Follow-up to Alternatives to Selling a Position

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Make sure you read the disclaimer listed in the frame of this site. Here's the TL/DR:  You are responsible for your actions, and I am not.

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Last week I wrote about a hypothetical position in PINS that was up 115% since entry.  The price when I wrote the piece was $80.54 and had a stock basis of $37.44.  Review that entry here ( https://greekgodtrading.blogspot.com/2021/02/alternatives-to-selling-position.html )

I ran the scenario that if PINS dropped below the 65d EMA and if this was your trigger to exit, that there were other alternatives to unloading the position (IF your long-term outlook in PINS was bullish).  

The idea behind the approach was to buy a at-the-money (ATM) or in-the-money (ITM) put, so if price fell, you would be protected at some level until the option expired.

The scenario bought the 18 June 75 Put, which was $9.35 per contract.  You paid $935 per contract for this protection.

Friday, 3/5, saw PINS close at $68.40, BELOW the 65d EMA.

If you were holding the $75 put, would you be protected?

Short answer:  yes, for the amount below $75.  Here's the math:

Total cost of the stock:  $3,744

Total cost of option: $935
Total cost:  Stock + Option = $4,679

Stock value @ $68.40:  $6,840

Option value @ $68.40: ($75 - $68.40) = $6.60 * 100 shares = $660

Stock and Option value @ $68.40: $660 + $6,840 = $7,500

Total Value = $7,500 - $4,697 = $2,821

Total position gain:  $2,821/$4,697 = 60.1%

I note that no matter how far down PINS drops that the gain on the position will remain at 60.1%, at least until June 18th.

If PINS moves above $75 the position will gain 1:1, as expected.

Buying insurance could have been a good approach to hold onto the stock as it closed below the 65d.  It may be still a good option (no pun intended), but realize, it will cost more because the volatility is  higher.

~~~~~~~~~~

So, what if you weren't a believer last weekend and now you are?  

Between last week's post and this one I've shown how to calculate the overall "Total Position Gain %" with the option in place.  Now, without proof, if you want to still employ a strategy like this, here are the insurance levels for various strikes, assuming you enter at the "ask" early Monday morning, 3/8, using the weekend option prices for the June 18th put:

Strike:  $65

Ask:  $8.80

% Return (insurance level):  40.6%

Strike:  $70

Ask:  $11.80

% Return (insurance level):  42.2%

Strike:  $75

Ask:  $14.80

% Return (insurance level):  43.6%

Strike:  $80

Ask:  $18.25

% Return (insurance level):  43.7%

From this exercise you can see that buying progressively deeper ITM puts doesn't really protect you more, and this is because the total cost of protection goes up with the put strike level. Hence, with a close at $68.40 on Friday, while you could spend more to go from the $70 strike to the $80 strike, it's not overly beneficial for the position.  Why spend more on the position than you have to?

For those of you who like to graphically see what is happening, here is the risk profile using the original $75 put strike:

Click on the image to enlarge

The graphic shows that below $75 we are completely protected (blue line), and because of variable time premium between now and June, the yellow line shows that we have greater value today than we will in June (time premium decays -- "theta" -- as we get closer to expiration).

~~~~~~~~

To offset the cost of the insurance, we can sell short-duration OTM calls that have little chance of being ITM at OE.  Last week I decided to sell the 89 strike call that expired 3/5, since PINS offers weekly options.  This allowed me to collect $0.70 per contract, taking the cost of the original stock and the put option down from $46.79 to $46.09. 

This week, because the price of PINS has dropped a significant amount, the call strike that I'm going to sell has dropped too.  Here's what I'm thinking:

Sell the $80 call that expires 3/12 for $0.31.  This will reduce the basis to $45.63, moving the "floor" of the insurance policy from 60.3% (without selling calls) UP to 64.4% (having sold calls).

 

For those of you who like to graphically see what is happening, things get a bit strange when we bring multiple option expiration dates to the table.  The spread in dates (March 12, June 18th) causes the display to get difficult to interpret.  Hence, to simplify this and show that we are covered, I'm going to display only one OE -- the nearest one -- and you can see the shape of the risk profile that we are exposed to:

Click on the image to enlarge

The take away from this graph is that we are fully protected below $75 and above $80 we cap our profits.  The protection at the $75 level lasts until June 18 and the cap at the $80 level lasts only until 3/12.  Note that on the y-axis the difference in the blue line is $500, which is the spread between $75 and $80 * 100 shares, which is what we expect.

If it appears that PINS will be above $80 on 3/12 (or before) I can roll the call upward (higher strike) and out in time, perhaps for a cost, perhaps for a credit.  Depends on how fast we move towards $80 (if we do).

So, we'll continue to watch this trade and see what PINS does.

 Please do not hesitate to ask questions.

Regards,

pgd

Alternatives to Selling a Position

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Make sure you read the disclaimer listed in the frame of this site. Here's the TL/DR:  You are responsible for your actions, and I am not.

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One of the rules that I have for my stock positions is that the stock must be sold, at least in part, if it closes below the 21 day moving average ( simple or exponential ).  If the stock drops below the 50-day it triggers another sell, and a close of two days below the 50d generally is an exit signal.  Certainly, a close below the 65d will have me running for cash in the position, as I never see stocks at the 65d (until I do, of course ....)

Some use other moving averages to take profits, others simply exit if they see a behavioral change, that is, "...it's been above the 21d for the last 3 months so I'll lock in profits now..." or something to this effect.

The challenge here is that the markets shake out positions from time to time.  For long-term traders who want to hold stocks that are true market leaders (TML), the key is to developing a methodology to keep holding these when the inevitable shakeout occurs.

The rest of this note will focus on an option strategy to lock in a significant portion of unrealized profits, and will present various decision points to evaluate on possibly improving upon the initial transaction.  The goal here is to hold a "Stage 2 Stock" (https://www.swing-trade-stocks.com/stock-market-stages.html) as long as possible.

You Bought Well, and the Stock has Increased a Significant Amount

Stocks that are TMLs have massive gains over their Stage 2 life.  Do the research.  Part of this process  is a downside:  they often "pause", and even pull back, and traditional rules such as "sell if the stock closes 2 days under the 50 SMA" or "sell if the stock closes any time below the 65d EMA" can trigger you out of the position.  While you may have gains at these levels, you may miss some of the recovery and subsequent move upwards, resulting in missed opportunities.

Here's an example that should help this make sense.

• You were bullish on PINS and you placed an order back in September 2020 and it was filled at $37.44.
  
