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Well, after being inundated today on posts and PMs, here is some basics on covered calls using DITM LEAPS. First, why would we use a LEAP for a covered call using DITM LEAPS, as opposed to just buying the stock outright? Simple -- higher returns using the leverage of options. For this example, we'll use AAPL, using last Thursday's prices. AAPL cost $663. You could sell the weekly call (making it a covered call), at the following strikes/prices: 660 $10.50 665 $7.80 670 $5.60 675 $3.95 At this point you want to allow some room for upside, so you pick the 670 strike. What are the possible outcomes? 1. AAPL stays the same, you earn $5.60 on the covered call, or 0.84% (yes less than 1%, but remember it is weekly); 2. AAPL goes up, but stays under 670, lets say to 669. At this point you keep the $5.60 in premium, and your stock has appreciated (a good thing). If you were to exit, you would have a gain of $11.60 ($6 in capital gain, $5.60 in premium), or 1.749%; 3. AAPL goes up, above 670. Well this is the same result as number two, except your stock would get called away at 670. So it doesn't matter how much it goes up in price, it still would get called away at 670. So your maximum gain is $12.60 (let's not consider rolling yet); 4. AAPL goes down. Well you again keep the premium, but lose value in the underlying stock. Why CAN (not necessarily, but why can) using LEAPS be better? Well you can do the same strategy for "cheaper" (the cost being higher risk in terms of losses -- as discussed further below). For starters, to sell a call on AAPPL requires you to own at least 100 shares, at a cost of $66,300.00. Let's instead look at the Apr 2013 600 option. That can be purchased for $101.00. I typically would go further DITM, to get my delta closer to 1, but for this example, we'll stay at 600 to keep the math simple. For the price of $10,100.00 you can own the equivalent position as outlaying $66,300.00. But you can get the same amount of premium selling the weekly option short. In other words, I still get $5.60 for selling the weekly 670. So my return is now 5.54% per week instead of under one percent. Over the course of an entire year, this is the difference in turning $10,000.00 into $165,000.00 and turning that same $10,000.00 into $15,549.00. (compound interest is fun). (side note -- that won't happen -- don't expect it -- it won't). Still that difference gives you the flexibility needed to make the trade worthwhile. So what are the outcomes of selling against a LEAP, as opposed to just the stock? If the price stays the same, or rises, the outcome is just as good, if not better, than owning the stock. 1. AAPL stays the same -- keep the premium, return 5.54%, theta is basically zero, so gain; 2. AAPL increases, but to under 670 -- again the same result, keep the premium, and keep the gain in the April call. However, the gain in the april call well be more than just owning the stock on a percentage basis. Let's say the price goes up to the same 669. You keep the $5.60 in premium and the call option has increased in value by $6.00, so now $107.00. So you've gained the same $11.60 on $101 instead of on $663 -- a much better situation. 3. AAPL increases above 670 -- well your gains are capped at $12 (rolling will be discussed later) At this point, this seems like the perfect trade. Unfortunately it is not -- dealing with losses is also leveraged up. If the price of AAPL falls 50 points when you own AAPL, you're looking at a 7.5% loss ((663-50)/663)), whereas you're looking at a FIFTY PERCENT loss on owning the LEAP ($101 - $50 = $51). So, before ever entering this type of trade, realize the potential losses are MUCH larger than in just owning the stock itself. The returns are also much larger -- that's the power of options. Part 2 of this column will discuss how to handle the trade when it starts moving against you. A preliminary suggestion though -- always known when you are going to get out and at what levels and stick to those loss points. If you say I can take a 25% loss on this trade, get out at that point, don't hold "hoping" for the price to rebound).

In times of lower volatility (e.g. now), I'm sure everyone has noticed that the IV earnings trades, straddles in general, and even ICs and RICs don't necessarily perform as well. I know my performance is down, even having a down September (first down month in nine months). So, I start too look for possible other trades, and have come across a strategy that, at FIRST LOOK, seems very promising. However, if anyone is interested, I need help back testing it across different underlying instruments over a full calendar year (preferably three years, but lets start with one). It's a variation of a double diagonal using either LEAPs, or at least longer dated options. Here are the premises: 1. Have to find a stock that trades LEAPs, and weeklies, with sufficient volume (e.g. AAPL, SPY, T, MSFT, MCD, GOOG, XOM, GS -- those are the 8 I'd like to start testing). 2. You'll eventually enter a double diagonal (I use the DD TOS platform function). First, identify a period out (for testing purposes I'm using at least six weeks, three months, and one year). Go in the money, ideally to delta's around .80 and BUY that. 3. Then SELL the weekly, slightly OTM, option against it, targeting a five percent (5%) weekly return. Roll forward each week. For initial testing assume NO inweek adjustments (we want worst case, if we can improve on that, great). Here's an example using AAPL. Assume I were to enter the trade last month on 9/6. AAPL was trading at 676. I would look at the December options (three months) at .80 deltas and would identify: Dec 595 Call cost $94.25 and has a delta of .80 Dec 775 Put cost 109.60 and has a delta of -.80 To target the 5% weekly return, I would then SELL the Sep 14 690 Call for $5.00 (.90) Sep 14 665 Put for $5.60 (.18) Then next week (9/13 I buy those back for the amounts in () above and purchase: Sep 21 695 Call 4.30 (5.00) 675 Put 5.60 (0.11) Then: Sep 28 705 Call 5.75 (0.07) 690 Put 5.00 (9.40) Then: Oct 3 695 Call 4.30 (0.22) 670 Put (6.20) So over a month you gross $41.20 and pay to buy back $22.08 for a net gain of $19.12 on a $203.85 investment, or a 9.4% monthly return. And that's WITHOUT any adjustments (you would adjust before hitting the 9.40 loss point). I have finished running AAPL using options three months forward over the past year, and it worked spectacularly. For MSFT over the same period, not so much (prices too low). I need assistance back testing AAPL, SPY, T, MSFT, MCD, GOOG, XOM, and GS against options that are six weeks (so Nov), three months (Dec/Jan), and one year (LEAP) and test the performance. That's 24 separate backtesting models. If eight people would just take one stock, we could whip this out by next week and maybe have a good low volatility strategy to complement the IV earnings trades. I'll take AAPL, because I've already started it. If you want to take one, or are just willing to, please just post which one and PM (or post) the results. Again, assume no adjustments during the week -- just roll on Thursday's. If you have any questions about the strategy, or don't understand it, please just ask. If you want to pick a different stock (or index) to back test, by all means dive right in. I will also be opening paper trades tomorrow on all eight of those instruments to monitor going forward as well. I'll be opening 24 paper trades using the NOV, JAN, and as close to one year forward as I can get, always with around a .80 delta.