TradeLogic - SKF Double Diagonal
by Phil - September 17th, 2008 4:39 am
This will be the first in a new series in which we will examine potential plays and follow them through in discussions attached to the post.
Hopefully it will be a good exercise in trading mechanics and help members to understand the goals of a trade, the logic of a trade and how to manage it through the process. A double diagonal is an extended form of a butterfly spread in which you buy long puts and calls in a longer month than the short puts and calls you sell. Our primary goal in this type of play is to gather premiums from our shorts, we are fairly neutral as to direction.
In yesterday’s (Sept 16th) market excitement, Chemistry said: "The premiums on SKF are so huge, there must be a quick play on that premium with opex so close." That led us to decide to look at the following play:
| Buy 1 SKF JAN 2009 135 Call (.SKFAT) | $26.40 | $2,640.00 |
| Sell -1 SKF SEP 2008 130 Call (.SKFIU) | $8.60 | ($860.00) |
| Sell -1 SKF SEP 2008 130 Put (.SKFUU) | $10.30 | ($1,030.00) |
| Buy 1 SKF JAN 2009 125 Put (.SKFMR) | $26.50 | $2,650.00 |
We had been discussing the SKFs as covers since last Monday, when it opened at $97.30, to offset losses by concentrating on the ultra-short finanical ETF (the sector we thought was in most trouble) while the maket shook itself out but yesterday, right at 9:41 I said: "SKF - Well below the $140 line now, good protection that seems to have run its course for the moment." During the day we kept watching different levels and we finished the day close to my lowest target ($115) that we were looking at from 11:07.
The above play came up at 1:35, ahead of the Fed where we expected a volatility crush on the short options so we wanted to find something that sold the most possible premium. This trade puts $3,400 at risk and, since the longs are $125 puts and $135 calls, if the play runs out to January between those strikes, the January contracts expire worthless.
There are two schools of thought to managing a play like this: You can either leave the long side alone and keep rolling the short side to maximize premium (assuming you have a firm long-side target) or you can adjust the trade when advantageous. The long contracts are simply placeholders that allow you to sell puts and calls but they also have a LOT of premium and we never like that. This play was put up when the SKF was at $127 and we closed at…
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Trivia Time!
by OptionSage - August 18th, 2008 11:37 pm
Let’s say you decide to deposit $100,000 into a brokerage account. You decide you will check your portfolio on a weekly basis. Now let’s further assume that the first week has passed and you are about to log in to your account. But before you do, you are told that one of two things has happened in the past week.
[1] Your portfolio went up $10,000 and then dropped $10,000
[2] Your portfolio went up 10% and then dropped 10%.
So, the trivia question is: In case [1], what should you expect your account value to be and is that the same figure as in case [2]?
If you answered $100,000 in case [1], you would be absolutely correct! If you answered that this is the same as in case [2] you would be absolutely incorrect! Why? Well let’s take a look at what happens when the portfolio rises 10% first; it goes from $100,000 to $110,000. But then we’re told it drops 10%. 10% of $110,000 is $11,000. So the portfolio drops from $110,000 to $99,000.
Now how can this help us in our trading decisions? In its simplest form, this tells us that if we were to simply buy stocks that over the long run had a tendency to rise up substantially and fall down substantially ie starting at 0% and rising up and ultimately falling back to 0%, the volatility is impacting long-term returns. In statistics, that percentage swing would denote variance, which in turn is often equated with risk. Another term for risk is beta. High beta stocks tend to move more than the market and tend to have greater variance.
So, if you are in the market for the long-term, you should certainly pay close attention to the impact of variance. Over time the impact to the $100,000 portfolio is not just a drop of $1,000 as in the period shown above, but that portfolio erosion continues over time to the detriment of overall wealth. Unless….
Unless, you know how to take advantage of such volatility. Buying and holding stocks is about as advanced a trading technique in this day and age as owning a cell phone that simply operates as a phone. Why accept bare functionality when you can combine the basics with so much more. In the stock market, this means using options. (In cell phones we already know they come with email, calculators, personal organizers, GPS etc).
Phil, Opt, fellow PSW…
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Vacation Proofing Your Portfolio
by OptionSage - July 25th, 2008 6:43 am
NEW INFORMATION = TAKE ACTION
Save it. Post-it. Record it. Use it.