  
• PINS grows over time, and here on February 26, 2021, PINS has grown to $80.54.  You have a significant gain:   ($80.54 - $37.44) = $43.10 and on a percentage basis, this is $43.10 / $37.44 = 115%.
  
  
• PINS starts to increase in daily trading range, causing it to become more volatile and test key moving averages (KMAs).  You do not want to sell PINS, as you still have a bullish outlook over the longer term, but your rules could force you to liquidate the position if the stock heads downward.
  
  
• KMAs are:  21dEMA:  $80.46, 50dSMA: $74.58, and 65dEMA: $72.41

The question at this point is whether to take partial profits or to hold on to the position.  In this example you're up over 100%, so you have a lot of cushion, right?  If your "exit at all costs" rule is the 65d EMA then exiting around $72.41 would net you a ($72.41 - $37.44)/$37.44 = 93% return.  Not bad.

In context of a graphic profit and loss (P&L) graph, here's the chart:

Click on the image to enlarge

In the image above the x-axis is price and the y-axis is profit (or loss).  The blue line is the profit-loss for the position, and it goes all the way down to zero (not shown) as well as out to infinity (also not shown :o).  As price varies, the blue line reflects the gain on the account, if you have 100 shares.

You can see that the vertical line at the "last" price of 80.54 produces a gain of ($80.54 - $37.44) = $43.10 per share, and if you have 100 shares, you have a paper gain of $4,310 on the original investment of $3,744.  You can see this by looking at the y-axis.  

I've added two vertical lines.  The first, in orange, intersects the blue line at the 50d SMA of $74.58.  The other, in red, is the 65d EMA and it intersects the blue line at $72.41.  You can infer from the y-axis that you'll still be up quite a bit if you sold at the 65d EMA, as I calculated above.

The other thing to note in the graphic is the dark black area vs. the gray area.  The black area shows the expected range of PINS, as measured through 3/19/21.  All things being equal, this black area shows the higher-probability occurrence that PINS will be in this range as of the close on 3/19.  You can see that there is a non-zero chance of taking out the lower 65d EMA, and then some.

Let's presume you set a stop loss at the 65d EMA (or just below, whatever).  Let's also presume it gets hit.  The obvious downside is that once you lock this profit in, you're out.   You will have to wait for the next setup to reenter the stock, and this could take some time.   In addition, you'll miss the recovery (if one occurs).

There is another approach.

Revisiting the "Married Put"

When we own at least 100 shares of a stock we unlock the potential to transact options with respect to that stock position.  A well-known conservative options strategy is called a "Covered Call" or "Buy-Write", and essentially, we purchase 100-share increments of a stock (the "underlying") and also sell a call contract against the underlying shares.  A lesser-known options strategy is the "Married Put", where we buy the stock (again, the "underlying") and at some point in the future (generally), we buy a put.  If you are new to options lingo when you buy a put you have a right, but not an obligation, to sell the underlying stock at the put strike.  Options have an expiration date ("option expiration", or OE), and your right to sell the put is valid all the way up to the OE date.

In the example of PINS above presume that we are sitting on a really sweet paper profit.  Also assume that we don't want to sell the position as our outlook for PINS is bullish, but we're encountering some increased volatility.

Can the Married Put (MP) strategy help here?  Of course it can, or I wouldn't be writing about it.

Like everything else though, there are pros and cons.  Only you can decide in the alternatives analysis on what path you want to take.

If we're willing to give up all of our paper gains down to the 65d EMA because of our strategy rules, it would make sense to buy an insurance policy on PINS that protects us at the 65d and lower.  This way, we get to hold PINS, at least until options expiration, and ensure that at a minimum we achieve this gain in our portfolio.

• Options on PINS bracket the 65d EMA ( $72.41 ) at $70 and $75.  Let's take a closer look at the $75 strike, as it covers both the 50d as well as 65d moving averages.

The next decision point is how far out do we want the insurance policy to be valid?  I like at least 90-day increments, to give the market time to wiggle and because earnings are about every 13 weeks, which is 91 days.  There is nothing wrong with going out further, but the insurance policy costs more.

• I note that Estimize (www.estimize.com) has PINS earnings release on 5/20/21, before market open (BMO), so we want to go out at least this far.

When I open the option chains on PINS, I see the following:

Click on the image to enlarge

A few things are apparent to me from this:

1. PINS trades weekly options.  You can see this in orange.  We may use this information later.
   
   
2. There is a monthly expiration of PINS options one day after ER in May.  We *could* choose this date, but I'd rather go a bit beyond the ER date to allow things to settle, one way or another.
   
   
3. The $75 strike for the June 18 OE Put will cost $9.35 (Ask) or $8.50 (Bid), or somewhere in the middle if we were to place this trade as soon as markets open on 3/1.  For analysis purposes I like to use the worse-case (most conservative), and since I am buying the insurance, the highest cost of the $75-strike put is $9.35.  This means that I'll pay $935 per 100 shares of stock that I want to protect.
   
   
4. Over under the "Open Int" column, this is the open interest that exists as of today at that strike and OE.  Since this is in the 1000's, we are safe -- the option is liquid, should I want to sell it back in the future.  This is a good thing to see.

Let's presume that I'm willing to buy the 6/18/21 $75 put for $9.35.  This adds to my stock basis (which was $37.44), so the new stock basis is $37.44 + $9.35 = $46.79.  This seems like an expensive hit:  $9.35/$37.44 = 25% so it appears that I'm giving up a good percentage of my gains to pay for this insurance.

Well, truthfully, yes, insurance costs.  Just like it does for your car, house, etc.  You don't get protection for nothing.

This being said, let's look closely at what this does for us.  Here's the profit/loss graph:

Click on the image to enlarge

At the bottom of the image I've circled the cost of the option ($9.35), the put strike ($75), the original cost of the stock ($37.44), and the option expiration date (18 June 21).  This is simply to draw your eye to these inputs.

Two curves are shown, one is yellow, which is the profit curve as of placing the trade, and the blue curve, which is the final value of the transaction as of 6/18/21.  The blue curve is the WORSE CASE scenario for this strategy, and reveals a couple of key things:

1. The blue line is flat from $75 and below (to the left).  This is because we are 100% protected in our gains up to $75 up to 6/18/21.  Put another way, no matter what happens to PINS on the downside, a drop below $75 will not result in any gains less than $2,821 per 100 shares owned.  If PINS goes to $50, we still get to sell our 100 shares at $75 because of the put option.
   
