Sentiment 2012 Summer

SMAR T OPTIONS FOR TODAY’S INVESTOR

FALL 2012

BERNIE SCHAEFFER’S

14/ TAX TIPS FOR OPTION TRADERS

18/ A TRADE FOR INDECISION24/WHY DIVIDENDS

MATTER

> >

SIR13_Cover_RD2.qxd:pages.layout 2012-09-06 10:52 PM Page 1

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14Tax Tips for Option TradersYup, taxes are confusing. But you can’t avoid them.Whether you’re trading as an individual or a business, there are some tricks you ought to knowthat could be as beneficial to your P/L as yournext winning trade. /

18A Trade for IndecisionWhich way will it go? That’s the question ona trader’s mind at the outset of every trade.At least for one strategy—the straddle—you don’t have to pick a direction. Butthat doesn’t mean you’ll win every time.Just like anything else, there are rules. /

6The Sentiment ReportThere’s gold in themthar hills! Or is there?Looking at the chartsfrom a contrarian slantpaints a different picture. /

10Making News, Etc.Options industry bits,trade ideas for storystocks, and importantoptions dates to mark onyour calendar./

13Ask BernieOur founder tackles yourtough options questions,including one populardilemma among shortoption traders./

24Back to BasicsYou may not realize it,but cost of carry (interestand dividends) can havean impact on your trades. /

26Idea LabSpeaking ofstraddles...Volatilitymatters when it comesto trading them.+ SITE FEATURE: Bernie Schaeffer onCharts

Photographed by Fredrik Brodén /

4At the OpenBefore hedging tail riskwith volatility options,consider the alternatives.

/

28.COMWhere to go and whatto see right now at Schaeffer’s Researchonline.

/

30Pro PearlsTD Ameritrade’s Fast Money trader, Joe Kinahan, dishes fourrules for entering orders./

SMAR T OPTIONS FOR TODAY’S INVESTOR

FALL 2012


14/ TAX TIPS FOR OPTION TRADERS

18/ A TRADE FOR INDECISION24/WHY DIVIDENDS

MATTER

> >

FEATURES COLUMNS

COVER

REGULARS

PUBLISHERT3 Publishing LLCEMAIL: [email protected]

ADVERTISING CONTACTKatie Schaeffer513.589.3800 [email protected]

Schaeffer’s Investment ResearchMAIN OFFICE: 513.589.3800MAIN FAX: 513.589.3810CUSTOMER SERVICE:800.327.8833 prompt #2E-MAIL: [email protected]: 800.448.2080 prompt #4

5151 Pfeiffer Road, Suite 250Cincinnati, OH 45242www.SchaeffersResearch.com

SENTIMENT is published quarterly.

If you prefer not to receive this publication, please call 800.327.8833.

To view SENTIMENT online, go to schaeffersresearch.com/sentiment.

Please send your comments and questionsto the editor at [email protected].


SENTIMENT™

EDITORIAL DIRECTORKevin Lund

CONTRIBUTING WRITERSTodd Salamone, Rocky White, Elizabeth Harrow, Andrea Kramer,Jim Cunningham, Bryan Sapp

ART DIRECTORTom Brown

ASSISTANT EDITOREileen Sutton

DESIGNERJennifer Roberts

CHIEF PHOTOGRAPHERFredrik Brodén

CONTRIBUTING ILLUSTRATORJoe Morse

www.schaeffersresearch.com FALL 2012 Contents 3

SIR13_Contents_RD2.qxd:pages.layout 2012-09-06 10:55 PM Page 3

Letter fromBernie

4 S E N T I M E N TFALL 2012

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EVEN AS HEDGE FUNDS DIAL DOWN their equity exposure and the individualinvestor is deep into a migration away fromthe equity markets, volume and open interestin volatility-based listed options productscontinues to soar to record levels. Call openinterest on the most prominent of thesevolatility instruments — the CBOE VolatilityIndex (VIX)— reached a record 4.64 millioncontracts at June expiration, about 10%above the previous all-time call open interestpeaks achieved in March, April, and May.The purchase of VIX calls has been a verypopular method of hedging against the so-called “tail risk” associated with stock marketcrashes, as volatility indices such as the VIXinvariably soar under those circumstances asinvestors scramble to protect themselves.

Those of a contrarian bent might well sug-gest that an obsession with equity volatility(and, in particular, with potential surges inequity volatility) represents a bubble in “tailrisk protection” and perhaps even a buy sig-

nal for the stock market based on the reliableinvesting maxim that when the crowd isobsessed with risk and is taking fear-basedaction (in the form of lowering equity expo-sure and increasingly protecting theirremaining exposure from the risk of a crash),the underlying crowd psychology is consis-tent with the despair that prevails at marketbottoms.

The options market in 2012 has had a dis-tinctive “feast or famine” flavor, with much ofthe activity concentrated in non-traditionalvehicles such the VIX and the iPath S&P 500VIX Short Term Futures ETN (VXX), as wellas options on the ProShares UltraShort S&P500 ETF (SDS), a leveraged vehicle forshorting the market. Traditional options onindividual equities have not been in heavydemand, unless they fall into the wildly popu-lar weekly category or they relate to a veryselect handful of names like Apple Inc.(where contract volume and open interestfigures would be even greater had the sharesbeen split), Facebook (whose level of optionactivity since its IPO in May 2012 has beenunprecedented in the history of new optionlistings), and Bank of America.

My advice for you would be to avoid thecrowd and instead look for option tradingopportunities in the “roads less traveled,”specifically by buying option premium onnames that have the proven capability tomake strong directional moves in time frames

Bernie Schaeffer has been bringing you trading tipsand market-timing insight with the Option Advisornewsletter for more than 30 years. For a free copy, go to: www.sentiment.com/opad13

of 1-3 months. And if you are even a little bitintrigued by the idea of forgoing picking thespecific direction of these moves and insteadpositioning yourself to achieve significantprofits from accelerated stock moves ineither direction, I encourage you to read myinterview on page 18 with Schaeffer’s traderBryan Sapp, who explains how he developsthe trade recommendations for our highlysuccessful Volatility Trader service.

Bernie SchaefferFounder and CEO, Schaeffer’s Investment Research

/ / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / /

>> Please let us know your thoughts. Send your feed-back to [email protected]./ / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / /

At the Open

THE TAIL RISKSOLUTION

ELIZABETH HARROWDigital Content Develop-ment Manager for Schaef-fers Research.com. Sheco-authors Schaeffer’s DailyBulletin, writes the OptionTrends column, and edits theMonday Morning Outlook.

BRYAN SAPPSenior Trading Analyst spe-cializing in analysis of volatil-ity-based options trading.Bryan holds an MBA with anEntrepreneurship focus andhis market commentaryappears almost daily onSchaeffersResearch.com.

Schaeffer’sContributorsto This Issue

ROCKY WHITE Senior Quantitative Analystand contributor to MondayMorning Outlook. He holdsa master’s degree in financial engineering, andhis research is quoted onBloomberg TV, CNBC, and Fox Business News.

TODD SALAMONESenior VP of Research andauthor of the MondayMorning Outlook. His market insight is featuredregularly on CNBC,Bloomberg, The Wall StreetJournal, and Fox BusinessNews.

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The Sentiment Report6 S E N T I M E N TFALL 2012

OLD HAS TRADITIONALLY BEEN VIEWEDviewed as a “safe haven” for nervousinvestors, and the precious metal has certainlytraded on its reputation as a refuge from thebroader market’s twists and turns. Withmacroeconomic drama out of Europe, China,and the U.S. still dominating headlines, itseems that nearly everyone -- from hedge-fund managers to major investment houses --is expecting gold to rally through the end ofthe year. But is all of this optimism justified, orare gold bugs on track for a major disappoint-ment?

Hype or Help?Let’s start by sifting through some of thehype. “Celebrity” investors such as DavidEinhorn, John Paulson, and George Soroshave all copped to being long the yellowmetal in recent months. In the same vein,Morgan Stanley made a bullish call on goldearlier this year; Goldman Sachs, meanwhile,reiterated a forecast for gold prices to rise ashigh as $1,840 by the end of 2012. Goldman’shigh hopes for the commodity are based in nosmall part on the Fed, with ongoing stimulusefforts expected to stifle the U.S. dollar andprovide a corresponding boost for goldfutures.

About that QE3 ... this seems to be arecurring theme when gold bulls step up tothe soapbox. On the surface, the theorymakes sense: Further monetary easing byglobal central banks seems likely to spurinterest in gold, as the metal is frequentlyused as a currency hedge.

However, it’s hard to imagine that anystimulus-minded investors are still sitting onthe sidelines, waiting for central bankers tomake a big policy announcement before they

pile into gold. As of early July, a group of pri-mary dealers surveyed by Reuters was pre-dicting a 70% chance of QE3, substantiallyhigher than the 50% chance at the end ofJune. In other words, there’s a good chancethat plenty of stimulus-related upside hasalready been priced into the precious metal.

It’s also important to remember that cur-rency fluctuations aren’t the sole fundamen-tal driver for gold. With emerging marketsexperiencing a slowdown in their previouslyexplosive economic growth, recent mediareports have cited evidence of weakeningphysical demand for bullion among such keyconsumers as China and India.

The Technical TakeAnd technically speaking, neither risingQE3 hopes, nor bleak economic data, northe seemingly endless euro-zone debt crisishave been sufficient to keep gold afloat onthe charts. The SPDR Gold Trust (GLD) haslately encountered steady resistance at its80-day moving average, which has cappednearly all rally attempts since mid-March.