When driving a car and some object appears on the road ahead do you usually run right over it or do your best to avoid it? Don’t we all take action in real-life based on the new information we receive that changes the old paradigm? Take the first two guys in this video: Who would you rather be, the first or the second guy? While the second gentleman reacts and looks ridiculous in so doing, he’s the guy that is more likely to survive when real disaster hits because he’s reacting to new information. In fact he doesn’t even know what’s making everyone else react, he just knows that when 99% are moving one way in panic, it’s best not to fight the crowd or he will be trampled. It’s no different in the market. Pride, ego and old theses have no place when new information directly contradicts an existing trade.
When the market is up, we use DIA puts and calls to "react" to quick changes in the market while we wait for better information before making more permanent changes in our positions. This gave us the benefit of the quick reaction of gentleman #2, the one who went unquestioningly with the crowd, while also giving us the "wisdom" of gentleman #1, who was confident (or oblivious) enough to soldier onward, despite the fact that the world seemed briefly to be against him.
When new information does arrive, one of the first things I look to do is minimize risk - hedging the existing position. The next step for me is to become more aggressive in reacting to the new information and shifting the bias of the trade in the opposite direction. In this article, I will outline our basic strategy for protecting your portfolio from a major dip, which can then be used to adjust your risk profile, based on changes in outlook arising from new information.
The strategy outlined can be applied also when you know that you will be unable to monitor your positions. Many of you will likely be taking vacations this summer and, with them, a break from actively monitoring your positions. With that in mind, it’s always prudent to protect your positions from the “just in case” events that can derail your positions in a flash when you are not attending to them. Those “just in case” events are a…
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The Trading Virus
by OptionSage - July 23rd, 2008 10:22 am
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Vampiric!
by OptionSage - July 13th, 2008 11:48 pm
Black Hole: a region of space in which the gravitational field is so powerful that nothing, not even light, can escape its pull after having fallen past its event horizon. The term "Black Hole" comes from the fact that, at a certain point, even electromagnetic radiation (e.g. visible light) is unable to break away from the attraction of these massive objects. This renders the hole’s interior invisible or, rather, black like the appearance of space itself.
If it ever felt like the market had a black hole, now might be that time! An inescapable magnetism with vampiric tendencies is exhausting the patience and energy of the most steely and experienced stock market traders. In the depths of the gloom and amid the contagion of panic, solace and wisdom can often be found in the words of those who have seen it all before, long before any of us had begun to even dabble. The following quote is from Remiscences of a Stock Operator:
"And right here let me say one thing: After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: It never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight! It is no trick at all to be right on the market. You always find lots of early bulls in bull markets and early bears in bear markets. I’ve known many men who were right at exactly the right time, and began buying and selling stocks when prices were at the very level which should show the greatest profit. And their experience invariably matched mine – that is, they made no real money out of it. Men who can both be right and sit tight are uncommon. I found it one of the hardest things to learn. But it is only after a stock operator has firmly grasped this that he can make big money."
Having dipped a little toe in the water this week only to find blood-thirsty sharks hiding under the surface, this quote serves the purpose of reminding not just the reader but the author of the imprudence of ignoring market sentiment. But words tend to be poor descriptors of raw sentiment. Instead pictures have a habit of conveying the heart of an issue. And perhaps, this chart of Fannie Mae in freefall suffices to illustrate the current market…
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A Noisy World
by OptionSage - July 6th, 2008 12:04 pm
All around us signals are transmitted and received each day. Within those signals valuable information is intertwined with spurious content. As a result, receiving devices have filters built in to discern the ’signal’ from the ‘noise’. High Signal to Noise ratios convey A LOT of information while low Signal to Noise ratios convey very little information! Indeed, when the noise levels increase above threshold levels, signals may be corrupted entirely, resulting in no information at the receiving end.
But what has this to do with the stock market? As traders, we are receiving information each day that we must learn to process and indeed we must learn to filter some of it out. This is an enormously challenging task because our natural inclination is to apply bias to the information we receive. For example, if we are bullish on a stock and an analyst disseminates a report that aligns with our views, our opinions are more likely to strengthen. In order to achieve our objective of trading without bias, we must recognize that history is laden with examples of the stock market confounding expectations.
