Last week Gary Smith
penned a piece in which he discussed the importance of reviewing your past picks. Exercises such as these aren't about self-glorification or telling fish tales about the big one you almost landed -- quite the opposite, in fact. As Gary pointed out, the real benefit comes from identifying mistakes and hopefully learning from them.
Following Gary's example, I thought it was time to conduct a review of my own. One difference between Gary's review and mine is that because some of the options positions I've written about are still open, I'll focus on how those are performing and decide whether any adjustments need to be made. I'll also provide a quick review of some closed positions and the lessons that can be gleaned.
Before getting into the specifics, some general observations can be made. Over the past few months I've suggested a dozen different strategies. The overall performance has been profitable. Four positions realized maximum, albeit limited, profitability, two expired as a wash, one incurred a 1% loss, and six positions remain open and are all providing a chance for profitability. Given the incredibly treacherous and volatile nature of the market, I hope the limited risk/reward scenarios I've presented will work to dispel the belief that options are incredibly dangerous investment tools.
"The biggest misconception about options is they are viewed as risky," says George Fontanills, a co-founder and president emeritus of Optionetics. "The biggest mistake made using options is they are used in a risky manner. People should look at their portfolios and realize they can be recreated for a lower cost, lower risk, using options." Fontanills also runs the Pinnacle Appreciation Fund, an all-option hedge fund recently closed to new investors.
Mulling Our Options
A great example of how options can offer a more conservative approach to building a position is the pairs trade.
My suggestion was to get long
by purchasing its May 25 call and shorting the
April 40 call. The position was established in November for a 55-cent credit when Home Depot was trading at $25 and Lowe's was at $39.
Even though my thesis has been wrong so far, with the spread between Home Depot and Lowe's widening from $14 to $16, the option position is currently showing only a 30-cent loss. But now, with just one month remaining until the short Lowe's calls expire and two months remaining in the long Home Depot calls, the position's leverage is squarely in our favor. The risk of Lowe's running much further than Home Depot diminishes as the clock ticks.
A similar example in which the desired move hasn't yet played out, but where the position's risk/reward keeps improving, is
the calendar spread for homebuilder
. On Nov. 13, with the stock at $51, my example involved buying the May 45 put and selling the December 45 put for a net debit of $3.35. The notion was that the stock would work its way lower over the next six months.
A key element to this strategy was that if the stock stayed above $45 as the near month expired, we would roll the short puts into the next nearest month, thereby reducing the cost of the long May puts. Lennar has traded between $48.20 and $57 since then. Unfortunately, the dips didn't coincide with option expiration. So unless you had extraordinary timing, you would've been selling the January, February and March 45 puts with the stock at an average price of $53, receiving about $1 for each put.
Still, that means we've taken in another $3 in premium, bringing the cost of the May puts down to just 55 cents. With Lennar trading at $53, one can sell the April 45 put for 80 cents, and that makes this a no-cost proposition.
Nailing down a reasonable oil strategy was a bit of challenge. So far the
idea of selling the bearish April call spread against selling a bullish June put spread is working. Again, the maximum profit will be realized if April oil goes out under $35 and June oil closes above $31. Considering the volatile nature of the market, I'd stand pat with this position.
Another position that remains open but at the mercy of the market is
the butterfly spread in the
. On the call side, we had the April 850/875/900 butterfly, and on the put side, the April 725/750/775. Each position was established for roughly a $2 debit and afforded a maximum profit of $23. Right now the odds tilt in favor of the S&P landing on 875 come the April expiration. Again, given the limited risk, this is a position where you watch and wait. As expiration approaches, trading off of one side might be possible.
The most recent strategy suggested
selling puts against short stock, which illustrates both the good and the bad of options strategies. Since I put forth this bearish strategy last week, the S&P has rocketed some 7.5%. But as I emphasized in the article, you need to be very particular in choosing which stocks to employ with this position.
The three I mentioned,
Cognizant Technology Solutions
, are all trading lower than the recommended sale price. That's good, and it speaks to the value of technical analysis.
But specifically in the case of Cognizant, which has dropped from $69 to $62, I would have been much better off just shorting the stock and not getting too cute by also selling puts. Though I can take off the position for a profit right now, if I want to realize the maximum gain, I'm stuck until the April expiration.
I also want to address one position that ultimately realized the maximum gain but would've caused incredible pain along the way:
the shorting of the S&P 500 March 825 put for 23 when the index was trading at 845 in early February. Now, with the S&P at 860, it looks like the put will go out worthless this Friday, and we'll collect that premium.
But during this past month, as the S&P broke below 800, the position would have been registering a huge drawdown, to say nothing of the many sleepless nights you would have had to endure. This is a great example of why options work best when you create a limited-risk scenario.
Steven Smith writes regularly for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He invites you to send your feedback to