Volatility Rider

Oil Musings

2006-10-04T14:33:00.000-07:00

Econopundit has an amazing chart of historical oil inventories here:

Oil Inventories

Apparently oil inventories aren't too far off from their all-time high, and this inventory could take 2 or 3 years to work off. If the high inventories aren't caused by a slow economy, just imagine what a 2 or 3 year glut of energy supply could do for the economy and the stock market. It's interesting that now OPEC members are seeking to reduce production. I think that OPEC learned a valuable lesson from the past years' energy price spikes. That lesson is that oil can stay above 50 bucks or so, without causing the world economy to collapse and immediately cause a drop in demand which lowers prices. Just a few years ago who would have thought that oil could hit 70 without starting a recession?

Now I know almost nothing about the global politics or macro-economics, so I'm going to engage in some wild speculation and assume some facts where I have no idea if they are really true or not. I wonder if the parts of OPEC that are pushing for production cuts might be primarily those dominated by Venezuela and Iran. Iran and Venezuela's reserves are declining, while at the same time due to mismanagement, their ability to find and extract new reserves is almost non-existent. They both need money very much in the short-term to maintain their regimes. Iran needs money for it's military build-up and to pay for the Hezbollah/Lebanon fiasco. Chavez needs a constant flow of money to give away as hand-outs to the poor and to pay off his cronies in order to maintain his power. These major oil producers need oil to stay high in the short term as they need cash-flow right now.

On the other hand you have nations like Saudi Arabia, Kuwait, and Dubai who have lots of oil, plus advanced oil exploration capabilities thanks to their partnerships with western corporations. These countries are basically financially sound at 25 dollar oil or at 50 dollar oil. Although 50 dollar oil doesn't cause the global economy to collapse it does make a lot of exploration, alternative energy, and conservation economical that wouldn't be at even 30 dollar oil. I wonder if these OPEC members would prefer if oil were lower. Over time 50 dollar oil is going to reduce their power in the global market as substitutes are found in the rest of the world. Since these nations probably have more marginal supply than the likes of Iran and Venezuela they probably hold enough production power to influence the price of oil moreso than Iran and Venezuela.

Although I generally think conspiracy theories about various "evil factions" manipulating the price of oil to influence the US economy and Elections are stupid....I'm going to indulge and be stupid anyway....forgive me: It seems to me that the leaders of the Sunni nations such as Saudi Arabia, Kuwait, and Dubai would prefer that the US have a strong military presence in the Middle East, despite what they might say publicly. We are the only thing standing between them and the Shiites in Iran and Iraq now that Saddam Hussein is gone. They need us there to keep the Shiites contained.

The leaders of Saudi Arabia, Kuwait, and Dubai must know that the Democratic leadership in Congress favors withdrawing from Iraq and appeasement of Iran, so I wonder if they might be pushing oil prices down in order to encourage a Republican victory in the '06 elections? If anyone really has the ability to manipulate the global oil markets in such a way, it would be these guys who could actually pull it off.

Is the drop in oil a sign that China's economic bubble is beginning to pop?

2006-09-09T11:10:00.000-07:00

It seems like I remember it said by many analysts and commentators who were/are bullish on oil that U.S. demand doesn't matter so much anymore. I think the argument is that the price of oil is driven by marginal demand in China now-a-days and that this is why oil has to go to $100/barrel or whatever, because they will buy all excess inventory available to fuel their "unstoppable" economic expansion. Now, I am noticing in the articles I read,that the recent decline in the price of oil seems to be attributed by the analysts to U.S. factors...stuff like the U.S. economy is slowing, U.S. consumers are conserving, etc.. China doesn't seem to be mentioned that much anymore. I wonder, though if the original idea is correct, and if so is this an early sign that the Chinese economy is in trouble? (FWIW, I guess I'm currently fading the oil move since I'm long OIH Jan 07 135 Calls.)

Stock Prices and Terror

2006-08-10T12:50:00.000-07:00

Does today's thwarted terrorist attack remove the implicit terrorist discount from the US equities markets? I occasionally see it said that ever since the attacks of 9/11, that the market prices in the threat of terrorist attacks. This means that all else being equal, stocks trade at a lower price than they otherwise would, because they are pricing in the threat to company profits resulting from future terrorism.

If this was intended to be the next big follow-up to 9/11 then it took them almost 5 years to put it in place and they were completely stopped by the authorities. Does this give us at least another 5 years before we have to worry about another big attack?

Pour some out for my dead homies...

2006-06-13T16:45:00.000-07:00

James Altucher had some interesting comments in the realmoney.com columnist conversation today. He says that volatility sellers are getting creamed and that index put selling hedge funds were getting liquidated today. The resultant put-buying and associated hedging is pushing the market down, and when those liquidations are complete (maybe tomorrow!) he believes the selling may stop. As someone who has been doing their best to provide some small liquidity to those buying July index puts since the middle of last week, I sure hope he's correct, otherwise I'll be joining my put-selling brethren in some forced margin liquidations of my own!

Bernanke doin' his best to make you and me poorer...

2006-06-12T12:45:00.000-07:00

I think it's interesting how when Bernanke's appointment was announced many people characterized him incorrectly as an "inflation dove" based off of a speech he made one day where he said something to the effect that we don't need to worry about deflation because the Government "owns this thing called a printing press" and can "drop money out of helicopters" if necessary to fight deflation. It seems to me in retrospect that those comments were extremely hawkish. What he was really telling us at the time was that he doesn't take deflation seriously as a threat at all, and is only going to be focused on inflation concerns. I get the sense that many commentators still think he is really a "dove" deep down and that he will return to his true "dovish" nature once he is done "flexing his muscles" to get some "hawkish street-cred" as a new fed-chair.

In less than a month trillions of dollars have disappeared from the economy through the stock market decline. At least as much wealth has probably evaporated in the real-estate market as well, but that won't be fully appreciated until later due to the relative illiquidity of the real-estate market as compared to the stock-market. Sounds like some serious deflation happening in this economy here...doesn't it? Unfortunately, Bernanke won't see any of this because he evidently doesn't believe in deflation and is going to be watching out-dated inflation measures that have oil prices as an input...but alas there is nothing Bernanke can do to lower the price of oil other than destroy the economy. The stock market seems to think that this is exactly what he is going to do.

Mark Cuban is a Whiner!

2006-05-10T08:45:00.000-07:00

Mark Cuban has a great post on his blog today. I imagine that one of the best things about being a billionaire is that when some loser calls you a whiner you can always respond like this:

http://www.blogmaverick.com/entry/1234000210073685/

My favorite part is near the end where he describes a non-whiner as someone who "has so little distaste for watching people around him get hurt, he does nothing." I think Mark Cuban is writing a little tongue-in-cheek though. It's one thing to whine, it's entirely another to whine and actually do something. It's the former class that gives whining its bad connotations.

Murphy's Option Law: A Stock will make its big move when you are not net-long contracts!

2006-05-04T10:05:00.000-07:00

So I have been playing a simple counter-trend system lately using options. I've been playing it Telab style by using the system's signals to build butterflies with extra wings. Basically it works like this. When the system signals a stock purchase, I would sell a bull put spread with an extra long put (This is actually called a backspread). Then, when the system signalled a sale, I'd sell a bear call spread and buy an extra long call. (Again this is really a backspread) Sometimes I would buy the extra options at the same strike and sometimes I would buy them a little further out of the money. At first, I was very disciplined about buying those extra options every time, but lately I had began to feel like a sucker giving up so much of my premium to buy those extra long options so I had stopped buying them, and was simply building butterflies without the extra wings. This leaves me protected from "black-swan" events, but I was no longer positioned to profit from them.

Well, I had my first really big moves (since I started using this system) in 2 of my positions today...and whatdayaknowit...of the 20 or so positions I had put on using this system, they were in 2 of the 4 where I didn't have those extra wing options! Niether of these were "black swan" moves, but one of them at least was big enough that it would have really made my month if I had purchased those extra calls. The stocks were WFMI which was up 12% and EXPD which was up almost 20%. For the WFMI position, the system had not trigered a sale since the initial purchase trigger so I had not finished building the butterfly and I went into this move with a deep in the money bull put spread,. There was a nice, but limited profit from this move. If I had completed the butterfly with extra wings I probably would have not made much money from this position or taken a small loss, since the 12% move, although large, wasn't enough to produce much of a profit from an extra out of the money call.

With the EXPD butterfly, I definately would have made good money from this position, on the order of several hundred percent return on the capital risked if I had purchased those extra wings, instead of taking a limited loss like I did. As it is, the pnl from both the WFMI and the EXPD positions about cancelled each other out today.

Assuming, I continue to use this system after May expiration, I think I will modify the strategy like this. When I enter the vertical spreads, I will move an extra strike out of the money, and always buy 2 of the long option part of the spread. (Buying 2 of the long options changes the vertical spread into a backspread.) This way I won't have to give up so much premium to buy the extra wings, which will make it emotionally easier to always buy extra wings. This will increase the amount of capital at risk however, so I will have to take less of the trades signaled by the system. This is not a problem, though, because I have allready become more picky about which signals I trade. I would have made money from these moves today (taking a small loss on WFMI, while making large profits on EXPD) had I been using this modification to the strategy.

Account Size and Flexibility

2006-03-16T09:04:00.001-08:00

I've noticed that as my trading account has grown, it has become easier to make good trades. A large account size allows me to place a smaller amount of capital in each trade and it allows me to increase my divirsification. These factors decrease my risk. Smaller proportional risk in turn, enahnces the decision making process. I find that I make decisions faster and miss less oportunities. I worry less about my positions which helps me to let my winners run, and gives me the patience to let trades work that have gone against me a little bit. Ideally one would risk less than 2% of capital per trade. With a small account this is very hard to do, because of minimum transaction sizes and transaction costs. I'm finally starting to get to the point where I can do most trades that I want to without having to risk too much of my Capital, although I still risk more capital than is ideal in most cases. I'm also still not there, in terms of how much capital I need to really be able to trade every instrument and opportunity that I want to. Just this week I've passed on 2 trades that would have been very good trades to have made in hindsight. I had to pass on these trades because the amount of capital I would have had to risk to do the trades properly was above my comfort level. But over all I like how things are going. I would like for there to be less volatility in my long-term portfolio, however. To that end, I have been accumulating less volatile stocks with a focus on good dividend earners. My goal is to eventually be at the point where stocks like SHLD and GOOG are not such large proportions of my long-term portfolio. I love these stocks, but having them as my biggest positions makes my portfolio more volatile than I'd like. Their proportion in my Portfolio has shrunk but I still have a lot of stock to buy (in other companies) before these become less than 5% of my portfolio since I am not going to sell any of the SHLD or GOOG I hold any time soon.

Made in America

2006-03-14T11:01:00.000-08:00

I just cought the tail end of a segment on CNBC where some president of an American company (it looked like they sold liquor) was discussing how well his products were selling in China. He said that the Chinese consumers prefer American brands made in America. They see this as a sign of quality. I thought this was interesting because it reminded me of a story that one of my friends told me a few years ago. This friend does business in China and visits the country frequently. On one of his trips to China he was being treated to a "fancy" dinner. His hosts brought out a box of Franzia Wine to the table instead of the usual Chinese Liquor he had been served at less ostentatious restaurants. Note I said "box" not "bottle" for those of you who might have missed that detail. Why were they serving Franzia boxed wine instead of Chinese Liquor on this occasion? Because they said "It is the best selling wine in America so it msut be the best wine in the world!". Does this portend a bright future for the likes of Robert Mondavi or Ravenswood once the average Chinese becomes more afluent and develops better taste in Wine? I suspect that there are a few more years to go before the Chinese move up from Franzia to the better mass-produced American wines, but the story will probably be good for any well known American brand that moves into China, especially those that represent low-cost products here. Cramer has highlighted this allready happening with Starbucks and Kentucky Fried Chicken. I wonder what other products like Franzia sitting on the shelves of my local Walmart are big hits in China?

Products Designed For Nerds

2006-02-24T14:37:00.000-08:00

I went ahead and bought MSFT today for my long-term portfolio. I'm a little aprehensive about this addition because having capital tied up in Microsoft stock is like watching paint dry. Even though this is a boring stock I think that Microsoft may be on the verge of some good things finally happening. Perhaps they will finally be able to get some press in the next year or two that moves the stock a little.

Among those good things is the "Origami Project" which I just read about on Slashdot . Could it be that amidst all of the headlines surrounding Research In Motions' legal troubles that Microsoft quietly developed a viable competitor to the blackberry? Just from the long list of features and looking at the picture of the "Origami" device, I'm inclined to answer that question with "NO". What really stands out to me from skimming this article is that it has a ton of features and that it looks kind of big and clunky to me. Of course it's hard to tell from the picture how big it really is. We will know more on March 4th presumably. My major concern here is that MSFT may have done what they always try to do with their products. They throw in a ton of features which are poorly integrated and cumbersome to use. For the most part, the blockbuster consumer electronics products lately have all been sleek, cool, and simple. Think iPod, Razor, blackberry...All small, intuitive, simple devices that look cool.

I think the problem with MSFT is that they are a company run by engineers, which is usually a good thing for a tech company, but when you want to market a consumer electronics device that will be carried around in the pockets of millioins of regular people you have to know what's cool. Most engineers just don't know what that is.

Because I am a computer programmer, and perhaps also because I am the type of person who reads Slashdot everyday, I know what goes through these guys heads when they visualize their ideal portable consumer electronic device. What really excites engineers is a product that packs tons of features above all else. They don't mind (and may even enjoy) having to read a manual to figure out exactly how to use all of these powerful features. When a normal person buys a camera phone for instance, if it takes an hour to figure out how to e-mail a picture to a friend, assuming they don't give up, they feel absolutely disgusted and angered by the process. An engineer on the other hand feels a sense of triumph when he (and I definately mean"he") finally figures out how to use a confusing new device. For the engineer complexity is a desired feature.

When the engineer gets a new electronic device he is excited by the thought of spending an hour or two exploring every single feature. Then after the thing is thoroughly explored he can't wait to hang the thing on his belt as a geek trophy and walk outside so that everyone can see that he has the newest and most powerful technology at his finger tips. In this respect, if the device is a little oversized it is percieved as a little bit of a plus in his mind because it makes this thing that much more visible.

As an aside, there is just something that I have to get off of my chest here. Since only my friends read this blog and most of them are engineers I'm hesitent to say this. I worry that I will offend many, but this is just too important to be left unsaid...I'm trying to think of a delicate way to say this...but...umm..I can't, so I'll just go and say it because you guys look like fucking dorks when you do these things: When you are out on the town if you feel the need to cary cell phones, pagers, or palm sized computers...these things all belong hidden away inside your pockets. They should not be hanging on your belt for all to see. No matter how expensive, state of the art, or technologically advanced the device is it not a cool fashion accessory. Period. It just isn't cool. Proudly sporting your new pager and cell phone hanging on your belt in a club says "I'm a huge Nerd". And for God's sake, please don't whip out your new cell phones and size them up across the table, side by side in bars and restaurants. That's especially pathetic.

Anyway, this is my concern with the new Microsoft device. My fear is that they have designed this thing for the "I wanna hang the latest high tech gadget on my belt crowd", rather than for the cool people who Apple, Research in Motion, and Motorolla design their products for.

However, there is one huge advantage that Microsoft has going for them. It is very expensive for a company to buy and set up the Blackberry infrastructure on the server side I am told. With a Microsoft product on the other hand, the only infrastructure the company needs is the Microsoft Exchange server which is allready paid for and running more or less just fine in the company's server room right now at this very moment. If a few employees want to try out the Microsoft product, it will allready be integrated with the companies information infrastructure without much new investment. Because of this fact, I suspect that Microsoft will be able to do what they have always done best. That of course is to leverage an existing monopoly to get their products into customers hands. This is why I think Microsoft has a good chance to compete in this venue, even if their product does end up being dorky and hard to use. Furthermore, I may be surprised. Maybe this thing will actually be cool too...

Technical Trading, Neural Networks and the All-Mighty Bid-Ask Spread

2005-11-30T18:15:00.000-08:00

I haven't posted in awhile. In the evenings I either write on my blog or I write code. Lately I've been mostly writing code instead. I hope to post some results of some of the experiments I've done later, but in the meantime here is a summary of the stuff I've been working on over the past month or so.

* I finally got my option data in a usable form. I used this to backtest various simple volatility trading strategies involving dynamic hedging. I was mainly interested in finding some useful long-gamma scalping strategies. Nothing really interesting came about from this. The main utility of these experiments was that it was a good practical test of my data access and cleaning routines. Bad data points were a big problem. This project forced me to create more-robust data-scrubing routines which will be invaluable later on.

Generally the long-gamma trading ideas I tested showed piss-poor results. I was surprised in general how poorly hedging the options with stock seemed to work. One revealing experiment was my first one. I tested buying an ATM option and replicating it with black-scholes, hedging the the delta with stock using the end-of-day prices for both the options and the stock. One would expect such a basic strategy would generally not make significant profits or losses (assuming no transaction costs). Going long options and hedging the delta was almost always a big loser on the stocks I tested. This was even the case if I simulated with buying the option at the bid price, and closing it out on the offered price as a market maker would. That replication via black-scholles works so poorly using end of day data, suggest to me that maybe I need to be testing long gamma volatility trading stratagies with intra-day (high-frequency) data.

Now my data is from 2003 to 2005, which is a period over which volatility has generally trended down, so I would expect a straight unfiltered option buying strategies to perform well in general, but I would not expect this strategy to fair as poorly as it did. I can't believe that options trade at such a high premium to actual realized volatility as these results would suggest. I think I read in Telab's Dynamic Hedging that historical volatilities measured at higher frequencies tend to be higher. This would explain the results I was getting from these experiments with end of day data. Presumably if it is true that historical volatility is higher when the measurements are made at higher frequencies then adjusting the delta hedge at higher frequencies would be more profitable.

* I then experimented with a bollinger band system based loosly on the one mentioned in Altucher's Trade Like a Hedge Fund. In the past I had experimented heavily with bollinger band counter-trend based trading systems (by experiment I mean mostly backtests, and a little bit of actual trading). These systems I tested generally are characterized by having a high-probablility of making a small return, and a small probability of having a large loss every now and then. Sounds like selling options short right? This isn't surprising that such systems have a similar risk profile as selling an option short, because trading counter-trend is essentially replicating a short option position. Anyway I was interested in experimenting with trading counter-trend and buying long options or spreads to limit the risk. Another idea I had was using bollinger bands to choose entry points for legging into butterflies. Some of the various schemes I looked at had some promise. What I mainly took away from these experiments was a greater apreciation for the market maker's edge in option markets. It was pretty incredible how much more profitable a system would become if I simulated it by buying the options on the bid and selling on the offer like a market maker. It does seem though that the bid/offer spreads in my end of day option data are a little wider than what I usually actually see in options markets. I will need to look into this later. It may be that the end of day option price data I have is nearly worthless for testing any spreading strategy.

* Currently, I am experimenting with Neural Networks. In my most basic experiment I attempted to predict the next day's return using a basic back-propagation neural network, trained on daily open,close,high,low, volume time-series data. I didn't really expect to get any practical trading systems out of this. Mainly this was just to get my feet wet with neural networks., and to build a toolset for future experimentation. Interestingly enough the simple network described above generally does seem to show *some* statistically significant predictive ability for next day returns on the SPY, but nothing that is tradeable. (SPY is the only stock I've worked with much so far using Neural Networks.) I hope to write a blog-post presenting my results so far a little later on.

My real goal with the neural networks is to explore predicting high-frequency returns. Some of the literature I've read suggest that they work pretty well on high-frequency data and I'd like to check that out. I also want to try out using neural networks trained on option open interest and volume data across a range of strikes and expiration. This would require a lot of data preperation and structuring. I'm still thinking about good ways to handle the data for an experiment like that.

Currently I'm writing new neural network code to be able to handle more advanced network structures, mainly networks that incorporate some sort of feedback loop. I've read at least 2 articles where the authors use networks with feedback-loops on financial time-series data. Other articles I've read about time-series forcasting in general mentions these types of neural networks as a standard tool.

My main take-away from what I've worked on recently is that I want to obtain some high-frequency data. Unfortunately, high frequency data is very expensive to buy. My plan is to write a program to collect this data myself for a few stocks over a month or so and use that as a starting point. There are two major chalanges with working with high frequency market data. The first one is that there is a lot of it. Saving tick data for even one stock could easily be many megabytes a day. Secondly from what I read, high frequency data needs to be filtered to be useful. It tends to have many outlying (bad) data points.

I think I got shaken out.

