What next?

I haven't posted in the last couple of days because I haven't altered my prognosis thinking that much. I'm still looking to get long and will use today's weakness to put on some trades. If skew goes up then I think it will be a good time to sell some of that skew and go long deltas via ratio spreads (or some variant like BWBs) or sell some out of the money puts. Yesterday we started off weak but staged a noon rally to only close slightly lower. Cumulative ticks actually were down 20,000 early and then finished up 20,000. Market internals were all slightly negative. At this stage some of my quants are predicting some further strength 1 week out or so. Another quant study also showed that a strong month often ends with some profit taking before the buying resumes at the start of the month, therefore I want to position myself accordingly using some weekly options.

If I come up with some trades toda I'll post them up tomorrow.

Yesterday's session recap

A lacklustre day on the markets yesterday. Most of the major indices finished slightly lower apart from the Dow. Market internals were a little weak with breadth coming in 60% negative and A/D lines around -400 for both exchanges. Cumulative ticks finished at a paltry +5,000. Volume was a bit of a surprise coming in quite strong on both the ES and the SPY. SPY was particularly strong finishing above the 30 day median average. From a logic point of view, I'd say that most of the shorter term traders that caught this nice move up probably closed out their positions and we probably got a few other traders opening up some new ones on the pullback. The market may pull back from here a little but from my point of view, that would be another opportunity to get long. I finally exited my the remaining short call spreads on the RUT and so I'm firmly long now (long RUT, AAPL, GS) and short the bonds via short out of the money call spreads on the ZB. At this point, for trade ideas I still like going long via short term (weekly) butterflies.

Trading and performance

Those who have been trading for a while know that trading is a high performance profession. If you are not performing then you are most likely not making any money and if you do that enough times to deplete all of your trading capital then you are out of the game. It’s as simple as that. In the faceless world of the trading arena, nobody could care less that there is one less trader in this world. That’s the stark and harsh reality of what trading failure means. So what can a trader do to ensure that they stay on the right side of the ledger? Well I did say that trading is a high performance profession. So what are the things that a trader should do to achieve consistently high performance?

It’s a good question and something that I’ve given a great deal of thought after having being provoked through the reading of the book “Talent is overrated” by Geoff Colvin. I’m half way through it but essentially the message of the book is that great performers are made not born and it provides research and anecdotal evidence to support the author’s claim. For example did you know that both Mozart and Tiger Woods received expert tuition in their chosen fields from an incredibly early age? (Tiger got his first putter at age 7 months). More importantly the book also aims to describe the things that give rise to great performers/performance based on the research. It’s compelling reading because it dispels the myth that certain people will never be good at certain things (aspiring successful traders take note here – myself included!) and provides some really good insight for what needs to happen for great performance to occur. One should really read the book to do it justice but I’m going to list a few of the points that I feel are worth mentioning and then apply them from a trading point of view.

Great performance:
1. Requires a lot of hard work (I suppose you knew this one already). There is the concept of the ten-year rule out there, where it says that to be an expert at something, takes about 2 hours of practice every day for at least 10 years. Hopefully it won’t take me this long but I do know that I’ve been spending at least 2 hours a day for the past 6 years learning, reading, thinking and doing trading (clicking away on my trading platform).
2. Requires “deliberate practice”. Now this is an interesting term and it forms the main content in the book. It’s a concept used to explain why some people who work hard over a long period of time at something never get any better whilst some other folk are able to become masters of it. Well what is it? Deliberate practice is specifically designed training to improve performance. It can be repeated a lot, feedback on results is continually available, it’s highly demanding mentally and it isn’t much fun. One of the key words mentioned here is designed. For traders struggling to make money how the heck do you know what you should be doing to get better? I mean how does one design something to specifically improve performance if they are not performing at all (making money). I.e. you don’t know what you don’t know do you? Well this is where the role of a mentor or coach comes in. Notice that in other high performance fields like sports, you have coaches for everything. Why? Because coaches can provide knowledge of the techniques, strategies and specific training required to be successful. They have the experience and background. Lots of successful retired players who go on to become great coaches are able to because they have been there and done that. Furthermore coaches and mentors can also provide you with the feedback and perspective necessary for improvement (it’s why I enlisted the services of Option Pit for mentoring). So there’s one tip for you unsuccessful traders out there. Find someone who is successful to give you some advice and feedback. Better yet get them to be your mentor! Hmmm…..I’m going to leave it there for the time being seeing as this post is already more than one page in length. I am writing a blog post and not a book after all! Stay tuned though for part two of this story.

Are equities going out of style?

Well they must be because institutions were buying them like they were! Cumulative ticks finished at close to........you guessed it, +100,000 again (90,000 to be exact)! They trended higher the whole day which was the big clue that it would be a trending day for the day traders. Internals finished strong yet again but not quite as strong as some of the last few sessions. Volume was significantly lower though on the SPY so perhaps, just perhaps, the bulls are beginning to run out of bullets (don't bet the house on it though).  I managed to close nearly all of my short delta positions save for 4 contracts of the short 690/700 Aug call spread on the RUT (this index has been a monster of late). The fact that the riskier indices like the NDX and the RUT are showing relative strength seems to confirm how much risk appetite is back in style. More thoughts later....

My intuition is telling me.........

I think we should be in for some consolidation early this week as the market digest's last week's strong gains. A slight pullback may be in order before we move higher. I also think we will take out the 1125 level in the SPX before going higher to test the 1170 level in the intermediate term. In line with that I will be scaling out of short delta positions and going long probably by selling out of the money put spreads. For this week I'm thinking of putting on a OEX weekly BWB, probably one that is slightly in the money (to get the trade on for a credit). I will also be adjusting my ZB long bond iron condor probably by selling more of the call 131/133 call spreads and buying back some of my 125/123 put spreads.

It's all about the ticks!