From a longer-termperspective, GLD’s140-day trendline pre-viously served as sup-port since 2009, butwas broken in Decem-ber 2011. This sametrendline would laterkeep a tight lid on thesecurity’s progressthroughout the monthof March. Even moretroubling, the 320-daymoving average con-tained the April 2009and December 2011lows, but was uncere-moniously violated inMay. Shortly there-

after, this trendline was unsuccessfullyretested in June, and could continue in itsnewfound role as a technical ceiling goingforward.

As a point of caution, GLD has so far heldsupport around $152, which roughly coin-cides with its year-to-date breakeven. Thatsaid, it would seem the overall trend isheaded lower, with multiple layers of formi-dable resistance looming overhead.

Despite the technical breakdown, ana-lysts remain relentlessly upbeat, followingsuit with Wall Street’s hedge-fund super-stars. At press time, only 9% of stocks in theprecious metals sector were trading abovetheir respective 200-day moving averages --the third-lowest among the 42 industrygroups we track at Schaeffer’s -- and yet the

group collectively boasted62% “buy” ratings frombrokerage firms. This con-figuration opens the doorfor future downgrades,which could weigh heav-ily on gold stocks.

Chasing Fool’s Gold?

NO DOUBT, GOLD HAS BEEN ON A TEAR. BUT ARE INVESTORS STILL INTERESTED? >> Todd Salamone and Elizabeth HarrowG

FIGURE 1: Fallen Angel? After a multi-year tear, gold has been consolidat-ing since June 2012. Look to the charts and investor sentiment to give youclues on its next evolution.

THE BIG IDEA SEE PAGE 8 FORMORE IDEAS ON GOLD AND GOLD MINERS

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03/11/09 10/02/09 04/28/10 11/18/10 06/15/11 01/06/12

180

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GLD80-DAY MA

140-DAY MA

320-DAY MA

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E*TRADE credits and offers may be subject to U.S. withholding taxes and reporting at retail value. Taxes related to these credits and offers are the customer’s responsibility. Important Note: Options involve risk and are not suitable for all investors. For more information, please read the Characteristics and Risks of Standardized Options available by visiting etrade.com/options disclosure, calling 1-800-ETRADE-1 or writing to E*TRADE Securities LLC, P.O. Box 484, Jersey City, NJ 07303-0484. Theoretical outcomes based on parameters set by the user. E*TRADE Securities does not guarantee the accuracy of calculated outcomes. Results will vary with each use and over time.1. Offer applies to new accounts opened by December 31, 2012 and funded with a minimum $2,000 deposit from an external bank or brokerage account within 60 days. Credits for deposits made within 45 days of account open from external accounts will receive $500 for $250,000+; $250 for $100,000-$249,999; $100 for $50,000-$99,999; and $50 for $25,000-$49,999 within 45 days. Credit will be provided for up to 500 stock and options trades made within 60 days of the deposited funds being made available for investment in the new account. E*TRADE Securities reserves the right to terminate this offer at any time. For additional information and details about the Commission-Free Trade offer, please visit www.etrade.com/tradefree.Securities products and services are offered by E*TRADE Securities LLC, Member FINRA/SIPC.System response and account access times may vary due to a variety of factors, including trading volumes, market conditions, system performance and other factors.©2012 E*TRADE Financial Corporation. All rights reserved.

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The Sentiment Report8 S E N T I M E N TFALL 2012

THE RATIONALE THE PUT OPTIONALLOWS YOU TOPROFIT FROM ADOWNSIDE MOVE,WHILE THE SIMULTA-NEOUS PURCHASE OFTHE CALL MEANS YOUCAN BENEFIT EVEN IF GOLD UNEXPECT-EDLY RALLIES.

PROS: THIS STRATEGYOFFERS PROFITPOTENTIAL ON A SIGNIFICANT PRICESWING IN EITHERDIRECTION, GIVINGYOU SOME PROTEC-TION AGAINST UNEXPECTED MACROECONOMIC DEVELOPMENTS.

CONS:WHILE AT LEAST ONELEG OF THE TRADEWILL BEAR INTRINSICVALUE AT EXPIRA-TION, THE WORST-CASE SCENARIO IS A SIDEWAYS GRINDBY THE UNDERLYINGSECURITY.

THE TRADE A BEARISHLY SKEWED,IN-THE-MONEYSTRANGLE (A.K.A."LONG GUTS")

THE SETUPBUY AN IN-THE-MONEY PUT ON AGOLD-RELATED STOCKOR ETF, AND THENBUY A LOWER-DELTA, IN-THE-MONEY CALLAT A DIFFERENT STRIKE.

What It Should Look Like:

THE SKEWED, IN-THE-MONEY

STRANGLE

Stock at $100, buy a 110-strike put for $13.00. Simultaneously,

buy a 95-strike call for $8.50. The net debit is $21.50.

Paths to profit: The strangle will reap a profit if the stock moves beneath

the lower breakeven at $88.50 (put strike minus net debit), or moves

above the upper breakeven at $116.50 (call strike plus net debit). In other words, the security needs

to lose at least 11.5% (or gain at least16.5%) prior to expiration.

Maximum potential profit: Theoretically unlimited on the call, and limited to the strike price less

net debit on the put.

Maximum potential loss:If the stock remains stuck between

95 and 110 through expiration, the maximum loss is

limited to the net debit, minus the difference between the call and put

strikes—in this case, $6.50.

GOLDETF PLAYERS:

/ / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / /

SPDR Gold Trust

(GLD)17%

(15th annual percentile)-

Market Vectors Gold MinersETF (GDX)

Barrick Gold (ABX)

Goldcorp, Inc. (GG)

Newmont Mining(NEM)

AngloGold Ashanti Ltd. (AU)

Market VectorsJunior Gold Miners

ETF (GDXJ)

John Hancock Bank & Thrift Op

(BTO)Silvercorp Metals Inc.

(SVM)Rubicon Minerals Corp

(RBY)

ETF TOP HOLDINGS SVI*

SCHAEFFER’SVOLATILITY INDEX (SVI)The SVI helps you tellwhether options prices fora stock are relatively“cheap” or “expensive,”based on prior impliedvolatility. It measuresimplied volatility relative to itself and plots it overtime. A run-up in the SVImight pose a risk to options premium buyers,for example, but could be an opportunity for premium sellers. CurrentSVI readings are at schaeffersresearch.com/svi.

STRATEGYWATCH

////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////

To see what other sectors Todd and Elizabeth aretalking about each week, follow along in Schaeffer’sMonday Morning Outlook. Sign up at sentiment.com/mmo13

34%(28th annual percentile)

STOCK PRICE AT EXPIRATION

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42 46 50 54 58

45%(30th annual percentile)

CALL OPTION PROFIT PUT OPTION PROFIT

S T O C K P R I C E A T E X P I R A T I O N

80 90 100 110 120

30

20

10

0

-10

-20

STRANGLE P&L

S T O C K P R I C E A T E X P I R A T I O N

80 90 100 110 120

40

20

0

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-40


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OCTOBER

17Volatility IndexOptions Expire

(VIX)

MakingNews, Etc.10 S E N T I M E N TFALL 2012

Saving Face Facebook (FB)—the most anticipated IPO ofthe year—fizzled out, and as of this writing, sits about 57% offits high.As investors attempt to stabilize the stock over thecoming months, there’s hope, in light of the commitment tomake Facebook integration a more substantial part of theApple (AAPL) ecosystem. As an option trader, if you think aneventual surge in price is due, you could take a semi-bullishstance by selling out-of-the-money put-vertical spreads, whileimplied volatility is elevated.

Re-Kindling the Flame When it released the Kindle Fire, Amazon (AMZN) showed it was possible to break some of thestranglehold Apple (AAPL) had on the tablet market. Whilereleased with a lot of fanfare, it also paved the way for the mostsincere type of flattery: imitation. With Google (GOOG) andMicrosoft (MSFT) creating their own seven-inch tablets, and withthe great possibility that tablet-leader Apple will also release asmaller tablet,AMZN could lose its lead. In fact, the companythat prides itself on razor-thin margins may not see the samesuccess with its second-generation Kindle Fire. If you’re negativeon AMZN’s outlook, but not a super-bear, you can buy low-costput spreads with a near-month expiration, choosing strikes thatgenerate about a 3-to-1 reward-to-risk ratio.

OPTION MARKETDATESYOU SHOULDKNOW

1> You might know Schaeffer’s as one of themost recognizable namesin the options game, butour trading portfolio iscertainly not limited tocalls and puts. Using ourunique ExpectationalAnalysis® methodology,we also comb the marketfor profitable contrarianstock trades. Everymorning, Schaeffer’sDaily Bulletin provides alist of bullish and bearishstock picks — along witha detailed commentary,profit target, and stop-loss on our FeaturedStock of the Day. Mean-while, curious investorscan trade right along withBernie Schaeffer by sub-scribing to his Schaeffer’sMaster Portfolio andMaster Portfolio Short.Check out our Products& Services page to learnmore.

3>When The WallStreet Journal penneda June 27 blog aboutthe significance of“death crosses” as atechnical indicator,they turned to Schaef-fer’s contrarianexperts for insight.The cross of a secu-rity’s 50-day movingaverage below its 200-day counterpart is tra-ditionally viewed as agrim indicator (hencethe funerealmoniker), but SeniorTechnical StrategistRyan Detrickobserved, “spikes toextremes, whichshould be very bearishsituations, are actuallyvery bullish on boththe near term as wellas longer term.” WSJreporter ChrisDieterich also citedthe exhaustiveresearch of SeniorQuantitative AnalystRocky White, observ-ing, “the S&P 500 isup 13% since theweek ending August12, when the number

NOVEMBER

15Schaeffer’s

Option Advisor

Released

OCTOBER

19Equity & OEXIndex OptionsStop Trading

OCTOBER

25Schaeffer’s

Option Advisor Released

NOVEMBER

15SPX, RUT, DJXIndex OptionsStop Trading

2COOL TOOLS

SIR IN THE MEDIA

of stocks to chart adeath cross jumped tothe highest weeklytotal ever recorded bySchaeffer’s.”