2005-10-28T12:22:00.000-07:00

Yesterday as I was watching most my profits over the past month or so evaporate, I was saying to myself if only the market could come back I'll do the right thing and hedge like I should have a few days ago when I wrote my last post. This morning with the market up I felt that the fear I had experienced yesterday shows that I was too leveraged right now. I didn't want to end up being negative on the year because I got too bullish near the end (this happened last year). The market at this point wasn't up enough so that I could put on the hedges that would make me feel good about weathering a downside while still having plenty of opportunity to benefit from more upward movement, like I could have when I made my last post. So I decided to use the up day to do a little bit of liquidating. I think I liquidated too much, and now I feel worst then I did yesterday. Obviously if the bottom falls out of the market I'll be happy that I lightened up so heavily, but I really feel that my bearishness got out of hand this morning.

My take away is that when I'm up big I need to take some profits. When I wrote my last post, I could have hedged most of my spy inventory for almost a guaranteed profit and still be long wing gamma. I could have hedged all of my XLE for a guaranteed profit, by completing a bullish butterfly for a credit, and still had the opportunity to benefit for further major upside gains. I could have liquidated half of my SMH position and eliminated almost all of the risk going forward in SMH as well.

(NOTE: I'm only talking about my short-term options portfolio. My long term portfolio is untouched.)

Stocks flying along with my ego.

2005-10-24T13:15:00.000-07:00

Today's trading was difficult even as my account soared into new all-time highs. My trading has been near flawless for several weeks. As my account rises each day, so does my ego. On days like this, I have to remind myself that I used to get excited when I made this much money in one day, and yet my fear of losing these profits is completely absent, while in the past I couldn't stop myself from locking in profits on days like this. I have to remind myself that most of the profits today are all paper and could evaporate on another day easily.

In an attempt to fight my ego back, I remind myself of the huge mistake I made last week when I did not hedge to Delta Neutral in ECA the day it was up almost 5 bucks on take-over rumors. The next morning I shorted shares against my calls, after it had given up half that gain even though the rumors were somewhat true. (Apparently they had been offered 65 a share earlier and turned it down.) My ego fights back though. I remember when I hedged my short calls way too soon a month back into the beginnning of the decline, and missed making twice as much money off of that short position as I did.

My Spy position and my XLE positions were up big today. I was 100% long in both. I unhedged all of my ECA on Thurseday near the close. I have scalped those calls enough so that the options are essentially free, but I could give up significant profits from a downward move in the stock or the implied volatility. ECA common was up a buck sixty or so today and yet my calls were only up 0.05. I haven't checked where IV was at prior to today. It looks pretty high today, so it must have declined off some pretty high levels for me to not have made money off such a strong move in the underlying today.

On balance I think my ego won the battle. I did lock in some of my profits in SPY by hedging 40% of my deltas. I didn't hedge any of my gains in the oil sector though. At least I didn't do any new buying today.

Did I turn bullish?

2005-10-13T13:26:00.000-07:00

With the close of trading today, I have to wonder if I turned from short-term bearish to bullish? I don't feel very confident in this market, but my trading says something else. I found myself buying stock and selling puts today.

I lightened up on my ECA stock short today, returning my position in ECA to delta-neutral. I think I have have scalped about $0.45ish off of the long ECA calls at this point (I would have to look through my statements to get the exact number). I wrote in my last post that I planned on covering all of my short stock after the profits from the short position were large enough to cover the entire price of the calls, leaving me with a free call option. At one point today I probably could have done this while hanging onto almost a buck in profits. I just couldn't bring myself to do this though. I still feel that ECA will go lower.

I also bought GG shares against some GG puts I purchased a couple days ago, to bring myself to delta-neutral in this position. This locks in about 70 cents in profit on those puts at this point. This puts me into the synthetic GG Jan 20 straddle at about $1.80 I think. This is almost half the current market price to buy the straddle.

My buying today was not limited to getting delta neutral in my straddles though. I have been closing out my inventory of SPY options over the past few days to lock in profits on the bearish side. My position in SPY as of today, now consists entirely of some Dec 113 short puts (which was originally part of a bull put debit spread). I also opened up a position in the SMH Nov 35/32.5 bull credit spread which is profitable by about 0.80 on the close. I am pleased with the execution of the SMH position. I believe I legged into this spread for what was the highest credit a retail trader could have obtained today for that spread.

My long term portfolio has given up almost all of the gains I had in this latest decline. Fortunately, gains from my shorter term trading during this decline have offset about half of that loss. So far this leaves me still nicely positive for the year. I do really regret being to quick to hedge my short SPY calls early in the decline. They could have offset all of the losses and then some...

With my new bullish positions in SMH and SPY I am now more exposed to downward market movement than I have been so far during this decline. I definately need and am betting for a turn-around soon, so regardless of how I "feel" about the market, I must be a strong bull.

Trade Dissection: ECA Synthetic Straddle

2005-10-06T16:24:00.000-07:00

One of the advantages of options trading is that as a trade progresses, one type of risk can be traded for another. Buying stock is kind of a crapshoot. You make a guess and you hope you're correct. Once your in the position there isn't much you can do to change your odds, aside from closing part or all of the position out. For example if you buy stock for 50 bucks and it goes up a dollar, without using options the only way to close the position out is to sell some of the stock. If you sell all of your stock though, you can't profit from further movement. Alternatively, you could sell half your shares instead. This gives you the opportunity to profit from further upward movement, but substantial capital is still at risk. There is no good way to fine-tune these adjustments with just the underlying issue. Since options have a non-linear profit graph, they provide the power to fine-tune the nature and type of risk that the trader is exposed to.

Here's an example of what I mean by trading one type of risk for another. Yesterday in about the last hour trading, I was looking at Encana (Symbol:ECA). ECA had allready fallen over 3 bucks that day. This was on top oflarge losses the day before as well. Cramer had written an article on Realmoney.com basically stating that he though companies with natural gas exposure like ECA would have good earnings and their stocks would go up on those earnings. (I don't think he was saying to buy at that instant though.) The entire energy sector was imploding, and ECA was down almost 10 % in 2 days. This was not the time to play countertrend. I was not interested in entering any bullish positions in ECA at that point in time but I was interesting in positioning myself for the earnings report.

Going long or short is kind of a crapshoot. In a volatile time like this, I would prefer to get into a position where I can benefit from large volatility whether or not the stock goes up or down. I didn't know where ECA would be in a month, but I was reasonably confident that in a month, it would make a big move away from the current price it was trading at, which was 54ish. The easiest way to construct a position that can benefit from a big move when you don't really know which way the move will be is to buy a straddle. The problem is, I was not the only one who thought ECA could make a big move. Everone thinks this, and the price of the at the money (ATM) November straddle reflected this. It would cost well over 7 bucks per straddle. This means ECA would have to move over 7 bucks for me to merely break even. The stock had almost moved that much in 2 days allready, so it might not have been that bad of a bet to make. (I will explain later why I wanted November instead of October.)

I wanted to get into the straddle at a better price though. My plan was to leg into a synthetic straddle. To build a synthetic straddle, one buys/shorts stock and also buys 2 puts/calls for every share of stock bought/shorted. In order to get a better price than 7 bucks or so for the straddle, my plan was to leg into the straddle.

This is what I mean by "legging into a trade". A straddle is a combination between a bullish and bearish position (like most option strategies). In my case the bearish position would be shorting a share of stock, and the bullish position would be buying 2 calls for each share of stock shorted. One can reduce the price of the over all straddle by entering the bullish position at a lower price than when you enter the bearish position. The idea is to speculate on the short-term movement of the stock in an outright directional trade. By speculating correctly, the profits can be used to reduce the cost of the eventual neutral position.

Why did I choose to use the synthetic straddle(short stock + 2 calls) instead of the regular straddle (put + call)? I had recently read this article on the Daily Options Report Blog about shorting stock and buying calls on a ratio. He says he gets better executions this way, so I just wanted to give it a try.

Yesterday, the entire energy sector was selling off in a panic. ECA had dropped quite a bit. I didn't think that ECA (or the energy sector in general) was done selling off, so even though I felt like I was late to the party I decided to sell ECA stock short in the last hour of trading. I waited for ECA to uptick about 10 cents and then put in my short order. I was executed, and the stock dropped another 40 cents or so from my execution by the end of the day, so the trade was off to a good start.

Selling the stock short was the first leg of my straddle. I was taking on a lot of upside directional risk for hopefully a short period of time. Hopefully by being early enough into the sell-off, the upside risk would be small, but there was no real way to know at that time if I was early enough into the sell-off (a sell-off that had been going on for 2 days). It turns out that this time, shorting the stock worked. This mornign when I woke up, ECA was down over 3 bucks on the day.

Now I had 3.74 profit on my ECA short. The November 50 calls were selling for 3.70 bid and 3.80 offered, so my profits from the ECA short were just about enough to pay for about half of the spread, since I need to buy 2 calls for every share shorted. Afterwards I glanced at the puts and they were 3.30 bidand 3.50 offered, so I definately was getting a better execution buying the calls then I would have obtained buying the call and the put. I saved myself 10 cents extra by not having to pay that 20 cent spread in the put. (The spread in ECA shares themselves the day before would have been like a penny or 2.) By legging into the trade, and using the synthetic straddle instead of the regular straddle, I purchased the straddle for 3.86 when the market offer price was 7.30. This puts me into the straddle for about half of what the risk would otherwise now be at that point, but I had to take all of that upward directional risk to get to this point.

Making 3.74 over night was just about ideal. This turned out better than I had hoped. At that point I could have just covered my short and taken the 3.74 profit and I would have been quite happy to do so. I wanted to do better than the 3.74 though, and that is why I changed the position into the straddle. The profit gave me the opportunity to stay in the game, but change my odds going forward by building a better trade than what I started out with.

This is how the trade looks now. At the moment I am completely delta hedged. That means that I have no risk of losing money do to changes in the stock price. In the near term I have locked in most of that 3.74 profit from the short sale by turning the position delta-neutral. This is what I meant earlier by trading one risk for another. I have traded my delta risk for theta risk and vega risk. Since I am negative theta and long gamma, this means that I will lose money slowly every day. I need the stock to move enough to overcome this time-decay. Assuming, I hold the position until expiration I need the stock tomove at least 3.74 between now and then to overcome my theta and any potential vega losses. If I had not legged into the trade I would need a movement of 7.30 instead.

Vega risk is my exposure to changes in the implied volatility. Volatility in ECA is high and my straddle will be worth less money if implied volatility lowers. With earnings aproaching, I doubt that there will be much IV loss any time soon. I also make money if IV goes up, but most likely the bulk of any gains will come from actual stock market movement. If there is an IV increase between now and when I sell the calls this most likely be small bonus. It is unlikely that IV will increase enough in these calls to create profits significant compared to those that could be obtained from actual stock movement.

Here is my plan going forward. If the profits from the short stock part of the straddle exceed the cost of the calls in a short period of time, I will probably look to cover the short stock. If that happens, going forward the trade would be completely risk free, as I would be sitting on a free call option. The plan at that point would then be to hold the call into ECA's earnings which are on Oct 26th I think.

This is why I chose to buy the Nov. Call, instead of the Oct. call. I wanted the ability to hold through earnings. The Oct. call expires 5 days prior to earnings. However, I won't necessarily hold through earnings. I just wanted the option to do so if I need to. If there has been a lot of apreciation in the stock prior to the earnings, and if I have a profit I will consider closing the position out just before earnings. After the earnings come out there is danger of a volatility implosion (remember my Vega risk) since uncertainty will be removed from the market.

With a little luck in my timing, I might capture downside profits as the energy sector continues to sell off, and then make money on the way up if ECA recovers into earnings.

Hasty Decisions

2005-10-05T13:04:00.000-07:00

I slept in today, and I think this negatively affected my trading today. I rarely make a point of waking up in time for the market open. Over the years I've generally found that when I trade in the morning I usually trade poorly. My solution to this has been to wait until the afternoon before placing trades. Generally, I've prefered to make my trades in the last 5 minutes of trading.

Recently though, I've been legging into a lot of trades, and have modified this plan. I've still been entering new trades in the afternoon, but when there are adjustments to an existing trade that I want to make, I've been making a point to wake up in time for the market opening. The morning is usually the most volatile time of the day, and this can provide good opportunities to get the prices I need to finish an option spread at the price I want. This has been working well for me lately. I still have a specific routine though. I wake up and then turn on CNBC so that I can see where the market is while my computer boots up. Then I load up Trader Workstation, take a glance at my positions, and then I read Realmoney.com, Niederhoffer's site, and the options report before I make any trades. This gives me the opportunity to see what is going on in the market before I make trades.

This morning I made a point to not wake up for the open. I thought that the market would probably open near it's high for the day, and continue in it's downtrend as the day progressed, so I would allow myself to sleep in and miss the temptation to adjust my bearish positions at bad prices in case the market gapped up.

The S&P and the OIH were both down a little bit when I woke up this morning.
My plan for OIH was this. OIH was well below the bearish wing of the former iron condor, I mentioned yesterday. Yesterday I had closed the short portion of the bull wing of the iron condor. This left me with long gamma to the downside. I was hoping to close out the rest of the IC with the OIH at around 115. If I didn't get that price, my plan was to wait for a few days, and then just close the position out at whatever price at that point. Right about the moment that Trader Workstation booted up the oil inventory numbers were released and the OIH immediately reversed and turned positive. I panicked and closed out all of my OIH options. This cost me 30 cents or so of profit. Almost the second I was out of all of my OIH options the OIH reversed again and plunged almost a buck as traders finished reading the report and concluded that the report was bearishinstead of bullish (do to low gasoline demand I believe). Lesson learned: "Don't trade immediately when news gets released!!". I should allready know this lesson... I could have easily gotten another buck per spread if I had been more patient, which would have put me right at my profit target.

At about the same time as the OIH fiasco SPY also ticked up slightly. I immediately finished the 117/120/123 SPY butterfly by buying the OCT 117 calls on the offer. This puts me into that flys for a little over a $1 credit. The thing is, I had decided last night to let my shorts run, and not try to complete the butterfly, since the current profit from the SHORTS was allready better than half the maximum profit from the butterfly. But I made a hasty decision. At the very least it would have made more sense to just close half my naked 120 calls at a great profit, and leave the rest to run as bear spreads, with no or almost no risk. This probably would have been the optimal decision at that point with regards to risk/reward. As I stand now, I've locked in a little less than half of my current short profits, with an opportunity to keep the rest of them, and potentially make another 33% or so, if the market doesn't move too much between now and expiration (not a likely prospect).

Basically what happened today was I woke up late at the exact same time that news was breaking which moved the market, so I skipped my usual routine that gives me perspective. This lead to emotional trading. Waking up earlier would have given me more time to prepare and be calm. Waking up later would have helped a lot too, as I would not have been trading into the morning volatility. Maybe I should make a point of sleeping in until lunch time in New York anytime I can't wake up before the market opening? If I am going to trade during the volatile morning, I need time before the market opens to be ready for it.

Volatility!

2005-10-04T13:04:00.000-07:00

Wow! What a move!. With the market so strong early in the day, I was pleasantly surprised to see that I was moving into new all-time highs for my portfolio. These gains came despite a large short position in the October 120 SPY calls, that I built up into last week's strength. Early in the day I benefitted because tech was much stronger than the market as a whole. My long-term portfolio is overweight in tech, and has slightly positive gamma. Even though I was taking losses in my large (large for me) SPY short, the gains in QCOM, QQQQ, LU, more than made up for the losses in SPY which surprised me. Oil moved down quite a bit today too. The OIH was down around 2 to 3 bucks early in the day. This was also probably helping to hold the SPY back, since the oil sector has become a larger portion of the S&P over the past year or so. The oil pull-bakc further mitigated my losses in the SPY short since this was taking OIH closer to the center of my 130/125/115/110 iron condors.

But if I thought things were going great when the market was going up, the portfolio really started to rocket when the market began to tank and my short SPY position started to kick in. I like to think I learned a lesson last week. I had the oportunity to hedge some of my upside risk in the SPY today and I took it, unlike last week where I had opportunities to reduce risk and I didn't. (In fact last week, I doubled up instead.) I turned my short SPY OCT 120 call position into the 120/123 call 2:1 backspread by buying some OCT 123 SPY calls in the last hour of trading. Now I am in that backspread at a pretty good price. More importantly my total position in SPY (I have other SPY option positions besides this backspread.) is now long gamma in both directions. I am still leaning strongly to the short side though.

At the end of the day, OIH really started to tank. It was down like over 4 bucks, and was now past the midpoint of my 130/125/115/110 iron condors. I legged into this IC position during the hurricanes for a debit of around $0.67 (including commissions), and was quite pleased with how I legged into it. It had a maximum profit potential of $4-something and a 10 point range over which the maximum profit could be made. Today the position was profitable for like 2.87. When OIH really tanked at the end of the day, I bought back the 115 put (for a profit). I may have panicked a little bit...I now have a bearish position in the OIH. Hopefully I can do as well of a job legging out of the position as I did legging into it, and maybe increase my profit...but I fear that after a move like today it will come-back some, and I may give back more profits. I just couldn't bring myself to close out the whole thing for only $2.87 today.

I think my fear with the OIH was this: I'm not sure if I believe the widely heald view that last week's broad market strength was purely end-of-quarter window dressing. However, I do believe that the strength in OIH last week was window-dressing, and I was very concerned about losing my profits to more downside movement in the OIH.

I need to be especially careful now though. The times when my portfolio is at highs are always very dangerous for me. The temptation to over-trade is great. Making money is intoxifying. It can make you feel like a genious who will never make a bad trade again.

The Hindenburg Omen

2005-10-03T16:30:00.000-07:00

I noticed there is a bit of chatter on the web about something called the "Hindenburg Omen". The Hindenburg Omen is a technical indicator that supposedly predicts crashes. Or more specifically, when the Hindenburg Omen is triggered, supposedly there is a high probability of a market crash in the next 30 days. This website explains how to compute the Hindenburg Omen, but it doesn't give any specific information for us to know what the past performance of this indicator has been. Specifically I wanted to know how many times this has happened in the past, and what was the average return of the S&P 30 days later. I Googled "Hindenburg Omen" and found lots of sites talking about this omen. Most seem to agree this is a "very bad sign", but amazingly almost none of the people who've discussed this indicator seem to have bothered to check if it has actually been a bad sign in the past. I would backtest it myself but I don't have the necessary data (or time). I was just about to give up, when I found this site which has a backtest of the "Hindenburg Omen" back to 1965.

The backtest has 35 instances of the Hindenburg Omen. The average return is -0.7%, so that may indeed indicate a negative tendacy after a Hindenburg Omen has been triggered. The Omen has indeed been triggered before several major market downturns, but it has also preceeded several major upturns as well. The author of the website seems to be saying that although the Hindenburg Omen doesn't necessarily portend a market crash, it might be predictive of volatility since the standard deviation is 8.5%:

...thought it would be instructive to include the standard deviations of returns, which are large. What does that tell us? It shows that while there may not be a distinct bias to S&P performance after these signals, the market does tend to move well in one direction or the other.

I pulled his numbers for the 30 day return after a Hindenburg Omen into Excel and I took the absolute value of the returns. The average 30 day move after a Hindenburg Omen has been 13%. This suggests that maybe it might be a good idea to buy some out of the money calls and puts when the Omen is triggered.

Here's the thing though. I kind of suspect there may be a little bit of curve-fitting happening here. Here's what I think may happen. Naturally the time periods prior to a crashes get heavily scrutinized by technicians after the fact. Just by shear coincidence there are bound to be some set of indicators that taken match up in some way across many of the pre-crash time periods scrutinized ( This is curve fitting). Since the Hindenburg Omen was most likely created after the fact to explain crashes that had allready happened, the sample space is biased because the time period being analyzed includes all of those crashes that we were looking at in the first place. Or more simply, the Hindenburg Omen probably has preceded volatility because the person who "discovered" the omen was looking at volatile times when he made the "discovery".

The most recent Hindenburg Omen was triggered 2 days a couple of weeks ago on September 20th and then the next day on the 21st. October options expire 30 days later on October 21. SPY options 6% out of the money are selling for around 10 to 15 cents. I think the Hindenburg Omen is probably bullshit, but I might just buy a few of the 116/127 combination just for th hell of it anyways.

This is where productivity comes from.

2005-09-30T14:00:00.000-07:00

I saw this link http://www.justfuckinggoogleit.com on Nev's Blog today. It cracked me up. It's true though. People who can use google effectively have a huge competitive advantage over those who don't. If you are internet literate, it may be hard to appreciate just how amazing Google is. You probably take it for granted. A while back I was helping my Father set up his blog. He has been programming computers since the punch-card days. Unfortunately, they didn't have Google back in the punch-card days. As I was helping him with his blog I was shocked by how limited his googling skills were. He'd ask a questions and I'd say "I don't know...look it up on google.". He would look it up and not find relevant results. I'd say "No search using this keywoard, or put that in quotes", and then he would get results that he needed.

