A Bunch of Trades

This morning, the SPY opened below its 200-day moving average after flirting with it on an intraday basis for the past three sessions.  This signalled "Exit" in the MACO component of CS|MACO, and so I closed the long SPY position at the open for a price of 127.80.  I changed the entry criteria a few months ago after doing some backtesting, and under the updated rules, CS|MACO would have bought SPY back in September 2010 for around 112.  Unfortunately, in real life I can't go back in time, so the SPY position only yielded about $1/share due to its much more recent entry.

The CiG trade has seen me in and out of S&P Futures several times this last month as the stock market went through its daily gyrations.  The trades have mostly been profitable, but it has been a challenge to risk-manage the positions when the stock market has opened up and closed lower, or vice-versa.  This debt deal nonsense going on, coupled with the worrisome economic numbers coming out lately, has the market on edge.  CiG is long S&P and underwater right now, and not far from its stop-loss on the current position.  As a counter-trend-fade trade, CiG is always destined to get hurt when the long term trend reverses instead of simply correcting.  Times like this one are built into the profit expectation, which makes them easier to take.  I am actually using a small number of SPY calls as a proxy for S&P Futures this time around, because CiG called for a long position on Friday amidst swirling rumors about debt ceiling activities over the weekend.  Since stop-loss orders don't work on Saturday, I felt something with a defined maximum loss was a good idea.  I spent the same in premium as I would have lost with a stopped-out position, which lets me keep the trade on no matter what the market action... in exchange for lower profits, if I ever see any.

Speaking of on-edge markets, I bought some deep out-of-the-money calls on GLD during the height (so far) of the debt ceiling circus.  My reasoning was that if the talks really broke down and no deal was formed, then the country's debt rating would be immediately downgraded, the stock market would crash, the economy would head straight into recession again, and the Fed would pledge QE3 to try to policy our way out of this gigantic mess we created for ourselves.  Panic + money printing = inflation expectations + falling dollar, and Gold would climb a wall of worry.  Having some leverage on the only thing likely to rally in that environment would help control the bleeding in my portfolio.  This was (almost) a Black Swan trade, and now that the clowns in Washington are getting back into their tiny car, I'm working to exit the position, starting with getting out of about 25% of the contracts at a 20% profit today. Considering what else would have happened if this position made a lot of money, I'm pretty glad it didn't come to pass.  But with lowered profit expectations, I still should be able to deleverage for a nice profit on the trade.

Despite my taking my finger off the big red button, I still don't have high hopes for the economy. I think the stock market is terribly overvalued (when don't I?), and we are so close to slipping into another deep and painful recession right now that I feel like I need to protect myself against a big market sell-off.  Back in May I bought some puts on SPY, and then took a lot of heat on them.  I was OK with this, as I was more interested in catching a big long-term sell-off throughout the summer than in a small short-term correction in the late spring.  We have now closed below the 2011 lows (125.28 on March 16), so the puts are starting to fulfill their roles as portfolio hedges.

In the midst of all the other excitement going on the last month or two, I sort of forgot about the Iron Condor.  Luckily for me, I placed some target-profit exiting orders before I forgot about the position.  While I ignored the trade the Russell oscillated up and down, taking out my exit orders and then returning to nearly unchanged before I went and looked at it today.  So I discovered a half-sized, well-centered, and very profitable Iron Condor position when I finally bothered to look at it.  Since it had already depreciated past my target for the trade and most of the way toward maximum return, I went ahead and closed it out the rest of the way, opening an Oct 860/870/690/680 IC while I was at it.  This "forget it and get lucky" approach is not a good one, but it happened to work this time.

One trade that didn't work out as I'd hoped was Office Max (OMX), which reported earnings this morning before the stock market open.  Historically, the stock has done very poorly on earnings announcements, and they were only expected to break even in the latest quarter.  Between that and the general skittishness in the market, I felt puts on Office Max were a low-risk play with a high probability of an overnight profit.  This is similar to how I like to play Research in Motion (RIMM) around earnings.  Office Max beat expectations with a 7c/share profit, however, and OMX quickly rallied 18% on the open.  I took the loss on the puts and moved on.

Quick Position Run-Down

• I have a Wal-Mart bond as well as a couple of Illinois muni bonds to control my portfolio volatility.
• I have a long position in a commodity ETF (DJP), which is primarily energy, metals, and agriculture - this is a "China needs stuff" long-term investment.
• I still have a sizable position in GLD call options, as well as long-term holdings of GLD and GDX - to take advantage of this record-setting gold bull market and to partially protect against a market apocalypse.
• I have an investment-grade corporate bond ETF (LQD), which is designed to capture the strength of companies relative to people, without being directly correlated to the stock market.
• I have puts on SPY at both the 129 and 126 strike level; not a huge number, but enough to turn my trading screen green on ugly days like today.
• I have recently started accumulating exposure to oil via USO.  I've been watching crude-oil futures every day at work for months, and I feel like buying USO on big crude dips is a good idea.  I bought my first batch when oil dropped below $95/barrel, and I'll buy some more during the next recession.  Maybe a lot more, since this is also a long-term "China needs stuff" investment.
• I have puts on Xilinx (XLNX), and I'm working an order to close the position for a 125% profit.  This position has hung around longer than I would have liked, but it is finally starting to work itself out.  It started out as an earnings season pessimism trade and turned into a general bearish trending position.
• I am long the Canadian Dollar ETF (FXC), which I bought at par.  This is another US Dollar hedge, and I don't have a specific plan for when to close this position.
• I'm still long Microsoft (MSFT) from a long time ago.  I keep looking for opportunities to write covered calls or something against this position, but the collectable premium is so bad that I can't justify the risk of losing the stock at ex-div, even though the yield is only 2%.  I really need to unload the stock soon, though, as its membership in the DJIA guarantees a rough couple of years when the recession hits.  Mental note: get on this one.
• I have a small position in inflation-protected treasury bonds (TIP), as another hedge against inflation getting away from Uncle Ben.
• I also have a small position in Verizon (VZ).  I took half of it off a few months ago, and have been working a target exit ever since.  Meanwhile, the dividend yield on the stock is 5.5%, which is easy to procrastinate getting rid of.

