Options Trade of the Week

We are nearing the end of the year so it’s time to reflect on what worked and what didn’t. First, credit spreads with durations of around 30 days or more were difficult. But, as I have been stating for roughly six months, the next bull market will be in volatility and when it does occur, selling options will be the strategy of choice.

However, the other three portfolios that I run for the Options Advantage service performed very well during 2014. Our Weekly Options Portfolio had a return on capital over 130% and I’ve only been running the portfolio since late February. So, unlike the longer duration credit spreads, the shorter durations have been working very well. We’ve also had great success in our Apple Portfolio and Selling Puts portfolio.
But I wanted to discuss the Weekly Options portfolio a bit further. Unlike most options services that trade weekly options, well, weekly, I wait until we see overbought/oversold extremes. I discuss this in great detail in my latest webinar. Click here to watch.
How to Use My Weekly Options Strategy
As I said before, we have had great success in our Weekly Options Portfolio during the course of 2014.
The following is a very good example of how I use “Weeklys.”
The market has rallied this past week, more specifically the Russell 2000 (IWM).  The small-cap ETF is currently in a very overbought state (as seen in the chart below) according to my favorite mean-reversion indicator, the Relative Strength Index (RSI).

So, now that we have confirmation that one of the highly liquid ETFs we follow is in an overbought state, in this case IWM, we want to look towards an appropriate options strategy. Since IWM is in an overbought state we would want to wrap a bear call strategy around the ETF.
By looking at the options chain of IWM we can best select which probability of success we would like to have on the trade. I prefer a probability of success around 80%.

With IWM trading for roughly $119 and in a “very overbought” state, again, I want to use a strategy like a bear call spread. A bear call spread enables me to have a margin of error just in case the current directional trend, in this case a bullish trend, continues.
As I said before, the next step is to choose the actual spread. I start my search for a high-probability spread in the Prob. OTM column. If I were to choose the strike price closest to 80%, I would need to sell the 120.5 strike. And since I only want to go out one strike wide I would need to buy the 121.5 strike.
I can sell the 120.5/121.5 bear call spread for $0.15 ($0.26-$0.11). By selling the strike with a slightly lower probability of success I am able to make a return of 17.6% over the next seven days. Again, the decision always rests with how much probability you want to have in your trade. In this case, we are going with a 77.34% probability of success.
As I said before, I’ve been trading weekly options in my Options Advantage service since late February and so far I have had two losing trades. More importantly, the return on capital is over 130%.
I trade weekly options a bit differently than other options-based services. I do not make a trade every week. I wait for overbought/oversold extremes to enter the market and then I begin to look for a trade. Once again, you can learn more about how I trade weekly options as well as the other three portfolios I run within the Options Advantage service by clicking here.
I hope all of you have a wonderful and safe holiday season.