Long time no post

I just checked the usage info for my blog here and I noticed I've been getting quite a few page views recently over the past 4-6 weeks... In case you're new to my blog, and looking for how it is organized, here's a table of contents of sorts:

Top part of the blog (ie: the post starting directly below this one): Just random trades based mainly on technical analysis. This is when I started getting real busy at work, and transistioning into a new role trading at a hedge fund which now consumes most of my time--this is also the reason why I haven't posted for about 3 months until now.

Middle part: Technical Analysis of futures trades (oil, bonds, equity indexes, etc), and the output/results of a couple algorithmic trading systems I developed.

Bottom of the blog (scroll all the way to the bottom of this webpage):
THIS IS WHERE ALL THE FUN IS!!
This part outlines, and provides many examples of my options trading styles and strategies. You can see how I trade a direction neutral, unleveraged, options only (and futures) portfolio using analysis of the greeks as the basis for portfolio construction and risk mgmt. This is my favorite way of trading, but had to abandon doing it for the profit of my personal account when I started working jobs with trading restrictions imposed--one day I'll be able to trade this way again and relive the good ol' days of grad school and making easy money in the SPX/OEX/SPY/RUT/IWM... :) Well, I guess it wasn't always "easy," but it was fun and not that difficult. You can see how I made great "paper-money" (not quite as fun as the real green stuff though!) in these trading vehicles by reading the record of papertrades I made trading when starting this blog. You can find these starting at the very bottom of this blog...

Please scroll all the way to the bottom of this webpage and read the very last past--this is actually the first post of the entire blog, since it chronologically puts the most recent post at the top of the page (this one) . I was updating the blog every couple of days back then and listing my current greek situation and how I put on options spread trades in order to neutralize/hedge my risk going into the next trading day/week.

-Justin
justin@justinlent.com

Martha Stewart Update & Gettin' Paid

Remember the MSO trade I wrote about on Sept 19?
You know, buy the MAR2007 20 calls for 95 cents because they were a steal at that price...

MSO stock rocketed up this week... the calls officially doubled by yesterday's close and were being bid at 2.25 by today's close.... absolutely love it... gonna have to close out some and let the rest ride into the earnings call Oct 31. Considering the substantial volume behind the up-move this week, I'm guessing some big institutional money knows something. No concern here though--gotta take some off the table, regardless, as its the prudent thing to do.

Although, the better trade would be to just short common stock against the calls on a 1:3 ratio because shorting common against in-the-money calls is essentially a free short that you can trade a small short position around (which is why you do just the 1:3) and profit from short term pullbacks (via covering the short common, and getting more net long via the same calls), while leaving the call position intact--basically this keeps you from paying the nickel or dime spread (bid/ask) on the options and just paying the penny spread in the stock, but still actively trade around the core options position. But since I can't short I'm just stuck selling the calls for a profit--trust me, I'm still pretty happy about a trade that's gone up 130%, and if all trades turned out this nicely, I would gladly give up the ability to short common forever! :)

not to shabby an outcome for the only equity options trade I suggested on this blog--maybe I should do this more often?

What's NEW and Trade Updates/Closings

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UPDATE: CLICK ON THE PICTURES TO VIEW THEM BIGGER

Been busy the past several weeks. I'm currently transitioning from the large firm I'm currently working for, to a smaller hedge fund. I've closed out just about all my sector mutual fund trades that I mentioned several weeks ago, and below I'll go through each of the setups and why I took them and how they resulted from a P&L standpoint. I basically look at the sector ETFs in order to get trading ideas, and then try and find a mutual fund that should correlate very closely to the ETF (again, I've been forced to trade mutual funds because of my firm's short-term trading restrictions from trading anything that trades intraday).

So... now, onto the trades!

US Treasury Futures/Interest Rates
First, an update of the US Treasuries trade that I have discussed endlessly in the past few weeks both from a fundamental and technical standpoint. (Scroll down a post or two to see the initial technical and fundamental analysis I did on the interest rate market.) No real update on the analysis. My inclination about the Fed not being as comfortable with inflation as the rates market indicated over the past couple weeks all came to fruition this past week when the Fed said they are still slightly concerned with housing, and inflationary aspects of the economy--which then caused the bond market to sell off fast and swiftly as I was predicting--Again, sure wish I was trading the futures with this trade, but I was stuck trading the ridiculous RYJUX fund inorder to profit. See the chart in the previous two posts--with my entry and exits were discussed in previous posts below from a couple weeks ago... I basically profitted from entering the trade when the 10yr was 4.55% and exiting when it was 4.76%. Anyone who trades interest knows that capturing a 21 bps move in a short period of time doesn't happen everyday. I really liked the discipline I showed on this trade. Namely, 1) taking a small position at first, 2) having the position go against me, 3) doing the fundamental research again to support my technical analysis to keep me in the trade, and 4) having the convicion in my analysis to put on another position at a better price, and of course, 5) taking my profit quickly once I caught the swift move in my direction.

Large Cap Biotech ETF (symbo: BBH)
This was my best trade from a "worked as expected" standpoint. The setup here was purely technical. Sellers (ie: excess supply) seemed to consistently dry up quicker and quicker as the BBH has had its downmoves over the past couple of months. This was telling me that the supply/demand situation for the traders in this space was starting to tip into the favor of buying demand stepping up, rather than sellers (and supply) continuing to send the price of the BBH (and its underlying constituents) down to lower levels. Also, in the chart below, notice how volume was when the BBH moved down, while volume was much more on moves up--just another supporting argument for demand outstepping supply as the BBH has been trading the past month. This description and supply/demand analysis pretty much defines why technical analysts jump into "Flat-top Triangle" patterns whenever they get a chance!

Typically if I had the ability to trade intraday, and with more flexibility beyond the mutual funds I am stuck with, usually I like to anticipate that the pattern will end up working out with a small size trade and initiate positions as it sells down to the lower uptrend line, and then piece out of it a bit as it bumps up against the upper support line, then if it breaks out, I will add an additional position. I don't really have a clue WHEN (or if) the chart will breakout, but I can still grind out short-term trading profits while it trades within the range of the pattern--and then if/when it breaks out (like the pattern and supply/demand suggest it will), the profits from the breakout will just be icing on the cake. On the flipside, if the pattern does NOT hold, and the pattern sells through and breaksdown below the lower uptrend line, then I would get out of the positions, and the intention from my strategy standpoint, is that the small profits I grinded out will trading the range of the pattern, will make up for the loss if the pattern breaksdown. Obviously, in this case of the BBH, the pattern held (ie: Did not breakdown through the lower uptrend line), and it turned into a nicely profitabel trade-both as it traded between the pattern range, as well as when it brokeout to the upside and traded straight up to the next upper resistance line (at 190).


Basic Materials ETF (symbol: XLB)
Very similar setup to the BBH. So I'll just show the chart...

I did not get the breakout to the upside as I did with the BBH, but I captured a quick pattern range bound profit. I decided to exit the trade because Alcoa (AA) is the largest weight in this ETF and they reported a horrendous quarter (as they have been known to do the past 3-4 quarters-will mgmt there ever get a clue?) Anyway, the pattern still looks good but I just do not want to be in a sector trade where the biggest weight in the ETF/fund is a poor performer... This actually begs the question for a good trade for those capable-why not buy the XLB and short AA against it perhaps on a ratio with a net long bias?

You can see the XLB chart above with my entry and exit points (I used the fund RYBIX to trade this for my own account).

Regional Banks ETF (symbol: RKF)

Again, a very similar setup as the XLB and BBH trades, except that the "Flat-top Triangle" breakout is occuring at the RKH 52-week high area, rather than at a local low point (like in the BBH, and XLB setup). I used the RYKIX fund to trade this ETF in mutual fund world.

Eventhough I got the breakout that I was looking for, and as the pattern suggested, I decided to exit the trade because I did not like the volume follow through on the breakout. I basically would have liked to have seen more buying volume on the breakout. Since I anticipated the pattern correctly, I was able to catch a quick profit, with a very low risk (because my stop in all these setups all go slightly below the lower uptrending line (I usually give it some leeway because of the floor traders who like to "stop-hunt" the technical traders who just place their stops 1 penny below their trendline. 1 penny below their trendline?? This business is not that scientifically precise-especially with trendlines that can be drawn with easily 10 cent to 25 cent variations depending on the trader.) For 100 dollar stocks/ETF's like the RKF, I like to use a stop of about 50 to 75 cents below whatever support/resistance trendline that I am using-this allows me to stay out of the whipsaws and being taken too early out of a good trade setup.


Oil Service ETF (symbol: OIH)
Who hasn't noticed the dramatic selloff in oil? Wouldn't you have liked to catch a bit of the selloff on the short side? Here's what I did. Notice, that I missed the brunt of the move down, but I still was able to capture a nice sized move over just a couple of days from a very low risk trading setup after the OIH market had already shown its hand.

Here is the chart setup with entry and exit point that I used (I used the fund SNPIX in order to get my short exposure)...

On a similar note, I think a very similar setup is in play right now-I actually just got short again at this level, with my stop/evaluaion to close the trade if the OIH closes at a price above the 132.50 level. My profit target is around around 120 or even as low as 115 in a washout sell out low scenario-2 point potential loss, 10 point potential reward-a 5 to 1 risk/reward ratio is a beautiful thing.

US Treasuries UPDATE

..Updated this post now with Today's closing chart for 10yr Note


Had to update midday just to get this on for reference... A couple days after my mental stop price of 108'16 was hit intraday on the 10yr T-notes, I decided to stay short my T-note/bond position eventhough we had a close above 108'16 in the 10yr (closed at 108'18 I believe)..