The Dangers of Stubbornness

A facebook friend enjoyed the comment I made in my previous post: "Or else it's the beginning of a downtrend, and your position is doomed - you can never tell which." Reading her comment on facebook, I started to reply in place and realized I had a lot more to say than a couple of lines.  So I'll put it here.

As I said earlier, the Collaboration is Good trade is a mean-reversion trade.  This is actually a misnomer, as there is no "mean" the market is returning to; a more accurate term would be "trend-reversion", but the industry uses the terms it uses.  In any case, the general principle is that when a market is in a long-term trend, and has a short period (the length of this period varies by market) of returns counter to that trend, a correction back toward the long-term trend is more likely than a continuation of the short term counter trend.  I realize for most readers, that makes very little sense, so let me illustrate.

Example: A Rubber Band

Go get a rubber band - say a medium-sized one about 4 inches long, and hold it in your left hand at a stationary height. With your right hand, grasp its other end and stretch it a few inches downward and release it.  It snaps back, but not too violently, right?  Now stretch it a lot farther than you did before - to something like 12-14 inches.  Notice how you feel the band begin to fight you, equaling out the force of your hand with its own elastic properties?  OK, release it, and notice how much faster it returns to slack.  In fact, it probably bounced up past the fingers of your left hand - in finance, we call this over-correction.  It may have snapped your fingers, too, which provides a good object lesson on why you shouldn't take my blog commentary as advice.

The problem with the rubber band example is that the market is not being held stationary in someone's left hand.  Because of the vast chaos and complexity that exists in the capital markets, there is plenty of room for contrary viewpoints.  One of these is the Random Walk Hypothesis.  In a nutshell, it states that the market cannot be predicted, and any apparent successes in doing so are simply luck.

Counter Example: The Coin-Flip Fallacy

Imagine we have a fair coin for flipping, one that gives heads 50% of the time, and tails 50% of the time.  Now, if we flip this coin 3 times and then report its results in percentage terms without giving the flip count, it will look terribly weighted toward one or the other (67%/33%, or even 100%/0%).  As we flip it more and more, though, we naturally expect it to approach 50/50.  Does that mean that a long run of all heads makes tails somehow more likely?  Of course not - any reasonably aware person can see that the results of any given flip of the coin are independent of all previous flips.

But when roulette players mutter about a particular number being "due", isn't that the exact same thing?  As the number of variables increase, the complexity goes up; this, in turn, makes the game look more and more beatable.  Now how much more complex is the capital market system than a game of roulette?  If it is indeed just a random environment, no human has the ability to intuitively detect that - we're just not wired that way.

I was once forced to "prove" to a previous employer that die rolls in a craps game were independent of each other.  I put it in quotes because the only thing that constituted proof, to him, was a complete model of the entire game that he could run various betting systems on until he managed to convince himself it was just a negative expected-value game of chance.  This man was a trader - none of us are immune.

I personally prefer to believe that the market is not random - instead, it is the numerical result of millions of complex and confusing variables and herd psychology.  Whenever I evaluate a strategy, I try to understand the underlying causes for the apparent pattern. If I can't identify any, I find it very difficult to trust the predictive nature of the strategy.

Real-World Data Sample

Starting in March, 2009, the S&P (proxied here by SPY) enjoyed a massive 14-month, 85% rally.  One leg of that rally started in July and ended in October. Backtesting reveals that CiG would have signaled a buy on September 28, after 3 days of counter-trend price movement.  That time period is visible here, with a couple of trendlines to help remove some of the noise (click the picture for a larger view).  For the curious, yes there were other signals - profitable ones - near Aug 17 and Sep 2.  But they had more bowl-shaped corrective rallies, and thus were not as clear an example as Sep 28, took its profits after a single day.


Here is a zoomed-in view of SPY at the time of the trade signal.  I've overlayed a Relative Strength Indicator to help illustrate the stretching rubber band effect that CiG is designed to capture.

As you can see, SPY built up three days of upward corrective pressure, shown by the red counter-trend line. Finally, nearly all that pressure was relieved on Sep 28 with a 19-point (in the futures) rally. CiG would have signaled a buy on the close of Sep 25 (Friday), and a flattening sell on the close on the next trading day, Sep 28, booking a $950/contract profit.

Double-Down or Go Home

Essentially, the reasoning behind doubling one's investment in a trade that has lost money goes like this:

1. I still think the trade will work out and be profitable; in fact, I feel that it is more likely to have a winning result now that the security I'm trading is even more incorrectly priced.
2. Given that the probability of success is higher now than when I originally entered the trade, I should allocate more capital to it.

Notice that there is a very fine line between this reasoning and the degenerate gambler's muttered mantra, "If I can win one big bet I can make back all my losses." A very fine line indeed.  Also bear in mind that doubling down is a reasonable possibility only for trades that revert.  Such an attitude for a trend-follower or an option spreader would quickly lead to the end of the trader's career.

Even if it makes sense for the trade at hand, it ultimately is a Martingale.  If a trader decides to take this approach, even after some soul-searching and healthy self-doubt, he ought to first clearly define his risk-management rules.  The truly dangerous nature of a Martingale, to the plan-deprived, is that at any given moment during this trade, booking the loss looks worse than taking on a little more risk.  Notice that the reasoning above doesn't ask two important questions: can I bet a greater slice of my financial life that my model is flawless and applies to this situation? and do I have more capital to allocate?

CiG doesn't attempt to answer these questions - good strategies shouldn't presume to be that comprehensive.  Instead, it does not allow increasing position size within a security, and limits the list of securities traded; it also has predefined stop-loss limits.  When the limit is crossed, the position is closed and the loss is booked.  Period.