   
2. If PINS collapses to $0 (unlikely) the $6,565 Max Profit on the Put (see the lower right corner) reflects the value of the option on 6/18/21.  This is $7,500 - $935 = $6,565.  We paid 12% ($935 / $7,500) for the option and in this worse-case scenario, our return on option is nearly 700% ($6,565 / $935).
   
   
3. The blue line rises linearly from $75.01 to the right.  This is because we have not capped our upside -- if PINS goes "to the moon" we will go "to the moon" with it.  Our gains are unlimited, and you can see this again in the lower-right with the Max Profit on the stock position being infinity.
   

What the setup does is that no matter what, we are guaranteeing a minimum profit of 60.3% for any price movement below $75.  This is easily calculated as:

Total cost of stock:  $3,744

Total cost of option: $935

Total cost:  Stock + Option = $4,679

Stock value @ $75:  $7,500

Option value @ $75 on 6/18/21:  $7,500 - $7,500 = $0

Total value @ $75 on 6/18/21:  $0 + $7,500 = $7,500

Profit @ $75:  Total Value - Total Cost = $7,500 - $4,679 = $2,821

% Return @ $75 = Total Profit / Total Cost = $2,821 / $4,679 = 60.3%

If the stock drops below the 65d EMA and remains there through 6/18, there is nothing to worry about.  Let's presume that the stock drops to $50:

Total cost of stock:  $3,744

Total cost of option: $935

Total cost:  Stock + Option = $4,679

Stock value @ $50:  $5,000

Option value @ $50 on 6/18/21:  $7,500 - $5,000 = $2,500

Total value @ $50 on 6/18/21:  $2,500 + $5,000 = $7500

Profit @ $50:  Total Value - Total Cost = $7,500 - $4,679 = $2,821

% Return @ $50 = Total Profit / Total Cost = $2,821 / $4,679 = 60.3%

Let's presume that the stock goes to $100 as of 6/18:

Total cost of stock:  $3,744

Total cost of option: $935

Total cost:  Stock + Option = $4,679

Stock value @ $100:  $10,000

Option value @ $100 on 6/18/21:  $7,500 - $7,500 = $0

Total value @ $100 on 6/18/21:  $0 + $10,000 = $10,000

Profit @ $100:  Total Value - Total Cost = $10,000  - $4,679 = $5,321

% Return @ $100 = Total Profit / Total Cost = $5,321 / $4,679 = 113.7%

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Given all of this, what is the downside?

"Downside" is relative.  We bought insurance, and we have to pay for it.

The "downside" is that if we were truly buy-and-hold, with no regard to risk management (exiting when our rules say to exit), then we will always underperform buy-and-hold with a married put strategy.  This is because the put option costs money, and this subtracts from profits.

This is really the only negative in the entire process.

~~~~~~~~~~~~

In the end, there are a number of positives here:

1. If the stock drops below our sell point (wherever that is), we have the psychological confidence that we are fully protected if we placed the put strike at or above this level.  This confidence exists through the life of the option contract.
   
   
2. If there is an ER event during the period the put is active (e.g. before 6/18/21), we are fully protected and do not limit our upside.  We simply do not care about ER and are happy to hold across ER.
   
   
3. If, as in the case of PINS, there is a huge earnings blowout and PINS jumps up a huge amount, we can still sell the put before OE and recover a portion of what we paid for the put.  This is NOT factored into the discussion above but would add to the overall gains for the position.  If you don't understand this, ask, as it's important.

~~~~~~~~~~~~

A variant here is to raise the MP purchase of the put to being at-the-money (e.g., $80-strike), or even making it an in-the-money (ITM) put (e.g. $85, $90, $95, etc.).  While you pay 1:1 for the amount between the strike and the current price (e.g., if you are buying the $85 put strike, and the price of the underlying is $80.54, you will pay $85 - $80.54 = $4.46 for this (Intrinsic Value) plus the time value (Extrinsic Value) of the option (currently around $9.89 as I write this).  There are advantages to this too.

The next post will look at how to improve on the Married Put by selling short-term out-of-the money (OTM) calls on PINS.  I will show that even with decaying volatility (which means premiums received from the sale of the OTM calls go downward), it is possible to push the minimum gain received above from 60.3% to over 90%, over the same period (March to June) with very conservative strike selections.

Please do not hesitate to ask questions.

Regards,

pgd

Where to Find Current Market Discussions

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Hello all!

Paul Duncan here.

As many of you are aware, I lead the Northern Virginia Computer Investing Special Interest Group (CISIG) which is associated with the American Association of Individual Investors (AAII) ( https://www.aaii.com/ ) and the Washington, DC Chapter of AAII ( http://www.aaiidcmetro.com/ ).  As such, I'm focusing my time and writing to supporting that group and am not positing here.

If you are interested in becoming better positioned to deal with the stock market, please join our discussion group at the following link:

CISIG+subscribe@groups.io

Because of automated bots and other bad actors, PLEASE send a separate note to me personally at GreekGodTrading [ a t ] gmail [d o t] com (fixing the email address as you know how to do) indicating that you want to join the CISIG group and the email you used to send the request.  This will help me keep the noise out of the group.

See you there!

Regards,

Paul Duncan
March 19, 2020

Oct 6 - Question about Gamma

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If you need to reach me, you can do so using the block at the bottom of the blog or send me an email.  I prefer that you use the box at the bottom of this entry, but of course, you can send an email to GreekGodTrading [ a t] g m   a i l [d ot] c o m (intentionally made difficult for the bots to read and spam me -- so fix it as your intuition tells you).

I'm also available in the HGSI DOC Live Discord forum here:  https://discordapp.com/invite/4QAUqyd

~~~~~~~~~~

Regarding the Greeks ...

A question came in a week or so ago regarding "gamma" and that "short dated options are prone to gamma effect and therefore are not a good idea".  "What am I missing?"

First of all, let me make clear that I do not watch "gamma", "theta", or any of the greeks that are associated with options.  The only greek that I really care about is delta, and I care about it only because:

1. it's a rough proxy for the probability of the option hitting expiration and being out of the money (OTM), and
2. I have set a minimum threshold of delta that I will sell premium (-0.25 or smaller for puts, 0.25 or smaller for calls).

Since I sell options and collect the premium from the sale, I want my options to expire OTM, which means they are worthless.  The take away is that if the option is OTM then I pocket all of the money I received when I sold it, and that's that.  Smaller deltas --> greater chance of option being OTM.

What follows is a bit technical, and in the big picture of cash-secured puts and covered calls, is really not needed.  It shows a bit of mental gymnastics, and the end shows that there MAY be a reason to trade short duration options (e.g. sell them), but the conclusions I make are a reach and note, I don't really pay attention to this.  It *could* be one of the factors of why selling premium is successful -- I simply don't know.

That being said, I'm willing to look at this a bit more ... I always like option analysis.

