Writing Covered Calls Is Stupid

Dear Terry -   

 

Writing covered calls is a stupid way to maximize investment returns.

 

More than a dozen websites advocate writing covered calls as a sound investment strategy.  Thousands of subscribers pay millions of dollars to get advice on profitable covered calls to write.

 

I believe they are wasting their money.  Writing covered calls only limits the potential gain you might enjoy.

 

Letís take an example.  You buy 100 shares of XYZ for $80 and write (sell) an at-the-money two-month call ($80 strike price) for $4.00.  If the stock stays flat, you will earn 5% on your money for the period (plus collect a dividend if there is one).  If you can do this six times a year (write a 2-month call 6 times), you will earn 30% annually (less commissions); or so goes the promise. 

 

That is the maximum amount you can earn.  No matter how high XYZ goes in price, you can never earn more than 30%.  And the bottom line truth is that you will NEVER earn that 30%.  The reason is that no stock price ever stays the same.  If the stock goes up by $5 in the first sixty days, you will either lose your stock (through exercise), or more likely, you will buy back the call you wrote, paying $5, and losing $1 on the call (but making $5 on the increase in the price of the stock).  So for the first 60 days, you actually made a 5% net gain.

 

Presumably, you then sell another 60-day at-the-money call (now at the $85 strike) and collect perhaps $4.25.  Then the stock falls back to $80.  Your gains on the calls you wrote now total $3.25 for a 120-day period (you lost $1 in the first period and gained $4.25 in the second).  The stock is flat (just what you hoped to earn your 30% for the year). 

 

At this rate, your annual return will be $9.75, or 12.2% on the original $80 stock.  Commissions on six sales of calls over the year will considerably reduce this return - to 10% or so.  Not a bad return, but certainly not 30%.  And itís an awful lot of work for a 10% return.

 

What is even better than writing covered calls?  My 10K Strategy, of course.  This strategy can make over 100% a year in good years and bad.  It involves buying long-term options (usually calls), and selling short-term options against them (most of the time being careful not to sell as many options as you own).

 

At the beginning of 2003, I put $10,000 in an account to demonstrate how my 10K Strategy worked.  I decided to invest exclusively in the NASDAQ 100 tracking stock (QQQQ) to avoid the difficult decision of picking the right stock.  I told Terry's Tips Insiders every trade I planned to make before I made it so they could mirror my trades if they wished.

 

By the end of the year, the account had grown in value to over $29,600, an incredible increase of over 196%.

 

Has anyone ever made 196% in a single year by writing covered calls?   I donít think so.  But every single person who followed my advice in 2003 made 196% with my 10K Strategy (the same strategy I used, with a few tweaks, to make over 200% on Fannie Mae while the stock fell by 8.6%).

 

This same strategy earned an average annualized gain of 103% for 8 actual portfolios we offered in 2005. Results were not as extraordinary in 2006, but any subscriber who mirrored all our portfolios would have gained over 44%.

 

If you donít want to mirror my trades (it does take a little effort), you can have your broker make the trades for you through their Auto-Trade program.  More details on these programs coming soon.

 

I invite you to learn all the details of investing in the 10K Strategy as well as other profitable option strategies that have proved to be more successful than writing covered calls.

 

You have only 2 days, until midnight on Monday, August 25 to take advantage of my special offer - For a one-time fee of only $79.95, you receive the White Paper (which normally costs $79.95 by itself), my special report –"How the 2005 Apple Portfolio Doubled in 4 Months", a $50.00 value, and 2 months of the Terry's Tips Stock Options Tutorial Program, a $49.90 value.  But you must sign on by midnight on Monday, August 25. Select Option #1 and enter Product Code 196.  Click on https://www.terrystips.com/secure/order.php to join.

 

Become a Terry's Tips Insider today, and enjoy a lifetime of extraordinary gains, and forget about writing covered calls forever.  It could be the best investment you ever make.   Terry

 

 

Why IWM could be the Perfect Stock for Option Trading

Why the Russell 2000 (Small-Cap – IWM) could be the Perfect Stock for Option Trading.
The Russell 2000 (IWM) is the most widely recognized index for small-cap publicly traded companies.   The Russell 2000 Index contains the smallest 2000 stocks (based on market cap) held by the Russell 3000.  Because of the small size on its component stocks, it represents only 7% of the value of all U.S. equities.  The average firm carries a market cap of just under $1 billion.

