Trading Options In An IRA Without Blowing Up The Account

Trading Options In An IRA Without Blowing Up The Account terry@terrywalters.com July 12, 2018 Version 2

The Disclaimer I am not a broker/dealer, CFP, RIA or a licensed advisor of any kind. I cannot give you advice. I have nothing to sell you. Investing is risky. You could lose all of your money. I am not giving advice; I am only telling you what I do. I could be wrong. If you do the things that I do, you could make some of the dumb trades that I have made. Consider what you do carefully; you re on your own. So, please don t sue me.

The Overview The personal situation The investing thesis I am an investor not a trader Investing in an IRA How much should I risk? Which underlying equities should I use? Synthetic Bonds Collared Long Stock Bull Call Spreads and Bull Put Spreads Monthly Account Performance

The Situation: Husband and wife retired Have capital to invest Have time the inclination to manage the investments Not satisfied with professional money management Need monthly income Primary Goal Monthly income should cover living expenses Want capital appreciation Secondary Goal Capital appreciation should compound - the money you never spend. Capital drawdowns are acceptable within limits The Plan: Study derivatives investing get an equivalent Masters Degree PHD Develop investing activities as one would for any world-class business. Become the industry equal of any professional fund manager.

I believe My Investing Thesis Fundamental Investing: Discounted Cash Flow (DCF) analysis is a good predictor of the Fair Value (FV) of an equity in the long term; that is, one to two years. While there are many fundamental numbers, DCF is used because it causes the observer to have a deep understanding of how the underlying makes money in its markets and how its markets fit into the global economy. I take long positions when the current price is below the Fair Value by a reasonable Margin Of Safety (MOS) or my thesis indicates upside exists. The options pricing model is not a good predictor of the value of an equity one to two years out. Options Investing: The options pricing model is a good predictor of the price of an equity option in the short term; that is 4 to 90 days. In the short term, markets themselves force individual equity prices to move out of sync with the Fair Value of future cash flows of the underlying equity. Opportunity: There is an opportunity to invest for the long term, and trade against the long term equity with options. Capital appreciation can be gained from the long equity positions and current income can be had from the options.

Main Joint Brokerage (PMA) Wife s Joint Brokerage (MA) Wife s Roth (MA) The Portfolio Terry IRA (MA) Terry Roth (MA) The Portfolio consists of these five accounts managed together. Each account holds a minimum of about 8 equity positions. Naturally, the PM account is the largest and holds 10 to 40 positions. Opportunity trades are placed in the PM account small lots. Accounts can be hedged individually. I am no longer tracking monthly premiums separately as income. I am simply tracking EOM brokerage statement balances. IRAs are traded very differently from taxable accounts.

A Campaign of trades I am a directional trader. Since I am an investor, my intention is to maintain my investment in the underlying equity over time. My trading is not a group of one off trades. I see my trading as a campaign. A series of trades. Each trade rolls to the next month as long as I believe that institutional investors will continue their support of the underlying business.

IRAs How much capital am I willing to risk? Net Liquidation Value = 100% of the account 40% Capital At Risk CAR Call Debit Spreads, and Long Puts to Hedge 60% Capital Not At Risk Synthetic Bonds Cash

IRAs How much could I make? 40% Spread Trades.40 X 8.4% X 12 = 40% 50% Synthetic Bonds.50 X 5% = 2.5% 10% Cash 0.0% Possible, but not likely = 42.5% Some trades will lose. Could lose 100% of the spread trades, but not likely.

Selecting the Equity - Discounted Cash Flow Analysis: I will trade an equity if it trades above the FV if the business case is sound, management is in control and institutional investors have supported the price. But, if the underlying is trading above its Fair Value it is by definition speculative. I need watch for any change in the fundamental business case and always be prepared to exit. I watch for value traps - GE, GILD, IBM, etc. I don t trade turn around stories. I don t trade drug developers.

Selecting the Equity - Moving Averages: I trade trending stocks. I want to trade a stock that has been trending up-n-to the right for a year or more. I use the 50/100 EMA. I stay in products that are trending upward. I consider exiting when the 50 day crosses below the 100 day on a 2Yr chart.

