Bullet-Dodging

Intel (INTC), IBM, and Xilinx (XLNX) all reported earnings last night. Being the pessimistic contrarian that I am, I intended to buy puts on all three of these companies. In fact I was working orders to buy puts on Monday, but didn't get filled. I like to buy the puts a couple of days early, because experience with Research in Motion (previously RIMM, now BBRY) has shown that option cost goes through the roof shortly before an earnings announcement. Apparently the market makers are aware that earnings announcements move stocks, and so are building more expected volatility into the vega. So I exchange a couple of days of market risk for lower implied volatility cost, as long as I feel I'm getting a good price for the options.

Anyway, I didn't get filled on Monday, and intended to place my orders again on Tuesday -- I don't believe in GTC for options entry orders, that's the way to get a really nasty surprise after forgetting about the orders. But life intervened, and it completely slipped my mind until last night long after the market close. I went ahead and checked the price action on those three stocks this morning, and this is what I found:

• INTC opened at 23.47, down from its close of 24.15. Their earnings missed expectations by $0.005/share. My put would have increased in price by about 50% overnight.
• IBM opened at 198.27, up from its close of 194.55. Their earnings were $3.97/share, crushing the expected $3.77/share. My put would have decreased in price by 67% overnight.
• XLNX opened at 45 and rallied to 46 in the first 15 minutes of the trading day, up from its close of 43.53. Their earnings were 56c/share, handily beating estimates of 47c/share. By the time I got out of it, my put would have decreased in price by 75%.

That's a pretty big bullet my absent-mindedness helped me dodge! Just how big? Let's say I put $1000 into each of those positions:

• INTC: $1000 * 50% profit = $500 profit
• IBM: $1000 * 67% loss = $670 loss
• XLNX: $1000 * 75% loss = $750 loss
• Total Loss: $920 on a $3000 investment, or -31% overnight. Ouch.

Sometimes forgetfulness saves money.

Right on Target

On December 14, 2012, gun violence erupted in Newton, Connecticut. A lone gunman entered a school and killed 20 children and 6 teachers and administrators. The topic of gun control, both pro- and anti-, had already been a fairly hot one; now, it was the leading conversation topic on everyone's minds. Folks lined up predictably: conservatives generally tended to be against it, citing quotes like "guns don't kill people, people kill people," and the 4th Amendment; liberals were equally vocal from the other perspective, quoting statistics from countries with strong gun control legislation, as well as making emotional appeals. Stocks of gun makers slid, as the market anticipated changes that would be negative for their bottom lines.

One such gun maker was Smith & Wesson, perhaps the best-known American gun maker of all time. Smith & Wesson can be traded via its holding company, Smith & Wesson Holding Corp (SWHC). Just a week or so before, SWHC reported earnings higher than analysts had estimated, and raised guidance for 2013. Regardless, SWHC stock dropped from its high of $11.25 to $9.40 in two of the days leading up to the Dec 14 violence. Afterward, SWHC slid even further, closing at $7.79 three days later.

On December 19, 2012, President Obama gave a press conference discussing various topics, including the Dec 14 tragedy and the possibility of gun control in the future. The full transcript of that speech can be found on the Washington Post website. The chatter on facebook, where I do most of my crowd-watching because of its raw knee-jerk flavor, universally agreed that massive gun control measures were coming; some people opined with satisfaction, others with chagrin. I watched this flood of prognosticating carefully for the next two days. The daily traded volume of SWHC eclipsed any other volume spike that year by about 60%, including the massive two-day 37% rally it enjoyed in September, 2012, following a truly magnificent earnings report.

On December 21, 2012, I bought SWHC at $8. My reasoning was that the entire nation was overreacting in its prediction of the policy outcome. Call me cynical, call me contrarian, call me cold and heartless, I don't care. But I saw a stock that had no business being nearly 30% lower with rising profits. I also saw that many conservatives were taking the President's comments as a call to buy guns before it became too difficult to do so. SWHC continued to bounce around on Dec 21, closing just 10c above my purchase price. I said at the time that I would hold it as long as necessary to get a good return out of it. I had a soft mental stop price of about $7 to start worrying, and a pie-in-the-sky profit exit of about $16: double my money. I didn't expect $16, of course, but if it got there, I would take the money and run.

In the second week of January, I traveled to Salt Lake City, UT, for my annual ski trip. One evening after skiing, I proposed that we go to a local gun range and store for some target shooting. John and I did so, and the place was so packed that we gave up and tried the next night. We arrived a little earlier and found the store a little less crazy but still very, very busy. And folks weren't just looking, they were buying. I asked the store owner why he thought it was so busy, and he looked at me and chuckled, saying, "why do you think?" We had fun shooting, and I went home feeling very optimistic about my investment.

