Making Hay While the Sun Shines

Making Hay While the Sun Shines
Sep

14

2017

Making Hay While the Sun Shines

2017 Has Been a Banner Year for Many Stock Option Sellers. But the Good Fortune May Only Last as Long as the Bull Market


“Enjoy it while it lasts kid…because it never does.”

-Veteran Stock Broker (Hal Holbrook) to Rookie Stock Broker (Charlie Sheen) in 1987 movie “Wall Street”


Don’t look now but its September. We’re rounding the corner and soon headed into the final stretch of 2017 (It really does go faster as you get older.)

From the feedback we’re getting from clients and followers, it has been a banner year for stock option sellers (as you may know, many commodity option sellers start out as stock option sellers and “convert” – or – continue to do both.)

S&P 500

GRAPH: S&P 500


2017’s bull market in stocks has been a boon to many sellers of equities options


And why shouldn’t it be? Despite utter turmoil in Washington, warning lights on several key economic indicators and an on again off again threat of war with North Korea, the stock market has, for the most part, kept on its steady chug to ever more dizzying heights.

But warning lights are flashing. At the time of this writing, the S&P is still up 9% on the year. The Nasdaq, however, has seen 4 straight losing weeks. And the Russell 2000 is now flat on the year.

I’ve long since given up trying to figure it out. Fortunately, that’s not my job.

The Best of Times

What I do know is this. The last couple of years have been the best of times for stock option sellers. If you sell cash secured puts, you’ll do well in bull markets. In fact, its pretty hard to lose money selling puts in a bull market.

If you take assignment and then sell covered calls on your stock, you’ll also do exceptionally well in bull markets. If the stock doesn’t move, you get an extra paycheck from your holdings. If it moves higher, you get the profit from your stock AND your premium.

Thus, whether you’re selling puts or calls on your stocks, 2017 should be a good year for you so far (if it hasn’t been, you’re doing something wrong).

Stock Options Inherent Weakness

But selling stock options has an inherent weakness. It’s a weakness a successful stock option seller can easily forget, especially in such heady times as 2017.

Stock option sellers (not you of course, I mean those “other” stock option sellers) tend to think this way: “I’ve made 10% (15%, 20% whatever) this year. If I do that for the next 10 years, I’ll be up xxx%!”

“This stock option business is the greatest,” they think to themselves, “I’ve got the system down!”

Well, yes and no. Stock option selling, at least the way most people do it, works great…when the market is going up.

When it stops going up, well, not so much. But sellers who know nothing else tend to forget or ignore that fact.

If you’ve ever heard Aesop’s story of the Donkey, the Rooster and Lion, it contains a relevant lesson for the stock option seller of today.

The Donkey, The Rooster and The Lion

A donkey and a rooster are eating breakfast in a barnyard. Out of nowhere appears a hungry lion. He approaches and prepares to attack the donkey. The rooster, knowing the lion has an acute yet single aversion to its voice, lets out a magnificent crow. The frightened lion turns and runs off into the brush as fast as he can. The donkey, seeing the lion’s trepidation at the mere crowing of a rooster, summons the courage to attack the lion and charges after him into the brush. A way down the trial, the donkey catches the lion at which point the lion turns and rips him to pieces.


Moral: Overconfidence can be deadly.

Buffet once said a rising tide floats all boats and that includes (perhaps especially) stock option sellers.

All they have ever seen is the lion running away. Going in after him, year after year, has proved fruitful so far.

But they haven’t caught him yet.

Buffet once said a rising tide floats all boats and that includes (perhaps especially) stock option sellers. Everybody makes money in bull markets.

But a sudden and steep correction in stocks can turn a good year into bad quickly.

Why?

Because stocks, while sectors may be diversified, tend to move as one asset class . You can have the best stocks and the best fill and the highest odds options in the world. If the index turns as a whole, its likely going to have a major impact on your whole portfolio.

The Fate of Bear Market Stock Option Sellers

And what if this raging bull turns into a bona fide bear market lasting 1, 2, even 3 years? What happens to the stock option portfolio? Most likely, it suffers or simply becomes defunct until the market starts back up. How is this any different than simply stashing capital in a stock index fund and avoiding all the hassles?

As a stock option seller, you cannot afford to forget this. You’re using a good strategy but you’re still beholden to a mercurial master. Your fate is still painfully dependent on the direction of the overall index. Thus, you have to make hay while the sun shines and hunker down when it doesn’t.

Making Hay

Stock option sellers need to “make hay while the sun shines.” But what about when it rains?


If you have significant assets to protect, that isn’t always the best route to consistent growth.

The “All Weather” Asset

Commodities of course, are not perfect either. I do not pretend that they offer a “buy all end all” solution to easy, risk free returns.

But you can consider selling options on them an “all weather” asset.

For in the event of a stock correction or even a protracted bear market in stocks, a commodity option selling portfolio can keep chugging along – even excelling in such conditions.

This is not only because the commodities sector is uncorrelated to equities. It is also because in commodities, one can sell calls as easily as puts, without ever having to take assignment of the underlying contract. Thus, you can just as easily make money in a bear market as a bull market.

Some of my very best years as an option seller have come in bear markets.

Now, is this a blatant advertisement for selling commodities options?

I prefer to call it advocating. I’m here to provide the best investment advice I can, regardless. From my training and experiences, that is the best advice I can give.

That doesn’t mean you should run out and start selling soybean options today (especially without any training.)

GRAPH:

An “all weather” asset can potentially deliver in any type of market condition – sun, rain or otherwise.


What it does mean is that if you’re currently toasting your success as a stock option seller, enjoy! But remember that you may have a lot less control over your results than you think.

Avoiding the Lion’s Teeth

Overconfidence in the ability of your stock option portfolio to perform is an easy trap to fall into during a bull market. But you’re chasing a lion down the path. Sooner or later, you’re going to catch him.

lion and the mule

Overconfidence can be deadly.


Diversifying into an asset class that includes several uncorrelated sectors, all of which are uncorrelated to stocks, interest rates or even the economy, can keep you out of the big cat’s teeth. In the event of an equities market downturn, having other assets still working in your favor can provide a real coat of security, especially for those of us with considerable assets to protect and grow.

That is of course, what this newsletter attempts to help you do.

In the meantime, I hope this banner year does continue for you, should you sell stock options as an investment avenue.

Just remember, that lion might not be running away from you.

He might have just heard a rooster crow.

Have a great month of premium collection whether you sell stock or commodities options!

Regards,

James

  1. Thomas Lindegard Says:
    September 15, 2017 at 6:54 am

    Dear James,

    Thanks once again for sharing your knowledge and experiences in such a nice format, soaked in common sense! When it comes to selling options in the stock market, I do think it is possible taking advantage also of a bear market, using call options. As a trend follower, I can study the trend by for example the 40 week moving average and sell calls when the stock index is below that average. The problem is that call options in the stock market are generally cheaper than puts, so using your technique with selecting options with a long time to expiry is great to ensure adequate premium.

    If the stock market is in a bear mode, I do tend to allocate more capital to selling commodity options, but I believe selling calls and puts in stock indexes does have a place in a well diversified option selling portfolio.

    Best regards,

    Thomas

    • Michael Gross Says:
      September 18, 2017 at 2:25 pm

      Thomas,

      Thanks for your feedback and agreed! Selling both stock and commodities options is a way to build solid diversification into a portfolio that can potentially perform in any kind of market, bull, bear or otherwise.

      Best wishes in your investments.

      Regards,
      Michael

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