During several conversations over the holiday I noticed myself noting quite often how much “things have changed.”  And in a somewhat unsettling turn of events, I actually found myself uttering the phrase “Back in the day” with surprising regularity.  At this point I would use the “it was the beer talking” excuse, except I only had one and it mostly just made me sleepy. 

So maybe things really have changed.  Or maybe it’s just me.  As I told a few people, I have never claimed to be able to “predict” anything regarding where the stock market was headed next.  But I always seemed to have a pretty good “feel” for where things might go and how to take advantage of it if it did and what to do if things didn’t go the way I “felt” they would.  That just doesn’t seem be the case these days.  Every day “feels” like just one more potential “white knuckle” affair. 

I am still a big fan of “trends”, but I find that a lot of the “buy strength” strategies that I relied on for years just don’t seem as reliable as they used to be, as strong trends seem to die out more quickly rather than extend to ever higher new high ground.  Which is a pity.  So as a result I am guessing that a lot of other traders feel like I do – that they are more often engaged in “hand to hand combat” than in good old-fashioned trading.

So under the circumstances it would seem to be a good time to look at new and unique ideas.  If “thinking outside of the box” wasn’t such an overused and clichéd, well, cliché, I would use it.  Same for “pushing the envelope”.  So let’s just say we are going to try “thinking outside of the envelope”.  And if that doesn’t work then we can try “pushing the box” and see what happens.

The Modidor Spread

There is an option trading spread strategy known as the “Condor” which tends to have a polar opposite effect on option traders versus non option traders.  When option traders speak of a condor spread it tends to “get their juices flowing” so to speak, as we consider myriad possibilities.  Non option traders typically react to any mention of a condor spread with that age old “glazed look in the eyes.”   And not without good reason I suppose. 

So imagine when someone (in this case a gentleman named Mitch Genser) comes up with a “modified” version of the condor spread and calls it the “Modidor”.  Now the option trader types really get excited and the non option trader types really get glazed over.  Still, since we are “thinking outside the envelope” here, even if you are not an option trader, please consider the possibilities offered by using “unique” strategies.

For the record, a condor spread essentially involves selling an out-of-the-money call and put option that are roughly the same distance away from the underlying stock price and also buying a further out-of-the-money call and out-of-the-money put.  The net effect is a position that will make money if the stock stays within a given price range, and that has roughly equal risk on both the upside and the downside.  A “modidor” simply modifies the spacing of the strike prices of the options traded in order to create a position that has most or all of the risk on one side (either upside or downside).

Figures 1 and 2 display a modidor spread using options on ticker LVS trading August options

Figure 1 – August LVS Modidor Spread

Figure 2 – August LVS Modidor Spread

As you can see:

-To trade a 6-lot requires margin capital of $2,292.

-As this is written the stock is trading at $43.58.

-The trade will show a profit at expiration is LVS is above $39.82.

-The maximum profit of $708 will be realized if LVS is between $41 and $46 at expiration. 

From a position management perspective:

-There are 43 days left until the options expire.

-If we place a stop-loss at $39.82 (meaning if LVS falls to that price we will exit the entire position), then we are risking a loss of somewhere between $0 and -$500 (depending on how soon.

-If LVS moves above $47 a share prior to expiration, we can consider taking an early profit.

The Long-Term (Way) Out-of-The-Money Butterfly

As you can see in Figure 3, the weekly Elliott Wave count for spot Gold is projecting the potential for a move to sharply higher levels between now and the end of 2013. 

Figure 3 – Weekly Spot Gold with Elliott Wave Count

Will this projection turn out to be correct?  I have to go with my standard answer here, “It beats me.”  The only real question in my mind is “do I want to have a position in gold just in case it does go way up?”

Instead of trading in gold futures (which let’s face it, is way too scary for the average investor) we will look at using option on the exchange-traded fund ticker GLD, which tracks the price of gold divided by 10.  Figures 4 and 5 display a directional OTM butterfly position.

Figure 4 – GLD January 2014 OTM Butterfly Spread

Figure 5 – GLD January 2014 OTM Butterfly Spread

A few things to note:

-This position costs $1,530 to enter in a ratio of 2 x 3 x 2.

-This position enjoys unlimited profit potential

-If gold happens to reach $2,000 an ounce this position can generate a profit of at least $960 (and quite likely a lot more if the up move happens sooner than later).

The reality is that most people who never trade options will not consider a position like this.  Likewise, most people who do trade options don’t have the patience to stay in a position like this one long enough to do them any good. 

Which come to think of it, are two good reasons for a person to actually consider this position.

Summary

“Traditional” investing strategies – finding great companies and buying and holding their stock for years, investing in “growth” mutual funds, riding the “hot sector” for many months and so on and so forth – just don't seem to be generating the types of returns that they used to. 

Or maybe it’s just me.  Or maybe just by me suggesting that “traditional” investing seems to be coming more passé will be enough to get them going again.

Just my way of trying to help.

Jay Kaeppel

Staff Writer and Trading Strategist

Optionetics.com ~ Your Options Education Site

NOTES:

Interested in covered call writing? Log onto www.MoneySteps.com for a free trial.  Course videos by Tom Gentile and Monday/Thursday Case Study updates by Jay Kaeppel.