My trading style is not a ‘set and forget’ method. You have to be aware of all your positions every day. If you can’t take the time to analyze each one each day, then find another methodology (more on that in the next few posts).

The week of expiration I had unanticipated duties that interfered with my daily routine and took a lot of time away from my computer. (No, I don’t have an iPhone and I won’t get one – too expensive to buy and own for my tastes.) That’s not really a good excuse, but it is a great lesson. Because of the distractions, I was unable to concentrate on the best action to take on many losing positions. I believe there was a bit of bad luck thrown in to boot in the form of a market bounce when I was very short.

The Weeklys had a big impact and have me reconsidering that strategy. Turns out if the trade goes against you, there is not any time left to make a good adjustment and the best course seems to take the lose and get out. That’s not the type of trading I like to do. I have back-tested a more conservative Weekly expiration methodology and I will detail that, along with a video, in my next post.

So net-net, I am down $2,181 so far for this month. Of my current open positions there is not much there to help the July 2010 number – unless the market gets very Bearish in the next few days.

I’m not going to go into all the gory details on each trade – nobody likes to hear bad news (although some might be cheering or saying “I told you so”). Suffice to say the distractions and lack of concentration (aka following rules) is to blame for almost all. Some of the big losses were at earnings, for cryin’ out loud. How many times have I said “Never, never, never hold through earnings!”

As I have said many times in the past when I have a bad month, it’s a painful but great way to learn a lesson. Education isn’t cheap. Good news is the Year-to-date numbers are still good. Whew!

◄ Jeff ►

Some of you may have noticed that some of the Covered Calls that the Guru has in the Conservative Account are ITM, but they have not been assigned (called) early. There are ways to minimize that possibility.

First, let’s discuss why an options trader buys a Call.

• It could be part of a option spread, in which case the trader is probably not interested in owning the stock.
• The trader may want to leverage an anticipated rise in the price of the stock and may also not be interested in owning the stock.
• The trader may be hedging and intends to buy the stock at a discount. In this case, the trader buys the call in anticipation of an event, particularly the date you need to own the stock in order to collect the dividend. In this case, if the extrinsic value of the option falls below the value of the dividend and it near the ExDiv date, the trader will exercise the Call option, buy the stock at the strike price, collect the dividend and make a few bucks on the deal. The trader then may sell the stock or hang on to it.

Those are just a few of the reasons a trader might buy a Call option. What I want to do is focus on the third bullet so we can create a strategy to avoid being called out on our Covered Calls.

Let’s use an example the Guru has in his Conservative Account right now. Eli Lilly (LLY) is a very good one since it’s ITM, pays a huge dividend and it’s a very good company. It currently has 1.1B shares outstanding and over 700,000,000 are held by institutions. Does this mean anything? Only that the institutions are not run by idiots and they are willing to do anything to grab more shares of this company at a ‘discount’. Look at the snapshot to the left (from www.dividendinvestor.com). Attractive, don’t you think? Forty-two years of consecutive dividend increases. Wow!

OK, back to business. You can see on the chart below that the Guru is short AUG 34 Calls and the price of the stock closed at 34.64 on Friday. The ExDiv Date is 8/11, so you need to own the stock on that date and hold it overnight in order to collect the dividend to be paid on 9/10.

So why hasn’t the Guru been called on this yet? Look at the option data below from the TOS platform.

The 34 option is currently 0.64 ITM, so the Intrinsic value is 0.64. Since the option is currently valued at 1.1955 (mid point of the bid/ask) the Extrinsic or Time Value of the option is 0.555 as shown in that column.

Notice also that as the strikes go deeper ITM the Extrinsic decreases. This is because delta increases as the strike price goes deeper ITM and the option price starts to move (almost) dollar-for-dollar with the price of the underlying.

So now the trader that’s holding the Call (or wants to buy some) is watching these number very closely. Once the Extrinsic falls below the Dividend, he may want to exercise his Call but will probably wait until close to the DivEx date. Why? Many times dividends get ‘priced in’ to the price of the underlying. If you look back on a chart of LLY you will see that around almost every DivEx date, the stock moves up by at least the value of the dividend. Coincidence? Maybe.

One other thing to consider – we don’t know when the trader bought that Call. Just ’cause we sold it last week, doesn’t mean it won’t get exercised because the buyer paid a huge premium. It’s not a one-for-one thing. You could get Called Out from a trader that buys a Call on 8/9 and exercises it on 8/10 even though you sold it on 7/14. It’s all a random thing. This quote is from www.theoptionsguide.com:

Once an option is sold, there exist a possibility for the option writer to be assigned to fulfill his or her obligation to buy or sell shares of the underlying stock on any business day. One can never tell when an assignment will take place. To ensure a fair distribution of assignments, the Options Clearing Corporation uses a random procedure to assign exercise notices to the accounts maintained with OCC by each Clearing Member. In turn, the assigned firm must use an exchange approved way to allocate those notices to individual accounts which have the short positions on those options.

