I’m tweaking my trading model a little bit for 2011 and started the shift today. I’ll be rolling this into my account gradually over the next few weeks (maybe longer). The short version is that instead of selling options only one to two months out I’m going to create a base of diversified index LEAPS (Long-Term Equity Anticipation Securities) that I believe will cover me for a decent return yearly with some downside cushion and then use shorter term options to push for a much better return. By using the LEAPS (think of them the same as regular options, just with a longer duration) as a base I will try to reduce the chances of another year like 2010 where I finish below the indices’ returns, but spend a lot of time churning my account. I could look back and use the excuse that if it wasn’t for VXX I’d be right in line with the indices, but what’s the good of being in line with the broad market averages if I’m working harder than just sticking my cash in index ETFs.
I started the change with MDY since my December MDY naked puts expired on Friday and I needed to add some more mid-cap exposure back into my account anyway. While MDY was trading at $164.14 I sold one MDY January 2012 $175 naked put for $22.10 and received $2209.19 after commissions. Based on my account balance today I plan to add another MDY put still, but didn’t want to sell both on the same day to make sure I’m not selling at a near term high. By selling the 175 strike I need for MDY to gain $10.86 or 8.75% by the time it expires in 13 months to make a full profit, but even if it stays flat I still make 7.35% on the time value erosion. If the next 13 months turn out to be a bear market instead of the 10% higher bull market I’m expecting then I have 6.84% of a cushion to the downside before it turns into a losing position. The extra added benefit on using a LEAP instead of a normal option that expires within a few months is that my gain will be a long term gain will have lower tax burden than my usual trades do. The downside is that I’m limited to an 11.5% upside if we get a better year than I expect. If that’s the case my other short term options will help me stay ahead of the curve.
I plan to use 75% of my equities-focused account in LEAPS and then another 75-125% in other positions. The way I’ve done the math I should have an account return better than 14% from the LEAPS alone once I’m fully invested if the markets move higher by 8.5-9% overall.
As I mentioned at the beginning of this post, this doesn’t mean I’m abandoning shorter term options. I still have a decent exposure as it is and will have to manage it too. Part of that exposure is in VNQ where I took ownership of 200 shares after being assigned my puts from December. I bought the shares at $56.00 and while VNQ was trading at $54.15 I sold two VNQ February $55 covered calls for $1.05 each and received $208.57 after commissions. This brings my cost per share down to $53.36. I thought about selling in the money to position myself for a higher probability of profiting from the position, but VNQ goes ex-dividend this week and I didn’t want my shares called away a day early before I could get the $90+ in dividends. The benefit of selling in the money and having my shares called away early would have been that I could’ve freed up my cash two months early and moved on, but I preferred to keep the exposure and try for bigger profits, especially since I’m already sitting on a paper profit as of today.
Once I have my LEAPS in place I might be more inclined to sell in the money on my covered calls with the mindset that if I can break even on my bad trades and just profit on only a few of the shorter term options I’ll still come out ahead. Most likely I’ll change my mind a few times during the year depending on market conditions for that. I don’t plan to close my LEAPS early unless we see a huge gain in the first six months and I decide at the time that a turn lower is coming. Moves of 5% won’t make me change my LEAPS.
I have a suggestion for you…I’ve had good years, bad years, some better or worse, respectively, than others. I feel your pain for 2010. Personally I had a great year trading (VXX notwithstanding – finally learned how to use that sucker around September!!) and, for those of us who follow you fairly closely (or religiously, depending on sentiment), why don’t you try this: instead of deciding in a void what your new strategy is going to be, why not ask your “minions” for suggestions and comments? I can assure you that you’d probably get some good ideas from it.
Look at it this way: you’ve been kind enough to share your methods and beliefs with us; let us return the favor.
I’d love to hear some suggestions from as many of you who are willing to share what has worked and what hasn’t. Lay it on me. Any exchange of ideas could help all of us.
I’m trying out a couple of things at the moment.
I want to work on a few positions like the SKX one I detailed in the comments section of the previous post. If that position is looking successful in a couple of months, which will require a reduction of my basis on the Jan ’12 Calls without a significant drop in the underlying stock, I’ll select another stock to apply the strategy to.
I also want to add a few low-beta dividend paying stocks as CORE holding. I’ve been looking at JNJ and a few others (WMT looks interesting here). I’ve kind of shifted away from JNJ lately because I don’t like the hip-replacement device recall and associated lawsuits. For that reason, I’m more inclined to keep an eye on ABT.
With these dividend paying stocks, I intend to sell Covered Calls 3-months out whilst looking for a 1% Premium – thus adding 4% to the return achieved via dividends.
For the higher risk stocks, I’ll continue with my current, basic Naked Put/Covered Call strategy.
My pension fund I consider separate. I’m Irish and get a deal through work – they pay an advice company separately so Legal and General only charge a 0.5% Annual Management Charge (half the going rate for Ireland) for a selection of funds.
I recently rebalanced and, at the same time, shifted most of my UK exposure to the Far East (Incl Japan). The fund consists of the following in equal proportions for 2011: International/Far East (Incl Japan)/Europe/US.