~~~~

The stock price, the option price, option delta, and option gamma are all related.  While option pricing is beyond the scope of where I want to take this blog entry, let's simply assume that an option price is established by and is fairly valued by the market.  An example is a good way to think about this; let's start with the stock price, option price, option Delta, then move into Gamma.

This past Friday INTC fired an alert in the GreekGodTrading Twitter account ( https://twitter.com/GreekGodTrading  ) and here is an echo of what went out to the folks who follow me:

INTC:!P_CSPv1.6. INTC 191025P48, MinBid=$0.68, MinPrem=$56.88, Last=$50.88, AROO=21%, Prob=70%, Spread=$0.01, ROO=1.3%, Days2Exp=22, CashReqd=$5020, IVRank=16.1, StrikeInc=$0.50, Delta=-0.2418, ImplVol=0.38, Fisher=2. 10/4/2019 3:28:40 PM

Lots of info there, but there are a couple of things that are important for this discussion:

• Last=$50.88:  INTC was trading at $50.88 when this alert fired
• MinBid=$0.68:  The half-way point between the ask and the bid, for the option INTC 191025P48, was $0.68, meaning, one contract would net you $68, less commissions, if you sold the contract when the alert sounded.
• Delta=-0.2418:  the option INTC 191025P48 had a delta of -0.2418; what does this mean?

Delta is simply how much the option price changes for every dollar change in the stock.  If INTC went from $50.88 to $51.88 (an increase of +$1.00), then we would expect that the option INTC 191025P48 would DROP from $0.68 to ($0.68 - 0.2418) ~ $0.44.  Note the minus sign -- PUTS have a negative delta, and calls have a positive delta.  This is because as the stock price moves away from the put strike (in this case strike = $48), the put becomes less valuable.

The units on Delta are "$ change in option price per $ change in underlying".

When an alert fires, various prices (underlying, option) are fairly stable.  Here's a table of INTC and consecutive entries where if the previous line would not have triggered an alert, the following one would have.  You can see that INTC fired more/less solidly for about 30 minutes this past Friday:

Price of INTC is in the 2nd column from the left; Delta is in the right column.  Bid/Ask, in the middle of the able, show the relative tightness of the spread (typically $0.01).  The time span is about 32 minutes.

What should be evident is that everything remains in a tight range, so even if you are late to an alert, the overall conditions are fairly stationary.  This is important for you if you desire to echo my trades (not recommended by the way -- this is only for informational purposes).

Here's a chart that shows the same data:

The x-axis is the underlying price of INTC.  The option price of INTC 191025P48 is shown on the left axis, and the Delta of the option is shown on the right axis.

What is evident here is that as price goes up, option price decreases (left axis, blue dots), as we expect, AND, option Delta changes (decreases in magnitude - becomes less negative) as price goes up of the stock.

So what?  Well, all this simply shows is that there is some behavior out there that relates stock price (x-axis), put option price (left axis, blue), and option delta (right axis, orange).  It isn't overly useful except to say that it is understood.

This next graph shows a general relationship between the delta of an option (0 to -0.3), the days to expiration for the option (8 to 29), and the number of strike intervals from the price (1-4).  Options are listed in these intervals ($0.50, $1.00, $2.50, $5.00, etc.) so it is important to know where various option deltas lay vs. days to expiration (DTE) as well as the option chain strike intervals:

The colored part of the graph shows Delta as a function of Days to Expiration as well as the number of intervals we are from a strike price.  Anywhere in the orange represents a delta of -0.25 to -0.20, and for the data set shown, this could be 2-3 option chain strike intervals below the current price, especially if we are out 29 days or more, OR, if we are within 8-15 days, it most certainly points to being within 1 strike of the current price of the stock.

In the picture above, Gamma is the slope of the change in delta, and now, you can see that it is a function of Days to Expiration as well as as how far we are away from the stock price.

There are other things that influence Gamma, but think of a marble on the surface of the Delta curve .... as it rolls, does it pick up speed?  If so, then Gamma is not constant, e.g., it has some influence on the option price and option delta.

A view-from-the-top of the same graph is shown below, and makes this "where is Delta in the -0.2 to -0.25 range (?) a bit easier to see:

Now, with all of that Delta stuff behind us ...

The original question was about trading Gamma, and a statement that short-duration options have poor Gamma so they should not be traded.

If I take the option prices as shown above in the two graphics, and then take the difference between the Deltas and do some simple manipulations, I can get a picture of the Gamma:

The relationship is kind of "concave" or somewhat parabolic -- for the shortest days to expiration (8), we have virtually no gamma (no change in delta as a function of time duration to expiration), and out beyond 15 days, the influence becomes less and less, to where at 29 days, it is virtually nil.

The arrow I drew points to the 15-day evaluation point, and shows a maximum negative gamma occurs when we are 2-3 strikes away from the underlying price, AND, we are at 15-days to expiration.  Note that the X-Y chart above, with the underlying price of INTC, the option price, and the option Delta are all for an option expiring on 10/25, or 18 days from the time this is written.  That puts us on the "back wall" of the surface shown above, so Gamma is clearly not zero.

A couple of things are evident to me:

• Trades that are within two weeks of expiration show a lessening of gamma -- the change in delta, as a function of distance to the underlying stock price AND the number of days to expiration, gets less and less as we march closer to options expiration.  If we choose to care about Gamma as we get closer to option expiration we can care less about it.
• Trades that are longer than two weeks from expiration, say 4 weeks, see very little influence of gamma too (evaluated with n = 100 optionable stocks or so).  Hence, selling premium out at 4 weeks before OE should see the change in delta remain fairly constant.
• I'm not seeing a real problem with a changing Gamma in the bigger picture.  Even if I choose a 15-day period to expiration, and I am 3 strikes away from the current stock strike price (the minimum in the surface graph so the maximum influence of Gamma for the data shown), it really doesn't matter to me.  At this point I'm seeing a $0.07 change per $1.00 change in Delta, or 7% of an already small number, so the influence on option pricing is pretty insignificant.

In the end I think it boils down to this:  if you are selling premium, delta matters more than gamma.  Gamma may matter around the 15-day to OE mark, but in general, it isn't driving a major decision.

~~~~~~~

I welcome input from those who have studied this more than I.

~~~~~~

As with all my ramblings, you are responsible for your own actions and I am not.  Nothing I've written here is advice to buy or sell any security, so don't do it unless you absolutely take ownership for your actions.