January 16, 2013, was a big day for SWHC: it opened at $8.40 and closed at $8.91, seeing a high for the day of $9.25. During the ensuing price action, I placed an order to sell covered calls against it: targeting a strike price of $10 with a March expiry. I wasn't filled that day, but early the next my calls sold for 55c/share. When I do covered-call trades, I like to discount the purchase price by the amount of the premium; thus my effective buying price for SWHC was now $7.45, 22c/share lower than the low on Dec 18 at the height of the gun control sell-off.

On March 5, 2013, SWHC hit its high since the December sell-off, peaking at $10.63 and eventually closing at $10.22. That evening it missed estimated earnings, and subsequently sold off into the options expiry weekend, closing at $9.21 on March 15. My covered calls expired worthless that weekend, and I started working a new covered call order the next week. In retrospect, I could have maximized my profits by selling $9 strikes in January instead of $10 strikes. But of course that would have required me to see the future, which I cannot do.

I sort of lost track of my SWHC position for almost a month, refreshing my covered call order in mid-April, and finally getting filled on April 25, selling June expiry calls with a strike price of $9 at 45c/share. This brought my effective purchase price down to a nice round $7/share.

I hoped for similar price action to the previous quarter, since that would allow me to sell even more calls at strike prices above my purchase price, but alas the next earnings report was much more positive, and I was assigned my calls over the June 21, 2013, expiry weekend. I was out of SWHC at $9/share, with an effective purchase price of $7/share. That's about 28% in 6 months. Maybe I could have squeezed a little more money out of this trade, but considering I would forget about it for months at a time, I'm pretty happy with it.

Contrarian investing is not for the faint of heart. I have doubled down on GLD calls three times now during the 9-month bear market we've been experiencing, and it seems that Bernanke has a personal vendetta against my position. But sometimes, when the world is screaming "Sell" at the top of its lungs, it is very profitable to accommodate them. This was one of those times.

Thanks, Uncle Ben!

It's been a very long time since my last trading/investing post. I've continued to ride my CSMACO position (long SPY since May), and made a few covered call trades (Microsoft, Canadian Dollars were both good ones the last few months). And the Collaboration is Good trade has signaled an entry now and then in S&P Futures. Some I took, some I didn't, thanks to the distractions of moving across the country. I've also made some bearish bets on Salesforce.com (what is their revenue model really?) and Apple (haven't you hipsters run out of money yet?), which have not worked out too well. I trimmed back some of my poorly performing gold-related positions to offset some gains in other things immediately before the gold rally resumed - figures. But I still have a moderate stake in gold, so all is not lost. Overall it's been a tough but slightly positive quarter, but the trading has been pretty muted, and nothing interesting enough to write about.

But when it became clear, a few days ago, that the Fed was almost certainly going to announce a 3rd round of quantitative easing (QE3) in the September FOMC meeting, I knew I had to take a leveraged stake. Unfortunately real life kept me from finding time to enter a position until the last minute, but the market gave me the courtesy of a downtick on Sep 10th. This let me get a pretty good price on a sizable chunk of SPY calls, which I held through the announcement today.

Everyone knew QE3 was coming, and just about everyone was sure it was today. But there is a kind of gun-shy quality to this market: it reacts some to the rumor, but it prefers to wait for the actual news before making a decisive move. Call it what you will, but I like to think of it as a confirmation rally.

Going into the announcement, SPY was just about unchanged from yesterday, and random-walking market movements had already given me a small return on the calls. Sure enough Ben Bernanke announced QE3 and made a lot of meaningless bluster about "doing whatever it takes", etc etc, designed to give the masses confidences that he knows what he's doing and he'll make your life better. He doesn't, and he won't. But in the meantime, the entire financial system rallied: stocks, bonds, currencies (not the dollar, of course), commodities. Every single thing on my watch list is green today, except for the VIX. The S&P chart looks like a bottle-rocket going off.

I exited half the position at twice the entry price, meaning that I have my initial investment out and future proceeds are all profit. QE rallies usually take a few days to play out, so I'll hold the other half for a little while and see if I can improve the return a little.

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.

*POP*!

It has been a busy month, and except for my mechanical trades (an update on those is coming soon), I haven't found the time to wander around looking at areas of the market that I don't usually trade.  About a week ago, though, I realized that I had heard a lot of buzz around the office about silver.  A month ago almost none of our traders were interested in trading silver futures, and now suddenly I was hearing about it from several different directions.  Curious, I brought up a chart.

