BDH has two options, maybe, for the first month and very little open interest... 4 and 5 contracts and huge spreads...not worth looking at...no LEAPS either.
Rather than shifting to the second string ETF I looked at the underlying holdings that represent stocks from the sector in this ETF. About 20. I picked 6 that were priced around $5 to $20 just to keep a larger range of possible options and to stay out of the penny stock range.
ALU, SWKS, QCOM, GLW, CIEN, BRCM
Running these on a performance comparison yields SWKS as the clear winner.
SWKS closed at $13.84 today, in mid-March it was under $8 ($7.75). For interest sake running a single trade on March 12th to September 27th again would yield a $13.25 price... $5.50 gain or 71%. Not bad... running four scaled trades is an ACB of $8.88, $4.37 at 400 shares makes $1748 or 49.2%.
So it is a cheap trade on it's own but I want to get it even cheaper...so into the option chain.
At today's price the options are at strikes of 2.5 to 25 in 2.5 increments. The open interest is between 5K and 15K, lots of liquidity near the money. Buying close to the money but still out of the money today would cost 35 cents at 15 strike and $1.70 at 12.5. As the price is near the mid line I expect that ATM might be in the $1 range.
Assuming that back on March 12th puts the ATM calls at 7.5 and the stock price at $7.75. The call is only 25 cents ITM so make it a $1.25 option for the next month... 40 or so days to expiry.
Buying the options a month at a time and only counting intrinsic appreciation (extrinsic becomes a cost) the first option (April expiry) would be worth $1.50 at expiry. After costing$1.25 that makes a 25 cent gain... Considering that the ROI on that is actually 20%. Not bad but no commissions are counted AND if the stock price does not go up the $1.25 is a loss.
I think that these sector BPI moves are pretty long term so I would need to go way outside to be able to hold a single option trade for this time frame.
Enter the LEAP.
January 2011 expiry today would cost about $3 for ATM options. Seeing as my stop loss for a stock trade is likely to end up being $3 per share this is in line for a Maximum Loss Allowance. Had I bought a LEAP in March at that price...or so... the intrinsic value would have been up by $5.25 and I would be down by about $1.20 of the extrinsic value. Total gain of about $4 ($400 per contract). Total ROI of 133%.
The key for LEAPS would be to roll them over while they still have some extrinsic value, 3 months out, and take the gains, buy the next LEAP in the same or perhaps in a better performing stock or ETF.
The cost is always going to be the lost extrinsic value but the ROI on a per trade basis is large and profits can be taken while buying back into the same stock options at a cost similar to the very first trade... that is something that cannot be done with a stock or ETF.
A side note worth mentioning is that at a $3 initial option cost and a 1 year plus timeframe on the LEAP I could set a stop loss at $1.50 in order to keep my MLA lower and allow me to double my position sizing. Using the example a 2 contract trade costing $3 per share would put the trade at $600 stop loss at $300. End profits at $800. Scaling in I won't try to figure out but it would increase the absolute dollar return and depending upon how it all gets executed, realized gains will be had along the way.
I really just need to get working on a live trade for this. The only trouble is that, while I can have trades on all the time, I was not planning on starting with bear trades AND I am not at a prime entry point on any one sector that I have prepared. I also am torn between trying to keep it simple by using only S&P500 sectors vs using the Investors Intelligence 46 sectors...even though it makes sense to do, it will take more work.
Jeff.
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