Pre-Post background
As many of you who follow this blog are probably aware, Jason has been the primary contributor for about the last six months or since I got an opportunity to move into the trading group at the company I work for. Prior to this trading opportunity I was working as a financial analyst and trading options in my personal account. I started trading in 2007 and have come so far from those early days. Although I was learning the markets since I began, I did not start to make huge progress until I met Jason sometime in early 2009. We began the blog in May of 2009 and the learning curve has been exponential since the start of this blog. It really was probably because of this job and the things Jason and I have learned together that afforded me the opportunity to be offered a full time trading job.
The Job
When I was first offered the job I was considered for my technical know how and deep understanding of the ins and outs of options. My first charge was to get a Options and futures trade book going...which was fairly foreign to the company, but what I considered my specialty. As I use technical analysis to plan my options trades. Although I had never traded energy futures the knowledge I had in trading options and technical analysis was transferable, and I adapted nicely. When it comes to options trading I am a net premium seller and I put together my strategy accordingly. My second charge was to develop a Hedge program around our regular business operations.We took several months collaborating before finalizing a program that I know execute on a daily basis through the use of futures and options. My third charge and what will be the meat and potatoes of this blog post was to take over an existing West coast products EFP trade book.
8 Months in
So I am eight months in to the trading job that I was originally offered back in July of 2010.The hedge program is working as planned and the options and futures trade book for profit had been seeing nice gains and going smoothly. But as the middle east tensions escalating causing implied volatility to double from what it had been running the prior 7 months, management got scared due to a prior history that resulted in sizable losses back in 2008 when they made there first attempt at options trading. Since they did not fully understand what I was doing and up too this point any MTM loss I may have had in the past was very small they were comfortable with my trading even if they didn't fully understand the risks of the aggregate of all the positions I had on. In short basically with an elevated implied volatility environment positions that still had plenty of room to be profitable were showing large or at least larger MTM losses then management had been use to seeing the past 7 months and so they have halted trading in this book until they better understand what I am doing and what my risk is. The big disconnect is their lack of understanding between the difference of MTM vs Intrinsic value. But I am confident that in the coming months that we will get this book going again once management has a better understanding of how and increase in implied volatility can cause a huge MTM loss when the intrinsic value of the position is still in a position of profitability. Let me know if you need further explanation of this. So I tell you this to paint a picture of where I am today. I have yet to talk much about the west coast products EFP trade book. When I first started this was at the end of my priority list as it was the thing I was least familiar with....nonetheless I was learning to trade the west coast physical gas and dsl market during the past eight months. But since the options and futures book is on hold for now, this is now my primary focus. At first I was bummed because I love to trade options but then the more I thought about the EFP trade book the more I have decided to embrace it and make it my own. As it is just another market and all the trading skills I have acquired up to know are all adaptable. I just have to learn a new market.
West Coast products Trading on EFP
First, the reason I decided to write this post was to shed some light on a market that has very little in the way of information and/or resources out there. This is not a market that you can pick up a book and learn about. It is a market that you get thrown into and you either sink or you learn to swim. About the only information you can find out there is a definition of what an EFP is.
EFP Definition: an EFP (exchange for physical) is a transaction that is negotiated off market where one party buys the physical asset and sells futures and the other party sells the physical asset and buys futures. For more information click the following link http://www.riskex.com/Exchange-for-Physicals.pdf
So by trading a EFP you are only exposed to "basis risk" or in other words the spread between the physical (say LA Carbob, which is gasoline) and the futures market. So lets say January RBOB is trading at $3/gal and you see an offer at +15 cts vs January RBOB...If you choose to go long the basis or differential you would buy the physical at $3.15 and sell the January RBOB at $3. So now you make money if the basis increases say goes from +15 to +20 cts vs January RBOB. You just made 5 cts per galllon. Looking at it the other way if it goes down to +10 then you just lost 5 cts per gallon.