(Silver ETF through May 2, 2011)

This, ladies and gents, is a bubble.  Having lived through the economic aftermath, we all have heard of the Tech Bubble of 2000 and the Housing Bubble of 2008.  Smaller financial instruments like silver don't get capitalized names, dates, and a lot of mainstream attention, because they don't push the economy around.  But here's a couple more from recent memory: the Oil bubble of 2007-2008, and the Agricultural bubble of 2007.  In the charts below, I have helpfully included the bubble-popping aftermath for 20/20 hindsight, which I held back in the Silver graph again (for the impatient, there is a full chart near the bottom of this post).

(Nasdaq ETF Apr1999-Apr2000)

(Oil ETF Mar2007-Jul2008)

(Commodity ETF Jan2007-Mar2008)

Sadly I can't find an ETF that captures the housing bubble well, but here is an excellent chart from another blog (thanks to James Parsons).  I haven't verified the source data, but it looks more or less correct.  The volume isn't pictured; in the context of home prices, that would be the real estate sales activity.  I could go do a bunch of research, but I won't.  We all remember the "flipping" craze of 2006-2007, right?

Housing prices 1970-2010, nominal and inflation-adjusted

In all of the charts above, notice the accelerating prices near the end of the bubble, and the corresponding accelerating daily volume.  This represents the "final blow-off phase", where everyone just has to be involved in this instrument.  Retail amateur investors do not belong in a frothy market like the ones pictured above, but the siren song of water-fountain stories about how Bob from Accounting doubled his money last month is a powerful draw.

In 2000, I had been reaping the rewards of the Tech Revolution, as I saw it, by working as an independent consultant on the side, more than doubling my salary by charging consultant rates and putting in 20-30 extra hours a week.  I suddenly realized that a lot of people had been making a lot of money in the stock market for a long time, and I was determined not to miss out on any additional free money.  I started reading the Motley Fool and buying more or less any stock that made a new high, with no regard for earnings (there weren't any) or prices.  I came late to the party, like most investors did, but I was convinced this New Economy (remember that?) was one that would love me and my technical mind, cradling me in its hammock of cash.  So I bought Yahoo at $120.  When it fell to $100, I listened to the Buy&Holders telling me what a great new bargain it was offering me, and I bought more.  When it fell to $60, I bought more.  When it fell to $40, I made my last purchase while gritting my teeth.  I don't remember where I sold it, but it certainly wasn't higher than $15.

I learned a lot in the next 8 years.  In 2008, when stock valuations were ridiculously high, the housing market was quietly imploding, and credit was rapidly shrinking, I heard a sudden increase in questions from people not involved in finance about how to get involved in finance.  I had doctors, dentists, and engineers wanting to argue with me about where oil was going in the next 5 years.  I had people telling me that $1.5million wasn't that much to spend on a 4-bedroom house with no land, and besides, you could just sell it for $1.8 in a couple of months! Suddenly everyone was a speculator, and everyone was loving the party.  Meanwhile I was reading economic analysis by folks like the Head Economist at Merrill Lynch, who was pointing out how silly it all was.  Every week he bemoaned the rapidly accelerating speculative frenzy, and forecasted a recession with increasing certainty and severity.  Finally in the summer 2008, I think in August, I decided it was time to take a position.  I bought puts on SPY, a lot of them.  I made about 800% on that trade; no, that is not a typo.  The money I made in that trade did not make up for the money I lost in my stock-index retirement accounts, but it certainly helped.

So a week ago, when I suddenly woke up and realized that I was seeing the top of a bubble in silver, I bought puts in silver.  I didn't buy many, because I'm unfamiliar with the market and I don't want to extend myself too far into a clearly volatile situation when I don't know what fundamental forces might be driving it.  Well, it turns out to be speculative craziness.  The CME decided to increase the margin requirements on its silver futures contract (SI), because it was seeing bigger daily ranges and was concerned that too many small speculators would be unable to make margin, leading to a meltdown (irony?).  Silver immediately turned about 120 degrees and headed straight for the floor.  I bought my puts the day after that announcement, so I missed the first big down day.  But here's the full-year chart of silver I held back at the top of this post:

SLV through present day

Is that not the most perfect bubble chart you've ever seen???