Regards,

Paul

Saturday, September 21 Update

If you are on the blog page in a web browser from a computer, please subscribe to this using the "Follow by Email" link to the left.  If you're on a mobile device you should see something in the frame that allows you to subscribe.  Having your email helps me to notify you when Google mucks up email distribution.

If you need to reach me, you can do so using the block at the bottom of the blog or send me an email.  I prefer that you use the box at the bottom of this entry, but of course, you can send an email to GreekGodTrading [ a t] g m   a i l [d ot] c o m (intentionally made difficult for the bots to read and spam me -- so fix it as your intuition tells you).

I'm also available in the HGSI DOC Live Discord forum here:  https://discordapp.com/invite/4QAUqyd

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I've not updated performance in a while so I thought I would take the time to document the selling cash-secured-put (CSP) and covered call (CC) strategy that I've had in play since December 2017.  For those of you who have written and I've not responded, I've been crazy-busy in my professional life so it's been a bit of a challenge to find time to do more than just the minimums of day-to-day portfolio management.  

It is my intent to use this entry to give a high-level update of the strategy.

Strategy Overview

I sell premium on options.  I generally start with the put option ("cash secured put", or CSP), as this has lower market exposure risk than starting with a covered call (CC), but if I see a CC that I like I will also buy the stock and sell the appropriate call in the same transaction.

My timeframe is generally on the order of a week out to about 5 weeks out.  I sell both weekly options (my preference) as well as monthlies.  When I see an alert form on my weeklies I almost always take it -- monthlies, not so much.  Simply personal preference.

Alerts are automatically formed by some software that I wrote that runs within the TradeStation platform.  The alerts are echo'd in real time to Twitter, and you can follow them for free simply by going to https://twitter.com/GreekGodTrading and following my account.  All my trades are echo'd there too, so nothing is hidden.  You get to see the good, (rarely) bad, and (never) ugly of my actual performance.

The alerts have a number of criteria but one of the important ones is that I selected a minimum threshold of Annualized Return on Option (AROO) before the alert will fire.  Hence, if I sell the premium and hold it to the expiration, I'm guaranteed to get at least that AROO on the position.  Right now that number is 18%, and this provides a solid, relatively straight-line performance.  More on that later.

Once I've sold the position, I generally attempt to buy it back at $0.05.  Not only does this accelerate the annualization calculations (instead of 100% profit over 4 weeks perhaps I get 95% of the profit in 2 weeks), it also returns the money to my account and lets me adapt to market changing conditions.  This is why I like weekly options over monthly options.

Stock selection is important.  I use my "Greenfield Stocks" selection criteria, which I've written about extensively in this blog and you can go find past references for yourself.  It has been a staple of my investing for well over a decade and I'm a firm believer that it all starts with proper stock selection.

I trade in three accounts:  a Traditional IRA, a SEP-IRA, and a margin account.  I use the funds of the tax-sheltered accounts first, then generally only trade monthlies in the margin account.  I try not to use margin for this strategy, although there is no reason why it would not work.  I just don't want the headache of accounting.

I keep perfect logs of my trades.  Every trade is logged, and every expired worthless trade is also logged.  You'll see some of the graphs below.  If you don't measure it, you can't fix it, and that will be evident in my pictures.

Strategy Performance

Let's start with the monthly net performance chart:

The "red" probably catches your eye first; these are the January months, and they are associated with market pullbacks and me rolling positions, mostly call positions.  Each January has been a loss, so I am watching carefully as we approach December of 2019 to not have a repeat.  Here's TradeStation's reporting of the same time period:

TradeStation has an error in how it reports some trades, so this is only approximate in numbers, but you see that the trend is there and intact. 

Here's what happens when I bucket by month.  Again, all that matters is the relative shape in each month; the overall values are less in TradeStation because they do not log profits due to expired (worthless) contracts or called positions:

So, October could present a challenge (historically), as may January.  I'm on the watch.

On a weekly basis, here's what it looks like:

You can see some weeks with really thin trades -- if the market is acting poorly, my system keeps me out of the market (but there is a lag -- it is not predictive).  

All of this suggests just north of 30% annual performance, net of all fees, commissions, kitchen sink charges, etc.

.... and I don't do a lot of work to get that 30%.  It's largely on autopilot.

This figure provides the view of history -- it really gives me a view of how TradeStation is records transactions.  Note, these are round-trip, closed transactions -- those that expired worthless (which is an ideal situation) are ignored by the TradeStation platform.  Note that the 19.57% gain over 589 significantly under represents the actual IRR performance of 32.2%.

The last line in the figure is the historical performance, to the beginning of September 2019.  Basically, for every dollar that I trade, I make back $2.55.  This is based on 589 round-trip trades, with 83% of them profitable.  Expectation of profit on each trade is currently about $49, net.

This last picture shows the drawdown the account has experienced, which is an indicator of how well risk is managed in the strategy:

Worse-case, I've lived through 3% drawdown from the previous equity high, since December 2017.  I can live with that.

Summary

Using the "Rule of 72", I'm basically on track to double the account in 2.5 years, using historical performance.  

I'm not inclined to "tweak" the strategy at this point -- it works well enough, and my time per day to service the strategy is less than 15-minutes or so.  If I miss a day due to travel no big deal -- I simply use the previous day's stock list and most likely no new trades (on the sell premium side) are executed.  Trades related to buy-to-close at the $0.05 are GTC orders and will execute at any time, up to options expiration.

Take away:  selling BOTH puts and calls is a good business.

