I don’t want to presume, but I want to start planning ahead.
If you’ve followed my long term market analogue, it suggests that there is still one last phase to the bull cycle. If we’re about to engage in such conditions, I think it would be best to discuss the topic of asset allocation to optimize your returns while managing portfolio risk in trending market conditions. We’ve discussed this at length on After Hours with Option Addict, but its always good to review how to allocate a portfolio. You don’t want to get overleveraged, but nor do you want to sit out years of epic opportunity staying 98% cash during easy market conditions. Such behavior is likened to deserting your post in a war. Furthermore, only a paranoid asshole psychopath would pass up an opportunity to earn in easy conditions based solely out of fear.
So how should one start to build in terms of allocation? If I took you through the standard model I would need your age, time until retirement, dependents, goals, ambitions and would want to experience your personality a little. This way I might be able to recommend suitable strategies and instruments that are conducive to your personal strengths and weaknesses.
Assuming my reader is 47.5 years of age, is thinking about retirement, still has years of earning power under his/her belt, and wants to risk their nut, here is a starting point that is a little more aggressive based on our current market analogue.
Leveraged instruments (Options, Futures, etc): 10-20%
Equities (Growth/Value/Foreign): 50-70%
Fixed Income (Bonds/Dividends): 0-20%
Cash: 15-25%
Again, an aggressive allocation model will emphasize more weight in equities, and less weight in fixed income. Personally, I’d rather utilize covered calls as a way to generate income on a portfolio of stocks as opposed to focusing on yield through dividends only. Best case scenario, you double dip and sell calls against your dividend paying stocks. Either way, the premium on a weekly/monthly basis in most equities, especially growth oriented stocks, will produce a steady yield based on the going rate of option premiums in general.
I want to take options a step further in this discussion, especially on their use in an investment portfolio. If you are using options in a conservative manner (high delta, ample time til expiration) you might opt to allocate more funds to this strategy. If you are using options in an aggressive manner (low delta, less time til expiration) you might opt to allocate less. In terms of position sizing per trade, I’d rather risk more on a conservative option (up to 5% per trade) and manage fewer positions. If I am trading options aggressively, which I do, I’d rather risk less on an aggressive option (up to 2%) and manage multiple positions.
Going forward, I have started to up my position sizes slowly, and will start to allocate more to options as market conditions dictate. I know many are still cash heavy here, but if the volatility leaves and the market starts to grind, I’d start looking towards building out the portfolio a little more as conditions improve.
I know each individual has a different set of circumstances, but if you have a question that can open up some dialogue on this, feel free to post comments in the chat.
OA
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Hi OA, I’m 46 and have dependent(house wife). I don’t and will not trade options but only stocks. This moment 20% stocks(all long term) and 80% cash. I lost 20% last year for trading, so I need to be very careful this year. What is/are your recommend for me to build up ? Thanks ! .
Start utilizing covered calls. Learn them, love them. You can do quite well moving in and out of stocks and renting them back to the market while they are in your portfolio.
Dumb question: If you sold a covered call, do you need to buy it back to sell the underlying equity?
If you have to sell the stock and are short a call, yes. You can also wait til the call expires, or your stock is assigned.
OA, I’ve got two quick questions for clarification purposes. First, if you decide to hold onto your shares through expiration, you wouldn’t need to buy the call back, correct? Second, if the call you sold ends up OTM, how likely is it that your underlying shares can get assigned? Thanks for all your help, it is much appreciated.
If the stock price is anywhere below the strike at expiration, the call expires worthless. Ex: Stock $19.99 or lower and you are short a $20 call. There is nobody that will buy the stock from you at $20 when they can buy it cheaper in the open market. So, 0% chance.
When I sell calls, I am trying to be careful as to not lose the stock.
Thanks for the answer and the feedback. Also, was I correct in my first question about not having to buy the call back if you’r holding the stock through expiration? Sorry for not separating that question in a more clear manner. I really appreciate you addressing these questions and providing insight into skills that I would love to add to my arsenal.
You don’t have to buy buy it back…if you are staying in the stock, you’d only buy back as the stock price starts to trade above the strike. If this isn’t a risk, you let it expire.
Got it. thank you for your patience and explanations.
Thanks! I plan to put 1/3 of my asset to Index fund, then haven’t done so. Not enough dip yet. Hope I have steady year.
I would love to hear more about covered call strategies. When to write them and when not to. Maybe an after hours topic?
