This can't continue indefinitely.......

Further to my previous post, the current move cannot continue forever as expectations of greater liquidity and thus inflation will indeed become self fulfilling causing central banks to begin to raise rates. Of course they will err on the side of caution then risk raising rates too early so expect a continued rise in risk assets.

Oh by the way, quant studies continue to point to higher prices, 3 months to 1 year out.

Current market thoughts & observations

As you all know the market has been trending higher and is exhibiting very bullish tape action. My thoughts are that we are going to continue to see more stimulus from central banks and continued liquidity in the form of bailouts etc etc. This is all reinforcing the risk trade and that's why we continue to see equity markets higher, oil higher, gold higher etc etc even though fundamentally something like oil really shouldn't be higher given that inventories came in yesterday well above expectations (2.9 mil versus 1.6 mil). The mentality of late that I've been seeing in the early morning futures trade has been to wait for the flush out early in the morning and then buy the lows as we have ripped every time.

Really, really tough to trade option income trades in this environment in my opinion. The best trades for the last 2 weeks have been to sell puts or buy call spreads. I will update later with a trade that I have on the SPX which is a unbalanced iron condor but I have had to keep massaging it by buying call spreads just to keep the deltas in line with my theta. At this point, we are so close to retesting the recent highs of 1344 on the SPX that it would absolutely shock me that we don't get there. I think it's a given that the market wants to go there. This might set up some interesting spec trades like long some cheap out the money call spreads as we head into the last 2 weeks of expiration.

Mass liquidation??

A bit of risk aversion all across the board. Everything that has probably been bought on leverage is starting to unwind and that includes crude, gold, silver etc etc. All market internals are solidly negative. In fact they stink and the robots (ie program buying) that have bought at low levels on each time we've had weakness lately are now where to be seen. Ticks are solidly negative and cumulatively we are down -20,000 already. Seeing a massive jump in volume today which shows that a lot of distribution is going on. I myself did go with the open but I did fade the first bounce we got on the TF for a nice winner. I don't think we will see any meaningful bounces today to be honest. Still you never know with this market. Very quiet in the pits though so not a sign that we've hit some sort of extreme just yet (normally lots of noise indicates that selling or buying is reaching an extreme). Treasuries and the dollar are up so definitely some safe haven allocation going on.

Back to regular programming soon!

Hi folks,

I've been a bit busy lately since I got back from holidays and I haven't yet gotten into the blogging mood but I will rectify this over the weekend. Current thoughts are:

• Very strong inverse correlation between crude futures and the e-minis. The fear to me at this stage seems to be that if we get a large spike in the price of crude, then this may force central bankers to start raising rates earlier than expected. Note that the comments from one of the ECB bankers a couple of days ago really spooked the Euro and it had quite a bit of a meltdown (normally you would have expected the Euro to rise but I guess traders are thinking more about the longer term effects that higher interest rates would have on the struggling PIIGS to repay their debts and what that would mean to the Euro if any one of them defaulted). Any rise in interest rates would signal an end to the flood of liquidity we've had and that would not be good for equities or the global economy as a whole as it is still recovering.
• Based on quant studies such as patterns, the odds still point to a higher market in the intermediate term 3-6 months out. ie any nice pull back or correction sell off is likely to be a good opportunity to get long.
• The short term technical picture for the S&P shows that we are forming a triangle pattern as longs and shorts keep building positions by fading the lows and highs. Watch for an eventual break of this range soon as all we need is a catalyst to make a big push in one direction and one side is forced to cover. I might make a separate post about this.
• We've had some pretty good distribution days of late as seen by cumulative tick action (there's been 3 days over the last 2 weeks where we had more than -60,000 in cumulative ticks).
• Each day that we begin with a weak opening and a bit of a sell off, I've observed program buying stepping in and pushing the market back higher again at key levels. How do I know?? Because I keep hearing alerts on my trading platform when I get spikes in NYSE tick action of +600 to +1000. How long does this last I do not know
• We are seeing large gap downs in the overnight futures right now below the low of the cash session. This presents a high probability that the gap will not fill and is suggestive of a continuation move down in the cash session. It will be interesting to see whether the low of a few days ago, 1302 in the ES, holds.

Will be away for a few days

There will be no posts for the next few days as I'm on vacation.

Safe trading everyone!

The selling did come but not before I went to bed!

