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Archive for January 22nd, 2011

Deep OTM NP Strategy – January Results

Posted by mounddweller on January 22, 2011

Fellow Traders,

It was a ‘so-so’ month for our Deep OTM NP Strategy.  Certainly it was not an auspicious start for 2011 nor for the beginning of posting this trading strategy on my blog.  Enough of the lamenting let’s get on with reviewing the results.

This month we had 27 trades in our strategy to choose from.  After the market close on Friday (1/21), 23 of them closed OTM.  That’s a success rate of 85%.  Certainly not bad given the types of stocks that meet our trading criteria.  In the current market environment most of our trades involve small and mid-cap stocks with less than stellar fundamentals.  However, it is not nearly as good as the 96% success rate I was experiencing last year before I began publishing my results.

Had you chosen to sell puts (using the capital allocation plan I outlined in an earlier post) on all 27 selected trades this month it would have required a capital balance of $175,925.  Remember, this assumes you are trading in a tax-advantaged retirement account which does not allow the use of margin.   Doing so would have generated total premiums of $2,756.60 (net of commissions).  This equates to a 1.57% ROIC, which is 16.82% annualized.

But wait, you say, what about the losers?  Yes, my friends we have to account for our capital losses.  We had 4 trades that finished ITM.  On Monday we will have to purchase these 4 stocks.  They are PSDV, LPHI, SVU, and CREE.  Assuming we did nothing to mitigate our losses by either (1) buying to close the puts at the first sign of trouble, or (2) holding the stock after assignment and possibly selling CCs against it, our total capital losses (based on Friday’s closing prices) would equal $2,764.80.  The net result (premiums plus capital losses) would be a very small loss of $8.20.

However, as I mentioned above we have several options (pun intended) available to us to mitigate that loss and perhaps we could have ended the month with a significant gain had we proactively managed the trades.  Let’s look at each of the four losers and see what our best course of action might have been.

First up, let’s look at PSDV.  We sold 10 JAN $5 puts back on 12/19/2010 when the stock was trading at $5.70.  It closed Friday at $4.53.  This left us with a capital loss of $0.47/share or $470.00 on 10 contracts.  However, we had plently of time to recognize the trade was in trouble and could have avoided the loss by not holding the contract to expiration.  The stock gapped down on 12/27.  Over the ensuing 3 1/2 weeks we would have had many opportunities to close the trade with a small loss or possibly even a profit.  Alternatively, we could have chosen to take assignment and hold the shares until they get back above $5.  It’s not unreasonable to assume this could occur over the course of the next week.

Next is LPHI.  Unfortunately, there wasn’t much opportunity to avoid this sizeable loss.  The stock dropped almost $2.50 on 1/20, just one day before expiration.  Given the significant gap between the closing price on Friday ($11.82) and our strike price of $14.75 there also appears to be little sense in waiting for an uptick in price before selling the stock.  In this situation in my opinion the best course of action is to just suck it up and take the loss by selling the shares on Monday.  This trade represented the bulk of our capital losses ($1,473.95 of $2,764.80).

Our third loser was SVU.  Recall on 1/7/2011 we sold 10 JAN $7.50 puts on SVU.  SVU was trading at $8.66.  Friday it closed at $7.33.  SVU gapped down on 1/11/2011 closing at $7.59.  Again, like PSDV, we had a couple of weeks to get out of this trade if we wanted to.  Even if we hadn’t we still aren’t in a bad position.  Having closed only $0.17 below our strike price it is very likely we will have been able to sell it above $7.50 at somepoint on Monday.

Our last loser was CREE.  On 1/14/2011, with the stock at $63.77, we sold 1 JAN $57.50 put.  On Friday the stock closed at $51.26.  It had gapped down earlier in the week, falling from $62.71 to $53.63.  Their really wasn’t a good way to avoid this loss.  However, we could have lessened the size of the loss by buying to close our puts when the stock gapped down on 1/19. 

Well, there you have it my friends.  I’ll be back later this weekend with another post to announce the first round of February selections in our Deep OTM NP Strategy.  I’d be interested in hearing if anyone selected any of the picks from my strategy in January.  If you’d like please post your results as a comment to this message.

Regards,

Troy

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