In a June 30 guestcolumn for Barron’s,Founder and CEOBernie Schaeffer dis-sected Wall Street’sgrowing obsessionwith volatility as anasset class. “When thecrowd is obsessed withrisk, or any other mar-ket issue, and actingout of fear, the psy-chology is consistentwith the despair thattends to define marketbottoms,” he wrote.“In essence, contrari-ans could concludethat the crowd isreducing equity expo-sure and increasinglyprotecting what equi-ties they do own withtail-risk hedges. Thisis a developmentworth watching,arguably even more sothan the current fasci-nation with mutual-fund flows into bondand equity funds.”

SEPTEMBER

28Quarterly

Options Expire

OCTOBER

18SPX, RUT, DJX

Index Options

Stop Trading

NEW HIGHS AND LOWS

SIR13_MakingNews_RD3.qxd:pages.layout 2012-09-06 11:02 PM Page 10

DECEMBER

27Schaeffer’s

Option Advisor Released

NOVEMBER

21Volatility IndexOptions Expire

(VIX)

www.schaeffersresearch.com FALL 2012 Making News, Etc. 11

The More the MerrierThe Securities and Exchange Commission has granted permission forthe introduction of three new electronic options exchanges, bringingthe total number of options venues to twelve. You can expect to haveorders executed by the Miami Options Exchange (MIAX), the NasdaqOMX BX Exchange, and ISE 2, beginning later in 2012. While newexchanges may lead to increased competition, and hence greater mar-ket liquidity, fragmenting the current landscape even further may turnout to be a negative for the industry as a whole.

Range OptionsThere was a time when if you wanted to create a complex option strat-egy, you had to do it yourself. Those days are behind us, now that theCBOE has introduced Range Options. These option contracts mimicthe construction of a strategy called a condor. As some of you may know,a condor is a strategy that allows time decay to work in your favor, pro-vided that the market remains in a given trading range. It involves thepurchase and the sale of different options. Range Options take the heavylifting out of the picture by bundling a range-bound strategy in one easy-to-trade package. As a side benefit, while a condor is typically a four-commission trade, the Range Option can accomplish the same goal foronly one commission. Furthermore, it’s likely your broker will allow youto trade Range Options with a lower clearance level than what youwould need to trade condor spreads.

4SIR 0N THE WEB

>Twitter has becomean indispensable tool forinvestors, with tradersusing the site to sharetips and breaking mar-ket news throughoutthe day. While you mayalready be following our@schaeffers updates, besure you don’t miss themusings of our SeniorV.P. of Research, ToddSalamone, via@toddsalamone. Here,Todd shares intradaystats and analysis,options updates, quicktakes on equity movers,and must-read marketcommentaries fromaround the web. Roundout your reading withTodd’s Monday Morn-ing Outlook column —posted each weekend toSchaeffersResearch.com— where he often revis-its and expands upon hislatest tweets.

OPTION BITS

Implied SpreadsThe International SecuritiesExchange (ISE) became the firstexchange to offer something called“implied order functionality.” (Alsoknown as “legging orders.”) Thismeans there’s an increased possibilityyou’ll see tighter bid-ask spreads. Therationale? When some other tradersends a spread order to the ISE, andthat order does not get filled, the ISE

has found a way to use market forces, in con-junction with the spread price, to tighten themarket for customers like you. This is goodnews for traders everywhere, since the abilityto create these implied quotes can dramati-cally reduce the likelihood of trade-throughs,as traders across different strategies are nowable to find each other on a given exchange.

Weeklies Every WeekThe ever-growing popularity of short-termweekly options (known as “weeklies”) has ledto the introduction of more expiration weeksfor some products. While weeklies have typi-cally been offered with one and two weeks toexpiration, the S&P 500 Cash Index (SPX)now has up to five consecutive expirationweeks running simultaneously. The availabilityof these new short-term expirations allowstraders more flexibility when it comes to creat-ing new option strategies. As these new optionsgrow in popularity, it may only be a matter oftime before you start to see added weeks inother broad-based index options, and in someof the more popular equity-option series.

DECEMBER

20SPX, RUT, DJXIndex OptionsStop Trading

NOVEMBER

16Equity & OEX

Index Options

Stop Trading

DECEMBER

21Equity & OEX

Index Options

Stop Trading

NOVEMBER

22Trading Holiday

(Thanksgiving Day)

DECEMBER

25Trading Holiday(Christmas Day)

DECEMBER19Volatility IndexOptions Expire(VIX)

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DECEMBER

31Quarterly

Options Expire

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What is auto-exercise?BERNIE: Auto-exercise is something that hap-pens at expiration with in-the-money optionscontracts. Remember that all options have afixed expiration date. If the contract is out-of-the-money (OTM) or at-the-money (ATM)at expiration, the contract will expire worth-less. There is no real reason to exercise anOTM or ATM options contract.

In-the-money options (ITM), on the otherhand, have real, or intrinsic, value. A calloption is in-the-money if the strike price isbelow the current market price of the stock,because you can exercise the call, buy (or“call”) the stock at the strike price, and sell itat the higher market price to bank a profit onthe trade. A put option, on the other hand,has intrinsic value if the strike price is abovethe stock price. If you own an ITM put, youcan buy the stock at the current market price,then sell (or “put”) it to someone else at thehigher strike price of the options contract,which also results in a profit.

Options Clearing Corporation (OCC)rules dictate that any ITM option should be

automatically exercised at the expiration.This auto-exercise rule is designed to pro-tect investors from inadvertently leavingmoney on the table. However, if you don’tintend to buy or short the stock, it typicallymakes sense to close in-the-money optionpositions to avoid an unwanted position inthe stock, or worse, a loss, should the stockmake an adverse move in the days followingexpiration.

Q: If I think the stock is going to trade flat,and I want to write at-the-money options onthat stock, is it better to sell put options orcall options?BERNIE: While buying puts and calls is a popu-lar strategy among many investors, sometimesit makes more sense to write (or sell) optionsinstead. In fact, since options are wastingassets, and are continuously losing value dueto time decay, option sellers have an impor-tant advantage relative to option buyers:Time is actually on their side.

Selling puts is generally viewed as a bullishstrategy, because the investor normally wantsthe stock to move higher, and for the option toexpire worthless. If the stock falls instead, theyare on the hook to buy shares at the strikeprice of the option.

Call writing is typically considered a bear-ish play on an underlying stock, because theinvestor wants shares to move lower, and forthe calls to expire worthless. Investors withpositions in shares and a predetermined exitprice could write calls against stock positions.

What happens if the strategist expects thestock to trade sideways? You can look forimplied volatility skews at sentiment.com/ivto help determine whether to write puts orcalls. If there’s much higher implied volatilityin the puts relative to calls, which is often thecase for many securities, it probably makesmore sense to sell puts, as they are a bit richer.In addition, it’s generally better to write puts,rather than calls, on securities that pay divi-dends. A call-option writer might exercise acall option to buy the stock and collect thedividend, which could result in assignment ofthe contract, forcing you out of the short callposition.

Auto-Exercise is Not aFitness Program

DON'T TAKE YOUR EYES OFF OF IN-THE-MONEYOPTIONS AT EXPIRATION>> By Bernie Schaeffer

Bernie Schaeffer isfounder and CEO ofSchaeffer’s InvestmentResearch, Inc., a leadingprovider of research andanalysis on the stock andoptions market. Hereceived the Best of the

Best Award from theMarket Technicians Asso-ciation for his ground-breaking work onsentiment analysis, andhis award-winning SchaeffersResearch.comsite is consistently ranked

#1 in the options cate-gory by Alexa.com. Heappears frequently onCNBC and The NightlyBusiness Report and is reg-ularly quoted in the WallStreet Journal, Business-Week, and USA Today.

Only have a limitedtime to learn how totrade options?Go to sentiment.com/HSP13

Q:

The Man withthe Answers:Bernie Schaeffer

www.schaeffersresearch.com FALL 2012 Ask Bernie 13Ph

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>> Got a question for Bernie? Send it [email protected]./ / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / /

SIR13_AskBernie_RD2.qxd:pages.layout 2012-09-06 10:57 PM Page 13

Trader Taxes14 S E N T I M E N TFALL 2012

TIPS FOROPTIONTRADERS

Yup, taxes are confusing. But youcan’t avoid them.Whether you’retrading as anindividual or a business, there aresome tricks youought to know that could be as beneficial to yourprofit/loss as your next winningtrade.

By FREDERIC RUFFYPHOTOGRAPH BY FREDRIK BRODÉN

SIR13_TaxesFeature_RD2.qxd:pages.layout 2012-09-06 11:05 PM Page 14


Trader Taxes16

utting together a taxplan for your options tradessounds as exciting as watching achess match. Taxes are dry. Andthe rules have become complex.Indeed, it often makes sense tohire a professional when dealingwith specific rules, schedules, andfilings. Still, learning a few trader-relevant tax strategies and tipscan sometimes save you a lot ofmoney when it’s time to file areturn. Perhaps it could even turna losing year into a winner.

IF NOT NOW, WHEN?If you’re an individual investor, trading fewerthan a dozen or so contracts every threemonths, preparing an elaborate tax plan does-n’t make much sense. It will be easy to keeptrack of all of your trades, and report the gainsor losses on your 1040’s Schedule D. In fact,today, many online brokerage firms providethe information electronically. If you had awinning year, you will probably pay taxes onthe gains. If you suffered trading losses, theindividual investor can write off up to $3,000 ayear. Any additional amount can be carriedforward and reported in future periods.

