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Dow 20000?

Today, I’ll talk about James Altucher‘s appearance on CNBC this week,  in which he made the case for Dow 20,000 within the next 12-18 months. I had two directions I could go with this, but for today, I’ll answer the first question I had – “If this is so, how can I use an options strategy to leverage this [insanely] high forecast?” For sake of context, and the chance this is read years from now, the Dow closed this week at 12,151, so 20,000 represents a 65% increase from this point. I’ve taken the liberty of switching to the S&P to implement the strategy I’ll discuss, as the options tend to be available in better volume at the strike prices that interest me. With the S&P at 1300, a 65% upside means Mr. Altucher is looking for about 2140 for this index. To trade on the S&P, I look to its most common ETF, the SPY.

(Note – you can right-click this image to see it more clearly) The SPY trades for 1/10 the value of the S&P, so the 65% upside would put it at 214 or so. A 65% increase sounds great, right? I will now show you how through the use of options, you can a 10 fold return if this prediction is only half right. You see, the market can have some wild swings, from a low of 666 in March of 2009 it more than doubled to its recent peak of 1344. Still, let’s look at a strategy to go for the big return with a much higher chance of success.

These are the Call Options for SPY, with an expiration date in Jan, 2013. If you buy the 170 call, you will spend $62 (options trade in lots of 100), and will see a profit once the SPY exceeds 170.62. By also selling the 175 call for $26, you reduce your cost to $36, and if the S&P closes just 34% higher from today, 1750, you will see $500 for your $36, a 10 to 1 return. If your brokerage account is set up for options trading, you can actually do this. There are two commissions involved, usually less than $10 for the two purchases, so your cost will be closer to $50 which is why I say 10 to 1. If you are convinced this rise is imminent, and willing to make a higher wager, the commission will be a far lower percent of your cost, and the trade will look like a 13 to 1 return.

Here’s a chart that may help illustrate this idea a bit better. A final note – This post should be considered an observation, not a recommendation. Think of it this way – the market is willing to bet you at 13 to 1 odds that the S&P will not be over 1750 on the third Friday of January, 2013.

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