Options are usually exercised when they get closer to expiration. The reason is that it does not make much sense to exercise an option when there is still time value left. Its more profitable to sell the option instead.

Over the years, only about 17% of options have been exercised. However, it does not mean that only 17% of your short options will be exercised. Many of those options that were not exercised were probably out-of-the-money to begin with and had expired worthless. In any case, at any point in time, the deeper into-the-money the short options, the more likely they will be exercised.

So what can the Guru do about this if the underlying stays ITM close to the ExDiv date? Pretty simple, really. The rule the Guru follows is: when the Extrinsic is near or at the value of the next dividend and the expiration date of the short Call is later than the date of the ExDiv, roll out or roll up/out to the next available month.

In the case of LLY, the ExDiv is prior to the AUG expiration. The Extrinsic is currently at 0.555 and the Dividend is 0.49. The option data will be monitored very closely was we near 8/11 and the appropriate action will be taken. Don’t worry, I will let you know what the Guru does.

Incidentally, the same rule for rolling applies as the expiration day draws nearer. I roll ITM Calls near expiration when the Extrinsic nears 0.10. Ultimately, though, it’s not the end of the world if you get called (see the If Called Return table on the right) – unless you are upside down and your cost basis is higher than you short Call strike. That’s an unfortunate situation and should be avoided at all costs.

A Quick Update on QCOM

I mentioned last week that the Guru wanted to dump it because of the low dividend yield. Well, he decided to wait another month when the opportunity came up to roll the JUL 37 to AUG for 1.03 in credit on Friday. How could anyone pass up $309? The next DivEx date is 8/25, so he will be in the market to unload it after that. The dividend of 0.19 was declared on 7/8 and that will bring the cost basis down to 35.12 and the Guru told me that now he wants to hold it until then. If the price is above 37 at AUG expiration, he may roll to SEP “something-or-other”.

It took me a long time to write this – I hope I was able to get my point across and I didn’t screw up.

◄ Jeff ►

Greed – the downfall of many a trader. It breeds arrogance and over-confidence – the “I can beat the market” attitude. On the other hand, it gives us messages and lessons that, if listened to, can improve our chance for success.

The Tale of Two Trades

I’m going to relay to you a short story about two trades in the July expiration cycle. One was successful and the other is currently underwater and may be a big looser. I always like to handle the bad news first – so here goes.

Freeport-McMoRan Copper & Gold (FCX)

Right now the so called Guru has an open JUL Bear Call spread with the short at 65. I entered this trade on 6/30. Go and look at a chart and tell me what you would do on this date. Go ahead, I’ll wait…

I remember exactly what I was thinking. I let my market bias allow me to take a risk that, if I had been able to breach that bias, I would not have taken. You see, I should not have entered this trade if I had been following my trading plan. Here’s why:

1. It’s too close to expiration for a short vertical. This forced me to have a short strike too close on a volatile stock. The Delta on the 65 was .30 and on the 67.5 it was 0.16. In order to make a decent profit, I had to use the 65 as my short.
2. The short strike is below the previous high. Heck, even a novice should know that!
3. My thinking at the time was that the market was heading for the crapper and any negative delta is good. That, in my thick head, justifies high risk.
4. I wanted (needed?) to trade that day. Always a dangerous emotion.

I’m still in this trade and as of Friday, FCX has 46% chance of finishing for a profit. I am down $322 right now. My plan is to get out on Monday – it’s expiration week anyway and I only have two other JUL cycles open (AAPL, IBM) both of which have very hefty Theta’s. If the market moves down I will luck out and limit my loss. If it moves up it could have a significant impact on the Guru’s performance for this expiration. That’ll teach him!

Google, Inc (GOOG)

Even while I still had a JUN 530 Bear Call open, I recognized considerable weakness in GOOG and was able to enter the JUL 520 for a very nice credit $2.40. I don’t believe my Bearsih market bias affected my decision, and here’s why:

1. GOOG had a very nice 7 candle Bear Flag with convincing confirmation.
2. There was a Person Pivot Bear indicator 2 days prior to entry.
3. The short strike is way above the previous high and at a May resistance of 520.