We had another very bullish session last night as indicated by the internals. Cumulative ticks finished at close to +100,000 again. This is the third reading of +100,000 in 4 trading days and is a very rare occurrence. To put this reading into perspective most trading days sees cumulative tick readings of between +/- 50,000. (For those wanting to understand what the tick indicator is see here). The cumulative tick indicator that I'm talking about is just a running total of the 1minute instantaneous tick readings which I get from Rennie Yang of Market Tells who is one of the quant subscriptions that I use. It's a great and valuable service by the way and I think all traders should check it out (there are loads of charts and other indicators that you won't get anywhere else). Other internals also finished in very bullish territory with breadth coming in at 80% & 70% for NYSE and Nasdaq respectively and A/D lines were +1800 and +1500 for both exchanges. Volume was close to the 30 day median average but below the big volume on Thursday (SPY).

So where to from here? Well 1125 on the ES seems like the next logical place where the bears might reload (area of resistance). I'm still seeing a fair few active bearish signals from my quant subscriptions but for the short term at least I'm bullish and even for the intermediate term I think you have to favor the bulls judging from the recent tape action. I mentioned before that this week was likely to be an important one for the market and any failure to bounce would be detrimental for the longer term. As it was the market passed with flying colours. So while I think some question marks still remain for the longer term (there is probably a good chance that there will be some future shocks) but for now I think the market wants to move higher. Volatility skews have flattened a fair bit so that implies that the market is pricing in less tail risk.

SPY 1/3/2 Butterfly Trade Update

Ok I'm back to my good self again! Apologies to those expecting more updates and more details in my posts but I was recovering from a self induced beer coma (I am human after all!). I exited the above trade on Thursday's session for a $0.42 debit. ie a loss of $27 per contract after accounting for the initial credit. Reasons for exiting were pretty clear for me. As mentioned earlier in one of my market updates during Thursday's session, the market internals and the trend of the ticks were extremely bullish and so there was no point in holding onto the trade as my prognosis was that the market was going higher.

Noon update

Despite the mixed price action, breadth & AD lines and the fact that we are only up slightly, cumulative ticks continue to trend upwards (at +28,000) implying that sentiment beneath the surface is bullish........

Quick recap

Cumulative ticks finished at a whopping +100,000 again. This is a very good sign for the bulls along with the increased volume. I think traders should be positioning themselves for further gains in the intermediate term as yesterday's showing was a big vote that the institutions think that things will be ok going forward.......

Noon update

And we have lift off! Well it's like someone put a rocket under the market this morning as the internals are very strong. A/D lines well over 2000 and 1800 on the NYSE and Nasdaq and breadth is 90% up volume versus 10% down on both exchanges. Volume is extremely heavy too for both the SPY and ES. Both are running well above the 30 day median average. Ticks trended straight up to +45,000 at 11.30am but has since levelled off. Also we did not get a negative tick reading in the first half hour which usually points to a trending type day. We have the dollar down and bonds down (although not nearly as much as what equities are up). Everything else is green. Transports, homebuilders, banking and gold are the strongest sectors today. All this on a day when unemployment and housing numbers came in worst than expected. I guess the market is really loving all that better than expected manufacturing data coming out of Europe earlier. Well whatever the reason, it is what it is.....

As for my trades, the AAPL trade is going well and GS is going so so. The SPY trade is underwater now so barring a pull back tomorrow it looks as though I could be taking a small loss especially given that the odds are we close higher from this point (ie trending day).

The power of the Fed……..

After reviewing yesterday’s action, I’m beginning to feel that I was absolutely dead wrong about the reasons for the market rally the previous day. No it had nothing to do with the China rumours of a more relaxed monetary & fiscal policy stance but everything to do with what the future actions of the Fed might be. Here is the evidence. From the market open, NYSE & NASDAQ breadth trended sideways right on the zero line, A/D lines were a similar story and cumulative ticks were in slightly positive territory (+10,000). Volume was also coming in well below yesterday’s levels as the market was in a holding pattern. After Bernanke began to speak at 2pm E.T. volume surged in both the SPY and on the ES to the 30 day median level and market internal indicators began to weaken significantly. The A/D lines went from flat to -1000 on both exchanges, the breadth went from 50/50 to 80% down volume versus 20% up volume and cumulative ticks went from +10,000 to finish at -10,000. To me it seems quite clear that the Fed is still the 600 pound gorilla sitting in the room when it comes to talking about who has got the muscle to move this market (remember the rally off the March 09 lows came just days after the Fed announced the first quantitative easing program). I suppose the market was expecting Ben to drop more dollars from his helicopter in the form of another quantitative easing program or something similar but it never happened as Ben stuck to the same story that the Fed is ready and willing to act when it’s time to do so. This type of uncertainty just ain’t going to cut it as the markets hate uncertainty! I suppose the current economic conditions are just not bad enough for any Fed policy action (the Fed is still forecasting 3.5% growth in 2011). We probably have to see much more weakness from the data and the SPX to drop about 300 points from here to invoke any kind of policy response from the Fed.

So there you have it. We have a pretty much a directionless market at the moment, what we do know is that earnings season hasn’t been that stellar to date, economic data points are now weakening and we won’t see any help from the Fed for now. If I was a bull I’d be wondering what catalyst going forward is going to continue to support this market. To me it is clear that economic news will continue to drive the market as investors look for any kind of information to determine what fair value for this market is. The worrying thing for the bulls is that the trend of economic data of late seems to indicate deteriorating conditions. If it doesn’t improve rapidly, the uncertainty of it all is going to make investors dump equities into something more certain like that of fixed income assets. We are already seeing U.S treasury (UST’s) bonds rally close to the highs of the last couple of years so perhaps that is a telling sign. From a game theory perspective UST’s still remain a dominant strategy compared to equities. If the economy weakens, the safe haven and fixed income aspect of it becomes all the more attractive, whilst if the economy weakens to a point that the Fed steps in and we get another round of QE then that extra demand will support prices. Obviously we should see some type of rally in equities at this point just like March 09 as investors will once again be looking for inflation hedges ie buying hard assets – no doubt that was a reason why commodities and materials rose so strongly the day before on anticipation of another QE type program (I note the AUD and other commodities are all off today). Really the only fear in being long bonds at this point is the spectre of hyper inflation but that fear is simply not justified at this point as CPI is well within 2%. To be honest if you were long bonds one would have ample time to see a rapid rise in inflation coming anyway and have plenty of time to exit positions as the first sign of coming inflation is tied intimately to the employment picture (capacity utilization). So far that hasn’t improved. It’s not like we are going to have 9.5% unemployment one month and then have 8.5% employment the next. Or that CPI is going to be 2% this month and the next it is 4%.