In hindsight, I totally mucked up yesterday's short trade. After stating that I would likely fade the gap fill and that the suckers would try and buy the opening weakness and push the market higher, I went short right at the open with a 5 point stop on the ES expecting it to be a full blown trend day. ie sell off from the open and never look back. For the first 5 mins there, it did look that to be the case. However once the paper sellers stopped, the locals who were then all long having absorbed all the supply were able to push higher along with all the gap faders. However the locals then failed to find paper buyers after a nice 6 point run and so were forced to flatten up after that which then took the market lower again. After that it just became an avalanche as those who faded the open began to cover their longs as there were just no buyers to be found. For me the error was due to a couple of things:

• Getting the market structure slightly wrong by not anticipating that there would be an upward bias on the open as weakness of late has been bought. This would have caused me to fade the gap fill at a slightly higher level.
• Setting my stop too tight on a day where we were bound to get an expansion in the range (or volatility)
• Trading the ES instead of the TF as the ES showed remarkable resiliency to the early onslaught. It is likely I would have covered my short position in the TF within the first 5 mins as it absolutely got smacked about 3.5 points.

I will remember this lesson for next time!

Absence of paper sellers

No avalanche and the pervasive bullishness continues as the futures hold up. Paper sellers are absent after heavy selling off the open which is why we continue to push higher. I am now stopped out of my ES position after covering about 5 points higher. A nice loss today!

Goldman a big seller in the pits

As expected a lot of "paper sellers" this morning with Goldman selling a couple of thousand off the open. Oddly enough the ES is holding up considerably better than the other e-minis which have now bottomed somewhat but internals are still very weak. I'm short from 1326 on the ES. Should be an interesting session. Watch for a break of the first hour range here. Volume as you would expect is extremely heavy. At this stage, the locals are heavily long after buying from paper so anymore continued selling will create an avalanche of supply and they will be forced to cover, thus pushing the futures lower. At this juncture, the locals will try and push higher from here and try to trigger some buy stops from those that are short (myself included).

Volatility analysis

Well after week of capturing the volatility data from my TOS platform and doing the calcs, I can already notice a few things:

• The VIX is not a very reliable indicator of vols as it finished relatively flat on the week but the at the money implied volatility on March options actually crept higher. Check out Mark's article about this. (Option Pit blog)

• Downside skew has also been picking up. Was this an early indication that the market was pricing in some kind of a sell off and the Libyan situation happened to give it an excuse?
• Contango between March and April term structure is on the increase after the spread was very tight a couple of weeks back. Will this continue as it has remained high over the last 2 years relative to how it normally is or will it come down to these levels again after this sell off? In my opinion I do think that elevated levels of contango will remain for years to come as I still see various and frequent shocks continuing to hit the world's financial markets (I think the world is in longer term a transition period).

18th February 2011 - Market Recap

Cumulative ticks: +35,000 but traded sideways since hitting a peak of 40,000 at 1pm.
A/D: +350 for the NYSE and 0 for the NAS. The NYSE finished off the highs hit at noon of 700 while the NAS was well off the opening print of 700.
Breadth: approx 50% positive for both the NYSE and the NAS. Both basically traded at this level the whole day.

SPX front month 10 delta put skew: March 160.34% (21.55/13.44)
SPX front month 10 delta call skew: March 89% (10.9/12.24)
SPX Horizontal skew or Front month versus next month: 12.84% (average of March ATM options) versus 14.67% (average of April ATM options).

VIX: 16.43 (-0.16)
SPY volume: Finished 3.5% below the 30 day median average.

Quant Predictions


1-3 days: Bearish in terms of pattern and bearish in terms of seasonals
1-4 weeks: Bullish
3-6 months: Bullish

Well on Friday, I faded the morning gap up (as that was what the gap guides provided over at masterthegap.com ) showed to be the best setup. The TF was the weapon of choice because the gaps were quite large and I didn't want to hold for entire gap fill in case we again rallied so the TF being the most leveraged of the e-minis was ideal as the extra leverage would give me a decent profit if I was right and I would be able to get in and out of the trade quickly as I wouldn't have to hold it for too long in case I was wrong. As it turned out I went short at 835.20 and covered at 833.20 for 2 points or $200 per contract right after the first 10 mins of the open. Thankfully I covered because after the first 20 mins after the open all of the futures bottomed and rallied higher till noon from when it preceded to sell off into the close right back to where it opened. This kind of pattern is unusual and perhaps it is a clue that some of the longer term time frame traders have hit their targets. Either that or some people knew that the situation in the Middle East was going to unravel over the weekend and no one wanted to hold positions over the long weekend. (Maybe Goldman knew as it was a quiet big seller on Thursday according to Ben from Trader's Audio).

