Skip to main content
  1. News
  2. Business & Finance
  3. Stock Market

Leaping Ahead

See also

Recently Stephen Todd pointed out that since 1900 there have only been three times that the stock market has risen five consecutive years up until now: the '20s, '40s, and '80s, which did not end well! A fourth time it rose 9 years - 1990s (say no more). For this reason it seems logical to assume a sideways to down market-strategy would be prudent. I also thought this in May 2009, when I started testing my DITM (deep-in-the-money covered call) hedging strategy, which happened to coincide with the recent 4th five-year up market, although my test account actually rose 11% per year for 4 years, then flatlined due to poor/early sector selection and low option Volatility caused by the Up market. It also increased the cushion from being 5 to 10% in the money protection, to much higher, for which I am now thankful.

With a higher likelihood of stocks now moving sideways to down for the near future, an even more prudent strategy is being tested - one that a client successfully employed several years ago when I was a senior option trader (ROP) with Charles Schwab. This client would turn the tables, so to speak, from being the "patsy" in the game to being the House, or casino - by selling options rather than speculating on potential direction. The concept is to buy a quality stock in the $5 to 20 range that has LEAP options and sell a covered call (never a "naked" one), and simultaneously selling the same year Leap put- both slightly out of the money.

Normally one can immediately bring between 1/3 and 1/2 of the funds spent on buying the stock, providing a better cushion than the above DITM plan; although being similar to it, the Safety and Reward are both considerably higher, and the monitoring is almost negligible for about two years- at which time the options expire. Although potential annual double-digit profits are likely, direction is not important, but being called away at expiry does increase the return.

Since one year ago I have amassed a Leap portfolio of 20 positions, mostly done recently.

As with any investing strategy there are Risks attached:

Below is the logic of the strategy with a theoretical example, and the "Visible Hand" of five fingers ( A through E) of what can happen over time.

As with "E", more stock can be put to the investor - so they must want to own the stock.

Stock gets taken over or involved in merger - adjusted options gets complicated, but no loss involved; XYZ goes bankrupt: 1 in 1,000
Profits on other 15-20 stocks make up for loss.
***commissions not included; stocks bought in IRAs, etc. must sequester Max Loss(e.g.$700)
A Strangle is just a Straddle with different prices for calls and puts

Theoretical Leap Strangle .......... DEBIT CREDIT
Stock: XYZ $9
Buy 100 shares at $9 ..............$900
Sell 1 Leap covered call
Jan.2016 10-strike @1.20 ...................$120
Sell 1 Leap naked put
Jan.2016 8-strike @$.80 .....................$80
4% dividend; 9 quarters .......................$81
TOTALS: 900 281
%Profit 31.22%
Annualized 14.4%
"Visible Hand" Scenario
A: Stock called away in 2016: $281 + $100 apprec.=381
42.33%
B: Stock settles at $10 at expiry: Max. profit, repeat to 2018
C: Stock stays at $9: Keep 281, repeat to 2018
D: Stock falls to $7: Keep put and call premium, paper loss of $2,
so lower Strangle to $6 and $8, respectively
E: Worst Case: Stock drops below $7 - more stock put to you, or exit.

Advertisement

News

  • Israel, Hamas clash in Gaza
    At least 550 Palestinians have been killed in Gaza in the third week of the war
    Video
    Video
  • Pro-Russia guards
    President Obama criticizes pro-Russian rebels for blocking off the MH17 crash site
    World News
  • National Guard at Texas border
    Texas Gov. Rick Perry sending National Guard troops to the US-Mexico border
    US News
  • Unlikely Putin defender
    The unlikeliest US politician comes to the defense of Russia's president, Vladimir Putin
    Politics
  • iPhone 6 coming soon
    Apple is gearing up for the iPhone 6, orders tens of millions of units
    Tech
  • Gynecologist settlement
    Johns Hopkins agrees to $190M settlement for patients recorded by gynecologist
    Strange News