on entry and exit.  Notice how Adam just bought his Jan13 options about a week before mine, and he has almost 2x returns.  He bought before Aug. 2nd which had a huge impact on TLT, no doubt.

The best way to play this one, IMO, is to wait for one of those days when all 3 assets in the PP drop.  We've seen several days like that recently.  Any day that the entire portfolio is down is as good a day to enter a position as any.

It sure will be interesting to see if you would come out better by doing the short term play or the long term play over time.  I'm really curious to see what those LEAPS are worth a year from now...

[kka]

Delete

[stone]

I'm totally ignorant about this. Is part of the reason why the LEAPS PP has done so well recently is because we have made a transition from a period of mild price volatility when the options were purchased to exceptional price volatility now? If someone were to buy options now and then things quietened down, would they loose out? Is having a LEAPS PP rather than a regular PP basically a bet on future panic? If so, then might it make sense to just have regular stocks balanced against LTT and gold options since panic is unlikely to be good for stocks? So have a variable portfolio that was say 80% stocks, 10% LTT call options, 10% LTT call options?

[clacy]

I'm totally ignorant about this. Is part of the reason why the LEAPS PP has done so well recently is because we have made a transition from a period of mild price volatility when the options were purchased to exceptional price volatility now? If someone were to buy options now and then things quietened down, would they loose out? Is having a LEAPS PP rather than a regular PP basically a bet on future panic? If so, then might it make sense to just have regular stocks balanced against LTT and gold options since panic is unlikely to be good for stocks? So have a variable portfolio that was say 80% stocks, 10% LTT call options, 10% LTT call options?

That is a good point and one that I have asked myself as well.  I don't know a whole lot about options, but I believe volatility is important to options trading.  I think if two or three of the assets were on a small, gradual pace, you may have completely different outcomes.

[Storm]

I'm totally ignorant about this. Is part of the reason why the LEAPS PP has done so well recently is because we have made a transition from a period of mild price volatility when the options were purchased to exceptional price volatility now? If someone were to buy options now and then things quietened down, would they loose out? Is having a LEAPS PP rather than a regular PP basically a bet on future panic? If so, then might it make sense to just have regular stocks balanced against LTT and gold options since panic is unlikely to be good for stocks? So have a variable portfolio that was say 80% stocks, 10% LTT call options, 10% LTT call options?

Stone, that is an interesting thought.  I think you meant 80/10/10 stocks, TLT options, and GLD options, right?  In my opinion, the LEAPS PP is similar to the 2x leveraged PP, except you're cranking the leverage up to about 6x or 8x.  The time period that Adam and I purchased was right around the August 2nd debt ceiling fiasco, and both of our test portfolios benefited greatly from the jump in long bonds and gold.

If you were to purchase in a time of relative economic stability, you might not have a great enough price movements to make your options worth much.  Another big risk is that your options are worth almost nothing by the time you sell them, if those assets have dropped in value.

I think the LEAPs PP is worth pursuing with a small amount of play money in a VP, but it would require extensive backtesting and speculation to convert your entire PP to an 80/10/10 portfolio.  The problem with backtesting is that options on GLD and TLT have not been around that long, so it's difficult to really tell what would happen in certain scenarios.

[clacy]

The problem with backtesting is that options on GLD and TLT have not been around that long, so it's difficult to really tell what would happen in certain scenarios.

True, but options on Gold and Treasury futures have existed for quite some time. I don't have the ability to backtest such, but I'm sure it exists for someone that has the proper data.

[AdamA]

I'm totally ignorant about this. Is part of the reason why the LEAPS PP has done so well recently is because we have made a transition from a period of mild price volatility when the options were purchased to exceptional price volatility now?s?

Yes.  

Both GLD and TLT went nuts (in the up direction) right after I bought the calls.  They are already very close to their break-even price, and have a lot of time value left.  

If these two assets were to suddenly become stagnant and remained so until they reach expiration, they would expire worthless.  

Even if they make it over the break-even price, they will still continue to lose time value, so they (the underlying assets) could continue to rise, but the calls could be worth less a year from now.  

This would be a very difficulty strategy to implement, even if it back-tested well.  Would you sell your positions (up 90% after a month) or would you hang on to them as planned (until next August, when you'd, in theory, roll them over).  

[stone]

Storm, I'm not numerate enough to understand it but aren't there equations for pricing options
http://en.wikipedia.org/wiki/Black–Scholes
They are undoubtedly a bit wrong, but would give some idea of what the price is likely to be depending on what the market is doing. So if volatility is high, then option prices will reflect the fact that due to the high volatility, there is a good chance that the price will spike up so as to give a profitable exersizing of the option (I hope I'm using the correct words for all of this). So you are best buying options BEFORE everyone else thinks prices might spike in the future. I thought that that is what fortuitously was done with the LEAPS PP talked about here.

In principle you could use Black-Scholes to calculate hypothetical predicted option prices even if no options were available at that time.

I'm probably in a total muddle about all of this.

[AdamA]

I thought that that is what fortuitously was done with the LEAPS PP talked about here.

What you're saying is exactly right. 

Also, "fortuitously" is the key word above.