THE PANDEMIC BREEDS A NEW HOBBY
This year was the most unusual in my lifetime. The coronavirus pandemic changed so many aspects of life, and, being one of the most, if not the most, cautious person I know about ensuring that I don’t get infected, I spent a lot of time indoors alone. I’ve always spent a significant amount of time reading and monitoring my stock investments, but in 2020 I needed some other activities to occupy myself. While I’ve occasionally used LEAPS and other options for my investing for many years, it was neither a consistent trading activity nor something I’ve tracked. After the pandemic lockdowns were instituted, I stepped up my options trading activity and started logging all my options trades. It was not only a way for me to occupy myself but also an experiment to test whether I could consistently earn additional income from trading options. To define what I mean by trading options, I’ll contrast it to what I normally do which is investing.
STOCK INVESTING DEFINED
When I invest in a stock, it is with the intention of holding a stock for a long period. To make an investment decision, I must feel confident that the stock that I am buying will increase in value over the long run. I can only feel confident in the long-term prospects of my investment after I’ve thoroughly researched the company, its market(s), its competition, and other important factors. It’s also important to check that the valuation of the stock is not too frothy and that there aren’t better investments that I could choose. By the time I’ve invested, I know a substantial amount about the company, enough to know that I’m comfortable with the risk-reward. I recently posted that I occasionally use LEAPS, which are options. However, I consider my LEAPS to be investments and not options trades.
OPTIONS TRADING DEFINED
In contrast, when I’m making a trading decision, I’m trying to earn a quick return over a short time period and get out with my profit (or cut my loss). My options trades are all short-term which I’ll define as a trade that will be closed within 3 months. In fact, all of my options trades are on options that expire within 3 months and the vast majority of them have been weeklies that expire within a couple of weeks after I open the position.
MY OPTIONS TRADING ADVANTAGE
There are many thousands – if not millions – of traders, many of whom trade stock options. My advantage, what I feel distinguishes me from the vast majority of the traders out there, is that I have a thorough understanding of the underlying company/business/stock on which I trade options. I am not an expert on options and all the jargon. I’ve never read a book on options. In fact, another investor recently pointed out that a LEAPS in not a LEAP(s) as I had written in my first draft of my post on LEAPS. I’ve learned what I know simply by doing: trading options based on what I think makes sense and learnings some tricks and lesson along the way. Most important, the foundation of my decisions rests on my understanding of the underlying company. Without this foundation, I don’t believe that I’d be very successful. Layered on top of the foundation are a number of facts, observations, analyses, assessments, and predictions that I use to drive my options trading decisions.
OPTIONS TRADING EXPERIMENT
What started as an experiment this past Spring turned into 747 opened trades by the end of 2020. In this post, I will detail the results of my experiments and introduce the handful of trading tactics that I used. I will expand on each tactic in separate posts in the coming weeks.
OPTIONS TRADING SUMMARY RESULTS
| Start date | 4/20/2020 |
| Total trades opened | 740 |
| Closed trades | 737 |
| Open trades (remaining) | 12 |
| Winning trades | 451 |
| Losing trades | 285 |
| Adjusted avg win | 1.000 |
| Adjusted avg loss | -1.0756 |
| Net win | 451 – 307 = 144 |
(Win# times Adj avg win) – (Loss# times Adj avg loss)
| Trade Type | # of Trades |
|---|---|
| Long call | 113 |
| Short call | 243 |
| Long put | 0 |
| Short put | 390 |
OPTIONS TRADING DETAILED RESULTS
Between 4/20/2020 and 12/31/2020, I opened 749 new options trades (legs). When I closed a trade or when an option position expired worthless, the closing transaction was not counted a second time. These results do not include my LEAPS or any options that had 90 or more days until expiration. Of the 749 trades, 737 options positions were closed out prior to the end of 2020 and 12 options positions have expiration dates in January 2021; these open positions were not counted as a winning or losing trades since the outcome of those trades is yet to be determined.