Two days later, I had more than doubled my money on the puts.  I sold a little less than half of them for more than I paid for the full position.  Now that remaining part of the position is worth more than twice my original investment.  In just a week, I'm up over 350% overall.  I like to use options for short-term directional plays like this, because I get leverage and limited risk.  I bought options worth about 4x more than I would normally initially invest in anything, and I spent about 5% of that on premium.  That 5% of the notional value is my maximum loss; leveraged out, I'm risking 20% of a unit of capital on this play.  It carries a high risk of loss, since the option really can (and often does) go to zero, but the leverage carries with it a high reward potential. 

Disclaimer:  it's tough to make money buying options.  It usually only works out well when there is a sudden violent movement - in the right direction - of my underlying stock/ETF/etc.  The problem, though, is that the probability of a sudden violent movement is captured in the term "expected volatility", and that's one component in the price of the option.  Just as you would pay more for car insurance if you had a history of vehicular homicide, you'll pay more for a put option on a stock that has a history of portfolio homicide.  So buying options usually loses money, and the art is to control that money loss and not let the option price go to zero.  But when they make money, oh boy.  I can turn a 30% drop in silver into a 350% profit.  That makes up for a lot of lost option bets.

This is usually where someone (you know who you are, Dad) tells me that I'm "profiting off the misery of others".  I see it a different way.  Do we all remember how it was the Evil Speculators that caused the 2008 crash?  Well, it's those same Evil Speculators that drove the silver price up above all reason.  Keep in mind, the catalyst for bursting this bubble was the CME increasing its margin requirements.  Do you really think that increased margin requirements are going to stop a hedger from buying silver futures because he needs a few truckloads of silver in a few months?  Of course not.  Do you think it would seriously impair the normal healthy speculation activities of the professional trading firms that provide markets to the hedgers, thus facilitating the modern financial system, as is their Patriotic Duty?  Certainly not - most trading firms have millions, if not tens of millions, in their margin accounts.  The only people severely affected by increased margin requirements are small-size speculators with underfunded accounts:  those 1-lot and 2-lot traders that are in there driving up the volume and generating water-cooler war stories.  These guys are cruising along with $10,000 to $50,000 in a futures trading account, and they're sitting at their desks trading silver all day long when they should be doing something productive.  This is why the Chinese are winning, people.

Think of it as weeding.  Sometimes you have to kill off some buckthorn so the oaks can thrive.  Think of me as a chipper/shredder.

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.

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.

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.

Collar Trade for the Month

This weekend was expiry for November 2010 options, and the collar trade was short Nov 53-calls.  Since QQQQ closed on Friday at 52.47, those calls expired worthless.  I sold new Dec 54-calls this afternoon for 38c/share.  With QQQQ trading at 52.70 when I placed the trade, this just barely violated my "at least 2.5% out of the money" rule.  But the next strike up (55) would have been 4.4% out of the money and barely worth the commissions, so I felt it was close enough.

Not really anything else to say there... it's a pretty mechanical trade, and there was nothing all that complicated to consider this month.

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.

January Iron Condor

As I planned on Friday, this morning I closed the rest of my December RUT iron condor position for a total profit of 86c per original contract.  I opened the December position on 6 October, so that means I had just about an 8% return on initial margin over the past month.  By normal investing standards, that's an amazing return, but let's put this in context: the same strategy lost 7% on its November position and just under 2% on its October position.  To a normal buy & hold investor, this is pretty frightening levels of risk; to a professional in the futures industry that plays poker and trades options on the side, 8% in a month is bordering on boring.  All a matter of perspective.

On 15 October, I made a pretty big delta adjustment by buying a 760 call.  The original call spread was 770/780, so this is what is known as a "mouse-ear" adjustment.  This is one of the most expensive adjustments that can be made, but also one of the most effective.  I feel like given the market action during that time I should have taken a less extreme approach, but after the prior two losing months I was a little gun-shy.  Despite leaving some profit on the table by solving a minor problem with a big hammer, my confidence definitely benefited from a nice smooth month of price action resulting in a near-target profit.

I also opened a January 2011 position (650/660/810/820) this morning, although with implied volatility as low as it is I don't feel that great about the price I managed to get for it: only a 2.90 credit.  This is a little on the low side, and that reflects the low VIX environment that we're in.  I probably should have waited until VIX popped back up some, but this puts me into unfamiliar territory: I know that a good price during this time-frame is about 3.50, but I'm not quite sure what a good price is a week or more from now.  Rather than sail into unfamiliar waters, I chose to limit my profits over the next month or so.  I'm not sure that was a great decision, but I will persevere.

This is why we paper-trade.