Even if a trade is good, even if the market is irrational and you have positioned yourself to take advantage of it when it returns to normalcy, you may not have the required funds to reap those benefits.  As John Maynard Keynes famously said: markets can remain irrational a lot longer than you and I can remain solvent.

And that, my friends, is the Risk of Ruin.

Victory From the Jaws of Defeat

It's been another exciting week in the markets.  Last Friday, the CiG trade sent up a buy signal on S&P Futures.  At the close, I dutifully bought at 1297.  Monday morning, all looked well as the market opened nearly unchanged and immediately rallied a couple points; that would prove to be the best price this position would ever see.  It fell the rest of the day, closing at 1285.25, a loss of $587.50/contract.  Tuesday looked great for a while, accelerating upward overnight to 1292 and reaching a high of 1295.5 - only a $75/contract loss - before giving it all back again in the last 2 hours of trading, ultimately closing at 1284.50, down another $50 from the previous day.  Wednesday was uneventful but painful, opening at 1282.25 and closing at 1277.5 - total per-contract loss: $975, ouch.  But then something interesting happened.  Another buy signal came along, this one on Russell 2000 Futures, giving me a decision to make.

In a previous trade a few weeks ago, I found myself in a similar situation: S&P had continued to move down for a couple days after initiating a position, costing me losses and threatening my stop-loss; then Russell signaled.  In that previous trade, I elected not to take the second entry signal, reasoning that in a real money account I probably wouldn't have or wouldn't care to risk additional margin on what I knew to be a highly correlated market.  That time, I watched as the Russell rocketed up the next day - I think I ended up scratching the S&P position, and missed a $1500 winner in the Russell.  After thinking about it some, I realized that a secondary entry like that is an even stronger signal.  CiG is a mean-reversion trade, entering a buy order when the market has sold down too much.  When it moves down even further, even more correctional pressure builds up, indicating a higher probability of the market returning to (or near) its previous range.

Or else it's the beginning of a downtrend, and your position is doomed - you never can tell which.

Since I try to learn from my trading mistakes (my many, many trading mistakes), this time I decided to take that secondary signal.  I bought Russell Futures at the Wednesday close for 787.  Thursday was the corrective rally I'd been looking for, with Russell reaching a high of 796.70, and S&P a high of 1294.  When it was clear I was seeing my rally, I changed my stop-losses into trailing stops so that I wouldn't have to babysit the position (I do have work to do, after all).  When the market started to sell off hard after 2:00pm, both of my trailing stops exited me from the trade at better prices than if I had waited for the close: 1289.50 for the S&P ($375/contract loss), and 794.10 for the Russell ($710/contract profit).

NeighborTrader pointed out that technically there was no exit signal in either product, and he's right.  But it was clear to me that the corrective rally had come and gone - staying in the trade any longer was asking for trouble, in my opinion.  Sure enough, Friday was another down day, with the S&P and Russell closing at 1269.75 and 779, respectively - representing a total stop-constrained loss of over $2000/contract.

I'll take a $365 profit while avoiding a $2000 loss any day, won't you?

CS|MACO... Finally!

Mea Culpa

First, I need to relate a painful but valuable lesson I learned last week.  In my previous post, I said that the CiG trade had fired a Buy signal on S&P Futures.  As a fade strategy, the CiG trade frequently signals trades that I view as bat-shit crazy.  It takes some teeth-gritting and reminding myself that this is fake money in order for me to be able to enter the trade sometimes.  Last Wednesday was one of those times.

I dutifully entered the trade, but I put a $500/contract stop-loss order in, instead of the $1000 that the script calls for.  I congratulated myself a couple of hours later when my stop-loss was hit, closing me out for a $500 loss, on saving the other $500 dollars.  Well... go look at a chart for S&P Futures.  My max unrealized loss that evening would have been about $700, and over the next two days we had a sizable rally.  By the time the exit signal arrived, the trade as designed would have been up over $2000/contract, a big return.  Instead, I was sitting on the sidelines with a $500 loss.  My "judgement", in this case, cost me a total of $2500/contract.  Ouch.

So why did I go against the trade as back-tested by NeighborTrader?  My rationale at the time was that this was a fundamental market move, and we were in uncharted territory that couldn't possibly be handled by back-testing.  OK, fair enough, and that's what judgement is for.  But I took the wrong action based on that judgement: instead of tightening my stop, which cut my max loss by 50% but increased my probability of experiencing that loss by far more than 100%, I should have opted not to place the trade at all.  If my comfort level with the risk is insufficient to execute the trade as designed, I should avoid the trade entirely - not cripple it and damn it to fail.

My conclusion was invalid, even if my assertion (these unprecedented times are likely to cause the trade not to work) was valid.  But what about my assertion?  If we want to look at unprecedented times, let's look at May 7, 2010, the day after the "Flash Crash" (I hate this term, by the way).  CiG would have similarly fired a Buy signal at the end of the day that day, and the exit signal would have come two trading days later, for a profit of over $2200/contract.  And here's the thing: NT back-tested this trade before May 7, 2010.  That's out-of-sample data, and thus can't be discarded as sample bias in his back-testing.

So my assertion -- unprecedented times invalidates the trade signal -- was invalid, and my conclusion on how to act on it -- tighten the stop -- was invalid as well.  Look, I'm not perfect, but if I had gotten either thing right, I'd feel a lot better about it.  Anyway, $2500 lesson learned: either follow the trade, or don't do the trade - don't adjust the trade on the fly based on my gut.

Oh, and you may recall me mentioning that "by rights, I should be short Ten Year Futures, too". That trade, if entered, would have made another $1250/contract over the course of three trading days.  Sigh.