When your trading becomes a primarysource of income, it’s probably time to explore

a tax plan. While you can start anytime, Sep-tember or October is often optimal, as you’vealready generated a substantial trading historyfor the fiscal year, and still have a few monthsto make needed changes.

THE BUSINESS OF TRADINGIf you’re trading as a business, rather than asan individual investor, you might realizesome important advantages. But, setting upa separate entity takes time and costs money.The simplest way to transition from an indi-vidual investor to a trading business is to setup a sole proprietorship, or LLC, and beginreporting profits and losses as a businessrather than an individual. An importantrequirement when establishing this type ofsole proprietorship, according to the IRS, isto demonstrate “regular, frequent, and con-tinuous” trading.

Alternatively, a trader can set up a busi-ness by incorporating under “Subchapter S”or other corporate entity.

“If you left your job to trade full time, youmight want to consider setting up a tradingbusiness,” according to Chris Spiehs, CPA ofTraders Accounting (www.tradersaccount-ing.com). Given the expenses of setting up aseparate entity, not to mention the book-keeping and regular filing required by theIRS, only serious investors trading for a living

typically trade as sole proprietors or corpora-tions. The table in Figure 1 shows a few of themajor advantages of trading as a business vs.an individual.

Once a trading business is created, thebenefits can be substantial. For example, theexpenses associated with investing, like soft-ware, education, and home-office expenses,can often be deducted from profits. Health-insurance premiums can often be expensed.By getting favorable tax breaks on items thatwould be purchased anyway, the investorcan save thousands of dollars by tradingthrough a business rather than as an individ-ual investor.

Another important benefit to establish-ing a business entity is the ability to avoidthe wash-sale rule by choosing to elect Sec-tion 475—marked-to-market accounting. Awash sale occurs when an investor repur-chases a stock within 30 days after they hadpreviously sold the same (or very similar)

position at a loss. According to therule, the investor cannot record acapital loss on the trade if the sameposition is bought again within 30days. Therefore, if tax time isapproaching and you want to sellthat losing stock position for thetax benefit, the wash-sale rule pre-vents you from buying it backwithin 30 days.

Electing Section 475 within atrading business changes theaccounting methodology to markedto market. When taxes are pre-pared, all open positions are treatedas if they were sold on December31st. You don’t need to sell or liqui-date anything in order to record theloss on losing positions. In addition,Section 475 also allows investors tobook losses greater than $3,000 peryear, and also carry losses over tofuture periods. But it must beelected on the due date for the firstyear of the tax return.

TRADING AS A BUSINESS can offer some distinct tax advan-tages over individual investors who qualify for “trader status.”

INDIVIDUAL

Can deduct a maximumof $3,000 per year intrading losses

No deduction for healthinsurance expenses andcannot contribute to aretirement account(unless through an IRA)

Limited deductions forbusiness expense,related to other earnedincome

Bound by wash-salerule; cannot book a losson equities bought backwithin 30 days of sale

BUSINESS

Can deduct more than$3,000 per year in capi-tal losses, if usingmarked-to-market(election 475)

Can contribute toretirement accountsand deduct health insur-ance premiums

Deductions allowed fortrading expenses likecomputers, seminars,subscriptions, and use ofhome office

Can elect Section 475(marked to market), andbook end-of-year losseson equities without selling them


TRADER TAX TIPSIf you’re not trading full time, a trading busi-ness might not make sense. But a few strate-gies and tips can potentially help lessen thetax burden for individual investors as well.

Trade index options. Long-term investmentsare taxed at a lower rate than short-termtrades. The timeframe that separates the twois one year, meaning if a position is held formore than 365 days, it’s considered a longer-term investment, and any gains are subject tothe lower tax rate.

Index options and other “1256 contracts”have favorable tax treatment with the IRS,because a percentage of the gains are taxed atthe lower tax rate—regardless of the holdingperiod. Any foreign exchange contract,futures, and certain index contracts like theS&P 500 Index (SPX), and S&P 100 Index(OEX) options are examples. Today, 1256investments are subject to a unique 60/40 rule,in which 60% of any gains are taxed at longer-term rates, while 40% are taxed at short-termrates. It doesn’t matter how long you’ve heldthe position—60% of any gains will be taxed atthe more favorable longer-term rates.

Use LEAPS. Trading Longer-Term EquityAnticipation Securities [LEAPS], which aresimply longer-term contracts that typicallyexpire in more than a year, can also have animportant tax advantage, relative to buyingand selling short-term contracts. Of course,the holding period of the position will dictatewhether the trade is treated as a short-term, orlong-term, gain. For instance, if an investoruses LEAPS as a tool for building a longer-ternportfolio, and holds positions for more than365 days, any profits will be traded as longer-term, rather than as short-term gains.

Use puts to drag out short-term gains. Usingoptions along with stocks can also help in situ-ations when the investor has a tax problem.For example, if you have a large position show-ing a substantial gain, but you don’t want tobank the profit for fear of the short-term-gaintax consequences, buy puts on your stock tohedge your gains instead. That is, turn your

stock position into a “married put” and hold itfor twelve months. If the stock falls, the putswill increase in value and offset the losses onthe shares. The downside is that the putoption position will lose value over timeand/or if the stock rallies. Buy in-the-moneyoptions, with a strike price above the stockprice, which can help mitigate some of theoption-decay risk because ITM options haverelatively little time value.

Trade in an IRA. Trading in a self-directedretirement account, such as an IndividualRetirement Account (IRA), can have taxbenefits as well. Since nothing is taxed until adistribution is made from the account, thewash-sale rule doesn’t apply. Brokers will varyon rules for trading with retirement accounts.Some don’t allow options. Others limit thetrading to only certain strategies.

Buyer beware! Though the wash-sale ruledoesn’t apply to retirement accounts, transac-tions in an IRA can cause a wash sale in a tax-able account. In other words, the IRS will lookat the holdings in both accounts to determineif the wash-sale rule was violated in the tax-able account.

Beware the curse of the 1099-B. This maysound obvious, but many traders unnecessar-ily pay more than they should because theydidn’t report the correct cost basis—theamount that was paid to enter a trade—to theIRS. This information comes from your 1099-B, sent from your brokerage firm, but cansometimes be misread. For example, if you failto report the cost basis, the IRS could incor-rectly tax you on the gross sale, not includingthe cost basis of the trade. The result is a muchhigher tax bill. By asking brokerage firms toprovide cost basis information on 1099-Bs, theIRS reduced the burden on individualinvestors to maintain detailed records aboutwhen trades were opened and closed.

TAX TIMEPhew! While the topics are far from excitingand somewhat complex, a basic understand-ing is worthwhile, if it can save you enoughdollars at tax time. If you’re still trading smallsizes and just a few contracts per month,you’re probably not a candidate for trading asa business. But, as your trading accountgrows, and your trading frequency increases,it’s time to start asking some questions. Doesit makes sense to trade in a retirementaccount like an IRA or 529 plan? Is it worththe time and expense to set up a business ifyou’re becoming a full-time trader? Will thewash sale affect you this year? Are you usingoptions along with current holdings to mini-mize potential taxing issues? Have you con-sidered strategies using LEAPS or 1256contracts to benefit from the beneficial taxtreatment of long-term gains?

Whether you’re in business making a liv-ing as a full-time trader, or a novice individ-ual investor, ask yourself the right questions,and the answers might help you cut morechecks to your trading account rather thanto Uncle Sam.

17Trader Taxeswww.schaeffersresearch.com FALL 2012

TECH IT UPInvesting in a little technology can go a longway. If you’re trading many different markets,and hundreds of contracts per year, spread-sheets and accounting software will beinstrumental in staying organized. ChrisSpiehs of Trader’s Accounting suggests thatactive traders look at software called TradeAccountant, but there are others, such asGainsKeeper, which has partnered with afew major online brokerage firms to providetheir clients with free access to these tax-reporting tools. Be sure to check with yourbroker to see what tools they might haveavailable, and check the records of yourtrading history as well.

In fact, starting in 2011, the IRS put theonus on brokerage firms to provide salesand cost-basis information for “coveredsecurities,” and asked investors to completeform 8949, in addition to a Schedule D. Thenew form 8949 is used to report mostshort-term and long-term gains and is tiedto the Schedule D. Most firms provide thetrading information after the end of the fis-cal year in a 1099-B. The details are listed onform 8949, and the Schedule D offers a sum-mary of the trading activity.

As a reminder, subscriptions to Schaeffer's servicesmay be 100% tax deductible as an investmentexpense. The services are fully tax deductible as abusiness expense by most corporations.


Straddles18 S E N T I M E N TFALL 2012

WHICH WAY WILL IT GO? THAT’S THE QUESTION ON ATRADER’S MIND AT THE OUTSET OF EVERY TRADE. BUT WHAT IF YOU

DIDN’T HAVE TO DECIDE? AT LEAST FOR ONE STRATEGY—THESTRADDLE—YOU DON’T. BUT THAT DOESN’T MEAN YOU’LL WIN

EVERY TIME. JUST LIKE ANYTHING ELSE, THERE ARE RULES.

The Cure for

Indecision

A CHAT BETWEEN BERNIE SCHAEFFERAND SCHAEFFER’S OWN BRYAN SAPP

ILLUSTRATIONS BY JOE MORSE

SIR13_Straddles_RD2.qxd:pages.layout 2012-09-06 11:05 PM Page 18


(Bernie G. Schaeffer) Buying a call and aput with identical strikes and expirationdates on the same underlying stock isderided by some as “copping out on pick-ing stock direction” and “paying doublepremium for no good reason.” How wouldyou address these criticisms of the straddlestrategy in terms of how we at Schaeffer’sapproach trading this strategy?

