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I recently delved into another book exploring the options strategy I previously mentioned: "Intrinsic" by Michael Yuen.

Yuen's take offers a fresh perspective compared to the original text. His analysis starts with a compelling statistic: If you were to randomly select any tech stock from the QQQ over the last 10 or 20 years, you'd have approximately a 75% chance of outperforming the S&P index. Even if we extend the horizon to 30 years, the stocks within the QQQ at the time would still have outpaced the S&P. The following forms the foundation of his approach – identifying stocks trading 5-10% below their 52-week highs, exhibiting a consistent upward trajectory over time, and possessing a competitive advantage or "moat." Yuen also emphasizes the importance of a tight breakeven point for the deep in the money (DITM) LEAP options he targets, ideally within 5% or less above the current stock price. He will go to 10% if that is all that is available. He favors DITM LEAPs with a delta near one and expiration dates of two years or more.

The brilliance of this strategy lies in the math. The call options are cheaper than purchasing the stock outright but capture the same dollar gains. For instance, if the option premium is $25 and the stock is priced at $40, a $10 increase in stock price results in a 40% profit for the option holder versus 25% for the stockholder.

Of course, the downside risk is amplified in declining markets, but given historical market trends and the multi-year horizon of this strategy, it often outpaces the S&P significantly. Despite its apparent advantages, one might wonder why this strategy isn't more widely adopted.

identifying stocks trading 5-10% below their 52-week highs,
ok

exhibiting a consistent upward trajectory over time,
ok. How does he measure that? What period? RS? SMA? eyeball a chart? handwaving?

possessing a competitive advantage or "moat."
Not exactly mechanical.


tight breakeven point for the deep in the money (DITM) LEAP options he targets, ideally within 5% or less above the current stock price.
...
He favors DITM LEAPs with a delta near one and expiration dates of two years or more.

What does he call "near one"? MSFT is 424, CBOE says the 215 (about 50% ITM) Dec'2026 call delta is 0.9611

I recently found a broker who showed the deltas in the options chain, but cannot find it now. My main brokers only show it for one option at a time. Darn.

For GOOG, the farthest is Jan'2026. Lowest strike is 65 with delta 0.9797. Midpoint price is 97.5. GOOG is 156. That's 4.2% above current stock price.

I think you'd also want to factor in what Jim calls the "implied interest rate".


Despite its apparent advantages, one might wonder why this strategy isn't more widely adopted.

You need to have tight risk control. If the stock loses 25% your option loses 40%. In the blink of an eye. Prices drop steeply but climb slowly.

How much would he have lost in 2022 when MSFT went from 335 to 224? 33% loss on the stock. Near 100% loss on a DITM call.

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I haven't written any books, but take a look at how buy&hold of TQQQ has done compared to QQQ. https://www.portfoliovisualizer.com/backtest-portf...

Last 14 years, QQQ up 10X, TQQQ up 132X. QLD up 50X.
They warn you against holding these 2X & 3X daily leveraged investments, but WOW!

Pretty nosebleed on the MaxDD, though. -33% for QQQ, -79% for TQQQ.

How much would he have lost in 2022 when MSFT went from 335 to 224? 33% loss on the stock. Near 100% loss on a DITM call.

It depends on the time frame. MSFT is now trading at 422 so if it was a two year leap, or some combination of rollover, I would say pretty good.

Aussi

Since, I have pretty much finished the book, I can respond to everything you said.



exhibiting a consistent upward trajectory over time,
ok. How does he measure that? What period? RS? SMA? eyeball a chart? handwaving?<I/>

Believe it or not, more eyeballing.

possessing a competitive advantage or "moat."
Not exactly mechanical.

That is why I started with OT


tight breakeven point for the deep in the money (DITM) LEAP options he targets, ideally within 5% or less above the current stock price.

He will go up to having the Breakeven be 10% above the stock price, but prefers 5% or less.
...
He favors DITM LEAPs with a delta near one and expiration dates of two years or more.

What does he call "near one"? MSFT is 424, CBOE says the 215 (about 50% ITM) Dec'2026 call delta is 0.9611

I looked in the book, and could not find the delta quickly, but my guess is that, since the idea is to catch most of the gain of the stock, on the option, that .95 would be fine.



I think you'd also want to factor in what Jim calls the "implied interest rate".

Can some explain that to me?




Despite its apparent advantages, one might wonder why this strategy isn't more widely adopted.