Tom you need to stop managing your own money! Sorry for the directness! “I lost 20% last year and need to be very careful” and “I don’t and will not trade options, only stocks”. You just asked a guy with the moniker Option Addict for advice, maybe this is why you lost 20%?
Should I change my handle?
Don’t be sorry. Of course I know OA is Option god, and I don’t trade option. However, I really enjoy reading and learning OA’s blog and useing some long term ideas. I really respect OA as an great trader/invester, educator and human being. Actually, I asked OA to manage my money last year, and OA said ask him end of the year. OA, would you please manage my little nest ?
The other thing to keep in mind (and something OA has said previously) is that you could do really well by playing the AH strategies with common stock. Find a great technical entry point, buy the stock, and be prepared to sell if it breaks down below your predetermined stop.
It requires (a lot) more capital, but the payouts are the same or better because theta isn’t eating into it. There are a lot of positions that aren’t technically wrong, but don’t pay out as well as we hoped because they take too long to develop.
You ought to try substituting your next stock position with an ITM call. You don’t need to lay out the capital and it will move 1 for 1 with the stock. No time decay either.
Great topic to cover for sure.
Of course you shouldn’t change your handle. His comment made no sense to me. The QQQ calls we discussed yesterday made 130% overnight. Took them off today. Have to make hay when it is time to make hay!
I know covered calls, I’ve traded covered calls, I get it, I’m a CFP (no that it means anything to trading), and personally, I loathe them for the simple fact that I hate the opportunity cost risk. You need the right market conditions for the strategy to be optimal, and even then, you have to take on more risk because the options are priced accordingly. It’s not as easy as it seems.
I have a method that works well as to not limit your upside, but you might not be able to put the trade on every month.
Hey Jeff, what if you’re a degenerate that wants to gamble with the kids’ college fund
On a serious note, I wouldn’t mind talking about how to play options long term. As a group, the farthest out is usually the second month, and that’s rare. If 2015 shapes up to be a big year, what opportunities are out there for long runs?
Good question. I think this could be a topic we hit in AHWOA. I haven’t really applied this strategy since prior to the 08 crisis. I stopped trusting the market “long term.”
However, I had a method that worked very well, legging in and out of diagonal spreads for longer dated call positions.
You haven’t gambled with the kids’ college fund since 08′? Maybe this is the time to roll the dice a little bro.
No, that’s a long story that probably involves reading way too much ZH. It’s mostly shameful bear shit. Buying bonds while the S&P melted up and other similar stupidity.
I didn’t find IBC until about this time last year, when somebody sent me a link to Fly’s tribulations with the four horsemen.
Id like to bet the house on TWTR, FEYE, and home builders.
There should be a MATT ETF. You’ve been blazin hot.
Wow. Coming from you. I’m printing a screen shot of this.
Recommendation on best way to play home builders?
play the re-test on BZH around 16.75. I’ll be adding to leaps there. If you want KBH, make sure 13.70 holds. With KBH i have 2 patterns potentially in play. A downward channel which has a high around 17 and a low around 11…or a bid wedge with the bottom at 13.70
Thanks for the response matt
Big fan of MHO is a pure home builder, and WCIC for specialized home builder (concentrates on retirement communities in Florida; boomer play). Both long-term holds of mine.
Great post OA.
Indeud!
OA–I held KING Feb calls through earnings and there was a surprise dividend of .94 per share for shareholders as of March 4th. Will that value be built into the option price tomorrow morning?
I’d like to acquire some stock and hold through March 4 to get the dividend…is that assholish?
So I’m trying to figure out if I should accept delivery or sell my itm calls and buy stock with proceeds.
Also wondering if the stock might be vulnerable to a sell off on March 5th, after the dividend date?
Thanks!
Agreed, great post. As you mention each situation is unique but I think it’s easy for someone to read this and apply it no matter where they fall on the risk spectrum. Thanks!
How does one allocate 20% to options? Do you mean leaps? Deep in the money? Otherwise you can easily lose the whole 20% in a few months.
If you are working with a portfolio of 100K, allocate $20K to options – so 20 positions at $1K each.
And that money only needs to be invested as opportunity dictates.
Jeff – Thoughts on concentrated portfolios? About me: I’m 36, now manage my family’s (2 little ones) money full time so no salary. I spend most of my day assessing downside risk to my holdings and research the shit out of them, which gives me comfort when holding only a max of 4 stocks at a time. Sometimes if I’m really confident about a stock I’ll go all in, like with FCAU. But I’ll cut bait no matter what if it moves against me a decent amt. But I am a firm believer in only holding a few positions, primarily because you can’t possibly know enough about more than a handful of stocks.