For many reasons, I believe that IWM is the perfect underlying stock for trading stock options:

1) Since I am dealing with the weighted average of 2000 stocks, I am not exposed to the possibility that a single bad news event for one company will cause the value of my holdings to plummet in a single day.  (And I don't have to worry about picking the right individual stock).

2) There is plenty of liquidity in these options (they are more actively traded than just about any other option).  This means that there is a small spread between the bid and asked prices (compared to options for individual stocks), so I will be able to get good prices.  (For most other stocks, there may be only a single market maker trading in those options, and it is rare to get a better price than buying at the asked price, and selling at the bid price.

3) There are strike prices at each dollar increment for IWM, giving me far more flexibility than is possible with other stocks having strike prices $5 or more apart.

4) Options trade in penny increments.  Most options trade in $.05 increments if the price is under $3.00, and $.10 increments if over $3.00.  Starting in 2007, IWM and a handful of other options began trading in penny increments.  This means that transaction costs are often significantly less when trades are made.  Since you usually have to pay the asked price when you buy an option, and it is immediately worth the bid price (since that is what you could sell it for), every trade includes what we call a bid-asked-spread-penalty.  With IWM, this penalty is usually considerably less than with most other options.

5) The component companies of the Russell 2000 are changed on a regular basis.  Once a year, the selection of companies changes.  Weaker companies are taken off the list, and stronger companies added to it.  Assuming that stronger companies continue to improve, and weaker ones continue their downward pattern, the net effect of these adjustments causes an upward bias to the performance of IWM.

6) According to several CPA's I have spoken with, options on IWM, (as well as QQQQ, DIA and SPX) are considered to be Section 1256 equities (although they are not specifically mentioned in the statutes).  If so (and the IRS has told these CPA‚s that they are indeed 1256 equities), special tax advantages are available. No matter how long you own an IWM option (even for one day), 60% of your profits are considered to be long-term capital gains, and taxed at a maximum of 15%.  Furthermore, the options may receive mark-to-market accounting treatment which means you do not have to match up each option purchase and sale when preparing your tax return.

For many years, I believed that the best underlying stock for option trading might be QQQQ, the tracking stock of the NASDAQ 100 - the 100 largest non-financial companies traded on the NASDAQ. Microsoft is the largest of these companies (and makes up about 11% of the average).  

However, there are several reasons why IWM is even better than QQQQ.  The absolute price of IWM is about double that of QQQQ, option prices are generally higher, and IWM has out-performed QQQQ over the past several years.  Even more importantly, from my personal experience, QQQQ has fluctuated in both directions more than IWM has, and such fluctuations are what give the 10K Strategy the most difficulty.

We have also had excellent success with another index-tracking type stock – Oil Service Holders Trust (OIH) which has many of the advantages of the better-known indexes (e.g., IWM and QQQQ) but excluding the possible tax advantages, and also enjoys even higher option premiums.

The OIH index is made up of 18 companies serving the oil industry – drilling, exploring, repairing rigs, etc.  We have carried out three 10K Strategy portfolios using OIH as the underlying in the last three years, and each one has gained 70% annualized.

An investment marriage made in heaven –OIH and the 10K Strategy.   In combination, I believe that they will provide extraordinary annual returns for many years.  The 10K Strategy has been my bread-and-butter strategy for more than two decades.  You have seen how it worked with Fannie Mae, and I will show you how we used it to make 196% with QQQQ in 2003, and how we doubled our money with Apple Computer in 2005 in only 4 months.

I have made a good living using this strategy, year after year.  Now I want to share that strategy with you.  If you respond in 3 days, by Monday, August 25 , you can take advantage of my special offer:

Become a Terry‚s Tips Insider, pay only $79.95, and receive my 72-page White Paper which explains my favorite option strategies in detail with complete Trading Rules for each, including the 10K Strategy that earned over 200% with Fannie Mae in a single year, and get all these benefits absolutely free.

1)    My special report, "How the 2005 Apple Portfolio Doubled in 4 Months," with every trade itemized, and an explanation of how it was made in accordance with the Trading Rules for the 10K Strategy – 23 pages of valuable real-time option trading advice, a $50.00 value in itself

2)    Two free months of my Stock Options Tutorial Program service (a $49.90 value).