From a trading standpoint, and in line with my prognosis above I might investigate the idea of an iron cockroach (or unbalanced iron condor) on the ZB for next month with the trade skewed for more upside (danger side). More on that later.

Trade updates

Here is the AAPL trade I talked about earlier:

It is underwater a bit at the moment as the whole market pulled back. I will let it ride for a little bit but the concerning thing to me at this stage is that I put the trade on with the prognosis that AAPL would move higher but it hasn't done that. ie Whenever you put on a trade and the underlying isn't doing what you thought it would then the alarm bells should start ringing in your head and you should be planning your exit or an adjustment. At this stage, it feels as though the market wants to fill the gap so we'll see what eventuates. Again I don't think AAPL  is likely to fall off a cliff and I'm very confident that at lower prices buyers will be stepping up to the plate (perhaps there is a trade opportunity if that eventuates??) - Note that I had to show a simulated trade above as the TOS platform still shows carry over on the risk graph from my weekly trade even though I've exited it.

The other trade I put on last night was a SPY weekly trade as I alluded to you in an earlier post. This trade was made based on the fact that I thought the market would stall a bit from here (or limited upside). As per the other trades the weapon of choice was a 1/3/2 call butterfly as this gives me short deltas but also a nice profit zone to the upside if I'm wrong and we do get a little pop. Here is how it looks:

As you can see I'm up a modest  $44 in the trade on $346 of risk as the market pulled back in the afternoon. My breakeven is well within the 1std deviation expected move band so at this stage I don't really have to do much on this trade. The thing I don't really like about this trade is that it's commission intensive. Commissions cost me $18 (and that's because I get a very good discount) whilst the credit received overall was $54. That's a paltry sum compared to the risk you have to take. Yes I could have traded the OEX but it's highly doubtful I would have received much more and it's also harder to get filled as the options trade in nickels and not pennies.
At the moment the trade only looks good because I was right on direction which begs the question: If my direction picking skills are that good are there other trades that could better exploit that edge? Probably but not without taking more risk (ie lower probability). Also I'm not sure if I'm asking this question with the benefit of hindsight here (hindsight bias again - I probably am).

Occupational hazard....

It would be easy to be feeling sick in the stomach right about now as the AAPL trade is now trading around $3.10 credit but as a poker player who has played his fair share of hands and folded when he had the best hand after his opponent showed him his cards, it's easy to make this kind of an observation and say that I should have held onto the trade. After all that's the human thing to do (it's called hindsight bias). As traders however, living in the past is a dangerous thing (so it can be too for poker players) and it's all about trading what you see right there in front of you. The market making you look stupid because your trade was so good in hindsight is something you learn to live with and accept. Call it an occupational hazard. Remember at the time I exited the trade, I thought I was making the best decision and that really is all that matters!

I'm still bullish on AAPL here and I've bought myself a 260/250/230 put BWB for $0.14 credit. A very conservative trade indeed especially if I'm bullish and AAPL keeps on climbing but I more confident on AAPL not tanking at this point rather than it exploding up so I'll take the higher prob trade.

Option Pit

I just want to announce that I am excited to be working with Mark Sebastian from Option Pit. I've been following Mark's blog at the defunct Option911 for a while and Mark's style of trading resonates well with me as it's more of an opportunistic and flexible approach (ie taking what the market gives) which is something I feel is more suited with the current market conditions that can change so quickly from week to week. His knowledge of options and in particular option volatility is something that I would very much like to build upon for better strategy selection.

AAPL trade

Okay I couldn't handle the excitement so I got out of the AAPL trade for a $1.32 credit!! Excitement aside my prognosis is that AAPL will probably move higher so I prefer to bank my money. Also the fact that I'm short 3 of the 260 calls for every one of the 250 calls I own means that it won't take much up movement for the negative deltas to start stacking up once AAPL starts moving higher.

Looks like the quants were spot on again as we see the early strength being faded........It would have been a good gap fade on the ES today! Cumulative ticks so far off the open are down so we'll see. Probably an inside day today.....

Stealth attack!

Well it was a stealth attack for the bears yesterday. After gapping down huge on the open, the ES found support at 1050 (weekly S1 floor trader pivot) and then trended higher all day. Cumulative ticks finished at a whopping +100,000 indicating institutions were buying all day. In fact on the NYSE tick, we got an instantaneous tick reading of +1633 which is the highest level in years. Other internals like the A/D line and breadth started off extremely poor but by the time we closed, the NYSE A/D line had gone from -2000 at the open to almost +2000 and it was a similar story with the breadth having gone from 90% down volume versus up volume to finish with almost 90% up volume versus down volume. It was a similar story on the NASDAQ although not quite as strong of a reversal. On the volume front, volume finished well above the low volume of recent days with SPY volume finishing on par with the 30 day median average (there was quite a surge after 1.30pm E.T) which was probably attributed to some short covering and/or breakout buying as the 107 level was taken out. Note that a similar thing occurred on the ES when 1070 was taken out although this occurred 40 minutes earlier.

