DEFINITIVE DITM HEDGE

As I have written copiously about DITM (Deep-In-The-Money) covered calls as being a safe haven for investors/traders seeking an alternative to less risky strategies, with my extensive testing of it for nearly five years, solid proof came today in my most recent trade. Although DITM missed out on much of the unexpected 30-someting point 2013 rally, the upsurge did provide a wider cushion with further ITM security. It also hedged this losing trade, which I finally gave up on - one of the very few, and first of 2014: Ensco (ESV).

Looking back, just about all of the DITM losses were a result of being in the wrong Sector(s) - Energy, Precious Metals, Natural Resources: CLF, VALE, QRE, PGH, etc.

ESV also belongs there.

I bought only 100 shares of ESV in May of 2013 for just over $62 - $6214; selling the Sept. $57.5 ITM call and again the Jan.2014 call, as well as  nice 5.1/2% dividends, I finally sold the shares today at $52 5/8, or$5253. Instead of suffering a $1000 loss on the 100 shares, my net loss was $57 - if I would have waited for an uptick I could have broken even!  So basically what I lost was Time - much like leaving $$ in a MMF at zero percent.

After four years of testing in my small IRA, which gained @ 11% per year average, 2013 was a flat year, partially due to my Sector selection (see above) expecting a reversal, and also the steadily rising markets produced a mild Volatility, which impacted the option prices negatively. That is why I moved much of my assets into another defensive strategy - more Reward and even less Risk, but a little more complicated for option tyros: LEAP Strangles ( buying $5 to 15 stocks and selling Leap Out-Of-The -Money Covered Calls

 and Puts against them. This is outlined in recent posts of my DITM blog: http://ditmcalls.blogspot.com/  

A few of my Leap holdings (not recommendations!) include F, BAC, FTR, NOK, et.al.

DITM Recap 2013

As mentioned before in this blog, after 4 years of  11% average returns in my small IRA - the microcosm of the DITM strategy, 2013 finally hit stall speed; partly because the steady rise of the market killed Implied Volatility (IV), rendering the VIX @ 13-14, and partly because my stock selection happened to be premature - going into Energy, Chemicals, and gold.

Here is the non-GAAP best-efforts analysis of the round trip trades closed out in 2013:

First the winners - 20 total, averaging 12.70% with an average 5.1 month duration.

Losing trades were only 3, but which amounted to over 40% of the winners, since losses are usually quite a bit larger by the time they are under water and decided upon.

Since it is difficult to arrive at a profit/loss since the same money is used for more than 1 position during the year, the annualized percent of 7.16% is based on the net profit. Hopefully 2014 will be an improvement, especially of there is a substantial correction, which is hedged against, raising the Volatility and premium of the sold Call options, as well as the 3%+ dividends from the underlying. Hopefully the commodity sector will rebound this year as well.

Happy New Year

As readers have noticed there has not been much activity in DITM recently. After 4 years of successful 11% returns per year in my small IRA ( a surrogate for DITM) the Groundhog Day steady rise in the markets have crushed Volatility, and new positions and rollouts have been infrequent.

More concentration has been on the Leap Strangle strategy which I embarked on just over a year ago. This has done better, despite a errant reliance on gold and precious metals' stocks, which should recover in time. Those that do not will result in rolling down of the calls and taking on more stock via the sold OTM puts (in a sense, doubling down).

As of today, with the first position - BAC- taken in Dec.'12, and adding 1 or 2 laddered monthly through last week, where I leapt into YRCW! Quite a risky trade, but the IV was over 100 on both puts and calls, to where I brought in with option premium almost as much as I spent on the stock! There is a reason for high IV - RISK- which I saw the next few days, when the stock dropped to below my sold put, at least temporarily.

Even with a very recent paper loss in YRCW and four other gold, silver and coal stocks ( of the 17 now in the strategy) going negative so far, the winners have propelled the 13 month return to a cumulative 13.67%. This does not include any max loss requirement for the puts if done in an IRA.

Quantifying the LEAP

Quantifying the LEAP: TSL Trina Solar Co.

At the risk of defeating my purpose of Long Term Holding of the LEAP strategy, here is a fine tuning of the TSL trade - a stock that has run up recently. It sacrifices Risk for Reward by rolling up Puts and Calls with the stock, and moving out  in time to 2016 as well.

                                                                        DEBIT          CREDIT

Aug. 2013: Bought 500 TSL at $8.97  :          $4494

            Sold 5 2015 Leap Calls - 10-strike:                            $1211

            Sold 5 2015 Leap Puts - 7 strike:                                $937

Oct 29: With stock "Leaping" to 15,

            Rolled 7-strike Puts up to 10:                                     493      (net of  936-443)        

Nov.18: Rolled Calls from 10-strike to 15        596                           (net of 4093 -3496,

            and out to 2016                                                                       releasing $2500 call

If called in Jan.2016 at 15:                                                     7500

                                                TOTAL:          $5090              $10,141

Current position: In the money covered calls, with stock at $16.77. Per cent profit if called away at 15 or above: 99% over 2 1/2 years (without further tweaking- TSL pays no dividends; most commission costs are included).

If stock settles between $10 and 15 ON! January 2016 expiry date, keep all option money, but paper loss of  $2500 on stock - $5 on 500 shares. Put on another Leap Strangle at current prices, e.g. $12 Call and $7 Put for 2018.

If TSL falls below $10 in 2016 expiry, you will have to buy back Put or take on 500 shares stock and do another OTM strangle.

If done in an IRA account, one must allow for the cash up front requirement of the puts - $7 X 500 ; in a margin account marginability of the stock bought plus Put and Call receipts should cover margin req., although minimum account margin ($5000?) is also required in an account.

GROWING BY LEAPS AND BOUNDS

Subsequent to my talk before the S.F. Bay Area Options Group last month, I decided to update my LEAP portfolio for YTD (year so far) results. I was happily surprised that the amount earned on paper ( marking to the market as no trades have been completed) was so high. Entry into these 15 trades was staggered, starting in Dec. of '12, then pretty much monthly up until October, so I did not expect much profit, especially from the later trades. Much like a long distance track race, each stock starts at a different place, but ends simultaneously, on January 2015, for those Leaps, although I have started doing 2016 Leaps, now that they are out as of October expiry.

Despite several dubious candidates ( e.g., gold, metals) that have underperformed short term - expected to rally by 2015- there were counterbalancing trades such as NOK, RAD, TSL and F that rose enough over their short time to allow a rollout and up with the puts.

Bottom line, of the $60,000 invested over 2013, current profit is just under $7,000 for an 11.67% gain, due to the consistent decay of both calls and puts sold, with an occasional dividend thrown in. There are several metal stocks "under water" (below the Leap put price, which, if they do not rise by Jan.2015 expiry, will force me to take on more stock, do another Leap strangle two years out, and lower down in price - since I already own the original shares there is no cost basis there!

I have run this by several option "experts", such as people in the SF Option Group, Alex Jacobson - the prior instructor at the CBOE , and my old Schwab team who handle Friends of Chuck. Possible risks, but very minor, are total bankruptcy, and either a merger or takeover which have variable consequences. One such high risk trade could be on JCPenney, around for a century or so: a 2016 strangle brings in an immediate 75% return  of principal (no dividend yet). At expiry, another 2-year strangle should double one's money, no matter what the price of JCP. Caveat Emptor!

Obviously, stocks in the $5 to $15 range will probably not be the highest quality, but early profits and exits are also likely, although LEAPs needs very little monitoring or tweaking. My estimates are 20 to 60% returns, with annualized returns in the 20%s.