fuzzballl 12:13 pm on Thursday, February 2, 2023

Breaking News!!

No, I’m not pregnant. 🙂 🙂 🙂

Been waiting awhile for a chance to do this. This big runup has presented the perfect opportunity. Been an interesting 13 months but I’ve managed to stay 100 percent in the market the entire time. With this rally and all accounts sitting at lifetime highs I’m closing all non SPY positions and from this point forward will only be trading SPY. Looking at my history during the last couple years I’ve managed to do pretty good with it in all kinds of markets. Can’t beat the liquidity and expirations available. A little bit of a divvy kicker to boot and ZERO single stock risk.

It was a mixed bag over the last year but more and bigger winners than losers so can’t complain. Here’s a summary of every ticker for the last 13 months.

(Very) Big Winners:

SPY
XBI

Big Losers:

ARKK
NFLX
SOXL
TQQQ

Medium Winners:

ADBE
AMZN
EWZ
MSFT
SVXY
TBT
TLT
TSLA

Medium Losers

NVDA

Small winners:

COST
QYLD
ROKU
SNOW
SPX
SPXL
TNA

Small losers

/ES
ISRG
LABU
RSX

Breakeven:

COST
FAS
FXI
HOOD
KWEB
META

I can’t say that I won’t take advantage of opportunities if I see them but it would have to be something like XBI at 60 or TLT at 90. 🙂 🙂 🙂 Still holding TLT and some XBI at this point while gradually unwinding them. Everything else is gone except some current SPY positions I elected to keep.

jsd501 12:21 pm on Thursday, February 2, 2023

I am with you but will look at TQQQ from time to time. As of now all my positions are in SPY except for 3 stocks that I will let expire.
geewhiz112 12:26 pm on Thursday, February 2, 2023

I wanted to be in contention for Godfather. I guess it would have been @Jeff, king of the bistro and spinner of top albums.
MikeL 12:27 pm on Thursday, February 2, 2023

One thing I noticed with SPY is a very low premium level when VIX is low.
I think this is why most people switch to individual stocks with higher volatility.
What is your experience during low VIX?
- fuzzballl 12:33 pm on Thursday, February 2, 2023
  
  I’ll just take what the market gives me. Some of the single stock debacles I’ve been in aren’t worth the extra premium I might get. I’m getting too old to be waking up and finding out the CEO had an affair with the COO’s 19 year old daughter and ran off with the 75 million dollar petty cash fund and the stock is down 40 percent.
  
  LOL!
- fuzzballl 12:38 pm on Thursday, February 2, 2023
  
  I’ve also been playing around with the numbers on SPY. I just bought a bunch of Jan 2024 180 strike puts to put a floor on SPY. That should allow a lot of extra positions in the IRA since I won’t be margined to zero. That should also make up for some low volatility times we will end up in.
fuzzballl 12:42 pm on Thursday, February 2, 2023

A little refresher on what I would like to eventually be in. I originally designed this as an exercise for a friend learning option trading. We traded it together in a paper account for over a year and it worked great. I wish I would have kept up with it during 2022 since I think it would have been fantastic.

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Part 1

What would I do in the option market if I had an account the size of “you know who”? Easiest way to go about this is listing some of the requirements I would want the plan to meet.

1. Simple and easy to follow
2. Safe (as possible)
3. Generate enough return to justify the risk

For simplcity it would involve only a single ticker. I would choose SPY since it’s the most liquid and easy to trade product anywhere in the world and has many, many options expirations to choose from…typically three per week and in some cases as many as four.

For safety SPY eliminates single stock risk and pays a dividend if I ever get in a situation where the stock would actually be owned for any length of time.

For risk containment I would rarely be “all in” and in most cases only dedicate half the account to this strategy while leaving the other half in cash. There is generally 2-3 times in any given year where the opportunity arises to ramp up the size. That’s what the cash side would be doing…standing by for these chances.

OK…now what. Here comes the nuts and bolts and the public math. Also, a rudimentary understanding of the options market is required.

The facts:

1. Half the account is roughly 600 grand
2. I’ll be selling nothing but cash secured puts
3. SPY has Mon Wed Fri expirations every week
4. I’ll be selling a variety of expirations to spread the risk
5. Maximum time decay of an option contract begins at about the 45 day mark

Next, what is the allocation for each expiration?

With 600 grand available and every put sale being cash secured I can calculate how many contracts I can sell. Assuming sales in the 275-300 strike levels ($27,500-$30,000 required per contract) that’s roughly 21 contracts available. If I sell 3 per week then that’s 7 weeks of sales available which nicely corresponds to the optimum 45 day entry.