(Bryan) I’ve typically had the best successwith straddle trades in which I’m completelyuncertain as to the ultimate direction of theunderlying over the option holding period(whose maximum is defined by the amountof time remaining until option expiration). Inother words, these straddle situations wouldsimply not be traded if I had to pick a direc-tion and buy a straight call or a straight put.

I’m looking for situations in which theunderlying is about to make an explosivemove. This is often right after a relativelyquiet period, which helps keep my costsdown because the impliedvolatility (IV) component ofthe option price will tend todrift lower over such periods.These straddle set-ups wouldtypically be considered unat-tractive for a directionaltrade.

With straddle buying inyour arsenal, you can viewthe indicator landscape—his-torical and implied volatility,short-interest levels andtrends, “coil” patterns oncharts, earnings (and othermacro catalysts) and optionactivity— from the perspec-tive of the probability of theunderlying making an unusu-ally strong directional movewithin the defined timeframe. Straddle buying is notabout being relatively uncer-tain on whether to be bullishor bearish on the underlyingover the holding period andthus paying “double pre-mium” to hedge your bets.Rather, successful straddlebuying is about developing an

Straddles20 S E N T I M E N TFALL 2012

RECENTLY SAT DOWNwith Senior Trading AnalystBryan Sapp to discuss theexcellent performance ofSchaeffer’s Volatility Trader, asubscription service we offer atSchaeffer’s Research, whosefocus is on buying straddles(see “Straddles 101,” right).Sapp develops the trading rec-ommendations for VolatilityTrader, which as we go toprint, has generated a remark-able portfolio return of 106%(compared to 8% for the S&P500) from January 1, 2011 todate. After reviewing mynotes, I realized there can beno better way to explain oursuccessful approach to profit-ing from big moves in equities,regardless of direction, than tocreate a transcript of our dis-cussion and present it to youin SENTIMENT. So pleaseread on, as you may as a resultachieve a significant break-through in the consistency ofyour option trading profits.

indicator set that allows you to be relativelycertain about the probability of stronger-than-expected directional movement by the under-lying over the holding period, and then usingstraddles to leverage your profits from this sce-nario. Note also I am not forecasting highervolatility over the holding period, but rather Iam forecasting unusually strong directionalmovement (which may or may not be accom-panied by higher volatility). This may seemlike a trivial distinction at first blush, but whenyou do some serious thinking about it, yourealize it is the key to successful straddle buy-ing. As you have said many times about buyingoption premium, you pay for volatility whenyou enter your option position, but the “cur-rency” for your payoff for an options trade isthe extent of the directional movement (andnot the volatility) over the holding period.

(BGS) Based on a standard “off the shelf”analysis of the probability of profit parame-ters for an at-the-money straddle purchase

STRADDLES 101The straddle trade is established by buying a call and aput at the same strike, on the same underlying—typi-cally at-the-money (ATM). The profit/loss chart lookslike a “V” centered on the ATM strike (see graph). Themain positive of this trade is it could profit either waythe stock goes, so long as the move is large enough.Because you’re buying two ATM contracts, this trade canbe fairly expensive. Traders will want to do their home-work and study how the particular stock they’re watch-ing reacts to certain news (such as earnings) and makethe determination as to whether capturing theexpected price move is worth the premium involved.

Breakeven

( + )

( - )

LONG STRADDLE

Loss

Profit

S T O C K P R I C E

CURRENT EXPIRATION


Straddles 21

must have a profit probability of less than50%, due to the simple fact that you are pay-ing a time premium for the privilege of own-ing the price appreciation of the security (inthe case of a call purchase) above the strikeprice until the option expires. A straddle buywill have a higher probability of profit than astraight call or put purchase due primarily tothe fact that you can profit from a robustmove by the underlying in either direction.But your profit probability still must be lessthan 50%, again because of the time pre-mium you are paying.

2. Probability of a total loss – In the case of astraight at-the-money call or put buy, theprobability you incur a total loss is prettystraightforward at 50%, as you are basicallybetting the stock (which is trading at thestrike price) will be above (in the case of a

call buy) or below (in the case of a put buy)the strike by expiration — which is a cointoss—and if you are wrong you incur a totalloss. In the case of an at-the-money straddle,the probability of a total loss is negligible, asit requires a precise close at the strike onexpiration day for it to occur.

3. Probability of a large profit – In the case ofa straight at-the-money call or put buy, theprobability of at least doubling your moneyby expiration is about 21%, while the proba-bility of doubling your money on an at-the-money straddle is about 11%. So, in theory,the “double premium” factor in straddle buy-ing does directly and negatively impact yourchances of achieving large profits.

So, in essence, buying at-the-moneystraddles provides us with an increasedchance of achieving profitable trades with analmost negligible chance of incurring totallosses, but in exchange our probability ofachieving big profits is reduced relative tobuying at-the-money calls or puts.

While the comparison of these parame-ters is certainly interesting and should be onthe radar of all options traders, I’d suggestthat the real benchmarks for the attractive-ness of straddle buying relate more to yourability to find attractive straddle set-ups andmanage your positions in such a way as tooptimize your returns. As I indicated earlier,I don’t buy straddles as a substitute for buy-ing calls or puts. I look for completely differ-ent trade set-ups for my straddle trading.

(BGS) We’ve already discussed the nega-tive impact the “double premium” aspectof buying straddles has on the theoreticalprobability of achieving triple-digit profits(+100% or more) on successful straddletrades. How do you address this theoreti-cal impediment in your straddle trading?

(Bryan) I don’t feel I’m operating at a disad-vantage on the triple-digit-profit front ascompared to those who trade directionally.I’ve had success with aligning the time frameof the straddle with the VIX environment(as a proxy for overall volatility levels). So, ifwe’re running at a 40 VIX, for example, I’dtend to trade shorter-term straddles andvice-versa if the VIX is on the low side. The

compared to the parameters for an at-the-money call purchase (or put purchase), it isclear that by buying a straddle you sharplyreduce your probability of incurring a totalloss (to the point where it is negligible) andyou also increase your chances for achiev-ing a profitable trade. How do these sharplydifferent profit and loss parameters (alongwith the higher total straddle premium)affect the attractiveness of the straddlestrategy and how you select and then man-age straddle positions?

(Bryan) Comparing the parameters of at-the-money call (or put) buying to those for buyingat-the-money straddles leads to some veryinteresting contrasts on the following fronts:

1. Probability of profit – The probability thatthe buyer of an at-the-money call (or an at-the-money put) will be at break-even levelor better if the position is held until expira-tion is about 35%. For the buyer of an at-the-money straddle, this probability of profit atexpiration is about 42.5%. So despite the so-called “double premium” expense of buying astraddle, your chances of breaking even aresignificantly increased relative to thestraight purchase of a call or a put. Theseprobabilities are best understood in the fol-lowing framework. A straight call or put buy

"I’VE TYPICALLY HAD THE BESTSUCCESS WITH STRADDLE TRADES IN WHICH I’M COMPLETELY UNCERTAIN AS TO THE ULTIMATE DIRECTION OF THE UNDERLYING."


premise behind this approach is that volatil-ity is mean-reverting, so you obviously don’twant to lock in multiple months of time pre-mium at a high IV. In my opinion, the key toachieving big straddle winners is the timingand location of your entry. This is where mywork with Bollinger Band width reallyhelps—I like to see Bollinger Bands at ornear annual lows, or turning higher fromannual/multi-year lows.

(BGS) The “low” dollar premium forweekly options would seem to create greattemptation for the straddle buyer. Whatare the benefits and the pitfalls of buyingstraddles on the weeklies? How should astraddle trader manage a weekly position tomaximize his or her chances for success?

(Bryan) The weeklies can be great straddlevehicles in a high-VIX environment Thetradeoff is they’re very volatile and you run amuch higher risk of larger losses due to the“pinning” of stock prices at or close to strikelevels at weekly expiration. The major bene-fit of trading straddles using weekly optionsis the potential to generate huge winningtrades due to their significantly lower dollarcost. The biggest winner we’ve had so far inSchaeffer’s Volatility Trader was a straddle inthe weekly options that was closed for a240% gain. Simply stated, the higher risk ofthe weeklies can be accompanied by much

higher reward. For position management ofsuch straddles, I think the “half-life” rule is agood guide. If you have not achieved thedesired move in the first few days after youenter the position (which will often occur atthe point at which the weekly option hasabout half its original time remaining untilexpiration), then it’s generally a good idea toclose your position and move on to the nexttrade.

(BGS) The current equity options envi-ronment can probably be characterized as“low- to-modest implied volatility”. Doesa lower IV environment present additionalprofit opportunity for the straddle buyer?Are there pitfalls for the straddle buyer insuch an environment?(Bryan) Low IV can be good, but I actuallyprefer a higher volatility environment (25-35

on the VIX seems to be the spot where Scha-effer’s Volatility Trader has had the most suc-cess). The biggest benefit of low volenvironments is the potential for a stock tosteadily trend with the market. If this hap-pens, you don’t get “chopped up” and will atleast show some profit. However, the bigstraddle winners typically come at timeswhen we see 2%+ intraday moves on theindices. The ability to time inflection pointson single stocks is aided by big market moves.Once again, it comes back to the risk/rewardprinciple. I typically have a higher win rate inlower vol environments, but the 150%+winners aren’t there as often as they would bewhen we have big swings overall.

(BGS) No trade setup is ever ideal, andsometimes those that look “too good” caninvolve more danger than opportunity.But with these caveats, how would youdescribe an ideal setup for a straddle trade?