Of the 737 closed trades, 451 produced a gain, 285 produced a loss, and one broke even. In order to produce an overall profit, the average size of the winning trades times the number of winning trades needs to be greater than the average size of the losing trades times the number of losing trades. The average losing trade showed a loss that was about 7.56% higher than the average gain from the winning trades. From 4/20/2020 through the end of November 2020, the average gain from the winning trades was in the mid-single digit percent higher than the losses from the losing trades. I made oversized bets on several of the calendar Q3 2020 earnings results, the largest being ZM, that resulting in some big losses. The net-net of these bets skewed the average losing trade to be greater than the average winning trade and caused me to give back about 20% of the trading profits that I had accumulated over the first 6 months of my options trading experiment. Despite this temporary setback, I still managed to show significant profits. In 2020, the total gain on my portfolio was 245.6% which includes both gains on my investments as well as profits from my options trading. The split between investment gains and options trading was 222.9% for the investment gain and 22.7% for the options trading gain. Thus, without my options trading, my 2020 portfolio return would have been 222.9% instead of 245.6%.
| Stock | # of Trades | Options trading (% of total) |
|---|---|---|
| AYX | 8 | 4.57% |
| CASA | 4 | 0.00% |
| CRWD | 168 | 61.04% |
| DDOG | 9 | 1.36% |
| DOCU | 33 | 1.12% |
| EVER | 2 | 0.05% |
| FSLY | 48 | 20.21% |
| GOLD | 127 | 1.51% |
| LLNW | 6 | 0.60% |
| LVGO | 24 | 11.00% |
| MGNI | 3 | 0.80% |
| NEM | 66 | 0.66% |
| NET | 3 | 0.44% |
| OKTA | 12 | -0.72% |
| PTON | 33 | 3.52% |
| SDOW | 2 | -1.35% |
| SHOP | 2 | -1.41% |
| TEAM | 4 | 0.91% |
| ZM | 179 | -4.18% |
The table above shows the number of closed trades and, for each stock, the percentage of the total options trading profit. The profits from CRWD, FSLY, and LVGO account for 92% of the profits. I had a very large profit (around 20% of the of the total at that time) from my ZM trades going into to the Q3 2020 earnings; four short put and long call positions held through the earnings report wiped out all of my ZM profits and some. I had a large number of my trades on GOLD and NEM, yet the profits from these trades don’t comprise a significant portion of the total. I am harvesting decaying time value from GOLD and NEM on a weekly basis using the short straddles/short deep ITM puts tactic (see below), but since the underlying shares have dropped about 20% since I started, I only managed to eke out some small gains as the losses from the deep ITM puts have eaten into most of the profits from the decaying time value. I expect my weekly GOLD and NEM to contribute a nice income stream if their stock prices stay stable or rise.
TYPE OF OPTIONS TRADES
I’ll briefly describe the various types of options trading tactics that I employed. I won’t get too detailed about them in this post, but I’ll probably write a more in-depth post on each of them in the future. As I stated above, I learned what I know primarily by trying stuff out and talking with some of my investor friends so I may not know all the options vocabulary. There may be actual names for some of the strategies that I describe below.
Selling an ATM Straddle and a Deep ITM Put
This is a three-legged options trade consisting of the following legs:
- Sell to Open 1 at-the-money call (one week or less until expiration)
- Sell to Open 1 at-the-money put (one week or less until expiration)
- Sell to Open 1 deep in-the money put (usually 15-20% in the money; two weeks or less until expiration)
The above trade was by far the most common trade that I used during my 8 ½ month options trading experiment. Since this trade contains two short put legs, the downside risk is considerable should the underlying stock tank while this position is open. Therefore, I only use this trade when I am reasonably comfortable that the underlying stock won’t drop significantly. In fact, I look for stocks that I believe are undervalued and likely to trend upward in the near-term. Additionally, I like this type of trade when the volatility of the underlying stock is high as is common in the several weeks leading into an earnings announcement catalyst. The upcoming earnings catalyst also serves to often, but not always, keep the stock price from dropping. Much of the profit on this trade is made by harvesting the decaying time value. I earn profits if the stock rises, stays in a tight trading range, or drops slightly. I lose if the stock drops moderately, and I lose my shirt if the stock tanks. It is common for me to stop rolling forward and close out the position just prior to the earnings announcement date.
