One trade for uncertain markets

  My favorite ETF is EWZ which tracks Brazilian Index. It is trading 8 times earnings and yielding 6.17% in dividends. Just for comparison, IWM, Russell 2000 index trades at 15 PE and yields 1.39%. INP, tracking Indian Index trades at 21 PE.

    I am bullish on EWZ, don’t mind outright buying the shares today at market price of $56.92 but would be a greater buy, if the shares drop lower. In this article I will discuss about a trade called Put Ratio Spread and how I can place that trade on EWZ, to suit my situation.

   In a put ratio spread, we buy puts at higher strike price and selling more puts at lower strike price to offset our cost. In case of EWZ, I can buy one Feb,2012 57.00 put for $2.80 which will cost me $280 and sell three Feb,2012 51.00 puts, for $0.96 which will give me credit of $288.  Placing this trade will cost me nothing or almost nothing and I will be buying the stock for $48.00, if it craters below $51.00

   On the options expiration date, for every dollar the stock drops below $57.00, this trade will gain $100 up to $51.00. For every dollar the stock drops below $51.00, this trade will loose $200. Maximum possible profit is $600. Break even price is $48.00. Maximum loss will be $9600, if stock goes to $0.00.

  If the stock is higher than $57.00 on options expiration date, we neither gain nor loose anything. Even if the stock is higher this trade could be closed for gain, few days before options expiration because lower strike puts decay faster than higher strike puts.

Disclaimer: This article does not constitute individual investment advice. It is only for entertainment.

Source: Yahoo Finance.

Disclosure: I own put ratio spread on EWZ.

How will I trade your $100000?

"They say a good chess player can see up to twenty moves deep. That means that in some games, you've calculated every possible move in your head. The game's over before it's even really started”.               –Confidence.

   Let us see if we can come up something close to the above statement, in our field, trading stocks. 

A trading strategy, which can factor every possible scenario! Give us an upper hand to outperform the market.

  One doesn’t need to be a genius to realize the possible outcomes after you buy a stock; stock goes up, stock goes down or remains flat at the same price, depending on your time horizon.  So all we need to do is capture the upside and not loose on the down side. This can be done easily by simply buying puts. But protection is not cheap. If we spend 10% of the underlying position to buy puts, that will protect us for a year and our position does not move more than 10% in that time frame, we have lost money.

If I know, my stock is not going to bankrupt, all I would need is limited protection. If the stock is trading at $100, instead of protection for $100, all I might need is downside protection for first $20 or $30. Only way, I can be confident that my position will not decimate completely is to get into indexes.  What are the chances of SPY or IWM going to zero?

  My ideal portfolio should always maintain cash. If we are fully invested or borrowed on margin, we panic when the market crashes. On the other hand, we will see it as an opportunity to increase our position or open new positions at sale price, if we have cash. At the same time, if the market is on rise, we will underperform the market because we are not fully invested. This can be offset by using options.

  If I am, a portfolio manager or running an insurance company, this is how I would invest your one hundred thousand dollars:

 Inception date: Dec 25, 2011

Symbol	Description	Quantity	Price	Value
IWM	iShares Russell 2000 Index	400	$74.55	$29,820
-iwm130119c75	IWM Jan2013 75 call	5	$8.91	$4,455
-iwm130119c90	IWM Jan2013 90 call	-9	$2.89	-$2,601
-iwm130119p75	IWM Jan2013 75 put	6	$10.81	$6,486
-iwm130119p60	IWM Jan2013 60 put	-10	$5.13	-$5,013
EWZ	iShares MSCI Brazil index	500	$58.33	$29,165
-ewz130119c58	EWZ Jan2013 58 call	6	$7.75	$4,650
-ewz130119c70	EWZ Jan2013 70 call	-11	$3.00	-$3,300
-ewz130119c58	EWZ Jan2013 58 put	8	$8.70	$6,960
-ewz130119c45	EWZ Jan2013 45 put	-13	$3.90	-$5,070
Total				$65,552
Cash Remaining				$34,448
Total portfolio				$100,000

    Now that I have shown the portfolio, let us run few scenarios.