Here is one example in particular. My Dad took Latin in college, and knows it well enough to read whole books written in their original latin, although he cannot actually speak it. My Dad wanted to use a particular Latin quote in his blog. He couldn't remember the exact wording of the quote. He also wanted to confirm that the quote was from Cisero. He had googled it, and Google had returned lots of sites about Latin, including several full of famous old latin quotes from famous ancient Romans. He had spent some time searching through these sites but had not found his particular information that he needed. I said "hey let me try". I typed something into Google, and within 15 seconds, I had his quote up there, with its translation and source, right there highlighted on the screen. (I don't remember exactly what I was doing differently than him.) Despite the fact that he knows more about Latin than me, in that particular instant in time for that particular Latin problem, I knew more about Latin than he did, because I knew more about how to use Google than he did.

Using Google to find information is an art. It isn't simply typing a keyword in. Often effectively using Google is about figuring out what keyword will ONLY bring up the subject matter your interested in. It can be like a puzzle. With practice some people learn to solve the puzzle better than others. Google came out when I was in college or shortly after, I don't remember. Before Google I used Yahoo or Alta-Vista, mainly Alta-Vista. The problem was that as hard as it is sometimes with Google now-a-days to find relevant results, it was often impossible with Alta-Vista. I remember there was a period of time when no matter what you searched for in Alta-Vista, half the results would be porno sites and credit card scam sites. Search engines back then were not very good at determining relevance. Even worse, they were also easily gameable by the spam-site opporators, and so at times, they returned mostly spam. They just weren't very useful for finding information that wasn't fairly direct and trivial. As a result I didn't start honing my "googling" skills until sometime after college.

Now remember the scenario with my Dad and me? I am often a participant in the same scenario but with the roles reversed. Anytime I am using a computer with anyone younger than me, they always seem to be better at using google than me. An example is my girlfriend. Sometimes I have trouble finding stuff on Google. I ask her to help and she finds what I need almost immediately. The difference is that Google was out almost the entire time she was in college. When I was in college one still mostly did research in the library. My College Writing class actually addressed how to add a paranthetical reference to a website, but I'm pretty sure I was the only person in my class who used any internet research for our final research paper assignment. Not my girlfriend though. When she was in college, kids basically only used Google for doing research, apparently. She has a lot more experience using google than me. Despite the fact that I use google every day, several times a day to do my work, I still don't seem to be catching up.

I have several programmers who work for me. Google came out while they were still in highschool, so they have been using it since their teens. I am often amazed by the types of problems they are able to solve. Sometimes they have projects that I think they probably won't really be able to do because they don't know as much about Math as me, or because they haven't been programming as long as me, and they'll probably ask for my help later. The thing is they often don't need my help on this stuff that I think they will need me for. It doesn't matter that they don't know as much math as me, or haven't been programming as long. What matters is that they know how to use google, and this puts the expertise of the entire world at their fingertips. Someone, somewhere on the web who knows a lot more about Math than me has probably come up with the formula they need for whatever problem they are working on and posted it somewhere, and these kids know how to find it using google, so they don't need to know as much about Math or whatever.

American workers are the most productive in the world, and productivity has been increasing at a high rate since the 90's. I think Google is a big part of why this is. It will only accelerate as the young kids who are expert googlers reach their prime working years and begin to obtain positions of power in politics and industry.

Chasing Flies

2005-09-28T15:12:00.000-07:00

I'm trying to work into the Oct 117/120/123 SPY butterfly for a credit between 0.20 to a 0.50. I started today by shorting the 120 calls for 2.85. This put me into a bearish position in the SPY with potentially unlimited upside risk. (Being short an in-the-money call is pretty close to the same as being short stock when the stock moves up.) In order to establish the position for a credit I need to buy the 117/123 call wings for less than 5.70 (2.85*2). I was prepared for this to take several days, if I am able to even pull it off at all. During that time I am exposed to the upside risk. If the fly gets completed for a credit it will be a nearly risk-free trade at that point. So that's the goal.

Now today it seemed like the market had quite a wide intra-day swing. After I shorted the 120 calls the market dropped quite a bit. At several points today, I could have completed the fly for free or a 0.05 credit easily. The question in my mind is should I have? I feel bearish about the market and think that I have a good chance of of buying those wings cheap enough to get into the fly for a good-sized credit.. This would then give me a guaranteed profit (at a nice rate of return) with an opportunity to make an even greater profit if the market settles down somewhere around 120 at expiration. The free fly (one where I buy the wings for exactly 5.7) would only give me a free oportunity to make a profit. I really wanted that guaranteed profit so I did not complete the fly.

Being able to get into a free butterfly that isn't that far out of the money in return for taking on an hours worth of directional risk seems like quite a gift from the market. (Although I don't have enough experience with this type of trade to really know how often this happens.) I hate to pass up good fortune. I fear that I was greedy. Holding a naked short overnight is a order of magnitude more risky than holding one for an hour. I could have mitigated the risk, and still heald out the oportunity to make a nice profit. The 123 call has a small delta and won't go down a whole lot as the market goes down. Most of the price reduction that will allow me to get into the fly for a credit if the market goes down will be in the 117 call as it is deeply in the money and has a high delta. It would have made sense to at least buy the 123 call and mitigate some of my upside risk. In hindsight, I regret not doing this.

Google's Core Business and the Demise of the Cellular Carriers

2005-09-20T12:45:00.000-07:00

Many people think that the reason that GOOG raised all of that money in their secondary offering for the purposes of creating a nationwide Wi-Fi network. I see a lot of comentary that sounds like this:

A WiFi service, which offers a high-speed connection to the Internet, would take Google even further from its Internet search roots and move it into the fiercely competitive world of Internet access providers and telecommunications companies.

This isn't a departure from Google's core business, though. Google isn't in the "search" business. Google is in the business of placing context sensitive ads in front of your face as often as possible, by whatever means possible. Search is just one way they do that. Like most internet users, every time I use the internet I use Google. Every time I use a Google product, I give Google's software an opportunity to learn what I'm interested in by analyzing the words I type into the Google product (search engine, blogger, chat, gmail, etc.), so that Google can present an advertisement in front of me that reflects my interests. Because I use Google's products repeatedly every time I use the internet, it is in their best interest to make sure that I am able to access the internet as often as possible. Every time I use the internet the likelyhood that I might click on a google-ad increases. This is why a nation-wide free Wi-Fi network fits in perfectly with Google's business model. They have become such a ubiquitous and essential part of internet usage that they are in a position to benefit from increasing internet usage in general.

Google's new Wi-Fi network is a major threat to the cellular phone carriers business. Google's new chat software gives everyone essentially free internet phone calls. It has been widely recognized that companies like Skype and now Google represent serious competition to the phone companies land-line services. In a couple years no one is going to pay for land-line phone service when you can get that for free over the internet. I personally haven't had a land phone-line for almost 7 years. One thing I am willing to pay for still is cell phone service.

Now consider this. Almost everyone I know uses Google Talk now. Those people not on Google Talk are on MSN Messanger service. This includes freinds, family, and business. Everyone I need to talk to I can get ahold of using internet chat clients. If there was Wi-Fi internet access everywhere I go, and if the sound quality of the voice-chat in Google Talk is as good as cellular phone reception (it is), then why would I ever need to pay for cellular service for voice and text messanging? I could use any generic portable Wii-Fi enabled internet device for what I now use a cellular phone for. So now, not only are the legacy phone companies endangered by google talk, but also so are the cellular carriers.

(Disclosure: I'm currently long GOOG and QCOM call options.)

Wrong on OIH but I Still Made a Little Money

2005-09-19T13:11:00.000-07:00

A while back I opened up a put ratio spread in the OIH. I was short the 115 puts and long the 120 October puts in a 2:1 ratio. This was a bet that volatility in the oil service industry might decrease with a slightly bearish directional bias. I know it seems crazy to go short volatility on the OIH (or any stock for that matter) in this environment. My thinking was this. In the aftermath of Katrina it seemed like there was a lot of fear in the market regarding the price of oil. Furthermore it seemed like everyone was bullish on oil volatility. It was getting a lot of press and I thought things were probably as bad as they were going to get, and at that point more than likely things would be just fine (comparitively speaking) and that volatility and the price of oil might decrease. Basically I was thinking of a slow drift downwards off of the prices at that time. Since I don't have a futures account, I decided to use OIH as a rough proxy for my oil idea.My feeling was that the main danger was that the OIH might experience large upward gaps. I had very little fear of a large downside move. The nice thing about a put ratio spread is that it can be (and almost always is) constructed with no upside risk. The position was established for a small credit which I would get to keep if OIH closed above 120.

Well I turned out to be wrong on OIH. It has stayed volatile and generally been going up. Today it was up over 4 bucks. There is concern about this new hurricane off of the Flordia Keys, and I think there has been some M&A activity in the sector. Whatever the cause, I was clearly wrong. I should have gotten long volatility, and I should have been bullish instead of bearish. The nice thing is that OIH has gone up so much that today it was very close to the maximum upside credit for the position. So I closed out almost all of the spread today. The profit from the credit actually turns out to not be that bad of a ROI considering how long the position has been open. I left a small amount of the 115 short puts open, in an attempt to capture some more premium since I feel much more bullish on the sector now (which means it's probably going to go down since I'm almost always wrong when I try to guess the short-term direction of a stock) The position is now pretty bullish, but I am still short gamma which is probably unwise.

AAPL trade = more trouble than its worth

2005-09-15T14:26:00.000-07:00

I got some clarification on how margin works from Interactive Brokers and from reading around on the web. I don't exactly understand why my margin ran out even though my account had excess liquidity, but the important thing is that I know how to know if it is going to happen again. Apparently I ran out of "Regulation T" margin for establishing new positions. This check is made 5 minutes before the closing bell by Interactive Brokers. I nievely assumed that if I opened my account window and the excess liquidity it showed was greater than zero I had plenty of margin to open new trades. Apparently this is not the case. I need to check another field called my "SMA" account. I don't really fully understand how this is calculated, and I don't care really. Due to my extreme distaste for losing large amounts of money I rarely use anywhere close to the max margin. The important thing is that I now know that if the SMA value is negative then I'm going to get a margin liquidation. I'm surprised this has never been a problem before. This was my first margin call/liquidation ever.

I closed out the AAPL positions today. The trade wasn't working, and it was using up tons of margin so it seemed prudent to take my losses now rather than try to keep working it to try to reduce losses further or get a profit from this point considering how much capital was required to keep the AAPL common short open. It's pretty stupid that a position that has the exact same risk as a put option (short stock, long a call) that can be purchased for a few bucks requires the same margin as a shorting a share of common stock. I know there is some move to switch equity options over to SPAN margining which is what is used in the Futures market. Maybe that will be addressed then, although I really don't know the ins and outs of SPAN margin calculations. I was able to narrow my losses slightly. I did manage to get out of the position with only a 66 cent loss instead of the 84 cent loss I was running yesterday. If you count the gains I made from my forced DJ position liquidation yesterday the loss was only 40ish cents. I'm going to count the DJ liquidation gains as part of this trade since the liquidation was caused by shorting all of those AAPL shares.

When good trades go bad!

2005-09-14T12:44:00.000-07:00

I haven't felt like writing lately. I've mainly just been busy, and when I haven't been busy I haven't been able to think about anything to say. To get back into the swing of things I guess I'll just write about the interesting thing that happened with my AAPL trade today. Yesterday APPL sold off and seemed to be recovering. At that point I decided to try to leg into a free butterfly. First I purchased the wings of the butterfly, by buying the AAPL October 45 calls and the 55 calls. Then I put in a GTC (Good 'Till Cancelled) order to sell short the October 50 calls. My reasoning was that AAPL seemed to be moving up so I entered the bullish portion of the butterfly first. The over-all plan was to take some directional risk for a short period of time, in an attempt to build a risk-free trade at a later period of time.

Unfortunately AAPL stalled out and did not continue to go up, and thus my limit order to sell the body of the butterfly remained un-executed. My plan for today was this. If AAPL was up, I was going to give my GTC limit order to sell the body of the butterfly more time to work. If the stock was down, I was going to hedge my delta at the end of the day. This would lock in a loss, but I would still have the oportunity to either profit from a major move to the downside or still get into my butterfly at a good price if AAPL moved up enough, although I would probably no longer attempt to get into the butterfly for free.

When I woke up this morning AAPL was only down a few cents, so I was waiting to hedge my delta. I noticed the S&P started to sell off, and AAPL was trading a little below where it had been most of the day, so fearing a sell-off, I sold enough AAPL shares short to get to delta-neutral earlier than I planned. I still left my GTC order open to sell the body of the butterfly. It appears in hind-sight that my instinct to hedge was a good one since AAPL almost immediately sold off hard for over a buck just after I filled my order. I need to resist patting myself on the back for my great trading though, because more than likely I was just lucky.

The position is now basically equivielent to a long 45/55 combination (long strangle) that I have paid around 80 cents too much for. If AAPL has another day or two like today the position will probably be profitable. At that point I will have to decide whether or not to close the position or whether to adjust again.

A strange thing happened though. I had also been trying to leg into a bear credit spread in DJ all day today. I had sold short the OCT 40 calls, and I had an order to buy the Oct 45 calls to complete the spread. The position was working for me very nicely. DJ sold off slowly all day. Near the end of the day I noticed that DJ was now at a price where my order to buy the oct 45 call should be executed, but the order wasn't there and I had no position! Then I noticed that my Oct 40 short call position had been covered! Furthermore, my GTC order to sell the AAPL Oct 50 calls was also cancelled. I checked the executions page and sure enough there was an order to buy back the Oct 45 call that had been executed, but I never entered any such order.

Here's what I think happened. Even though I had plenty of excess liquidity in my account, I think I got a margin call (Interactive Brokers doesn't actually issue margin calls, they just liquidate your positions automatically) and this is how I think it happened. It has definately seemed in the past that some sort of margin check happens with open orders. It's not exactly clear how un-executed orders affect the margin calculation but I have noticed in the past it does have some effect in that Interactive brokers will cancel some of your orders automatically if executing all of your orders would exceed your margin requirements. (Often when legging into spreads I temporarily use more margin than the actual spread will use once it is completed.)

When I shorted my AAPL shares I used up some margin, although the account page showed that I still had plenty of margin left. I think what happened was that the GTC order in the system was affecting my margin maybe? My assumption is that that AAPL GTC order somehow affected my margin and caused that order to buy the DJ 45 Call to get cancelled. The strange thing is how did my DJ 40 Call get covered? It seems surprising that an open order would actually cause a liquidation. Even with the naked DJ 40 calls I still had plenty of margin as far as I could tell. Whatever happened it is very frustrating. The execution of the purchase of the 45 call would have greatly reduced my margin usage, and the DJ trade was going well. Furthermore my GTC order to sell the AAPL 50 calls had 0 chance to get executed so if that triggered this liquidation then that really sucks. If the order to sell the AAPL 50 calls had become even close to getting executed I would have long since covered my AAPL short position...which would also have greatly reduced my margin. Looking on the bright side, I guess I can be happy that the liquidation of the DJ trade did result in a decent day-trading profit...

I have an email in to Interactive Brokers asking for clarification of what happened. At any rate I think I learned a lesson today to not have too many large open orders.

Late Summer Trading System Development

2005-08-20T22:30:00.000-07:00

Late Summer seems to be the time of year when I become interested in developing technical trading systems. Last Summer I spent a lot of time working on technical trading systems in C#. I had one that used bollinger-bands to play counter-trend moves that showed some promise....but a lot more work needs to be done on that one. This is a task I haven't been interested in committing myself too so far, but it's on the ol' "to-do list".

A few weeks ago I was reading this thread on Elite Trader, about High Frequency Trading. There has been a lot of buzz recently about High Frequency Trading, because some famous hedge-fund manager with an incredible track-record recently announced a new fund that uses HFT strategies and he's accepting huge amounts of money. The buzz has got me thinking about HFT ideas. As far as I can tell, HFT is mostly intermarket arbitrage, statistical arbitrage, and liquidity providing strategies all done very rapidly on an intraday basis. They have an edge from processing information (including order book analysis) very rapidly using computers, and because they have a superior speed of execution.

I don't have access to intraday tick historical data, but I was thinking that maybe a liquidity providing strategy might work on a longer time-span, especially if the strategy buys and sells against the market direction when it is making slightly above average movements. My thought was that during such times the market might be slightly out of balance, and the strategy might be able to make a profit by taking the other side of the market herd's trade. The goal of the strategy was to be buying and selling at the fringes of the current volatility.

The system consists of two independant agents. A bullish contrarian and a bearish contrarian. They each make a decision on whether or not to buy or sell stock, and the program consolidates their trades into a net decision on how much stock to buy or sell. The agent's entry points are scaled by recent historical volatility (I was generally using 30 days). The system is intiated on the first day with both agents intiating a position. The bear agent shorts a unit of stock, and the bull agent buys a unit of stock. Both of their trades cancel each other out so no actual net-trade is made. This gives both agents a point of reference on which to make subsequent trades. Any time the stock price moves one daily standard-deviation in either direction away from the last trade on the agent's virtual book that agent initiates a new trade. Furthermore if the stock price has moved more than one daily standard-deviation that results in a profit for any trades in the agent's virtual book, the agent closes those trades for a profit. The 2 agent's trades are then consolidated and used to make a net trade on the real account. Every time the stock moves more than one daily standard deviation both agents make new positions, but one agent will be cancelling out his new position initiation with a profit taking on a previously opened trade so his book does not actually change.

The major problem for the system is trending markets. Eventually one agent will accumulate positions it will never be able to get out of because the stock will never reach those levels again. I tried several variations to deal with this. One system bought options and basically allowed the unprofitable options to expire while rolling the profitable ones forward. Another versions used various price-stop losses and time-based stop losses. Most of my time was spent writing code to handle the accounting. Since the system always has a position on the books which it is adding to or depleting from, it was hard to figure out a good way to pair the trades so that I could compute useful statistics for evaluating the system such as the winning trades percentage, losing trade percentage, expectancy, etc...It was easy to compute total PnL and do drawdown analysis though.

At times the system seemed like it was going to be wildly successful and I was quite excited. Always this turned out to be due to a bug or a data flaw which when fixed also erased the phantom profits. I was back-testing it on a just a few stocks. My final conclusion was that the system wasn't that great so I didn't bother to do a wide-scale backtest on hundreds of stocks, yet.

It looks like it might have some promise if one could somehow identify times when a stock isn't actively trending. I also am kicking around ideas for how to make the system adjust the strategy during trending markets as positions accumulate. In general the stop losses schemes didn't help the system much. They did mitigate losses during times when the system was taking large losses, but they also reduced the profits too much. Also, I realize that I need to change the entry/exit decisions to use the standard deviation for the time period elapsed since the last trade instead of the daily standard-deviation. I think this would cause the system to be puting on trades after the market has made more extreme moves which are typically good times to be accumulating positions for counter-trend systems like this. As it is now, the system is puting on trades often when nothing significant is really happening in the market. Someday maybe I'll test this strategy with intra-day data. With intra-day data the system would be implemented with limit orders at the price trigger points, and would profit from the bid/ask spread which would probably help the system out quite a bit.

It was an interesting idea. I am fascinated by the idea of simple agents interacting together to produce complicated behavior. This type of phenomena is called cellular-automata. I've successfully used cellular-automata ideas to solve some tricky image-processing problems in the past in my main business (computer graphics). I'm definately intrigued by the idea of using cellular-automata for trading. This may even inspire me to actually finish reading A New Kind Of Science which is supposedly a good book about cellular automata. Like most owners of this book, I haven't read past the first few chapters because it's the size of a phonebook and incredibly dull, but maybe it could spawn some new trading system ideas. I've read a lot of books in the past year about derivitive pricing, so my tolerance for boring books may be much higher than when I first attempted to read A New Kind of Science years ago.

CSCO continued...

2005-08-12T10:02:00.000-07:00

I had major computer problems the past few days so I wasn't able to follow up on the CSCO idea that much. I did check the underlying price the day after earnings and it looks like my idea that CSCO earnings wouldn't be a big deal, was wrong. The stock broke below the break-even points for every one of those trade ideas so most likely they were losses.

CSCO

2005-08-09T12:02:00.000-07:00

My suspician is that CSCO's earnings after the bell today won't move the stock much. I was trying to think of an option position to enter in advance of earnings today that might profit. I decided that I'm too inexperienced with this type of trade to make a good judgement on what type to make, so I decided to write some ideas down instead and then check to see what happens tomorrow.

The obvious strategy I guess would be to short a straddle. The front-month 20.0 straddle is 1.10 bid x 1.20 offered. This would have a maximum profit of 1.20, with break-evens at 21.10, and 18.90. The idea selling a straddle ahead of earnings makes me nervous. I think the earnings won't be a big deal, but hey I'm very likely wrong....I'd hate to pay a serious penalty if I was wrong....

The next idea I thought of was to buy a butterfly. The 17.50-20.00-22.50 call butterfly is 1.35 bid x 1.60 offered. If I am calculating correctly, that would be a potential max profit of 3.45, with break evens at 19.10 and 20.90.

I was also thinking about time-spreads. Time-spreads are always confusing to me. Sell the aug 20.00 call at .35 and buy the sept at .60? The front month has a volatility of 40.2% or so while the sept has a volatility of 29.0%. This seems like it would be favorable since I'd be selling a high-volatility option and buying a low volatility option. The thing is IV is I think volatility will decrease after earnings. Time-spreads generally are hurt by implied volatility drops.