I expect some big time selling tonight as people bail on positions so will likely be fading the gap fill. 

Large down gaps in the futures

Seeing a lot of risk aversion at the moment largely sparked by the situation in the Middle East. Futures are well down at the moment and as I've pointed out many times in the past that when you have very large gaps >0.5% and gaps that open above the highs or below the lows of the previous session, the odds of gap fill are low whilst the chance of a trending day is high. Therefore the best trade should we open around here (<1336 on the ES) is to fade the "gap fill" ie go with the direction of the gap. No doubt there will be a lot of the amateurs trying to buy this open and early morning weakness expecting us to rally as we have done for the last 2 weeks or so but I expect these "suckers" to get run over. I will be listening to Ben from Trader's Audio for clues to see whether the big institutions are net buyers or sellers off the open. I expect them to be net sellers in a big way meaning the locals will be forced to cover as the supply will become too much for them to hold.

16th February 2011 - Market Recap

Cumulative ticks: +15,000 but off the early morning highs of 20,000
A/D: 1300 for the NYSE and 800 for the NAS. Both A/D lines again trading off the morning highs.
Breadth: approx 70% positive for NYSE and 73% for NAS. Both basically traded at this level the whole day but slightly off the highs in the morning.

SPX front month 10 delta put skew: March 147.1% (21.8/14.82)
SPX front month 10 delta call skew: March 88.6% (11.15/12.58)
SPX Horizontal skew or Front month versus next month: 13.7% (average of March ATM options) versus 14.55% (average of April ATM options).

VIX: 16.72
SPY volume: Finished 5% above the 30 day median average.

Quant Predictions


1-3 days: Bearish in terms of pattern and bearish in terms of seasonals
1-4 weeks: Bullish
3-6 months: Bullish

Looking for a short here on yesterday's highs. Gap probabilities at this point look ok with these small gaps. However the best play may still be to fade the gap fill.

15th February 2011 - Market Recap

Cumulative ticks: -10,000 which was the lows after bouncing to 5000 during 1.09pm ET
A/D: -600 for the NYSE and -600 for the NAS. Both A/D lines traded in a narrow range but off its lows whereas the NAS finished near its lows.

Breadth: approx 60% positive for NYSE and 60% for NAS. Both basically traded at this level the whole day.

SPX front month 10 delta put skew: March 148% (21.35/14.34)
SPX front month 10 delta call skew: March 87.1% (10.8/12.4)
SPX Horizontal skew or Front month versus next month: 13.37% (average of March ATM options) versus 14.19% (average of April ATM options)

VIX: 16.37
SPY volume: Finished 16% below the 30 day median average.

Quant Predictions


1-3 days: Neutral
1-4 weeks: Bullish
3-6 months: Bullish

Once again the dip buyers showed up as the futures sold off in the morning. However the highs and lows were established after that and the futures just traded within that range. It still amazes me how the dip buyers are showing up every time. It seems to be the lay up trade of the last week or so. Anyway we have decent gaps up in the futures this morning but the odds show a mixed bag in terms of probabilities for fading it so I will probably stand aside and watch to see what happens from here. Bonds selling off a bit after the PPI numbers came in pretty high again. I think we are starting to see inflationary pressures build and that would be bad for bonds and could be bad for this market.

Market Recap - Monday 14th Feb 2011

Cumulative ticks: +34,000 after trending higher from 11.09am ET
A/D: 250 for the NYSE and 200 for the NAS. Both A/D lines traded in a wide range before narrowing at the end of the day (indecisive market).
Breadth: approx 60% positive for NYSE and 60% for NAS. Both basically traded at this level the whole day.
SPX front month 10 delta put skew: 131% (21.55/16.46) - March 144% (20.97/14.53)
SPX front month 10 delta call skew: 98.7% (11.8/11.95) - March 89.6% (10.67/11.91)
SPX Horizontal skew or Front month versus next month: 14.20% (average of Feb ATM options) versus 13.22% (average of March ATM options).

VIX: 15.95
SPY volume: Finished 35% below the 30 day median average.