Reasons are several:

1) With speculative longs in the 10yr being about 3 times greater than spec shorts (Commitment of Traders Report says spec longs=800k and shorts=300k. see here: http://futures.tradingcharts.com/cotcharts/TY), I had a good feeling that most of the recent surge upwards could not be upheld because of a lack of any more "long" firepower to fuel any more up surge.

2) Interestingly, the COT report for the 30yr did not confirm the same rate inclinations as the 10yr and had about equal longs and short (see here: http://futures.tradingcharts.com/cotcharts/US ) which tells me that the hedgies may have just been gunning the 10yr, since its the Treasury of choice to trade when betting on rates--all the more reason to think that the up surge was coming to an end.

3) FLEXIBILITY is the name of the game here folks--that's why I use mental stops rather than hard stops many times on mean-reversion, convergence trades. If the mental stop gets hit-then I go out and do additional research to see if the story has changed or not. Then I react-either taking the stop, staying strong, putting on more position-this is also another reason why I like to trade small-therefore, getting bigger doesn't cause me to turn into Mr. Amaranth, Brian Hunter, the Invincible.

Again reevaluating my research, and ever-changing supply and demand environment caused me to have the conviction to stay short and actually add to my short position, rather than stop out a at my original stop price. As we know, treasuries have sold off sharply the past 2 days, and i'm now looking to book partial profits on thes short positions...

I also read this similar analysis by the Macroeconomic guru, Tony Crescenzi, on RealMoney.com. Below is what he said regarding the excessive spec longs in Treasuries.

*********
Two reliable indicators suggest that the bond market is leaning heavily on one side of the boat, suggesting a possible correction soon unless the market continues to receive a dose of weak economic news.

On Friday, for example, the Commodity Futures Trading Commission (CFTC) reported that in the week ended Tuesday, large speculators (non-commercial traders) once again added to their existing record net long position, marking the fifth record in six weeks of trading. Longs now outnumber shorts by 2.5 to 1.

The second indication of extreme longs is in the cash market, where in a survey by Stone & McCarthy, portfolio managers now have their highest aggregate duration in three years, with duration at 101.2% of bogeys (typical range is 96% to 104%). I am obviously quite familiar with the axiom, "The market can remain irrational for longer than you can remain liquid," but these indicators tend to have a fairly short lead time, meaning it is more likely than not that the bond market will soon correct.

Index Options Paper-folio Back in Action

PORTFOLIO GREEKS
(SPX beta-weighted)
Delta: -33
Gamma: -4
Theta: 149
Vega: 137
Buying power: ""UPDATE""
"Paper-folio" Value: ""UPDATE""

Why I'm jumping around from Paper-folio to Directional Futures
Decided to start up the paper-folio index options book again, which, incidentally was the original purpose of this blog. If you scroll all the way down the botom of this page, you can see the first post and understand the who, what, when, why of this blog. I digressed into TA of futures contracts partly because I wanted to actually make money trading again rather than just trade the paperfolio. Because of my work restrictions I can no longer trade index options like I would like to, but I can trade certain types of mutual funds. With the proliferation recently of mutual funds creating funds that directly track individual sectors, I decided to jump back into trading oil, gold and stock index futures directionally via these mutual funds that I am not restricted from trading. Just trying to earn an honest buck... even if I gotta deal with the difficulties and inefficiencies of only being able to trade mutual funds-which only price at the close, which forces me to be REALLY right on the timing of my shortterm in-and-outs... its turned out pretty well so far (eventhough the couple trades I have highlighted on this blog have not necessarily turned out as well as the others). My hit rate thus far has been as follows:

Total trades: 24
Total Winners: 19
Total Losers: 5
Avg Winner: +5%
Avg Loser: -6%

Current Directional Trades
I am in 5 directional trades right now-one of which being the short Treasuries trade I analyzed over the past few posts. (UPDATE on this: I shorted more on Friday close. I actually doubled my position size since I was so small in it when I initiated the position-I really like to scale into positions small, particularly when I am playing a counter-trend or mean-reversion trade. My game plan right now is to stop out of 60% of the position on any CLOSE above 108'16 in the 10yr note, and close out the rest on any close above 110. Eventhough I "doubled up," even if I get stopped out of the whole position the total loss will only cost me about 1% of my portfolio-once-again, the benefits of trading "small" and not letting emotions get in the way of things, and letting trades play themselves out.)

Back to Paper-folio Direction-neutral Trading
But, now I am getting the itch again to trade the directional-neutral thing again (even if I cannot immediately make money from it.) I basically just want to keep these skill fresh, and I also feel like it will give me a better all-encompassing feel for understanding the stock index futures market a bit more intimately-such that my directional trading of the S&P500 and Nasdaq via mutual funds will improve in the process.

So, I just started from fresh, a whole new options book in the SPY and IWM (Russell 2000) at the close on Friday, resulting in the following greeks shown at the top of this post.

Positions Opened
Pretty basic stuff here. I put on some iron condors for OCT in both the SPY and IWM. Then I put on a bunch of calendars/diagonals across OCT/NOV and OCT/DECqu (DECqu=December Quarterly option). I used the DECqu because the standard DEC options have not come out yet. The liquidity of the quarterlies have been pretty darn good, so I am not worried too much about it-plus as DEC approaches these quarterlies will begin getting more natural action as people roll their OCT and NOV options to DEC expiration.

UPDATE - US Treasuries (T-note and 30-yr)

First the charts.... I wanted to post this yesterday, hence the 1-day old chart (no big deal really, the t-note and 30-yr futures contracts each essentially finished unchanged today and all the technical levels and patterns shown below still hold true after todays close)

30-yr bond weekly chart going back to 2002 (US1 continuous contract for Bloomberg)

10 yr T-note weekly chart going back to 2002

10-yr T-note Daily chart from 2005-2006....

And the close up of the 10yr T-note front-month contract only...

Now the quick and dirty technical analysis. Just looking at the last daily chart that is marked up with trendlines:

1) The same double chart that I discussed two posts ago is still intact, even after the strong rally on Tuesday (No surprise here that as strong as this rally was, it didn't breach the first high). I guess this was the test of the old (local) high and now officially makes it a double-top.

2) Also, notice how this second-top was formed from a short-term *megaphone" pattern (I drew in the light blue lines to illustrate). This is like a 180-degree horizontal flip of a *pennant* pattern. One big thing though, while a pennant pattern typically predicts a continuation of the trend in which the pennant was formed, a megaphone is often very predictive of a trend REVERSAL. Since this megaphone is occurring while aligning itself with a double-top, it makes me that much more confident in the short trade I am recommending here.

3) I also drew in a green line that has contained the most recent rally. This is what I'm going to use for my stop-loss placement. Yes, I know these are bond futures and I know each tick is alot of money-So just trade a couple contracts-Do not try and be some hot shot like Brian Hunter of the Amaranth hedge fund that just blew up because of his over allocation to natural gas! continuing this green trendline cross almost precisely 108'00, therefore I would put my stop loss a couple ticks beyond this so as to not get stopped out of the trade by those pit traders who often hunt for stop-loss orders sitting in the book because people put their stops too close to support and resistance. I like to keep looser stops, and because of this additional dollars at risk by using looser stops, I just trade smaller size.

4) FUNDAMENTAL REASON: Wow, dont see too much fundie analysis from me on this sight, but personally I don't see 10yr or 30yr rates going back to 4.5% before going to 5.25%. Considering they are each around 4.75% right now, my risk is 25 basis points down risk versus 50 basis points upside reward. 2 to 1 risk reward isn't spectacular, but its better than a sharp stick in the eye. Plus, with the inflation picture still around (granted it IS less that it was a few months ago, but the Fed is still insistent on popping the housing bubble and concerned with energy, and other implications associated with the recent commodity bull market of the past 2 years.)

5) I will consider adding to my short on any additional rally in these bonds that approaches the green trendline.

Position disclosure: Short T-notes and T-bonds via the Rydex 200% inverse mutual fund (symbol RYJUX)

Random Stock Analysis - MSO - Martha Stewart

You know what looks as juicy as a Ruth's Chris steak?

The MSO MAR2007 20 calls for .95

Yep, that's the symbol for Martha Stewart stock. I think it has bottomed and on the verge of a breakout.

I took down some today for what seems to be a real "cheap" trade for all the potential upside that could come from any one or a combination of the following reasons:

1) Any good news out of the MSO camp would be a welcome change

2) People might start spending more of their discretionary cash to remodel/redecorate their home now that gas prices are down, and MSO could be a decent derivative play off of a housing rebound (Have you noticed the strength in the Homebuilder ETF lately? Symbol: XHB)

3) only about half of the analysts that cover the stock have buy ratings on MSO

4) potential heavy short covering from the nearly 10% of the float that is outstanding

5) Even a non-chartist can see the very solid base at 16 that MSO seems to have broken free of, and held strongly for the past month (starting with the high-volume gap up July 27).

6) Who knows, with that recent newspaper article about Eddie Lampert being on the prowl for another aquisition target... maybe he'll see some value in MSO (he sure as heck has a bit of experience with the brand since MSO products were a stable of Kmart stores)...

7) Current expectations for MSO 2007 revenue is horrible, and any upward revision of guidance will pop the stock from short covering alone. And if MSO benefits from a good holiday shopping season, well, its off to the races for the stock.