CS|MACO

Last Wednesday night, not long after my stop-out, AAII's sentiment survey for March 17 was posted, and those inversely prophetic investors had some pretty negative things to say about the market.  Bullishness dropped all the way to 28.5%, just below the CS Buy signal level of 31.5.  With SPY trading between its 25SMA and its 200SMA, the MACO component was giving a hearty "meh" signal.  Buy + don't-care = Buy.  So I bought a unit of SPY the next morning... at 128.  SPY is still in MACO's "meh" territory, but up 1.66/share from my buy price; AAII publishes another weekly survey overnight tonight.  If my individual investor peers recognize the cessation of the downtrend last week and get more bullish ("bullisher"?), I might find myself selling SPY on the open tomorrow morning.  But they'll have to get a lot "bullisher" - 41.5% or more - for me to take my profits and go home.  We'll see.

General Thoughts

As regular readers of this blog know, I run multiple trades in my paperMoney account at ThinkOrSwim.  Besides the ones mentioned above, I also have a bullish NDX option vertical spread on to simulate a collar, a bearish SPX option vertical spread, an Iron Condor in RUT (Russell 2000) and naked-long SPY puts.  I'm also looking for a dip in gold to buy back some GLD calls, after having exited my March calls before expiration.  The problem that I am starting to run into is that I have too many trades on the stock market - and many of them are nearly perfectly inversely correlated.  The worst offenders are the bearish SPX and bullish NDX spreads.  CiG and CS|MACO only hold positions once in a while - but the option spreads are there all month long, every month.

This false diversification doesn't benefit me at all - if they were real trades I would be spinning my wheels spending commission on an expectation of about 0 profit.  In a paperMoney account, this isn't so bad, because I can use the excuse that I am looking for profitable trades: the unprofitable ones will never "go pro" into a real money account.  But this is kind of a hollow argument, because any of these trades can be profitable or unprofitable, depending on the market conditions.

This issue bears more consideration.

And a Micro Rant

"They", whoever they are, changed the Nasdaq-100 ETF's symbol from QQQQ to QQQ last night.  WTF???  Didn't they just change it from QQQ to QQQQ a few years ago?  Make up your minds!

Keep Your Head Back

Let's lead this one with a chart, courtesy of BigCharts.com.  I'm using SPY here as a proxy for the S&P 500... mostly because I couldn't figure out how to hide the volume, and the index's volume is empty and boring.  The shape is the same, so it doesn't matter.  It looks a lot like the first 60 seconds on an awesome roller coaster.

Let's put this in perspective.  This is a 6-month chart, so it goes back through mid-September.  SPY was somewhere around 112 back then, and it closed at 126.xx today.  That's a 12.5% return over 6 months, or 25% annualized.  Wow, what a great stock market!  OK, yes, from the high of 134.xx one month ago on February 18, SPY is down 6%, or 72% annualized -- but of course if you really think it's going to continue at this pace for 11 more months, I have some swampland to sell you.  But let's look at the last month, shall we?

• Major unrest in the Middle East, including full-scale revolt in many of our oil suppliers, has caused Crude Oil futures to shoot up above $100/bbl (only $98/bbl today - what a bargain): well into production-drag territory;
• Japan suffered the worst earthquake in... what? forever? a long freaking time, anyway, and its nuclear plants are about to unleash a glowing hell on the Pacific Rim;
• The festering pimples in the European economy are starting to look like they're about to pop one after another: Ireland, Portugal, Greece, etc;
• The Federal Reserve's credibility is finally starting to be questioned, and major indications have started surfacing that inflation will be a bigger problem than people have been assuming;
• And Charlie Sheen, OMG.

Watching the activity in the market on Feb 23, I started worrying that we were about to see another Flash-Crash-type event.  The spreads were widening and the markets were looking really jittery.  I bought some puts on SPY, expiring in April.  I still have them, and I see no reason to sell them just yet.  I also have a bullish option spread that simulates a collar in NDX.  It's pretty deep underwater (duh), but this is a continuation of the collar trade I've been running for a long time, and I won't be changing it now.

Besides the stock market, what have been the other financial effects over the last month or so?  And just for fun, I'll talk about my activities where appropriate.

• The Canadian Dollar roared up and then slunk back, since the Fed-bashing started early on, but the flight-to-quality has taken over the last few days.
• I bought FXC (the Canadian Dollar ETF) today.
• The Ten Year Note, in a strong downtrend at the end of the year and trading sideways-to-down through mid-February, suddenly pointed its nose at the sky as of the end of last week and turned on the after-burners.
• By rights, the CiG trade should be short the ten-year note futures, but I opted for buying S&P futures instead, reasoning that the return on S&P should be more extreme than on Ten Years.  I was right.  I bought S&P on the close, and was just stopped out for my max loss a moment ago.
• Crude Oil futures traded as high as $107/bbl on March 7, and are back down to $97/bbl now in a pretty (but meaningless) isosceles triangle pattern on the chart.  Daily ranges expanded big-time, as the market tried to constantly adjust to unfolding events in the Middle East.  It's back down now mostly on Dollar strength, I think, but 97 is still far above the 85 it started from in February.
• Agriculture futures (corn, wheat, soybeans) all have the same triangle pattern as Crude Oil, without the big gap-up at the beginning.  Again, USD strength as everyone runs like hell into something "safe".
• I hold DJP, which is a commodity ETF which holds 33% energy, 30% agriculture, and 31% metals.  This is a long-term play against the USD that I put on back in January.  I have no interest in selling it at this point -- I only wish I'd bought a long time ago.
• Gold has traded pretty sideways recently, victim of the risk-on/risk-off tug-of-war that's been going on since Charlie Sheen started distracting us from trivial Middle Eastern matters.
• I've had big gold positions on for a long time, and just today I sold some calls that are due to expire on Friday, taking a small loss.  When the nuclear crisis in Japan finally settles down, I'll buy some more, because the dollar will suddenly seem like a bad idea again.