On the quant front, the fact that we saw so much buying pressure after such a weak opening appears to favour limited upside and a slightly bearish tone in the next couple of sessions by virtue of the fact that buying pressure in the short term is exhausted (one example is the 1633 tick reading). Again I still think this market is hovering around near value and the fact that the large gap down was immediately bought by the institutions points implies that the market is definitely not at value lower down even though we had weaker housing numbers yet again. Perhaps the buying may have been instigated by the rumors earlier in the Asian session, that China will soon be allow a loosening of its fiscal and monetary policy. After all the Aussie Dollar (commodity currency) held up extremely well amid the early weakness and it was in positive territory the entire day. Also commodities or materials to be more exact were by far the best performing group/sector for the day.

On the trade front, I still don’t feel too directionally biased either way and so will likely keep playing it small and short term until I see/feel that we are going to break one way or another. I still feel that selling out of the money put spreads on the long bonds is a good trade idea and will be looking to enter a trade for August expiration. Another trade idea I will be exploring more is shorter term trades using the SPY weekly options to better exploit my quant subscriptions prognosis and short term direction picking skills. More on that later.

Earnings, earnings, earnings.........

Here is the update on the GS trade:

The trade is up a very modest $44 on  $968 of risk but if GS can just hang around here for 30 days then I can make a bit more according to my risk graph which is in day step mode (each day represents 8 days of time passing). I will just hold for now but a lot will depend on the overall market. Technically GS is right near resistance at 150. Remember this GS trade is using August options and not weeklies.

Just before I went to bed last night I decided to put on a speculative earnings trade on AAPL. I was slightly bearish on the stock so I decided to go for a 1/3/2 unbalanced call butterfly using 250/260/270 strikes (knowing that it would give me short deltas and short vega heading into earnings) using the weekly options. As it was, I felt that I didn't have much of a chance getting filled as AAPL was at 246 and the trade was fluctuating around $0.08 - $0.20 debit. Anyway I decided to put in a couple of orders anyway. One was for 2 contracts at even and another was for 1 contract for $0.06 debit (I know this is breaking my rule on this type of play but I was kinda hoping to get one trade on last night - I really need to practice a bit more patience and discipline). Well upon waking up this morning I found that I got filled on both trades. Here is how it looks.

AAPL reported stellar earnings last night after the close and the stock is now up 9 bucks to finish at $259 which is right at my short strike. From the risk graph it would appear that my trade is now doing quite well - extremely well in fact but we'll have to see what happens on the open. My plan at this stage is probably to take most of the trade off even though these options expire on Friday meaning I get some big decay over the next 2 sessions. My intuition tells me that institutions will be all over AAPL when the normal session get's under way tomorrow and I expect some follow through but possibly not before a bit of profit taking on the open (gap will be faded slightly). I note that there is some resistance at the 262 area so perhaps I might take a wait and see approach to this one.

Morning Update

Market is all over the place at the moment after gapping down big, it has bounced a bit off the 1050 level on the ES. Internals are still fairly weak. Cumulative ticks were down right off the bat and now are back up positive and kind of oscillating indicating it's probably going to be a mixed day. Apparently the "locals" (floor traders) were short in the S&P futures pit and were forced to cover as "paper" (brokers acting for clients) started to buy - (You can listen to this audio feed from Trader's Audio or as a free service from the market cast chat room in TOS delivered by the always great Ben Lichtenstein).

As for my trades, I exited GOOG today for $1.57. Reasons were that I didn't like the big volatility today and the fact that GOOG has bounced nicely off 459. Also and more importantly it doesn't take much for a $460 stock to move $10 in a day. Current implied volatility levels give an expected move (1std deviation) of $9. Therefore you want to take profits when you can especially when most of the money made in the trade was due to falling implied volatility levels after earnings. As for the GS trade, that is working out nicely as the stock has recovered from the early weakness. Therefore I'm likely just to hold onto this and see how it works out.

At this point in time, I feel like it's prudent to trade smaller as the market seems a bit uncertain here and we could be in for some more volatility. Only trades I like here are longer term high prob iron condors 55 plus days out where I can get very wide break evens.

Where to now for the market??

First a quick recap of yesterday’s session.

Stocks rallied off a very mixed opening to finish slightly in the black. Despite the positive tone, volume came in very light. From a market internals perspective, breadth and A/D lines were mildly bullish and cumulative ticks did finish at close to 40,000 so indicating some bullish sentiment out there. All in all it was a fairly weak bounce considering last Friday’s action. Interesting to see that the futures are up ever so slightly in today’s electronic market even though tech giant IBM and Texas Instruments both missed earnings. Apparently, the market is giddy over the reports that China will relax its tightening policy in the near future. It seems to me that the pro-growth China story is the last thing holding this market up. That’s all well and good but I wonder how long it can last given that the pace of China’s double digit growth is clearly not sustainable without consequences (housing bubble, inflation etc etc). Perhaps after the last couple of months and weaker than expected economic data coming out of the U.S and elsewhere, the Beijing administration has finally come to the conclusion that global demand is not sufficient enough to drive further growth in the Chinese economy so a more lax monetary policy is required to stimulate further domestic demand. The big question is how much are they willing to pay to get this? 4-5% inflation? An even bigger housing bubble than they’ve already got? At the end of the day whatever goes up must come down even faster. So there you’ve been warned! Okay enough of my ranting market opinions so where to from here?

Well I think this week will be a very important one for the market. At this stage, I think the market is pretty much at value right now and is waiting to determine where future value may be. On a technical level, any failure to bounce much further from here and we could easily retest the lows at SPX 1000. In fact from an intermediate standpoint it is imperative that the market does bounce here or else the overall longer term technical picture just looks that much weaker. On the quant front, I’m now seeing bearish studies popping up for the both the shorter term and intermediate term. I still feel that any significant move will be to the downside. It’s notable to see that bonds moved higher again and are testing resistance. Not a good sign for equities.