I think MSO has the potential to trade to 25-26 by next March turning these .95 cent calls into a potential 5 bagger. Wouldn't buy common stock though, too much headline risk for that.

For those of you who can short stock, it might be a good play to short a little bit of common against the calls on any run ups above the 22-23 area... and trade around it.

Full disclosure: I'm long the MSO MAR07 20 calls

(Ordinarily I don't trade options because I have a 60-day holding period requirement imposed by my employer for anything I trade in my personal account, but since this trade goes out 6 months I decided to go for it-I don't see any real short-term catalyst, I just thought the options were "cheap" considering the risk/reward profile I feel is available in the trade.)

Go Short on US Treasury Long-bonds

Look at this chart of the 30 year T-bond.... The US1 continuous contract is what I have graphed below...


Pretty much a perfect Fibonacci retracement on the pattern here. We've retraced 60% (I like using round number, 61.8% implies a bit to much precision if you use the textbook Fib values). As most of you know who are well-versed in Fib trading, 38.2%, 50% and 61.8% retracements are all valid "continuation" patterns. Therefore, my belief is that the bonds sell off here (causing rates to go higher). I wish I had the longer term chart out to 2002 to post (I'll get it for tomorrow), as it shows this same sell-off, retracement of selloff, then continuation sell off two previous times in the past 4 years in the 30-year bond. Also, if you look at the more recent price action you can see a bit of short-term double top forming, and if you squint (or just click on the picture to enlarge) you can see a couple days ago the T-bond had back-to-back bearish engulfing bars... In the interest of full disclosure, I'm currently short these bonds via the Rydex 200% Inverse mutual fund RYJUX since I cannot trade the real futures contract (the US contract) due to certain trading restrictions from my employer).

A very similar setup is available on the 10 year Note (TY1 contract on Bloomberg).

Oil - Update - Will the Mo-mo Longs Turn Into Mo-mo Shorts?

Mea culpa, mea culpa... I was touting how what a great idea I thought it was to buy oil as it pulled into the trendline even after breaking the 200 day MA. So much for that idea!

The over-3-year upward channel broke decidedly today. No ifs, ands, or buts about it--and it showed! Every big long player who may have been defending their longs put on because of the pullback into the lower trendline of the channel bailed as crude futures dumped again eventhough it was grossly oversold going into the day. If you didn't take a stop on a crude futures long position by the close today (at least on a partial piece of your position--I definitely condone holding some as the odds of a decent bounce to sell into is likely), then you either like losing money, love pain, or your pockets are much deeper than mine.

Now, what to do?

Well, its still grossly oversold (see chart above), but its safe to assume that any momentum crude trader who was trading long previously, will likley switch sides and start trading the "mo-mo" short. Any bounce in crude at this point will be sold aggressively by most of the big players out there, and unless some sort of terrorist act, oil refinery shutdown, hurricane comes about, there won't be enough longs out there to get oil back over 70 in the near term, in my opinion.

Trading Ideas

I think since crude is as oversold as it is it could bounce down here and a good course of action could be to:

1) Sell any current longs that you are in on any bounce near/around the 200 day MA (which currently stands around 70).
2) Sell any current longs on any bounce to the middle Bollinger Band (aka the 20 day MA)
3) Initiate short positions on any retracement to the 200 day MA, or the 70 level. A safe stop on the short would be around 72, or if you like to have looser stops, the 74 level (just above the recent high buying blip in the current massive selloff.)

Oh well... a 3 year trendline has to break sometime, but as we can see, buying every previous retracement to the trendline would have (and should have!) made you a lot of money so taking a stop on this one should not have hurt too badly (if you took your stop that is!)

Other Markets...
I think Treasuries (10 yr Note, and 30 yr Bond) could be setting up for a great trade... will post more about this over the next couple of days, with some good charts and TA.

Oil - Another Big Move in the Works?

Looking Back at what Oil has done
1) First and foremost, notice in the charts (below the text) how even after the strong sell off in oil futures the past month that it is still trading in its long term uptrend channel. So therefore in my mind the bull trend is still intact. Since the trend has lasted as long as it has, I would give the lower trendline 50 cents to $1 of leeway before confirming that it has broken. Sometimes, the TA genius Helene Meisler over at RealMoney.com calls this *using a fat pencil* to draw your trendlines. This is one of those times as you definitely do not want to trade yourself out of a good trend because of some noise. As with most thing regarding trading, use judgement here. Maybe let intra-day price movement do what they may, and only stop out of the trade if the close is below the *fat-pencil* trendline, or maybe say, I will stop myself out after 2 concecutive closes below the trendline. Just pick a *reasonable* plan before entering the trade and stick to it.

2) Everyone has been harping about how oil has crossed below its 200-day simple moving average and this signifies an even larger and swifter downtrend is likely in the works. Ahem, ahem. Last I checked on my chart, oil futures have dropped below their 200-day no fewer than 6 times in the past 2 years. What did oil do after each previous break of its 200-day? Well, it usually had some basing action for a couple days or a week then it was off to the races again for another strong bull move. See for yourself, I conveniently circled in orange on the charts (charts below this text) everytime it broke the 200day previously, and notice the strength immediately thereafter.

What's Next?
So what is next for oil? When trying to determine what side to trade oil (or anything for that matter), I usually like to see what traders have done in the past when trading oil when it was previously trading in the same context as it is at present. I already mentioned above that the 200day break on the downside is a non-event (as far as a reason to become bearish), and if anything, the trading back above the 200day when it has commenced the upward move has acted as a catalyst to the new uptrend (breakout buyers, short covering, moving average cross-over type traders, etc).

Analyzing the Current State of the Oil Chart

Become Best-friends with Mr. RSI
Here is an explanation of one of my favorite, and simple, strength indicators, that also serves as my overbought-oversold indicator: Wilder RSI with a lookback of 7. The standard approach is to use a lookback of 14, but I find that using a shorter lookback of only 7 gives a better indicator for imminent turning points in a market because there is less "smoothing" oriented with the shorter lookback. This less smoothing also makes it easier to see price-strength divergences (ie: RSI increasing, even if prices continue to go down--this is a bullish signal, signifying underlying buying strength). But besides looking at price-strength divergences, I also like to compare how overbought something is in the daily timeframe, and compare it with how overbought-oversold it is in the weekly timeframe. For example, if just the daily chart is really oversold (RSI<30)>50) then more selling could be in the works and that any shortterm bounces could just result in more selling. But, if both timeframes are equally oversold, both daily and and weekly RSI<30,>Applying Everything Above to the Current Oil Chart

The DAILY chart is oversold right now, but this is nothing really new. Look and how many other times RSI has gotten at or below the 30 level on the DAILY timeframe! But, if you match up many of these oversold points on the DAILY chart with the equivalent point on the WEEKLY chart, you'll see that many of the daily oversold readings DO NOT alost correspond to a WEEKLY oversold reading. I placed the daily chart above the weekly chart, below, for easy comparison. However, if you notice, that whenever the daily AND weekly chart are both oversold something significant is upon us. I've circled the oversold readings on the daily that also correspond with oversold readings on the weekly. Notice how each and everytime when RSI was oversold on BOTH the daily and weekly timeframe, oil traded much higher at some point 1 to 2 months in the future.

One trick that I should mention when reading the RSI on the weekly chart. If you are looking at a strongly trending market over a long time period (like oil) in the weekly timeframe, RSI will rarely get *officially* oversold where RSI<30,>How Much Risk is there in Going Long Here?
Well, like I just said, there isn't too much risk when going long if both daily and weekly RSI are oversold, but if I were to quantify it further, I would look at the most recent price action and attempt to see just how much lower oil might go before it turns. What I have shown in the 3rd chart are daily bars of the most recent price action. Usually when something sells off as hard as oil did from a recent high, it will sell off hard and furiously, take a break and retrace, then sell off hard and furiously again for about the same amount of time and price. As you can see in the chart, I have highlighted how oil is in the 2nd piece of its hard selloff and the 2nd selloff has almost gone down as far as the first selloff (7.5 points). If it goes the entire 7.5 points in this second selloff, it will get to 66. If you are a more conservative trader, maybe you wait to go long at 66. But if you are afraid of missing the bounce, maybe you just piece into a long position and go long 25% of whatever you want and buy a little more if it keeps going down into 66. Of course, again, remember to set stops accordingly.

More Reasons to Go Long
1) Also, as you can see in this chart, the 66 level in crude was the level of the last breakout, so this should act as strong support.

2) And, if you still need another reason to get long crude, look at the descending wedge I drew into the most recent price action chart. Most of the time this is a very bullish indicator IF and WHEN the upper trendline is broken. A conservative way to trade this would be to just enter long positions only if the uppertrendline is broken on a breakout--this will keep you from the whole "catching a falling knife" thing.

3) This one is just anecdotal at best: Jim Cramer, Wall Streets biggest oil bull for the past 3 years (definitely correctly!), has just in the past week turned bearish on oil, barring any exogenous act like terrorism, etc. Sometimes when the biggest bull turns bearish in the face of a huge selloff, is the best time to get bullish again-Jim should know this after the Trading Goddess bailed him out in 1998... (By the way, I have read that chapter in his book Confessions of a Street Addict countless times, because its one of the most motivational and inspirational things for me as a trader to know that even at the absolute worst of times, if you stick with it and keep fighting you can dig yourself out of a ditch and still win. Geesh, he was down 20% through October and ends up making it all back by end of the year and more in order to finish up profitable. Greatest comeback in history! But I digress...)

As you can see, the bullish picture has been painted. And as contrarian as it may sound right now, I think it is time to get long crude once again.