Oh, I also had a bullish option spread on SPX that I liquidated today for just about max-loss.  Option spreads are great because they let you define your max profit-loss range and sleep well knowing that you will neither make nor lose more than that range.  I had been fighting the uptrend in the stock market for 6 months, and finally capitulated with this option spread.  I told myself when I suffered a loss I would reverse direction and start doing bearish spreads instead.  That's tomorrow's trade.

CiG Finally Closed

As I mentioned in my previous post, the Collaboration-is-Good trade signalled a Buy on S&P Futures on Tuesday at the close.  This is a fade trade -- others might call it a mean-reverting trade, but it isn't really, since there is no "mean" we're reverting to.  By fade trade, I mean that it buys on strong dips of otherwise up-trending markets, and sells on strong rallies of otherwise down-trending markets.  So when S&P Futures shed 28 points on Tuesday after trending up quietly and strongly for months, CiG jumped on it. 

I bought S&P futures in my fake-money account at the close on Tuesday for 1314.50.  Wednesday close was 1305.25 (down another 9.50) and Thursday was 1302.25 (down another 3).  If I had simply held that position throughout that time, by Friday morning it would have been down $612.50 per contract, or about 11%.  But I didn't. 

Wednesday morning before the stock market opened, I saw the hard sell-off at 2am from the mess in Libya, and I decided that although futures had come mostly back that night, I should move my stop up to 1312.  Sure enough right after the open, the S&P sold off and hit my stop.  I got a little lucky on the execution, and sold it for 1312.25, saving $12.50/contract in losses.

By the close on Wednesday, the trade was still signalled, so I rebought at 1306, starting at -$112.50/contract.  Thursday was quieter, moving mostly sideways and a little down, and my trailing stop-loss of 10 points ($500/contract) was never hit.  It was still a down day, however, so the trade stayed signalled.

Friday morning, my tour de force of trading skill failed me.  I saw that the rally had finally started, and I wanted to set a closer stop before heading off to work.  Somehow I mis-entered the price, and instead of putting in a stop order to get me out on another big sell-off, I accidentally sold at the market, then 1311, for a reversal in fortune to +$137.50/contract.  Nice to have a profit, for sure, but I didn't want out at that point.

After arriving at the office, I kept an eye on the market and managed to buy back in at 1310 about an hour before the markets opened.  I then set a 5-point trailing stop, which is generally way too little room for this trade, but I was pretty skittish of the stock market by this time; and got to work on my day job.  Somewhere around 11am, after rallying all morning, there was a little market dip that closed me out at 1313, for another $150/contract.  I saw no reason to press my luck further, and closed the trade.

Total profit: $287.50/contract, or about 5% on margin capital.  If I had not been so skittish with my stop order on Friday, the close signal would have come in the afternoon at around 1318.75, profiting $575/contract, or about 10%.  On the other hand, my discretionary trading had a positive impact: if I had just bought on Wednesday afternoon and held on, the trade-prescribed 100-tick stop-loss would have just barely not kicked in at the low on Thursday, so my open-to-close profit would have been $225/contract.  So to recap, my discretionary trading was good, but I got a little more nervous on Friday than I should have.

Making the decision to violate the rules of a mechanical trade in real-time is always a tough judgement call.  Mechanical trades are useful for finding entry and exit points when an emotional human might not be able to pull the trigger on his own.  But blindly following them is not a long-term profitable decision -- despite my active trading behaviors, I believe in an efficient market most of the time.  In this context, that means that if there were a profitable mechanical trade out there, someone has already done it so much that it has been used up. 

By carefully considering whether now is the time to stray off the path laid out by the mechanical trade plan, and using the plan to question his decisions and lend some objectivity to their logic, an experienced trader can enhance his returns.  I'm not experienced enough to do that reliably, but in this case I had the help of NeighborTrader to reason out the pluses and minuses of each individual trading decision, and it worked out very well.

Collaboration, it seems, is indeed good.

Some Trades Are More Frightening Than Others

Not Frightening
Over the weekend, the Collar trade was assigned on its QQQQ calls, meaning that my QQQQ position was closed out at 58.  After the events over the weekend, and the markets today, that ended up being a great trade all by itself (QQQQ closed today at 57.03, down 1.70 on the day).

The QQQQ Collar trade has been one of the few that I have been running with real money, and it has been going for about 18 months now.  Over the last 18 months we have had, overall, a pretty significant up-trend to the market; and a limited-profit trade like a collar is going to underperform during strong up-trend periods.  Sure enough, I've made some pretty good money in the collar trade: just under 16% in 18 months.  But if I had just bought QQQQ and held it, I would have had a much better return: close to 39% over the same period.  Despite this drastic underperformance, the trade is a success - it is a super-long-term trade, and in losing years, its losses are much more limited than a simple buy-and-hold.  If it had not underperformed, that would be a signal that something wasn't being hedged correctly.

This trade is not without its problems, however.  First, there is a great deal of subjectivity about what strikes to use for the covered calls and the protective put - I tried to solve this problem by setting some range parameters.  Next, I have been running this trade in an online broker that is geared more toward stock traders than option traders.  As a result, its commissions for options are terrible: $10.75 for a one-way one-lot option trade, vs the $1.50 I negotiated with thinkorswim.  When I'm doing 14 option trades a year, plus the fairly frequent assignment fee of $25 followed immediately by the need to repurchase the QQQQ outright for $7 flat, it gets expensive fast.  Finally, I have noticed that the time value on the about-to-be-front-month options drains significantly over expiry weekend.  But since my online broker is very touchy about naked short options, I have to choose between an expensive fee-to-price ratio rolling trade, or letting the premium disappear over the weekend.

Since the collar essentially closed itself out over the weekend, I decided now would be a good time to transfer its required capital to thinkorswim and run it there.  I may retain the stock/call/put configuration, or I may run an equivalent position of a simple bullish vertical option spread.  If I do that, I lose the calendar component of the 6-month put vs the 6 1-month calls, but I'm not convinced that component is valuable anyway.  In any case, I have some research to do before the money transfer settles.

