Systems for writing options are lots of fun to design. But it¬ís hard to tell if they work or not without letting them run for a long time through different market conditions. I am currently testing several.
One interesting system under test I described in an earlier posting. I bought 10 puts of Bank of America expiring in January 2013 at a strike price of 5 as a continuing hedge against a drop below 5. The plan was then to sell puts at strike prices over 5 each month while the hedge is in place.
This worked well for the first three months. In January and February, I was able to profitably sell puts at 6, 7 and 8 for a profit of $600. I paid $600 for the hedge, so I had recouped my investment after three months, and had eight more months of selling to create a profit from the system.
But then in March the stock took a big dip, and I lost $455. I rewrote a new position and then in April the stock took an even bigger drop and I lost $1,250. I wrote a new position for July, at $7, and that looks like it should hold for a $600 profit.
The bottom line at the half way mark is a small loss of just over $1,000, but with another 5 chances to write puts at a profit. With the financial sector improving as it has, I¬ím optimistic that the system will provide a profit by the end of the year, but as they say, ¬ìtime will tell.¬î One thing is sure, no matter how clever the system, in times of volatility it¬ís hard to make a profit selling options. One does much better during periods of stability.
Last week I sold puts against JP Morgan. This is something I often do. I think that good or bad news on a company is compounded in the market by a psychological factor. So when there were reports of heavy losses by JP Morgan, the stock dropped significantly. But as big as billion dollar losses seem, they didn¬ít seem to me to be so big compared to the annual profits of the company. So while I agree that billion dollar losses are not good for a company, I think the market over-reacts to this kind of news, and the stock drops for a while and then rebounds. At least that¬ís the bet that I¬íve made.
So at the end of May when the stock dropped below $32 I started to look at it. While looking it jumped back up over $33. I finally put in my trade when the stock was around $34, having missed the best opportunity by being too slow. I sold 10 of the Dec. 30 puts and bought the Dec. 22 puts to hedge (and avoid a margin call in my account) and took in $1,150 in premium. That¬ís not a huge trade for a six month position, but the way I look at it I have a risk of $7,000 for six months for which I stand to gain over $1,000, so it¬ís like a 30 percent return on my money if it works, so it¬ís a reasonable risk. Since I wrote the trade the stock has continued an upward trend in spite of renewed bad news, so I¬ím feeling pretty good about it.
I¬ím writing this from the south of France, where I usually spend the spring. Everyone here is talking about the European economy. Most are pessimistic, yet there are signs of a long term recovery from the problems of the countries like Greece that are bankrupt and need support from the community.
For me, I am not investing in Europe, and I am reducing investment in U.S. companies that rely heavily on sales into Europe. I am reinvesting in U.S. companies selling into Asia and the third world. This has been my consistent position now for about one year, and I am more convinced than ever that it is the best position.
For information about Merv Hecht and more details on the strategies and stocks he writes about in this column, visit his website at DoubleYourYield.com.