Normally I would wait until the short strike was worth a nickle or less before I close this trade, the strong move on 7/7 convinced me to take my money off the table. This ended up a very nice trade and allowed me to retain 95% of the original credit.

Conclusion? Multiple choice:

A) Nobody can be right 100% of the time  B) Be true to you plan  C) Even the pros make mistakes  D) I am only human  E) all the above

Conservative Account

As usual, at this time of the expiration cycle, I am rolling Call strikes that are ITM out to next month. I still have KFT and NYX to roll, provided they are still ITM or close on Monday. Anything that is OTM will be rolled Thursday or Friday. Why roll them? Well, there is no commission if the short is under 0.05 (and it probably will be) and although it may be a wash, the AUG options will have more premium this week than after expiration this Friday.

I am a bit troubled by QCOM. This is a stock that was a darling of the late 90′s upon which I made a lot of money. But now? I have been wondering what possessed me to add this to my conservative account. The dividend isn’t all that good and the stock is not a good performer – down over 20% since I entered. I am not hesitant to dump losers, so I may do that soon. Earnings on 7/21. They beat the last two but still gaped down each time. Hmmm.

◄ Jeff ►

I mentioned in my previous post that there are now weekly expirations on many new underlyings. (they are: SPY, QQQQ, IWM, GLD, XLF, EEM, C, BAC, AAPL, BP, F and GOOG).

Just in case you were wondering how to do it, or what strategy to use, or how you might back test; I made a new video called Using TOS OnDemand to Trade Weekly Expirations. You will find it on the far right column under the New Downloads section.

If you are a TOS customer and you haven’t been using OnDemand, this is your opportunity to get a look at how it works.

◄ Jeff ►

While the S&P 500 was down, both the Spread and Conservative accounts are up. The Spread account is easy to explain, while the Conservative account is a bit more difficult since it’s exclusively Covered Calls right now and almost all the underlyings are down for the month. But what I think is happening (without digging all the way down) is that the rolls from last month have put the cost basis for the underlyings below the current depressed price. So the premium collected for last months rolls and a few dividends are beginning to add up. I expected this to take some time and I’m glad it’s beginning to jell.

From 5,000 feet, the Spread account gained 5.01% and $2,570 in cold hard cash, and the Conservative account gained 0.22% and $75 in cash.

As I had mentioned in previous posts regarding major support for the S&P index, we can see that the last two days have held up, with Thursday finishing at 1027 and Friday at 1022. Remember, I had identified major support in the 1000-1020 range based on Fibonacci levels (see my Post What Could Happen).

This is a interesting zoom-in on the SPX chart from the close on Thursday. Notice how the candle bears a striking similarity to an oil drilling platform. Just an observation – I’m sure it means nothing.

Weeklys

In case you haven’t checked, the CBOE offers weekly expiration cycles on a few stocks and ETFs in addition to the major indices. They are: SPY, QQQQ, IWM, GLD, XLF, EEM, C, BAC, AAPL, BP, F and GOOG. I’m not sure I understand why some are these are there – like C; at $3.79 the stock is priced like an option with no time decay!

I have enjoyed playing SPY weekly for the last 3 expirations and it has worked out well. It’s easier to risk a consolidation or directional trade for 8 days rather than 25 or more.

Speaking of days, the CBOE announced this week that the weekly options will open on Thursday rather than Friday. This is to accommodate those traders who like to roll from week to week. I noticed that this Thursday and got in with a Condor on SPY (101/103/106/108) this is working out very nicely so far, and I get to capture 3 days of decay while we celebrate our country’s birthday this weekend.

For my US readers, enjoy our 224th birthday. For the rest, savor the 3-day weekend.

On May 9^th (Mother’s Day) I wrote a post (What Could Happen) about my observation on where I think significant support is for the S&P 500 index – in the 1000 to 1020 range. You can go back and read that post to get an understanding of why I think it’s significant.

As I write this, the S&P Futures hit 1023 after the market close. I can’t tell you what the market will do, but if this support holds, then we will likely see a some sort of Bull bounce, but I just don’t think it will be significant and I don’t expect it to make a higher high and therefore remain below 1125 (last high).

The current Bear move is very strong and any trend lines move us lower (see the Weekly chart below). If the index should break through the 1000-1020 level, then look for another major support area at 875 – yes, you heard me 875!

Many institutional investors have been moving into bonds. For us retail options traders, Bear Call or Bear Puts are the way to profit from a strong bear market. Make sure you wait and enter on the spike. FYI – I just opened a JUN Bear Call on FCX today. This week is the last week to enter into any JUN option trades.

