Time to Build a Portfolio as Market Breaks Downtrend

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Dominic

SPY put back ratio

I just went to update this trade as I closed it out and realized that I never posted the initial trade. Last week after I closed my losing SPY call back ratio I immediately put on a put ratio for August. I bought a 1x2 110/102 put back ratio for $1.02 debit and just closed at $1.62. Because of my experience last month of trying to go for a home run and ending up losing big, I decided to take some profit now and risk missing another home run. Since this is a five week cycle and we still have plenty of time I wanted to book this profit now and look to enter another bearish trade if we bounce higher. I'm also a little perplexed at the TA chart action. I wasn't expecting another breach higher of the resistance line so maybe it's time to accept that that line is no longer valid. But again, since I'm not entirely sure where we're at I took the trade off and will look to re-enter.

July 2010 OPEX Results

It's hard to believe now that the month is over that it caused me so much stress. I got in a bit over my head by being too aggressive on a few trades, and not having an exit point or hedging strategy ahead of time on another. It's easy to say that I learned a lot and therefore I'm OK with the loss, but that's not true. While I am grateful for all I learned, I'm truly upset at losing because of my mismanagement. I was on tilt for a while so it's time to regroup and plan/trade more effectively so this doesn't happen again. I basically traded slightly negative with commissions making up the majority of the losses.

August SPY trade

I sold (10) 110/111 SPY call spreads for .45

Earnings Season Stats and Key Reports This Week

Incase anyone wants to make some earnings plays this week.

 

 

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Earnings Season Stats and Key Reports This Week

via Think BIG by Bespoke on 7/12/10

With earnings season kicking off this afternoon, we thought we'd highlight a few stats on the subject.  Over at Bespoke Premium, we have a database with every single earnings report for US stocks going back to 2001.  This totals out to 65,210 individual quarterly reports.  Of these 65,210 earnings releases, 62% of companies beat EPS estimates while 25% missed.  Sixty-two percent have also beaten revenue estimates, while 38% have missed. 

Predicting whether any random stock will go up or down on the day in response to its report is just about like a coin flip.  Of the 65,210 reports in our database, the stock has gone higher on the day 32,563 times and lower on the day 32,251 times (396 times the stock closed the day flat).  Unless you dig deeper into the numbers, it's basically hit or miss.

Below we highlight the number of earnings reports per day this earnings season through August 6th.  While things get started this week, it isn't until late July when things really pick up.  Nevertheless, we've provided a table of the key companies set to report in the coming days.  Alcoa (AA) is obviously reporting after the close today.  Tomorrow we get Intel (INTC), Thursday we get JP Morgan (JPM) and Google (GOOG), and Friday we get Citigroup (C), Bank of America (BAC), and General Electric (GE).

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A way to play Alcoa into earnings...

Volatility in the front month is running close to 100% going into earnings with vol in the back months and later at about 50%. One way to play this is to get short vol by way of a double calendar play. You could buy the 11 call calendar for $0.26 and the 10 put calendar for $0.23 . You would be selling 76% vol on the call calendar and selling 82% vol on the put calendar, while buying 46% and 48% vol. The break evens on this trade would be 9.50 and 11.66. This gives you about 12% to the downside and 8% to the upside. Options markets are factoring in about a 8.5% move. So your thesis would be that it will be at least less then this on a move to the upside and up too 12% on the downside, ideally less either way.

The average return for a 10 lot would be about $150.

I am not sure if I will take the trade, but I just thought I would share the idea.

Update of SPY position into OPEX

As we all know this week is options week as well as the kick off to earnings season with Alcoa reporting after the bell. Two weeks ago the price action in the market made you feel like the world was getting ready to end again, but then last week I think surprised a lot of people. I think a lot of people expected a bounce but not as big of a one that we got. The SPY bounced about 6-7% in three sessions. I am not really sure what to make of the price action, but I am still holding my ground and am prepared to make adjustments as necessary.