Real Time Data (RTD) functions in Microsoft Office Excel The spreadsheets depend on TOS and Excel on Windows Thinkorswim supports the RTD function allowing me to create Excel spreadsheets using live data from the TOS streams. Export data from a TOS window To Microsoft Excel Paste the data into a Worksheet to invoke the function in Excel As long as TOS is running the workbook will pull live data from TOS

The Synthetic Bond Conversion Arbitrage or Collared Stock Trade Structure Buy stock - sell a call - buy a put Effect of Dividends on Returns Get a boost. Effect of Implied Vol on the call side May help. Getting Filled Bid/Ask spreads will be wide; be careful. Assignment Risk - Knowing a good trade entry position. Exiting the Trade I am waiting until expiration; but Splitting the Strikes Collared Stock Rolling the Short Call More gains, but added risk.

The Synthetic Bond Conversion Arbitrage or Collared Stock This spreadsheet and explanation are available at www.terrywalters.com/tools.html Conversion Arbitrage - Synthetic Bond Analysis Rolling the Short Call Trade Setup Simulated Trade Actual Trade Stock Ticker GE GE Expiration Date 1/17/2020 1/17/2020 ATM Put Strike (Buy to Open) 5.00 5.00 OTM Call Strike (Sell to Open) 5.00 5.00 Existing Call Strike 5 Trade Date 6/22/2018 6/22/2018 Lot Size of Active Trade 100 Current Stock Price $12.87 12.88 Date ATM Put Price - Mark $0.08 $0.09 Stock Price OTM Call Price - Mark $8.08 $7.97 Lot Size 1 100 Existing Call Price Dividend Cycles 6 6 Pick a higher strike Dividend - Quarterly Amount 0.12 0.12 New Call's Premium Sumulate the trade at the Mid and the Natural Mid Nat DTE 574 574 574 Total Dividends per share for the trade 0.77 0.77 0.72 Total Potential Dividend Dollars 76.53 76.53 7200.00 Buy Shares - Capital Required $1,286.50 $1,286.50 $128,750.00 Buy Put - Dollars Spent ($7.50) ($10.00) ($900.00) Sell Call - Dollars Received $807.50 $800.00 $79,700.00 Rolling Trade Credit (Debit) $0.00 Option Trade - Credit (Debit) at Time of Trade $800.00 $790.00 $78,800.00 Additional Gain at Expiration ($50,000.00) Max Loss at Expiration (stock cost minus put notional plus credit) $13.50 $3.50 $50.00 Rolling Ratio 0% Max Gain at Expiration (call notional minus stock cost plus credit) $13.50 $3.50 $50.00 Total Cost of Trade $486.50 $496.50 $49,950.00 Notional Long Put - the "Cash" $500.00 $500.00 $50,000.00 New Total Cost of Trade $49,950.00 Notional Long Call- the "Cap" $500.00 $500.00 $50,000.00 New Notional Long Call $0.00 Trade At Expiration Trade At Expiration Gain - Underlying trades above Call Strike (includes dividends) $90.03 $80.03 $7,250.00 Max Gain ($42,750.00) Total Return On Capital 18.51% 16.12% 14.51% Total ROC 0.00% Rreturn On Capital Anualized 11.77% 10.25% 9.23% ROC Anualized 0.00% Gain - Underlying is below Put Strike (includes dividends) $90.03 $80.03 $7,250.00 Max Loss $7,250.00 Total Return On Capital 18.51% 16.12% 14.51% Total ROC 0.00% Rreturn On Capital Anualized 11.77% 10.25% 9.23% ROC Anualized 0.00% Max Value - Includes Dividends $576.53 $576.53 $57,200.00 Min Value - Cash Substitute - Can't go below this value. $500.00 $500.00 $50,000.00 Min Value - Cash Substitute with dividends $576.53 $576.53 $57,200.00 Spreadsheet Version 21

Bull Call Spread, Call Debit Spread, Long Call Vertical, etc. Trade Structure Buy a deep in the money call - sell a call near the money. The long call acts as a stock replacement, about 90 delta. I think of the short call as a covered call. I enter a profitable but safe trade Max Return On Capital per Month Greater than 8.4% Probability of Breakeven or Better Approx. 80% Equity Decline % at Breakeven Greater than 5% I will need to trade Trader Stocks : Lot Size % of Open Interest Greater than 10% Fill Risk Prefer below 20%, or hold out for a fill very close to the Mid Rolling the trade is an important part of the strategy.

