Thanksgiving Top Trades Review – Using Options To Reduce Risk And Increase Profits

Happy Thanksgiving (almost)!  

We added a new feature last month called Top Trades™ (Members Only) so I thought it would be a good time to see how we're doing as well as give a few tricks and tips to our new subscribers.  Top Trade Alerts are sent out once or twice a week via EMail and Text Message from our Basic and Premium Live Member's Chat Room.  These trades are just a very small portion of what we discuss during chat each day, but hopefully a good representative sample.  Let's see how they performed so far:

We already reviewed our first Top Trade Alert™ in Thursday's post and our first 7 ideas are already up a combined 3.7% for the month but, officially, GSK was the actual Top Trade that day, and it's already up 6.1% for the month – a great way to get started!  Also on Thursday, we checked out out 2nd Top Trade Idea for CAT and, with Friday's 4.27% gain, the stock is already up 9% in a month but, of course, we don't just play boring old stocks at Philstockworld – our option trade Idea was:

As a new trade on CAT, I'd sell the 2017 $80 puts for $7.30 for a very nice $72.70 net entry.  That's more than the $5.60 dividend you'd make owning the stock for 2 years and a 26% discount if put to you.  That's great as a stand-alone play or it can be paired with the $100/115 bull call spread at $5.50 and you still have a net $1.80 credit (so net $78.20 entry – 20% off) but 100% of the upside over $100 for the next two years.  

As of yesterday's close, the $80 puts were $5.70 (up 21.9%) and the bull call spread is now $7.35 for net $1.65 plus the original $1.80 credit is $3.45, up 191% in a month on the option play.  Isn't that more fun than just making 9% on the stock?  

This is what we teach our Members at Philstockworld.  Rather than buying 100 shares of CAT for $97.60 ($9,760) back on 10/23 and making $879 in a month (which is not terrible either), our trade idea could be used to buy, for example, 5 of the spreads for a $900 credit and now, a month later, you have a $1,725 profit.  The short puts used $2,360 in margin plus the $2,750 in cash tied up in the spread vs. tying up $9,760 on the stock and the return is almost double!  

Our next Top Trade Alert went out on October 27th, and that was for USO as we added a position to our $25,000 Portfolio in Member Chat.  We were too early in calling the bottom as USO was at $22.50 at the time and is now $21.36 (down 5%) but our trade idea was the April $28/32 bull call spread at $2.30, which has since dropped to $1.64 – down a whopping 28.7% on the $2,300 spread.

That's how leverage can turn against you - but how bad is it really?  Aside from the obvious note that it's way too early to worry about the position with USO at $29.10 ($1.10 in the money on the spread), the loss on 10 contracts is $660.  Had we instead bought 1,000 shares of the stock for $22,500, rather than spending just $2,300 to control 1,000 shares, we'd be down $1,140 (5%).  

Professor Einstein is absolutely correct – by using options to both leverage AND hedge our position, we actually REDUCED the risk – even though we leveraged the upside.  Our trade required 90% less cash and had almost 50% less downside exposure than the stock did – that's a SMART way to play the markets, isn't it?

By reducing the cash and margin required for each position, we are also able to take a diversified group of positions without putting too much of our cash to work.  As our Members were just reminded last month, it's a really good feeling to have a lot of cash in your portfolio when the market pulls back.  It leaves you very flexible and able to take full advantage of a pullback while other investors are panicking out of their positions.  

Tuesday, Oct 27th gave us a two-fer in Top Trades as we used our 2013 and 2014 (and maybe 2015) Stock of the Year, AAPL once again for a nice, bullish way to make 140% in an up market with the 2017 $90/120 bull call spread at $12.50 per contract.  At $120 in Jan 2017, that trade pays back $30 for a $17.50 profit (140%) for two year's "work."  

The stock was $105.50 that morning and already closed Friday at $116.47, up a very nice 10.4% in 3 weeks but not as nice as the bull call spread, which is now $15.35 – up a quick 22.8% on our leveraged play.  Again it's a stunning difference as it's a high-priced stock as 10 of these contracts cost $12,500 with the potential to make $17,500 and are already up $2,850 in 3 weeks vs buying, for example, $10,550 worth of AAPL stock (100 shares) that would be $11,647 today – up $1,097, less than HALF of what the option play does for you.  