Option Software Screnshots

2005-07-26T13:32:00.000-07:00

Well anyway like I said in my last post, I wrote a real-time options probability calculator in C#. This is to aide the mechanics of evaluating potential options trades once I have a stock I am intersted in. I still need to develop software to aide the picking of the actual stocks.

Screenshot 1: The options quote and greeks (Click on the picture for a larger image)

Screenshot 2: The option probabilities (Click on the picture for a larger image)

Here's how the software works. I have a separate tabbed worksheet for each option strategy type. Currently, only 2 worksheets are implemented: Naked Puts and Naked Calls. (Straddles and combinations will probably be next.) Once you enter a stock symbol, a list of available contracts is presented to you, and a real-time quote of the stock symbol turns on at the top of the page, above the option worksheets. I would prefer to be able to load all of the option contracts for a given security in the worksheets. Unfortunately, interactive brokers limits the number of real-time quotes I can subscribe to at any particular time, and that would exceed the limits. Therefore, the contracts must be evaluated in the worksheets, one expiration date at a time, which the user can pick. There is a second set of expiration dates which is disabled. This is for the future implementation of the time-spreads worksheet.

Once the user picks the expiration date, all of the strikes with quotes are automatically selected. Alternatively, the user can choose specific strikes if desired. Once the user chooses which strikes to evaluate, by clicking the "Load Options" button, the worksheets become "alive". In the case of the Naked Put worksheet, real-time quotes of all of the puts for the selected strikes start to update, along with the computed quantities. In addition, the "cumulative-weighted-IV" for all of the strikes at the current expiration begins to be displayed. This is a weighted average of all of the contracts individual implied volatilities, weighted by how far out of the money they are, and how much volume they have traded today. This quantitiy is only updated every 5 seconds.

The first screenshot displays the basic option quote, the "greeks" from the black-scholes model, and the implied volatilities for each contract. All of these are displayed in real-time, as the quote updates. The second screenshot shows the probabilities. Most of these are also displayed in real-time, but some are computed at a fixed 5 second interval.

Profit Prob: This is the probability of profit at expiration. Given a volatility assumption, this is the probability that the stock will be above the "break-even" price for a particular naked put sale at the put's expiration.

No Touch Prob: I call the next quantity the "No-Touch Probability". This is the probability that the put will never go below it's strike between now and the expiration date. Any time the stock drops below the naked put's strike price I will definately be "sweating" and may close the trade, so it is very nice to have an idea of how likely this is ahead of time. The free web-based probability calculator I was using doesn't compute this quantity.

Expected Profit: Assuming you could make the exact same trade a large number of times, and the stock's movements were distributed randomly every time with the given volatility, this is how much money you would expect to make per trade at the expiration date. To compute this quantity, I intigrate the probability function multiplied by the option price at every possible stock price. The method of intigration I use is trapazoidal intigration, and is very basic and slow, so this quantity is only updated every 5 seconds. I'm not sure if this value is being computed accurately. The values computed seem reasonable for the out of the money options, but they seem to balloon when the option is in-the-money. I don't sell naked in-the-money options so this isn't terribly important in itself, but this reduces my confidence in the code. Until I've used the program more, and gotten more opportunities to compare the computed values to the free web based probability calculators, I won't feel very confident using this value.

Yield: This is simply how much the premium the option would yield, if the option were to expire worthless and no leverage were to be used. Basically, this is the premium divided by the strike price (and then scaled to an annualized basis.)

Expected Yield: This is the same as the yield above, but instead of the premium, I use the expected profit for computing the yield.

The controls above the options quote allow the user to change the parameters used for the calculated fields:

Volatility: The volatility assumption is the key input for all of the computations the program makes. All of these computed numbers are only as accurate as the volatility assumption. These radio buttions allow the user to change the volatility used for these calulations. By default, for each contract, the volatility used is that contract's implied volatility. Alternatively, I can specify to use the cumulative-weighted IV for all of the options, or put in my own assumption. For example, right now the implied volatility for the S&P is extremely low. So, if one were to sell a SPY naked put, it might make sense to put a higher volatility estimate than the current implied volatility, since volatility tends to mean-revert. If there were naked puts that looked favorible with the low volatility estimate, they would be less favorable with a higher volatility, so entering a higher volatility estimate would be more conservative.

Price for Calculations: This allows you to choose which market quote to use for the calculations. By default the put worksheet uses the curent bid. If I feel that it might be possible to split the bid, I could use the halfway point, or if I felt that I could get filled on the offer I could use the offer price instead. For getting the correct implied volatility, it might make sense to use the last sale price in a liquid option. After the bell, I have to use the Closing price.

Black Scholes Parameters: The last set of controls are for entering the specific values required for the black-scholes model.

Recalculate Button: After you change the black-scholes parameters, the worksheet will not reflect the changes for a particular contract until the next quote from IB forces an update. Clicking this button, updates all of the calculated values immediately.

Weighted IV: This is a weighted average of all of the contract's implied volatility, where each IV is weighted accourding to the volume of contracts traded so far today, and it's distance from the underlying stock's current price.

The Mechanics of Making a Trade (software screenshots postponed)

2005-07-26T12:05:00.000-07:00

I wrote an application in C# that interfaces with my brokerage's software to compute option probabilities and greeks in real-time. At the simplest level, this application is a substitute for excel, and various free web based probability calculators I use. The application goes further though. It computes quantities that I previously couldn't, using excel and web based calculators. The progam should also prove to be a huge time-saver, by eliminating the need to manually enter values into excel and by removing the need to visit various web-sites. As the program evolves, I see it developing into a general-purpose option strategy evaluator.

Before I get into the screenshots, let me explain a little about the actual mechanics of how I enter a trade, so that it will be clear what the purpose of this program is. Say, I'm interested in entering a bullish position in a stock. The first thing I'll do is check out the options and see if there is a way for me to modify my risk/reward profile by selling puts or going long calls. For example, if implied volatility is high, and the market is fearful, high-yielding puts with a high probability of profit may have a high expectation (based off of the statistics, not necessarily the reality) of profits. So, since I hate taking losses, I might choose to sell those puts with a high probability of profit, if I think the market is too fearful of a large move to the downside.

Often if I'm interested in a entering a bullish position in a stock and I don't find "good" puts to sell, I'll forget about it. This is because even if I do have a "bullish" opinion, it usually isn't a very strong one, and so I feel that I should also have the extra "edge" of selling expensive volatility. Furthermore, I like to be able to have a high-frequency of profitable trades, which selling out of the money options gives me.

Now, if I really have a strong opinion and I don't see puts with a good probability, I will often buy deeply in the money calls as a substitute for stock if the trade is a short-term one. This gives me a degree of downside protection if the stock should make an unexpected extreme move, although in practice the option is far enough in-the-money that if the stock were to move enough so that that downside protection actually kicks in we'd be talking about a catastrophic move and I would be taking huge losses nevertheless. The main reason for using the deep in-the-money calls is not for loss-protection. It is so that I don't tie up a lot of capital for the trade. This used to be my "bread-and butter" trade...but this year I have not been very successful speculating with in-the-money options. I think this is partially due to the fact that I have generally been puting on larger trades than I used to when making these types of trades, and this has clouded my judgement. Come to think of it, I'm not even making these types of bets in the same types of scenarios that I used to. (I just had a major epiphany here. I'll try to remember to make a blog post later.)

Sometimes when I check out the options for a stock (I'll use a bullish example again), I find that out-of-the money or perhaps at-the-money calls have a high expectation of profit relative to the amount of money that needs to be put down to buy the calls. If it is a stock that makes explosive moves, I might be inclined to place a low-cost bet. This is a low-probability trade, meaning more than likely I'll lose money. The potential reward though is high. This is usually a longer-term strategy for me. (6 months or more.) This is a newer strategy for me, and I have not taken any profits yet using it so I don't know how well this is going to work for me. So far I am showing an unrealized profit on my long-term call purchases.

The final type of trade I make are the very long term stock purchases that I make. I don't even look at options for those trades.

Well, I meant to show you screenshots of my software...but I seem to have filled up this post talking about the mechanics of how I place an option trade. Since this post is allready long, I will make another post about the software specifically.

2 Months Profit lost in 2 days

2005-07-21T16:31:00.000-07:00

I closed out the INTC and STX trades today. Yesterday, I was proud of myself for not selling into the early lows for the day. The stocks recovered later in the day, so I decided to let another day go by before closing them. That was a bad choice in retrospect. The stocks were both down more today, especially STX. This fiasco represents a loss of almost 2 months profits in 2 days. I need to refocus on what has worked for me, and shrink my trade size. The VIX was up a fair amount today. Maybe it will be time to start selling puts again soon. I am nervous about selling options short. It seems like it has become such a popular strategy now-a-days. It has been too long since anyone famous has blown up, selling options. I would feel more confident if my tools were finished. I did finish up the real-time put worksheet that I started (and came close to finishing) over the 4th of July weekend. It is usable now, but still has a few kinks. (I will post screen-shots, once I figure out a good way to host the images.)

One thing is for sure: I will not be listening to Cramer on anymore short term trades. I think he may be too visible now to make effective short-term calls. I'm still happy with the long-term picks he has gotten me into. (Especially SHLD!)

Infected by Cramer's Madness?

2005-07-19T13:19:00.000-07:00

Today, Cramer wrote in an article to buy INTC,MOT, and STX today all ahead of earnings. I bought INTC Aug25 calls @ $3.91 and STX Aug15 calls @ 4.71. I was almost to embarrased to write on this blog that I was following one of Cramer's calls, but if I don't write it down and experience the shame how will I ever learn? In the past, I've generally made good money following Cramer when he has made wildly bullish calls right before earnings. It seems lately, mainly this year, trading [short-term] his market calls on realmoney.com haven't been as good as I remember in the past. Maybe if I lose money on this, it will be the catalyst to stop listening to him. It looks like intc just announced, and is getting a sell-the-news reaction, after hours.

I also subscribed to realmoney.com's 30-day free trial to their options newsletter and put on the 2 recommended trades in SPY. They are doing a different type of trading than I usually do, so this might be a good opportunity to get some experience using strategies I don't use very much. The only problem is that I have to make slightly bigger trades than I would normally do when I am experimenting with new ideas since they will be "trading around" positions so I need enough contracts to be able to do that.

The Right Tool For The Job

2005-07-18T18:54:00.000-07:00

When I was 10, my Parents purchased a then state-of-the-art IBM AT Compatible 80286 computer with the 80287 math co-processor for our family. I was fortunate at that age to have a computer. I was the only kid I knew actually who had a computer. Back then Intel CPU's couldn't do floating point calculations natively. The calculations had to be emulated in software which was very slow, unless you had one of the expensive x87 math co-processors. The 80486 was the first intel CPU to include a floating point unit built in.

Why back in oh 1989 did we need such a high-end computer? My Father was a statistician, and needed to run a statistical programming package called SAS on our computer. It required a math co-processor. My Mother was a CPA and needed to run a program called LOTUS 123 on our computer which didn't require a co-processor but it benefitted from one.

In 6th grade, my math teacher was really into computers, and believed that it was important for our education to know how to use them. His classroom was full of those old style Apple computers. (They were hardly ever used for anything other than playing "Oregon Trail", and "Where in the World is Carmen Sandiego".) At one point, he tought us how to use a spreadsheet on those Apple computers, and after that point we were allowed to do all of our math homework using spreadsheets if we wanted to. I was actually the only kid in the class who took him up on this. I had my mom show me how to use Lotus 123 on our home computer and from that point on I did almost all of my Math homework in Lotus...which made it pathetically easy. I didn't learn much math for the rest of the year (which hurt me in 7th grade), but I did learn how to use a spreadsheet pretty well.

In my Freshman year of college, our chemistry lab instructor encouraged us to do our Chemistry labs using spreadsheets. Despite the fact that I knew spreadsheets backwards and forwards, for some reason I never did use a spreadsheet for my chemistry labs except for the one or two labs for which it was explicitly required. I recieved a barely-passing D+ my second semester of General Chemistry. ("D's get degrees!") During my sophomore year, I took physics. The physics lab-instructor also encouraged us to use a spreadsheet for our lab experiments. For whatever reason, perhaps because I liked my physics lab instructor better than my chemistry lab instructor, I listened to his advice, and did all of my labs using Microsoft Excel. I enjoyed the Physics labs, and I got A's. It was great, but it also sucked because I realized that if I had been using Excel my freshman year (which was very tough for me) I would have had so much more free time, so much less stress, and I know I would have learned more and recieved a much better grade in Chemistry. The lesson was learned, and from there-on, I always did the calculations for my labs using Excel.

My Chemistry advisor and my math professors started to encourage their students to learn to use a program called Mathematica during my Sophomore year of college. I never really bothered. By the time of the second semester of my Senior year, I only needed one more class to complete my Chemistry degree: Quantum Mechanics. The class happened to be taught by my Chemistry Advisor. He basically required that we use Mathematica for our assignments, labs, and tests, so I became fairly proficient in the use of Mathematica. With Mathematica, Quantum Mechanics was intresting and fun, and I did well in the class. However, I had the same feeling of regret that I had experienced my sophomore year when I realized how easy Excel had made my lab assignments: "Arrrggghhh! Why didn't I learn to use Mathematica sooner!" What a shame. It would have made allmost all of the classes that were hard for me easy, and would have freed up so much of my time.

I've noticed that as I study option trading, statistical calculations are usually required. Hopefully if I learned anything in college, it was to not make my life harder by refusing to learn and use software tools that are readily available to me. So in that spirit, I have decided to learn to use a statistical package called "R". R is an open-source implementation of a statistical programming language called "S". This is very much similar to the program SAS I mentioned earlier that my Dad used to use when I was younger. I ordered the book Introductory Statistics with R from amazon.com, and I am currently working through it. Assuming I am able to easily access my data, I think this will turn out to be an excellent platform for experimenting with options trading systems.

Another day, more bad trades.

2005-07-10T22:10:00.000-07:00

The bad trading in the gamma-scalping experiment continues. I don't even want to write about it. I'll just summarize it like this. I'm leaning short into this powerful market. (On the experiment that is...overall my portfolio is very much net-long.) Instead I'll write about my programming progress.

It is surprising how difficult it is to simply move a little data from one MySQL server to another. The standard tool mysql provides for some reason just didn't work for me. I have 2 windows GUI tools...MySQLFront and Navicat. They are both patheticly slow. Obviously neither is intended for large databases. I wanted to move all of my existing equity data off of my main computer to a separate Database server I set up. Then, my plan was to re-import my option data from stricknet on that server. Transfering the equity data using Navicat took 3 or 4 days. (To re-download all of that data from finance.yahoo.com wouldn't have taken much longer than that.) Then I began the options data import. This took about 48 hours.

There is a silver lining though to this long and tedious data import. During the time that my data was importing (especially over the 4th of July weekend.) I started working on my real-time options analysis tools again, and I made excellent progress in a short amount of time. What the program does, is for an entire put options chain, it computes the implied volatility for each contract plus the cumulative weighted volatility for the chain, and then computes all of the "greeks", plus the expected return, probablility of profit, and the probability of the strike never getting touched, all in real-time, for an entire options chain, and then I can sort the chain by any of those statistics. I can also plug in my own volatility estimates for comparison purposes.

The program is about 90% done. Unfortunately I won't get a chance to finish it up for at least a week. In the future, I plan on adding a custom tab page each common options strategy Right now I only have a page for selling naked puts, since this is the strategy I use most often. I also want to add a tab page for analyzing the volatility skew in real-time. So far, I'm very proud of how the program has turned out. I hope to be able to post screenshots of all of the options analysis software I've written soon after I get back from my business trip.

So busy...

2005-07-07T21:51:00.000-07:00

I've been very busy with my main business (writing niche software applications) , preparing for a business trip so I haven't been able to blog much. Here's a round-up of what has been going on.

My trading lately has been piss-poor. Remember those RIMM puts I covered ahead of earnings? The stock dropped hard after earnings...yet the RIMM puts also dropped due to the volatility crash. This was a good lesson in the post-event implied-volatility crush. I'm still not sure whether it was a good decision to close the position out or not. Hey, I shouldn't complain about making money I guess, but when has that ever stopped me?

The main area where I have been trading poorly though, is the gamma-scalping expiriment. I need to decide whether I am position trading or if I am actually going to scalp the gamma. I wrote that I had hedged my position to delta-neutral by shorting some SPY shares when the market was up about a buck. I then had at least 2 chances to make round trips for a profit of around $20 each time, but I felt very strongly that the market was heading down and so each time the market was down to where I had previously determined that I would re-balance to delta-neutral by covering my short SPY shares...I heald onto them and the market rallied back to around where I originally shorted. Then after Teusday's big rally, I decided that the market was too strong, and I covered at a loss of around 10 bucks. Then on Wednesday I changed my mind and decided that I needed to really give this gamma-scalping a try, so I hedged back to delta neutral by selling 38 shares of SPY short again. That turned out to be a good trade. Thurseday morning after the London Terrorist attack I covered this time and made about $45. It's a good thing I covered. The market was strong all day. The thing is...I still feel the market should be heading for a short-term down move....next time I short to get delta neutral (assuming the market goes up first) will I decide to play it as a position trade, or will I stick with the gamma-scalping plan? I don't know. Furthermore..what if I buy stock to hedge to delta-neutral in the down-turn and I miss out making the big money on a big down move because I was hedged?

It's funny how even though this is a small experimental trade, I still succomb to all of the usual greed and fear emotions . This is why I have to have some money on the table when trying out a new strategy. Without the emotions of having actual money on the table, it just isn't real enough. I wouldn't pay as close attention to the trade if it was just simulated, and even if I did, I wouldn't be able to have this kind of emotional reaction during simulated trades. Part of learning to trade a new instrument or new technique is mastering the emotions that come up. I find that eventually I come to a point where I just "feel comfortable" and can make my trades rationally. So far it does seem like if one stuck to the plan, this gamma-scalping could be very effective.

One really good trade I made last week was selling some UNH July 50 puts short. They had such a great yield and expected return over only 15 days that they seemed almost too good to be true. After I sold them, even though UNH seemed to be going up, the puts hardly lost any value. Presumably the implied volatility was increasing during this time (I haven't looked at a graph). I think I checked on finance.yahoo.com and saw that an earnings announcement was coming just prior to expiration. I've traded UNH options a lot and this seemed like unusual behavior for UNH going into earnings, but I just accepted that the earnings must be the reason for the dramatic IV increase. Well, then on Wednesday UNH was halted because they announced an acquisition. So I guess someone knew ahead of time and that is why the IV was moving up so much and why the expected yield on those puts looked so nice. It's a good lesson I learn over and over again...often options are "over-valued" for a really good reason...something big is about to happen. The nice thing is, it never has really hurt me much when this has happened. It seems that often in my case even though the options market has anticipated news...the level of fear has been too high.

The stock was halted most of the day. Usually the (acquiring) stock goes down after the company announces an acquisition because it dilutes the existing shareholder's equity. I wasn't really worried though. My puts were enough out of the money, that the market would have had to really hate the deal to drop the stock enough for me to lose money. The deal was not particularly large, and people generally like this company. The stock seems like it only goes up and up and up, with relatively little volatility. That's the kind of stock, shareholders are willing to forgive if the company does a bad-acquisition. Furthermore, I had a feeling that even if the stock sunk, in the evening Cramer would have UNH written on his knuckles as this is one of his favorite stocks. It seems like lately, Cramer has been able to move even big stocks (Even though, I'm a little skeptical that he was solely responsible for the big CSCO move...) with his television show. I was hoping that this would be enough to keep me above the strike until expiration. Little did I know he was on vacation and so there would be no stock-pumping Wednesday night even if I needed it. It turns out to have been a moot point though. UNH actually moved up once trading resumed! The puts plunged in value. I am now patiently waiting for expiration to squeeze the last dime out of the puts.

The Gamma-Trading experiment.

2005-06-29T19:08:00.000-07:00

I have no big positions for July expiration. I'm just sitting here mostly in cash, waiting for the next buying opportunity. It sucks that I have few positions for the July expiration coming up, but I want to be patient and only sell puts when conditions are favorable for that type of trade. I feel like better buying (naked put selling) opportunities are ahead. I closed out my RIMM puts at $0.20 today ahead of the earnings announcement. This is a $0.63 profit per put. I would have liked to have heald out for the remaining $0.20, since I probably won't put that capital back to work anytime soon. Too many times I have waited to make an extra 10 or 20 cents and ended up losing money. I'd feel pretty stupid If I lost a buck tomorrow to make 20 cents. PALM also reports after the bell today (or is that tomorrow). Anyway, I'm not covering my PALM puts, as they are farther out of the money and still retain about half their premium (these are NOV puts anyway.)