(Bryan) The symmetrical triangle, or “coil”pattern on the charts, is still my favorite setupfor consistency for straddle trades (see Figure1). The longer the “coiling period,” typicallythe bigger the move will be if and when thetriangle breaks. Coupled with this chart pat-tern, I like to see increasing levels of shortinterest (either a big recent spike, or shortinterest at multi-year highs), and low-to-modest implied volatility. These parametershave defined the core of the trades for Schaef-fer’s Volatility Trader, and we have achievedmore than our share of big winners. I’m alwayson the lookout for symmetrical triangle pat-terns, but I also need to see short interest andIV’s positioned the way that I like.

S E N T I M E N TFALL 2012Straddles22

Straddle UpReversals and overnight trade gaps can be a thing ofthe past. Receive 4-6 straddle recommendationsper month with our Volatility Trader alert service.Just go to sentiment.com/vt13

FIGURE 1: The “Coil” setup.The symmetrical triangle pattern, like the one pictured above, is idealfor straddles. The longer the coil, the bigger the potential move. And with volatility typically fairlylow, option premiums are usually lower than when the stock is trending.

IF YOU HAVE NOT ACHIEVEDTHE DESIRED MOVE IN THE FIRST FEW DAYS AFTER YOU ENTER A STRADDLE USING WEEKLIES, THEN IT’SGENERALLY A GOOD IDEA TO CLOSE YOUR POSITIONAND MOVE ON TO THE NEXT TRADE.


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E*TRADE credits and offers may be subject to U.S. withholding taxes and reporting at retail value. Taxes related to these credits and offers are the customer’s responsibility. Important Note: Options involve risk and are not suitable for all investors. For more information, please read the Characteristics and Risks of Standardized Options available by visiting etrade.com/options disclosure, calling 1-800-ETRADE-1 or writing to E*TRADE Securities LLC, P.O. Box 484, Jersey City, NJ 07303-0484. Theoretical outcomes based on parameters set by the user. E*TRADE Securities does not guarantee the accuracy of calculated outcomes. Results will vary with each use and over time.1. Offer applies to new accounts opened by December 31, 2012 and funded with a minimum $2,000 deposit from an external bank or brokerage account within 60 days. Credits for deposits made within 45 days of account open from external accounts will receive $500 for $250,000+; $250 for $100,000-$249,999; $100 for $50,000-$99,999; and $50 for $25,000-$49,999 within 45 days. Credit will be provided for up to 500 stock and options trades made within 60 days of the deposited funds being made available for investment in the new account. E*TRADE Securities reserves the right to terminate this offer at any time. For additional information and details about the Commission-Free Trade offer, please visit www.etrade.com/tradefree.Securities products and services are offered by E*TRADE Securities LLC, Member FINRA/SIPC.System response and account access times may vary due to a variety of factors, including trading volumes, market conditions, system performance and other factors.©2012 E*TRADE Financial Corporation. All rights reserved.

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OU MAY HAVE HEARD THE PHRASE,“A call option is worth more alive than dead.”In other words, if you’re going to carry a finan-cial instrument around, you’d prefer a calloption rather than its underlying security.Why? The lower “cost of carry” of the call—i.e. your cost to hold this position.

So where does cost of carry come from inequity options? Interest and dividends. But,should you care? That depends.

INTERESTSince a call option allows you to buy stock atthe strike price, the money you need to makethe purchase has a cost. To illustrate:

Suppose XYZ stock is trading at $58 ashare. The 50-strike call is deep in-the-money, and trading for real value of $8. Youcould buy 100 shares of stock for $5,800 andlose your ability to collect interest on the cash.Or you could buy the 50 call. Because eachoption contract controls 100 shares, youwould be, in essence, paying $800 for theoption to pay $5,000 at a later date—makingyour total commitment the same $5,800 asthe first scenario. The difference here is thatuntil the option expiration date, you can leavethe $5,000 in the bank collecting interest.

Being that both buying stock, or buying thecall, lead to controlling 100 shares of XYZstock, both outcomes should be priced identi-

cally. However, the long call has the addedperk of collecting interest on $50 per shareuntil option expiration. To keep things fair, themarketplace adds that amount of interest intothe price of your call option by inflating it.

What About the Put Option? Since a putoption gives an investor the right to sell stock,an investor who owns stock can sell thatstock. The cash generated from the sale can bedeposited in a bank account to collect interest.If he doesn’t own the stock, then by exercisingthe put option, he enters into a short-stockposition, by which he once again receivescash. This cash can be deposited in the bankto collect interest.

By owning the put and not exercising it, aninvestor is, in a sense, foregoing interest col-lection. To keep things fair, the marketplacecredits the investor this interest amount.Therefore, the interest component means thatput options are priced lower than they other-wise would be.

DIVIDENDSTo understand how option prices are affectedby dividends, it’s important to understand howdividends affect stockholders. To wit:

1 / Shareholders get dividends.2 / Investors who have a short-stock posi-

tion must pay dividends.3/ When a dividend is paid out, the stock

price is adjusted lower, to reflect thatthe company now has less value than itdid prior to parting with the cash thatmade up the dividend.

So, if a dividend is to be paid out prior tooption expiration, a call option’s price isdeflated some by the amount of the upcomingdividend. Because if the option ends up in-

the-money at expiration, and the stock isexercised, the shareholder will not receive thedividend.

What About the Put Option? If the investorowns the stock, then by exercising a putoption, he’d have to sell the stock and fail tocollect the dividend. On the other hand, if theinvestor doesn’t own the stock, then by exer-cising the put, he’d then have a short-stockposition, through which he would once againhave to pay out a dividend.

To keep things fair, put options on divi-dend-paying stocks are priced higher than putoptions on stocks that don’t pay dividends. Allthings being equal, this allows put options toremain unchanged in value when the stock isadjusted by the dividend amount.

BY UNDERSTANDING COST OF CARRY, you can begin to see how the markets factor innecessary nuances to price options accuratelyand fairly. In options with little time to expira-tion, or with small dividends, these costs mayseem somewhat inconsequential. However, foroptions on stocks that pay large dividends, orfor options with substantial time to expiration,the cost of carry could be quite significant.

Should You Care about Cost of Carry?

THE COST OF HOLDING AN OPTION MIGHTBE MORE THAN YOU THINK.

>> ByAlex Mendoza / PHOTOGRAPH BY FREDRIK BRODÉN

Y

Back to Basics24 S E N T I M E N TFALL 2012

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buy options on LULUrather than MCD?The answer is thatLULU was a muchmore volatile stockthan MCD and there-fore was more capableof making a big short-term move.

LOW IMPLIEDS VS.HIGH IMPLIEDS So what tradeoff ismore attractive foroption buyers? Is it abetter strategy to pur-chase options on slow-moving, big-cap stocksor to take chances withthe higher-priced (butmore volatile) equi-ties? One way to meas-ure the extent to

which options are mispriced is to look atstraddle returns for individual stocks. Astraddle strategy is simply the simultaneouspurchase of one call and one put with thesame strike prices and the same expirationdates. Straddles make money when the stockmoves enough in either direction to com-pensate for the combined premium paid.

See Figure 1. Going back to 2010, I con-sidered liquid optionable stocks and assumeda long straddle was purchased each month,three weeks ahead of expiration. I alsoassumed the trader held the straddle untilexpiration day and closed it out at intrinsicvalue. For each expiration period, I groupedthe stocks into four sets, based on theirimplied volatilities. Then I summarized thestraddle returns for each implied volatility(IV) level.

OUR CONTRARIAN TRADING

methodology looks fornames with a dichotomybetween sentiment andprice action. We feel theideal buying opportunityarises when a stock is ina sustained uptrend, yetinvestors keep predict-

ing its fall. The pessimismessentially indicatesthere are ample con-verts to win over, withsideline cash that coulddrive the stock higher.We use this sameapproach when analyz-ing sectors. A quick way

to gauge performance isto find the percentage ofstocks in the sectortrading above their 200-day moving average. Tomeasure sentiment, weaggregate analysts' "buy"recommendations inthat sector. This table

IdeaLab26 S E N T I M E N TFALL 2012

N ORDER TO BE SUCCESSFUL, ONE OF THEfirst things option players must realize is theimportance not only of a stock’s price, but ofits volatility. Option premiums differ basedon how volatile option traders expect a stockto be. This leaves you with a tradeoff to con-sider when deciding which options to pur-chase.

Options on stocks with low impliedvolatilities do not need to make very bigmoves to yield an attractive profit, but thenagain, those stocks generally don’t have ahistory of making surprisingly big moves.“Expensive” options—those with highimplied volatilities—need to make muchbigger moves for a decent profit, but thechance of a bigger move is generally greater.

Big-cap, well-established companies tendto have lower implied volatilities than

newer, small-cap companies. For example,with about three weeks to go before Juneexpiration, an at-the-money call option onMcDonald’s (MCD) had an implied volatil-ity of just 14.3%. To break even, McDonald’sstock had to increase by about 2%.

Contrast that with Lululemon Athletica(LULU)—a company that specializes in yogaapparel—which had an implied volatility of58%. To break even, that stock had to gainalmost 6% by expiration. Why would anyone

I

TURNING TRADITIONAL

MARKETR&D ON ITS

HEAD

LOW IMPLIEDS V. HIGH IMPLIEDS

THE THIRD DIMENSION OF OPTIONS

idea #1

shows some attractivesectors based on thesequick metrics. Despite alarge majority of stockstrading above their 200-day moving average, noteven half of the analystrecommendations are“buys.”

SENTIMENTAND PRICEACTION

F Y I

FIGURES 1 & 2: SINCE 2010, ONE THING IS CLEAR—trading straddles onstocks with high implied volatilities (IV) would have produced a net loss. Stockswith fairly low IV would have fared the best.

