I <3 Theta

I see theta as a way of being on the house side of the wall street casino. By being a seller of options, I make money on days when the market doesn't even move. I read all these articles about how great dividends are, how it's great to be a dividend investor. Anyone can turn their long stock position into an income vehicle by selling out-of-the-money covered calls. Sell the call at a price you told yourself you'd sell your position anyways. Then you get paid to follow your investment plan... a little easier to stick to your plan when you're getting paid to do it.

Contemplating Taking Gains (wait, I can't)

When the price of the July $125 put got down to $5.90 this morning I was tempted to close out my position. I didn't really want to close out my position, but rather sell half of my position to take some gains. Too bad that's not possible with a single put option.

I wonder at what point an investor feels like he has enough money to pursue all of his ideas, without being limited by securities available. At that point is probably where you start to feel limited by the time it takes to do due diligence on an investment that makes up only 1% of your portfolio. I think no matter how large my portfolio gets I should limit myself to a manageable number of investments that I can track fundamentals as closely as I can. At the primary source, though, listening to conference calls, reading balance sheets, etc.

The market's action since last Fall has made me firmly reject the notion that 'tracking fundamentals is pointless because the chart reflects the company's worth'. Also, faith in a company's fundamentals also enables you to hold or add to your position in tough times.

Looks Like Apple is continuing to be range bound around 125. If I had another 125 put that I'd been flipping at the top and bottom of this range, I'd be looking at a sizeable gain. However, there are always opportunities that look good in hindsight and even though the coin flipped heads 3 times in a row, there's still a 50% chance next flip. APPL $125 July put is now back to $6.90. At least I'm eating my $6 worth of theta everyday.

Dollar Devaluation

All of my current leverage comes from the short AAPL July $125 put option. I am very comfortable with holding this position until expiration. Why so comfortable? Aside from the company's great fundamentals that I already addressed, the biggest threat is obviously the macroeconomic situation.

Over the past couple months, it is becoming increasingly clear that deflation is not going to be a threat. If it becomes a threat again, governments will respond by printing more money than ever before again. If the S&P tries to retest March lows more money will be printed. It is clear that devaluing the dollar is preferred by the Fed to having retirement accounts and home values down 50% (and consumer budgets cut accordingly). The devaluation* of the dollar is eminent, another reserve currency (yuan) will be there before the next financial or asset-bubble collapse, and the U.S. will not be able to reap the benefits of being the world's sole reserve currency.

*devaluation is different that just inflation. Devaluation is the dollar becoming worth less relative to other currencies. Devaluation of the dollar occurs when the dollar out inflates other currencies.

Apple is in a good position to handle a devaluation of the dollar because 45% of their revenue is generated from overseas. International demand for Apple products will continue to increase, and who knows, maybe if international sales reach 75% of revenue AAPL will become the world's reserve currency.

How Greedy are you Mr. Market?

We are in the middle of one of the sharpest and strongest rallies in history. Today, the VIX got below 33 for the first time since September. That is at the upper end of a historically normal range for the VIX. I personally think valuations were just too cheap in early March and we've bounced off of very oversold levels. A VIX that low tells me that people are not expecting to retest the March lows, to which I agree. However, I expect and hope that the rally stagnates at this valuation level. I have already taken more agressive positions in AAPL short puts throughout this rally. Mr. Market wants me to get even more aggressive. I think I'll wait until my short AAPL put expires worthless.

On another note. I am kicking myself of late about CMG. I am a big Chipotle fan, believe in the company and management. I'm pretty sure 100 shares of Chipotle held til retirement would leave me a happy camper. At it's current valuation $80, I think it's a little too expensive of an entry. When it was in the 50s a couple months ago, I thought about opening a position and was deterred by the extremely large short interest. At the time 50% of float was short, the most out of any stock in the S&P 1500. I thought it was odd that Chipotle, a well managed company that will definitely survive the recession would be a favorite for the shorts. I totally forgot about the B shares!!!

CMG.B shares are trading at a significant discount to the A shares, even though B shares have 10x the voting power of A. Apparently, shorting the A shares and buying the B shares was a popular pair trade. So many people did it, that CMG has gotten much more volatile with some short squeezes that exacerbated the B share discount. Chipotle management addressed the B share issue in their latest conference call, and are investigating ways they could merge the B shares into the A. Anyways, I was dumb for not taking the little bit of extra effort to investigate the A and B share pair trade that accounts for the high short interest.

Disclosure: short APPL put option

My (Current) Strategy

I have fully disclosed my actions, and some reasoning behind those positions. However, I would like to clarify what I envision as the long-term strategy I am building towards with these positions.

The reason I say current strategy is that I think there is a right strategy for optimizing reward and minimizing risk depending on where we are in the market cycle. I would label our current market cycle as a bottom trading range, with the possibility of a full recovery and bull market.

In this part of a market cycle my ideal portfolio would consist of holding fairly valued large-cap stocks from which I could routinely sell OTM call options. These large-cap stocks would be the core positions of my portfolio. The other part of the portfolio would consist of OTM put options for small-cap companies with a higher beta. These small-caps are great companies, but are too overpriced to justify buying at their current valuations.

The portfolio is leveraged because the capital required for the put options if they were to be exercised is not in cash, rather the large-cap companies. If the market were to fall again, the large-caps would be sold at a loss, but you would enter small-caps with potential for explosive growth when the recovery does happen. If the market stays in its range, you have made a nice return, repeat. If the market goes up, you have made a nice gain, think about adjusting your strategy.

I think the best way to explain would be through an example, I'll make the example the portfolio I am building towards.

Long position in AAPL stock

Short Dec '09 CMG $55 put

Short Jan '10 ISRG $100 put