I bought a SPY 119 straddle on Monday I think (maybe it was Friday). I rarely buy straddles. This is mainly an expiriment, so I only bought one straddle. The market seems complacent. Regular readers know I usually like to sell premium...particularily naked puts. I haven't seen any options I've really wanted to sell lately, so this seemed like a good time to experiment with a different type of position while I wait for the time to put on big positions to come around. According to McMillan on Options, volatility often reaches a seasonal low in June or July. Furthermore, the market seems especially complacent right now. Complacency often precedes big moves. The complacency can be measured with the VIX index. This is a measure of the implied volatility of the S&P 500. It has been fairly low for some time, and even though the market sold off fairly hard last week, the index hardly moved at all.

I originally bought the straddle for the reasons explained above, but I am also thinking of using the position for expirimenting with" gamma scalping". To explain what that means, I'll have to get into the Black-Scholes model. The Black-Scholes model is a differential equation that gives the price of an option as a function of the stock price (or the price of any underlying instrument), time to expiration, the strike price, future volatility, and the risk-free interest rate. If you take the partial derivitives of the equation with respect to each of the individual parameters you get what is called "the greeks". Each greek tells you how the option price will move in response to a unit movement of the respective input parameter.

Probably the most important greek is the derivitive with respect to the underlying stock price. This is called Delta. Delta is the amount the price of the option will change when the stock price changes. If a position has zero delta then it is said to be "delta-neutral". For example, an exactly at the money straddle would have a delta of 0 since the put's negative delta would exactly cancel out the call's positive delta. Gamma is the second derivitive of the option price with respect to the underlying price. This tells us how much delta will change as the underlying stock price changes. Gamma can be thought of as the profit potential to be gained from hedging the delta of an option position. Theta is the derivitive of the option's price with respect to time.

For example, when I sell naked puts I have a negative gamma and a Positive theta. This means that the passage of time tends to be profitible, but if I want to hedge my delta as the underlying moves (to protect myself from large losses), I will tend to lose money doing so. A Straddle has negative theta, and positive gamma. So here is how scalping the stradde's gamma works:

Assuming the straddle was exactly at the money when purchased, it would have a delta of zero. Then if the stock moves in one direction, one could compute the delta at that time, and then buy or sell a quantity of stock to bring the delta back to zero. An option will always have a delta between -1 and 1. A share of stock always has a delta of 1. As one buys and sells stock in this way to bring the delta back to zero in response to the movements of the underlying stock, then this will tend to result in buying high and selling low, producing small profits over time. It's important to remember that even as one may be profitably scalping gamma, those profits may not be enough to overcome the time-decay (negative theta) of the position. It's kind of like a race between the gamma trader and theta. If the stock isn't volatile enough to profitibly trade the gamma enough times before expiration, then the trader will lose the race.

Yesterday the SPY's moved up about a buck. This morning as a result of that move my put contract was down about 40 bucks, and my call contract was up about 40 bucks. According to Interactive Broker's trading software (TWS), The delta of my position was around 30, so I sold 30 SPY shares short to bring my delta to zero. Now, if the S&P moves down again, I will have to buy back some of those shares I sold short to bring the delta back to zero which would result in a profit. I plan on re-adjusting the hedge every time SPY moves about a buck. With such-infrequent adjustments, I doubt I will make enough money to overcome time-decay, but I am curious how much can be made. The danger of hedging the delta like this as the stock moves, is that I may give up substantial profits if the stock makes a big move against the hedge.

Private property rights died today.

2005-06-23T15:46:00.000-07:00

Normally I don't write about politics but the supreme court ruling on eminent domain today, really pisses me off. Briefly, the court ruled that cities have the right to take your land, and sell it to someone else if they think the "someone else" will pay more property taxes than youd do. In this particular case the city of New London, Conn. is trying to take these people's old victorian homes which are located on riverfront property and sell it to a big developer to build luxury condos, an Office Complex, and a Health Club on it. Their justification is that the new property owners will pay more property taxes than the current owners of the property do.

It almost makes me glad that I'm not a homeowner. All of my property is paper assets and intellectual property, rather than land. No city-council is ever going to want to take my QQQQ LEAPS and build a Costco on top of them. Nor do I have to worry about my software copyrights being confiscated so that Donal Trump's can build a limo parking lot on top of them, but all of you people who own actual physical property should be worried and pissed off!

UPDATE: I found this nice post on slashdot. (For the record I thought of this possibility too.):

And that creates a new way around California's Proposition 13 (which keeps them from raising property taxes on your house and land until it sells). Watch for this:

1) Emminent domain the tax-capped house.
2) Sell it to another buyer. (Taxes now at new rate.)
3) Previous owner has to buy a different house. (Taxes now at new rate.)

UPDATE: Here's a post I made on EliteTrade. I definately think that the poor and the middle class get hurt the most by eminent domain, but here's a plausible scenario for how the rich could be hurt as well. Unless one has Gates/Buffet/Soros quantities of wealth, most "rich" people are still "poor" compared to the resources and power of a publicly traded corporation.

... there are lots of beautiful beach-front properties in California with mansions on them that would be far more valuable if it they were developed into condos instead. A developer could easily turn a 29 million dollar beach-front La Jolla estate into a two-hundred million dollar condo complex, selling 2 bedroom condos for a million and a half each. The only thing stopping it is zoning and the willingness of the rich guy to sell his estate.

I could imagine scenarios where a big corporate developers worth 100's of millions of dollars might lobby government to kick rich guys off their land, tear down those mansions, bulldoze their sprawling gardens, and build high-density beach-front luxury condos for the "good of the public". The political power and resources of a rich guy worth tens of millions of dollars, though impressive are still no match for the money and power that a publicly traded corporation like KB homes could muster. When government has this kind of power, no one is safe.

George Costanza Investing

2005-06-23T13:23:00.000-07:00

Remember that episode of Sienfield where George Costanza realizes that every instinct he has ever had has been wrong...that ever decision he makes is doomed to fail? So he decides to begin doing the exact opposite of everything that seems right to him, and immediately his life turns around. He gets a girlfirend, a great job, and starts to become successful. Sometimes, this is what I think trading as a contrarian is like. So often when a trade feels like a great idea it's absolutely wrong. Often my best trades feel so stupid, risky, and wrong as I'm making them. I need to get better at embracing my inner Goerge Costanza when I trade. It seems like so often every instinct I have is absolutely wrong and I need to do the exact opposite of my impulses!

Case in Point: The Market finally declined today. You'd think with those in-the-money QQQQ Puts I'd be pretty happy about this? Today, when I logged in all of my stocks were up, my account near at all-time highs and I'm thinking to myself "What the hell am I doing shorting this market? I must be insane. I hope I can get out of these puts without losing too much money". So, I put a limit order in to sell them for $0.18 below what I bought them at after commissions. A while later after taking a shower I look at my screen and see that I no longer have a position. For a brief moment a wave of relief washes over me that I was able to get out of these things for such a small loss. Then, I noticed the Q's were down a fair amount. I look over at CNBC and I see the Dow is down big, and the Nasdaq is holding in there, but has still had a considerable drop while I was in the shower. It looks like I sold into the very beginning of today's downdrop. This has to be the dumbest trade I've made all year. Those puts have made me nervous ever since I put the position on...in retrospect I should have recognized my nervousness as a good sign.

Remembering back to April when we had that huge sell-off. I remember the one day the market was up, and how relieved I was to be able to establish bullish positions into TWX and UNH before the market "rallied without me"...only to see both selling for lower every day that week. I also remember how I bought(well sold puts short) on almost every down day there-after and how it almost physically hurt to make some of those purchases, most of which turned out to be great trades. (The bad one GS...was bad because I panicked later and closed too soon, not because I didn't buy at a good price that week. ) I also remember how later in May how relieved I was to cover May GS put shorts...which it turns out was at the absolute worst price I possibly could have covered at prior to expiration. To make matters worse they even recovered their strike in time for expiration, days after I covered.

It's so hard to ignore my instincts. Every time I feel relieved at selling a position at the bottom...I usually realize at the time that I'm probably selling at the bottom and yet I still feel great about how I'm "limiting my risks by using stops". When I chase a stock up because I'm afraid I'll miss my chance to make money...I almost always realize at the time that I'm over-paying yet I do it anyway. Somewhere there is George Costanza in me and I need to find him if I'm going to continue to trade on a purely discretionary basis.

This further emphasizes the need for developing more quantitative methods for picking my positions so that I can remove my instincts from the process entirely. Even the basic techniques I use for picking puts right now help me immensely. No matter how much I like a stock, I only sell OTM puts with high theoretical odds and a 10% anual yield. This weeds out many of the non-contrarian plays. Puts get a high yield and high theoretical odds for a simple reason: Most people don't want to sell them so the price rises. When I find puts with those characteristics and short them, at least I know I'm not trading with the majority. This alone isn't the holy grail. Often the majority is avoiding the position for good reason, but at least it's a start, and has prevented me from getting slaughtered with the herd a few times now.

Low Implied Volatility in CSCO

2005-06-21T16:17:00.000-07:00

I was tempted to close my QQQQ put trade several times today, for no good reason other than that I just feel bullish. Today I noticed the guy at Hedging Options wrote " Unbelievably, CSCO atm July 20 calls are at a 15 IV", so I loaded up CSCO in my new program for ranking a stock's past historical volatilities. I set it to load the past 1000 trading days:

Current Historical Volatility (as of June 17th)
20 day: 19.64%
50 day: 20.22%
100 day: 20.5%

Past Historical Volatility:
Rank % 20day 50day 100day
0th 13.01 18.8 20.5
10th 21.65 23.59 26.86
20th 26.85 28.81 31.01
30th 29.64 30.65 33.28
40th 33.1 33.75 34.25
50th 36.69 37.37 35.03 <--- this is the median
60th 43.24 40.53 38.13
70th 49.78 54.85 57.83
80th 57.82 65.41 66.19
90th 69.26 72.26 68.73
100th 107.76 83.09 72.44

The 50th percentile ranking is the median volatility. The program confirms what hedging options said...those CSCO calls are trading well below typical volatilities for CSCO. The guy at hedging options uses more complicated strategies than I usually do. I think he generally enters delta neutral positions with positive gamma, and then scalps against the gamma. I don't have any experience with that and am not interested in giving it a try at this point. Just as an experiment though, I bought 1 July 20 Call contract for 30 bucks just for the hell of it. Let's see if it goes up now! (This isn't exactly a high probability trade.)

If I ever get the option data imported into my database I'll do some real expiriments. I'm really interested in backtesting some long gamma, long volatility strategies as well as building a useful screen for finding puts to sell. My copy of McMillan on Options just arrived from Amazon.com. McMillan's other book Options as a Strategic Investment is hands-down my favorite options book. It's almost always on my desk, so I'm really looking forward to reading this book. I'll post a review when I'm done.

High Oil is Bullish!

2005-06-21T09:09:00.000-07:00

High Oil prices are a sign that the economy is healthy. All of the oil in the world that can be pumped is getting pumped right now. Eventually the high prices will create incentives to conserve and produce more capacity, which could reduce prices...but that is a long-term thing. There's only one thing that will bring Oil back into the low 40's or even lower in the near future (the next year or so). A recession. As long as there is economic growth in oil consuming countries (like ours), Oil's going to stay expensive. So when you see Oil futures surging that is a sign that the markets forsee a healthy economy. Be happy that it costs you 50 bucks to fill your tank. It's a good omen for the future!

If I feel great about the market, does that mean I should get short now?

2005-06-20T16:49:00.000-07:00

I bought some in-the-money QQQQ July 42.5 puts today. I feel really good about my portfolio. It's at all time high's. Just about every stock I own in my long-term portfolio today was up quite a bit...SHLD, CMCSA, even LU! When I feel this good about my long-term stock holdings often this means it's time to short the Q's. I hope I'm not shorting too early here. Most of the time I've been actively trading has been during markets where this type of strategy has worked well. (range-bound and bear markets).

I hope past success hasn't conditioned me to get hurt by shorting an extended rally. I do feel bullish long-term, but my gut tells me to get short for a counter-trend. This is a very small position. However, one of the happy consequences of writing this blog is that I now pay more attention to my small side-trades. One thing that has become apparent under this increased scrutiny is the small really losses add up. Since my main strategy (selling option premium) is to take lots of small gains...I need to be careful about allowing myself to take too many small losses as well while trading these random "gut feelings" I get.

I got all of my stricknet.com options data imported into my database by Friday night. The next step here is to compute implied volatilities for every price-record. Saturday, I wrote some routines to work with the Black-Scholes equation in C#. The appendix in Option Volatility & Pricing by Natenberg was especially invaluable for this. This was my main source for this undertaking. The information in this book's appendix was refreshingly complete and concise. I also cross-referenced with Options as a Strategic Investment by McMillan. One of the things I love about McMillan's book is he throws in so much practical stuff for programmers...not just formulas and theories, but actual sample data and sample step-by-step calculations so you can check your work. This was key for me while debugging my code.

Next, I needed a source of historical interest rates. (The "risk-free" interest rate is one of the variables in the Black-Scholes equation.) The daily Fed-Funds rates are available at the federal reserve's website. I wrote a parser to pull this data into my database. Now I was armed with everything I needed to compute IV's for each of the 83 million individual option price records.
At this point I started to get excited. Could it be that in another few hours I would have 3 years of historical options data for backtesting at my virtual finger-tips? I wrote an sql query to query all of the variables to compute IV, and executed it to make sure the syntax was right. I waited about an hour and it still wasn't done running, so I decided to check this out in the MySQL query analyzer. Well without getting into too many more boring details, it turns out the query was very bad. I bet the universe would end before it was done. So I decided to add 2 indexes that I thought would help matters considerably. I added one to the daily equity prices table, and one to the daily option prices table, and then I waited, and waited and waited and waited. Then finally, Sunday night after I had gone to bed, I walked past my computer on the way to the kitchen to get a glass of water, when I heard a little "beep". Just at that moment, it had finally finished computing the index on the equities price table. This table is considerably smaller than the option price table and it took what? over 48 hours maybe?

Well, it doesn't even take that long to import the options data in the first place. So I decided what I'll do is delete the options data, add my index to the empty table, then re-import all of the data. I am going to write code to compute IV's and put this in the database along with the data to save myself having to re-read all of the data later. I think this will save me a lot of time in the longer run. I've also decided to bite the bullet and set up a separate database server, so that in the future I can run long operations without slowing down my main working computer.

Holy crap! What a pain in the ass this has been! I thought I was used to working with fairly large and complicated databases with my main business. These were nothing compared to this option price data. One pleasant result is that while waiting for the re-indexing to complete I wrote a program I have been meaning to write for some time. On page 800 of Options as a Strategic Investment by McMillan, he writes about a technique for ranking the historical volatilities of a stock, to get a picture of where current volatilities are in relation to the stock's past volatility behavior. This can be easily implemented using the AdjustedClose field from the historical stock market data at finance.yahoo.com. I wrote a neat little windows-forms app to do this analysis using the historical yahoo data I allready have. I will write more about this program, the technique, and what the next steps I hope to undertake to enhance it, in a later post after I find a place to host some screen-shots.

June Performance

2005-06-17T13:02:00.000-07:00

I had a good day today. Most of my stuff was up. My last position expiring in June was DY and it was even up a little. The options were illiquid, so I decided to try something new for closing this position. I shorted DY at 19.23. When I get assigned shares at 20, they will cover my short and lock in a loss of $0.77 per share. I collected $0.39 of premium per share so I believe I have locked in a loss of only $38 per contract. This was my only loss this month. I'm very happy that it was only 38 bucks. At times this contract was selling for 150 or so.

Remember those "short-squeeze" plays I entered into because of a Cramer article? Well I sold my TXCC common a while back for a push (0.02 per share profit). I probably would have sold my in-the-money MLNM options too if the contract had been more liquid, but the bid-ask spread was huge and the stock wasn't doing much so I opted to just wait until closer to expiration when hopefully the contract might become more liquid. Well I woke up to a nice surprise today. MLNM was up over a buck. Maybe the short-squeeze I've been waiting so long for is finally starting...

Here's a quick-and-dirty run-down of the June short put Portfolio (commissions included):

MOVI: +$33
NVDA:+$43
MO:+$74
GS:+$84
CBH:+$49
ONXX:+$59
DY:-$38

With hedging and transaction costs I earned aproximately 2.05% on margined capital. This would be a 19.9% annualized (non-compounded) return. Had DY expired worthless, I would have made around 2.63% ROI instead. This would have been an annualized return of 25.6%. The maximum return I could have achieved from this portfolio would have been around 2.85% , assuming all options expired worthless without any early position closures (and associated transaction costs). I am pleased with these results. I would be happy if I could duplicate this every month. We'll see if I can.

On Monday I will be seriously underinvested. Expiring in July, currently I only have RIMM 60 puts short @ $0.84 and DNA 75 puts short @ $1.04. Both positions are presently showing profits. I also have NOV 20 PLMO puts short @ $0.84. That's it. Interestingly enough, even though PLMO was up over a buck today, the NOV puts were at break-even. Implied Volatility must be expanding quickly in these options.

Even though I'm underinvested I am reluctant to open new positions. I just don't see anything I'm terribly excited about out there. Allso, I am reluctant to open positions until I have some better option analysis tools. Currently I use these free web based tools to examine and screen options I'm interested in: finance.yahoo.com, IVolatility.com, and OptionsClub.com. These sites are pretty useful, but there are some more specific types of screens and analysis I would like to be able to do which I just cannot do using those publicly available tools.

One tool that I really need is a program that can compute the probability of profit and theoretical odds (according to Black-Scholes) of an arbitrary option contract. The above tools can do this to some capacity, but they are generally screening tools so you have to figure out a screen that will bring up the particular option your interested in. Often I just can't get the info for a particular option to display. Furthermore, in addition to probability of profit, I'd like to compute the probability of the option ever being in the money before arbitrary time intervals. I hope to write a program in the near future to do all of this using Monte-Carlo analysis. The program would ultimately integrate my stricknet.com data, and perhaps realtime quotes through interactive brokers TWS API. I think this could be done in a good solid weekend. I'm so busy though and the San Diego Summers are so warm. The beach beckons.

A Strategy Adjustment

2005-06-16T15:09:00.000-07:00

ONXX was up today. I covered my puts at $0.10 for a profit of $0.59. They'll probably expire worthless tomorrow but this stock is volatile and I don't want to risk a major portion of my profits for the month to make another 10 cents. DY was up nicely today and yesterday too. DY seemed to make an intra-day reversal yesterday. I was tempted then at the low of the day to close DY and ONXX both, so I could be done watching the markets for the week and lock in a profitable month. I'm glad I was patient in this case. DY has recovered a little and I think it may continue to do so. This stock could still cost me significant profits this month, but I decided to hang onto my DY position for another day since the premium was still around ~20+ cents above parity, and because of my hope that DY will continue to recover some of its losses. It's price is close to my break-even price at expiration. I'll probably end up letting myself be assigned DY shares tomorrow, and unload them on Monday if the options don't trade to within 5 cents of parity on the offer tomorrow.

I am in good spirits. Now that I am out of ONXX it looks like most likely I will have a decent ROI for June. I've felt confident that I would come out with a gain the entire month after taking significant profits in MOVI and NVDA early. For the past few weeks though, it has looked like ONXX and DY would cost me significant profits, yielding a low return for the month which would have left me in low spirits after last month's negative return.

I sold short PLMO Nov 20 puts @ $0.85 today. PLMO was up 90 cents selling around 28 bucks. PLMO's implied volatility has been ramping up ahead of earnings which come out at the end of June according to finance.yahoo.com. I'm apprehensive about this play. It seems like the market expects a tumultuous earnings report so I wanted to sell options very far out of the money to give myself a wide margin of error on this trade.

This position represents a small change in strategy. I am trying to move into selling options with longer expiration dates instead of primarily front and second month option contracts as I have mostly done in the past.

One of the surest ways to increase your profits in the markets is to reduce your transaction cots. Interactive brokers commissions are low and these are not the transaction costs I'm primarily talking about. I'm talking about the bid/ask spread which is a minimum of 5 bucks a contract each way. By trading options with longer expirations I will be reducing my transaction costs in two ways. First of all Options with longer times to expiration have larger premiums. Thus that 5 cents will be a smaller percentage of the premium collected. Secondly, I'll probably end up trading less frequently since my capital will be tied up for longer periods of time which will reduce my opportunities to pay transaction costs.

Another advantage of trading options with expirations further out is that my break-even level will be lowered, giving me a larger absolute margin of safety. However, there is a price to pay for selling longer dated options. You just can't get as high a return, assuming the positions are heald to expiratoin. I like to sell options that yield a minimum of a 10 percent annualized yield on unmargined capital. Selling this far out, it's often hard to find that.