On the trade front, the GOOG trade is doing well as GOOG bounced and the trade is showing a 20% profit. At this point I’m inclined to ride it out for another day or so and will put in contingent orders to take me out of the trade based on price so I can hang on to my profit whilst I’m asleep (I should have done this from the beginning of the trade so take note!). I will also update my trade on GS – yes I did put on a put BWB at 145/140/130 for a small credit. So far this trade is slightly underwater and it will be interesting to see how the market reacts to GS earnings later tonight. (Also notable to see AAPL sell off a bit yesterday, they also report tonight so how the market reacts to its earnings is likely to offer a big clue on the current market sentiment).

Friday's session recap

Well it was an ugly day yesterday price wise. All the majors were down more than 2.5% plus with the Nasdaq and the RUT getting special treatment as they were both taken out to the woodshed and spanked down 3% plus. Market internals were just ugly all day with no bounce in A/D lines or breadth and cumulative ticks trended down all day (that was a big clue early on when ticks were trending down solidly - a good indication of a possible trending day down as I alluded too when viewed with the other market internal indicators). The only positives for the bulls was that as bad as it was in terms of price, the cumulative ticks only finished at -40,000 (compared to a -100,000 figure a couple of weeks back) and volume was well below Thursday so it wasn't like the institutions were frantically pressing the sell button. It was more an orderly exit the whole day. Worst sectors were homebuilders, banks and internets. No surprise there as BAC and C both missed earnings and GOOG was hit hard, gapping down and finishing at the dead lows of the day (not a good sign). I think there is a good chance that GOOG falls lower to find support at 455 which is where the Person pivot level is and the 61.8% fibbo retracement of the last swing move. (The GOOG BWB trade is still up $70!!)

For Monday I would expect that some buyers will step due to the fact that $TRIN finished well above 3 and generally a weak Op-Ex day has generally been followed by a positive day the next week. As for the GOOG trade, I'm still in a favourable position as any sort of consolidation or buying on Monday is going to help. My trigger to exit will be below the 455 area. 

Market internals update

I'd be very careful about bullish trades today. The market internals are very weak, A/D lines down over 2000 on the NYSE and breadth is very weak too. Cumulative ticks have trended straight down and we are at minus 16,000 already. This could be a trending day down......

Still GS is holding up strong which is what I expect if there is real strength in a stock (up when everything else is down).

And the result is....

The GOOG trade is up! It's up around $100 at the moment to be more precise. Even though the stock has tanked $25 the 470 options have gained just over a $1 and the short 460 puts have gone up just a tad. It just goes to show how over inflated the options were. Even with a $25 move, the owner of the 470 puts is up only 15% on their investment. If GOOG had not dropped but that much or worse stayed the same or gone up, there wouldn't be much premium left in those weekly puts. For the time being I will monitor this trade and put a GTC order in for probably around 20% of the risk ie I will take it off for a $2.00 credit if I can.

As for the ES trade, I took that off for $2.60 credit right off the open netting a total of around $3.45 credit (original BWB was put on for $0.85 credit). You may be thinking as to what caused me to take the trade off straight away right?? Well a couple of things really, firstly was the fact that my quants are still showing bearish studies for today and the fact that one of my other quantitative subscriptions, that being the gap guide from www.masterthegap.com showed that a down gap today has a very weak historical win rate of filling (ie market likely to move lower instead of filling the gap). Therefore I made the snap decision to take the trade off. This is one of those times where one in the hand is worth more than two in the bush!!

At the present time, I'm eyeing off GS as a potential trade. I'm bullish on it given the news of the settlement and earnings is next week. I expect this move to be real as the SEC probe was a constant cloud over the stock but now that's it lifted, GS can focus on what it does best and that is to make a ton of money. I will be looking at a put BWB if I'm conservative (income) or a long call spread if I want to take on more risk (speculative trade).

Game On!!

It's going to be an interesting night as the ES is sitting pretty much at the middle of my short strike on the call BWB. So far the trade is showing a profit of $240 on about $3000 risk (SPAN margining with futures options versus a theoretical max risk of $5000). You might be wondering why it's showing such a small amount of profit given that the options expire tonight and I'm so close to the middle strike. Well that's because the strike separation between my long and my short option is only $10 on a $1100 beast. That is simply too small given the way the time value curve (bell) of an options decay (the ES can easily move 10 points intraday meaning that my butterfly can easily move out of money by days end). This is why maximum strike separation is very important if you are looking to trade a BWB from the point of view of making a decent profit from having the underlying within the profit zone and more importantly to be able to show a profit in the position as early as possible before expiration day. Also the more strike separation you have, the more protection against a big move. If you are not going to maximize strike separation then I would ensure that:

1. You get a very decent credit for the trade and
2. The trade is as far out of the money as possible (preferably greater than 1.5 standard deviation out of the money)

The reasons above is why I wasn't particularly happy with the GOOG trade that I've got on. I've got the bare minimum strike separation and I'm not really all that out of the money. As it stands, GOOG missed earnings expectations and the stock is down $20 bucks after market and is sitting awfully close to my long strike at 470 (GOOG @ $474). It will be interesting to see how it holds up when the cash market opens tonight to see whether the gap is real or will it be faded by the pros. Also interesting to see how implied volatility goes if it holds up then it probably means that the move is real and the market is pricing GOOG lower. Still I've got a decent shot now that GOOG is within striking distance of my profit zone and I do have time decay in my favour as the options expire next Friday. One thing is for certain and that is the profit on the trade is unlikely to start opening up before expiration day next week. Stay tuned for updates on the trade.  

Mid session update

Ticks are not extremely bearish although A/D lines and breadth have seen much better days. Volume is well above yesterdays level but still below the 30 day median. The big mover today has been in the bond market with the long bond (30 year) moving up almost up 1% which is a lot for bonds. I suppose they didn't like the Philly manufacturing number and the growth numbers that came out of China today. I see that other risk assets like the Aussie dollar are well down especially against the safe haven Yen and also to the USD although to a lesser degree (this is in line with my hypothesis that slowing economic growth in the U.S should lead to a lower USD over time). Probably not a bad time to take profits if you've been long the past week and a bit. It would seem that both of my quant subscription prediction's have gotten it spot on for today.

and here is one that I made earlier.......