ImpliedVolatility

Level

Average ImpliedVolatility

AverageReturn

PercentPositive

PercentDoubled

STRADDLE RETURNS SINCE 2010 (ALL OPTIONABLE STOCKS)

Low IV’s

Fairly Low IV’s

Fairly High IV’s

High IV’s

24%

33%

42%

59%

-3.10%

-0.93%

-0.33%

-5.68%

40.5%

41.8%

41.6%

38.5%

9.6%

9.8%

10.7%

9.0%

ImpliedVolatility

Level

Average ImpliedVolatility

AverageReturn

PercentPositive

PercentDoubled

STRADDLE RETURNS 2ND QUARTER OF 2012 (ALL OPTIONABLE STOCKS)

Low IV’s

Fairly Low IV’s

Fairly High IV’s

High IV’s

20%

30%

38%

56%

12.52%

15.31%

11.33%

-1.16%

45.2%

45.1%

43.7%

39.5%

16.4%

18.0%

18.5%

12.4%

No. ofStocks

Stock Above200-Day MA

AnalystPercent Buys

Sector

Real Estate 106 90% 41%

Utilities 91 75% 40%

Buildings 67 79% 44%

Banks 98 68% 37%

Foods/Beverages/Soaps 64 63% 46%

SIR13_IdeaLab_RD2.qxd:pages.layout 2012-09-06 11:01 PM Page 26

www.schaeffersresearch.com FALL 2012 Idea Lab 27

Straddles on stocks with the highestimplied volatilities performed the worst dur-ing the time of this study, averaging a loss ofalmost 6%. Also, it was the only group wherefewer than 40% of the returns were positive.However, this did not mean it was a goodidea to buy options on stocks with the lowestimplied volatilities. The most inexpensiveoptions were not very close to profitableeither, averaging a loss of about 3%. Themoderately priced options performed thebest over this time period.

A RECENT TENDENCY When working in dynamic markets, indicatorssuch as these go through cycles. In the verylong run, things often even out but there areperiods where a clear trend occurs and can beexploited. Therefore, I did the same analysis asabove but I only looked at the most recentquarter (2012 second quarter) for the results inFigure 2.

Notice the straddle returns overall in thesecond quarter were impressive, thanks to a10% drop that occurred in the S&P 500 withinthose three months. Straddles purchased dur-ing that time gained an average of around10%. But buying straddles on the expensive,high-implied stocks actually lost money. Thosestocks did not move enough to cover the highpremiums paid for the options. The optionsthat paid off the most in the second quarterwere those that had low, or moderately low,implied volatilities.

So, when picking stocks for options trades,we have recently seen it pays to avoid theexpensive high-priced options on volatilestocks. Meanwhile, the slower-moving stockshave been surprising option players by makingbigger moves than expected, resulting inexceptional options profits on these names.///////////////////////////////////////////////////////////////////////////////////////////////////////////////////////

> > Rocky White Senior Quantitative Analyst, Schaeffer’s Investment Research///////////////////////////////////////////////////////////////////////////////////////////////////////////////////////

S READERS OF SCHAEFFERSRESEARCH.COM know, our traders have beenmore vocal than ever of late, writing articles and blogs on everything from equities, indexes, andsectors, to the broad-market sentiment on Wall Street. However, readers can now get an evenmore unique perspective of the collective trader mindset with Bernie Schaeffer On Charts.

In our newest feature, Schaeffer’s founder and CEO offers his perspective on technical and sen-timent developments he’s seeing in the equity, commodity, and options markets. Whether it’s note-worthy option activity for the CBOE Market Volatility Index (VIX), amplified short selling on theiShares Silver Trust (SLV) exchange-traded fund (ETF), or technical challenges for JPMorgan Chase(JPM), Bernie’s annotated charts give readers a leg up on what to watch.

What’s more, you can now be the proverbial fly on the wall, thanks to running commentaryfrom our traders and quantitative analysts. Senior Quantitative Analyst Rocky White noted that inmid-June, “these three assets’ year-to-date returns were separated by only 1.86 percentage points,”marking the tightest range ever. Meanwhile, Senior Technical Strategist Ryan Detrick weighed inwith comments that surely perked up a few contrarian ears, observing the “outright dislike ofstocks” and continual safe-haven appeal of bonds, “ even though the S&P 500 is up more than 100%the past few years.”

However, the valuable insight provided by Bernie Schaeffer On Charts may be even betterdemonstrated by his inaugural post, “This Volatility Trendline Could Spell Opportunity.” On June 6,Bernie highlighted two critical levels that, if breached, could offer a potential “buy” signal: the 80-daymoving average on the iPath S&P 500 VIX Short Term Futures ETN (VXX), and the 20.49-21.70region for the VIX. As we now know, both of these areas were violated in mid-June, and the DowJones Industrial Average (DJI) enjoyed its best month of the year, adding 3.9%.

Successful trading is naturally more than just making blanket bets on volatility indicators. Butwhether you’re an options novice or a seasoned expert, Bernie’s veteran observations—as well asthe subsequent conversations prompted with our top traders and analysts—could help you stay astep or two ahead of the curve.

SITE FEATURE“BERNIE SCHAEFFER ON CHARTS”

idea #2

A

More of Rocky White’s market research studies can be found each week in the Monday MorningOutlook at sentiment.com/mmo13

FIGURES 1: SCHAEFFER ON CHARTS Get a unique perspective on thetechnical going-ons of the market, whether it's stocks, indices, or volatility.Go to schaeffersresearch.com/schaefferoncharts

SIR13_IdeaLab_RD2.qxd:pages.layout 2012-09-06 11:01 PM Page 27

www.schaeffersresearch.com

www.schaeffersresearch.com/schaefferoncharts

28

FROM THE TOP HAS VOLATILITY HIT LUNATIC’ LEVELS? A WIDELY QUOTED ANALYSTRECENTLY REFERRED TO THEGYRATIONS IN THE STOCK MAR-KET AS "LUNATIC." IN FACT, IWOULD SUGGEST THAT THEMARKET HAS BEEN BEHAVING,BOTH IN TERMS OF PRICE ANDVOLATILITY, IN A RATHERORDERLY MANNER IN RECENTMONTHS, ALBEIT ONE THAT HASBEEN FRUSTRATING TO THOSEOF US OF A BULLISH BENT…

OUTSIDE THE BOXSHOULD YOU ROLL THE DICEWITH THE EARNINGS-BASEDCALENDAR SPREAD? A CALENDAR SPREAD REALLYONLY WORKS WELL WHEN YOUBUY THE CALENDAR THAT ENDSUP CLOSEST TO THE MONEY. SO,IF YOU HAVE A THOUGHT WHEREA STOCK MIGHT GO AFTEREARNINGS, BY ALL MEANS, USECALENDAR SPREADS. THEY ARELOW-RISK, BUT ALSO LOW-REWARD. THE MOST COMMONRESULT IS YOU DON’T GET THEEXACT RIGHT STRIKE, AND YOUMAKE OR LOSE SMALL.—To read these posts and moreof Schaeffer’s blogs, go to sentiment.com/blogs13

The Extra Edge(SPRING 2009)If you’re looking for theholy grail, there’s no suchthing. If you’re looking for aleg up, Expectational Analy-sis could provide the edgeyou’re looking for. Here arethe essentials.

The Three Components (FALL 2009 & WINTER 2010)Combining fundamental,technical, and sentimentanalysis comprises thesecret sauce of Expecta-tional Analysis. Each of thethree are broken down indetail with these primers.

Prose from the Pros

.COM

SENTIMENT’SGREATESTHITS: EXPEC-TATIONALANALYSIS®

PRIMERS

commentary

INDICATOR OF THE WEEK: STOCKS AFTER THEY CRASH

FORWARD> Burrito maker and high-flying stock Chipotle Mexican Grill(NYSE:CMG) got crushed on Friday in reaction to a bad earnings report.The stock lost about 21% of its value in one day. I thought this was interest-ing enough to look back at other stocks in similar situations to see how theyperformed going forward. Hopefully, we can get some idea as to where CMGand other recently hard-hit stocks might go from here.

FOLLOWING A BIG DROP:> I went back to 2000 and looked at all stocksthat had a market capitalization of at least $1 billion. Then I found the onesthat fell at least 20% on a single day and looked at how they did moving for-ward. Overall, the returns look pretty good, averaging a gain of 33% one yearlater. However, there is some survivorship bias in my method, as I only have alist of currently active stocks. Companies that went bankrupt are notincluded in this study. While the three-month performance shows a positivereturn of 3.76%, more than half of them are negative…

/ / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / /

/ / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / /

Rocky WhiteMonday MorningOutlook

S E N T I M E N TFALL 2012

Blog Exclusives

Online:WEB:www.schaeffersresearch.com

TWITTER:www.twitter.com/schaeffers

FACEBOOK:www.schaeffersresearch.com/fb

/ / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / /

Market Commentary:MONDAY MORNING OUTLOOK(Weekly market analysis)sentiment.com/mmo13

SCHAEFFER’S OPENING VIEW(Daily, before the bell)sentiment.com/ov13

SCHAEFFER’S MARKET RECAP(Daily, after the bell)sentiment.com/mr13

/ / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / /

SENTIMENT magazine:WEB: sentiment.com/archive13

IPAD:schaeffers.com/ipad13

ANDROID:schaeffers.com/android13

CONNECT TO SCHAEFFER’S

If you think the optionsgreeks are part of anoption’s price, you’d bewrong. They simplygive you an idea ofwhere the option price

may go given a set of circumstances—i.e.changes in price, time, volatility, and inter-est rates.