3)    Weekly updates on several actual portfolio accounts with every trade ever made in each one. Each account is a real-time unfolding of one of the basic strategies developed in the White Paper.  Different underlyings or investment amounts are used for each portfolio

4)    If you would like, I will email you with every trade I make in each of these accounts, so you can make those same trades yourself if you wish, maybe at even better prices.

To take advantage of this Special Offer, you must order by midnight on Monday, August 25.    Select Option #1 and enter Product Code 196.  Click on https://www.terrystips.com/secure/order.php to join.

It may be the best investment move you ever make – for less than 1 share of IWM.  Think about it.  Terry

Picking the Right Stock is One Tough Job

Picking the Right Stock Is One Tough Job

 
Picking stocks is more an element of art (or luck) than it is a science.  As some sage once noted, it is extremely difficult to make predictions, especially when they involve the future.
 
I would like to share a personal experience I had a couple years ago.  At the beginning of 2004, I created an Auto-Trade portfolio for people who believed the market might crash.  I set out to find three or four companies that were hopelessly overvalued or otherwise expected to fall in value.  Once I found these companies, I planned to place option positions using puts that would escalate in value as the stock prices fell.  This way, the portfolio could be expected to make money in a general market crash, or when these individual companies fell to their "true" value.
 
I read dozens of articles looking for dogs.  I checked to see what the analysts were recommending to sell short.  I read a dozen investment newsletters looking for overvalued stocks. Two magazine articles were particularly noteworthy – each asked four top analysts to select the one stock they would sell short, and to give their reasons why this one stock was sure to plummet in price. These guys were real experts – they had to have outperformed the S & P 500 for the prior year even to be considered for the survey.
 
Two of the analysts picked RIMM (a Canadian company that makes the BlackBerry paging device), then selling at $40. "Hopelessly overvalued", one analyst noted – "true value about $15".  Eight months later, RIMM was selling for almost $160 and a 2-for-1 stock split took place.   Investors who had taken these analysts‚ advice would have lost almost 400% on their money.  (It is really hard to lose over 100% of your investment, but you can manage it if you sell short).
 
Anther popular pan was Dillards Department Stores (DDS). "They can't compete with K-Mart or Walmart on price, or get the margins of more upscale stores," one analyst opined.  While most analysts rank companies as "strong buy", "buy", or "hold" (which is generally a euphemism for "sell"), an amazing 70% of analysts rated DDS as "sell" or "strong sell".  I have never seen such a universal condemnation of a company like this. Over the next eight months, while the market fell 8% or so, DDS rose by 50%.  So much for these analysts.
 
Another company many "experts" disparaged was EBAY.  They pointed out that EBAY's (forward) price/earnings ratio of 120 was ridiculously high.  Some analysts calculated that if EBAY had expensed employee stock options as they should have, the company would never had shown a dollar of profit in its entire existence.  Over the next eight months, EBAY rose by over 25%.
 
I had selected all three of these companies proclaimed as "dogs" by the experts for my Cover Your Butt Strategy portfolio, and set up positions so that we would prosper if these companies fell in price and break even if they stayed flat. Only in the unlikely event that they went up in price would we lose money.  Of course, we lost money.
 
I am now convinced more than ever that it is pure folly to try to succeed in the stock market by picking the right individual stocks, especially if you are trying to find ones that will fall in value.

 
Selecting good stable stocks is so difficult that one alternative is not to pick a stock at all, but to use an index as the underlying.  Three of my favorites are the Dow Jones Industrial Average tracking stock (DIA),  the Russell 2000 Small Cap (IWM), and the ETF Oil Services (OIH).
 
Even though the option premiums are also very low in DIA, we have created our most conservation portfolio using DIA as the underlying - which is made up of 30 very large and established companies in a variety of industries, each paying a dividend. It tends to be more stable (less volatile than most individual stocks).  This portfolio has gained over 26% every single year for the nearly-three years we have conducted it, even in 2005 while DIA fell slightly for the year.  
 