CHART 1: The Daily Chart...

CHART 2: The Weekly chart...

CHART 3: Daily Chart of Current Front Month Contract (October 06-CLV06)

Gettin Your Hedge On--Part 2

.....


I forgot to mention one thing in last nights post about suggestions to hedge a short strike gone bad:

Here is a 4th idea, and following it, a couple reasons on how NOT to get scared out of your short strikes too early:

4) Another suggestion is to trade directional calendars/diagonals to get the delta you need to offset your Iron Condor short strike problem.
Diagonals are cool in that a put diagonal can either have negative delta associated with it OR positive delta associate with it depending on the strikes you choose (same goes for calls). Using the same example as before: assume your short 1320 call is causing you problems resulting in your being short too many deltas and you want to get more delta neutral. One of my previous suggestions was to just sell some put verticals. But, say, you do not want to sell put verticals in this cheap volatility environment (low VIX), and you would rather BUY cheap volatility (always good to buy low, sell high, even when your talking volatility). Buying diagonals is a way to buy cheap volatility, and if you choose the strikes of the put diagonal properly you will get the positive deltas you need to offset your negative delta situation.

The directional delta you get from a calendar/diagonal spread will not be as much as you get from a vertical spread (which means you’ll have to trade more total spreads when doing the calendars if you want to create the same amount of delta), but it does fall in line with not only trading price, and including the current state of volatility as component of you decision making process of hedging.

In the end, choosing between verticals and calendars/diagonals when hedging comes down a lot to personal preference, including total amount of buying power you want to spend on the hedge, and how long you really think you’ll want the hedge in place (if you think that you only want the hedge for a week or 2, and don’t want to deal with the overhead of the hedge after that, you might not want to get your self into a 3 month calendar spread with you hedge-although I would argue that you could just roll the hedge into a real position after its hedging purposes are complete-but that’s a whole other ball of wax.).

Do Not Jump Ship Too Early

A huge point to also discuss is the idea of getting scared out of your short strike too early:

1) It is LESS likely for you to get scared out of 1 short strike if you are managing the whole portfolio rather than just one position.

2) If you are short an iron condor, or even just a vertical spread, the short strike actually has a much higher probability of being touched before expiration than you might think. The brokers I trade with at http://www.thinkorswim.com/ actually have a neat probability calculator built into the options quote monitor to show people that you almost have to EXPECT YOUR SHORT STRIKE TO BE TOUCHED, and to understand this and not worry about this (of course, again, this is easier to not worry about when you are trading a portfolio of options rather that just individual spreads.)

A calculator is not needed to predict the likelihood of your short strike to be touched before it expires. For out-of-the-money options it is actually just about 2 times the absolute value of the delta. To see what I am talking about, look at the Think Or Swim trading system screen shot that I just took for the SPY chain (the pic is at the top of this post, click to enlarge) to compare the deltas of the strikes to the calculated probability of touching that particular strike prior to expiration.

When Options Positions Go Bad a.k.a. *Getting Your Hedge On*

-
Someone who commented on my previous post asked the following:

How do you manage the gamma risk of ICs [Iron Condors] as the market approaches your short strikes?

My Response follows:

First things first (unrelated to the question at hand, but, completely related to the general trading of index options):

Why are you trading the SPX?, If I may ask, And not the SPY?

Do you like giving free lunches to these Chicago pit traders? Actually, I shouldn't be so harsh, I used to trade the SPX options also until I learned that the fills are usually real bad if you're not patient. Reason being: the SPX is still a proprietary product and only trades in the Chicago pit, so there aren't any other exchanges competing for your order, so the Chicago pit basically gets what they want--which is why the spreads are often inordinately wide and fills are usually far from fair value if you don't work the order for while. So your next question might be, "So what, I'll just find the middle between the huge 2.50 wide bid/offer spread I'm getting quoted for my 4 leg iron condor, and enter a limit order for the spread at what my options calculator is saying is fair value and they'll fill me somewhere around that." Good Luck with that. Actually, if you work an order for a while, you'll probably get a decent fill--still, it'll probably be about 20 or 30 cents off of fair value (if you're trading a spread comprised of several options), but you'll still get filled at a better price than if you try to just get a position on in 5 minutes. But the problem REALLY arises when you want to trade the SPX options in a fast market. What if the market is moving swiftly and you don't have time to work an order for 30 minutes so you can get a fair value fill? You know what you get?--you get to take what the SPX pit gives you, which will be a horrible bid and equally ugly offer. Now, I usually always trade the SPY options. Eventhough you have to trade a lot more contracts (resulting in more commission--this is the only downside to trading the SPY over SPX) in order to trade the same dollar "size" of the SPX, the SPY options are quoted only about .10 wide, and the near the money options are often a nickel wide with fair value being somewhere within that nickel wide bid/offer. No need to mindlessly work orders for 30 minutes, like often necessary in the SPX to get a fair fill. Plus, multiple exchanges will compete for your SPY option trades, which will naturally cause a better drilling down to the "most fair" bids and offers for you. Trade the SPY to get the best amount of edge via fairest price possible.

Now onto the nuts and bolts of the original question:
How do you manage the gamma risk of ICs [Iron Condors] as the market approaches your short strikes?

3 immediate ways come to mind, and I use all of them--depending on the total structure of my portfolio (more on portfolio structure at the end of this post):

1) Sell some out-of-the-money credit spreads to hedge the directional delta/gamma exposure. (ie: get more delta neutral, and benefit from more time decay in the process.)
For example, using the S&P from today that closed around 1304: If you are short the SEPT SPX 1320/1340 call spread as a part of your iron condor, you have probably been feeling some pain the past 5-7 days as the market slowly melted upwards. If I was in this situation (and STILL haven’t done anything about it until today) I would probably have sold a few SEPT SPX 1270/1260 put spreads at today’s close to hedge my deltas which are getting more and more negative (a short biased) as the market gets closer to my 1320 call short strike and further away from my Iron Condor’s short put strike. By selling this 1270/1260 put spread I would take in some decent time premium as well. This is a bit more of an indirect way of hedging the additional gamma your options, but it also has the benefit of giving you more daily time decay besides just the hedge. I really like to hedge exposure by selling additional spreads to neutralize things, because it allows me to increase my time decay, while at the same time neutralizing the directional aspect of the particular greek I'm not comfortable with at the same time.

2) Buy some directional butterflies near the short strike of the side of your iron condor going agaist you.
If you’re comfortable filling your options book with a lot of strikes/contracts and you understand how all the options interact with each other, then butterflies are the way to go as they are cheap and they pack a nice reward profile (and insurance policy against your iron condors) if they work. Butterflies really work best when expiration Friday is less than 2 weeks away as the butterfly spread will expand (ie: it becomes worth more than you paid for it—a good thing!) as expiration day gets closer and the market gets closer to the short strikes of the butterfly body. Therefore, if the butterfly gets more expensive as the market nears the butterfly body, align the body of the butterfly (the 2 short strikes in a purchased butterfly) near the strike of your “bad” short strike going against you in your iron condor. Using today’s closing prices (16 days left until SEPT expiration) you could buy the 10-point wide call butterfly with strikes 1305/1315/1325 in the SPX for about 3.00 (its bid 1.90, offered at 3.80—too darn wide—reason again to trade the SPY!!). But, this 3.00 ($300) position can potentially widen all the way to 10.00 ($1000) if the SPX is trading exactly at the strike of the body of the butterfly on expiration day. Obviously, you probably wouldn’t hold it all the way until expiration, but even if it trades to the middle strike during the final week up to expiration it will like get up to around at least $500-$700, which means it around doubles in value which should more than make up for the losses from your short 1320 call if enough butterflies were purchased. The ratio of butterflies to iron condors is up to the individual trader (basically, “how much insurance do you really want?”). Sometimes I just like to buy a lot of them, and take them off incrementally if they profit—What can I say, it’s a “feel thing.”

3) Trade S&P futures contracts intra-day as a hedge against the deltas going against you because of your increased gamma from the near strikes you are short in your iron condor.
(This the most aggressive, but also the easiest to execute, easiest to hedge dollar-for-dollar, and easiest to profit from if you’re skilled at trading short-term breakouts from support/resistance levels). If the market is trending strongly and my short strikes are getting near, sometimes I’ll just aggressively trade breakouts using basically the same amount (or maybe a little more) of emini futures as would equally hedge my SPX (or SPY) option deltas that are going against me. The basic idea behind this is that overbought markets can get MORE overbought (same goes for oversold markets getting more OVERSOLD), and that it’s only a matter of time until the move reverses, or at least takes a breather and that your short strike will eventually be OK. Using the same scenario as in #1, with the S&P currently at 1304, and I have short strike exposure at the 1320 call that I’m worried about, I would be a buyer of the S&P emini on any “breakouts” to the upside and keep profitting on the long futures trades until the market reverses (i know, i know, easier said than done). Determining what defines a “breakout” is left up to the individual trader, as no 2 people are likely to agree on this from both a trading perspective or a risk mgmt perspective. Personally, I find using the previous day’s high as a good breakout signal after the market has consistently gone up (seems like everyone wants to get on the runaway train at least for a little while!)—therefore I’d buy emini’s as the market crossed the previous day’s high and hold through the end of the day—this effectively hedges all your upside risk against your short strike for the whole day if bought on the correct ratio against your short options deltas. I like to be a bit more aggressive with a few of the emini contracts within the trade and sell them as the market trades up into short-term chart resisitance, and then potentially re-buy them if the S&P comes back to retest the breakout point (the previous day high, in the case of this example). Setting stops on these futures trades is also important—the simple stop point is the low of the previous day, but if the range is wide the previous day, then a tick or two below the halfway point of the previous day is usually a good stop that won’t prematurely kick you out of too many trades. Remember, if you lose money on the futures trades, it almost "no big deal" because that means your options book will likely be making money... interesting concept--sometimes I think I'm a better futures trader when I know that all I'm doing is "hedging" so emotionally I'm less attached to the directional aspect of the trade--I would almost consider this too be some good "edge" int he trade, and is why I'm always looking for an opportunity to trade futures around a core options portfolio--Psychologically, it works for me. Incidentally, RARELY will I carry any futures exposure overnight since I really don't want the gap risk associated with a futures contract--If my deltas were really bad, then I might hold a couple, but nothing substantial, and I'd be more inclined to hold short futures contracts than long ones, only because it is very rare for the market to gap up huge at the open, but a huge gap down open happens more often (therefore holding short futures position overnight reward/risk profite is slightly better, than the risk/reward of holding a long futures position overnight.)