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That's all for now.  If you have questions -- ask.

~~~~~~~~~

As with all my ramblings, you are responsible for your own actions and I am not.  Nothing I've written here is advice to buy or sell any security, so don't do it unless you absolutely take ownership for your actions.

Regards,

Paul

edit:  updated the actual performance using the daily account balance and presuming that I "cash out" account value on 9/21/2019.  IRR updates to 32.2%, net of everything:  all fees, all commissions, subscriptions for data feeds, platform fees, etc.

Selling CC and CSP Strategy Lessons Learned

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If you are on the blog page in a web browser from a computer, please subscribe to this using the "Follow by Email" link to the left.  If you're on a mobile device you should see something in the frame that allows you to subscribe.  Having your email helps me to notify you when Google mucks up email distribution.

If you need to reach me, you can do so using the block at the bottom of the blog or send me an email.  I prefer that you use the box at the bottom of this entry, but of course, you can send an email to GreekGodTrading [a t] g m a i l [d ot] c o m (intentionally made difficult for the bots to read and spam me -- so fix it as your intuition tells you).

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Many of you are aware that I developed a strategy, tested it using a variety of methods, and finally decided to "take the plunge" with real money around December 11, 2017, almost 19 months ago.  Lots of water has flowed under the bridge since then, and while there have been a few rocky points due to my own trial/error, the underlying mechanics of the strategy have proven themselves and are sound.

In the event you have no idea what I'm talking about, I sell options on quality stocks, with the intent that the options expire worthless.  Doing so allows me to pocket the premium received for selling the option, and it simply becomes a rinse/repeat sequence.  There is a high expectation of profitability if the stocks are "quality" and if I do not try to get "cute" and squeeze out every last nickel of a trade.  I've settled into a normal routine and it appears that I should be able to continue this effort independent of what the markets do (although gains slow or go slightly negative in a down market).

Net Performance (Your Actual Performance May Vary)

Most of you want to know the information in the following figures:

First, a monthly performance graph.  Green means I made money in the period, and red means I lost money in the period:

Click on the image to enlarge

Next, same net data, but with WEEKLY resolution (instead of monthly):

Click on the image to enlarge

Obviously, the lower-left / upper-right (LLUR) direction of the equity graphs are the direction that I want to go, so I'm happy with this.  Starting capital was around $71,000, and despite some bumpy roads in January 2018 as well as January 2019, my net return is north of 15% CAGR, with all expenses, platform fees, commissions, etc. included.  Solid revenue.

What Causes Losses (for me)?

I log EVERY trade.  Every one.  I've made a total of 586 round-trip trades, and 12 of them were BUYING protective puts.  You lose money on a protective put if the stock continues higher.  I'm am not using protective puts right now, but they are useful in my arsenal should I need them.  Overall, the markets are moving higher, so buying puts is not a key component of my strategy.

The losses in January 2018 -- nearly 17 months ago -- were due to just getting started and being careless.  These losses, which resulted in ($2,339) of losses on a $71,000 portfolio forced me to develop key position sizing rules.   Here is the fundamental of that rule:  with little exception, no position should occupy more than 14% of your portfolio.  I usually start in the 2-5% range, and if the trade works out, I'll add to it by selling another put and/or selling a call to straddle an assigned position.  It is rare that I sell an initial position that is 14% of my portfolio, but I've done it.  I generally attempt to sell a 1/4 or 1/2 position first, then work from there if assigned.

The following chart will highlight something I'm REALLY weak at:  Rolling for profit:

Click on the image to enlarge

The chart shows that my losses are predominantly from rolling options (79 positions rolled for an average loss of ($114.01) per roll.  This has accounted for over $9,007 in portfolio losses.  My other loss mechanism is the "sell if the stock hit hits -3% below my entry strike", but you can see that has only occurred 3 times out of all of my trades.

To address this I have greatly curtailed my roll operations.  With little exception, I have decided NOT to roll, rather just let the stock get called away and be done with it.  I'll still retain discretion to use a roll when it makes sense, but the premise of a roll operation when holding the call is simply not a good one.

This position is further supported in other data that I have.  Despite the roll operations being a big negative influence on my performance, positions that I DID roll into have been profitable, but not nearly to the extent necessary to make up for the difference.  In fact, I've only recovered $24.65 on average out of the lost ($114.01) due to the roll, so rolling is not a long-term viable strategy.

Key takeaway:  minimize rolling positions.

Other Nuances of My Strategy and Trading Performance

The following graph shows which months have been profitable and which have not been so profitable:

Click on the image to enlarge

The December-June period has had 2 years of data rolled into the chart, whereas July - November still only have one year of data (July 2018 - November 2018).  I know what caused issues for both January months, and looking at trades from September and October 2018, I can see that rolling heavily offset some of my gains.  A few positions were put and/or called against my desires, and there is nothing that you can do about early assignment except manage the position.  Whatever you do, DON'T PANIC.  If your position size is correct, you'll take a hit, but you will not lose your portfolio.

An important graph is this:

Click on the image to enlarge

This is a graph of drawdown, which is the amount the portfolio dropped once it hit an equity high.  You can see that for the PORTFOLIO, although some positions fell enough to cause heartache, the impact on the PORTFOLIO over the last 19 months has only been a -3% (less than) drop in overall value. 

Think about that from a risk management point of view.

Currently, the portfolio is making new highs, as exemplified by the green dots in the equity line:

Click on the image to enlarge

The next few graphs help answer whether selling a cash-secured put (CSP, or Sput in the graph), a covered call (CC), or rolling the position  (Roll) has resulted in greater gains:

Click on the image to enlarge

It's pretty clear that the Ccall graph -- the middle one -- has spent the majority of the time above it's 20d MA.  This suggests that CC's have a definite place in my strategy.

It's also pretty clear that the Sput graph -- the top one -- has also spent most of its time in an uptrend.  Same comment as CC.

Finally, rolling positions suck, or at least, I'm bad at it.  In my defense I think I'm not too bad at it, but rolling the position when it is already moving towards being in-the-money means that you are losing value on the call option -- rolling it just locks in that loss with the "hope" of recovering it later, either through stock appreciation or through collection of higher premium.  I'm obviously minimizing my roll activity.

Take away:  selling BOTH puts and calls is a good business.