By the way, if anyone tells you how easy it is to make money with Iron Condors, don't believe them - and definitely don't give them any money to manage.  It is a very difficult strategy that takes a lot of creativity and experience to manage effectively.  I'm certainly not an expert, and it might be tempting to discount my assertions of how difficult it is; but clearing companies' databases are littered with busted accounts that jumped into the trade without an appreciation for its subtlety and dangers.  I am determined to learn this trade and how to profit with it, and to succeed where so many others have failed.

Speaking of boring trades, CS|MACO is still dead-locked flat as CS is screaming short and MACO is screaming long.  Remember I said a trending market is not CS|MACO's friend? Yeah.  The other boring one is the trade I wrote up in Collaboration is Good, which apparently I haven't named - let's call it CiG.  No trades in 10-year note futures there, either, so I think I'll start running it in S&P and Eurodollar futures also.  I ran back through the chart for the last couple of weeks, and it wouldn't have traded anyway, so I haven't missed anything.

Iron Condor: December Adjustments

The upside protection I added to the December iron condor on October 15 has proven to be a profitable adjustment.  As the market wandered higher, I was able to bleed off theta while keeping the position pretty close to delta-neutral.  I've had some low-ball exiting orders working for a while, since getting out is still in front of me, and yesterday one of those orders filled, closing out a portion of my 620/610 put spread and locking in a nice profit on that portion. 

My work schedule yesterday was weird, so I didn't actually notice the fill until this morning before the open.  When I came in this morning, I discovered that between the closing of part of the put spread and the traveling of the market down the curve toward my call spread, my overall position was -20 delta.  That's a lot more delta-negative than I want it to be, so I started looking at ways to adjust it again.

My original plan was to bring the delta back to nearly 0 without turning the theta negative or increasing the overall risk, since after all I have only a little more than a month before expiry, and increasing position at this stage would be kind of dumb.  But the more analysis I do, it seems the best choice is to just close the position entirely.  From where the market closed today, net liquidation value on the position is about 82c per contract.  That's pretty close to the 1.00/contract level that I said made me "thrilled", so that's just fine.

I had already started working orders to adjust the delta before the close, and when I do that I always make the position-decreasing orders more aggressive than the position-increasing orders.  Today was a good example of why I do this, since only one of my orders filled and I didn't have a chance to adjust my other orders to make sure they filled on the close.  As it turns out, that's just as well, since I think I want to cancel my position-increasing orders anyway.

My original plan was to roll the 770/780 call spreads up to 790/800, also decreasing the position.  This costs a fair amount of cash, but it also brings my delta up to +4 again, and makes theta a very healthy +9.  But what am I really gaining by opening that 790/800 position?  My thinking was that I needed to partially finance the 770/780 call spreads, but if I can make 82% of my "thrilled" level just by closing the position, there's no financing I need to do.

So here's my current position, which reflects the partial closing the 770/780 call spreads, but nothing else.  Delta is all out of whack the other way, at +17, and theta is right at 0.  I've got orders working to close the rest a little behind the market.  Once it's open on Monday, I'll adjust everything around to be just about at the market, and put this December iron condor to rest.

Then I'll start looking at opening a new January position.

In other news, I was at the FIA Futures and Options Expo on Wednesday and chatted a bit with the people at the Think or Swim booth about why they're so mean about screen shots.  I actually talked to a young lady who works with Scott Garland, and she indicated that everyone there is nervous about overstepping their bounds with TD Ameritrade, the recent purchasers of Think or Swim.  So far TDA has more less left them alone, but the concern is that they'll get a lot more involved in the day-to-day business instead of just treating ToS like a profit center.

I understand their perspective, but I'm still a little steamed that I can't accurately depict my current position value here because of their concerns about intellectual property.

So Much For That Plan

Gold for Cash
In my last post, just two days ago, I briefly outlined my plan for disposing of my GLD Dec calls.  I said that I wanted to hit a price or time target, and when either thing happened I was out.  Of course the very next day gold prices dropped 3%, and then another 2% today, wiping out 20% of the value of my calls.  I'm not quite sure what's going on, but that was outside my comfort zone, and I dumped the calls today for quite a lot less than I planned.  Now that I'm out, I'll detail my price/time limits a little more.

I bought the then-ATM calls over the summer for $5/share of GLD, believing that gold would appreciate in the fall.  Boy did it, and it wasn't long before I was able to sell less than half of them for about $11/share.  That took my initial investment off the table, and I kept the rest riding.  I saw them reach somewhere around $17/share at their high, and I had a price target of $25/share to get out of the rest.  That was pretty aggressive, but I also had a time limit.