Frightening
Back to fake money, the CiG trade lit up like a Christmas tree today, thanks to those crazy Libyans.  S&P futures sold off 28 points or about 2%, which signalled a Buy at the close.  I have been bearish S&P for about 6 months (it has gained 300 points during that time) but this is a mechanical trade -- my viewpoint doesn't figure into it.  Have you ever tried to make yourself buy something when you don't believe in it and it has just sold off by 2%? It isn't easy.

The gold futures trade last month wasn't easy, either, but it turned out fine; by the law of single-datapoint-patterns, that means this one should be just fine too.  Nevertheless, NeighborTrader and I did have some vertiginous fun imagining that we were each managing million-dollar accounts and thus had to buy 100 futures knowing that each point would make or lose $5000.  That would make today a $140,000 losing day for that account, had it been long that amount.  I think I'm happier in fake money for now.

I also had a preliminary Sell signal setting up in Ten Year Note futures... we'll see what tomorrow brings on that one.

Somewhere in Between
Rounding out the flurry of activity today, the sudden market downturn made the volatility indexes pop about 4 points.  Everyone has heard of the VIX, which measures implied volatility in options on the S&P 500.  Since my iron condor trade is on Russell (RUT), I use the VIX's cousin: RVX.  Anyway, the 4 point pop in the RVX was just what I needed to get a better price on opening an iron condor position, since it is a negative-vega trade.  I put on the 760/770/900/910 April Iron Condor, for a credit of $3.25/share.  Pretty respectable, considering the low-IV environment we've had the last few weeks.  If the RVX is predictive, however, I'll be in for a roller coaster ride this month.

Trade Catchup

Iron Condor
This month I did something I swore I wouldn't do: I rode an iron condor position all the way to expiry.  Almost daily I took a good hard look at the position, and just didn't see a reason to close it.  It was somewhat underwater and getting worse as the gamma spiked up, but it wasn't through any of the strikes yet.  I reasoned that the increased loss incurred after the short strike went into the money didn't outweigh, on probability-weighted terms, the near-instant profit up to max I stood to make if it settled where it traded nearly all week last week.  If I had seen an inkling of a bullish follow-through in the Russell (my IC index), things would have been different.

I would have much preferred to get out of the IC early like I usually do, but it was a headache the whole way this month, trending up like crazy and refusing to give me any pullbacks to use for exiting opportunities.  Until the last week before expiry, that is.

With the market sell-off last week, we had a minor RVX spike, which I took advantage of by initiating the March condor position on Thursday.  I never did open a February position - January was keeping me busy, and the implied volatility was crappy.  March is already proving to be better than January, in that yesterday the call spreads inexplicably were priced at only a little higher than half what I sold them for.  I covered a couple of them, leaving most of the rest on.  March's strikes are 690/700/860/870, and they generated 2.35/contract in income when opened.

CiG
The big news is that the Collaboration is Good trade fired a buy signal on gold futures yesterday at the close.  Gold has had an ugly 3-week sell-off, and honestly I was starting to be concerned about my other gold positions in GLD, GDX, AEM, and GLD calls.  Gold futures have a $6750 margin requirement per contract, so I was glad this trade was in the paperMoney account, saving myself some sleep. Also, buying a gold futures contract after a 100-point sell-off would be a lot tougher in a real-money account, especially since with a contract size of 100oz, I'm looking at $100 per point per contract.  That's a lot of leverage: 100 oz of gold, with a street value of more than $130,000, for $6750.

Today the position started about 5pts in the red and continued to slide, bottoming out at about -7pts before gold suddenly started to go parabolic on an intraday basis before the FOMC announcement at 1:15 CST.  By the close, a profit-exit signal had fired, and I closed the position with a nice $1100 profit.  It rallied so hard during and after FOMC that it started to encourage me about my other gold positions.  A good hard rally after a CiG buy signal, historically, seems to result in some follow-through.

NeighborTrader, who was running this with real actual money, claimed he was going home to vomit into a trash can after closing his position this afternoon.   Sounds like it's time to increase the size...

Earnings Plays
Microsoft and Starbucks announce earnings this week: Microsoft tomorrow and Starbucks as I write this.  I have a sizable Microsoft position already, so I bought some puts on it as a hedge in case the stock slides after the announcement.  On the other hand, I have no position in Starbucks stock - but I have a natural short position in their products (nerdy trading humor, meaning I drink a lot of their coffee).  The market has been room-temperature on Starbucks for some time (insert more nerdy humor about room-temperature coffee here, if you like), and I recently saw some compelling arguments why a good report should send the stock higher overnight, so I bought some calls.  The conference call is still going on, but the numbers are out: Starbucks beat estimates and jumped its income by 44% this quarter, so of course the stock immediately slumped by 2.5% after losing 1% throughout the trading day.  Apparently they didn't raise their guidance enough to make everyone happy.

Oh well.

How should I root for Microsoft tomorrow?  Should I root for bad news, making a lot of money on the puts while watching my Microsoft position suffer?  Yeah, that's probably the best play, because I can use the profit from the puts to buy more stock at bargain prices.  Microsoft is a money-generating machine, and its stock price just makes no sense.

Collar
The most boring trade in my portfolio, the Nasdaq Collar, saw its covered call for January expire worthless last weekend, and I opened a new covered call position for February with a strike of 58.  Ho-hum.

Now I Can Afford That Operation

The CiG trade, which bought Eurodollars on an entry signal a week ago, finally gave an exit signal on Monday at the close, so I exited the position by selling GEH1 at 99.59.  That gives a $75 profit.  Since I trade this in paperMoney, I wasn't paying a great deal of attention to how much I should trade, but this one really brought that home.  The risk of one Eurodollar contract is not equal to the risk of one S&P contract - not even close - and the margin requirements reflect that.  Eurodollars carry a margin requirement of $877.50 per contract, while S&P futures require $5625 per contract.  In order to take the same amount of risk, I should be trading 6-7 Eurodollars for every contract of S&P I'm willing to commit margin for.  If I had, this $75 profit would have been $450-525... very similar to the $500 I made on the S&P signal.

