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Options Theory: A Bear Tamer Update

January 11, 2019

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One of the carefully crafted and thoroughly vetted systems introduced in the Bear Market Survival Guide is the Bear Tamer. In the video series we spelled out how it works, and in the monthly Mastermind meetings I adjust and manage the position per the rules. Today I want to provide a quick overview of how it has fared during these tumultuous times.

In case you were wondering, the gist of the system is to allow us to participate in the long-term growth of the stock market while drastically muting the volatility along the way.

At the outset of the trade (Sep 20th, 2018) we took three actions:

First, we purchased 100 shares of IWM for $170.19.

Second, we bought a June 2019 $153 protective put for $4.07

Third, we sold the October $175 call for 39 cents.

IWM – The Swan Dive

I take pride in the fact that we almost top ticked the bull market. IWM peaked at $173.39, so our $170 was oh-so-close to the worst possible purchase price. Nothing like testing the efficacy of the system right off the bat, am I right? Really, this has been a perfect environment to prove just how well we can control market losses through the use of options.

The game plan for the stock is simple: do nothing. We don’t use stop losses because we’re minimizing the risk with puts. And we don’t have a profit target because we’re not looking to ring the register for years and years and years. Instead, we will stay the course, trusting in the long-term growth of the capital markets to rake profits into the till.

For now, IWM is perched at $143.50 and has fallen some 15% from our purchase price. On 100 shares that translates into an unrealized loss of $2,650.

Get Yer Rent Check

Since the initial selling of the Oct covered call, we have gone on to sell a total of nine separate calls against the stock. Because of the virtually continuous descent in IWM, every call has been closed at a profit. Though, with the rapid snap-back in the market over the past two weeks, February may end up giving us our first loss on the call side. All told, we’ve raked in around $266 in profits on the calls serving to offset some 10% ($266/$2,650) of the stock loss.

If you’re wondering why we only received $266 through the selling of nine covered calls, it’s because the Bear Tamer system consists of selling far OTM calls (delta is usually around 0.10) that lack the protective power of using closer-to-the-money calls.

While 10% may not sound like much, it’s only been four months since we entered the position, so we haven’t had much time to harness the power of shorting calls against our equity. Nonetheless, I’m satisfied with the risk reduction. The short calls have worked as planned.

Protective Puts (Look Ma, I Growed Big)

With this system, it’s really the long puts that do the heavy lifting on the protective side. The once small June 153 put has grown into a mighty oak. It’s more than tripled in value from $4.07 to $12.66. Admittedly, it was much more impressive at the end of December before IWM’s wicked 15% rebound off the lows.

If we tack on the $859 gain on the put ($12.66 – $4.07), our stock loss is further mitigated to $1,525. To make sure nothing is lost in translation, let’s list everything.

IWM stock loss: -$2,650

Covered Call gains: $266

Protective Put gains: $859

Total Loss: -$1,525

Here’s my summary:

The buy and hold investors lacking the know-how and skill to use the Bear Tamer has seen their $17,019 investment ($170.19) in IWM dwindle by $2,650 or 15.6%. In contrast, by harnessing the protective power of puts and cash flow producing ability of covered calls, we’re only suffering a $1,525 or 8.9% drawdown.

That means we’ve reduced the damage by almost 50%.

 

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