I believe though that my yield may actually end up being higher than initially expected selling options farther out in time. If the stock moves in my favor sometimes I can exit the position very early and take most of the profits over a shorter period of time. For an example of this I have my recent NVDA trade. Earnings came out shortly after entering the position and the puts became next to worhtless very quickly. This was not only do to the favorable price-movement. The position also benefitted from the volatility collapse after the news event. I think I only heald that position for like 4 days instead of the 30+ that were left on the expiration. This gave me a much higher yield on the capital risked in that position than was originally expected. (Yield is profit divided by time)

For PLMO the only July puts today worth selling seemed to be the 22.5's. They could be sold for $0.30, and represent really high theoretical odds as well aa very nice yield on an annualized basis. Selling those short would be a break-even level of $22.2. With the stock trading north of $28.00, that's pretty far out of the money, but these PLMO options remind me of last months NVDA, MOVI, ONXX, and DY trades. There's a reason they look so attractive. They are probably riskier than they seem even though they are almost 6 bucks out of the money.

By selling the Nov. 20's@ 0.85 insted of the July 22.5's @ 0.30, I'm giving myself room for the stock to move almost 9 points against me instead of just 6. If the PLMO earnings are bad it will probably drop quite a bit and just sit until the next big bad event. The unfavorable price movement will increase the value of my options which will be bad, but hopefully they won't be in the money and that will allow me to sit tight and wait a few months for time-decay to work in my favor since there probably won't be as much movement after the earnings related movement settles down. Hopefully I'll get my expected 10% return assuming I've given my self enough of a safety margin. Furthermore I'll get some help from the post-event volatility drop. If PLMO rallies or stays the same, the options will lose a lot of their value right away due to this drop in volatility, and I will probably be able to cover them sooner than November, and earn a return better than 10%, assuming I am able to redeploy the capital elsewhere between now and then.

Better Living Through Code Optimization

2005-06-15T13:52:00.000-07:00

Well, I think I optimized my option data importer enough to be practical this last weekend. This turned out to be quite a chore. Some of you may wonder why speed was even an issue at all. I mean how long can it take to copy 6 megs of data from one place to antoher? The process of imporation was not mearly just one of moving data around. I use a more complex structure to store my data than the form which it arrives in from stricknet. When designing a database it's important to use a good "structure". When you have a well-structured database you find that it is easy to extract information from it. It will also be easy to intigrate new types data into the database at later times. Extracting information from a poorly-structured database is often such a chore that useful information never gets used or even discovered.

Among other things, a well-structured database, stores each fact only once. One reason for this, is to reduce over-all storage requirements. An even better reason is that it makes it easier to maintain consistancy across a database. As information changes and gets updated, you only have to update it in one place. If your storing the same information in multiple places, great care has to be taken to update it in all of those different tables and records. Furthermore there is a tendacy for information get lost due to uncertainty introduced to the database from inconsistencies resulting from incomplete updates.

Here's a practical example of what I mean. The data from stricknet arrives as two tables. In the equity table, you have rows that look like this for each trading day:

Symbol, Company Name, , Open, High, Low, Last, Volume

AA,Alcoa Inc,,29.99,30.0,28.64,28.7,6591100

It would be very easy to import that "raw" as is. One obvious problem with that though is that every day I will be writing the symbol and the company name into my database. Why do this for every date record? The symbol and company name don't change on a daily basis. Instead I have a table called "symbols", which looks kind of like this:

ID, Symbol, CompanyName

Then I have another table called "dailyequityprices" that looks something like this:

SymbolID, Open, High, Low, Last, Volume

So, when I import the data I first check if there is a symbol record for "AA", and if there isn't I write the record to symbols just once. Then for each date record I store just the id of that symbol record instead of storing the text for the symbol name and the company name. Not only is this more efficient, but now the equity data is cross-referenced to all of the data I allready have on alcoa in my database, because all of my existing data also references the same symbol record. For example, I allready have earnings data, split data, dividend data, etc.

This cross-referencing tends to multiply the useful information in a database. When I import the daily price facts I haven't just imported the price of a particular stock on a particular day. I've created new informaion as well, through the cross-referencing to other related facts which allready exist in my database. As new facts are imported into a relational database, the total information tends to grow faster than a linear rate if the database is well structured.

Another practical benefit that I mentioned earlier is that if I have to change some information I only have to change it in one place. For example when the symbol for the "QQQ" changed to "QQQQ", I didn't have to change every price record, every dividend record, and every split record in my database. I just changed one symbol record.

I used to regularily solve optimization problems years ago back during my short career as a game-developer, but it has been awhile since I've needed to undertake this type of chore. I guess it is like riding a bycle though. You never forget. Here are the general steps I use for optimizing code:

Step 1: Write bug-free, easy to understand, intuitive code. Ignore optimization issues.
The first step in writing optimized code is to not even try. You need a solid foundation on which to build the optimized code. If you try to optimize from the very beginning of a project, more than likely you'll only add complexity and bugs, without much of a speed increase. This is what I did. I wrote a very simple importer which imported the data one row at a time, while reading from the database before writing every single record to make sure that duplicates were not introduced and that the consistancy of relationships was maintained. Not all of these checks needed to be done for every record, but this was the easiest and most intuitive way to do it. I err on the side of caution, by not eliminating checks that might be redundant.

So after writing my simple implementation of the importer, I found that it took well over an hour to run. I never actually ran it to completion for even one day of data (From my retrospective measurements, I now know it would have taken the better part of a day.) It simply took too long.

Step 2: Measure everything.
Often ineficiencies in a relatively few lines of code will account for the vast majority of the slowness. If you don't measure, you waste a lot of effort optimizing lots of code, with little effect on execution time.

The data comes in a zip file, which I decompress on the fly as I read the data in. Decompression is a slow process. One of my first ideas for optimization was maybe I should decompress the zip files in batch ahead of time. So the first thing I did was time how long it takes to just decompress the zip file the way I was doing it. To do this I disabled all of the parsing code and database access and ran one file through. It took less than 0.8 seconds. Hmm..maybe the parsing is slow. So I enabled that as well. It still took around 0.8 seconds to execute. So then I knew there were no easy optimizations. To get a baseline, I disabled all but the simplest database operation...symply checking if an equity symbol allready exists for each line of text in the zip file. So I executed this, and it took over 4 hours and was still not done. Wow! what an eye opener.

Well, one way to speed up database record retrievals is to add strategic indicies to your database, so I added indicies throughout my database. Then I enabled everything and ran the importation again. It was still taking forever.

So, next I did an experiment. I ran a query on an empty table for every record in my options zip file. I would expect the actual sql query should run in a trivial amount of time. This took like 10 minutes to run. The lesson here was clear. Merely opening a connection to the database and transmitting query code is a significant process. I now knew what I would have to do. Batch all of my database operations. For example to query the database and return 1 option symbol record, takes about the same amount of time as to query all 140000+ option symbol records. So instead of doing all of those one at a time for each record in the zip file, I needed to read all of the information ahead of time.

In order to batch all of my database operations, and still ensure consistancy in my database required importing the data in batches, building hash tables in memory, etc...In short it greatly increased the complexity of my code, introduced many bugs that had to be found, and my code is not as robust as my original implementation. However, now importing a striknet zip file only takes 20 seconds for the first zip file. The time then slowly increases as the data grows, so that now after running the importation over night, the time to import one zip file is up to 5 minutes after importing the vast majority of the data. 20 seconds to 5 minutes is much better than over 4 hours, so the trade-off in development time, complexity, and robustness in exchange for speed seems well worth it in this case. My original code probably would have taken months, if not years to import all of the data.

An example long-only option portfolio.

2005-06-14T13:48:00.000-07:00

There were some great posts on Niederhoffer's site today. By the time you read this, they will probably no longer be at the top of the site. For the first article search for "Roger Arnold writes of the Sage". It's a great article about Warren Buffet.

The other great article is a basically a backtest of buying QQQQ LEAP calls. Search the site for "Nasdaq Options, by Charles Pennington". If I understand this article correctly, ATM QQQQ Calls 18 months out usually return about 3:1.

I've been asked lately about how a long option premium portfolio would work. (Remember I usually short option premium.) So, I'll use these QQQQ leaps as an example of how a very conservative long-option portfolio could be constructed. Say you have $10000. You could use that money to buy a 10 year Treasury bond yielding almost 4.60%. Today the options in the article mentioned in the paragraph above could be purchased for $460 per contract. (I purchased at that price today.)

So here is how the portfolio could work. You could purchase a 10-year Treasury Bond, and use the interest each year to buy one of these option contracts. If the options on average return 3:1 over 18 months, then that is around 200% return over 12 months, right? So now instead of earning a riskless 4.6% interest you are getting 4.6%*200% = 9.2% return, and the return is still basically riskless since none of your principal is at risk. That's a pretty nice rate of return for almost no risk isn't it? If I was allready wealthy I'd be seriously tempted to put most of my money in a strategy like that. (not exactly like that though.)

Here are some potential problems with this quick and dirty analysis. First of all I'm doing this all in my head, and may have made some very simple math errors that could ruin the whole thing. Secondly I know almost nothing about bonds...I may be missing something important here, especially with regard to the whole mechanics of how bonds work. For example, I'm not sure if treasury bonds actually pay an annual coupon or not, also you would be buying the first option contract a year before you would actually have accrued any interest.

Probably the most important problem with a strategy based on buying exactly those options though, is that there are only 13 independant data points in the sample set. I think my Dad (who happens to be a professional statastition) once told me that as a general rule of thumb you want at least 29 data points if I recall correctly. Based just on the information in that article, there isn't enough information to know if buying those options is a good idea or not. But anyway, this illustrates the general idea of when I talk about building a long-option portfolio. I'd put the bulk of the capital in a safe place (preferably earning decent interest) and use a small percentage..like 10% a year or less, buying options that are well-leveraged to their underlying issue. One of my favorite options books Options as a Strategic Investment by McMillan has a chapter about this type of strategy. Once I get my option database set up I hope to investigate these types of strategies more thouroughly.

Yesterday I bought some more SHLD common for my long term portfolio. I have been watching SHLD closely during this sell-off in the stock. I was hoping to increase my position in this sell-off, by at least 50%. Yesterday I bought half of that (I've held SHLD for a little over a year now.) I wanted to buy at around 130, but I was concerned the sell-off might end before the stock hit that price so I bought some yesterday at around 135 I think, with the plan to buy the rest at around 130. The stock was up 3 bucks today...I wonder if I will ever get a chance to buy more. My gut tells me I won't. One thing that is kind of cool, is the money I spent yesterday buying the stock was basically the house's money, since my profits on the position were more than it cost me to buy what I bought yesterday, even when the stock was down so much.

As I mentioned before, I also bought those options mentioned on the daily-spec list today at $4.60 as another addition to my long-term portfolio. They expire in 18 months. I don't think I've ever actually heald a position for 18 months in my life. Maybe my CMCSA position is getting close to that length of time, but that would be about it.

Other than those 2 trades, I'm just patiently waiting for option expiration. I expect to make a profit this month. I have 2 positions which are problematic. ONXX is trading close to break even, and DY is at a considerable loss. Delta's on both of these are pretty high now. Either one could wipe out my profits for this month in the next 3 days. The rest of the positions I am still carrying, will almost certinately expire worthless, and are all presently trading with no bids. My PnL at this point will largely depend on the fortunes of those 2 stocks. This is the first expiration in a long time where I don't have to be concerned about getting assigned stock, as I am currently only using 65% of my margin capital. This makes it much easier to just relax, hang back and see how expiration goes.

I'm looking at several potential option short sales in the near term. I'm looking at establishing a new position in MO options, off of recent weakness...perhaps sep 65 or 60 puts. I want to wait to see if MO comes in a little more during this expiration week. I'm also looking at EBAY puts. Maybe Oct 32.5's or if ebay drops a little something in the 30 strike.

So much for backtesting?

2005-06-07T22:15:00.000-07:00

Well, I wrote some code this weekend to import my stricknet.com options data into my MySQL database. I had a few hours to burn tonight so I debugged it, and started importing one day of data as a test. The data from stricknet comes as a zip archivefor each day which contains 2 comma dileminated text files. The first one is about a 136KB uncompressed and contains end of day stock price data. There are around 2600 optionable stocks. The other one is about 6.1megs uncompressed and holds the options data. My program reads the files directly from the compressed zip archive and imports them into my MySQL database.

I need the data in a relational database. This gives me more flexibility, and makes it easier to do the complicated queries I will want to do as I develop quantitative options trading strategies. I also structure the data more efficiently than the simple comma deliminated list that stricknet provides. The comma deliminated lists contain much redundant information which I eliminate by using good data structure.

So anyway, I started importing the first zip file a long time ago and it's still not done. I don't know how long ago exactly. It wouldn't surprise me if this is taking over an hour for just one day's data. The stricknet data comes as 2 CD's and contains just a little over 2 years of data. There are what 240 trading days a year? 240 days * 2 years * 1 hour per day / 24 hours a day = 20 days to import the data...if it takes an hour to import each day's data. That estimate of 1 hour per day may be too low. This may be too long. If it takes that long I may never get all of the data imported and may never be able to do much backtesting.

I need to think of some optimizations. Maybe unzipping all of the data first would speed it up? I'll have to try that. I do a lot of checks to ensure the data-integrity as it gets imported. I suspect some are unnecessary, maybe eliminating some of these will speed it up a little. I could add some indicies to speed up the checks...but that would also slow down the inserting of new records.

I have another computer that I don't use for anything at all. It's a fairly fast computer. One of the first things I probably need to do is to set that up as a dedicated database server. Maybe that is what I do...Just start running the import program on that other computer 24 hours a day for a month or two.

This is a very discouraging development.

Hooey?

2005-06-07T16:38:00.000-07:00

Well, maybe all of that stuff about how you have to chase stocks sometimes to be a contrarian to justify my DNA entry was all bullshit? I could have gotten into DNA at a much better price today.

What it means to be a "contrarian" changes as the markets change.

2005-06-02T13:35:00.000-07:00

Last Friday I purchased some in the money QQQQ puts right before the close, because the market is overbought and sentiment had been very bullish for sometime. All weekend I felt like the trade was a mistake. The market felt (and still feels) like one of those markets where the market goes overbought and stays that way for a long time. When there is strong momentum, I don't think selling strong bullish sentiment works anymore. You just don't run out of buyers like you do in a down or range-bound market. The rising stock prices begin to attract new money, and stocks just keep going up. Shorting these markets too early can be suicidal. This is why I felt uncomfortable with the trade over the weekend. However on Tuesday, the market was down a little when I woke up. I resolved to stay in the trade. Then I read some article from Cramer on realmoney.com where he said he expected strength into the close. That was enough for me, and I exited the position at a small profit of $3.00/contract. By the end of the day as the market sold off into the close I felt stupid for listening to Cramer. I didn't feel dumb when I woke up on Wednesday to a really strong up market. I would have easily lost a minimum of 40 to 50 bucks a contract if I had still been in those puts.

Remember a while back when I said I was tempted to buy DNA LEAP CALLS? Remember how I congratulated myself for having the strength to resist my temptation to buy those calls? I would have made out like a bandit on those calls. They have almost doubled since then. I'm noting this, so that maybe I'll remember this next time I feel trepedation about buying premium. That pick would have made my long premium portfolio. PBG and NITE have been losers so far, but with the profits I could have made from DNA, would have more than made up for that. Remember the idea for being long out of the money puts and calls is to expect to lose money on most of your positions, and have one or two winners that are up so hugely that they make up for many small losses.

Part of the problem with a stock like DNA is the options I wanted to buy were so expensive on an absolute basis (they were cheap according to the Black Scholes Model however). At the time the call contract I wanted was around $280. When buying far out of the money options, I expect that more than likely I will have a complete loss on any individual position. Now losing 280 would not be a huge drawdown in capital for me. Over the timeframe of 6 to 9 months, I would barely even notice a loss that size. The problem is that a drawdown that size would be noticeable in terms of monthly profit/loss for my short premium portfolio in whatever month I took it. Right now I am focusing on learning to sell premium and being consistantly profitable every month. Psychologically the prospect of hurting my results in whatever month I potentially took a 280 loss was too much for me. I have found this year that even losing as little as 100 dollars on a trade here and there really adds up to hurt my performance over the long term. As I become more capitalized, I will be able to experiment more with trades like the DNA trade, because the loss from trading just 1 contract will become insignificant, since I will still be trading in the same size when I experiment.

The bottom line right now though is that I don't have enough capital to have a good expiremental long premium portfolio, as well as my primary short-premium portfolio. For a portfolio consisting of long puts and calls positions, I would want/need to be even more diversified than I am in my short-premium portfolio. I don't even have enough money right now to have a sufficiently diversified short premium portfolio. (I can be less diversified when short premium for a period of time because more than likely most of my trades will be profitable, so over any period of time my likelyhood of one position hurting me is small.) I should have 30 positions, all equal sized in my short premium portfolio. Right now I have like 9, and the position sizes vary more than is ideal. I would want at least 30 in a long premium portfolio to make sure my net was cast wide, since all of my profits would be coming from maybe as few as a couple of my positions in a year.

I sold short DNA JULY 75 puts today, with DNA around 82.85. Yes I'm chasing this stock up. Sometimes to be a contrarian I believe you have to chase stocks. Sometimes in markets "the crowd" is waiting for a pull-back to jump in. In such markets to be a contrarian you need to jump in early, since the crowd won't get their pull-back, and money will be made by the few who did jump in. Eventually the crowds will capitulate and buy, because their greed over the lost profits will be to much to bear, and the stock stops going up. Of course the chalenge is to know when we are in that accumulation rather than that capitulation stage. I guess we'll see.

I hope I am not jumping into this stock just because I feel bad for not pulling the trigger on that DNA LEAP call purchase last month. I don't think I am. I like the stock's prospects near term, and selling these options short has good theoretical odds and a high probability of profit according to the BS model. But really it's hard to know when bad emotions slip into trading decisions.

The June portfolio remains in good shape despite serius sell-offs in DY, GS, and ONXX. GS is still far above my break-even (around 10%). ONXX has sold off but seems like it wants to stay above the strike. DY is now in the money and below my break-even, but not hurting me badly yet. It's going to be awhile before I have to worry about being assigned. Since it is a small position and I have allready taken profits on some June positions, I will probably be ok if I'm assigned. Usually where I have to worry about assignment is when I'm transitioning into later month options, when at the same time I still have lots of front month options which I am waiting to expire. I often have to use most of my margin in such cases.

It's usually only for a few days that I am so highly margined...but unfortunately this is usually the few days when my danger of being assigned is highest. In such cases I get very nervous as an assignment would surely result in a margin call. I've never gotten a margin call so I'm not really sure how bad that would be. If my broker liquidated me out of really illiquid option positions that would really suck. I would lose significantly on the bid-ask spread. Interactive brokers doesn't actually give traditional margin calls...their computers just immediately liquidate your positions...I'm not exactly sure how that works since it has never happened to me. I think there is some way to set priorities for what gets liquidated first. I probably should do that...but I know I won't ever really worry about it until it hurts me. Sometimes lessons have to be learned the hard way. Maybe I'll get the opportunity to learn this one some day.

Am I addicted to trading?

2005-05-25T19:17:00.000-07:00

Well, I made several trades today, even though I was going to try to avoid over-trading this month. I bought a couple of the short-squeeze plays Cramer mentioned in Realmoney.com today. I bought some CIEN common at 2.35 and MLNM Jul $5.00 calls at 3.61. I was kicking myself after the MLNM calls. I noticed that there were august calls were offered at the exact same price...it seems like I should have bought the august calls and given myself an extra month for the trade to work, or attempted to split the bid/ask on the July calls.

RIMM is on my watchlist. Remember I have been trying not to pay close attention to the markets lately, lest I be tempted to overtrade. Well, about 4 minutes before the bell, I noticed RIMM was down a couple bucks and change. I ran the July $60.00 puts through my spreadsheet and they looked like a great risk/reward to sell them at $0.85. Then after I sold them short, I noticed that I had the June expiration date in the spreadsheet instead of July. No wonder they looked so great! I can't remember the last time I traded so closely to the end of the bell, when I didn't make a stupid mistake like this. It always happens. I always tell myself I won't do it again too. The last stupid trade I made near the close was also a RIMM trade in like February I think. The options still are a decent trade. If I allready didn't have a mostly full position for June...I would be interested in selling these for the July expiration. But considering that I allready have a good portfolio almost a month from the next expiration, I would have wanted to hold off for better oportunies.

I guess I was premature in declaring ONXX at a bottom the other day. It has sold off quite a bit and is now near the 25 strike. DY also continued to cause problems for the portfolio today, and closed below the 20 strike.

A Down day

2005-05-24T16:09:00.000-07:00

Most all of the stocks in the June portfolio were down a fair amount today. The only one that is really hurting me now is DY. What a stinker. That one gapped down and sold off all day. It's down like 19% or so to 20.34. My breakeven point for this one is 19.62. I'll be watching this one.

Fighting my own greed

2005-05-23T18:53:00.000-07:00

I know I said I would work on a synopsis of the May trades. I didn't get that done this weekend. One preliminary conclusion I have about the May trading is that I need to avoid over-trading. Over trading and impatience, turned what could have been a profitible month into a losing month.