Uncomfortable, as I said on Tuesday, with the many small indications of a coming correction in gold, I wanted out soon.  I think most people are idiots (see the CS part of the CS+MACO trade), and when everyone's bullish, it's time to sell.  Worse, literally the whole world is hanging on QE2-related verbiage expected in the minutes from the FOMC's meeting on November 2 & 3.  That economic release is doomed: QE2 is already fully priced in, and all the Fed can do now is disappoint.  At the very least, all the IV comes out of the options after the announcement because the inflection point will have passed.  I definitely wanted out by Nov 2.

I have assumed for quite some time that I am riding a bubble forming in gold, and I swore that unlike the turn-of-the-century tech bubble, I would neither miss the run-up nor hang on for dear life during the pop.  That's why I have been in and out of leveraged gold positions via calls for the last year or so, and that's why I'll get back in after the mid-bubble correction makes everyone hate gold again.  I'm pretty bummed that I gave up so much of my profits by dumping today, but I still made about 150% on the trade since August, so I have no major complaints.

Speaking of CS+MACO...
Adding to the bearish signals this week, AAII published its survey results yesterday after the close: more people are bullish again.  With the CS portion screaming "sell!" and the MACO portion insisting "buy!", CS+MACO is still flat and will stay there for at least another week.

Assorted Trades

Iron Condor
On Friday, I decided to add a little up-side protection to my December Iron Condor.  I'm trying to act when delta starts getting out of whack, and after a few days of stock market rallies the Dec IC was looking at a delta of about -20.  Sadly I can't be more precise on this because I forgot to jot it down (mental hand-slap).  Anyway, I decided the adjustment that made the most sense was to buy a Dec 760 call.  With my IC strikes at 610/620/770/780, this puts the naked-long call just one strike below my short call.  This adjustment brought my delta up to about +4 as of now, and didn't hurt the theta too much - still nearly 21.  It cost me 9.50, which is a big chunk of change, but I expect it to be the only upside adjustment I'll need to make to this position.

Until I come up with a better solution than Excel, unfortunately I can only display value-at-expiry.  Trust me when I say that current portfolio value is a lot curvier and much more attractive than this.

QQQQ Collar
Also on Friday, my October covered call on QQQQ as part of the collar trade expired in the money and I was assigned on the call.  Pursuant to the rules I set forth in September, I bought QQQQ back this morning at 51.50 and sold calls against it with a strike price of 53 for 56c.  Here are those rules again, since I keep having to search Facebook Notes for the numbers:

1. Monthly calls to be about 3%, and no less than 2.5%, out of the money.
2. 6-month put to be 8% out of the money.
3. No rolling prior to expiry.

Gold Leverage
I am still long-term bullish on gold, and I express that by being long GLD, GDX, and AEM.  I also currently have some Dec calls on GLD that are so profitable that I have sold off enough to cover my original investment and the remainder are worth almost twice what I paid for the whole stack.  Nevertheless, I'm becoming concerned with the borderline irrational expectations for QE2 lately, so I'm ready to take some profits.  I started working a fairly distant sell order on the rest of my GLD calls this morning.  Hopefully it will reach my target price and I'll exit there, but I also have a time limit on this trade; I'll exit when that time limit expires regardless of the price action.

December Iron Condor

In another of my paperMoney trades, I experiment with iron condors.  Today I opened a position on my next month's iron condor, expiring in December, on RUT.  RUT is the Russell 2000 index, and options on it are European-style and cash-settled.  This means they cannot be exercised early (very important for spreading), and in-the-money options at expiry won't cause securities to change hands - just money.  Settlement at expiry is weird, though, so it's best not to take them to expiry in any case.

WTF is an Iron Condor?
An iron condor is a market-neutral option strategy that is short volatility but with limited profit/loss ranges.  It consists of two vertical spreads: a put spread below the current index price, and a call spread above the current index price.  The long options in the spreads are both farther OTM than the short options, so opening an iron condor position generates a credit.  The farther apart the short option strikes are from each other, the lower the risk that the iron condor will lose money, but the less credit it generates on opening.

A picture is worth a thousand words.  Luckily for you, I have both.  Check out this page from Option Trading Tips:  Iron Condor Description.  I'm working on getting permission from ThinkOrSwim to include screen shots from their software.  In the meantime, this is the best I can do, sorry.

Terminology does not agree on how to refer to iron condors that generate a credit when opened.  They consist of two short vertical spreads, but many (including the website above) call that combination a Long Condor.  To me, selling means that I get money; buying means that I give up money.  So throughout this blog I will rightly or wrongly refer to iron condors like they're short: I sell them to open them and I buy them to get out.  So today I sold an iron condor, opening a short position, and I generated cash.  Questions? No? Excellent.