General Thoughts on Portfolio Structure
Honestly, 99% of the time, the only time I think of the individual positions as "Iron Condors, vertical spreads, calendars/diagonals, and butterflies" are at initiation of the trades themselves and how they fit the scope of the total portfolio when the trade is opened. After the trade enters the portfolio it merely becomes part of the total portfolio greeks. Butterflies I'll usually trade around as individual positions only if they are coming into play, but otherwise, they are merely hedging the risk of my nearest short strike from the greeks they give my whole portfolio.

As days/weeks go buy, the big thing I'll monitor is how many near month options I have expiring, and how many of those are pieces of calendars or just pieces of iron condors and verticals. If its part of a calendar then I need to try to time/manage around the best opportunity to roll the near month option to next month--that's a real trick that just takes experience. So, basically, I'm not "too concerned" about my short iron condor strikes getting hit, just really concerned about the total greeks of the portfolio. If the short strike getting hit is the reason why my greeks are all screwed up (ie: biggest problem=a delta that is really biased either long or short) then I'll attend to the bad short strike, otherwise, I'll just sell some verticals or buy some calendars/diagonals to give me the greek profile I want to have at that particular moment. Another reason I'm not too concerned about short iron condor strikes getting hit is that in the scheme of my whole options portfolios iron condors are really a pretty small percentage. The P/L swings with ICs are really too much for a huge portfolio that is aimed at achieving incremental revenue. Trading mostly calendars rather than just ICs really dampened the daily volatility of your P/L.

The most important thing I can leave you with is as follows:
The 2 greeks that I really manage my entire portfolio around are delta, and vega, and most of my strategy involved really understanding how my delta and my vega are going to put me in the best position to make money in the market tomorrow and through the next 5-7 day period.

The Basic Playbook
And the breakdown, at the 30,000 foot level, the portfolio would be comprised by options opened using the following structure:

15-20% : Iron Condors/Verticals in the front month
5-10% : Iron Condors/Verticals in the next month out
30-40% : Calendars/Verticals out to a max of 4 months
30-50% : CASH (I always like to have a lot of cash on hand for hedging and damage control purposes, and to exploit opportunities during big market events)

That's my basic playbook... Anything else would be too complicated to type into a blog (Like how I choose my strike prices for my ICs/calendars/diagonals/butterflies, how and when I roll my front month calendar options, and how/when I choose to close out my ICs--almost NEVER let them expire worthless, by the way!)

Whew... that was a long post...

Up tomorrow, hopefully I'll have time to update the tracking of my directional options trading system.

S&P Options Directional Trading System Update

P/L tracking chart....


UPDATE ON THIS (original post below this):
I added the "Expiration Friday" tweak into my backtest (used data from March 1992 through July 2006). Out of the total of 85 short signals generated by the system, 38 of the signals, using a maximum 5 day holding period, would have occurred over an expiration Friday.

Of these 38 signals, only 11 would have been unprofitable after the 5 day holding period.

So, I implemented the additional tweak of holding longer than 5 days if expiration Friday was one of the days within the 5 day window to test whether it was beneficial to lengthen the holding period a few days if this was the case.

By doing the following tweak if the short signal trades over an expiration all 38 out of 38 signals that held over an expiration Friday would have been profitable:

1) If the trade is profitable on day 5, close out the trade for a profit.

2) If the trade is not profitable on day 5, continue to hold it another day.

3) If the trade is profitable at the close on any succesive day after day 5, close the trade at market close.

By doing the above, all trades would have been profitable with the longest holding period being 10 days (5 days more than the original 5 day holding period)

So then I thought, what if I just change the basic system to "10 day maximum holding period" for all trades. Doing this drastically reduces the overall average P/L significantly. In my mind, this proves that at some level, some options week markup/markdown shenanigans do occur, and it is worth taking into consideration when developing short-term trading systems. Let the Efficient Market Hypothesis cultists put that in their pipe and smoke it...

I guess I'll see whether the 2 outstanding signals from last week will fall into the 38 for 38 profitable bucket if I extend the holding period out 5 days beyond the original 5 day maximum holding period making it 40 for 40, or if the very low volatility that is typical of August in the markets will give us our first losers. (Side note: I checked and of these 38 signals analyzed in greater detail, only 2 times did they fall in the month of August--years 1995 and 2000--both much more volatile times than what we've experienced the past couple of summers--OK that's enough digging into the details--these signals are either going to work or they aren't at this point as I don't want to unjustifieably "fit" the system to any more parameters)

ORIGINAL POST
Above (click to see the chart bigger) shows how the 2 short signals that were generated last week are doing. Again, the system trades the S&P500 via options contracts and currently has it's max holding period set at 5 days. But I'm thinking about "tweaking" the system to hold for 2-3 extra days if the 5 days overlap an options expiration Friday. I haven't added this tweak yet into my backtest results to see how it affects the long run average.

As the system currently stands, backtest results short signals are correct over 60% of the time, and long signals are correct over 70% of the time. (I'll post more backtest stats on these signals this coming weekend.)

As the chart above shows not a lot going on--basically flattish to slightly negative. See how it plays out over the next 2-3 trading sessions.

More Fun With Fear & Greed Symmetry!

Stumbled across this on RealMoney.com today.

Jeff Cooper (world-famous technical analyst, quantitative trader, and former consultant to Cramer when Cramer was running his hedge fund) posted the chart at right today in his analysis of the S&P today. I just had to grab a pic of it and post it here as I just posted something similar a short while ago regarding the symettric action the market often shows as fear and greed plays out with the buying and selling of stocks.

24 days down of FEAR, 24 days up of GREED... what's next... (see yesterday's post for my near-term feelings)


SIDE NOTE: Also, another point Jeff Cooper pointed out in an article I read about 3 months ago--He says that his analysis has shown that any time a move retraces over 70% of the original move that ALMOST ALWAYS does the retracement go back to the start of the original move (100% retracement). This may be why the market is stagnating in and around this 1295-1300 area right now, and has been for the past several days with buyers/sellers showing not a lot of conviction to either breakout or breakdown. The SPX is near the 70% area between the May highest close of 1326 and the June 13 lowest close of 1223.

Here's the math:

1326-1223=103 total S&P range
70% of 103 is about 72 points.
1223+72=1295
Almost scary. But still just anecdotal at present time, since we're waiting to see how it all plays out.

Like I said, I think the market sells off here "a little bit" (as opposed to getting back to the old high of 1326 in the near-term) as my trading system signals are on short sale signals, and the market is in modestly overbought territory with SP and Naz RSI above 70.

S&P Short Signals Generated from New System

No new trades in the paper-folio options portfolio yet since I went into all cash July 31.

Been working on some systematic program trading stuff in my spare time lately trying to develop directional trading systems that trade index options as well as index futures. These options trading systems are somewhat difficult to backtest on historical market data because I don't have access to historical options prices since they aren't available for free. I think I've figured a way to work around this by intuitively approximating the shape/curvature of the reverse volatility skew (found consistently in index options) depending on how many days are left to expiration of the backtested option trade, and figuring out the out-of-the-money strike implied volatility from inputting historical VIX quotes into my approximated volatility skew curve model. It was a bit of work, but at least now I can attempt to backtest some algorithmic trading systems that exclusively trade options. My rough approximation seems to be pretty accurate and valid enough for short-term trading systems that trade near-the-money options which are held for less than 10 days, so I'm gonna stick with it until I find a reason to believe it's not accurate enough...

I'll post the backtest results shortly. From what it looks like this one long/short S&P system that I just put together should complement the current trading strategy on this website very well because the current website strategy is fairly directional-neutral, while this new purely algortithmic system is aggresively directional. So, in theory, the purely algorithmic system should do a great job of making good profits when the more directional-neutral core portfolio is losing money or just languishing. But, I going to wait to see how they trade in the market a few times before actually throwing them into the current paper-folio portfolio.

Currently, this new algorthmic model is on 2 short signals. One was generated last Wednesday, and another one signaled on Thursday. The max holding period of each is 5 days, so I guess we'll see how it turns out--after today's down day these positions are about breakeven. I'm actually wondering whether to tweak the max holding period an extra 2 days because the trades' holding period is occurring over an expiration Friday, and too much "unnatural" trading usually occurs the Thursday before expiration Friday all the way through the Monday directly following the Friday expiration.

Up, Down, and Back Again...