Anyways first I want to put an updated chart of for the SPY with my range of profitability that I originally posted:

We are approaching the upper end of my range. I will admit I am a little uncomfortable but still remaining calm as I have a hedge in mind at SPY 109 that will stop my losses. But first lets look at my current P&L graph and risk profile:

I went through many iterations to try and come up with the best hedge possible. First off let me start off by saying that I need a hedge that will give me at least positive deltas to be delta neutral at SPY 110. This is where the 50 day MA is and is where I think the risk is to the upside. So with my analysis I have concluded that buying deep ITM call options would be the most effective and efficient use of capital. As my capital is limited it is not feasible for me to just go and buy the underlying to hedge my deltas. Not that I would if I had a less capital intensive way to accomplish the same goal.

Anyways onto the hedge. I have modeled my portfolio by adding 9 July '10 98 calls. Which basically gives me 900 long deltas with SPY above 107. This moves my break even on the downside to about 106.76 and 109.68, and I start making money past the 109.68 point and potential is unlimited to the upside. Here is a look:

Now two questions:

1) When do I put the hedge on?

I would add the hedge with the SPY trading at or above 109 which is about .15 above my current break-even at 108.85. I will re-evaluate the amount, but currently I would look to buy 9 deep ITM 98 calls.

2) When do I take it off?

I would take the hedge off on the downside at about SPY 107 which would lock in a loss of about $950 on the hedge but still in the sweet spot of my range of profitability. If it expired around 107 I would still gain to make about $350. Below this my max loss is about $600.

If it were to rally up again then I would look to put it back on at the same spot of about SPY 109.

I will keep you updated. 

SPY hedge update

I found an alteration to the trade that I'm happy with. The first picture below is my original position, the second is after I put on a 109/110 back ratio. This trade was a small debit and decreases my losses from 108.50 - 110.00, at 110.00 they are about the same, but at 111.00 or higher the losses get even greater. I had to use some additional buying power to put this on but not much. If SPY should rally strong next week and break the resistance line I would have to admit defeat and take my losses and get out. I'm not comfortable holding this position in to expiration. I didn't like the ES hedge risk/reward ideas I was coming up with.

Earnings Season Starts Monday

Something to keep in mind as we head into earnings seasons.

 

 

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Earnings Season Starts Monday

via Think BIG by Bespoke on 7/7/10

Earnings season starts Monday with Alcoa's (AA) report after the close.  People are hoping earnings season will get all of the other issues out there right now off the minds of investors, but that means earnings have to come in strong.  If the numbers come in weak, it could be a long reporting period.  Below we highlight the performance of the S&P 500 during earnings seasons and off-seasons since the bull market began in March 2009.  As shown, the last earnings season was the worst in terms of performance since the recovery began, and the current off-season has also been the worst.  Heading into this earnings season, one positive is that expectations don't seem too bullish.

 

 

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Added a SPY Put Condor Hedge

Yesterday I sold the 101/107 July Strangle for a $1.50 leaving my break evens at 99.5 and 108.5. I like the trade but the downside risk was making me a little uncomfortable so last night and this morning I was trying to come up with an affective hedge with a very low cost. I finally landed on the put Condor.

This morning I bought 7 100/99/98/97 put Condor for $0.09 or a total debit of $63. This effectively moved my break even down to 97.72 by July Expiration. The first picture below is the Condor in isolation, then I have the strangle (which by the way is now unbalanced by two additional 107 calls sold to the upside) and Condor in aggregate.

If you can think of a cheaper and more efficient way to accomplish such a hedge please comment.

SPY hedge update

This play is no longer a hedge as I've closed out all the downside risk I face. At this point with only 8 trading days left I'm going to alter the trade. Below is the before and after risk profile. All I'm going is closing out 4 of the long 104 puts. This leaves me with a 6-lot 104/101 long put spread and 10 naked 95 puts. What's interesting about my remaining inventory is the way you view it. I originally had on ratio put spread, followed later by a ratio call spread. With the remaining make up I essentially have a long put spread, long call spread, and short strangle at 95/107. What's also interesting is it looks like the area around 103-105 is a dead zone where little to no profits can be had. But keep in mind that is only an at expiration diagram.