It will be somewhat of an exciting day tomorrow as I have a call BWB on the ES that I put on a while back (around 2 weeks ago). This is one of those rare trades where the market has cooperated for you so far. However all my current profits could vanish at the drop of a hat tomorrow depending on what the market does. In all honesty trying to ride butterflies to expiration and hoping it falls within the tent is like shooting arrows at a moving target from 50 metres away! But this was the plan from the outset so I'm happy to see how it goes.

Earnings plays - This is my strategy and reasoning behind the GOOG play

Earnings Plays

Well it's almost getting into the start of Q2 earnings season so I'd like to share a couple of the strategies that I like to employ. I have two different strategies regarding earnings. One strategy is for earnings that are released just prior to options expiration whilst the other is for earnings that are released just after options expiry. The way both of them work are very different. I'll explain below.

Earnings released just before options expiry.

The foundation for this strategy is primarily a volatility play. The assumed edge comes from betting that the realized volatility after earnings will be less than the implied volatility. Hence we want to be short vega going into earnings and ideally our entry point is when the implied vols are at or near their typical pre-earnings levels (check implied vol chart). Note that there is an inbuilt edge here as typically the realized volatility is much less than the implied or else the market makers would be losing a bunch each and every earnings season to the straddle and strangle buyers. Therefore the probabilities are in the favour of those selling volatility but expect to lose significantly when the trade does goes against you eg. on a big move (similar characteristics to an income trade?? - maybe but we can increase our odds/edge - I'll give reasons below). So what are the short vega strategies that I like to employ? They are primarily the broken wing butterfly (with the wings spread out as far as I can) and the unbalanced butterfly in the ratio of 1/3/2 ie it is just like a normal butterfly but with an extra embedded credit spread (see example below). Both trades should be done for a credit or at least even. The reasons the trade should be done for a credit:

1) Is to give us one breakeven. As we expect the stock to move after earnings we want to only bet on one side of the movement and hopefully be on the right side. This further improves the probability of success in the trade.

2) To ensure you are getting a risk to reward of one to one in the trade (always my minimum goal with these types of trades).

Next we want to ensure that the wings are spreads as far as possible for two reasons:

1) To provide greater price protection in the event the stock does move and

2) to enhance the probabilities of profit when the implied vols do collapse as the volatility curve (the time value curve) for the out of the money options will decay much faster than the one you bought (closer to the money).

Finally, to increase probabilities even further, we want to look for stocks that have earnings just prior to Op Ex. Why? Well there are 2 reasons:

 1) we are taking advantage of the fact that the market makers have to keep the implied vols extremely elevated going into earnings even though it is near options expiration and premium should be decreasing (due to theta) because they don't want to get caught out on big move, hence when earnings is announced, the collapse in volatility is enormous (good for sellers).

2) if the stock does move after earnings, we would expect some follow through. However, the fact that Op Ex is just around the corner, you are safe with the knowledge that the move is limited to within that time frame.

The other things I like to do in my analysis of each trade is:

·         Ensure that the breakeven is outside of the 1 std deviation expected move at expiration

·         Ensure that you model realistically how much the implied volatility will breakdown after earnings combined with the price move to see the effects on your profit and loss.

Earnings released just after Options Expiry

This is not so much of a volatility play as it is more of a directional bet. The assumption and basis for this trade is that the stock will not much move prior to earnings and the probability is that the current prevailing trend will continue.

As the play here is not so much to do with volatility but with direction then one could employ any strategy that they see fit, but my preference is still for short vega strategies. Here I still like to use the broken wing and unbalanced butterfly but you will find that because the implied vols are not high, you will seldom be able to put these on for a credit. Hence my preference for just the regular butterfly with a good risk to reward (1:3) or an iron condor.  Again to reiterate, the assumed edge is that the underlying will not move significantly prior to earnings as no one wants to make a big bet, however, it the general market does sell off then that could drag the issue down with it so one needs to take this into account (another reason why I like the regular butterfly as it has better risk to reward characteristics).

If anyone has anything they wish to add, suggest or critique, I'd be happy to hear it.

Good trading!

GOOG trade

Okay just got filled on a put BWB on GOOG with the strikes 470/460/440. Rushed the trade a bit and got filled for $0.17 credit. I have to say it's not a trade that I feel 100% happy about as I'm only taking in 0.17credit for $10 of risk but this is one of those trades where it's more like a lottery ticket then anything else. If GOOG has better than expected earnings and takes off then I lose nothing, if the earnings comes out as expected and GOOG does nothing than I have a chance if GOOG just grinds it's way towards the long strike at 470 before the end of Friday. If GOOG has a disastrous earnings (which I don't think it will) then I will be in the dog house. Implied vol is still fairly high so I'm hoping for a bit of volatility drop after the announcement. Let's see how it works out.

GOOG earnings play

In case you didn't know, GOOG reports after the bell today. I will be looking for an earnings play tonight based on the new weekly options available for it which will be released tonight. In case you didn't know there are a host of other underlyings with weekly options now. For more info go here. At this stage I'm thinking of an broken wing butterfly or an unbalanced 1-3-2 butterfly. We'll see if I can get one on for a credit or not tonight. More later.........

What kind of market are we in?

First a quick daily update: The markets powered higher yesterday despite a lack of institutional buying as indicated by the tick indicator (cumulative ticks to be exact) finishing flat. Breadth and AD Lines were very bullish although volume again was well below average (another indication that the big boys weren't participating). Both of my quant subscriptions are now over run with short term bearish studies indicating a high probability that the market will have limited upside in the next few sessions with a good chance of a pullback. However on an intermediate term basis, more and more bullish studies are popping up suggesting that the market should move higher in the coming weeks.