PORTFOLIO GREEKS
(SPX beta-weighted)
Delta: 27.7
Gamma: 1.9
Theta: -119
Vega: 457
"Paper-folio" Value: $141,525

Up, Down and Back Again--for the S&P that is... The portfolio did nothing but go straight up this month. Love that! Made a sweet 5.5% net after all commish.

The S&P ended the month just about where it started the month eventhough it bounced around all over the place for 29 days in between! (See right-hand portion of chart.) After the first week of July the S&P sold off hard into the end of week 2, then it did a typical V-return to high manuever--it's really surprising how often stocks/indexes retest the old breakdown price level after reaching a short-term maximum level of "oversold-ness", but it happens consistently time and again. Also, interesting to note is how, once again (no surprise again either) that the chart held up its symettrics.

Many times if something sells off, for say 2 weeks, then it will take an equivalent time (2 weeks) to retest the high that it broke down from, forming a very symmetric looking chart--and is where the name "V-bottom" comes from. People consistently think this stuff is random, voodoo, mumbo jumbo. Hardly, it occurs time and time again and is really just a consequence of traders fear and greed acting out in equal and opposite directions. At the very least, I always expect at least a 50-60% retracement in a very short time period--again ONLY after a max oversold reading occurs on my oscillator) Sometimes if it's a real hard and and deep move down, it will take about 30% longer in time for the move up to retest the old breakdown point, making the right side of the "V" a little longer than the left side. I love how the psychology of market participants reeks of Newtonian Physics at times--namely how fear and greed often result in equivalent moves in opposite directions after having reached their illogical extremes! And this reason, to a certain extent, is why the market is so easily gameable especially at particular points in time AND price. Ok, enough of the philosophical digression...

Today, July 31, I basically closed out every one of my short options today, as well as some of the long options that were worth over .75

The paper-folio made a decent killing this month--netting over 5% profit--eventhough I didn't trade much, and tied up less than 30% of my portfolio in margin the whole time--the other 70%just sat in cash mostly. The options positions I had going into the month with good vega and theta across the backmonths did a great job of dampening the delta-neutral portfolio's volatility during the mid-month roller coaster ride. From what I can recall the portfolio only had 2 or 3 losing days, and the rest of the days were at least slightly profitable. Today it even made $695 dollars profit! Options Rule!

I'm OK staying out of any positions ahead of the Fed meeting next week--no sense trying to gamble on that. I may buy some butterflies way outta the money a day or two ahead of the meeting in order to catch a quick double if volatility picks up again and the S&P breaks out of its range either up or down. Other than that, I'm content to sit on the sidelines, and just earn some good interest on this huge cash position I have now of about $140,000 bucks.

The greeks shown above are purely the aggregate total of the remaining long options that are way OTM that I'm willing to let ride--Each contract is worth less tha .60, amounting to no more than 1% of my total portfolio's value at this point. If we catch a big move off the Fed next week, these could actually pay off pretty big for the little actual dollar amount I have at risk in them.

Tomorrow is Aug 1, which means I get a nice credit to my account with all the interest I earned in July. This should tack on a few hundred bucks because of how nicely the paper-folio has grown. I'll take it--better than a sharp stick in the eye! And definitely better than gambling on all the Fed shenanigans that are sure to ensue pretty soon!

S&P goes WHOOSH!

PORTFOLIO GREEKS
(SPX beta-weighted)
Delta: -4
Gamma: -3.5
Theta: 171
Vega: 255
"Paper-folio" Value: $140,948

Steady as she goes. No new positions--no need to hedge. It's pretty smooth sailing after putting a decent amount of cash to work and building up my back month book at the get go.

Paper-folio made over $3000 today...

PORTFOLIO GREEKS
(SPX beta-weighted)
Delta: 24
Gamma: -2.2
Theta: -90 (probably miscalculated for a bunch of my way OTM options that expire on Friday)
Vega: 244
"Paper-folio" Value: $140,798

$3033 is the mark-to-market gross profit for the day. I went into the day long about 110 deltas since the market had sold off so much the past week or so and I didn't really need to rehedge that much because I was nailing the intra-day emini futures trades on the short side in order to make money through some technical analysis driven "dynamic hedging". I'd much rather trade the emini whenever possible since its far cheaper from a transaction cost standpoint than trading hundreds of options contracts in a bunch of spreads.

As if the paper-folio needed even better news, i nailed the middle strike of another one of my open butterflies that I opend for .35 a week ago. I sold it today for .75--I'll take it.

I also covered my short puts in my IWM vertical bull put spreads since they were at the 69 strike and they have far too much gamma for my comfort with only two days left till expiration and the IWM's trading at 69.50 at the close.

Big Bang for My Butterfly Buck

PORTFOLIO GREEKS
(SPX beta-weighted)
Delta: 114
Gamma: -3.5
Theta: 159
Vega: 156
"Paper-folio" Value: $138,036

Didn't have time to write today. More tomorrow. But short story is the put butterfly spreads paid us off nicely, as well as some more excellently times S&P emini futures trades

More High Octane Alpha

PORTFOLIO GREEKS
(SPX beta-weighted)
Delta: 114
Gamma: -3.5
Theta: 159
Vega: 156
"Paper-folio" Value: $137,276


Wild day today! Israeli war in the Middle Easet started mid-day! The paperfolio made $502 all because of being prepared and knowing how to trade futures around short-term support and resisitance levels. The futures trades earned $2725 which more than made up for a day where the VIX was up 3.81 closing at 17.79 and the S&P500 was down 16.31 points which pretty much murdered my options positions for a loss of a little more than $2200. But who cares, it all nets out to making just over $500 on the day, and that ain't bad!

These are the type of days certain "delta-neutral only," and "short volaltility only" hedge funds get their rear-ends handed to them because of their inflexibility of trading futures "conservatively aggresive" around their core options positions. I say "conservatively aggresive" because I'm conservative about the small number of futures I'll take on for a position, and "aggresive" because I'm willing to take directional risk when the probability are with me to make simple intraday directional long/short trades. In short, I typically try to trade the right number of contracts that will somewhat equal and opposite hedge my intra day options deltas that are going against me.

The big point that marks the "easy" point to sell short through was yesterday's low in the S&P futures which was 1264.25... this is a pretty standard strategy, especially since yesterday was an "bearish engulfing bar":

Here are the futures trades that made up the profit:

1) SELL SHORT 3 contracts at 1264 STOP

2) BUY TO COVER 2 contracts at 1258.25 LIMIT (profit=$575, this hit within 1 hour, and still held 1 contract short through the end of the day.)

3) SELL SHORT 3 contracts at 1263.50 (The market actually rallied to over 1264 again, after order #2 was hit, so I re-sold short again a bit below my big point of 1264, and am short a total of 4 contracts now))

4) BUY TO COVER 2 contracts at 1258.25 LIMIT (profit=$525, this hit within minutes after Israel war news hit the tape, still short 2 contracts to hold into the close)

5) BUY TO COVER 2 contract MOC (The MOC order was filled at 1247.5, resulting in a profit of $1625)

(To the right is the 60 min. intraday chart of the S&P e-mini futures contract to see how these trade fit into the whole picture of the day. Below the 60 min chart is the chart with the daily bars also showing how 1264 was the "big point" and how 1258 was good support for a first round of profit taking.)

These aren't really that hard of trades to make, and are VERY SYSTEMATIC:

Sell through the low of the previous day's engulfing bar and take partial profit into short-term suppor (the 1258.25 level) then let the rest of the position ride into the close and close out MOC. The initial stop loss is set at either a couple ticks (or a full point) beyond the midpoint of the engulfing bar, or a point beyond the high of the engulfing bar--you must decide how much you are willing to risk based on the entire range (high minus low)of the engulfing bar.

If the market rallies above the low of the previous day after you've already taken partial profit, then look to sell through that same price level again, and again take a partial profit at around the same level you first took partial profit (again, the 1258.25 level)--the let the rest of the position ride and cover it into the close. I really just think a couple steps ahead the night before, see the support and resistance level, and have the whole game plan (and even orders set!) before the market opens the next day. The game plan just gets executed when the market is open. After getting practice and experience with this, I've become pretty confident in this type of planning the night ahead and execution during the day.

Lost a Bit Today, and Adding New Positions

PORTFOLIO GREEKS (SPX beta-weighted)

Before Re-balancing
Delta: 65
Gamma: -2
Theta: 84
Vega: 291
"Paper-folio" Value: $136,927

After Re-balancing
Delta: 17
Gamma: -5
Theta: 212
Vega: 54
Buying power: $79,053
"Paper-folio" Value: $136,777

The portfolio lost $497 today. No big deal--not too worried about it. Let's make some trades! I'm gonna kick up my theta today and get more delta-neutral in the process.

I'll re-balance my greeks a bit today (Again, using closing prices from today)

My re-balancing will be to get a bit more delta-neutral since I have a few too many positive deltas given the small amount of actual cash I've actually put to work.

The VIX spiked today so I'm interested in selling a little vol as I have lots of cash to still deploy still--thus I'll put on some more AUG Iron Condors (short put & call vertical). I'll also put on some calendars since vol is still statistically cheap on the 2-month time horizon so I don't mind buying some vol a few months out in the back-month option of my calendars.

In futures land, I'll have my usual stops above and below the market in order to catch a big breakout from these levels (At this point though, I'm a little more concerned with a sell off to "semi-test" the June lows--look at that engulfing bar today in the chart on the right...)

Steady is as Steady Goes...

