I bought TLT about three weeks ago for $96.85. It's an ETF that tracks 20+ year US Treasuries. I owned this stock last year and when I was doing taxes discovered that my lazy strategy of selling calls and puts and collecting dividends actually yielded some nice returns. But I sold out completely earlier this year (for a loss) because it was "quote" -- technically in a bear market phase. And I listened to some commentary that said bonds were going to zero, or something like that. I can't remember. All I remember is that I was scared. Three weeks ago I wasn't scared anymore and I jumped back in. Three days after I bought back in I was scared again. I picked a local top to go long. Again.
When I bought back in, I did so with gusto. Not only did I buy the stock, but I sold a naked put at 96 (with July expiration). I was taunting the market (not really, but kinda) to go lower. Technicals were in my favor with a golden cross in play. The put was sold for $1.07. This was very clever, I thought to myself, because if the stock goes down I will have added to my collection at a lower price. If I am exercised, I will own the stock at $94.93. I can live with that. My new cost-basis will be $95.89.
Adding to loser is a sticky issue. If you hear never-add-to-a-loser evangelism, it's likely coming from the pulpit of a scalper. Traders with a horizon of greater than a couple days don't mind building a position over the course of a week, and they are successful with doing things this way. If you're adding with the "it can't go lower" mentality, then go back to paper trading. Or just don't add. I want to play TLT all year, so I can add lower.
The problem with planning to add lower is if the stock actually goes lower and you have to follow through with your plan. When I bought my first lot of TLT along with my naked put, the stock started down. I suffered the typical anxiety, confusion and frustration that comes with picking a top. My solution was to sell an out-of-the-money call immediately. I sold the 97 call (July expiration again) for $0.93. Now I felt better because if TLT's little pullback became a death spiral, then I would own stock at even a lower cost-basis. I just paid myself $2.00 to help deal with the stress of it all.
Over the next couple days TLT continued to sell off. Maybe Gross was right. It sold off four days straight and traded in the low 93s. Uggh. This is when I started data mining how often this type of sell-off occurs, and what happens next. It turned out that there was a small edge for a bounce, so I stayed pat. We bounced off the lows and I let it ride towards expiration.
When expiration week rolled around, TLT was starting to show some life. On Tuesday, Wednesday and Thursday, it breached my short call strike of $97 and now I began to worry that I was giving up my TLT on the cheap. Who knows, maybe Hendry is right and we could go to the moon. Then how would I feel? I breathed the box and decided to let this ride. I would entertain myself watching it trade between $96 and $97, because if it closed there on Friday I would keep the $2.00 synthetic dividend and be on my merry way. On Thursday we closed at $96.01. The drama was becoming intoxicating. On Friday we gapped down to $95.29 and I consoled myself that I would double my TLT position come the weekend. But then we rallied and began trading above $96 again, but below $97. TLT was trading at $96.01 an hour before the close and closed at $96.17. I keep the proceeds with no exercise to the call or the put.
The technical name for my trade is a short strangle. There is no upside risk if you have stock to cover the call, unless you consider getting a small profit a risk and that's just plain dumb. The risk is to the downside. If TLT goes to zero, I lose it all. Twice because of the naked put.
If you have a favorite stock you trade and don't mind getting extra or giving away what you have, short strangles and straddles might be a candidate. I say might. The TLT trade requires one-contract un-leveraged capital north of $19,000 so I don't recommend this strategy until you can become comfortable with being confused.
Nice write-up. Really nails some of the emotions behind the trade. I've got a small position of TLT I've had for awhile and sell calls against. It's nice b/c of the safety of the underlying. If the investment were to blow up, well..we've all got bigger issues. Wish I had the same option to sell calls against treasuries in my company 401k.
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