You need to have tight risk control. If the stock loses 25% your option loses 40%. In the blink of an eye. Prices drop steeply but climb slowly.

How much would he have lost in 2022 when MSFT went from 335 to 224? 33% loss on the stock. Near 100% loss on a DITM call.

He addresses that quite a bit. He says that a lot of his options lose a lot of money quickly, sometimes in one day, but that he never panics, and just waits for the price to return. He is a Software Engineer with an MBA, so knows the companies very well.

--------------------

haven't written any books, but take a look at how buy&hold of TQQQ has done compared to QQQ. https://www.portfoliovisualizer.com/backtest-portf...

Last 14 years, QQQ up 10X, TQQQ up 132X. QLD up 50X.
They warn you against holding these 2X & 3X daily leveraged investments, but WOW!

If you go through the math with TQQQ, you will see why it is not a good strategy. Just go through five days, of simulated returns.

Now a question for you.

I have presented this strategy, and the other ones, "In The Money: The Simple Options Strategy That Always Beats the Market", and "In The Money: Bear Market Strategy: The Simple Options Strategy to Trade the Bear and Win"

Which of the two strategies do you think is better?

Thanks.

...[What is] the "implied interest rate".

From a 2017 post:
"To calculate the cost of the leverage, this is the math I do
Likely purchase cost of option = .25*bid + .75*ask.
Breakeven = strike + cost of option
"Extra cost" = breakeven - cost of stock now + your after-tax amount of all the expected dividends
Borrow amount = stock price now - option cost (the amount of money you don't have to put up yet).
Raw interest rate = extra cost / borrow
Annualized = raw rate * 365 / (calendar days till expiry)."

And from a 2019 post:
"(how much worse the ending break even price is buying calls today versus buying stock today) /
(the amount lower the cash cost is today buying calls instead of stock) * 365 / (days to expiry).

Unless I made a typo, that's
((strike + .25*bid + .75*ask)-stockprice)/(stockprice - (.25*bid + .75*ask)) * 365/830."

==========================================
If you go through the math with TQQQ, you will see why it is not a good strategy. Just go through five days, of simulated returns.

I did say that there is HUGE volatility.
Also, you only want to hold a daily leveraged QQQ when QQQ is rising.

==========================================
I have presented this strategy, and the other ones, "In The Money: The Simple Options Strategy That Always Beats the Market", and "In The Money: Bear Market Strategy: The Simple Options Strategy to Trade the Bear and Win"

Which of the two strategies do you think is better?

I am of the opinion that in a storm the best place to be is in a cave. Make hay when the sun is shining, shelter down when it is not.
The market is much more volatile during a bear market than a bull market. Using leverage with high volatility is dangerous.

You don't need to make profits in both bull and bear markets. It's okay to go to cash in bear markets. "Heads I win, tails I don't lose."

And that "Always Beats the Market" is just wrong. It's not "always". As Jim said, it's just leverage.
Kinda like card counting at Blackjack. When the odds are in your favor, bet big. When they are not, bet small.

possessing a competitive advantage or "moat."
Not exactly mechanical....

There is one quick test to get you firms that are a little more bemoated than others: high ROE.

It's dangerous to invest in firms with high ROE solely because they are overgeared, so best to first eliminate firms with seemingly dangerous levels of debt. e.g., total debt ought to be less than 5-10 times net earnings.

But, other than that, a consistently high ROE is a pretty good sign. Not all high ROE firms are great businesses, but almost all great businesses have high ROE.

The reason is relatively simple: book value is a shortcut proxy for the cost of a competitor to set up in competition with you with the same assets you have. If you are earning a lot on your assets, then a would-be competitor is strongly motivated to raise the money to compete against you, undercutting just a bit to steal some business. To the extent his cost of competitive entry is approximated by your book value, he'll earn outsize returns on his investment.

If your ROE has been very high for many years and is not falling (and your debt burden isn't rising), then there is some reason the competitors are NOT going up against you. The simplest one is that you have some very high cost of competitive entry or barrier to competitive entry (not quite the same thing), both of which might be called a business moat.

I like the ft.com global equity screener, which has a great field "five year average ROE".
But even most-recent-fiscal isn't so bad. Compare the performance of the highest ROE firms versus the lowest.
For example, in the VL universe 2000-2023
top 25% by ROE, CAGR 12.4%
S&P 500, CAGR 7.0%
bottom 5% by ROE, CAGR 3.8%

It isn't perfect, but it's a quick way to find a group highly correlated with the moated crowd.