PORTFOLIO GREEKS
(SPX beta-weighted)
Delta: 15
Gamma: -3
Theta: 93
Vega: 269
Buying power: $104,203
"Paper-folio" Value: $137,424

Portfolio made $545 bucks today. Same comments and orders apply for today as they did yesterday.

Not too bad, I'll take it

PORTFOLIO GREEKS
(SPX beta-weighted)
Delta: 35
Gamma: -2
Theta: 98
Vega: 256
Buying power: $100,265
"Paper-folio" Value: $136,879

Nothing too big happenedd today--the market was pretty flat for my purposes. However the paper-folio made a decent $320 bucks. Neither the buy stop nor the sell stop was hit so I made no futures trades today. I don't need to rebalance any of the greeks either. So we'll just wait until tomorrow and see what kind of action we get.

High Octane Alpha

PORTFOLIO GREEKS
(SPX beta-weighted)
Delta: 36
Gamma: -2
Theta: 93
Vega: 227
Buying power: $100,265
"Paper-folio" Value: $136,559

Well it sure was nice to have those sell stops below support sitting on my order book this morning in order to take advantage of that late-day market swoon (The exact orders were SELL -2 ES5U at 1277.00 STOP, triggers BUY +1 ES5U at 1271.50 LIMIT, BUY +1 ES5U 1274.00 right before the close). Basically that means I sold short the S&P Sept emini once the S&P Sept futures traded below 1277 then I automatically sent a limit order to cover 1 contract if the S&P Sept emini traded to as low as 1271.50 then just close out the 2nd contract right before the close (so I don't have any overnight directional risk in the futures). The futures trades were profitable $425 and the options book was essentially flat on the day (again helped by the fact that I had positive vega and positive theta going into the day as well as having -6 SPX deltas going into the day with the market going DOWN -9 points).

Not a great looking day for the bulls out there---the futures actually breached yesterdays high briefly, then turned around and took out yesterday's low (and then some!) by the time the market closed (see chart).

While I'm going into the weekend completely flat on my futures positions (closed out all my intraday shorts by the close to take profit), I'll be looking to re-open new intra-day shorts next week on any continued weakness--again, via sell stops below resistance. This strategy (continuing to sell short through support points) is how the paper-folio profited so strongly during the couple of dire sellofffs in May and June. Granted, some of these directional shorts lose money sometimes, but when they are traded properly (in reasonable size compared to the options part of the portfolio to where anyone futures trade isn't going to wipe out profits, but merely chew up a little here and there) they really do reduce a lot of intraday risk.

I really see risk as comprised of 2 components:
Total Risk = Intra-day risk + Overnight risk

I hate overnight risk. Just HATE it. That is why you will see me close out my directional futures trades intraday most of the time. Maybe I'll leave one or two contracts on if I've made a huge profit intraday on a much larger position of 6 or 7 contracts, but 95% of the time I'm flat on my futures book going overnight. I would actually go so far as to say that I embrace intraday risk. Intraday, I'm willing to take more "absolute risk" in dollar for dollar terms. But this is only because I feel like the intraday market is so technically driven (ie: chart patterns and short-term support/resistance technical analysis hold up well intraday), that it is very easy to define stop-loss points and profit taking targets. Since I've learned technical analysis from one of the best (Stan Ehrlich of http://www.stanehrlich.com/ and http://www.chartpattern.com/) I'm very confident in my ability to make the high-probabliity of success intra-day trades in order to scalp intra-day profits when market conditions are favorable (I define "favorable" as any trade that I feel like has a 75% chance of profit, or a futures trade that provides an "equal hedge" to my options book during the intraday timeframe). Since I always enter a stop loss for these short-term directional futures trades, and since I close them out 95% of the time intraday, I don't have any of the gap risk associated with holding positions overnight.

No new options positions today... I'm liking how my greeks are lookin' right now. I'll see how things open next week and decide how to rebalance things at Monday's close.

Steady as She Goes... and lookin' for a little Alpha!

PORTFOLIO GREEKS
(SPX beta-weighted)

Delta: -6.3
Gamma: -2.4
Theta: 110.2
Vega: 210.4
Buying power: $104,203
"Paper-folio" Value: $136,135

The paper-folio made $430 today as the SPY and IWM were slightly positive. The value is about where we started when I started opening positions a few days ago, so I guess I've already made enough to cover the commissions--not too exciting, but better than a sharp stick in the eye.

No need to put on anymore positions today, but I am going to put a buy stop above resistence and a sell stop below support for a couple S&P eminis, because the jobs number tomorrow is gonna break this market out of its little trading range big time tomorrow and I want to profit from what will likely be a large intraday move. If my stop order to open gets hit I'll have a contingent limit order automatically opened (to close half the position) a few S&P points away to just capitalize on the quick sharp move that is likely to happen once the S&P breaks out of it range. I'll let the other half of the position run until the close, then close it out MOC.

This futures trade is not really part of the "managing a delta-neutral" portfolio, but since the "paper-folio" is so profitable thus far this year, I don't mind being a little more aggressive with this "one-off" trades when the odds are in my favor (big headline event in the employment number tomorrow pre-market, coupled with the tight trading range should yield a large intraday move tomorrow, either up or down.)

These types of trades are the one's that I like to think makes my strategy stand-out from other PURE delta-neutral trading methods. I just don't like to sit back and watch my delta-neutral portfolio get slammed intraday when I intuitively "know" the market is going to make a huge directional move--so I try to profit from this directional intuition. And I don't want to take off my options positions either, because I like how my book is positioned right now for next week. This is kind of like the mutual fund manager who trades around a core position of his favorite stocks--always keeping a big chunk of stock on his books but selling some off on days when its up big, then buying the shares back if it comes back down. In my mind, these are the little things that really add up to serious alpha at the end of the year!

Butterflys and Condors

PORTFOLIO GREEKS (SPX beta-weighted)
Delta: 2.0
Gamma: -2.1
Theta: 108.1
Vega: 203.11
Buying power: $111,664

Analysis of Yesterday's Trades
Today was a great lesson as to why it is very beneficial to use Vega as a great hedge against your deltas. I was long 10 SPX deltas going into today. The SPX was down -9.23 points today. Being long deltas on a down -9 day should have results in me losing money (around 100 bucks if P/L was purely contingent on one's deltas). however, since I had a significant amount of positive vega in relation to my long deltas, I ended up losing no money (the paper-folio actually made +$50 today--not alot, but not bad considering I've only put about $10,000 to work so far). That is because on this down -9 day the VIX popped +1.10 points (see chart above), up to 14.15, just as I was expecting based on the rationale I laid out in yesterday's post, and is why I bought volatility (through calendars/diagonals) yesterday, and said that I would wait for a pop up in vol before I sell vol via outright verticals (ie: iron condors). Obviously, I not going to time it this perfectly (high vol can lead to higher vol, as well as low vol staying low vol), but if I at least make an intelligent effort and have a method of putting on trades at more opportunistic times, hitting these little singles add up to a lot of extra $$$ that add up to homeruns over longer time-frames---and its much better to have a plan based on statistical probability than a plan purely based on luck....

Now onto today's paper-folio trades (priced at today's close)...

I'm going to put on a few butterflys here--one above the market and one below the market. In fact, I'm going to spend 1% of my portfolio on these trades. Generally speaking a butterfly spread has the greatest ability to widen during these last 10-15 days before expiration, so spending 0.40 on a 2 point wide butterfly is a good risk/reward (0.40 was the average between what I spent on both butterflys). I'm opening butterflys both above and below with the intention of 1 side immediately doubling (to around .70-.95)--then I'll take half off and let the rest ride. I really hope that with the volatility we are experiencing that I can actually make some money on both butterflys. I don't mind risking a whole 1% of my portfolio on these as they are great risk/reward trades into expiration (40 cents risk, with potential 1.60 reward), and they also act as a bit of insurance as they help manage the negative gamma exposure in my short options in my front month (July).

I'm also going to put on a couple Iron Condors in both the SPY and IWM. I aimed to sell options with deltas less than 25 for my July's and deltas less than 20 for my Aug's. Still have a lot of buying power left...

One more thing...notice how wide apart the Bollinger Bands are. This is expected since the VIX spiked last week, then quickly reversed path after the panic was out of the air. Typically periods of high volatility are following by periods of low volatility and vice versa. This would lead me to believe that a period of lower volatility could be upon us, which would actually be about par for the course since it is summer, and the market usually sits in the summer doldrums between July-August trading somewhat rangebound--something I'll be keeping in mind as I start putting more of the portfolio $$$ to work over the next week.

Greeks going into July 5th

PORTFOLIO GREEKS (SPX beta-weighted)
Delta: 10.6
Gamma: 0.1
Theta: 26.0
Vega: 481.9
Buying power: $121,079

I put on a diagonal position in the SPY (JUL/SEP) and another diagonal position in the IWM (AUG/NOV) on Monday going into the July 4th holiday. Nothing big, as you can see from the buying power left. I wasn't compelled to sell much July premium as the market rallied pretty good Monday and the VIX is about 1 standard deviation below its 40-day moving avg (See yellow circle highlight at right of chart). Since vol is "statistically cheap" I decided to buy diagonals and buy volatility (as you can see from my positive vega). I suspected that the market will get a down day or two this week to pop the VIX back up a bit which will allow me to sell some premium with better premium. It looks like Wednesday I'll get the chance as the futures are pointing lower with all this N. Korea missile testing news hitting the headlines.

Thoughts on Oil and Trading Volatile Markets

I know this is an "Options Trading Blog" but I think I'll also start posting other trading related opinions here also from time to time. Someone asked if I thought oil would be at $100 by year end, and I ended up going into a deeper explanation that I originally thought, and I thought I'd post it here also.