Bull Call Spread, Call Debit Spread, Long Call Vertical, etc. This spreadsheet and explanation are available at www.terrywalters.com/tools.html New / Existing Bull Call Spread Stock Ticker.. AMZN Today is: 6/21/2018 Entry Date. 6/13/2018 Trade Date Expiration Date (Friday).. 7/20/2018 Expiration Date (Friday) 7/20/2018 Stock Price - Mark $1,704.86 Stock Price on Trade Date Long Strike (Buy To Open).. $1,520.00 Pick about.90 to.95 Delta Long Strike (Buy To Open) $1,530.00 Pick about.90 to.95 Delta Short Strike (Sell To Open). $1,620.00 Pick a call just below the ATM strike. Short Strike (Sell To Open) $1,630.00 Pick a call just below the ATM strike. Long Strike Premium - Mark.. $201.08 Price paid for this option Short Strike Premium - Mark. $110.43 Credit received for this option Long Strike Open Interest 246 Current Stock Price - Mark $1,754.80 Long Strike Open Interest 246 Lot Size % of Open Interest 1% Prefer less than 10% Long Call Mark $235.725 Lot Size % of Open Interest 1% Prefer less than 10% Fill Risk 40.9% (Nat-Mid)/Max Gain Short Call Mark $140.700 Fill Risk 62.2% (Nat-Mid)/Max Gain Long Strike Delta 1.00 Long Strike Delta 1.00 Short Strike Delta 0.92 Short Call % of Max Gain Short Strike Delta 0.90 Probability of Breakeven or Better 90% Prefer greater than 80% Probability of Breakeven or Better 91% Prefer greater than 80% Days To Expiration 37 Days To Expiration 29 Days To Expiration 29 Capital At Risk per 1 Lot $9,065.00 Equal to Max Loss Current Price - Credit (Debit) $95.03 Capital At Risk per 1 Lot $9,457.50 Equal to Max Loss Breakeven Stock Price $1,610.65 Trade breakeven at expiration. Gain (Loss) $4.38 Breakeven Stock Price $1,624.58 Trade breakeven at expiration. Max Gain, Total $ per 1 Lot $935.00 Gain (Loss) Total Dollars $437.50 Max Gain, Total $ per 1 Lot $542.50 Equity Decline % at Max Loss 10.8% Gain (Loss) Return On Capital 4.8% Equity Decline % at Max Loss 12.8% Equity Decline % at Breakeven 5.5% Prefer greater than 5% Current % of Max Gain -Loss 46.8% Equity Decline % at Breakeven 7.4% Prefer greater than 5% Max Return On Capital Per Month 8.4% Prefer greater than 8.4%. Remaining Potential Gain $ $930.62 Max Return On Buying Power 5.9% Prefer greater than 8.4%. Max Annual Return On Capital 100.4% Totsl $ Remaining vs Rolling -$45.00 Max Annual Return On Capital 71.2% Potential Profits Per Day $25.27 Potential Profits Per Day $17.16 Potential Profits Per Day $18.71 Account Management Progress Exit Analysis New Trade - Rolling Trade Rolling trade Account Net Liquidation Value Percent to Trade No. of Positions Lot Size Placed Lot Size of New Trade $600,000.00 40% 16 2 2 Lot Size Computed: Acccount Allocation Size: Total Max Gain Potential Dollars: Total Capital At Risk: 2 Total CDS Gain (loss) To Date $875.00 $37,500.00 Rolling Cash Credit (Debit) $90.00 Account Allocation Size: $37,500.00 $1,870.00 Total Gain - CDS Plus Roll $965.00 Total Max Gain Potential Dollars: $1,085.00 $18,130.00 Total Return On Capital At Risk 5% Total Capital at Risk: $18,915.00 Spreadsheet Version 23