In 2005 and 2006 we have had excellent success using an ETF, Oil Service Holders (OIH) as the underlying.  This index is made up of 18 companies serving the oil industry – drilling, exploring, repairing rigs, etc.  Our 10K Oil Services portfolios gained over 100% annualized in 2005, and a third OIH portfolio has made good gains in 2007 as well.
 
If you would like to learn about a great way to make 50% to 100% a year without picking the right stock, you only have 4 days left, until Monday, August 25 to take advantage of my special offer:
 
Become a Terry's Tips Insider, pay only $79.95, and receive my 72-page White Paper which explains my favorite option strategies in detail, including complete Trading Rules for each, including the 10K Strategy that earned over 200% with Fannie Mae in a single year, and get all these benefits absolutely free:
 
1)    My special report, "How the 2005 Apple Portfolio Doubled in 4 Months," with every trade itemized, and an explanation of how it was made in accordance with the Trading Rules for the 10K Strategy – 23 pages of valuable real-time option trading advice, a $50.00 value in itself.

 
2)   Two free months of my Stock Options Tutorial Program service (a $49.90 value).
 
3)   Weekly updates on several actual portfolio accounts with every trade ever made in each one.  Each account is a real-time unfolding of one of the basic strategies developed in the White Paper.  Different underlyings or investment amounts are used for each portfolio.
 
4)   If you would like, I will email you with every trade I make in each of these accounts, so you can make those same trades yourself if you wish, maybe at even better prices.

To take advantage of this Special Offer, you must order by midnight on Monday, August 25. Select Option #1 and enter Product Code 196.  Click on https://www.terrystips.com/secure/order.php to join.  
 
Why wait until the last minute to start your program for making extraordinary gains every year without even having to think about picking the right stock?  Do it today.  I‚m quite sure you will be glad you did.  Terry

Flat Markets Ahead -  What Should You Do?

Dear Terry - 

This letter has two messages: 

1)    There is strong evidence that there will be a flat market for the next few years, and

2)    I have developed a stock options strategy that can make 50% - 100% or more in a flat market.

I’m sure you have heard of Warren Buffett, the Oracle of Omaha, the man who has turned a $10,000 investment in 1965 when he took control of Berkshire Hathaway to over $50 million today.  In comparison, a $10,000 investment in the S&P 500 in 1965 would be worth about $500,000 today.  No wonder he is widely called the greatest stock market investor of modern times.

When Warren Buffett says that he thinks we are due for a market that will essentially be flat for ten full years, I, for one, pay attention.

Writing in the October 4, 2004 issue of Forbes, Rich Karlgaard said “Suppose Warren Buffett is right about the market's being under house arrest for another ten years.  If Buffett is correct, forget indexing. Forget buy and hold. If you want to achieve boffo returns, you'll have to adopt one of three methods: pick tomorrow's superstars, time the market or time prices”. 

There is another method, one that is far more likely to succeed than these three choices, at least in my opinion.  It is the 10K Strategy that has achieved 100%+ returns in many years while the market was flat.  Read on.

The Value Line Projection - Four Years of a Flat Stock Market Predicted 

One of the most accurate of all long-term market-timing models is the one based on projections from analysts at Value Line for price changes over the next three to five years for the 1,700+ stocks they monitor. While their short-term forecasts have not been particularly accurate, their longer-term predictions have been remarkably on the money for over 30 years.

Directly after the 9/11/01 terrorist attacks, many investors were pessimistic about the stock market. But those who followed the Value Line indicator (then at 105, the highest in a decade) were rewarded by a 20 percent cumulative gain over the next three years. 

In the summer of 2004, however, the indicator had fallen to 50, an extremely low level. Over the last 36 years, in fact, the reading has been this low only 11 percent of the time.

Why are the Value Line 3-5 year projections so accurate? First, their analysts are independent, immune from the pressures that can be found in research departments associated with investment banks and brokerage firms. 

Second, few other firms besides Value Line even bother to focus on what will happen in three to five years, concentrating instead on just the next 12 months.

Third, the large number of stocks they cover means that random errors in individual stocks become insignificant. (The indicator is the median projection of almost 2000 separate forecasts). Analyst errors on individual stocks tend to cancel each other out. 

So what is the best strategy for a flat market?

If the Value Line and Warren Buffett predictions hold true, how do you expect to earn decent returns on your invested capital over the next four years? Even if you own Index mutual funds (which outperform the huge majority of other mutual funds), you can’t expect to be very much ahead of where you are right now.