The overall “ladder” of positions will take awhile to establish. As of now July 19th is 45 days to expiration. That far out in time not all of the expirations are available yet. As days pass they will gradually become available and that’s when I would establish those.

The main goal of each sale would be to bring in 1 percent of the total cash required to secure the postion. For example, selling the 275 put requires 27,500 so I would be looking to bring in $275 (that’s premium of 2.75). A 300 strike sale would require 3.00 of premium against the $30,000 to secure the sale and so on.

My first sale would be something like:

Sell July 17 2020 270.0 strike put @ 3.05

That actually beats our goal slightly and is still outside the expected move that the market is pricing in. Seems pretty safe but you never know. The market is pricing in +/- 25 dollars of movement in SPY by July 17th. With SPY at 305 that would be a move down to 280 so I consider 270 as “aggressively safe”.

Beyond that sale I would consider July 2nd, 6th and 10th as well. After that as the other expirations become available I would add those.

EVENTUALLY THE ACCOUNT WOULD HAVE A SINGLE CONTRACT AT EVERY AVAILABLE EXPIRATION FOR 7 STRAIGHT WEEKS WITH EACH ONE BEGINNING NEAR THE 45 DAY MARK.

Ok…fast forward to where all of the positions are established. Assuming no crazy wild selloffs in the market that first sale will be winding down. As it gets down to it’s last few days and it becomes almost worthless I would close it and sell it again at the back of the ladder at 45 days out. Two days later the next one will be coming up and do the same thing. Eventually it becomes a nice rolling ladder. Closing old and re-selling out in time again while booking about $275-$300 each time. So looking roughly at $900 per week for 52 weeks which is about 8 percent annual on the part of the account that is always in. Not a huge return but fairly safe. Might do a little better depending on the market movement.

Question? YES! I have a few:

1. OK Mr. Options Guy what happens if we get a selloff similar to the one we recently had?

A. Since we are selling puts we are taking on the OBLIGATION of buying SPY at the strike we sold. That’s only mandatory if we hold the position to expiration. We can buy it back and re-sell it before we are assigned the stock. Another option is to go ahead and take the stock since it’s at a nice discount after the big selloff.

2. Can there come a time where the market is too risky to even have half of my account in?

A. Absolutely! When it gets to such overbought levels that you aren’t comfortable with the put strikes required to sell then scale back the size to maybe only one or two per week.

3. How the heck will I know when it’s time to put the cash half of the account to work?

A. That’s a great question that nobody can answer. Nothing says you have to get it in all at once. As the market is selling off start looking further out and much lower strikes and selling those. If nothing else it will eventually get a nice stock position at an averaged down cost basis…and when the market is selling off put premiums are going through the roof. We love that!

4. I’m just learning the market and know nothing about options. Any advice?

A. Set up a paper trading account!! Make these trades in that and just learn the mechanics of the trading platform. All that needs to be automatic when risking your hard earned cash.

5. This seems like a lot. I’m not sure I’m cut out for it. Any ideas?

A. You can always skip the whole option thing and give the money to a respectable financial advisor that will set up a nice passive investing plan and you’ll probably do just fine. I operate under the theory that nobody cares more about your money than you do.

Any more questions let me know. Learn the basics of the option market and how to read a stock chart also. Stock movements and option movements go hand in hand.

Part 2:

Now that there’s a basic plan for half the account I’ve been thinking about when and how to deploy the other half when the opportunity comes along (See Q&A number 3 in previous email). I felt there needed to be a systematic way to add the new positions in a long downtrending market that takes place over several months similar to 2008-09. By doing that it would give us a nice averaged down position in SPY to take advantage of any recovery.

At some point in time the market will sell off to such an extent that all of our 21 postions will be “in the money” and require some sort of management. Here’s the idea…

As each position reaches expiration day I will roll it out. In other words, buy back the position and re-sell it at the back of our ladder. This should result in additional credit being received each time. We could use the additional credit to roll it down to a lower strike possibly also. We’ll have to decide if that’s a better trade than the straight roll when the time comes. It really depends on how “deep in the money” it is.

This is also when we would put the additional capital to use to take advantage of the selloff and the nice put premiums that would be available. Here’s how:

If the position we are rolling is a Friday postion, we will add another put sale to the expiration we have rolled to. The new sale will be at a much lower strike than the original resulting in a nice average price if we end up with the stock eventually.

If the market stays down and we go through the entire original ladder and roll everything we would now have 28 positions. One on Mon and Wed and two on Fri throughout our ladder.

If the market is still down and we go through the list again we will do the same thing only this time we will add the additional sale on the Wed expirations. We would continue this again the third time through the list adding the new sales on the Mon expiration.

The entire adding process would take 21 weeks before we would be “all in”. For that to happen it would take a similar implosion to 2008-09 to reach this point. Don’t we wish we would’ve been all in during March of 2009 with SPY at 66?