I guess my question about concentrated portfolios matters if its options vs stocks. I don’t trade options so mine is just stocks. Anyway, what are your thoughts on this?
Asked another way…if you only hold stocks how many positions do u recommend at any one time?
Great question, but trusting that risk management is the first priority, I could concentrate in 4-5 positions.
Assuming stocks only right?
You did ask “only stocks”.
Yes.
What about someone trading options? How many positions do you think is ideal?
Watching $FB. It might not get back to $75.
Jeff, I’m holding 5 the Feb 20 TWTR calls @ strike of 48. When do I start to sell that? Not sure about decay and such.
Sell when it hits your target. What price were you aiming for?
I didn’t have one. Guess I should. I think it has more to go. Just don’t want to get too close to expiration.
Yes, a target is a must, otherwise you don’t sell.
Plan the trade, trade the plan!
It’s easy to get caught up in just buying anything that looks good. For me, entries have never been a problem, it was always the exit.
If the position started to swell, I would get emotional and start thinking “what if” while continuing to adjust the gains I would be satisfied with, and ultimately giving back much of those gains because I became obsessed with numbers I was dreaming up in my head.
On the flip side, when the position went against me, I’d always dig myself into a hole with the thought of “it’ll come back”. Even if it did, I wouldn’t end up scratching the trade even if it was broken because I’d get caught up in the “what if” game again.
Needless to say, Jeff has taught me a lot over the years, and I think one of the best things I’ve picked up is watching him plan out his trades. I’ve found that when I do the same with my own trades BEFORE I get into them, it takes out a lot of the emotional swings I was having before.
LVS and FEYE are ripping faces off.
How often are you looking for commodity trades to lower correlation to market risk? How do you handicap deflation risks? I think i started following you in mid 2008 so I missed seeing how you transitioned to a more gold, cash and put based portfolio, or when you started actively buying puts on banks. As an aggressive trader, how quickly do you flip from such an allocation as concerns grow of a correction/minor high?… And top/major high? I know in the past you have said Buy 1, sell 2-3… Or buy 2, sell 3-4 to begin to shift… But was that specific to the situation? How might that change in these later innings? And if you plan to shift from long to short once you think the top is here, how does that change?
I have so much to say on this. I could offer a recording on the topic as we address it. That ok? I’ll use 07 as the template when I moved to net short.
Sounds great.
I find it almost comical that a company with as much of an impact on the world as TWTR is worth 1/7th the valuation of FB.
Jon I just cringed a bit reading your last statement about going all in on a stock, especially if you do not have a salary. I can’t imagine what would happen with your family’s savings if you were all in on a stock and woke up to an SEC investigation into that company and the stock opens up down 50%. Sounds like you know what you are doing if you are doing this full time, but be careful man.
Woj – I generally focus on stocks that don’t have that risk. Companies like FCAU, TWTR, GOOGL, LNKD, WYNN etc. If its a smaller company then I have a smaller position.
Plus we have about 15 years worth of living expenses saved up so a larger hit, while it would suck, wouldn’t change our lives.
I was wrong and have taken measures. I’m loaded up on AG stocks and my VLO has been keeping me happy. I’m going to try and continue to look for individual shorts (e.g YY) but leaving the indices alone.
MON is going to be a monster over the next few months.
I have been poking around ag names as well. I didn’t see much I loved, probably $MON best over the other big names that have already been racing. I keep staring at that $AVD I mentioned a bit ago, but I’d like to see it back towards $11.50-11.75 range.
Anybody see a cup and handle forming on TWTR?
Great discussion thread today!
APPL looks like it has a good rising triangle going – yolo candidate for the afternoon to get back above 127
or not…
Okay Jeff, you convinced me. I’ve resisted studying options because I have so much to learn about trading stocks. But you’re the options addict and if this is a prime $$ making time then I’m gonna watch your options course and most likely pester you with questions….because I’m starting to make $$ on my stock trades and I’m loving it.
Taking a look at some oil names. Any thoughts on $RIG or $NDRO for those that have been deeper into the oil space? Would need a dip for $BTE, but I like that one and $ROSE as well.
Jeff – you mentioned targeting the $74 area for TWTR. What time frame are you thinking?
BPZ yesterday monster volume@ lows ..just sayin ..goodbye