Jim

He is a Software Engineer with an MBA, so knows the companies very well.

Heh. I'm a Software Engineer with an MBA, and I don't know any companies very well. Don't assume.

Elan

I am of the opinion that in a storm the best place to be is in a cave. Make hay when the sun is shining, shelter down when it is not.
The market is much more volatile during a bear market than a bull market. Using leverage with high volatility is dangerous.

You don't need to make profits in both bull and bear markets. It's okay to go to cash in bear markets. "Heads I win, tails I don't lose."

And that "Always Beats the Market" is just wrong. It's not "always". As Jim said, it's just leverage.
Kinda like card counting at Blackjack. When the odds are in your favor, bet big. When they are not, bet small.

So it sounds like you like Michael Yuen's book more than Heather Cullen's. I think he is more honest. He does not claim you can get almost zero time value, and he freely admits that while this works for him, it may not for us. He also says take from the book what you find useful, and ignore the rest.

Heather acts like she discovered penicillin.

Ray: Thank you for explaining implied interest
Jim: Thank you for your excellent Idea on finding a moat.
Elan: You are correct.

Thank you Jim.

What would you consider a good ROE?

What would you consider a good ROE?

Higher is always better than lower. But for a rough target, there are many firms that statistically do well with ROE north of 30%.
For a sense of the distribution, in the VL universe in the last ~20 years, using the annual "Return on Shareholders Equity" field
about 95% of covered firms have a stated ROE of some kind
about 83% of covered firms have positive ROE
about 35% of covered firms have ROE > 15%
about 10% of covered firms have ROE > 30%


So, either >30% or negative.

You may wonder why negative. The idea is that you want a company that can make excellent money with the fewest assets. A few very good firms can make money quite reliably with no net assets at all. So if a firm has positive earnings (and they aren't just a one-time anomaly) and negative book per share, you get a negative ROE but (statistically) a good investment. Positive earnings divided by negative net assets gives a negative ROE. Not to be confused with firms with negative earnings on positive assets! Avoid those.

e.g, you'll see good average performance from firms with negative book but positive current earnings, positive trailing earnings, and positive EPS growth forecast. In effect, and infinite ROE.
You'll get a lot of tobacco firms. Great financially in the past but I screen those out.


If looking for high ROE, don't forget that there are firms with high ROE and bad situations. An easy way for a firm to get a high ROE is to borrow way too much money and pay it all out as a dividend, leaving them vulnerable. What used to be called a "recap" long ago, but mostly known as LBO victims these days. Be sure to screen for sustainable debt levels before checking for high ROE. I check long term debt < N times typical net earnings. Another way to get a superficially high ROE is to have something weird on the balance sheet, like a truly gigantic loss in the past that wiped out the bookkeeping equity while leaving the actual business unchanged. That one is hard to screen for. It's one reason people also look at return on *tangible* assets rather than just return on net assets.


An interesting side effect: since the best firms have high ROE figures, and since many firms of all types trade at pretty similar multiples of earnings, you often see the best businesses trading at the highest P/B ratios. (same earnings, same price, lower book value, means higher P/B). This is why low P/B doesn't work as a value screening step...the very best firms need very few assets to make their money. Seeking low P/B firms is mostly the same as seeking firms with poor business economics: they need a lot of assets to earn each buck of profit. Counterintuitively, seeking the few firms with the highest P/B works pretty well as a screen. (not too many picks, as there aren't too many fantastic companies). This doesn't work because it's merely picking overpriced momentum picks that are going to keep zooming just a while longer...it often picks very good underlying businesses. In the VL world, top 10 monthly by P/B beat SPY by about 10%/year in the last 20 years, no other criteria at all.

Jim

I never would have thought that, but it makes sense. Thanks for the advice.

There's another one (I think a mention in passing from Jim) that looks good.

Monthly 1 month relative strength rotation between SPY PRF IWF QQQ.
Backtest Feb 2006 to Mar 2024:
CAGR 14.31% vs. 11.79% equal-weight vs. 10.12% SPY

# of months for each:
34 IWF
65 PRF
104 QQQ
16 SPY




Interestingly, since 1/4/2021 this has almost the same gain as the 25HTD30 above.
Backtested CAGR 13.90%
25HTD30 actual CAGR 13.76%
Backtested QQQ 11.97%

So how would you do that? Take the one that did the best the month before, and hold it for a month?