In other news, one of my Iron Condor exiting orders also filled on Monday, closing out my remaining 660/650 put spreads.  This leaves my protective debit put spreads on with nothing to protect, and it also tilts the delta into the negative territory again: -20.  With December expiry coming this weekend, and with implied volatility near its 52-week lows, it seems best to close this one out.  I'm working orders to close the two call spreads - the original 810/820 and the kite-component 830/840, the naked long 820-call of the kite, and the protective 630/640 put debit spreads.  Since my current position still has positive theta, though, I see no reason to rush things.  Either way the market moves it will approach my exiting limit orders, so hopefully over the next week or two we'll get a little end-of-year waggle so I can squeeze out a few cents per contract on the way out.  If not, I have a month before I have to make a final decision.  Once theta goes negative, or if delta gets uglier, the pressure will be on to make that decision a bit sooner.

I've had a limit-sell order working on Microsoft for a few weeks now, and it filled today.  I'm still a believer in the stock, but I bought quite a few shares of it when it was depressed, so I'm just rotating some capital out to bring my position value back down where I want it to be.  Readers of my facebook notes will recall that I had 5 "units" of capital in Microsoft.  This sell brings me back down to 5 units of capital in position value.

I'm expecting another increasingly bullish (for me that means bearish) sentiment survey this week, released tonight sometime.  If that's true, CS|MACO will still stand by and watch the Fed Cheerleaders... er, I mean Stock Market... without getting involved itself.

Such a Slacker

I've been distracted most evenings lately from the four Xbox games I picked up during Black Friday madness, and so it has taken me even longer than usual to record thoughts, trades, and rambling nonsense.  As if that weren't enough to eat up my attention, the Bintgoddess and I just received our HTC Incredibles we ordered through Amazon Wireless, and I at least have been spending more time than I should customizing and moving into my new phone.  I had intended to switch from AT&T+iPhone to Verizon+Android when my contract ran out in August, but the Bintgoddess' pre-pay plan ran out of minutes, and we could save more money to switch us both to a family plan now, despite the early termination fee from AT&T.  With nearly free phones (1 cent each from Amazon Wireless) and free 2-day shipping, the choice was pretty clear.  And yes, Amazon did charge my credit card $0.02.  Silliness.

Iron Condor
The January 2011 Iron Condor position has required some adjustment to keep it close to delta-neutral recently.  Recall that I opened a 650/660/810/820 iron condor on Nov 8, and then adjusted it Nov 16 by buying a 630/640 put spread.  Since we're into December, I'm now erring on the side of closing positions rather than opening them - but I'll still increase a position if it's the right thing to do for the risk or the greeks.

The stock market had been rallying pretty hard the last week or two - in fact, it has been rallying pretty hard ever since the day after I put on that downside protection.  This is not a surprise - it's just how I roll: don't believe me? watch me play poker on Full Tilt sometime.  But I digress.  With the stock market rallying and delta going pretty negative, it was time for some upside protection.

First, I bought back about half of the 810/820 call spreads for 1.40: a very reasonable 10c loss.  This moved the delta up about halfway to where it needed to be, but gamma was still pretty negative.  Another up-move and the position would be in trouble again, so I beat the rush and put on a Wolfinger Kite Spread.  Specifically, I bought back an extra 810 call for 3.70, and financed that by selling four 830/840 call spreads for 50c each.  Not only did this bring delta to a nice manageable level and give me some much-needed upside protection, it also significantly improved my max-loss on the upside.  Of course if MDW is reading this blog, he's probably seething that it isn't a perfect Kite Spread - I should have sold the 840/850s, or reduced the sales by 1 contract.  Tough.  I am convinced this was the right trade to make, whether it can rightfully be called a Kite or not.

The next day, I took advantage of another rally to buy back a few of the 660/650 put spreads for 45c.  This lowered delta a bit again, but like the previous day's adjustment, it really helped out in the max-loss department.  The total position now has a nice flat S-curve to it, and theta miraculously is still 13.  So a sideways market for the next 30 days should net me about .25 per contract - that may not sound like much, but that's 2.5% margin-return on a monthly trade.

It's also about time to be looking for a February trade, but I'll learn my lesson from January and wait for volatility to come up a bit.  Using paperMoney is nice, because I have so much fake margin in there that I can make trading decisions without having to be concerned about margin.  If I want to put on February before taking off January, so be it.  Doing that with real funds would take some very careful money management... or more money than I have.

CS|MACO
Still very bearish signals (53% are bullish as of last night, way too many for my taste) from investors, who happen to be right this time about the market as it sustains an uptrend, and bullish signals from the trend following MACO component.  As a result, it still waits in (fake) cash.

CiG
Eurodollar futures (GEH1) gave a bullish entry signal on Tuesday, so I bought them at the stock market close for 99.56.  Trading Eurodollar futures is similar to watching a bad horror movie: long periods of mind-numbing boredom punctuated by moments of pure terror.  So far I'm in the boredom phase - two days after buying them, I'm up 3 ticks.  W00t!  No exit signal yet, so I wait.

Trading Diary for Nov 19

CiG
On Tuesday, I closed a losing CiG trade at the open based on a view that the S&P Futures (ESZ0) were going to sell-off throughout the day.  It turned out I was right, and by the end of the day CiG had given a new Buy signal.  Following this signal with real money might have been psychologically difficult, since all Tuesday long the market was acting like the sky was falling; but that's the essence of a buy-the-dips strategy, and with paperMoney the buy decision was an easy one.