~~~~~~~~

That's all for now.  If you have questions -- ask.

~~~~~~~~~

As with all my ramblings, you are responsible for your own actions and I am not.  Nothing I've written here is advice to buy or sell any security, so don't do it unless you absolutely take ownership for your actions.

Regards,

Paul

How Many Dividend Champion Stocks do I need to perform better than the S&P 500

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If you are on the blog page in a web browser from a computer, please subscribe to this using the "Follow by Email" link to the left.  If you're on a mobile device you should see something in the frame that allows you to subscribe.  Having your email helps me to notify you when Google mucks up email distribution.

If you need to reach me, you can do so using the block at the bottom of the blog or send me an email.  I prefer that you use the box at the bottom of this entry, but of course, you can send an email to GreekGodTrading [a t] g m a i l [d ot] c o m (intentionally made difficult for the bots to read and spam me -- so fix it as your intuition tells you).

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I trust that everybody is enjoying the long Memorial Day weekend.  Let's pause and remember the reason for the holiday ...

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I received a question this week that was tied to last week's entry, specifically asking "How many Dividend Champion stocks should I hold to perform better than the S&P 500?"

This isn't as easy a question as it appears.

First of all -- "perform better".  In return?  In volatility?  Both?  Some other metric?  The question wasn't specific.

It isn't practical to hold 500 stocks.  Commissions would eat you, and management would be a pain in the tail.  Contrary to belief, funds that track indexes also do not invest in all the stocks of the index -- they use a subset for this very reason.

Not all stocks in the Dividend Champion list are in the S&P 500, which further complicates the decision tree.  

Not all stocks in the S&P 500 pay dividends, further complicating the answer.

Reformulating the question:  Using just stocks that pass Paul's Greenfield criteria, pay a dividend, and are on the Dividend Champions list, can I beat or outperform the S&P 500 in return and/or volatility?

So, let's start with the S&P 500 stocks.  I'm only interested in 

1) the Greenfield-critiera-passing subset, 

2) those stocks that pay a dividend and that are on the Dividend Champions list, and

3) have less or equivalent risk than the S&P 500.

Regarding the first two criteria, I've compiled that list for you, and it is here.

This seems to be a lot of trouble:  I *could* simply buy the SPY (an exchange traded fund that mirrors the performance of the the S&P 500) and be done with it.  If I were to do that, I'd have the expectation of the performance that I stated last week (5.97% return annually at an average volatility of 17.90%) and I'd presently capture a dividend yield of 1.85% (see this link as an example of how the dividend yield is determined).

Hmmmm....  1.85% dividend yield.

I'll not get into here but suffice to say, if I want a dividend yield of greater than 1.85% on a basket of stocks, then the "average" of all the yields of the subset of stocks that I invest in has to be greater than 1.85%.  

Since I don't *know* what stocks I'm looking for (yet), the way to address this is to only look at stocks that have a yield greater than 1.85%.  In doing this I am guaranteed, no matter what, to beat the current dividend yield of the SPY.

I've built the subset of stocks of the S&P 500 that 1) pass my greenfield criteria, and 2) have a dividend yield of greater than 1.85% as of 5/24 closing prices.  The stocks on the list are further screened against the May 2019 Dividend Champion CCC tab located here.  The final text list is here.  

It's still a long list.  76 stocks, to be clear.  I have no desire to invest in 76 stocks.  Still unmanageable.

Enter Portfolio Optimization

One way to select a basket of stocks is to do so such that some parameter is optimized.  Typical parameters are things like 1) maximizing Expected Return (ER), 2) minimizing volatility, 3) minimizing correlation, etc.  

If you were paying attention last week, you read that I mentioned the Sharpe Ratio (SR).  This is a metric which calculates ER and risk, the latter which is often interchanged with volatility.  Hence, for a given equivalent ER between two securities, the one with lower volatility has less risk (and corresponding higher SR).

So, a natural method to select stocks is to maximize SR within the entire portfolio.

But, here's a complicating component:  correlation between assets.  As one move up, the others may move up, or they may move down.  It all depends.

Here's an example that you can use to better understand this.  Let's take the exchange traded fund SPY, which I said is a proxy for the S&P 500, and the Vanugard mutual fund VFINX, which also is a proxy for the S&P 500.  Theoretically, both should move exactly in lock-step with the S&P 500, and hence, they should both be in sync.  

The reality is that yes, the SPY and the VFINX are almost 100% in step.  See the picture below:

Click on the image to enlarge

Calculating the SR's of the SPY and the VXF isn't enough -- the correlation between the two needs to be considered.  It would not provide any benefit to me to invest in BOTH -- there is no diversification -- and only expenses would go up.  There would be no other benefit that is hidden or not apparent.

So, when we are looking to reduce a basket of stocks, we want to choose stocks that lack correlation ... so, we specifically want to maximize SR but minimize correlation.  This becomes a multi-variate problem.  

As complicated as this sounds, there is software out there to crunch through the numbers.  Excel does a great job at this, and I have a great piece of Excel software to help me do this.

This concept of correlation is important in stock selection.  It is best to select stocks that are uncorrelated.  Stocks that are perfectly correlated have a correlation coefficient of "1".  Stocks that are perfectly INVERSELY correlated have a coefficient of "-1".  Stocks that are UNCORRELATED have a correlation coefficient of "0".  We want a basket of stocks with as low as a correlation coefficient as possible (close to zero as possible).

Let's take the 76 candidate stocks and calculate the correlation to the S&P 500, the Russell 2000 index, and each other.  The following figure is a small slice of that 76-stock universe:

Click on the image to enlarge

^GSPC is Yahoo's symbol for the S&P 500.  ^RUT is the symbol for the Russell 2000 index.  Other stocks are listed as shown.

The green "1"s that form a diagonal are due to the fact that a stock has a perfect correlation with itself.  

I've color-coded the figure to show that the closer the correlation, the greater the amount of green.  The more neutral, or uncorrelated, we see orange, and the more inversely correlated, we see red.

The S&P 500 (^GSPC) has a 0.908 correlation with the Russell 2000 (^RUT).  Both are darker green, so as one moves up, the other also moves up in almost the same manner.

Conversely, you see that WELL is more negatively correlated with the other stocks shown (see the negative numbers in RED).  

As I wrote above, this isn't important in the big picture, but it shows you how stock prices move with each other.  The goal in portfolio selection is to maximize diversification through as few selections as possible, and this is one way to get there.  We want a basket of stocks that has an average correlation as close to "0" as possible".

If you are looking for a slightly more in-depth treatment of the math behind this, go here or here.  

Portfolio Component Selection

How to choose which stocks?  How to ignore some, but select others?  How to weight each stock so to maximize some value?  The paper here gets into the gory details.  What is important here is that there is a trade off between a risk-free investment, a risk-free + risky investment, and a number of risky investments.  The goal is to figure out how to get as risk-less as possible but maximize return -- hence optimization of the Sharpe Ratio, while minimizing individual stock correlation.

Tying this back to the correlation thing above, when I crunch through the numbers, here is the correlation matrix for the "solution":

Click on the image to enlarge

Of significance is that there is NOT a great deal of green on the matrix -- most of these stocks are uncorrelated with each other, or probably better-aptly described, do not have a tight correlation.  The average correlation to each other is 0.341, which isn't bad.  0.000 would be ideal.