Take the one that did the best the month before, and hold it for a month?

Yes. In addition, if none have positive 1 month RS, the selection is cash. FLRN, FLOT, etc.

Monthly 1 month relative strength rotation between SPY PRF IWF QQQ.
Backtest Feb 2006 to Mar 2024:
CAGR 14.31% vs. 11.79% equal-weight vs. 10.12% SPY

I took a closer look at things and saw something embarrassing.

QQQ in the same period is CAGR 14.78%.
Slightly worst stdev, slightly worse Sortino Ratio.

We are constrained by PRF starting in 2006. Dropping PRF and using the same dates gives CAGR 12.78%.
Same dates with IWD instead of PRF, CAGR is 12.79%.

Replace IWB & IWF with IWB: 13.09%

Going back as far as possible, June 2000, the best is
SPY IWD IWF QQQ with 8.11% vs 7.50% for QQQ

So basically, it looks like this momentum model doesn't have much different results than just holding QQQ. Depending on the period, sometimes one is slightly better and sometimes the other is.
The momentum screen just has a slightly better stdev, maxdd, and Sortino.

All these backtests were run on PORTFOLIO VISUALIZER.

Thanks. I think things like Sharp ratio, Sortino ratio, Max dd are very important.

I remember the Nasdaq was down 80% in 2during the .com crash.

I took a closer look at things and saw something embarrassing.
QQQ in the same period is CAGR 14.78%...

A bigger issue with the rotation strategy is that the trading costs are pretty significant, depending on the mix of indexes among which you'd be switching. If you have a strategy that beats the broad index by 1.5%/year over a very long period, you're beating the vast majority of professional money managers. But not if your trading costs are over 1%/year.

I personally wouldn't own QQQ. It seems a pointless concoction to me. It is so amazingly concentrated in just a few firms that it makes no sense. 4 stocks are 28% of the fund. (and top 7 are 42%). If you have a strong idea about the future prospects of those specific few firms, buy them or short them as the case may be. If you don't have a strong and well-informed idea about their prospects you have no business investing in something so concentrated in them. As a side effect, it doesn't trend well and doesn't work very well in this type of momentum system...there is no "macro" moving the prices, mainly just the idiosyncratic moves of a few stocks.

Jim

I personally wouldn't own QQQ. It seems a pointless concoction to me. It is so amazingly concentrated in just a few firms that it makes no sense.

MSFT AAPL NVDA AMZN META AVGO GOOG/L TSLA COST

The same 10-15 stocks as in just about all the major ETFs & indexes. SPY, QQQ, IWB,
The only significant difference between these major indexes is the exact weighting of the top 10. The actual stocks are almost the same.

Might as well just go ahead and buy these top NN stocks yourself, maybe equal weight.
When these go down, the whole market will go down hard. Doesn't matter what stocks you own, they will go down too. Even BRK.

Just looking at IWF & IWD (Russell 1000 Growth & Value) these have no stock in common in the top 10.
Yet the 24 year returns are almost the same. 7.27% and 7.36%.
The 50/50 annually rebalanced and SPY are even more identical. 6.25% and 6.20%. The chart lines at portfoliovisualizer for these two are on top of one another.

I am inclined to agree with you about QQQ. IWD looks better. QQQ lagged until 2020.


Heh, just getting back from town, saw this headline on yahoo: 'Magnificent 7' power stock surge after CPI-fueled sell-off
"Members of the "Magnificent 7" tech stocks helped lead the rally with Apple (AAPL) and Nvidia (NVDA) both up more than 3% while Amazon (AMZN) gained more than 1.5% to hit a new all-time high."


To tell the truth, I'm really thinking that it wouldn't be such a bad idea to just bag everything and put it all in AMZN.
In the late 90's I bought some AMZN in my mother's account at 60, and sold it a year or so later for also 60.
But 60 after 12-1 splits.

just bag everything and put it all in AMZN.

er... maybe... be careful, AMZN has way underperformed QQQ over 5 years, especially since the Covid post-crash spike. It started a good relative recovery about a year ago early '23. That said, it's just returned to its '21 plateau after the big '22 bear.

https://stockcharts.com/sc3/ui/?s=AMZN%3AQQQ

A no look WAG - NVDA (seriously due for a mean reversion), AAPL and META have driven the Qs the most.

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