Number of Occurances March 31, 2018 Page 1 of 1 Yes, another spreadsheet www.terrywalters.com/tools.html Used the Morningstar hedge fund example report as a template Developed Excel spreadsheet to track data and fill in the template Simply enter data from monthly brokerage statements in the Source Data Tab. Portfolio Summary Investment Strategy The portfolio consists of core positions in US equities and indexes primarily via purchasing deep in the money calls 46 to 90 days into the future. Five to ten positions are secured and funds are divided roughly equally among assets at purchase. Short At The Money calls are sold in the same month to create a Call Debit Spread to generate income. The portfolio may be leveraged to appear more than 100% long through the use of long calls. The portfolio normally would hedge rather than converting to cash in a down market. Overall the fund is directional with investment decisions made on a discressionary basis using qualatative fundamental techinques. Index option spreads as well as futures are entered to hedge downside risk. Market conditions are used to determine if long delta, small delta or negative delta should be maintained as well as vega posture. The portfolio is theta positive. This portfolio is a mix of taxable and nontaxable accounts. Risk Meassurement, Portfolio and Modern Portfolio Theory Statistics calculations are based on Morningstar's formulas and use similar risk-free rates as Morningstar reports. Currency Benchmark USD S&P 500 Index Performance: Growth of $10,000 $16,000.00 $14,000.00 $12,000.00 $10,000.00 $8,000.00 $6,000.00 $4,000.00 $2,000.00 Morningstar Category HF Equity Net Long Exposure $0.00 Nov-16 Jan-17 Mar-17 Inception to May-17 Current Month Jul-17 Sep-17 Nov-17 Jan-18 Mar-18 Fund $13,872.33 Benchmark $12,329.65 Total Return From Incept. 39% Performance: Five Year Calendar Year 2013 2014 2015 2016 2017 23.30% Fund Total Return Calendar Yr 32.39% 13.69% 1.38% 11.96% 21.83% S&P 500 Total Return Performance: Relative to Current Date 30.00% 20.00% 10.00% 0.00% -10.00% Distribution of Monthly Returns Fund Benchmark YTD 1 Mo 3 Mo 6 Mo 1 Yr 3 yr* 5 Yr* 6.91% -3.29% 6.91% 1.56% 22.62% Fund Total Return -0.76% -2.54% -0.76% 5.84% 13.99% 10.78% 13.3% Benchmark Return * Returns for periods of more than 1 Yr. are geometric averages of annual returns. Return calculations are based on EOM brokerage statement balances; deposits are subtrated and withdrawls are added back for each month. -25-24 -23-22 -21-20 -19-18 -17-16 -15-14 -13-12 -11-10 -9-8 -7-6 -5-4 -3-2 -1 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Portfolio Manager Monthly Gain or Loss Rounded to Nearest Percent, Red = 0 Terry Walters Monthly Returns Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Operations 2012 Inception Date 11/30/2016 2013 Fund Assets (million) N/A 2014 Minimum Investment N/A 2015 Legal Structure N/A 2016 5.23% Management Fee N/A 2017 2.17% 2.20% 2.97% 3.14% -0.26% 4.21% 1.45% 3.60% 7.16% -4.94% -0.07% 0.00% High Watermark N/A 2018 10.24% 0.28% -3.29% Hurdle Rate N/A 2019 Lock Up N/A 2020 Redemption Frequency N/A Return/Risk Analysis Advanced Notice N/A Risk Measurement 1 Yr 3 Yr 5 Yr MPT Statistics 1 Yr 3 Yr 5 Yr Skewness (Pos = Right) 0.465 R-Squared 23.0 Kurtosis (Pos = Peaked) 0.323 Portfolio Beta 0.83 Positive Months 7 Alpha - Morningstar 10.36% Negative Months 4 Treynor Ratio 24.6 Worst Month -4.94% Average Return from Inception 2.13% -- -- Max Drawdown -4.94% 13 Week Treasury 0.16% -- -- Volatility Measures 1 Yr 3 Yr 5 Yr Volatility Measures - Benchmark 1 Yr 3 Yr 5 Yr Standard Deviation 14.61 Standard Deviation - Benchmark 8.47 10.26 9.87 Return 22.6% Return 14.0% 10.8% 13.3% Sharpe Ratio 1.38 Sharpe Ratio - Benchmark 1.44 0.99 1.28 Contact Information Sortino Ratio 3.31 Sortino Ratio - Benchmark 2.61 1.77 2.42 Cash & Income Performance - EOM Snapshot Terry A. Walters v2 Cash Percent of Portfolio 32.0% Interest % of Portfolio 0.000% Dividends % of Portfolio 0.0%

KEEP CALM AND TRADE ON