No. of Recommendations: 15
I hereby declare victory in the options board 1-year contest, by virtua of being the only entrant remaining for most of that year. I ended the year with $80506 of my initial $100K, for an overall 19.5% loss. Not exactly good, but I'll fill the rest of this post with mitigating excuses...

I mentioned last month that the best I could hope for was a 10% loss over the duration of the contest. As it turns out, I came pretty close to that goal. I made 17.5% this month, going out with a bang. My three strangle positions all ended between strike prices for a maximum gain. The two straddles both made money, but didn't quite reach the point of making money on both sides. All in all, this was exactly the kind of month I wanted to demonstrate when the contest began.

Position Option Gain

Short 48 SQLNA PMCS Feb 5 Put expired 1440
Short 48 SQLBU PMCS Feb 7.5 Call expired 720
Short 36 AYENB AYE Feb 10 Put AYE @ 7.89 -2736
Short 36 AYEBB AYE Feb 10 Call expired 3060
Short 70 QELNA AMKR Feb 5 Put AMKR @ 4.63 -840
Short 70 QELBA AMKR Feb 5 Call expired 5600
Short 50 RFZNA RFMD Feb 5 Put expired 500
Short 50 RFZBU RFMD Feb 7.5 Call expired 3000
Short 47 EUQNA CIEN Feb 5 Put expired 705
Short 47 EUQBU CIEN Feb 7.5 Call expired 705

Total 12154


Start 90752.44
Assignments -10186.00
Commission -60.00

Total Cash 80506.44 -19.5%

If I were to bother comparing by performance with the other entrants, I would probably find mine didn't do well, as it was the only one to continue suffering the ravages of time. Instead, in the spirit of the contest, I'll compare myself with The Fool. The contest was conceived with the notion of showing the world (or those few who cared to listen) that options weren't the risky black magic that the Fool Party Line made them out to be. Aside from being a contest among ourselves, it was also a comparison of risk/reward with the Fool portfolios.

I can't seem to find exact IRR numbers for the Rule Maker and Rule Break, both of which added funds throughout the year. Instead of calculating this myself, I computed gains for each portfolio as if the money was added at the beginning, computed another as if the money was added at the end, and averaged those two. As it turns out, the two measures were only a few percent apart.

The final tally:

2/21/2003 2/15/2002 Added Gain

Rule Breaker 275716.37 337192.18 25000.00 -24.76%
Rule Maker 27968.66 27930.90 6000.00 -19.46%
Short Straddles 80506.44 100000.00 0.00 -19.49%

And the winner is... Rule Maker, by 0.03%. Darn! It's close enough that I might have won if I knew the real Rule Maker IRR. Rule Maker was also helped by starting with $7000 uninvested, and keeping $4000 of last year's income in cash as well. With last year's market, the more cash the better.

There's one way the Fool portfolios have the upper hand: they're (mostly) long-stock buy and hold strategies in a bear market - one would expect them to lose value in such a secnario. The short straddles on the other hand are a market-neutral strategy that's supposed to work about as well in any market except the strongest trends. Was this bear year among the strongest trends? It was a pretty big decline, but not big enough to explain my problems.

There are three lessons I've learned from this contest:

1. Don't start a year-long contest right before the message boards get an admission fee.
2. Don't compare you preformance with the Rule Maker if it's gonna beat you by a hair.
3. Spreads will kill you.

I knew about Lesson 3 for a while, and it was a major reason for my decision to stop running the strategy with real money last May. But until I actually did the math, I didn't realize the extent of the problem. I went through the all my contest reports and isolated the spread buy comparing my credit (or debit) with the options' value at the other end of the closing spread:

Value Option Option Spread Loss
Value Cost

1 91425.00 (55685.00) (47110.00) 8575.00 5.2%
2 72298.00 (27804.00) (18645.00) 9159.00 7.3%
3 81667.00 37910.00 48480.00 10570.00 7.4%
4 71164.50 46735.00 43655.00 3080.00 2.3%
5 56449.50 32405.00 48990.00 16585.00 2.1%
6 56426.50 (33480.00) (26150.00) 7330.00 7.5%
7 49918.50 (27220.00) (22240.00) 4980.00 5.5%
8 57001.80 (22400.00) (18495.00) 3905.00 3.7%
9 55925.44 (47710.00) (39340.00) 8370.00 8.8%
10 55413.44 (30060.00) (24215.00) 5845.00 5.9%
11 57541.44 (31330.00) (24610.00) 6720.00 6.6%
12 58432.44 (32320.00) (22340.00) 9980.00 10.3%

The spread is simply the difference between the bid and ask, but since expiration strategies are only affected by the spread on opening, I'm really only hurt by half that amount: the fair market price of the option is presumably halfway between the bid and ask. By dividing this half-spread my that fair value, I ges the percentage of my portfolio lost to spread at every transaction.

That loss is significant. No, it's huge. It averages to 6.3% per opening transaction, or in the case of my strategy, 6.3% per month. Now if I had a strategy that made 6% per month, that would compound to 100% per year. This means my strategy would have to double every year before I started seeing any real money. This is a hurdle that at least no options strategy of mine can jump over. Were it not for spreads, I wouldn't have lost 19%, but gained 86%. The dollar loss from spreads added up to $47549.50 for the year, nearly half of what I started with.

- Jamie
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