A "Conservative" Stock Option Trading Strategy...

Tip #2 - All About the 36% Solution

The 36% Solution is a modification of the basic 10K Strategy (see Tip #6) which is the capstone strategy of the Terry's Tips program. Scroll to the bottom of this page for a great book offer that explains the strategy in detail.

Basic Concept

The 36% Solution is an options strategy that is based on the fact that all options become less valuable over time (assuming that the underlying stock price remains unchanged).  However, long-term options (LEAPS) fall at a much slower rate than short-term options.  The strategy consists of owning LEAPS and using them as collateral to sell short-term options to others.  Over time, as long as the underlying does not fluctuate too much, a gain is made because options we sold to someone else diminish in value more than the options we own.

A unique feature of this portfolio is that we remove $300 from it each month so that if it retains its $10,000 value, it will be earning 36% each year.  Our goal will be to maintain the value of investment at $10,000 while this 3% is taken out each month.  We have set up an actual broker account where this strategy is carried out through Auto-Trade according to Trade Alerts issued by Terry’s Tips.  Once a week, the account positions and values are published in the Saturday Report for Terry’s Tips Insiders.

Since the portfolio started, at least 3% has been withdrawn each month. In some months, 6% was withdrawn because the account had grown higher than the $10,000 we are trying to keep it at so new subscribers could mirror it for that amount. So far, the 36% Solution portfolio has gained at an annualized rate of over 50% (see the historical results for all the Terry's Tips portfolios at www.TerrysTips.com/TrackRecord.

Lower Risk Profile

The 36% Solution involves less risk than most of the portfolios carried out at Terry’s Tips.  It is one of 8 actual portfolios that are maintained for Terry’s Tips subscribers to monitor, and mirror if they wish.  Most of the portfolios are more aggressive, aiming for 50% - 100% gains each year.  Since options are leveraged investments, risks are inherently greater than traditional investments.  Otherwise, the lofty returns sought by Terry’s Tips subscribers would not be possible. 

The 36% Solution portfolio was set up in the fall of 2006 for subscribers who wanted to aim for a more modest annual gain, and have an extremely high likelihood of achieving that goal.  While 36% is far below what the average Terry’s Tips portfolio gained in 2005, it is about triple a typical expectation for traditional investments.

The 36% Solution modifies risk in several ways:

• Using an ETF rather than an individual stock as the underlying since volatility on a basket of stocks is likely to be less than it is for a single stock.

• Buying true LEAPS (often two years or more) for the long side so that there is plenty of time to recover from short-term adverse movements in the stock price.

• Using both puts and calls so that some long positions will go up in value no matter what the stock does.

• Selling short-term options at several different strikes so that the risk is spread over a range of possible stock prices.

• Following a pre-determined set of Adjustment Trading Rules when volatility does take place.

Selection of the Underlying

At the present time, the 36% Solution uses the Russell 2000 (Small Cap) ETF (IWM) as the underlying, although different underlyings may be selected in the future. Options on IWM are ideal for our purposes.  They are quite liquid, have small bid-asked spreads so we can get good executions, and strikes are available at every dollar increment to give us flexibility in making precise adjustments.

Of course, you can use the 36% Solution with any other stock or ETF of your choice, just as long as there are options available.  While option prices are generally higher for individual stocks (making the strategy potentially more profitable), there is usually more volatility for single stocks than there is for an index made up of 2000 stocks such as the Russell 2000.

Typical Monthly Expected Returns

Here is a typical risk profile graph of a $10,000 portfolio when the stock is selling just below $72.   It shows that a 10% gain will be made in 5 weeks if the stock ends up anywhere between $68.50 and $74.50. 

The chart shows that a profit will result if the stock lands anywhere between $68 and $77 in five weeks.   Since we have so many additional months over which to collect premium, we will not be overly concerned with the occasional months when the stock falls outside this range. (Adjustments we would make according to our Adjustment Trading Rules might reduce or eliminate a loss situation.) Many of the months should generate a profit of 10% or more, and we need only a monthly gain of 3% to keep the portfolio at or above $10,000.

Leave the Driving to Someone Else

The 36% Solution portfolio was set up to appeal to people who wanted to make a higher return than traditional investments without becoming on options guru on their own.  This can be accomplished by subscribing to Terry’s Tips and signing an Auto-Trade agreement with your broker authorizing him to make trades in your account in accordance with Trade Alerts issued by Terry’s Tips. 

At the present time, the only broker who offers an Auto-Trade program honoring Terry’s Tips’ Trade Alerts is a Chicago broker with the unlikely name of thinkorswim.  We anticipate that several other brokers will be adding Terry’s Tips to their list of investment newsletter providers, but we have not pursued any other brokers because we have been totally satisfied with thinkorswim.  In fact, our experience has taught us that there is not a single reason why any options investor should use a different broker for their Auto-Trade program.  Here are some of the reasons:

• Extremely options-friendly
• Best (free) options software available anywhere
• Low commissions.
• Choice of several commission plans depending whether your average option order quantities are small or large (10 or more).
• Great personal service.  For example, they will set up a 36% Solution portfolio on any Wednesday for you if you just call and ask (so you don’t have to place all the trades yourself).
• No extra charge for orders placed through a broker
• And best of all – they get excellent executions.  Barron’s named them the best broker for executing option orders, and our experience has been the same.  At one time, other brokers had Auto-Trade for Terry’s Tips, and many times we discovered that the thinkorswim brokers had executed far better prices than the other brokers received, saving subscribers many dollars (often enough to pay for their entire Terry’s Tips Premium Service subscription price).

And Now the Best News

I have written a short book that explains the 36% Solution completely.  It is called Making 36%: Duffer’s Guide to Breaking Par in the Market Every Year, In Good Years and Bad.  The book is written so that the entire strategy can be learned while you are playing one round of golf (if your partner is driving the cart). 

There are 18 chapters, each one only two or three pages long, so you don’t have to spend hours learning all about options to get the basic idea.  If you are interested in learning more about options, there are several appendices that will give you a good understanding of this investment alternative, including a discussion of the “Greek” measures of option prices.

The book is written with a golf motif to make it a little more interesting, but it is far more about an investment strategy than it is about golf.

The book was originally published at $19.95.  You will receive an electronic version so you can start right away, and the paperback version will be mailed to you free of shipping and handling charges.  Order it today at www.Making36Percent.com (Enter the discount code TEE and your cost will be only $12.94, including shipping). 

Here is what the book looks like (but the good stuff is inside):

This could be the best investment decision you ever make.  At least, you won’t be risking much to learn the strategy.  And it could change your investment outlook for a lifetime.  Total cost, including shipping only $12.94 - www.Making36Percent.com (Enter the discount code TEE). 

Back to TOP