In the 1970s, few envisioned that commodity prices would elevate to the degree they did or that bond yields would rise up to 15% by 1981 or that bond yields would decline to around 3% in 2003 or that a protracted equity bull market would ensue. Few expected that almost two deacdes after the Japanese market reached its peak, it would still be down 60% from its highs. Few recognized in 2000 that commodity prices were at historic lows while China and India were emerging rapidly.
Recognizing that the opinions you hear from others originate from a place of vested interest means critically analyzing comments becomes imperative. For example, just a couple of months ago, Lehman’s CEO announced that "the worst is behind us". It is evident from the chart below that the worst had certainly not been priced into the stock yet!
Clearly a delineation between expressed views and market action took place in all previous examples. The insurmountable challenge most traders encounter when confronted with such a delineation is their own attempt to justify the action. Why did Lehman go down? Why did bond yields surge? Why did commodity prices soar? Why has the Japanese market not recovered? A lot of calories may be wasted in striving to justify market action. The reason they are wasted is not because it is not a worthy process to understand the causes of market movements but because it often distracts…
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k1p - The k1 Portfolio
by k1 - July 5th, 2008 3:39 pm
New Members Entry Point - If you’ve arrived on this page looking for the k1 Project and all the reference material on Phil’s strategy, follow this: Front Page of the K1 Project.
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k1p - ETF Madness with SPY
by k1 - July 2nd, 2008 7:36 pm
New Members Entry Point - If you’ve arrived on this page looking for the k1 Project and all the reference material on Phil’s strategy, follow this: Front Page of the K1 Project.
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k1p - The k1 Portfolio
by k1 - June 29th, 2008 7:58 pm
New Members Entry Point - If you’ve arrived on this page looking for the k1 Project and all the reference material on Phil’s strategy, follow this: Front Page of the K1 Project
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Blame It On The Beatles!
by OptionSage - June 29th, 2008 5:02 pm
Maybe we can blame it all on the Beatles invasion of America. The bustling 60s with its expressions of freedom was the time when the transition seemed to sweep the nation. Instead of purchasing what we wished AFTER we had earned the capital to do so, as in generations past, we learned to purchase BEFORE we had earned sufficient capital to match our desires. The availability of credit has forced grown-ups to take a grown-up version of The Marshmallow Test.
Recall the MarshMallow Test was a test given to youngsters to determine the correlation between patience, self-discipline and success in life. A marshmallow would be placed in front of a child, who was told if the marshmallow had not been consumed by the time the adult returned to the room, the child would recieve a second marshmallow. The end result being children who passed the Marshmallow Test did better financially in life!
Most of the population are tempted by the proverbial marshmallow every day under the guise of credit offerings. These days credit card offerings are expected daily in the mail and homes have been turned into ATM machines. And those homes were in turn purchased through borrowing. The excesses are compounded by the fact that some studies have reported that over 9 out of 10 borrowers mis-represent their net worth during applications. Not only is most of the public failing the Marshmallow Test, but the government is too. A balanced budget, once demanded as part of fiscal responsibility, is now all but a distant memory.
The pervasive excesses of borrowing inevitably lead to greater gains during upswings and greater losses during corrective phases. During the declines, few stock market participants have a containment strategy. Account value fluctuations are exacerbated and panic sets in. Growth-oriented investors realize that declines in future earnings inflate P/E multiples and bargains soon turn into over-priced securities. Supposedly sophisticated quant funds who rely on black box models are often most at risk because leverage is frequently so integral to their performance. And as the models stop working, the losses are exacerbated by the earlier dependence on leverage.
For most it is too late to salvage a portfolio or to take corrective action when the news media frenzy reaches peak levels and the front covers of magazines tell tales of stock market woes. But the difference between defeat and failure is the difference between giving up and taking a lesson from the pain. …
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Philip R. Davis is a founder Phil's Stock World, a stock and options trading site that teaches the art of options trading to newcomers and devises advanced strategies for expert traders...
Ilene is editor and affiliate program
coordinator for PSW. She manages the Favorites backup site
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