Quant Predictions


1-3 days: Neutral to bearish
1-4 weeks: Bullish
3-6 months: Bullish

More comments later

Monday 14th of February - Pre Market Thoughts

All the futures are showing small gaps down apart from the TF. Probabilities for gap fill look good for these small down gaps especially given the overall bullish tone of the market. I will probably look to fade the gap for fill but will wait on the open to see if we can get a bit more selling so that I can get a better entry point. Not much news to speak of this morning so odds are that the market will have a positive bias and fill the gap. Given how overbought the market is, I would say that a 3 point winner in the ES would be worth taking. Anymore than that and you're probably risking it as I expect a bit of consolidation (ie range trading). 1323 would be a good entry methinks to the long side. That's if we can sell off a bit to there.

Trending day example - Market structure

Friday was a good example of a trending day. I say good because there are better examples (ie 28th of January when we had that nice down day). Here is what the market internals should look like on a trending day. This is a snapshot taken of Friday's market internals eg. breadth (up volume to down volume), A/D lines (advancers versus decliners) and ticks.

As you can see all the internal indicators trended up for the entire day.On a perfect example of a trend day the market internals will almost appear as a straight line as per the yellow trend lines I've drawn in. Another clue that we had a very strong bullish bias was that the bulk of the tick action was squarely above the zero line as captured by the two purple lines I've shown. Also the moving average line as indicated by the blue is also well above 0 indicating the positive bias for the day.

As a side point, (it might be hard to see) but we had an extreme tick reading of 1008 on the NYSE ticks at 11:15 E.T (the times you see are local time to my computer ie Perth) at which point the ES hit at that time a high of 1326.75 on heavy volume and then proceeded to pull back 5 points to 1320.5. This is can be considered a short term tick exhaustion move and John Carter does a good job of writing how extreme tick readings can be faded as a trade setup in his book Mastering the Trade.

Anyway, it's all very easy after the fact to write up an analysis on the day's market structure, the hard thing is to actually determine in real time what kind of market structure is developing before it's known to everyone in the trading universe. However you can get good clues from keeping a tabs on the market internals. Like I always preach, trading is a probability game and it's always pays to keep the probabilities on your side!

11th Feb 2011 - Friday market recap

Cumulative ticks: +17,000 after trending higher the whole day
A/D: 1421 for the NYSE and 882 for the NAS. After starting in negative territory, both trended higher the entire day and finished near the highs.
Breadth: approx 70% positive for NYSE and 60% for NAS. Again both rallied from the lows early in the session (80% & 60% negative) to finish at or near the highs.
SPX front month 10 delta put skew: 156% (19.98/12.8) - March 154% (21/13.63)
SPX front month 10 delta call skew: 88% (11.4/12.97) - March 85% (10.66/12.5)
SPX Horizontal skew or Front month versus next month: 12.89% (average of Feb ATM options) versus 13.06% (average of March ATM options).

VIX: 15.69 (-0.4)SPY volume: Finished 30% below the 30 day median average.

Quant Predictions


1-3 days: Conflicting studies here. Bullish based on seasonality but weakness based on pattern.
1-4 weeks: Bullish
3-6 months: Bullish


Well Friday was a good example of a trending day. The futures gapped lower on the open but that was pretty much the lows of the session as they all trended higher for the remainder of the day. Even though the gaps were fairly large and the probabilities I use for gap fill were low (ie the historical probabilities showed that there was a good chance the down gaps would not fill), the bullish pervasiveness prevailed yet again. Possibly on the Egypt news, consumer confidence or plain old POMO. I was inclined to fade the gap fill again but was away from my trading computer so did not trade at all on Friday. Good thing as I would have been run over. It's interesting to note from the above numbers that the vertical skew in the SPX has steepened from the day before. This is probably from the fact that ATM implieds have come in (moved up the curve) with the VIX falling to 15.69. Term structure or horizontal skew is pretty tight for Feb/Mar and not too bad for Mar/April so time spreads might not be such a bad trade for the income traders. Given that next week is OpEx I will probably start quoting the March options as front month to see what the vertical skew is to see whether normal flys are any good to trade (ie prefer flat skew for normal flys).