This trading world on the West coast is really a small world. From what I have experienced so far everyone knows everyone. It is a highly social market as well. From top traders as well as my boss I have been advised to spend as much time with other traders and anyone in the industry. As the more relationships you develop the more information you will garner...as everyone likes to talk there book. I was actually out with one of the legendary west coast traders last night and he said that his philosophy is that a trader can never have too many expenses on his expense account. At first glance this is a highly emotional and information driven market, driven off of mostly fundamentals. The reason this legendary trader made this comment is that it is his belief that the you need to get to learn how all the other traders react to different scenarios in the market and what their trading style is...also because in order to get a complete view of the market you need to gather all the pieces to the puzzle. Now from what I can gather so far traders look at simple historical charts but there is not much value given to a technical approach. This got me thinking if I could get really good at the relationship side of the business and supplement some of my own flare on technical analysis, I just might be able to create a edge different from any other market participant out there in west coast products. I have already began creating different technical tools of my own. As there is no pre-boxed software out there with what I want to look at. I bet if you asked a west coast trader what a candle stick chart was he could not tell you...or at the very least could not say he had ever used one for trading west coast products. So a charting platform is one of my tools in development...I am using excel for all my tools.
So in the meantime I am going to embrace the social aspect of the job to better my understanding of who is doing what and what drives the market. I have lots of resources at my disposal. For this purposes I am allowed to use my companies season tickets to hockey, basketball, football, and baseball events. I have authority to expense lunches and dinners with other traders or industry folks. I can attend industry conventions. We sponsor boxing events every month. And basically anything else I can think of to get people out is at my disposal. Not only will this be instrumental to my development as a west coast products trader...it will actually be a lot of fun. I have already started some of this on a small scale and to be honest have had a lot of fun and actually learned a lot in a short amount of time.
Here are some of the things I have already figured out that I need to watch in evaluating the market:
1) Refinery issues and turnarounds
2) Crack Spreads
3) DOE inventory report for PADD 5 (west coast)
4) Imports and exports (Are cargos coming or going)
5) Seasonal changes in products (RVP changes)
6) Market Inversions
7) Is the market in Backwardation or Contango
8) Seasonal tendencies
9) Demand
10) Any arbitrage that may exist
I will be using the above in conjunction with my technical tools I am developing to create my edge in this market. Along with anything I can learn from or about the habits of the other traders in the market.
I plan to have more posts on trading the west coast in the near future...and I may even share some of the tools that I have developed. My plan is to do at least one post a month.
Please comment if you have any questions or anything to add.
Dominic
This all sounds interesting. The ability to know your trading counter parts personally could obviously be a huge advantage, especially since it's a small market. You can't possible know the combined psyche of people trading something like AAPL, but if things are smell enough you can probably create the edge you're talking about. Sounds like the part of playing Poker that is intangible and separates the winners from losers. We can all do the math on probabilities, but knowing what your opponent, or in this case your counter trade partner might do can be a game changer. Good luck on this and keep me posted
ReplyDeleteHello,
ReplyDeleteInteresting post, I had never heard of West Coast products.
Could you explain what exactly you mean about the MTM losses still having intrinsic profitability? Would this be for example, like selling an April SPY 136/137 credit spread for 20 cents and seeing SPY go up to 134 at some point, making the price of that spread say 30 cents? So it would be showing a loss at the present time, but if nothing else changed and it was held to expiration it would expire worthless and show a 20 cent gain.
I am guessing that this example is analagous to what you are talking about, but if you mean something else I would be curious to know what it is.
Regards,
sandeep
So what I was trying to convey is the differnene between mark to market (MTM) vs Intrinsic Value. As you know all positions are marked to market, this is what your unrealized P&L is made up of. When thinking in terms of just buying and selling stock or futures your MTM gain or loss is very strait forward. For example if you buy Crude oil futures at $100 and crude goes up $2 to $102 then your MTM is +$2 or a unrealized gain of $2. Conversly if crude goes down $2 to $98 then your MTM is -$2 or a unrealized loss of $2. In this sense the concept of MTM is very strait forward...it is what it is.
ReplyDeleteWhere when it comes to options you have your MTM and then there is the intrinsic value of your position. Or the value of your position at expiration given that everything stays exactly the same as it is today or at any given point in time where your MTM gain/loss was calculated.
So yes your example of selling the 136/137 call spread is a perfect example of what I am talking about. In your example you sell the spread for 20cts and with an upward price move it is now worth 30 cts if you want to buy it back before expiration. So your MTM is a unrealized loss of 10 cts. But if you look at the intrinsic value of the position, it is really still worth zero. You don't actually start losing any money until SPY trades above 136.20 (the bottom strike plus the 20ct premium collected). The MTM is only a threat if you are forced to liquidate.
By the way I will have more posts in the near future on West coast products. But this is not really a market where the retail trader plays. This is really just a space where oil companies and energy trading houses play. The barrier to entry is too large (large capital requirements). Just know that I am basically just trading Gasoline and Diesel.