The last slide is two days before expiration where you can see that that area is actually almost as profitable as anywhere else in the analysis. I do plan on exiting the trade by the end of trade on the 14th as I'm on a plane the 15th and not available to trade on OPEX the 16th. So why is that dead zone profitable with only two days to expiration? Because in essence if we're trading in that range with only a few days to go, look at the inventory again and you'll see that what I would really have left at that point is a 104 long straddle. Very interesting how all the different strategies kind of blend in together and as time expires they essentially morph in to something else whether that was your original intention or not. The whole trade can also be looked at as one big 93/108.50 short strangle. This leaves me with room to run of 5.3% on the upside and 9.7% on the downside. This is comfortable with me as my view is still bearish. These ironically enough are right about where the channel lines are as well.

Before Adjustment

After selling 4 of the 104 long puts

Two days before expiration

SPY Chart

Another Short term Trade!

So last week, I used the weekly options for the SPY to construct a few calendar trades. As I expected the time premium in the "front week" vanished very quickly as we headed into the holiday weekend and into the last day to expiration. The theta or time decay was really cool to see. But something that I had not expected to happen was how fast the "back week" options lost time value. They lost much more value relative to the front week options than I had anticipated. From what I saw part of the drop which I had expected came from the time decay. But the part I had not anticipated what the huge drop in vol that totally just crushed the profit of the position. For example, at about $102 the position was suppose to make about $1,000 at initiation, by the end of the day on the front week expiration that profit shrunk to $100. Anyways I should had closed that position out on Friday instead of rolling it, but lessened learned and I will move on.

With that said, today I am initiated a short strangle trade for July '10 expiry. I am selling 3 101/107 strangles @ $1.50:

My break evens on this trade are 99.50 and 108.50. Maximum profit is realized between 101 and 107. Here is what it looks like on the chart:

I have highlighted the area of profitability on the chart above. Also take note of where July expiry is in relation to the price range. I have about $4.5 points of cushion on either side.

Here is a shot of the greeks at initiation:

I am relatively delta flat and have positive theta. My gamma is a little large, but I expect that the SPY will not move too much between now and next week so the closer we move to expiration this should start to shrink a bit. I will re-evaluate the market at the extreme end of either side of this strangle and possible trade around the position. Currently my soft stops are at 99 and 109 on the SPY.

Hedging my hedge

At this point the only real potential for gains I have left on the books is a SPY put hedge that can finish anywhere from -420 to +5000. Should the market rally back a bit and thus kick myself in the nuts for closing out a trade at -1620 instead of +840, I'm looking for a way to maybe capitalize off such a move. If we get a bounce tomorrow I'm thinking about putting on a call backspread, now that I know more about them. This is pretty close to the reverse of the SPY put play I have on but opposite. So below is the individual call backspread and the combined position should I put it on. My risk would be if SPY closed higher than 109, I just don't see SPX above 1090 two weeks from now and I'm willing to wager accordingly. I just think there are too many people who would love to get out at even money of anything they put on in the last few weeks. Closing above 1040 at this point would be a victory, I don't see another 50 points on top of that. This call backspread can be put on for 0 out of pocket with a max gain of $3000, average of $1500, and unlimited losses above SPX 1090.


The chart shows the needed trajectory line to reach 109, which is right at the downtrend resistance line. The blue line is a copy of the last bounce off of 1040, so should we see something similar or even bigger, I would lose money. Unless it happens immediately after I put this play on I should be safe. But anything can happen.

Dollar, Euro Break 50-Day Moving Averages

Looks like there could be a new sheriff in town. What I mean is new relationships might be forming in the market place. Equities were trading in lockstep with the Euro, but maybe that does not hold anymore. Will see!