Most investment magazine articles (like the one cited above) recommend that you try to pick the few stocks that will go up even if the market in general goes nowhere.  Of course, when you try this method, you are competing with the smartest professionals, the guys with essentially unlimited resources.  Even these guys can’t beat the indexes.  Year after year, over 85% of mutual funds under-perform the indexes, as we all know. 

In his wonderful book, Winning the Loser’s Game, my classmate Charles Ellis pointed out that only in the investment world do rank amateurs believe they can outwit and outperform the professionals. 

He compares this situation to professional tennis where 80% of the points are won when a player hits a winning shot, while in amateur tennis, 80% of the points are won because a player makes an error.  Professional tennis is a winner’s game, and amateur tennis a loser’s game. 

We understand that we wouldn’t have a chance against a professional tennis player.  But somehow, we think we can (in our spare time) beat a professional investment advisor even though he or she has superior education, training and research resources, and gives it full-time attention.

I think it is a loser’s game to try to pick winning stocks.

Over the past 25 years, I have developed an investment strategy using stock options that does best in a flat market.  As you saw in the Fannie Mae report, I made over 200% in a single year while the stock stayed flat (actually, it fell a little over 8%, and I still made that return).

In 2003, I employed my 10K Strategy on QQQQ for all Terry’s Tips Insiders to follow (and mirror if they wished).  I opened an actual brokerage account with $10,000 which was available for them to examine any time they wished.  At the end of the year, the $10,000 had grown to over $29,600, a 196% gain.

I believe that annual gains of 50% - 100%, or more, are possible using my 10K Strategy, especially in a flat market.  I have done it many times in the past and expect to in the future, especially if Warren Buffet and Value Line are right.

We all know that there are thousands of get-rich-quick investment scams circulating on the Internet.  Most of them are just that - scams. 

I am not a neophyte investor.  I graduated from the Harvard Business School.  I have a Doctorate in Business Administration from the University of Virginia.  I have held a seat on the Chicago Board Options Exchange (CBOE).  I have traded on the floor of the CBOE.  For over 25 years, I have bought and sold options virtually every trading day.

I have been so successful trading stock options that I have given away over $365,000 a year (my goal is to average $1,000 every day) to mostly Vermont charities for the last four years. Click here - http://www.terrystips.com/charity.shtml to see a complete list of the charities I have supported.

So here’s the offer - As a new Terry’s Tips Newsletter subscriber, if you sign up for Insider Status within 5 days, by Monday, August 25 2008, I will send you my White Paper which explains all my option strategies in detail, including  the Trading Rules for each strategy.  But that’s not all.

In addition to all the benefits of a Terry’s Tips Insider, I will send you my special report entitled “How the 2005 Apple Portfolio Doubled in 4 Months” which shows every trade and an explanation of why it was made according to the 10K Trading Rules. 

To be honest, some of the strategies are a little complicated, and require a good understanding of stock options.  For many investors, these strategies are worth the extra effort to learn.  How else could you expect to make 50% or 100% or more in a single year in a flat market?  By picking winning stocks?  I doubt it. 

If you do not want to learn these strategies for yourself, as a Terry’s Tips Insider, you can have them Auto-Traded in your account by one of several brokers.  Full details will be sent to you soon.

By gaining Insider Status to Terry’s Tips, you learn about all these strategies for a total price of $79.95.  If you act by Monday, August 25, you will also receive my special report, “How the 2005 Apple Portfolio Doubled in 4 Months,” with every trade itemized, and an explanation of how it was made in accordance with the Trading Rules for the 10K Strategy.

In addition, if you sign up for Insider Status within five days, you will receive two free months of my Stock Options Tutorial Program service (a $49.90 value).  As part of this program, I maintain at least 8 actual trading accounts that are updated for you each week.  Each account employs one of the basic strategies I describe in the White Paper using different underlying stocks or indexes.

By looking back at earlier editions of the Insider’s weekly Saturday Report, you can see every trade ever made in each of these accounts and follow their progress as the stock price changes over time.

Going forward, I will email you with every trade I make in all of the accounts so you can make those same trades yourself if you wish, maybe getting even better prices than I do.