 Market is down: Let us assume both IWM and EWZ are down 15%. IWM would be trading at 

$63.37 and EWZ would be trading at $49.58. IWM position will be worth $25,348 and our 6 puts will be worth $6,708. EWZ position will be worth $24,790 and our 8 puts will be worth   $7,000. Portfolio value will be $98,294 plus the dividends earned. I would be extremely happy at this situation and also increase positions with cash on hand.

 Market is up: Let us assume both IWM and EWZ are up 15%. IWM would be trading at   $85.73 and EWZ would be trading at $67.08. IWM position will be worth $34,292 and our 5 options will be worth $5,590. EWZ position will be   worth $33,540 and our 6 options will be worth $5,250. Portfolio value will be $113,120 plus the dividends earned.

 Market is flat: If both positions are flat, we have to close all options and puts two months before expiration to break even. This was the specific reason, we paired Russell index with Brazil index. 

There was no year, in which both Russell and Brazil index ended in flat line. If the global economy does not end up in recession next year, I would bet two cows and three goats that Brazil index would outperform over the next year.

 Market crashes: If both positions crash 30% our portfolio will be down around 8% and we will be doubling our core positions, waiting for markets to rebound. It will hurt that we are down, but will have the pleasure that our neighbors lost more than us.

   I will be tweaking this portfolio once or twice a year and review the portfolio every Dec 25^th for next four years. You can see how you would have done, if I was your portfolio manager for five years.

   Feel free to leave comments and poke holes in my strategy, to outperform the markets.

  Disclaimer: This article should not be treated as individual advice. Consult your financial adviser to review your risk tolerance and strategy that suits you.

 Source: Yahoo Finance

Disclosure: I have short and long puts in EWZ and do not plan on initiating position in IWM in next 72 hours.

Four ways to trade Rio Tinto plc (RIO)

In this article we will look at four strategies using our tools of the trade, options and puts, to trade RIO and possibly buy the stock below market price.  Rio Tinto plc (RIO)  is  a mining company with almost half of the revenues derived from Iron ore and around a quarter of revenues from gold, but also mines and process several other metals and minerals. RIO has an operating cash flow over $19 billion and pays a dividend of $1.07.  RIO currently earns $8.16 per share, has an average price target of $92 and currently trading for half that price.

Covered call option:  This is the most basic and safest strategy for an options trader. You simply buy the stock and sell later dated options, at the strike price, you are happy to sell the stock. While RIO is trading today at $47.40, options for January, 2013 $60 strike price can be sold for $4.50. So, using this strategy, one can buy the stock for roughly 10% below market price and still have a chance for $17.10 in upside. Also, earn a $1.07 in dividend.

Covered call option and option spread combo: In this strategy you buy the stock and open, a one by two credit spread. RIO January, 2013 $50 strike price option is trading for $8.50 and $60 strike price option is trading for $4.50. So following this strategy, for every 100 stock bought, you buy 1 contract of $50 strike price and sell 2 contracts of $60 strike price option, getting a credit of $0.50. You not only bought this stock for $0.50 below market price, but also have a chance to gain $2 for every $1 increase in stock price, up to $60.

Selling a put option: While waiting for the stock to fall to the predetermined price, you may generate revenue by selling put options at that strike price. So if you want to buy RIO for $40, you can sell April, 2012 $40 puts for $3.  Sell 1 contract for every 100 stock you want to buy. If the stock doesn't fall to $40, by April, 2012, you have made $3 in profit. If the stock dips to $40 or below, you are obligated to buy the stock and our buying price is $37.

Put and put spread combo: In this strategy, you buy one put at the money and sell two puts out of money. RIO April 2012, $45 strike price puts are trading for $4.60 while $40 puts are trading for $3. So, for every 1 contract of $45 puts bought, sell 2 contracts of $40 puts and you get a credit of $140. If stock falls to $40 by April, you made a profit of another $500. If stock falls below $40, you are obligated to buy the stock for $35, no matter how much the stock dips below $40. If the stock continues to climb higher from today, this trade can still be closed for profit before expiration, because with time, $40 puts deteriorate faster than $45 puts.

  This article is just a starting point. Do your due diligence before investing and according to your risk tolerance.

Source: Yahoo Finance

Disclosure: I do not own any position in RIO, but might initiate in the next 72 hours