2017 was a great year for stocks. I want to use this column to detail one particular trade I made in 2017 — my call option on TQQQ.
So first, why options? I have been trading stocks since in my early twenties, but trading options are new to me, something I have only done for a couple years now. Back in 2016 I spent a lot of time watching Robert Shiller’s OpenYale class on Financial Markets. In that class he talks about the development of options and futures markets. Options and futures are labeled as derivatives markets, but when you step back and think about it the options market IS the real market. Think about a soybean farmer in Texas. On December 1 she will not particularly care about the spot price of soybeans on that day- her land is all harvested and ready for next year’s planting. But she would be very interested in the price of soybeans in October of the following year, when she could bring a crop to market if she decides to plant it now. Same for a company: Delta Airlines does not care so much about the spot price of jet fuel today, but they do care very much about what it will be 1-24 months from now, and getting a predictable price so they can plan their capital expenditures and fare prices accordingly. In a lot of ways the options market is what drives real business and spot prices are not nearly as important. So from that view options are not merely gambling.
I trade almost exclusively in an IRA account, and you can trade options there — just no margin, which is fine for me. In my IRA I am granted level 1 options access, which means I can buy calls and puts. I have been comfortable with owning QQQ (Nasdaq 100) for 10+ years, one day in about 2013 I saw a ticker “TQQQ” pass on the bottom of the CNBC screen. I looked it up and it was 3x the QQQ return. I knew interest rates were ridiculously low then and I naively thought this fund achieved 3x by borrowing cash at low rates and using that to actually buy things like Apple and Cisco. So I went in – and it has done fantastically, returning about 1000% over that period.
In 2017 I decided to try TQQQ as an option. I’m not even sure that an option should be allowed on such a product as it is an option to being with. Sort of an option on an option. The thought was buy an out of the money call. My goal was to buy an instrument that worked as follows — if the market went up 20-30% in 2007 this option would return +700%. That is a significant return on a sizable investment that can potentially be somewhat life-changing. At least enough to buy a new car or along those lines. If the market went up less, say 10%, this option would return -100%. Fortunately I have an overall portfolio where I can stand to lose a few % if the option did not pan out and I was comfortable defining my risk this way so I decided to pull the trigger.
On 3/31/17 the TQQQ option book looked like this:
The underlying spot price was 88.21. I knew I wanted to give myself some time – to me a short term option is more like gambling but a longer term option is a call on the market. So I picked January 2018. (The actual expiration is 1/19/2018). I also knew I wanted an out-of-the-money call. The only real question was how out of the money? I felt there was a chance the Nasdaq could return 25%, which would imply a TQQQ 1 year return of about 75%. How strong was my conviction? A 75% return on an 88.21 price is 154.3 Doing analysis with those number you get the following:
All the numbers above assume an initial investment of $10,000.
If I picked a strike of 130 I would make 1,250%. A strike of 90 would result in a profit of 400%. In either case, if the market was down for 2017 I would have lost -100%.
In the end I debated hard between the 100 and 120 strikes. I really wanted to pull the trigger on the 120 strikes, but I felt there was too much risk there. For example, if the market had returned 10% last year the returns would have looked like this:
It would have been a good year, The market would have been up for most, but that 120 strike option would have returned -100%. A total wipeout in an excellent year for stocks was too painful for me to contemplate, so I pulled the trigger on the 100 strikes.
I bought 16 calls of TQQQ strike 100 / 1/19/2018 on April 11, 2017. The purchase price was $6.00 each contract.
Often when you have a big winner you sell too early. I did a that this time, but I don’t regret it. My goal was to let the $10k bet ride to Jan 18, 2018 and take what it was worth then. Instead after the position doubled (which turned out to be 1 month later on 5/11/2017) I sold half the position. I sold 8 contracts at $12.60, getting back my $10k investment. I would then let the rest of it ride to expiration.
Except I didn’t. On 12/4/2017 I sold another 4 of the contracts, knowing the end of the option period was near and I did not want to lose all my profit. I sold that lot at $36 each.
So now I am letting my 4 remaining options ride. Since they are now deep in the money calls near expiration, they trade at almost the exact difference between the underlying price and option strike price – $51 each. I will sell those for whatever the market bears on market open on 1/18/2018.
So my profit as it stands today is:
debit of $6 * 16 * 100 = -$9,600
credit of $12.60 * 8 * 100 = +$10,080
credit of $36 * 4 * 100 = +$14,400
credit of $51 * 4 * 100 = $20,400 <– unrealized, this part is still held
Total of $35,280
So a return of 350% in 9 months. That will do pig, that’ll do.
What if I had waited and not sold at all? Based on todays price my return would have been 800%.
What if I had done the 120 strike? There the return becomes a fantastic 1300%. The calculations to here have been using the ask price of the options, not the midpoint. Another problem with these options are the spreads. Look at the 120 strike- $2.8 to buy and $1.3 to sell. That means as soon as you execute your order your $10,000 position gets cut in half. Even though that would have worked wonders in 2017 it is still a hard call to pull that trigger.
So fo 2018 I am going to keep 10% of my portfolio in options. My thinking is to ladder 4 options, with strikes of 3,6, 9 and 12 months and $5,000 position each. I am also thinking of using XIV instead of TQQQ. I’ll detail how that works out in 2019.