The June portfolio is in excellent shape. Every position currently shows a profit. I'm more diversified then I have been in the past. Not only am I more diversified by holding more positions, but my positions are spread out over a wider variety of sectors. Typically in the past they have been concentrated in the internet and tech sectors. Furthermore I am currently using just a little under 50% of my margin. This represents a little under 2:1 leverage which is where I like to be.

Switching to naked puts from bull credit spreads is working beautifully. My one worry stock ONXX illustrates the benefit of the current strategy over the previous strategy. The stock took a huge plunge, but because I didn't pay for the insurance of a vertical spread I was able to be 20% out of the money, and I have not taken large losses. In fact I currently have a profit on that position. The price of the stock has stabalized, and IV has plunged.

I took profits in MOVI and NVDA today. They were both trading 5 dollars on the offer so I took it. I don't like paying the bid/ask spread twice, but when my options are allready almost worthless it would be a poor risk/reward decision to keep my capital tied up and at risk for another 28 days just to make another $5 per contract. This is the lesson I learned from my INTC position earlier this year, when I could have gotten out at $5 but waited and ended up getting out at I don't know $40 or so?

These stocks are another illustration of how the new methodology is an improvement over the old. Profits on MOVI were $33 a contract. Profits on NVDA were $43 a contract. If I had been in bull-put spreads, they would have been closer to in-the-money and would still be too wide to take profits this early. Even when the underlying moves in your favor strongly, vertical spreads tend to reach full profitability slowly. Furthermore if I was in bull spreads, and the spreads had narrowed enough to consider taking profits at this point, I would potentially have to pay double the transaction costs to close the spread...which makes it even harder to get out early at a good profit.

I want to put the capital that was in these positions to work in new positions. The loss of NVDA takes away tech exposure. I actually want tech exposure this month. I am tempted to put the capital to work right now by selling INTC June 25 puts, especially if I could get $0.20 for them. These puts have high theoretical odds, but yield a smaller return than I would normally like, but the money made from NVDA and MOVI probably exceeded 50% annualized return on capital (I haven't computed the exact numbers yet.) so putting that money to work at a smallerROI for the remainder of the month wouldn't be to bad, since I've "allready made my money for the month" with that capital so to speak. Any more returns on that capital would be gravy.

However, one lesson I learned from the last expiration period was to not over-trade. I recognize that I am starting to succomb to greed. The portfolio is in great shape, and I have benefitted from a strong rally, and yet I'm thinking about putting more capital to work to squeeze out even more returns. This feeling of greed, reminds me of how I felt in late December and January, when I had large gains and I became more agrressive buying more and more stock and calls as the market rallied hard, and then took some of my largest losses ever. I need to be ever vigilent against my own greed.

Because of this, I am intentionally trying to avoid watching the market and to avoid searching for new positions. When I am allreay almost fully invested and when the market has been rallying is not the time to put more capital to work. I need to be patient and wait for a good pull back.

Quiet expiration so far.

2005-05-18T15:33:00.000-07:00

There's not much to write about. I'm not looking to take on any new positions right now. I'm hoping to let Tol,ATK,UNH to expire worthless. Preliminary numbers look like May is going to be a push. I'll write up a postmortem later...maybe this weekend. It does look like I did sell GS at the absolute low @#$!@##$! When will I remember not to panic? If I sold today for example, I'd have gotten out even or a slight profit.

The June portfolio allready has considerable profits, despite onyx which looks like it may have bottomed. I'm looking to close the NVDA position at 5 cents if I can. If that happens I may start looking to add another June position. I feel very well positioned for June.

Sold at the low?

2005-05-16T19:50:00.000-07:00

Friday I blew out of the May GS position at a sizeable loss. I haven't computed the PnL yet because I've been too busy, but it's safe to say that that one loss will keep me from being profitable in May. I noticed that GS was up today (which was happy considering I have a June GS position.), I wonder if I sold at the absolute low between now and expiration? I guess we'll see in a few days.

The June portfolio is going well so far. ONXX is my worst position. That thing was down over 4 dollars today, but becasue my put was sold so far out of the money I'm not hurt to badly and still have another 2 to 3 bucks to go before it's in the money. I have high hopes for the change in strategy I mentioned in an earlier post. I'm selling naked puts now instead of bull put credit spreads. I would have been killed today on ONXX if that had been a bull spread becasue it would have had to have been closer to the in-the-money strike. I'm not out of the woods yet for onyxx. Another drop like today, obviously would cost me dearly. The June portfolio is actually slightly profitable at this point. I sold some MOVI puts. I actually opened this postion on Wednesday, but hadn't noticed until late Friday, that my offer was actually taken because it was on a different page in IB's Trader Workstation. I was mainly paying attention to my page entitled "May Position" due to the action in GS lately and ignoring my page "June Candidates".

Could you pass me some panic please?

2005-05-12T15:07:00.000-07:00

I sold NVDA 20 puts this morning for $0.50. Tech stocks have sucked for so long, and it seems like they've been getting stronger lately. I just thought I should get some exposure to these for the June portfolio. The stock has been trading down for the past few days, and it was up today. I felt a little bit like I was chasing the stock up a little, but I still wanted these options . Apparently NVidia had earnings today after the bell, and they were good. The thing is up another 2 bucks, since I bought it. I feel stupid for entering the position without checking out if there were earnings announcements coming up. I had no idea. But hey, if I made money, I'm not stupid...I must be brilliant right? right? So I guess will just call this a great call on my part!

GS on the otherhand....oh man...GS. Most of the day I was working, and didn't pay much attention to the market. Then, near the close I browsed the quotes and noticed GS was down 4 bucks! I couldn't find any specific reason for this and I believe you shoudl buy panic so I calmly sold the June 90 put. Shortly thereafter I saw on Realmoney.com that there was a rumor that GS has some bond problem unrelated to the GM situation. Now I changed my mind and decided that one should sell into a panic! I immediately began entering an order to close out my May 100 puts...but the closing bell rang just then and so I couldn't enter my order. We'll see tomorrow if that saved me from making a hasty decision or prevented me from cutting my losses...

GM, Convertable Arbitrage, and Rumors

2005-05-11T20:28:00.000-07:00

One of my friends asked me about GM today, so I said I'd write about it in my blog. Here's the deal. A lot of hedge funds use a strategy called "convertable arbitrage". Basically what they do is buy convertable bonds and sell the common stock short. If bad news hits the company (like bankruptcy for example), both the stock and the bonds will go down, but the bond will not go down as much as the stock, so they will make a profit if news is bad because the short stock position will make more money than they lose on the bonds. If news is good and the stock goes up, the hedge fund can always convert their bonds to stock to cover their short position. In the meantime in either case, the hedge fund collects interest on the bonds. (I'm simplifying things a little.) So it looks like a strategy where you can't lose money right? Sometimes weird things happen though. It had long been expected that GM's credit rating would be lowered to Junk status. At that point GM bonds and stock would both go down and as I wrote above, you still make money in the convertable-arb trade in that situation. Unfortunately for them shortly before that, something unexpected happened. Kerkorian made a tender offer to buy GM stock at a higher price than it was trading. People have a lot of confidence that Kerkorian will get involved and be able to turn GM around, so GM stock shot up. To make matters worse, GM hasn't cut it's dividend like everyone expected. This represents the worse case scenario for the converable-arb hedge funds. The stock is shooting up like a rocket while at the same time the bonds are going down do to the credit rating downgrade. So Monday a rumor was spreading that some big hedge fund blew up on this trade.

GS was down over 2 bucks on Monday. I think people were worried that GS might have some exposure to the GM convertable-arb trade. I was somewhat concerned. One more day like that and my short puts would be in the money...potentially causing me to lose serious money. Now, I didn't believe that GS would actually be hurt by exposure to the GM conv-arb trade, but I was worried that the fear might not blow over prior to options expiratoin. At that point it wouldn't really matter as far as I'm concerned. I'd still lose money.

Apparently the fear subsided. GS was up almost 2 bucks today (Tuesday). In retrospect, I should have sold GS 95 puts for the June Portfolio at the time. Unfounded fear is the ideal time to get long. I think I was so shell-shocked by the huge sell-off in GS that I didn't even bother to check June GS options out. Other than that Monday was uneventful.

Today was a pretty active day. First of all, I finally got my price for the June MO 60 puts. I wanted at least $0.70. This morning I sold them short for $0.75. I possibly could have gotten $0.80 if I had been more patient...but I had been waiting for days to get my price. I was tempted many times in the past few days to sell for $0.65. I'm glad I waited.

I also sold ONXX June 25 puts for $0.75. Normally I would kind of avoid selling naked puts on a biotech. I see them gaping up and down more than 50% all of the time. Cramer wrote an article about how there's some sort of cancer symposium this weekend and a bunch of biotechs including ONXX might make positive announcements at the conference. He liked ONXX because it hadn't run up, while the others had. I looked at the options, and these ones looked attractive. It's not like there is an FDA announcement coming out this weekend, so I don't see any potential for some huge gaps. The options are 19% out of the money, and the chart kind of looked like it had some support above that strike so I felt like there was enough safety to enter this position.

I feel like I have sold the minimum number of options for June expiration now. I would like to find more positions to enter, but the market is getting over-bought and will be max overbought around may expiration probably. It is becoming a time to sell not buy. I need to be careful not to chase the market up.

I tried to enter the GM convertable arb trade today. James Altucher wrote on Realmoney.com that this could be a good time to enter, because you'd be taking the other side of the hedge-funds that are supposedly being forced to liquidate. He writes in his book Trade Like a Hedge Fund, how to do this using prefered stock. In this case I wanted to buy GMS and sell GM at a 2:1 ratio. Of course I couldn't get any GM to short. Do to recent SEC regulatory changes, it is often very difficult for retail traders to short stock lately, but if there are massive liquidations of the GM conv-arb trade you'd think that there would be some shares available to short? Maybe this is a sign that the rumor wasn't true.

GOOG Profits

2005-05-09T15:21:00.000-07:00

I'm still looking for Summer premium to sell. I sold June 25 puts on CBH today. They are ~8% out of the money. I've been watching this stock as a candidate for several months. It was down today because some of their former executives got convicted or something. This was a pretty good price but not as much "edge" on them as I would have liked. Apparently Cramer says to wait a day to buy this stock. I might have been a little jumpy on the trigger finger today because I've been watching this stock for so long...maybe I should have waited.

I needed more capital for opening positions in summer options so I also closed out the May GOOG position for a profit of $93/spread.

It is looking like I was premature in closing out my TWX position last week. That thing has consistently stayed above the strike and I think it most likely will until expiration.

Doubling up on LU common for the longterm portfolio a little while ago, appears to have been a good idea in retrospect. LU is up big because they announced a buy back for some convertable prefered shares.

I worked on the earnings volatility buying system this weekend. I think my earnings data downloader is done, and I am currently testing it the background while I work. In a few hours when I've confirmed for sure that it works I'm going to start on step 2, by purchasing options data.

Am I an insurance salesman?

2005-05-06T13:19:00.000-07:00

I was pretty active today.

While I was looking for options to sell for summer expirations, I notice that TOL May 70 puts were selling for$0 .55, which is a pretty good return on capital for 14 days of risk. I don't feel terribly bullish on Toll Brothers. Toll brothers is a homebuilder, and homebuilders have run up big this year. The great jobs report today can't be very good for Toll Brothers, either. With the job market booming, the fed is more likely to continue to raise rates to pop the "housing bubble", but is there any pending events that could drop TOL 9 points in 14 days? I looked around on the net for news on TOL and didn't see any events coming up, except for their earnings which isn't until after expiration. I don't need to be terribly bullish on TOL to think that it won't drop 9 points in 14 days so I sold those options short. I am a little concerned that there is something I'm missing here, though.

I also purchased some HON common stock for the weekend. Cramer wrote on RealMoney.com that there was unusual call option buying in HON, so I bought some on the rumer that there will be a take-over bid...apparently a lot of other people had the same idea, as it was reported on extensively by CNBC today. I'm not terribly thrilled to be part of the herd buying a stock on a rumor, but I've made money before from what I consider to be similar Cramer calls, and the risk isn't large for this position....Oh great THIS JUST IN! Cramer just said on Mad Money that he would have sold the HON at the end of the day...He didn't outright say this on RealMoney.com...I kind of got the impression that he was saying to buy it for a few days. Oh well...and I was tempted to take my gains today....

Anyway I was looking for stuff to sell for summer expiration months. My favorite candidate is the MO June 60 puts, but I need to get at least $0.70 for those puts, a price that was unavailable today. I did sell DY June 20 puts for $0.40 today. In this stock I have slightly changed my approach, in several ways. Usually I take positions in stocks that I have been following and know something about. I had never even heard of this stock before yesterday evening. In the past I have rarely been able to find even 5 stocks to sell puts on. I would like to establish more positions going forward so I haveto cast a wider net, and am now selling puts on stocks I don't know as much about. This is for two reasons. First of all, I want to be more diversified. Secondly, I mostly follow stocks like GOOG, EBAY, QCOM, INTC, CSCO, LU etc...those are yesterday's stocks. Those stocks belonged to the 1990's (except GOOG of course). Going forward I need to start learning about other types of stocks, because I don't believe the nifty ninety's stocks are going to be the best stocks for the 00's. We'll see how well this turns out I guess.

The biggest change in approach is that I am selling naked options again, instead of selling only bull spreads like in March, April and May. For those unfamiliar with the term "bull spread", let me explain what I mean. If I sell a put short, I am entering into a contract that says I have to buy the stock at the options' strike price from my counter-party at his whim. Essentially I am selling insurance against losses, and my underwriting fee is the option premium. So for example if a stock is trading at $55, and I sell a put with a strike of $50 for say $0.45, I am now exposed to losses of around $5000 for a contract of 100 puts. So I am making 45bucks and being exposed to a risk of losing 5000 bucks. That doesn't seem like a very good deal does it? But that is what I do...I'll make a longer post some other day and explain why I do this.

Now it is unlikely that the stock will drop to zero, but what if the stock drops to say 25? That would still be a sizeable loss of around $2500 dollars. Since I am usually margined, that could very well be a 100% loss on the position. After reading Telab's Fooled By Randomness, I became less comfortable with naked put selling. Telab warns about the so called "Black Swan" events...Rare unexpected events that come along and wipe out traders like me who expose themselves to unlimited losses.

So what I have been doing is this. When I sell that 50 put short for $0.45, I also buy some insurance of my own in the form of purhcasing a 45 put for say $0.15. Now for this position I am only making $30 profit but my maximum downside risk is clearly defined at around $500. This is what I meant by the term "selling a bull spread". Note that even though I am making less money, my return on capital is actually higher. Before using %50 margin instead of the aproximately %25 margin I'm allowed on a naked put sale, it would cost me around 2500 to cary that position, so my return on investment would have been 45/2500 = 1.8%. But now I only need around 500 to cary the position so my return on investment would be 30/500 = 6%.
Another important reason for buying insurance was that I typically didn't have very many positions. Ideally I would need to have 20 to 30 positions to be well diversified instead of only 5. With my capital divided among only 5 positions, I'm especially exposed to extreme price moves which are common in any individual stock. If I had my capital divided among 30 positions then I would have less need for insuring each individual position. Instead I could just buy puts on the S&P to insure the whole portfolio, against an extreme market move, and absorb whatever individual stock risk I suffer on any individual stock since the capital in an individual position would be small.

So why have I decided to go back to selling naked puts instead of bull spreads? By not buying the insurance I can go down to a lower strike, increasing my chance of profit. For example let's look at this month's TWX fiasco. I sold TWX $17 puts for $0.20. I then insured myself by purchasing $16 puts for $0.10. This left me exposed to a maximum of $1.00 per spread for a 10 cent profit per spread. Now this was a stupid spread to enter, because transaction costs are too large for such a small profit...but I'm using it as an extreme example. Well if I had just sold the 16 puts naked for .10 I would have been making the same amount of money, but I would have a lot less to worry about because the risk of TWX dropping below 16 is much smaller than the risk of it dropping below 17. By giving up protection against rare events, like say TWX dropping to say 10 dollars in one day for example, I give myself more protection against common events like TWX dropping a buck maybe. I still plan to insure the whole portfolio against large market drops by purchasing index options.

The price of "peace of mind" = $0.16

2005-05-05T18:13:00.000-07:00

I closed the TWX position for about a $16 loss per contract. This was probably premature, but I just don't want to deal with it anymore. I had a bad feeling about this position all allong. I chased the stock up the day I bought it. Then to make matters worse, I sold bull spreads, even though the difference in option premiums was very narrow, and the profit potential was small. Hopefully I've learned good lessons from this fiasco. As I look for new positions to enter I do feel a little bit of a temptation to chase stocks up, and enter positions that I'm not terribly excited about. I need to keep reminding myself of TWX as I search for puts to sell. One stock I'm interested in is MO. I will be looking for a good entry into MO tomorrow.

Yesterday I finished reading Options as a Strategic Investment, by McMillan. I've learned so much from reading this book. This is definately the best book on options I've read. I have so many ideas I want to start working on. This motivated me to do a little bit of work on the Maestro's system which I posted about earlier. I'm almost finished with Step 1:"Write routines to import earnings from finance.yahoo.com.

Keep risk per trade constant!

2005-05-04T21:05:00.000-07:00

Friday evening I checked out the CBOE equity put/call ratio. It looked really high to me (.78 I think). Normally I would not want to be long puts with such a high put/call ratio. Sure enough Monday morning my SPY puts were down around $0.30. I offered 1/3 of the position 15 cents above the bid. I should have waited for that offer to get hit, because it would have in the next 30 minutes....but I panicked as SPY started to drop a little, so I hit the bid for all of my contracts. That is the problem with bigger positions. I get panicky and impatient which causes me to trade poorly. I probably could have halved my losses to 15 cents per contract if I had been more patient.

This loss erased my previous gains from trading the QQQQ's this month, and will take a good bite out of my profits from the May Portfolio (assuming I end up with any). I think one of the most important rules to follow in trading is to keep the amount risked per trade fairly constant. I didn't follow that rule this time and my % return this month will suffer because of that. It's interesting. I have a bookshelf full of books about the stock market and trading, but I can only think of 2 books that specifically mention this rule, although many implicitly state it when they discuss money management ideas. Maybe this idea is too obvious to be mentioned in most books. It certinately wasn't obvious to me as a beginner, and I frequently changed my bet sizes. I first read this rule explicitly stated in Practical Speculation. I remember reading it and thinking how important a principal that this was at the time. The only other book I can think of that explicitly states this rule is also one of my all time top favorites: The Zen of Gambling. This is kind of a hokey book, and it is written in an extremely simple style, but it is full of profound insights about what it means to be a contrarian. I should re-read these books.

On Tuesday I opened up a position in Pepsi. I bought some out of the money Dec 05 calls. This is a very small position. I'm going to be looking to establish a small portfolio of long term out of the money options in companies I like that have a good theoretical edge. I almost always sell volatility, and I need to get past my phobia for buying volatility. Most of these positions will be total losses. I need one or two to gain enough to overcome the losses on all of the rest. Hopefully I can get a feel for what it's like to buy options it instead of shorting them without losing too much money.

I'm not being exactly truthful to myself. I definately do have a feel for what it's like to buy volatility. I lose most of the time and it sucks. That's why I have the phobia! Basically I think trading methodologies come in 2 types.

Type 1: High probability of profit per trade. Losses are bigger than winners. These are your countertrend/reversal, and option premium selling methodologies.

Type 2: Low probability of profit per trade. Winners are bigger than losers. These are your trend-following systems, and premium buying methodologies.

I'm more comfortable with type 1 systems. Most of the time you are making money, and that feels good. The chalenge with type 1 systems is not to go broke when positions move several standard deviations against you. Fat-tails in the price-distribution curve are the enemy of type 1 systems. If you read my blog much, you've probably figured out that one of my favorite authors is Niederhoffer who is a type 1 trader and he busted his fund! Type 2 systems are harder systems to trade because most of the time you are losing money, which makes you doubt yourself. Type 2 traders benefit from the rare extreme moves. The chalenge with type 2 trading is to keep your losses as small as possible, while waiting for those extreme moves where you make all of your money.

One of the best books I've read this year was Fooled By Randomness, by Taleb who is a type 2 trader. Reading this book caused me to start thinking about buying option premium. I am not sure who is right Niederhoffer or Taleb, but I would like to learn to trade in the type 2 style just to expand my arsenal.

I have never been very disciplined when buying option premium. I think my main problem with buying premium is that many times I've put too much capital in individual positions. Since most of these positions will be losses the position size must be small.

I'm guessing that Time Warner's earnings were good. It was up big today. Now all of my May short puts are in great shape, for the time being. I could close all of my positions for 2/3's of the maximum possible profit right now. Two and a half weeks to expiration... I need to start thinking of some ideas for June/July expiration.