This is how I’ll trade the paper account and we’ll see how it plays out over time. Another thing to consider is the fact that the entire account could be tied up for awhile. In real life, I would consider having a couple years of living expenses set aside in extremely safe investments (like cash) to have as a backup so the recovery can be taken advantage of without having to withdraw anything in a down market. Safety!!

Part 3:

The entire account is tied up and we own SPY stock. Don’t say it can’t happen! So what now?

The upcoming SPY quarterly dividend got me thinking about this. I believe there is a reasonable way to continue generating income even if the entire account owns SPY stock. This would take a long down market where rolls weren’t working too well and we decided to let the stock get assigned to us.

For the entire account to own 5000 shares we would need an average cost of 240 dollars per share. I feel like in this situation we would have something lower than that but for simplicity let’s use this.

Here’s how we get some income in this setup:

1. Dividends received each quarter
2. Covered call selling on the stock

The dividend would be around 1.40 per share paid 4 times per year. This would generate 28 grand per year regardless of the stock price or anything we do. A great start with a 2.3 percent return for doing nothing.

We would also be selling calls against the stock to bring in more income. The big question is how far out and what strike price. We wouldn’t want to have the stock called away in most cases so it would have to be pretty conservative sales. To make it easy let’s look at selling the calls once per month.

NOTE: When selling calls against stock you are agreeing to sell the stock at the strike price sold if it is “in the money” at expiration so careful tracking of cost basis would be required to keep from selling at a loss. If our cost basis is below the strike price sold we could get pretty aggressive with the sales. This is where the real money would be made.

Looking at SPY right now out to the July monthly expiration (30 days out) I’m seeing about a 25 dollar expected move being priced in so looking outside that for safety. The 340 strike is out quite a bit but still has 75 cents in premium. Let’s do public math:

.75 x 5000 = 3750 which is 45,000 per year plus the dividend = 73,000 per year.

That’s pretty conservative so put any number in there you’d like to compare but I’m looking at NOT HAVING THE STOCK CALLED AWAY. If we’re wanting to get rid of the stock eventually, much more aggressive sales could be used. Check the math on the 325 strike which is VERY aggressive (half the expected move):

3.20 x 5000 = 16,000 which is 192,000 per year plus the dividend = 220,000 per year.

That’s a wide range but it would all depend on if we are wanting to keep the stock longer for more appreciation or unload it and go back to the beginning with the big put ladder and start over. Many other things possible too like selling a few aggressively and the rest safely. Options with options!

Just to repeat…the biggest risk to this is if the stock price is well below our cost basis. We would be selling covered calls below our basis which is always risky in the event of a huge crazy rally where the calls could get deep in the money and be difficult to roll.

Additional note on rolling…after playing with the numbers our goal on a roll will be to roll down and still get a credit. Unless the position is very DITM we’ll try to get at least our one percent goal based on the new strike and roll credit. This will give us a nice guide on what strike to selct for the roll.
- geewhiz112 12:51 pm on Thursday, February 2, 2023
  
  Your graciousness and sagacity are most appreciated. I will miss your jade lizards.
  - fuzzballl 1:00 pm on Thursday, February 2, 2023
    
    Can’t count out the SPY Lizard!
- MikeL 1:27 pm on Thursday, February 2, 2023
  
  Just curious.
  If your target is 1% for a put 45 days out, this works out to about 8% annualized return. Do you consider this to be sufficient considering possibility of rolls, etc…?
  I have to look for 10% annual, just to have some cushion, in case of a down market.
  Found it a bit difficult due to the need for using higher strikes.
  - fuzzballl 5:11 pm on Thursday, February 2, 2023
    
    That’s just a number I picked to make it easy for a newbie to select strikes….since this was a big training exercise I designed. It would also be a number that I could live comfortably on without much or any drawdown. Really about 5 percent would be my true goal to be able to live ok and anything above that would grow the account. I think a down market would make a lot more in the long run by getting a nice averaged in basis to own the stock. Since it takes 21 weeks to establish a true full position I’d think it would be a nice basis.
    
    More than likely I think I’d end up with a combination of stock, covered calls, and short puts. In that scenario you can bring in some nice income. That’s kinda where I’ve been sitting for the last 9 months or so in my SPY position. Stock, covered calls, puts, dividends is very fun. I did about 15 percent on my SPY position just trading around it.
    
    Of course everyone’s situation is different so definitely one size does not fit all. You are right…the worst thing for this strategy is a long uptrending dull, low VIX market.
    
    How am I actually going to trade SPY? Probably much more aggressively than the training plan. I’ll add quicker on down days and probably sell calls more aggressively as well.