Amazingly, you'll find the spread ALSO loses LESS money on the way down – this is why we LOVE our option plays.  This is also why we love BEING the HOUSE – Not the Gambler:

Now, you can see the tremendous upside potential in options and we're not done with our October 28th Alert yet as we also had a hedge in that post. TZA is an ultra-short ETF that tracks the Russell 2000 and, to help protect our bullish plays, we decided to add 50 of the Jan $15 calls for $1.75 and sell 50 of the Nov $17 calls for 0.42 for a net of $1.33 to our Short-Term Portfolio for a total cost of $6,650.

TZA dropped like a rock since our entry at $15.50 and is now $13.48 (down 13%) and the November calls expired worthless yesterday and the Jan $15 calls have dropped to 0.65, down 51% from our entry.  That's a loss of $3,400 at the moment but we PLANNED for this as it's a hedge and is supposed to lose money in an up market.  Now we need to follow-through and sell the Dec $15 calls for 0.35, covering half of our loss and we'll also invest 0.60 more into rolling the Jan $15 calls to the Jan $13 calls.

That will leave us with the Jan $13 calls and the short Dec $15 calls at a net of ($1.75 – 0.42 – 0.35 + 0.60) = $1.55 on 50 contracts ($7,750), a bit more than what we started with and we are 0.48 in the money on our spread and well-covered for the next 30 days.  That's how hedging works, it's an insurance policy against something bad happening to our longs – the trick is to learn to use the correct proportions relative to the downside risk your overall portfolio is exposed to.  That's something we teach every day over at Philstockworld.  

Not to rest on our laurels, we sent out another Top Trade Alert™ that Tuesday (28th), this time on CLF, which was way down at $9 that day and got cheaper in between but closed Friday at $9.91, up 10% for the month but, of course, we found an even better way to play it with options:

Our trade idea for CLF was to grab 30 of the 2017 $8/15 bull call spreads at $2.05 ($6,150) and to sell 30 2017 $10 puts for $4 ($12,000) for a net credit of $5,850.  That's right, this trade puts $5,850 in your pocket TODAY in exchange for your promise to buy 3,000 shares of CLF for net $8.05 in 2017 (18.7% below the current price).  The margin required for the trade is just $2,500 – much less than the cash it puts in your pocket and the upside potential, at $15, is $21,000 PLUS the $5,850 you already collected or $26,850 – a potential 458% upside.

The option spread is still the same price and I still love this trade idea, even though we closed it out at $10.50 last week in our Income Portfolio but that wasn't about this trade, we cashed in the whole portfolio into the Holidays.  

The last trade idea we'll look at in this review is our first trade idea for November, which came on Monday the 3rd, and was a short positon on EWJ (Japan ETF) as it spiked up to $12.25 that afternoon.  Talk about a PERFECT top call – we totally nailed that one! Already EWJ has fallen to $11.64 and that's +5% on the stock in 3 short weeks – par for the course with boring old stock picks.  

Our option trade idea, however, was to buy 40 of the EWJ Dec $12 puts for 0.25 ($1,000) and already they have popped to 0.47 ($1,880) for an $880 gain in just 3 weeks and, that's right, it's an 88% return on your investment!  If you didn't take the 100% gain off the table, however – shame on you.  We don't turn down 100% gains in less than a month – even if we think we can do better.   There's only 2 Trading Rules at PSW and they are:

  1. ALWAYS sell into the initial excitement
  2. When in doubt, sell half

In other words, we ALWAYS take advantage of big moves in our direction to SELL premium (Being the House) and, when we own a call or put and it jumps in price, that's premium we NEED to sell.  If we have a position with no premium or no position at all – that's when we look to sell some premium.  

Rule #2 is for those times you're felling greedy and making 100% in a month just doesn't satisfy you.  In the very least, SELL HALF – you'll feel like so much less of an idiot later if the stock moves against you and, if it doesn't, you'll still feel really good making 75% of your maximum profit potential.  

That'll be a wrap for our first Top Trades Review.  These are just a very small sample of the kinds of trades we do every single day in our Live Member Chat Room at Philstockworld (which you can join HERE), where we emphasize Smart Portfolio Management Techniques and, of course, how to use stock options to both leverage AND hedge your positions to maximize your profits while minimizing your risks.  

Have a happy holiday,

- Phil

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