You will receive all this for only $79.95 - a great investment which will benefit you for years to come. 

But to earn these savings, you must order within 5 days, by midnight on Monday, August 25 Sign up today at https://www.terrystips.com/secure/order.php.  Select Option #1 and enter “196” as the Product Code to get the Special Report for FREE.  It may be the best investment decision you ever make.

I look forward to having you on board.  Terry 

P.S. You might also consider Option #2 which is our Premium Service that includes everything in Option #1  plus real-time Trade Alerts and the ability to Auto-Trade these alerts with many brokers. 

Free Options Strategy Report

Thank you for subscribing to Terry's Tips FREE Newsletter.  Attached is the Special Report I promised.  Happy reading!

Terry

Click here to unsubscribe

Terry's Tips Portfolio August Expiration Report

All Six Portfolios Make Great Gains! The first expiration month using our modified 10K Strategy was a resounding success. In spite of devoting up to half of the entire portfolio value to an exotic butterfly spread that only provided insurance against a big market drop, substantial gains resulted in every portfolio.

The portfolios gained an average of 4.5% after commissions for the expiration month. That works out to be 54% annualized, far more than we expected. We had hoped for a 4% gain in those months where no adjustments were necessary. This month our gains exceeded this goal, and adjustments were made in every portfolio because it was a volatile month, with several market swings in both directions.

The Oil Services portfolio was the best example of the value of butterfly spreads. The underlying OIH fell by 11.3% for the month. In the past, this kind of volatility almost always resulted in large losses. This month, after the addition of a large number of butterfly spreads on the downside, the portfolio managed to gain of 6.4% in spite of the strong slide in the stock price.

Maybe we have indeed created an options strategy that never loses money. That is the ultimate goal of our modified strategy, and the first month's record was most encouraging.

The portfolios that had the greatest gains were the two that had been established before July - Mini-Russell (up 12% for the month) and Oil Services (up 6.4%). The four portfolios that were started in July had to cover the bid-asked spread penalty of a new portfolio, and the final results understate how well they did. Three of these portfolios were in existence for only 23 days, hardly enough to qualify for a month's results.

The lowest-gaining portfolio for the month, Mighty Stalagmite (up 2.6%) would cost about $10,560 to replicate now. This means that a fairer estimate of the gain was probably closer to 5%, and this was our worst-performer (largely because we made several adjustments that were later reversed).

Annualized Portfolio Gains for the August Expiration Month:

Mini-Russell (IWM) - up 144%

Oil Services (OIH) - up 77%

Durable Diamond* (DIA) - up 92%

Building BRIC* (EEM) - up 62%

Rising Russell* (IWM) - up 37%

Mighty Stalagmite (SPY) - up 31%

*Based on three week's results averaged over a year

You can see every position and every trade we made in each of these portfolios by becoming a Terry's Tips Insider - sign up HERE.

Next week we will discuss the economics of using what we call an exotic butterfly spread for downside protection.

Stock Option Trading Idea of the Week - August 11, 2008

Favorite Suggested Books for the Conservative Options Investor

I am often asked about my favorite books on investing (other than my own Making 36%: Duffer's Guide to Breaking Par in the Markets Every Year, In Good Years and Bad).

Here is my list of favorites:

McMillan on Options, by Lawrence G. McMillan, (New York: John Wiley & Sons, second edition, 2004). This is generally accepted as "The Bible" on options. It is fairly expensive and the text is ponderous for most people, but everything is there.

Options Plain and Simple, by Lenny Jordan. (London: Prentice Hall, 2000). One of many books which describe just about all the option strategies with some good advice as to which ones work under which conditions. Much lighter reading than McMillan on Options.

Winning the Loser's Game, by Charles D. Ellis, (New York, McGraw-Hill, 4th Edition, 2002). While this is not about options per se, it is just about the most sensible book I have ever found that discusses stock market investments in general.

The Little Book That Beats the Market, by Joel Greenblatt, (New York, John Wiley, 2006). Again, this book is not about options, but is perhaps the best book written in the past several years about how to select individual stocks.

The Little Book of Common Sense Investing, by John C. Bogle (New York, John Wiley, 2007), Another book which is not about options, but I challenge anyone to read this book because if they do, I believe there is no way they would ever buy a mutual fund again (except a no-load broad market index fund).