By Greg Jensen
One of the beauties of the options market is that it is usually possible to construct a strategy to suit any scenario you may envisage. The old clichéd strategy of “Sell in May and Go Away” has actually been pretty good advice in recent years, but for most retail investors there is usually a prohibitive cost in moving all to cash for a short period of time. If you own primarily mutual funds, you either can’t do it at all or will have to pay penalty fees, as most have rules to discourage trading. If you own individual securities, then selling everything and buying back in a couple of months creates a bonanza in fees for your broker, but your money will fund it. Not a smart idea. The problem is, you really want to do something when you look at this.
This is a chart of the Powershares QQQ Trust (QQQ) that tracks the Nasdaq 100 index. The thin yellow vertical lines mark the beginning of May 2011 and 2012. As you can see, selling in May and going away for a time has been a valid strategy. Of course, we all know that past performance is no guarantee of future success, but it looks mighty tempting.
Options make it possible to play the belief that May will see another swoon in the market, followed by a fall recovery, without an enormous outlay or a huge contribution of your money to your broker’s bottom line. At the time of writing, QQQ is trading at 67.62, and May 18th expiration 68.00 calls can be sold for $1.18 per share. The proceeds could then be used to buy, say September 21st expiration 72.00 calls at $0.96 per share. The remaining small credit balance should offset the transaction costs.
In an ideal scenario, QQQ will stay below the break-even point of 69.18 initially and the May calls that you sold will expire worthless, leaving you with September 72.00 calls at no cost. If the market did then recover, anything you got for them would be profit. Of course, there is potential to lose money. If QQQ fails to follow the pattern of the last two years and rallies strongly from now through May 18th you will have to buy back the May calls at a loss. This would be partially offset by a probable increase in the value of your September calls, but you could still expect a net loss.
As always, this is not a specific trade recommendation because by the time you read this, those prices will have changed, and options trading is highly leveraged and not for everybody. It is just another example of how those who understand and use options have an advantage. They have, I guess you could say, more options.