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Friday, February 24, 2012

Sold 100% Cash-Secured Puts -- iPath S&P 500 VIX Short-Term Futures ETN

Today, the Covered Calls Advisor established a new 100% Cash-Secured Puts position in iPath S&P 500 VIX Short-Term Futures ETN (Symbol VXX) with a Mar2012 expiration.

The transaction was as follows:
02/24/2012 Sold 3 iPath S&P 500 VIX Short-Term Futures ETN (VXX) Mar2012 $25.00 Put Options @ $2.49
Note: the price of VXX was $23.76 today when these Puts were sold.

The Covered Calls Advisor does not use margin, so the detailed information on this position and some potential results shown below reflect the fact that this position was established using 100% cash securitization for the three Put options sold.

Two possible overall performance results(including commissions) for this iPath S&P 500 VIX Short-Term Futures ETN (VXX) transaction would be as follows:
100% Cash-Secured Cost Basis: $7,500.00
= $25.00*300

Net Profit:
(a) Options Income: +$735.80
= ($2.49*300 shares) - $11.20 commissions
(b) Dividend Income: +$0.00
(c) Capital Appreciation (If VXX price unchanged at $23.76 at expiration): -$380.95
= ($23.76-$25.00)*300 - $8.95 commissions
(c) Capital Appreciation (If VXX above $25.00 at Mar2012 expiration): +$0.00
= ($25.00-$25.00)*300

Total Net Profit(If VXX price unchanged at $23.76): +$354.85
= (+$735.80 options income +$0.00 dividends -$380.95 capital appreciation)
Total Net Profit(If VXX above $25.00 at Mar2012 options expiration): +$735.80
= (+$735.80 +$0.00 +$0.00)

1. Absolute Return if Unchanged at $23.76: +4.7%
= +$354.85/$7,500.00
Annualized Return If Unchanged (ARIU): +78.5%
= (+$354.85/$7,500.00)*(365/22 days)

2. Absolute Return (If VXX above $25.00 at Mar2012 options expiration and Put options thus expire worthless): +9.8%
= +$735.80/$7,500.00
Annualized Return (If stock price above $19.00 at expiration): +162.8%
= (+$735.80/$7,500.00)*(365/22 days)

These very high potential returns are a direct result of the very high implied volatility currently available in the VXX options. The Mar2012 $25.00 put options implied volatility was at 74.0 when this position was established.

The downside 'breakeven price' at expiration is at $22.51 ($25.00 - $2.49).
Using the Black-Scholes Options Pricing Model in the Schwab Hypothetical Options Pricing calculator, the resulting probability of making a profit (if held until Mar2012 options expiration) for this iPath S&P 500 VIX Short-Term Futures ETN (VXX) cash-secured Puts position is 65.1%. This compares with a probability of profit of 53.6% for a buy-and-hold of VXX over the same time period.

The 'crossover price' at expiration is $26.25 ($23.76 + $2.49).
This is the price above which it would have been more profitable to simply buy-and-hold VXX until March 17, 2012 (the Mar2012 options expiration date) rather than holding the short Put options. The probability of exceeding this crossover price at expiration is 32.4%.

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