I closed that second long ESZ0 position on a standard CiG exit signal yesterday afternoon for a $900 profit.  I ended up with a $500 profit per $5500 in margin for the whole trade starting on Friday, which ends up being an overall above-average winning signal.  If I had gritted my teeth and held on instead of getting out Tuesday morning and getting back in Tuesday afternoon, the trade would be down $87.  Going with one's gut usually doesn't work this well, so I'm not sure whether to be proud of myself or not.  But I'm glad it worked out this time.

Yesterday's market was a perfect inverse of Tuesday's: everything was coming up roses, and nothing could ever stop the stock market's inevitable return to massive wealth-generating territory.  You know you're a contrarian if you read that last sentence and a little voice in your head screams "SELL"; in this case that was exactly the right thing to do.  At 9:05 CST, ESZ0 was back down to 1188.00, right back where it was when I dumped it on Tuesday.

I wonder if I'll get another buy signal today...

CS|MACO
On Wednesday, results from a new Independent Investor Survey were released and posted on aaii.com.  Not surprisingly, the rapidly falling S&P markets over the past week soured the backward-looking investors' outlook for the future; the bullish percentage dropped all the way to 40%, a massive 17.6% drop from the previous week.  This was enough to move CS from "initiate sell" to "no initiate, no exit".  Meanwhile, the bullish MACO signal had evaporated on Tuesday when SPY closed below its 25-day moving average.  So that meant the trade went from being locked flat due to opposing Sell!/Buy! signals to being flat due to apathetic meh/meh signals ("meh" is an official trading term I just made up that means "no clear view either way").

Yesterday, however, SPY shot up past its 25-day again and closed above it; this gives a clear new "Buy!" signal from MACO, and CS won't change its opinion until next Wednesday.  I should have bought SPY on the open today, but quite frankly I forgot all about it.  This calls for another official trading term to be thought up: I'll call this "psychological slippage".  In this case, however, I saved myself a little money since SPY was about 50c cheaper than yesterday's close when I realized my mistake and opened the position.  I'll take it.

Big News for Boring Trades

It's been a busy few days.  The CiG trade finally fired a signal on Friday, but I was in Colorado all weekend so I didn't have time to write it up.  Then I came home with a head-cold just in time to support a major roll-out at the office that went pretty wrong.  By the time I got home last night all I wanted to do was sleep.  So now here we are.  Excuses excuses.
 
Saving Money While Asleep
First the CiG trade on Friday.  You may recall I decided to run it on S&P futures as well as treasury note futures, because I feared that treasury notes would bore me to death.  On Friday, it signaled a buy-on-close on the S&P, so I did.  Things were looking good Monday morning, but not good enough to reach the target exit signal.  By this morning, the whole world was fleeing from risk again and the stock market opened significantly lower.  Since there are no clearly-defined stop rules, I decided to sell the position for a loss shortly after the stock market opened.  I felt that what we were seeing was not a momentary blip but in fact a setup for a selling day.  I was right: I sold the position at 1188 at 9:00.  At the 3:00 close, ES was down to 1176.

Because CiG tries to buy on dips, though, it had another buy signal come out on ES today.  Pleased at my ability to dodge at least some of the sell-off today, I decided to get back in with a new long position at the close.  So I'm still long from Friday, but I took a 12-point ($550/contract) hiatus.  That's almost a winning trade all by itself.  Not a bad money-saving siesta.

No joy in treasury note futures yet.  Yawn.

Insert Spy Pun Here
CS|MACO, another boring trade, is finally starting to see some life.  It has been locked flat while SPY has rallied over the last 3 months, due to the bearish signal coming out of the contrarian investor sentiment component and the bullish signal coming out of the moving-average-crossover component.  One of those two opposing forces was removed today when SPY closed below its 25-day moving average, breaking the SPY>25MA>200MA relationship that has been in place since October 4.  That's not a sell signal yet, though, because the terms of the trade state that I won't enter a position on the removal of a signal.  I need the CS component to affirm its bearishness tomorrow after the close before I can short this puppy.

A Boring Iron Condor is a Good Iron Condor
Unfortunately, this one is starting to get a little exciting.  When I opened the position I groused about my poor judgment a little bit regarding the low price I was paid to initiate.  Sure enough, the VIX almost immediately rallied while RUT flagged, causing my delta to increase as I rode the curve down toward my put spread.  Delta of +16 this morning, so time to adjust already.

It seems ridiculously early to be thinking about exit orders, but I could buy back my call spreads for only 60c already; so I put in some limit orders to buy back at 20c.  That doesn't help my delta, but it does lock in a profit on half the trade - and with some careful adjustment the other half might not cost too much.

As for the put spreads, I looked at the mouse-ear like I used last month and decided it was overkill: RUT was 710 or so when I was adjusting, and my put spreads are 660/650s.  A mouse-ear would throw my delta so horribly negative that I would have to buy back most if not all of my call spreads to contain it.  Plus it was crazy-expensive, at $21.

The next thing I looked at was simply reducing the call spread position.  That would certainly help the delta and the feel of the position, but I felt the cost was a little high.  A variant of this is to roll the call spread down a few strikes, also increasing the position a bit to finance the roll.  This increases risk, and I wasn't happy with the outcome or my perception of the risk-reward trade-off.

I also looked at Wolfinger's Kite Spread, which involves a naked long OTM put and a credit put spread even farther OTM with 3-4x the size on it for financing.  That had some real potential, but it really hurt the theta.  Ultimately I decided I could achieve my delta goals and flatten the value graph best by putting on some 630/640 debit put spreads.  I bought just enough (at 1.90) to get the delta under +5.  By the close, the delta was back up to +5 again, but that's within my parameters.

Boring News for Big Trades
I'm still not holding GLD calls, and I'm glad.  I'm looking for bargains in some of the mining companies right now, but I haven't had time to look very hard yet.  Earnings season is upon us, and if I can capture a couple of positive earnings surprises before the event-driven IV goes through the roof, I'll be a happy camper.