Now continuing on from yesterday's post where I alluded to the fact that I think that the current market is what I would call a cyclical bull market within the confines of a what is a longer term secular bear market. The reason I say this is because of the way the market has behaved. From the lows of March 09, the S&P rallied a staggering 550 or so points from 666 in the space of just over year. Since the top the market has sold off about 17% rallied back 10% then sold off another 10% and rallied again and so it continues. Only 2 weeks ago was everyone staring into the abyss at SPX 1000 and now we are almost at 1100 again. This market has been anything but calm. In the space of a year we've had many technical records broken. For example (and this is from memory so the facts may be slightly off) the SPY had 16 higher highs in a row (a record), the QQQs most recently had 10 consecutive lower lows (another record), VIX moved 10% up or down for 10 sessions in a row (another record) and so forth and so forth.  Compare these types of market movements to the years leading up to the GFC where global markets were in a nice steady uptrend (or a secular bull market as I like to call it). You never saw this kind of volatility where the market would move more than 1% a day which seems to be the norm nowadays and it wasn't one sided back then as it is now. Markets trended but it was slow, steady and predictable. There was a certainty about it. People knew what value the market was many months and perhaps a year into the future. With certainty comes low volatility. And with certainty everyone gets rich as in a bull market, the tide lifts all ships. Financial markets love certainty. To be more correct, people love certainty. Imagine not knowing what time you started work each day, or whether the price of milk was going to be $2 or $20 the next time you went to the shops. Life would be chaotic. I've always said that a perfect world is a certain world and so it is with the financial markets. The problem with the markets these days is that the level of uncertainty is so high that no one knows exactly what is value for the market anymore. One week it should be 1000 because their are fears that Europe will be bankrupt and the next it should be 1200 because that problem has been seen to be resolved to some degree and Intel just had great earnings. Fundamentally the market will want to climb higher because interest rates are almost 0% in most of the western economies but every time the market does rally then another shoe drops because structurally the problems are still there (primarily the over indebtedness of the private sector and now government sector). I've mentioned Japan in the past because Japan had the same type of credit crisis style recession that we've just had and look at how their markets have behaved for the last 20 years.

It's virtually gone nowhere but have a look at the number of times it has rallied and sold off more than 10%. Using my naked eye I can count at least 10 times of 10% plus rallies and sell offs in that time as the market attempted to find an equilibrium (especially right after the big crash in 1990). This is what I think will be the kind of market structure for the equity markets worldwide going forward. We will see these huge rallies and even bigger and sharper sell offs as the market attempts to find equilibrium or steady state to borrow an engineering term. Will it find it?? Nope I don't think that's going to happen for a while as underlying problems will persist and remain unpurged from the system. In the meantime though every time the market has a period where it cannot auction higher or lower (price holds steady for at least 3 days) then there's a good chance it will begin to turn the other way. As an option trader that employs premium selling strategies (income or range trading type strategies), I continue to see very little edge in trading this way. But more on how I propose to trade the market based on the view above in another post.

Understanding market structure through the price auction process and the concept of value

One trading book that I've been reading lately is called "Mind over Markets" by Dalton. It's a book on market profiles and structure so as to gain a better understanding as to where price is likely to move to. It also explains the concept of what happens in a market auction and the concepts of other timeframe buyers and sellers. Now I'm not big on reading technical analysis books and trading off classical chart patterns and the like as I'm a guy that likes to trade based on logic, probabilities and more importantly by trying to understand the fundamental workings of the market (Perhaps this comes from my engineering training!). For me this book and the theory behind it really hits the spot in that regard. The logic behind how price auctions and searches for value make incredible sense to me and has helped me to better understand what drives price and where price might be headed next. Some of the important points I've learnt from the book are:

1. Price is either at value or it is not at value
2. The longer price stays at a certain level implies that price is at value
3. Which way is the market trying to go? and
4. Is it doing a good job in it's attempt to go that way?

Co-incidentally, I'm also studying a postgraduate diploma in applied finance and the current unit I'm studying, "Techniques in Financial Analysis" had a couple of pages devoted to defining the concepts of value and the various financial valuation methods such as book value, fair value, intrinsic value, fire-sale value, replacement value etc etc as well as the distinction between price and value. The distinction between price and value was made incredibly clear through the following statement:

"Price is the amount actually realised in a transaction. Value is the estimate of what that price ought to be. Unlike value, price is observable and objective, eg. share price on the stock exchange". However, while price does provide evidence of value, it is merely a record of an event where the value perceptions of one buyer and one seller overlapped. It does not necessarily represent what all the other market participants believe to be the value of an asset."


So how can we apply any of this theory to practical trading? Well for one, starting to think in terms of whether the market is at value or not will help you to get a better read of the current market price action and be more confident in identifying where price is likely to go rather than where it has been . For instance only a week or so ago, the SPX was sitting near 1000. However as price failed to auction lower (sellers couldn't over come the buyers) then the market was likely to search for value at a higher level. Currently the way that price has behaved and the quick rejection of the 1000 level for the SPX would indicate that value for this market is higher and not at 1000. Also by thinking in terms of value, I've found that I'm much more pro-active (looking forward) rather than reactive (looking backwards) to the markets and I'm better at identifying the developing market structure to provide clues as to to where the market wants to go. This helps a lot, especially given the speed of market movement nowadays. I guess the difficulty in estimating what is value for the market and trying to identify market structure is that value changes so quickly from week to week. A few weeks ago, everybody was valuing the market lower and now it's valuing the market higher. Such is the uncertainty surrounding the market which I think is a characteristic of a secular bear market. I'll explain more about this in another post.