Given that this is the list of stocks with the lowest portfolio correlation, the next challenge is optimizing SR.   There is a large number of possible weightings of stocks to give us a return, and when we do that, we play with volatility.  It's possible to maximize Expected Return but have terrible volatility; conversely, it's possible to have extremely low volatility but not maximize Expected Return.

Everything has been leading up to this -- the calculations.  Don't worry, I won't go through the details.  Simply put, the Efficient Frontier and ER/Volatility points for all the stocks shown is here in the following graph:

Click on the image to enlarge.

If you are not familiar with Efficient Frontier go watch this (you REALLY need to watch that video if this is new to you).  In the example I've set the S&P 500 expected return to 5.97% (recall that this is the average annual performance of the S&P 500 over history, not including dividends).  Any stock below this value is an underperformer in terms of gain; and any stock above this is an overperformer in terms of gain. Further, recall that the S&P 500 volatility over history is about 17.90%, on average, and when you look at the graph above, you see that the majority of stocks have greater volatility than the S&P 500.

There is a unique condition in this process where two volatilities of greater than some number, when combined in the process, actually reduce the overall volatility of the combined set.  This means that it is possible to select stocks with higher ER (y-axis) and higher volatility (x-axis) yet come up with a solution that has LOWER volatility but higher ER.  This is the Efficient Frontier blue line in the picture.

The red line is the tangent line to the Efficient Frontier.  The slope of this line is determined by the risk-free interest rate -- currently a value of 2.37% and zero volatility.  The intersection of the straight red line and the blue line is the best the portfolio can be expected to do, given a risk free rate of 2.37% (go here).  It is shown as the purple triangle at the intersecting points.

So, provided you watched the video above and understand the construct, using weights between 0% and 100%, ALL of those stocks define portfolios that are boundaried by the blue line, and because the red line and the blue line are tangent (intersect at 1 point only), there is a theoretical solution to a unique portfolio that provides the optimum ER at the lowest volatility.

That is what I'm seeking.  Maximize ER while minimizing volatility.

For a reference point, the S&P 500 has a historical Sharpe Ratio of 0.3335, produced from an average yearly return of 5.97% and an average volatility of 17.90% (see last week's blog entry).

The portfolio shown above has an optimal Expected Return of  5.94% yet the volatility has dropped to 13.97%.  This is an improved SR that is 0.4252.  The method has the potential to produce the same behavior as the S&P 500 yet a a lower volatility, by specifically weighting each stock between 0% and 100%.

What is that weighting?  Here you go:

This is a big list of stocks, but you can see that the weights (next to the symbols in light yellow) get smaller and smaller as you go from top to bottom.  This is the "perfect solution", e.g., the one where the Efficient Frontier (blue line) and the risk-free interest rate line (red line) intersect.

Next to the weights are the closing prices for each of the stocks, as of the 5/24 close. 

To the right of the closing prices are the latest quarterly dividends that were paid for the stock.  Remember, our initial criteria specified that we had to pick stocks with a dividend yield of at least 1.85%.

To the right of the dividend levels are the number of shares, given a $1,000,000 starting level, rounded to the lowest whole number.  Note that the portfolio size is $1,000,000, and yet EQIX, at a close on 5/24 of $496.52, would only have you purchasing 9 shares.    You can see that some of these stocks will not be purchased if the starting level is much lower (as is the case with me).

Next to the number of shares are the yearly dividend payments, if everything remains constant.  Remember -- these are Dividend Champions -- so we have an expectation of dividend growth.  At a minimum, we can expect to see $29,644 over the next year.

The right column shows the actual dollar value committed for each stock.

At the bottom of the table, you can see that we have $29K in expected dividends as well as $999K committed in total portfolio, giving us a 2.97% dividend yield.  Note how much better this is than the 1.85% dividend yield cut off.  We will certainly beat the S&P 500 in terms of dividends received.

Impact of Starting Smaller

It is highly probable that most of us do not have $1,000,000 to throw at a new strategy.

What if we start with $10,000?  What happens then?

Here's the table:

The first thing that should be evident is that there is simply not enough cash to fund all of the positions. 

The next thing that is evident is that the share purchases of 1 share probably are not worth the cost of commissions.   In fact, I think the lowest number is probably around $200 per stock.

As an example, round-trip costs for me (to buy and to sell a security) are $1.00 each way with TradeStation, so I pay $2.00 round trip. If the stock moves 1% upward on a starting position size of $200 then I'm at break even.  If you take a look at the right column you can see that many of these position sizes are below $200, so it probably is not worth attempting to enter this portfolio with $10,000.

Commissions will eat into the portfolio, so it important that you understand the impact of round-trip fees.

If you use Fidelity, Schwab, or E-Trade the commissions are higher and you would be worse off.    I would simply buy the SPY and be done with it.

Impact of Starting at $100,000

If $1,000,000 is out of reach, and $10,000 doesn't make sense, what about starting at $100,000?

Here's the table:

This scenario isn't far off the mark.

You could argue that any position that is 2% or greater in size (invested capital ~ $2,000 minimum per position), the impact of commissions could be negligible.

If we choose not to invest in some positions, we throw off the weighting for each stock, and we also have cash left over.  The key is to deploy ALL our cash.

So, let's only pick those position sizes above greater than 2%.  Here's what the new portfolio looks like:

This portfolio contains 20 positions.

The starting level is $100,000.

You can see that you should receive nearly $3K in dividends the first year if you are invested in this portfolio and hold for the duration (obviously presumes that no company cuts their stock dividend).

The new calculated volatility of the portfolio has increased from 13.97% to 14.06%.  Not terrible, but not ideal.  Expected Return is constant at 5.94%.

You can also see that some of the position sizes jumped -- and a few others dropped.  Nevertheless, this should be an achievable portfolio if you have $100K or more to start.

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Summary

1) We started with the stocks comprising the S&P 500.

2) We downselected those stocks to choose only the dividend payers that were yielding greater than 1.85%, the present yield of the exchange traded fund SPY.

3) We further downselected stocks to make sure they were part of the Dividend Champions list.

4) We selected a smaller group of stocks that had the lowest correlation to each other.

5) We further selected weights of stocks to maximize the Sharpe Ratio of a portfolio.

6) We looked at investing $1M, $10K, and $100K in that basket of stocks.  It is probably better to simply buy the SPY if you only have $10K to invest.

7) We chose only the stocks of the original optimal SR solution that had a position size of 2% or greater (about $2,000), then we re-optimized.  SR dropped a bit on the re-optimization, as you would expect, since we used a subset of the previous optimized universe.

8) The answer to the question is 20 -- you need 20 stocks from the Dividend Champions list in order to perform better than the historical average of the S&P 500.  Stock selection matters.

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Next week I'll get into the rules of buying/selling and how to use options to get into some of the positions with a lot size of greater than 100 shares.

~~~~~~~~

That's all for now.  If you have questions -- ask.

~~~~~~~~~

As with all my ramblings, you are responsible for your own actions and I am not.  Nothing I've written here is advice to buy or sell any security, so don't do it unless you absolutely take ownership for your actions.

Regards,

Paul