Personal Hedge Fund : Methodology

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Calendar spreads are where the two types of options bought and sold are different only in the time of expiration. The number of options bought or sold and the strike price are equal. An example of a Calendar Call is:

Stock Price = 16.82 Buy 10 XYZ May 17.50 calls at 2.60 Sell 10 XYZ Feb 17.50 calls at 1.60

As you can see the number of calls sold and bought are the same and the striking price is the same. The only difference is one call expires several months later than the other. (In this case three months) In the above example the Feb calls will lose premium faster than the May calls, causing the spread to widen and increase. A .20 increase in the spread is a 20% return in less than 45 days or 160% annualized less commission. (You mileage may vary, but welcome to personal hedge funds!)

Vertical spreads are where the two types of options bought and sold are different only in the strike price.

Diagonal spreads are when the options bought and sold are two different Strikes and Time periods.

Inside the Black Box: The Power Factor

Our software each night takes every Diagonal, Calendar and Vertical spread option combination on the listed exchanges and calculates a Power Factor for that potential option spread. The Power Factor is an algorithm of the relationship of the sell price deterioration and buy price deterioration. The higher the Power Factor, the faster the deterioration in the sell price and slower in the buy price (All other things being equal). We then take into account other variables such as; buy sell cash outlay; Call/Put Ratios, open interest and volume etc. (see graphic below) and publish a report of the best Hedge spreads for portfolios. (Bull, Bear, Neutral)

Above is the control panel for our system. The report sent out to subscribers gives the exact symbol of the buy and sell option positions, and a target amount for the spread and estimated cost of the position. Each hedge position should average about $2000, so building your portfolio is quite inexpensive and extremely leveraged. We make it easier by giving you statistically better selections on 6 separate reports:

Vertical Calls
Vertical Puts
Calendar Calls
Calendar Puts
Diagonal Calls
Diagonal Puts

You can select a Hedge Spread from any report and model/balance your own portfolio.

By subscribing to our Selection Service with Portfolio Management direction, you receive trade buy sell alerts, selections and newsletters on portfolio management, and hedge fund trading tips and advice. See our newsletter below.

SAMPLE NEWSLETTERS

March 5, 2006 POSITION UPDATES

BMY, SMH, DELL, MO, AMD, MMM, NKTR all in line (SMH up 325%)

People ask how we get the returns on some of these positions that we recommend and again we will go through one of our more recent positions. On the 23rd of January we opened a position in SMH and we have had several transactions in the meantime. Our sheets indicated a buy with a spread of 2.05 and we opened the following position on Jan 23rd.

1/23/2006 Buy to Open	10 SMHHU	HLDRS$37.50	EXP 08/19/06	3.01	($3,027.45)	$17.45
1/23/2006 Sell to Open	10 SMHBU	HLDRS$37.50	EXP 02/18/06	0.96	$952.47	$7.50
2/17/2006 Buy to Close	10 SMHBU	HLDRS$37.50	EXP 02/18/06	0.48	($497.45)	$17.45
2/17/2006 Sell to Open	10 SMHCU	HLDRS$37.50	EXP 03/18/06	1.23	$1,222.46	$7.50

Closing price of two open positions March 3, 2006 SMHCU 1.05 SMHHU 3.10

In our nightly email just before expiration we profiled this transaction and on that Friday we Rolled out the position to the next month as displayed on the transactions of Feb 17th. So let’s review, our initial outlay was $2,074.98 on Jan 23rd and on Feb 17th we rolled out and received $725. At today’s prices we still could get out of the position for 2.05 (3.10-1.05) but why would we when the SMHCU at 1.05 has a .61 time premium left with two weeks to decay!! Why buy that back, 9 business days from now we will again decide weather to “Close out”,”Roll out”, or “Roll up” the open short position

NEXT WEEK WE WILL WRITE A QUICK ARTICLE ON WHEN TO CLOSE OUT, ROLL OUT OR ROLL UP!

March 12, 2006 (Don’t read further than you can execute at one time!)

Close Out, Roll Out or Roll Up, what do I do?

Personalhedgefunds Course 201 The Close out. I was hoping SMH would be a better example, but of course as I write this we still have 5 trading days to go, but as we look at how this position evolved and stands today, the SMHHU (AUG 37.50) is currently worth 1.85, still a great profit, and if SMH stayed here through next Friday we would let the SMHCU (MAR 37.50) expire worthless and sell the SMHHU for 1.85 and still pocket a tidy profit of $525. (Initial Spread 2.05 2,050 to get into the position; Received $725 on Feb 17th, and Receive 1,850 next Friday, net $525 or 25% in less than two months)

Personalhedgefunds Course 401 The Roll out The roll out occurs when the underlying security is near, at, or slightly into the money at expiration time and your long option is still many months out. At that point you would buy back (If you needed to) the short option and sell the next month long option, like we did last month with SMH. What we are doing is setting up another hedge spread with another decay in our favor. Nine times out of Ten, you will end up with another power factor (PF) of 2 or more if you execute this correctly. You can also roll out even if you are much further into the money, essentially ending up with a derivative that is going to act as a put in your portfolio (You are actually going to hope that the underlying security comes down in price) Also a good thing as you may be trying to balance your portfolio.

Time is money! Whoever said that actually had to have options in mind. When you have a long option that is several months out, it is worth more than you think. Try to set up another power factor (PF) of 2 with that position.

Personalhedgefunds Course 801 The Roll Up Not for Undergraduates The roll up is a dangerous and powerful strategy to move the selling option to the nearest strike price to sell the highest time premium available. Taking SMH for example, if the index was at 39.40 at this time, I might buy back the SMHCU at expiration time for $1.90 and sell the SMHDH (APR 40) for about 1.20. You have to write this down on paper, but if you never move Strikes again, and keep rolling out the 40’s each month, in August you exercise your 37.50, and your 40 gets exercised, and you make another $2.50 while collecting all the higher time premiums closer to the new Strike price.

Personalhedgefunds Course 823 The Balancing act Not for Undergraduates The Close out, Roll out and Roll up are not determined by the above criteria alone. The main objective is to write the highest possible time premium while reducing risk in your positions. Taking SMH for example, for some of our clients we have DELL, INTC, AMD and a couple of other computer related positions, and we would not want to be in a bullish position in all of the next month positions (There is that Market Neutral Investing thing again). For example, if SMH was on the cusp and we had rolled up to the next Strike of 40, we might then want to be a little more conservative on the INTC position and maybe sell a little further into the money on that Strike (setting up a sort of Bearish position) than we might normally or even close out a position, because we rolled out two others that were barely PF of 2. Once you have 50-100 positions open going into an expiration Friday you will understand how important this really is and by that time it will be very natural and intuitive on setting up your positions from one expiration Friday to the next months working positions.

Good luck with this weeks Expiration!!!!