Interesting session yesterday

Whilst the SPX managed to closed up slightly positive yesterday, the market internals were fairly weak to say the least with volume coming in well below average as well. This kind of a setup has led both of my quant subscriptions to suggest a very short term bearish edge, however as I type this, the market is surging higher on the back of the better than expected Alcoa earnings and no doubt that investors are anticipating that this tone will continue as earnings seasons kicks into full swing. Volume is coming in quite a bit higher yesterday and market internals look strong with the NYSE A/D line well over 2000 and breadth (up volume/ down volume) on the NYSE and Nasdaq in excess of 90% so far. We have gapped up and not look back this morning so the odds favour a trending day. Bonds are well off the highs now so that suggests that this rally is for real. It looks as though all the sovereign risk concerns and other issues are a distant memory. To me this kind of price action is typical of a cyclical bull market in an otherwise secular bear. I'll try and explain more about this in another post. At this point, I'm leaning towards the bullish side and we should see the market try to rally to 1130 on the SPX before the end of the week is out.

Is the market pricing in US economic weakness ahead?

There have been some notable movements in the cross markets in the last few weeks that, to me, signal a shift in the posture of what the market is pricing in with regards to growth in the US. They were correlations in the movement of the USD and US equity markets which have been trending lower on an intermediate time frame. I've included a chart to show the movements of some major asset classes for the past year below.

On the charts I've shown two arrows (click on the chart for a larger view). The first yellow arrow and the text that goes with it indicates when the USD started to move higher along with the equity markets. Prior to this point the USD had been steadily trending lower from the highs achieved during the worst of the GFC, as the USD is seen as a safe haven currency when risk aversion is high. Thus when global stock markets rallied in March of 09, risk appetite was back and so investors began to sell out of the USD. However a strange thing occurred in late November of 2009 when the USD started to rally along with the US equity markets. This was probably due to the stronger than expected economic data points coming out of the housing and unemployment numbers that signalled the US economy was now showing relative economic strength compared to the rest of world and so investors reallocated more capital to US denominated assets. (See this link to the forexfactory econ calendar to see just what the numbers were http://www.forexfactory.com/calendar.php?month=12&year=2009

From this it would be safe to hypothesize that the strength of a country's currency is a direct proxy for the strength of its economy. Therefore, the stronger the economy the stronger its currency. As someone that has studied finance, this is a generally accepted theory. What's concerning to global equity bulls of late is that the USD has sold off at the same time as the equity markets have sold off. No more of this flight to safety trade that we witnessed throughout the GFC where investors would sell equities and then buy US government treasuries, and indirectly the USD. I've highlighted with a red arrow when this took place and the possible weaker than expected economic data points for it. (See this link to the forexfactory econ calendar to see just what the numbers were http://www.forexfactory.com/calendar.phpc=2&week=1275177600&do=displayweek&month=6&year=2010

There are two things to take away from this. One is that the market is pricing in weaker US economic growth relative to the world (note that the Euro has rebounded quite significantly off its lows in recent weeks) and the other is that the normal machinations of global markets is in order as we starting to diverge away from the whole risk on/ risk off trade where everyone would run for the most liquid financial assets (usually USD's & Yen) at the first sign of financial market weakness. To me that's a positive sign because its shows that there is less fear and the market is probably not pricing in a double dip recession (just yet??).

With the unexpected weakness in the economic data however, we have seen a sharp rise in the price of bonds as indicated by the TLT indicating that bonds and not equities has probably become the dominant investment decision of investors and institutions alike. The other notable movement 2 weeks ago was to see gold come off it's highs moving lower along with the USD and the stock market. It's generally accepted that gold is seen as a store of value in times of uncertainty and as an inflation hedge. Perhaps the movement of late is indicating that while there is still a whole lot of uncertainty out there, the latter reason (inflation) is becoming less and less of a reason to buy gold (ie that deflationary forces are winning out). Certainly the movement in the bond market would seem to confirm that. Maybe global markets are heading for the Japanese style "lost decade" type of market where deflation still rules and the long term return of equity markets have gone basically nowhere, characterized by increased market volatility with impressive rallies and sell offs. Something to think about.........

10th July 2010 - Michael's Market Thoughts

Well a positive finish to a strong week. Looking at the market internals, it was strong across the board with up volume versus down volume both above 70% on the NYSE and Nasdaq and Advancers versus Decliners both finishing in very bullish territory. Notably Cumulative Ticks also finished at a very high 90,000 indicating a fair amount of institutional buying. What was concerning for the bulls was very low SPY and ES volume (multi-month lows) which according to one of my quant subscriptions has short term bearish historical ramifications going forward. Myself personally, I still have a short term target of 1085 on the ES and we are not far off that heading into Op-Ex week. My current trading thesis is that the markets are likely to stay within a wide trading range (1100 - 1000) on the SPX until we see more evidence of where the global economy is heading. So far the signs suggests that there are significant risks to the downside (especially sovereign) and whilst the markets have priced in a slow down in Europe and recently a slow down in the US, what it hasn't fully priced in is a slow down in China and that is my main concern going forward. On the short term horizon, we have the start of earnings season next week so expect more volatility going forward. It should be an interesting week!

And so it begins.......

Hello fellow traders, investors and financial market watchers/enthusiasts! After procrastinating for a while to start my own blog on the financial markets of which I follow everyday as a participant (derivatives trader, with options the weapon of choice), the time has begun to put up the first post and get it over with so that the next post may be something more informative! My primary aim of this blog will be share my thoughts and analysis on the financial markets with regards to the past and present so that I might be able to finally find the "holy grail" as a trader and predict the future! 

Finally, the blog will give me a personal avenue with which to to freely express my passion for the financial markets and allow me to record my thoughts in an organized and efficient manner other than sending out a bunch of emails to a host of different trading/investing groups and making random posts on the many trading forums that I'm a part of.

Time to stake my own piece of real estate in the financial blogosphere! How exciting!

I hope that everyone that reads my blog will get something useful out of it, if not than at least be entertained!