Neutral

2005-04-29T14:05:00.000-07:00

I opened a fairly sizeable position (by my standards) in SPY 118 puts at the close. These puts are around a a little over a couple bucks in-the-money. I'm in them at 280.6 per contract. I think (hope?) the market is going to rally after the FOMC meeting on Tuesday. Despite that sentiment, I opened this bearish bet because I don't believe this big run-up into the close. I think the people who made money short yesterday and this week, were covering to get flat in front of the weekend. In addition it's the last day of the month, and long-only funds may have been defending their positions. Furthermore, on Monday the SEC is dropping the short uptick rule for many stocks...maybe Monday there will be a tendacy for people to exercise their new found freedom to short at will. At any rate, I hope to be out of this position prior to the FOMC meeting. According to IB's interactive Analytics I am now completely delta neutral, going into Monday. I'm not sure if that was my intent but oh-well.

The May Portfolio got hit big time by TWX today. Right now if TWX doesn't recover that one position will cost me all of the potential profits from the May portfolio. Of course, if it goes worse, I could start to get really hurt.

Nothing to see here.

2005-04-28T16:46:00.000-07:00

I am very pleased how well the May Portfolio stood its ground today. We had a big sell-off today, and none of the May stocks dropped very much. A lot of these stocks were selling off big during some of the other sell-offs. I think this may mean that we have bottomed...yet I still have much trepidation with the fed meeting next week, and the market becoming overbought some time next week. Other than that, this was an un-eventful day for me tradingwise.

No more earnings plays.

2005-04-27T16:08:00.000-07:00

I traded out of my last earnings play today at a 50 dollar loss. I was probably pre-mature.

The May short-premium portfolio is doing well. It feels like theta decay is starting to set in. GS and UNH were strong today.

Indecisive

2005-04-26T13:30:00.000-07:00

I didn't do much trading today. I tried to get out of AFC at a small loss. This is the last earnings play I'm still holding. The spread was huge in this option. I offered in the middle, but never got lifted. I don't know why I want to get out of this position. Earnings don't come out until Friday. It's probably a good idea my offer never got lifted.

I also put in a bid at 2.80 for DNA September 85 Calls. According to optionetics' model it has a high theoretical edge. Eventually I cancelled my bid though, other than the theoretical edge I really didn't have a reason to buy. Furthermore, I have a general phobia against buying out of the money premium. I know that more than likely each time I do it I will lose money. If the expectation is high I should still be willing to lose money 2 out of 3 times, assuming I'll make it up every 3rd trade, I guess. Probably in this case it was a good idea to cancel the bid...I would have lost 30 cents by the end of the day.

I was tempted to buy QQQQ puts yesterday...wish I had. It just seemed to easy to keep trading counter-trend in the QQQQ's every day..I was concerned that my last 2 QQQQ successes in a short time frame was making me arrogant so I chose not to trade yesterday. Even though the market sold off today, I didn't buy either. I think it has been so easy to just buy every dip and flip the next day lately...the masses are going to catch on soon and get crushed. Maybe I'm out thinking the situation though? I'll be checking the Put/Call ratio tonight. If it ticks up again, I may be looking to buy if the market is down much tomorrow.

My May short-premium portfolio was down slightly today. I could get out of my May portfolio for a small loss at this point. If I trade around it a little I could maybe even get out for a push. I'm tempted to get out and wait for the easy money to return...it always returns right?

All my time on the tools...none on the actual work.

2005-04-25T18:47:00.000-07:00

On the Elite Trader message boards, a guy who posts under the user name of Maestro posted this message:

The only high probability straddle play is the IV play. I normally buy a straddle on the following conditions:

1. Typical historical IV of a security on the day of the report/announcement is >= 60%

2. There are 3 - 5 days before the announcement

3. There are 10 - 30 days to the expiration day

4. Current IV <= 30%

If those parameters are met then buy a straddle and sell it on the day of the announcement as the IV peaks. It typically makes 10 - 15 cents profit after commissions and slippage.

Cheers.

Most of what is posted on Elite Trader is garbage, and only useful as a contrary indicator, but what I like about the boards is that there are a fair amount of professional traders who frequent it, and you often see a few gems of insight. I think Maestro is one of those people. I want to systemize and backtest this trade he talks about in his message...not because I think it's a great system that will make me a lot of money, but mainly because it will be a good exercise to help me learn about volatility trading. The tasks I will need to do to implement this system are as follows:

(1) I will have to write routines to import historical earnings data, which can be obtained from finance.yahoo.com. This will give me another valuable source of market information to study.

(2) I will have to buy options data, and create a database structure to hold it. Gala suggests that I buy it from Stricknet.com. It like their prices, and I am going to go with them. Unfortunately I will only be able to obtain data back to 2003, but that will be fine to start with. I will have to be careful how I interpret any results I get from analyzing this data because volatility has been steadily declining since 2003...eventually I will need to get some data from periods during which volatility steadily increased. Creating the database structure and tools to import the data will probably be the biggest task, but cnce this is done, the door will be open for me to do most any options study I could think of. This will be a huge step forward in my quantitative toolset.

(3) I will need to write routines for calculating implied volatility, from the options data. This won't be a huge task. This will also be a very nice addition to my quantitiative toolset.

So as you can see, whether backtesting this system gives good results or not, I will have built some very useful tools and knowledge from just testing it out. One of my favorite stock market authors is Victor Niederhoffer who wrote 2 great books Education of a Speculator, and Practical Speculation. One of the important points I've picked up from his blog and his books is to test everything that can be tested, and that is also why I want to take on the task of testing Maestro's system.

I took a little break from my regular work Saturday to start on step (1) from above. I determined that I needed to speed up my database before moving forward. I mentioned previously that my database of stock market information has grown recently, and my structure was no longer able to handle the immense amounts of data. I spent some time learning how to optimize MySQL.

I have a program that is used for managing and viewing the data in my database. The first time I executed it a few weeks ago, after the new data had all been downloaded, it took more than 15 minutes to execute it's first query. I closed the program before it could finish. I spent a few hours learning about database optimization. I added a few indicies and removed most of the inidicies that I had previously added because I discovered they were inefective. The query now takes exactly 1 minute and 33 seconds to run now. That is the power of a relational database system, and I am quite impressed that without changing any code...just optimizing the structure a litte I was able to get such a dramatic increase. (even though I work with relational databases on a regular basis, I was still surprised...) I also now execute this query in a separate thread so that the main program can be used without having to wait for this query to execute.

Maybe I should only trade the Q's?

2005-04-25T14:01:00.000-07:00

I sold my QQQQ Calls today for a profit of 57.50 per contract. I'm pleased with my execution. I sold at 4.50, and I don't think I could have obtained a higher price today.

I buy or sell the QQQQ's in small quantity every now and then based on my "feel" for current market sentiment, which I get from reading the market news. If sentiment seems to bullish I short the Q's, and if sentiment seems to bearish I go long. I haven't maintained accurate records of these types of trades, but I think I almost always make money when I trade the QQQQ's, and when I don't my losses are usually small. Usually these trades are over a couple of days. I sometimes wonder if I should only do these types of trades. I would keep my entire account in cash, and just do these QQQQ swing trades in large size every few months.

The question is would I have enough discipline to do that? I would be following the markets every day, but only making trades every few months, or maybe every few weeks. I'm not sure I have the discipline not to overtrade. Furthermore, most of my Q's trades are short trades that I take on as a sort of hedge when I am nervous about my pre-existing positions in the market, which are always net bullish. If I didn't allready have bullish positions would I be able to take on the trades at timely market points without that gut bad feeling about my other positions? Finally, there is one other problem. Maybe I only remember the good trades and I'm not as good at trading the Q's as I think. This is the kind of thing this blog is for. Months from now, I will be able to look back at my trades and not only have a record of my trades, but also a record of how I felt about them at the time.

The May portfolio was down today. UNH dropped below its strike early today, but rallied and heald above the strike most of the day by a thread. Near the close it recovered a little. I am very concerned that this one position could wipe out all of my profits for the month, and maybe last month's profits too. I need this position to hold above the 90 strike for 4 more weeks...

On a side note, I have a volatility trading system I hope to backtest and post about soon. I still need to finish up some work for my main business, before I can feel good about spending a weekend programming trading strategies.

Easy Come...Easy Go

2005-04-22T16:10:00.000-07:00

I took some losses today. Apparently HAR's earnings didn't help the stock out. I took a $155 per spread loss on the HAR bull debit spread. This brings up a dilemma. I could have closed the spread up $70/spread yesterday. Almost every single earnings season, I have a position where I'm up big prior to earnings, and I wait for earnings and the stock loses the gains. Afterwards I tell myself that if I'm ever up big prior to earnings that I will sell before the announcement. Will this be the last time I don't sell in advance of earnings? I hope so.

I re-entered the QQQQ May 31 calls that I sold yesterday. I was pleased that my price was close to the lows for the day. I probably could not have bought any lower. After I bought them, the market rallied a fair amount. Generally on a Friday like this where the market has moved big in one direction, I expect a counter-trend to develop into the close as winners take profits and get flat for the weekend. It seemed like today's rally off the lows was particularly fast and strong...could this be a sign that shorts are nervous, and maybe we had a bit of a squeeze? Maybe this is wishful thinking because I am long.

I added a new position to my long-term portfolio. My long term portfolio consists of stocks I hold for 6 months+. I purhcased a small amount of NITE stock and some out of the money January-2006 NITE 10.00 calls. One of my favorite RealMoney.com columnists, James Altucher(Trade Like a Hedge Fund, Trade Like Warren Buffett) has written a series of articles recently highlighting NITE as a value play. Today in the Columnist Conversation section of RealMoney.com, Cody Willard, who is another one of my favorite columnists, mentioned that he was acting on James Altucher's idea by buying NITE stock and some out of the money calls, so I decided to try the trade too (in small size.) My other long term positions are SHLD, CMCSA, LU, and XEC. My long term positions almost always come from reading Realmoney.com articles.

The May portfolio is no longer at a positive P/L. All positions are still above their strikes. Considering how much the market sold off, I am pleased how well my positions heald up. Compared to the other recent market sell-offs, my positions were not so volatile today.

First Profits of the month!

2005-04-21T18:06:00.000-07:00

I took some profits today, and it felt great! I mentioned earlier that I had bought some option picks from two of Steven Smith's column on realmoney.com. In last week's column he had suggested YUM Calls, AFC Calls, and OSI Puts. I couldn't get a fill anywhere near the price he suggested buying the YUM calls at, but I did get fills in the AFC and OSI positions. OSI sunk today, and I sold my puts for a profit of $149 profit per contract. It was fortunate that I was not executed on the YUM calls. Yum's earnings weren't good enough, and it dropped today. I feel relieved that I did not chase that one up. If I had actually been able to get executed at the price he suggested it would have been a very small loss so it was actually a great call on his part, since it was such a low risk relative to the potential reward for the trade.

Steven Smith wrote another column yesterday where he suggested TXT and HAR calls as further earnings plays. Now this is a situation where I missed out because I was unwilling to chase the price up. He suggested buying TXT at $0.75. I put a limit order in at $0.75, and never got filled. There were plenty of opportunities to get executed at around $0.90 though after I read the article. The earnings for TXT must have been good, because the calls closed at 2.70 today, and traded well up into the mid $3.00s intra-day, so I missed out on a big gain. I did get executed on the out of hte money bull debit spread in HAR at about the price hs suggested. HAR was up big today ahead of the earnings, but the bull spread was still out of the money. Earnings were after the bell so we'll see tomorrow if I'm able to make any money off of this one.

I know why I was reluctant to chase these positions up. (TXT and YUM) It's because last week, I chased up TWX and UNH, which have been my most problematic positions. You win some, you lose some...phantom gains aside, it's still probably a good policy not to chase stocks that have run up. I must not let the missed opportunity in TXT affect my discipline.

I also sold my QQQQ May 31 Calls today. I feel very good about my other sale (OSI). By the time I woke up, it is unlikely I could have sold at a higher price than what I got. In fact I got executed within $0.10 of the high for the day. I do not feel very good about my sale of the QQQQ calls. I only made $28/contract. My intuition told me that the market would be strong all day. By the time I woke up, the market was up big, and I felt that shorts would be panicking on such strength and would cover into the close, pushing the Q's higher. Well after a small run in the nasdaq higher, the nasdaq ticked down a couple points and I opted to hit the bid on these options. I immediately felt dumb for it. It was pure emotion. I didn't want to risk having to get out of this position turn into a small loss. One camp says you can't go broke taking profits, but I disagree. For the amount of risk I was taking on in that position I should have had the patience to hang on for a bigger gain.

The May short premium portfolio ticked into the green today. The Good news for GOOG and EBAY obviously helped me quite a bit, but more importantly TWX moved up big today and is no longer in the money. I'm still concerned about GS and UNH. I suspect that the over-all market will trade higher between now and May expiration, and that should keep GS and UNH above their strikes. (I hope.)

A Green Day

2005-04-20T18:49:00.000-07:00

The May portfolio had its first up day ever. After being down every day for like a week this was a nice break. The market was anticipating good earnings for Ebay, and apparently Ebay delivered. TWX is slightly in the money now. I will waitat least for TWX's earnings on May 4th before closing that position. GS is within a day or 2 of going into the money. Unfortunately since GS and UNH have both allready released their earnings (and they were good), I have no catalyst up ahead to turn these stocks around. These two will only stop selling off once the broad market stops going down.

I took on a few small long option positions based off of some "earning surprises" picks from the option guy on Realmoney.com. I'm starting to feel a little uncomfortable with the amount of capital I have at risk, considering these are all out of the money long option positions. There is a very high likelyhood that some or all of them could be near total lossses. I'm going to look to sell off my QQQQ long option position soon. I bought it in case of a quick bounce back, and we haven't gotten it. I will look to sell it soon, maybe tomorrow.

A reprieve from the bleeding?

2005-04-19T15:51:00.000-07:00

Well it looks like the UNH CEO appearance on Cramer's show last night did the trick maybe? UNH was up today. TWX was up much of the day as well (closed 0.2 down though). Both are still above the strike of my short puts. Hopefully these 2 positions continue to hold out. INTC and Yahoo both reported good earnings and are way up after the close. Hopefully I get a nice pop on my QQQQ calls tomorrow. The yahoo earnings are also moving GOOG. This helps, but my GOOG short puts have always been comfortably out of the money, and have allready lost a lot of premium. I'm wondering if the yahoo quarter will be good for EBAY? EBAY is up after hours today....but if YHOO is doing well maybe that means EBAY has to spend to much for internet advertising?

Only 32 more days until options expiration. I'm starting to notice a monthly cycle. I'm biting my nails for the few weeks after expiration as my new positions for the next expiration get put on. The premium is largely a function of volatility (vega) at this point, and theta (time) helps me very little. If the stocks move against me, I see large losses in my P/L, but when they move for me, the options premium barely budges in my favor. Then a week or two before expiration, the premium starts to evaporate at a high rate and I'm much more relaxed. Options expiration has become something I look forward to every month. It's the same feeling I'd get in school when I looked forward to school letting out for the Summer.

Actually I would feel pretty relaxed now, if UNH and TWX weren't so close to there strikes. Normally I have a much larger buffer this far out from expiration. I need TWX to stay above 17 and UNH to stay above 90. Hopefully in the future I'll remember this fiasco next time I'm tempted to chase stocks up.

The market didn't crash!

2005-04-18T17:56:00.000-07:00

Ok, I didn't really expect a crash today. It seems to me markets don't crash when all of the sentiment indicators say that we are at an extreme bearish reading, and the put/call ratio is high, but what do I know? I've never been in the market during a crash.

I bought the market every day last week, with my most bullish purchase on Friday at the close. Over the weekend I had nagging doubts, as I talked to my friends. It seemed most people weren't really aware of the extent of the sell-off that we had last week, which contradicted my feeling that the negativity was all priced in. I felt better Saturday Night. Flipping through the channels, I noticed the market decline got mentioned on Weekend Update of Saturday Night Live.

Anyway, I was a buyer almost every day last week. I tend to distrust volatile action during options expiration, and on top of options expiration, we had taxes. I was thinking that with the market down, people might be inclined to sell stock in order to lock in some capital losses to deduct on their tax returns, and that this could be aggravating the situation. Cramer had a column on realmoney.com with another tax angle. He said that the AMT is hitting more people than usual this year, and this is forcing people to sell in order to pay their unexpectedly large tax bills.

The May options portfolio is holding up ok except for 2 positions UNH, and TWX. I bought both of these guys right after the fed notes came out and the market had that huge reversal to the upside. I had been watching these 2 stocks, and was worried that I wouldn't find any more ideas for the May option portfolio. What a big mistake chasing those stocks was. These 2 positions are now close to being in the money. If I had waited a day or two I would have been in a much stronger risk/reward position. Furthermore I ended up finding plenty of other stock's to fill out a full portfolio for May expiration anyway...many of which were much more attractive than those damn TWX puts. I saw that the CEO of UNH was to appear on Cramer's mad money today. Unfortunately I had an appointment and had to miss the segment. Here's hoping he can pump up the stock. (I'm not optimistic.) I'm very dissappointed with myself for getting cought in that bull trap.

This is why I need to develop some good trading systems. Whenever you are trading on a discretionary basis...it's so easy to make huge lapses in judgement do to one's emotional state. My heart-rate was elevated while I made those trades. That should have been my first sign that they were a bad idea. It's been a long time since I've felt any kind of emotional response while actually making a trade.

Pairs Trading

2005-04-16T17:32:00.000-07:00

So it looked like I was going to have a little time this afternoon to work on trading systems. I recently re-vamped and re-structured my stock database. I also added a huge amount of new data. I felt like working on some Pairs-trading. I wrote a C# implimentation of the Unilateral Pairs trading strategy in James Altucher's book "Trade Like a Hedge Fund" last summer, but I never did anything else with pairs trading strategy, but I did moniter the system using the QQQ/SPY spread off and on this past year. I don't think the system works anymore. It does seem like I see a lot of "buzz" on the internet about people using Pairs strategies...maybe that's why. Perhaps it's a crowded trade now-a-days. Anyway I had some ideas for pairs trading strategies I wanted to look at this afternoon. So I opened my control center app that I wrote for viewing the data...and I waited...and I waited...and I waited. Apparently with all the new data I've added to my database the database is now way to slow as it is currently structured. So I guess I'll spend time trying to figure out how to optimize my database instead. The first thing I did was add a new index. (about an hour ago) Now I wait for MySql to index the data.

While waiting for the re-indexing I started this blog. I've wanted to keep a trading diary for some time, but I lacked the discipline. This blog will serve as that trading diary.

Well it looks like the re-indexing worked. Now the query only takes a few minutes instead of over 15 minutes. I still need to get this faster, waiting 2 or 3 minutes to load my program so I can debug will mean for slow development.

What a week.

2005-04-16T16:50:00.000-07:00

I'm so glad that April Expiration is over. Last week I was coming into expiration with a nice profit, and almost all positions profitable. I had read a link on Galatime (sorry don't remember post or link) about closing positions 4 to 10 days before expiration week. Basically the gist of the article was that options expiration week belongs to the professionals, and retail traders aren't equiped to compete at that time. This brought up a dillema...part of my rationale for selling out of the money premium was to avoid paying the spread both ways on most of my trades by just letting the option positions expire worthless, but still I could see the point of the article. So what I did was I closed some of the more volatile positions that were allready very profitable. I retained all of my positions that were trading at close to worthless ($5 to $10 on the ask for the short contracts), and I retained my volatile positions that still had a fair amount of premium left that were still well out of the money. Then options week came, and the market just started selling off. I ended up having to close several positions because they were getting in-the-money, or getting close to being so. I only lost money on one position which was good, but on many of my positions I ended up giving up substantial portions of the paper profits I had last week. The net effect was I gave up around half of the profits I could have taken last week. I suppose I should be happy I had profits at all after such a bad week I guess.

The one that hurt the most was a naked 32.5 INTC put, that I had sold around January for $125/contract. I could have covered that position weeks ago at $5 to $15 per spread easily. I ended up covering for $50 dollars on Friday. Ouch.

The question is what am I going to do moving forward? I don't know. In one sense this was kind of an extra-ordinary week. Maybe I shouldn't change my methodology because of one bad week. Options have such a large spread. I really hate to pay the spread twice. I don't know what I'll do next expiration, though.

I have 6 out of the money bull-put spread positions (GOOG, GS, UNH,TWX,ATK, EBAY) so far expiring in may. All are still out of the money, but I am starting to get nervous. One more day like Friday and some will start to move into the money. I also went long fairly deep in the money QQQ Calls (don't remember which strike) on Friday to attempt to catch a bounce next week. One nice thing about May's short option portfolio is that I had decided as I was building my positions for May expiration, to hedge with index puts for the first time. I went long some deep out of the money SPY puts in an attempt to protect the May portfolio against a 10% market decline. This is my first time hedging the whole portfolio with index puts...if the market keeps tanking maybe I'll get to see how well this works...

First Post

2005-04-16T16:42:00.000-07:00

Testing...