I wanted to title this post: “Get on Your Knees and Pray”, but I thought it might be a little too much. Let’s pray that it is.

Look for June detailed results the end of this week or this weekend. Kicked butt on the S&P again! Preliminary: Option Guru = +5.01%, S&P 500 = -5.45%

◄ Jeff ►

If you have been Bearish, you’ve done quite well this week. While you were not looking (meaning I didn’t post anything about it) I opened a very Bullish long vertical on BIDU at 80 – figuring the stock would continue on it’s merry way past that point. Maybe I should have waited, but I exited on the 24th for a $860 loss, taking quite a bite out of the June profit.

Overall my bias is still Bearish and still looking for SPX to hit the 1,000-10,025 support level. Recently the market was acting like it wanted to reverse and move higher and some people were calling a Head and Shoulders pattern. Maybe, but the Flash Crash sure messed things up. For a real reversal we need to look for two higher highs and two higher lows – not there yet – we have only one higher high and still looking for the next low.

Because of the movement of the market this week, the big winners are the Bear Calls I have on AMZN, GOOG and GS. My AAPL Bull Put is still hanging in there mostly based on Apple’s strength. CME made such a huge down move yesterday that I thought I may need to make an adjustment to the Put Calendar, but today’s rally brought it back into line with my wishes.

I did open a JUL Double Butterfly on IBM that cost $1,020 that could return $980 if it stays between $123 and $132 at JUL expiration. A picture is worth a thousand words, so check out the risk profile and price chart below. I constructed this with both Calls and Puts so I wouldn’t have any overlapping options and end up with a Condor, as was pointed out by DD on 6/14. When I adjust the Implied Volatility, the $980 profit point does not change – unlike a Calendar where I would have to be concerned about volatility collapse.

Based on the chart, it looks like it could be a very good trade – but only time will tell.

.

My test (actually, more of a confidence builder) of the weekly ETF’s turned out rather well. My trade was on SPY with a 110 Put Calendar that I opened on Friday the 18th and closed it yesterday for a gain of $40. Don’t laugh, a win is better than a loss and it did gain 60% on a risk of $66. To that end, I opened 4 -110/+113 Bear Calls for next Friday and collected a credit of $172. Why not another Calendar? I just feel that right now the market is moving too fast and due to the short expiration cycle, I would not have a chance to adjust.

◄ Jeff ►

I don’t think I have ever had a expiration cycle where there were no losers – until this one. On the other hand, no big winners either, just a fairly consistent return. Notice the mix of spreads: 5 Verticals, 4 Calendars and 1 Iron Condor. This month I had difficulty finding good Calendar and Double Calendar trades, whereas the Bearish trend provided highly profitable Bear Call spreads. Point is, trading more than one strategy (to fit current conditions) allows for more flexibility.

Although the month is not over yet, I have $2,472 in the bank and a 3.98% return on total account value (19.3% return on risk). The amount of capital at risk (so far) has been $12,787, which is only about 23% of my Spread Account.

Have you ever watched any of the TOS archived Chat Sessions? Check out the July 8, 2009 chat called Good Trade/Bad Trade with Tom and Tom. It presents some great ideas for applying different spread strategies under various conditions. If you are a TOS customer and haven’t watched any chat videos, you can get to them by clicking  and selecting the Seminars tab. Open the July 2009 section and pick that video (detailed below).

This week I opened a few trades for JUL expiration: AAPL Bull Put and AMZN Bear Call. Check them out on my In Play page.

Each day I scan my watch list for prospects. I noticed CME looks quite weak and in a strong bear trend (see chart).

Yesterday I opened a JUL/SEP 300 Calendar that should show a nice profit between $286 and $316, which is just about where the trend line will put it on JUL expiration. Because of the long Put is in SEP, I have the possibility of rolling the short Put to AUG – depending on the price of the stock. Stay tuned. Ah, the plans of mice and gurus

Friday I will be looking at the weekly options on SPY, DIA, QQQQ and IWM for potential prospects. It should be fun and may be able to pick up a few extra bucks at the same time.

◄ Jeff ►

Did a lot of that today in the Conservative Account. If any of the JUN expirations were ITM, them I rolled them to next month. For the last week or so I have been keeping a eye on the extrinsic value – making sure none of them were less than the declared dividend and no ExDiv dates were in the next two weeks. Then it was just a matter of timing. Today the market was up nicely in the morning, so I rolled a bunch.

This is what I did:

T – JUN to JUL 25 for 0.20 credit

KFT – JUN to JUL 29 for 0.31 credit

NYX – JUN to JUL 29 for 0.62 credit

All other positions already have JUL expirations on their Calls. I have included the table below that shows the gain on each position if it should be called out in July.

