Date Published: 2017-02-28
PREFACE
With the market at all-time highs there may be some discomfort in betting that the market will rise — but, given the immensely strong earnings in the mega caps like Facebook, Apple and Alphabet, perhaps the best bet is simply position ourselves to profit from the stocks not collapsing.
It turns out we can do that, and it has worked very well.
FACEBOOK
Facebook turned in blowout earnings last quarter, so there is reason to believe that in might have found a strong base. Now, here’s what we can do.
Selling an out of the money put spread is essentially a bet that a stock won’t go down a lot. The questions become:
(1) Does it make a large profit?
(2) When do we do it?
(3) How do we limit risk.?
All of those questions have magnificent answers when we are clever. Here go.
SHORT PUT SPREAD
If we sold an out of the money put spread in Facebook over the last three-years, every week, these were our results:
We can see a 348% return with 115 winning trades and 41 losing trades, or a 73.7% win-rate. We have proven the idea – but now we need to adjust for risk.
Next, we can look at how this exact same strategy did, but we can avoid earnings. That is, never hold any option position during earnings — just skip it altogether.
We can see that the return has risen from 348% to 366%, but that misses the point. We have just taken a massive amount of risk out of this strategy, and we see better returns. But, there’s more we can do.
Let’s turn to a six-month test of this strategy, first looking at avoiding earnings (left) versus earnings (right):
Focusing on the short-term results we can explicitly see how dangerous earnings have been, and how much risk we save by avoiding it. But there’s one last step for the highly intelligent trader.
Selling a put spread can carry a lot of risk — even if we avoid earnings. The loss on any given spread can actually be much larger than 100%. So, let’s explicitly cap the risk by putting in a stop loss at 200%.
All we’ve done is put a rule in that reads, if a certain put spread during the week hits a 200% loss, we just close it, and trade the next week — we do not hold a large losing position. Here are the results:
We can see a 107% gain in 6-months, and we have eliminated the risk of earnings, and capped our loss in any one week. Now we can answer rather explicitly:
Betting on a mega cap not going down has been very profitable, it can be adjusted to take less risk, and that risk reduced implementation has been even better.
We’ve just seen an explicit demonstration of the fact that there’s a lot less ‘luck’ and a lot more planning in successful option trading than many people realize. It really is easy, and really does matter. Here is a quick 4-minute demonstration video that will change your option trading life forever — it shows you how to do this any time you like and shows the results of doing this with Apple Inc (NASDAQ:AAPL):
Tap here to see the analysis in action
Thanks for reading, friends.
The author has no position in Facebook Inc (NASDAQ:FB) and is long shares of Apple Inc (NASDAQ:AAPL) at the time of this writing.
Risk Disclosure
Trading futures and options involves the risk of loss. Please consider carefully whether futures or options are appropriate to your financial situation. Only risk capital should be used when trading futures or options. Investors could lose more than their initial investment.
Past results are not necessarily indicative of future results. The risk of loss in trading can be substantial, carefully consider the inherent risks of such an investment in light of your financial condition.
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