Dear XYZ trader.
i don't think $100, but i think we'll get around $80ish sometime before Sept, then probably pull back to the $70 area again--maybe it pushes back to test the $80 area again by Dec, and potentially make a new high next year that could breach $100.... i think $100 would be too much of a "super-spike" in such a short time-frame (before year-end 2006) for something that is already "front-page news"... example is how gold super-spiked to the $730 area just recently, but it still wasn't as much of a news story as the oil market. these "super-spikes" usually don't last long, as noticed by the near immediate 20%+ correction in gold--super spikes usually occur before its the "easy trade," (ie: the gold spike just described, and the original almost immediate ramp from $48 to $68 in oil LAST summer--Gosh... Come to think of it, I should go dig out my trade confirmation from back then when I went long 1 crude future on the day that turned out to be the last day crude traded with a 4 handle. I shoulda held the darn thing longer, but I was content with dumping it around 52 in only a day or two, if remember correctly. Considering all the darn $$$$ I spend every day in gas at now $3.25/gal and oil in the $70's it should would be nice to remember the "good old days" of only $40 crude...but I digress) Anyway, my point and rationale is, that after something hits the front page and its such a popular trade, rarely will you get the "super spike".

Also,
The geopolitical picture has definitely been the fundamental driver of the crude market the past couple years. This political uncertainty is what has made the energy markets totally volatile, and totally fun to trade! I also I think an equally important factor is the increasingly extensive amount of speculative trading done by hedge funds and the prop desks at big investment banks (the Intercontinental Exchange's (the ICE) amount of electronic trading in these crude contracts has expanded a lot this year. This e-trading is mostly by new players who either can't afford a seat on the NYMEX, or traders who just want to attempt to arb/hedge the NYMEX market when the NYMEX is closed.) You can now trade crude around the clock for 22 hours a day on the ICE without being a member of various exchanges--can just do it through the ICE via an internet connection.

What this all boils down to in my mind is an expansion of both "smart" and "dumb" money, which increases total aggregate demand across the board. While it could be equivalent to a zero-sum gain (ie: the same amount of new "buys" vs "sells"), it probably will more likely result in much more traders/speculators/hedgers being on the wrong side of the market at certain points in the future. As these traders/firms unwind their large positions at likely extreme inflection points in price, the market will either go up or down much further than proper (ie: fluctuate far beyond true fundamental prices). A recent profeesor told me how prices of commodity futures contracts are governed much more by the supply and demand of hedgers vs. speculators, rather than the sole fundamental price of the underlying commodity in a macroeconomic sense.

Obviously some of the price of the actual commodity is priced into the price which the hedger is willing to buy or sell the futures contract, but there is also a speculative component (either an addition or substraction to the actual commodity price) that gets priced into whatever price the futures contract is being traded at by these purely speculative "buyers" versus "shorters". One good example of this was how the oil markets got slammed last October when REFCO went belly up. Apparently their internal prop trading book of energy contracts was completely long energy. When they had to begin bankruptcy proceedings and had to liquidate all assets, going completely to cash, they had to sell all their crude oil contracts before October expiration (which only gave them about 4-5 days to sell 100's of millions of dollars of contracts). This unnatural selling sold oil off to extremely low levels relatively speaking to what oil was trading at before the REFCO liquidation.

A similar "unnatural" situation could occur on the upside if a huge firm or hedge fund is short oil futures and a large, unforseen geopolitical event occurs that spikes oil up $5 overnight and the firm/hedge fund that is short (even worse if they're leveraged up on margin) gets short squeezed like crazy causing the fundamentally acceptable $5 increase, to turn into a sudden and sharp $10 increase over a couple days as the firm buys in contracts to cover their shorts. Obviously, once things settle down prices should revert to the "only up $5" price, but as a trader worried about managing the absolute risk associated with my positions I personally have to understand how extreme price scenarios play out when total aggregate demand in a market has increased greatly. It's actually very interesting how OFTEN extreme prices occur in the tradeable markets, which is why analyzing these markets is so fascinating, and so fun to trade!

Putting Cash to Work

I have the day off of work tomorrow (July 3), and the market's open for half a day of trading. It's been a while since I've been able to open positions during market hours (since I'm usually working). I'll be looking to put some of my cash position to work and initiate some new positions tomorrow. Looks like to VIX is down pretty hard as a result of the rally late last week. Given SP futures are up tonight, we could have a strong open which will likely depress the VIX even more. Given these conditions I'll likely be opening calendar and diagonal positions tomorrow, eventhough I'd like to sell some near month verticals on both the put and call side (iron condor) as July expiration is approaching in 3 Fridays. But I'd much rather sell vol on a spike in the VIX so I'll wait and see if the broad market sells off sometime this week causing the VIX to spike up back to the 15-16 level before I sell my iron condors.

Methodology...Mindset Part 1

Initiating New Positions
When inititating new positions, or hedging/rebalancing the entire portfolio, the first thing I look at are the overall deltas of my portfolio. I beta-weight all my positions to the SPX to give me a good idea about how much money the portfolio has at risk in absolute dollar terms with respect to every 1 point move in the S&P500. Since I trade only the Russell 2000 (via IWM) and the S&P500 (via SPY), beta-weighting to the SPX works well for me. Since I have a good feel for trading (ie: predicting) short-term 1 to 3 day moves in S&P500 via the futures, understanding risk in dollars vis a vis a 1 point move in the underlying SPX index allows me to associate my qualitative trading feel (on market direction) with quantitative options trading methods and technical indicators. Say what you want about trading off of "feel"--after you've watched the daily movements of a market for years (even down to the very last tick sometimes) you get a really good "feel" for what kind of market you're in--bull/bear, high/low volatility, breakout/breakdown, whether its good to follow the crowd or be contrarian. It works for me, and when it stops working, I'll look to try something else or go straight "quant" and relatively delta-neutral until I get my feel back. (Obviously, no model, quant or otherwise, will predict 2 airplanes running into buildings like on 9/11, and that type of event really is the *only" type of event I'm worried about when trading these methods of mine.)

I would say my trading of these methods tracked on this website is about 75% quant driven (managing greeks) and 25% qualitative. When the market is at extreme overbought/oversold levels, I'll qualitatively trade market direction either through the deltas of my options, or simply via going long/short S&P futures contracts.

The Delta-Neutral Basics
Managing a large options book dedicated to milking time premium across 3-6 expiration months can be quite a daunting task if you don't distill all your contracts down to the bare bones--the greeks. Since my main intent with this strategy is to always be net short option premium (ie: my total portfolio theta is positive at all times.), it is also usually my intent to also be as delta-neutral as possible, within reason (I won't "overtrade" just to achieve neutrality). But just because I'm always net short options premium, doesn't mean I never buy options! The portfolio is not leveraged in any way, and every short option position is always hedged at some level by an option I've bought (ie: making a vertical/calendar/diagonal spread). In my mind I have a comfort zone associated with how much delta exposure I'm comfortable having at any given time--usually the maximum exposure I want to any 1 point move in the S&P is about 0.25% of my total portfolio value. In the scope of this paper trading portfolio I'm running on this website, this 0.25% equates to about $350. Remember, this is $350 at risk for every 1 point the S&P500 moves *AGAINST* me. (ie: Assume I'm starting a new options portfolio with $100,000. So, 0.25% of $100,000 equates to $250. So, if my SPX beta-weighted delta ever got to +/- $250 I would look to rebalance/hedge.) This is quite a bit--at least for my conservative trading nature--as it's very common for the S&P500 to have 10 point swings intra-day and a 10 point move against me with an absolute delta equating to $350 would be a loss of $3500, or in terms of percentage of the portfolio that I used before 10*0.25%=2.5% of the total portfolio! (Generally, I would ensure my other greeks would "back up" my delta exposure--ie: if I have a lot of short deltas, I'll make sure I have a lot of positive vega exposure--more details on this later), so this 2.5% wouldn't actually be the case, and but I'll get into the details of using back-month vega and front-month gamma to help manage delta exposure later. Still though, I don't want to even come close to the 2.5% drawdown because of some mismanaged deltas--this is quite a bit, and is why this is my absolute maximum delta exposure I will usually have at any given point and time. The only time I would embrace this type of "risk" is when I actually want to take a short-term directional stance, which would only be at a significantly overbought/oversold time and when multiple technical indicators are indicating either a huge breakout, or swing in trend is imminent in the very short-term (ie: intra-day, up to 3 days). Below, I will discuss how (and why) I chose to trade directionally at times, given the overarching idea of managing a delta-neutral portfolio.

Intelligently Rebalancing to Delta-Neutral
In my mind, it's easier to trade the volatility of the S&P500 than it is to trade outright directional movement of the S&P500. (Forget that I also trade the Russell 2000, and remember that I beta-weight everything to the S&P500 for purposes of efficiently managing my greeks in a very short period of time.) The VIX is the easiest way to see how the market is viewing S&P500 volatility, and since the VIX is priced through backing out the volatility premium priced into SPX options, understanding what the VIX is trading at is of huge importance to me when trading my options for this portfolio. Remember, when the market is highly volatilie (ie: a high VIX), people are willing to pay more for insurance in the form of options contracts. The willingness to pay more will cause options premiums to increase relative to what they would be if the market were less volatile. Therefore, generally speaking, the higher the VIX is, means the more I will be able to take in from selling options, and the more I will have to pay for buying options.