Spread Account

Word has it that with volatility as ‘high’ as it is now, it’s a great time to sell options. On the other hand, they say we should be careful about selling Calendars since a reduction on volatility will hammer the far month long option premium, which I have seen happen a few times. Mostly, though, I think it’s splitting hairs. My experience with volatility collapse has been with holding Calendars through earnings and watching the trade go flat or maybe a slight loss, when the day before it was looking like a mountain of gold. Take PCLN for example. No, don’t! I don’t even want to talk about that right now (or maybe never).

If collapsing volatility is a concern, then Butterflies are a possible solution. You can do the same thing with them as you do with Calendars – do multiple ‘Flys to create a profit tent. Take for instance the possible trade below on AAPL.

The tent looks a lot like a Iron Condor with the exception that the trade is a debit instead of a credit and the risk to reward ratio is much better. In this trade, the risk is $409 but the max profit is $591 at expiration if the price is between $240.84 and $269.89. You can add more Butterflies at other strikes to stretch out the tent a bit more – it will increase our risk and and your reward, but not proportionately (somethin’ for nothin’? No way, Jose!). It’s also a good idea to make these Put Butterflies so you don’t have to worry about your Calls going ITM and getting assigned.

I also wanted to point out the IWM Bear Call I have open right now. Notice it’s a quarterly expiration and will expire on 6/30. It’s a way to add another 4 trades annually on this underlying. Other ETFs that have quarterly expirations include SPY, XLE, GLD and QQQQ. There are others, so check it out if you are interested. There is nothing different about them except the date.

On SPY, DIA, QQQQ and IWM, you can even do weekly expirations now!

“The Chicago Board Options Exchange (CBOE) today announced that on Friday, June 4, 2010, it will begin trading new Weekly options on four exchange traded funds (ETFs) Standard and Poor’s Depositary Receipts (SPY), Nasdaq-100 Index Tracking Stock (QQQQ), DIAMONDS Trust, Series 1 (DIA), and iShares Russell 2000 Index Fund (IWM).”

“New series for Weekly options are listed each Friday and expire the following Friday except that no Weeklys will be listed that would expire during the expiration week for standard options (the third Friday of each month).”

June expiration is looking pretty good. Right now I have $1,618 in the bank and the rest of the open positions in profitable places at this time. I don’t expect any surprises (who does?) and I will have exited them all by Wednesday’s market close. Remember, this is a triple witching month and strange things can happen – so don’t hold past Wednesday.

Good luck.

◄ Jeff ►

Look over on the far right under New Downloads for a video that I made on a live analysis, execution and documentation of an adjustment on Master Card (MA) Double Calendar. The stock price had been hovering around the lower breakeven for the last week, and with the drop in the market today, it made sense to do the adjustment at this time. You can either view it as streaming or download it and store it on your PC.

My Spread Account is doing very well so far this month, especially today with all the negative delta that I am carrying. As you can tell, looking at my open positions, I have 6 Bear Call spreads open. I opened the 6^th on Thursday with a quarterly expiration (6/30) on IWM.

I also opened a single Put Calendar on IBM on 6/2. I had head my head up my butt and only bought one, instead of 5 or 6 like I normally would have. I don’t like to have small positions that I need to monitor, so I will probably exit very soon.

June expiration (on 6/19) is a Triple Witching expiration (the contracts for stock index futures, stock index options and stock options all expire on the same day. Triple witching days happen four times a year on the third Friday of March, June, September and December). Count on most of the week being very volatile. If you have any trades that expire this month, it’s a very good idea to exit them either the week before or early expiration week. I will. It also frees up capital for the JUL expiration.

Conservative Account

I took my lumps on NOK and took a loss of $276. I did pick Altria Group (MO) as its replacement for several reasons: revenue growth of 25%, dividend yield of 7%, $813B in cash, and $20 stock price has been a key support area for several years. So I bought 300 sh for 20.25 Friday. I was in a bit of a hurry since the Div Ex date is 6/10 and I wanted to collect that 35¢ dividend that would bring the cost basis down to 19.90 when it pays on 7/9. I didn’t sell any Calls because I want to wait until the price gets above $21 before I make a decision.

Just as an FY, I get all of the fundamental data I use from two web sites:

• Dividend information from: http://dividendinvestor.com/
• Fundamental information from: http://ycharts.com/

Market Comment

Lovin’ it, man! VIX above 30 and an apparent range-bound market with wild ups and downs. Were you looking for a prediction? Not usually from me. Sorry.

◄ Jeff ►