On the quant side, all the seasonals point to a strong start to the week followed by weakness on the Thu/Fri before the President's day holiday. So overall I'm inclined to buy any weakness on the Monday/Tuesday and exit perhaps on Wednesday. Market is overbought here so tight stops would be preferred. The bulls do have POMO on their side though and one look at the schedule below from the New York Fed shows that there is an abundance of liquidity been injected into the system for the next 4 weeks. Perhaps this is the source of the pervasive bullishness??   


http://www.newyorkfed.org/markets/tot_operation_schedule.html

Looking further out beyond Feb and we do have the Irish elections coming up. It would appear that the opposition are set to take over and they have already mentioned the possibility of renegotiating the bailout agreement with the EU so that senior bondholders will take a hair cut on the debt currently owed. If this comes to fruition then it might set the cat amongst the pigeons. Clearly the Market has not priced this in but will have to do so if and when it becomes a reality (as it always does) (Feb 25th is the date of the elections so keep that in mind). Any pullback or meaningful correction in US equity markets arising from this should be bought if all the longer term quant studies especially from the current tape action are to be believed. Fundamentally money fleeing from Europe will make it's way to US equity markets just to the fact that the US is the strongest in relative terms of all the global economies (with most fund managers believing this to be so). This will continue to be helped with the fact that the US Fed will probably keep to it's loose monetary stance the longest as well (inflation measures are still benign in the US but they are showing up everywhere but - interesting isn't it??). Emerging markets are not faring as well (just look at their charts) and so I expect money to flow back from here to US equities as well. Supporting this is that the dollar seems to have bottomed somewhat and so have UST's. I expect both of these assets to trade sideways to up from here.

Fading today's gap fill

The market opened with large gap downs which according to the probabilities has a low chance of gap fill. Therefore when I saw that the TF had a huge pop off the open but the other indexes weren't showing the same strength, I decided to fade the gap fill on the TF. Went short at 807.4 and covered at 804.7 for a nice 3 point or $300 per contract winner. Once again the dip buyers have showed up and we are now well off the lows (the TF is a full 7 points off the lows - that would have been a nice trade if you caught it). Apparently the catalyst was of the news that Murbarak's resignation is imminent. I don't know what to believe but who cares.......

Cumulative ticks are now positive. I think we will chop it up for the rest of the day here.

Thursday morning update

From this point forward, I shall endeavour to summarise the main technical indicators that I use every morning. At the end of each trading day I will also summarise these indicators and also my outlook/forecast for the short term (1-3 days), intermediate term (1 - 4 weeks), long term (3-6 months). Doing this will help you as well as me as it will force me to record these values and give me an objective measure of the tape each day.

Time: 10.20am ET

Cumulative ticks: -3,000 and bouncing off the lows of -7,000
A/D: -323 for the NYSE and -71 for the NAS. Both well off the lows of sub 1000
Breadth: approx 60% negative (ie 40% positive) for both exchanges but well off the extreme of 80-90% negative
SPX front month 10 delta put skew: 134%
SPX front month 10 delta call skew: 81.3%
SPX Horizontal skew or Front month versus next month: 12.85% (average of Feb ATM options) versus 13.75% (average of March ATM options).
SPY volume: Currently 60% above the 30 day median average.

January Trading Recap

With January now past us, it was another successful month of income and spec trading. The ZB iron condor was closed on the 26th of Jan when the put spread was bought back for 0"05 debit. This meant that the second iron condor on the ZB for Feb returned a total of "17 ticks ($265) per contract traded or a ROI of around 28% (on SPAN margining).

On the spec side of things (futures trading), it has been going well but not quite as well as the ZB iron condors. Still struggling with psychological aspects in holding positions for longer than one day (probably due to conflicting analysis that I get). Anyway the combined result of both income and spec trading for the year is that the trading account is up 9.5% which I'm quite pleased about. I will have to work extra hard to maintain this type of consistency for the remainder of the year.

Not many trades on at this stage but I will be looking to leg into yet another ZB iron condor for March expiration (put side). Bonds have been and continue to get crushed with the improving economic data which brings us closer and closer to the day that these super low interest rates around the world will have to rise.

Still holding on to AAPL BWB which now looks like it will expire well out of the money. Overall the market continues to be bought on any dips and most sell offs have largely been contained and limited to one day. At this juncture consolidation is likely and I will be setting up day trades on the e-minis accordingly (I will post more about this later).

Longer term and intermediate quant studies still pointing to odds of higher prices, however in the very short term we will probably get consolidation this week (ie range trading).