If you know at least one option greek, it’sprobably delta—the rate of change in anoption’s price per one-dollar move in theunderlying. However, theta, vega, gamma,and rho are different stories. Meet delta’sfour lesser-known siblings—whom youwant to get to know. To access more articles on advanced options strategies, as well as other optionseducation, go to www.sentiment.com/edu13

SCHAEFFER’S U

ADVANCED OPTIONSTRATEGIES – ANODYSSEY THROUGHTHE GREEKS

/ / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / /

/ / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / /

///////////////////////////////

Putting It All Together(SPRING 2010)Once you understand whatmakes Expectational Analy-sis work, the trick is under-standing how to put it alltogether and apply each ofthe three components.

To read more of Rocky’s weekly commentary, sign up here: www.sentiment.com/mmo13

View any of the above SENTIMENT articles at schaeffersresearch.com/sentiment/ / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / /

SIR13_Com_RD2.qxd:pages.layout 2012-09-06 11:00 PM Page 28

08-IB12-398

How did Interactive Brokers become the largest electronic broker?

By offering

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Interactive Brokers LLC is a member of NYSE, FINRA, SIPC. Supporting documentation for any claims and statistical information will be provided upon request. Commission and Margin Rate surveys of IB competitors as of July 2, 2012. Services vary by firm. Barron’s is a registered trademark of Dow Jones & Co. Inc.

1 For additional information on margin loan rates, see www.interactivebrokers.com/interest.2 For additional information see www.interactivebrokers.com/bestexecution.

www.interactivebrokers.com/compareInteractive BrokersThe Professional’s Gateway to the World’s Markets

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Pro Pearls30 S E N T I M E N TFALL 2012

As I talk to many retailtraders across thecountry, all too often Ihear their frustrationand disappointment,not only in themselves,but in the markets aswell. Bad habits anduncertainty hinderspotential success.Nothing new. We allcan get “trader’s block”at times. Here are a fewtips to make things eas-ier on yourself.

1 / Watch your size.Don’t trade too big,period. This is one ofthe biggest mistakesnew options tradersmake. Start with asmall amount of con-tracts(this is almostalways less than youwant) and get comfort-able before you

increase your size.Starting smaller leavesyou more agile, but youput skin in the game.And you’ll likely learnmore without the pres-sure of things that maygo against you, costingtoo much money.

2 / Set realistic expectations. Many traders entertrades with a “got ahunch, bet a bunch”mentality, expecting tomake a fortune on onetrade. If your mindset isthat of someone play-ing the Lotto, you’llhave a tough timebeing successful. If youwant to gamble, fly toVegas. It’ll probably becheaper in the longrun, and the drinks arefree.

3 / Define your risk.This is a variation of#2 above. One of themajor differencesbetween a newbie anda professional trader isthat the newbie thinksabout how much hecan make, whereas theseasoned trader thinksabout how much hecan lose. The pro

knows that if hedefines his risk andunderstands the worst-case scenario goinginto a trade, he’ll beable to make betterdecisions as the tradeplays out. If youapproach your tradingmore systematically, bydefining your risk andreward, immediatelyyour expectation oflong-term successbecomes more realistic.

4 / Let it go. Don’twaste time on badtrades. Ever. Any goodtrader knows that therewill be winners and los-ers, and they accept it.The key is to keep thelosses small. Again,

defining risk helps, butmore important isaccepting when a tradeis unsalvageable, andmoving on to the nextopportunity. Too manytimes I’ve seen someonetry to “save” a bad trade.The problem is they’llspend too much timetrying to roll out monthto month, tie up pre-cious capital, and allowbetter opportunities topass them by. Youwouldn’t drive a car thatyour mechanic declaredas “junk,” so why wouldyou try to save a tradethat’s junk as well?You’ll know the differ-ence between a bad

trade and a loser thatcould turn around. It’sthe one that’s fallen andcan’t get up.

////////////////////////////////////////////

Options involve risk,and are not suitable forall investors. Pleaseread Characteristicsand Risks of Standard-ized Options beforetrading. A copy may beobtained from yourbroker or by contactingThe Options ClearingCorporation, OneNorth Wacker Dr.,Suite 500, Chicago, IL60606 (1-888-678-4667). TD Ameritrade,Inc., memberFINRA/SIPC/NFA.////////////////////////////////////////////

Pro Pearls

FRUSTRATED WITH YOUR OWNTRADING MISTAKES? TD AMERITRADE’S JOE KINAHAN LAYS OUT FOUR STRESS-REDUCERS TO SAVE YOU FROM YOURSELF.

/Joe “JJ” Kinahanis the Chief DerivativesStrategist for TD Ameritrade, and previously a marketmaker for the ChicagoBoard Options Exchange(CBOE) trading primarily in the S&P 100(OEX) and S&P 500(SPX) pits. JJ is also aCNBC Fast MoneyTrader, and is oftenquoted in the Wall StreetJournal, Reuters News,and many otherrespected media outlets.

Phot

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Schaeffer’s Investment ResearchMAIN OFFICE: 513.589.3800MAIN FAX: 513.589.3810CUSTOMER SERVICE:800.327.8833 prompt #2E-MAIL: [email protected]: 800.448.2080 prompt #4

5151 Pfeif fer Road, Suite 250Cincinnati, OH 45242www.SchaeffersResearch.com

SENTIMENT is published quarterly by Schaeffer’s Investment Research, Inc. (SIR). SIR is not a registered investment adviser. SIR relies upon the publishers exclusion from the definition of investment adviser under Section202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, SIR does not offer or provide personalized advice. We publish information about companies in which we believe our read-ers may be interested and this information reflects our sincere opinions. The information that we provide is not intended to be, and should not be construed in any manner whatsoever as, personalized advice. Also, the infor-mation provided by us should not be construed by any reader as SIR’s solicitation to effect, or attempt to effect, any transaction in a security. The information contained in SENTIMENT is not intended to be investmentadvice and is for illustrative purposes only.The investment strategies or the securities may not be suitable for you. The information provided herein has been obtained from sources believed to be reliable, but there is noguarantee of accuracy. Some of the articles and material in SENTIMENT have been written by third-party authors. In such cases, their views are those of the author, but are not necessarily the views of SIR. The risk of loss intrading securities, options, futures, and forex can be substantial. Readers should consider all relevant risk factors, including their own personal financial situations, before trading. Options involve risk and are not suitable forall investors. Readers should restrict commitments to funds that can be lost without undue financial hardship. Prior to buying or selling an option, an investor should read and understand the booklet “Characteristics andRisks of Standardized Options.” You can access and download a copy of the booklet on The Options Clearing Corporations (OCC) website at www.theocc.com/about/publications/character-risks.jsp. This link reference isprovided as a courtesy and does not imply that the OCC is endorsing SIR or its products. This booklet is also available for free from your broker or from any of the U.S. options exchanges, or you can call SIR toll-free at 1-800-327-8833 and we will send one to you. Prior to buying or selling a future, an investor should read and understand the booklet “Security Futures: An Introduction to Their Use and Risks.” You can access and downloada copy of the booklet at the National Futures Association website at www.nfa.futures.org/investor/security_futures/security_futures.pdf. This link reference is provided as a courtesy and does not imply that the NationalFutures Association is endorsing SIR or its products. This booklet is also available from your broker or from any of the U.S. Futures Exchanges, or you can call SIR toll-free at 1-800-327-8833 and we will send one to you. The security portfolio of our employees, officers, affiliated companies, and third-party writers may, in some instances, include securities mentioned in this issue. No part of this material may be reproduced in whole or in partwithout explicit permission from a duly authorized officer of SIR, except by established news media that wish to quote brief passages for purpose of review. Copyright 2011, Schaeffer’s Investment Research, Inc.

SIR13_ProPearls_RD2.qxd:pages.layout 2012-09-06 11:02 PM Page 30

SIR13_ProPearls_RD2.qxd:pages.layout 2012-09-06 11:02 PM Page 31

LOOKING FOR A POWERFUL WAY TO HELP DE-RISK YOUR PORTFOLIO?

DE-FY VOLATILITY

WITH VIX.®Turn volatility to your advantage with VIX options and futures. With its strong negative correlation to the broad market, VIX provides an effective way to get diversifi cation and protection when you need it most. No wonder investors are trading VIX in record numbers.* Manage risk, diversify your portfolio and leverage volatility with VIX options and futures, offered only at CBOE and CBOE Futures Exchange.

Learn more with the free strategy brief, “VIX Options: Taking the Fear out of the Fear Index.” Go to www.cboe.com/brief or snap the QR code below.

Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options (ODD). Copies are available from your broker, by calling 1-888-OPTIONS, or from The Options Clearing Corporation at www.theocc.com. Futures trading is not suitable for all investors, and involves risk of loss. Futures and options on CBOE’s volatility indexes have several unique features that distinguish them from most equity and index options, and investors are strongly encouraged to closely read and understand the ODD and the VIX options FAQ at http://www.cboe.com/micro/vix/vixoptionfaq.aspx and other informational material before investing. Investors should consult their tax advisor as to how taxes affect the outcome of contemplated options transactions. *Supporting documentation is available by contacting CBOE at [email protected]. CBOE® Chicago Board Options Exchange®, CBOE Volatility Index® and VIX® are registered trademarks and CBOE Futures Exchange is a service mark of Chicago Board Options Exchange, Incorporated (CBOE). S&P® and S&P 500® are trademarks of Standard & Poor’s Financial Services, LLC and have been licensed for use by CBOE and CBOE Futures Exchange, LLC. Copyright © 2012 CBOE. All rights reserved.

www.cboe.com/brief

PRSRT STDUS Postage PaidPermit #799Bolingbrook, IL

Schaeffer’s Investment ResearchMAIN OFFICE: 513.589.3800MAIN FAX: 513.589.3810CUSTOMER SERVICE: 800.327.8833 prompt #2E-MAIL: [email protected]: 800.448.2080 prompt #4

5151 Pfeiffer Road, Suite 250Cincinnati, OH 45242www.SchaeffersResearch.com

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