Buying Near-the-Money Calls and Selling ITM Puts
This is a two-legged trade with the following legs:
- Buy to Open 1 ATM or slightly OTM call (expiration after an upcoming catalyst event)
- Sell to Open 1 ITM (usually 10-20%) put (expiration is shortest available time left)
I may use the above trade if I believe that one of my stocks may rise sharply in response to an upcoming catalyst event such as an earnings announcement. My preference is to choose the strike prices resulting in an even money or a slight credit trade. For the long call option, I prefer the strike to be at-the-money or slightly out-of-the-money. For the put option, I try to choose a strike that I think may be an attainable share price so the put option leg would expire worthless. For the expiration date on the call, I usually choose the first available date after the catalyst event or one week after to allow analysts time to update their models and upgrade my stock. For the put expiration date, I almost always choose the closest expiration date for two reasons. First, sometimes the stock price on a company will rise prior to earnings which gives me an opportunity to close the put position prior to the catalyst event and leaves me with a “risk-free” freeroll on the call. Second, the nearest expiration date on the put gives me one or more weeks to roll the put forward for a net credit (i.e. harvesting some time value).
Buying Far OTM Calls
Buying far out-of-the-money calls prior to a known catalyst event is fairly new to me. I recently learned about them from my investing friend Bear (aka PaulWBryant on TMF), and I first tried to use them on some of my companies before they reported their Q3 2020 results. Unfortunately, I have not mastered using this tactic yet, and I lost on almost all my trades using this approach. However, Bear has been quite successful, particularly after Q2 2020 (note: his portfolio was up a whopping 319% in 2020!).
- Buy to Open 1 OTM call (typically 30-40% out of the money with expiration right after catalyst)
I think it is important to buy them for a very low price and mostly sell them before the catalyst and after the stock has run up some. There are several more important nuances, which I won’t get into in this post, about trading these options. The shares don’t need to rise anywhere close to the strike price to earn a high percentage return on these options.
Selling Covered Calls
This is selling calls against shares (or call options) that I own, and it is the most basic options trade. I rarely use it though because I don’t like to cap my upside on my hypergrowth stocks. I tend to use it when I’ve decided that I’m going to be selling some or all of my position soon. I’ve learned the hard way that it’s often better to just sell my shares immediately after I’ve decided that I will be selling. However, there are some cases, such as tax considerations, when I want to hold my shares before a new tax year begins or until my shares cross the one year holding period mark.
OPTIONS TRADING RESULTS SUMMARY
In 2020, my options trading experiment was highly successful and on its own delivered a 22.7% return on my entire portfolio. This result would be the envy of most investors, let alone traders. However, I do realize that 2020 was an unusual year, and, since I started this experiment after the huge rebound after the March 2020 crash, I’m aware that my successful experiment can’t necessarily be extrapolated forward. Almost all of my trades were net long, and we had quite an upward move in my stocks. It will be interesting how my trading works out in a down market. I hope to have the discipline and be able to adjust my tactics for changing market conditions. I’m not lost on the fact that trading and investing are completely different skill sets. I intend to continue to do both and hopefully improve my aptitude for trading. Again, this post was just intended to share my results and introduce some of the tactics. In future posts, I plan to focus on a particular tactic and go into deeper details on exactly how I use them.
The opinions, thoughts, analyses, stock selections, portfolio allocations, and other content is freely shared by GauchoRico. This information should not be taken as recommendations or advice. GauchoRico does not make recommendations and does not offer financial advice. Each person/investor is responsible for making and owning their own decisions, financial and otherwise.