Where To Begin...
Here I have to give Mark Wolfinger props again, because about a year ago I looked at iron condors briefly when a co-worker (not a professional trader, in this case) told me about how he was making a guaranteed 10%/month on them.  This seemed too good to be true, and after analyzing them a little I decided that it was: the probability-weighted return on his capital was far too low for the risk of ruin he was taking.  I dismissed iron condors as hardly better than naked option selling, and was ready to leave it at that.  In the process, however, I ran into Mark Wolfinger's blog Options for Rookies, and I started reading it regularly.  Over the next few months I realized that there was more to iron condor trading than I first assumed.  Guaranteeing 10%/month was indeed too good to be true, as I suspected.  But there was nevertheless a viable trade there for someone willing to put in the time and effort to build experience.  A firm believer that nothing worth doing is easy, I set out to learn.  I'm just getting started on that journey, and though it will never end, I hope that soon I will have made enough progress to begin profiting from it.  I don't know when that will be, but I know it isn't now yet.

I've followed MW's lead in a lot of respects, because I am more of a learn-by-doer than a learn-by-reader.  As I try different approaches and find my own comfort zones and style, I start to diverge from him; this is natural.  But some aspects of his trade are relatively arbitrary from my perspective:  he trades RUT because he feels that its volatility is not-too-high but not-too-small; he trades options with 60+ days to expiry because he feels that is the right mix of risk (gamma) and reward (theta).  Never having traded iron condors on any index, and never gotten burned in either direction in time-to-expiry, I figured 60+ days on RUT was as good a place to start as any.

My Own Trading Style
My current behavior pattern is to start looking for a new iron condor position around the first of the month two months before expiry.  This gives me 60-80 days or so before expiry.  Also like Mark, I look to get out of the condor early if the market is willing to let me buy back pieces of it at good prices.  I don't try to choose a low-risk / low-reward condor that I never have to adjust, but I try to give it enough room to move that I can make adjustment decisions after work for trading on the open the next day.  Taking some of his lessons to heart, I try not to increase my position in the course of adjustments; however, I will do so if I have previously reduced the position via cheap buy-backs.  I try very hard to evaluate what the position is now, instead of whether I'm up or down from my entry point.  This is a lot harder than it sounds, but Mark harps on it so much that it is starting to sink in.

In Theory, There Is No Difference Between Theory and Practice
A perfect situation in my trading style is to find a new iron condor on, say, October 1 for December expiry that I can put on generating 3.50 or so in premium while keeping the two short options a good 15-20 strikes apart.  For this situation to remain perfect, the market needs to move up and down some so I can cheaply (like 20c or so) get out of the two spread legs, but not so much that I feel I need to adjust to protect my position.  The perfect scenario ends about 30 days before expiry when I exit the last position without ever having to adjust.  Net profit when perfect: nearly $3.00 per contract, or about 30% on margin risked.

But In Practice, There Is
In reality, that scenario never happens.  I always have to adjust, I always agonize over how much insurance to buy and when, I seldom pay as little as 20c to buy back my spreads, I frequently enter the position for less than 3.50 credit, and I often find myself still trying to dump some position off with only 2 weeks to go.

I often have two condors on at any given time: one that I'm adjusting and working my way out of, and one that I'm watching eat up theta prior to its first adjustment.  If I end up with over 1.00 per original contract profit, I'm thrilled. Note that because of adjustments, 1.00 per original contract is a lot less than 10% margin profit, because the margin gets bigger and the profits get smaller with insurance.  If my net cash flows are positive at the end of a condor run, I'm satisfied.  If I learn something along the way, it's all worth it.

I'm slowly starting to get a feel for what values of delta make me nervous, and I'm better at choosing adjustments that don't give me a negative theta, since that would negate the whole purpose.  I'm always massively short vega, since that's the nature of an iron condor; and gamma doesn't really affect me too much 60 days out.  It is nevertheless always the shadow in the corner, and I keep an eye on it more and more the closer to expiry I find myself.  Experience has come very slowly, but it is starting to click.  That's a cool feeling.

Current Situation
Right now I have a heavily-adjusted November position on.  It's too complicated to explain without charts, so I won't try.  But despite the drop in volatility the past couple of days as the market rallied, I was able to put on my December iron condor position for my target price of 3.50.  It's a little tighter (short strikes are closer together) than some previous months, but I'm also getting a little more comfortable with adjustments; this lets me generate more premium credit at the start without so much fear.  My new RUT December condor is a 610/620/770/780, meaning that I am long the 610 puts and the 780 calls, and short the 620 puts and 770 calls.  Max profit: the 3.50 credit it generated.  Max loss: 6.50.