 

 

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Dollar, Euro Break 50-Day Moving Averages

via Think BIG by Bespoke on 7/1/10

The US Dollar and Euro have made big moves today.  The Dollar index is down 1.8%, while the Euro is up 2.29%.  These moves have caused the Dollar to drop right through its 50-day moving average, while the Euro has broken above its 50-day.  This is the first time since mid-April that both have been on this side of their 50-days.  If told of this big drop in the Dollar and rise in the Euro and asked which way stocks went today, most would probably guess higher, but that was not the case today. 

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Reflation/Deflation

When TA fails

Whoops, I'm sure Dennis Gartman and his "famed Gartman Letter" will be on Fast Money today saying how he got out of gold just in time when in fact he told the world two days ago that although he wasn't a gold bug, gold was about to go hyperbolic. It must be tough trying to predict the future. And in fact it is, that's why people try to play both sides of the fence at all times when doing public predictions. Stop listening to talking heads or bloggers and start listening to yourself. That's my free advice for today.

Part Deaux

AKAM close out

Yesterday was touch and go as until the last hour the stock was poised to close within the channel. However, even had it not closed in the channel I had already found myself starting to look for ways to stay in the trade past my trading rule threshold of no more than a 1% of trading capital loss, rather than just admit my planned exit strategy was at hand and exit the trade. Below are just some of the ludicrous ways which I tried to justify my actions. Trading rules are new to me, I never had them in the past and probably because I don't generally like rules. But since this is my capital at hand I understand their importance and happy that I did exit the trade within my rules. Had I not done so I would just be setting bad precedent for the future.

• Redrew lines to be more liberal to give myself some wiggle room
• Justified that only the intra-day move was outside the channel but the closing was not. The problem with this is my channel was drawn with intra-day lines, thus I was trying to redraw lines.
• Yes it's broken the channel, but let's see if the 50DMA will hold as support!! (where did this come from? I made this up on the fly)
• Well I've got a SPY put hedge on that will make up for most of these losses
• We're bound to get a short cover bounce and I can close out then at a lower cost
• Yes my trading rule says to exit, but I'm not quite at the 1% maximum allowed loss so doesn't this allow me to stay a few more days and hope for a miracle?

Trying to play a Vol Differential for a 1 day trade.

7/2/2010 Update: So here is an updated profitl loss graph of the original position as we head into the close:

Take note of the change in the profit potential. At $102 when I first put this on I had a max profit of about $1k and now it has shrank to $100. The vol collapsed just as I thought on the front month, but collapsed a lot faster then I thought on the long options. In the future I will need to find a better way to hedge the short puts sold. That may mean that I have to go a little further out in time to buy the long puts. With that said I did however roll the long puts into vertical spreads before vol completly collapsed this afternoon, and you can find the new P&L chart below:

I really did not want to take risk into the weekend until I saw todays price action. So I rolled in basically a double vertical spread. I start making money below 102 and max out at 99 on the SPY. My thesis is we get there next week. But I don't have much time to be right. So Like I said in my previous comment, I am taking a bit of a gamble on this one.

End of day Greek update:

Above I am trying to keep a record of how the greeks changed with the passage of time. Since I am using weekly's this will be easy to do in a short period. Theta nearly collapsed in half while my Delta exposure quadrupaled due to my Gamma position and how close we are to expiration and to the ATM strikes. My short options lost 60-70% of thier value today and my long options lost about 37-43%. The implied Vol differential also shrank from a spread about 7.5% to a spread of about 3%.

Update: Here are the Greeks on the position. Take notice of the large Theta position.

I bought the 100 and 102 calandar spreads for $0.86 each. The options that I sold expire tomorrow and the options that I bought expire next week. So I constructed this trade with all weekly options. There is about a 7.5% spread on the vol for the short vs the long puts. The shorts have the higher vol.

My break evens by tomorrow are 98.45 and 103.58. I could not help myself, this trade just stuck out to me and I like the RvR for one day.