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Option Trading Strategies 2014 - Helps You Trade Like A Pro
Every day, I get a Google alert for the words options trading so that I can keep up with what others, particularly those with blogs, are saying about options trading. I always wondered why my blogs have never appeared on the list I get each day. Maybe its because I dont use the exact words option trading like some of the blogs do.
Here is an example of how one company loaded up their first paragraph with these key words (I have changed a few words so Google doesnt think I am just copying it) -- Some experts will try to explain the right way to trade options by a number of steps. For example, you may see Trading Optionsin 6 Steps or 12 Easy Steps for Trading Options. This overly simplistic approach can often send the novice option trading investor down the wrong path and not teach the investor a solid methodology for options trading. (my emphasis) The key words options trading appeared 5 times in 3 sentences. Now that they are in my blog I will see if my blog gets picked up by Google.
Today I would like to share my thoughts on what 2014 might have in store for us, and offer an options strategy designed to capitalize on the year unfolding as I expect.
A Conservative Options Strategy for 2014
Whats in store for 2014? Most companies seem to be doing pretty well, although the markets P/E of 17 is a little higher than the historical average. Warren Buffett recently said that he felt it was fairly valued. Thirteen analysts surveyed by Forbes projected an average 2014 gain of just over 5% while two expected a loss of about 2%, as we discussed a couple of weeks ago. With interest rates so dreadfully low, there are not many places to put your money except in the stock market. CDs are yielding less than 1%. Bonds are scary to buy because when interest rates inevitably rise, bond prices will collapse. The Feds QE program is surely propping up the market, and some tapering will likely to take place in 2014. This weeks market drop was attributed to fears that tapering will come sooner than later.
When all these factors are considered, the best prognosis for 2014 seems to be that there will not be a huge move in the market in either direction. If economic indicators such as employment numbers, corporate profits and consumer spending improve, the market might be pushed higher except that tapering will then become more likely, and that possibility will push the market lower. The two might offset one another.
This kind of a market is ideal for a strategy of multiple calendar spreads, of course, the kind that we advocate at Terrys Tips. One portfolio I will set up for next year will use a Jan-16 at-the-money straddle as the long side (buying both a put and a call at the 180 strike price). Against those positions we will sell out-of-the-money monthly puts and calls which have a month of remaining life. The straddle will cost about $36 and in one year, will fall to about $24 if the stock doesnt move very much (if it does move a lot in either direction, the straddle will gain in value and may be worth more than $24 in one year). Since the average monthly decay of the straddle is about $1 per month, that is how much monthly premium needs to be collected to break even on theta. I would like to provide for a greater move on the downside just in case that tapering fears prevail (I do not expect that euphoria will propel the market unusually higher, but tapering fears might push it down quite a bit at some point). By selling puts which are further out of the money, we would enjoy more downside protection.
Here is the risk profile graph for my proposed portfolio with 3 straddles (portfolio value $10,000), selling out-of-the-money January-14 puts and calls. Over most of the curve there is a gain approaching 4% for the first month (a five-week period ending January 19, 2014). Probably a 3% gain would be a better expectation for a typical month. A gain over these 5 weeks should come about if SPY falls by $8 or less or moves higher by $5 or less. This seems like a fairly generous range.
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