A Little Free Advertising

I think some background might be useful before I jump into trade journal activities.  Most of the trades I will describe on this blog are being done in Think or Swim's paperMoney platform.  A few might be done with real money, and I hope that someday the realMoney/paperMoney ratio will increase.  But I have no intention to specify which ones are real and which ones are fake: my actual personal trading activities in the real market risking real capital are not something I want to put on the internet.  Likewise I don't plan to be very specific about position sizes or prices except where they are necessary to understand what I'm doing.  There also won't be profit/loss numbers.

There are two big reasons for not being very specific about these things.  The primary one is privacy: if I talk about my trading sizes, profit/loss, or which trades are real or fake, I give away personal financial information.  Additionally, though, I don't want anyone mimicking my trades.  If I wanted to be an investment advisor I would go off and get certified, and make a lot of money doing that.  Trades described in this blog are intended to be general ideas open for discussion, and they are certainly not recommendations or advice.  See that little disclaimer right under the title bar?  Yeah.  So if you're looking for stock tips, picks, predictions, or strategies, move along now and don't come back.  If you want to read about my own personal thrills and spills in the marketplace and interact with me about what I learn along the way, welcome.

In any case, assume that all positions are held in my paperMoney account (not real money).

So here's a little commentary about this thing called paperMoney, of which I am a huge fan.  Think or Swim has an interactive trading front-end written in Java.  This is great for me because I made the Windows-to-Linux switch about 18 months ago and I get kind of pissed off when I have to run a VM just to run a piece of software.  ToS's front-end is fully featured, providing charts, stock screening, real-time news feeds, trading grids, account/position management information, etc.  You hook it up to your trading account at thinkorswim.com and you're good to go: any trade you do goes against your buying power in the account and shows up both on your statements and in the front-end.

When you first connect, you choose between realMoney and paperMoney.  I have personally never used ToS's front-end for real-money trading - only paperMoney.  But from what I understand, paperMoney is exactly the same software except for two very important features: 1) trades in paperMoney don't actually make or lose you real money; and 2) market prices seen in the front-end under paperMoney are 20 minutes behind.  I'm sure that ToS does this because of republishing and licensing agreements with the exchanges providing the market data in the first place.  Another minor difference is that you start with $100k in your paperMoney account - I have no idea what you do if you go broke and hopefully I won't find out - so there is no depositing to do.  And execution is occasionally a little strange: ToS fills your limit order based on mid-prices instead of actual price action.  This is the best of a bunch of compromise approaches, in my opinion.  But you do sometimes get kind of a weird fill.  On May 6 (Flash Crash day), I had some limit orders working to exit some positions at ridiculous prices just so that I wouldn't forget about them, and they got filled at even better prices than I had specified.  What should have had a max-$2000 profit based on the option strategy ended up netting me $25k.  If only it was real...

The front-end is really well-tailored to options trading, which is why I selected it in the first place.  One of the screens shows position valuation graphs that can be played around with to examine the effects of underlying changes, delta changes, time, vega, etc etc.  Simulated trades can also be applied to positions from there so that an informed decision can be made before submitting the order.  I spend a lot of time on that screen before making adjustments.

I'm not sure how protective TD Ameritrade (owners of Think or Swim) are about screenshots and whatnot, so I won't post any here.  But check out thinkorswim.com and read all about it, if you haven't ever looked at their platform.  I'm really impressed with the software for having most of what I want in it, and I'm also really impressed at their willingness to let me paper-trade indefinitely without ever depositing any money.  That sort of accommodation shows confidence that their software is so good that I will still want to use it when/if I transition to a real-money option trader.  And that, my friends, is rare.

I sold some December 2010 calls on GLD today, taking my initial investment off the table.  My remaining position is all profit.  I did this today because of the fantastic run-up GLD has had over the past two months; some consolidation is due, and maybe a correction, so it seems like a good idea to reduce my risk and lock in a floor on my return.  Another reason is that the trader that sits next to me at work (we'll call him NeighborTrader, or NT) reported this morning that when he loaded up yahoo.com he noticed that the phrase "gold prices" was at the top of the Trending Now list.  That's a sign of a short-term top if I ever heard one.  It's a good time to hold a call option on my call position.

When NT's Iowa-residing grandfather asks about investing in gold, I'll sell the rest.