Options Trading Blog
Options Trading Tips and Strategies
In unusual activity we see a customer once again buy the DLPH March 30-35 Call Spread for $1.60 as this stock continues to see bullish order flow. We also see a customer seller of about 5500 CIGX May 2.5 Calls from $.70 which is the bearish acitivity I have seen today. In other bullish order flow, we saw a customer seller of SNTA August 5 Puts for $1.00 and a customer buyer of LPS Feb 19 Calls for $.90. I always try not to overtrade, but when I get a good trade like CIGX I jump on board on a short position. The rest of the afternoon might be slow, but I am always watching the unusual options activity for possible trades.
Of course the tough part is knowing when to switch trends. Wall Streeters use a million different indicators and ratios to try to figure this out, but as yet nobody has it down pat. Rather, all we can do is identify a major trend, and stay with it until is appears to be broken, and then move on. So what are the hot trends right now? What is going on out there that can make us some money? Market observers have commented on many trends that have been occurring for months.
For example, one key trend has been the high correlation of asset classes over the past months. Historically, some assets classes—such as gold, various bonds, and certain commodities have been good hedges against stocks. They go up when stocks go down and vice-versa. However, recently almost all assets classes have moved together—they go up together; they go down together. Is this trend continuing as we speak? Answer: uncertain. So far during 2012, certain market sectors (e.g. technology and banks), as well as bonds, haveclearly outperformed other investments (e.g. gold). But whether the overall high correlation trend is broken remains uncertain. Another commonly discussed trend is the low volume in the markets and the vast amount of funds sitting on the sidelines. Certainly, these funds becoming more active could help the market. In the last few days, volume has moved up somewhat, but it is again uncertain how long the low-volume trend will last.
However, there is one key trend that has lasted for years, and for me is the most important trend to watch and to react to with your money. That trend has to do with action in the dollar. This dollar trend has been amazingly consistent over the past few months. Under this trend, there has been a very strong correlation between high markets and a weak dollar. When the dollar is weak, markets go up. When the dollar strengthens, markets go down. This relationship has generally been holding true to form – day in and day out – month in and month out. This is the trend I am watching closest.Absent a Black Swan event, I believe that the markets will continue to do well as long as there is a weak dollar. While a strong dollar may be good for the US over the long term, a weak dollar helps stocks, gold, bonds, and commodities in the short term. If the dollar strengthens, the markets may well act very negatively in response.Past trends are not necessarily indications of the future. However, investors disregard current trends at their peril. In my opinion, following a current trend is simply wise investing—until that trend changes course. And right now the key trend out there is the weak dollar. If this trend changes, my current bullish attitude will likely change very, very quickly. Please follow me on Twitter @USKOTM
Some key European events that traders will be watching this week are German factory orders(December) on Mon and will be listening to the Eurogroup finance minister meetings. Tuesday, Bernanke will testify before the budget committee and Merkel will speak regarding Europe’s fiscal future.
In early morning trading, after 5 weeks of positive trading/strong macro data and the Dow making fresh 3 year highs the DJIA is down by 45 points and the S&P is down around 5 points. The VIX traded under 17 on Fri but closed near its highs after investors wanted cheap protection. Perhaps investors were seeking some cheap protection against a “Lehman-like” event.
If the 10 yr yield can trade comfortably above 2% and the Vix can trade under 20 I think the tape is set to trade much higher. Crude oil is trading around the 97$ level with a lot of risk premium still built in. Look for crude oil to go much lower unless some crazy geo-political news comes out of the middle east.
Buy & Hold Doesn’t Work Very Well Anymore
I used to be a die hard “buy & hold guy”. I worshipped at the altar of Warren Buffett and tried to buy only stocks that I thought I could hold forever. While I will hold a stock for a long time it is a rare occurrence. I reserve the buy & hold methodology for that rare company that is of the upmost quality. I currently hold two stocks in this category. Both are small caps and I’ve held one since 2001 and the other I’ve owned since 2006. They both share the same qualities. They are small, excellent management, absolutely no debt, have a nice chunk of cash, are growing at a decent clip, and aren’t self promotional. These kinds of companies are harder and harder to find every day.
Markets Are Manipulated
The most important thing I’ve learned from Mark Cuban is that the markets are highly manipulated. The investment game has grown so large that there is now so much “big money” sloshing around out there that the small investor is for the most part at a disadvantage. Peter Lynch used to say that the small investor had an edge because they could invest or do things the fund managers couldn’t. While this is true, nowadays the big money is out there manipulating the markets. Whether it’s the Federal Reserve pumping money into the system creating rising asset prices or the high frequency trading that is out there robbing investors with fake volume and bids, the markets are constantly being manipulated. With the government artificially suppressing interest rates, people are losing ground to inflation in their savings accounts and feel forced to participate in the market. This creates manias and bubbles by having people chasing the hot asset classes. It’s usually the small investor that hops on the bandwagon as the big money pulls the rug out from underneath them.
Pick Your Spots – Have a Specialty or an Angle
So what is the average investor to do? We’ve just spent over a decade where the stock market is below where it started. The “financial experts” who are “looking out for you” will tell you to just put as much into your 401k or mutual funds as you can each month and everything will be o.k. Funny thing is, is that they are only worried about their assets under management and gaining fees off of your account. Very few people in the financial industry have your best interests at heart. You have to have an angle or a specialty to trade this market. Figure out what it is and become an expert and be good at it. It could be trading on unusual options activity, investing in spin-off stocks, high yield dividend stocks, merger arbitrage, micro caps, sectors, or whatever you can find where you have an edge to protect yourself from the market manipulation. If you can be focused and knowledgeable you can trade this market.
Cash is an Asset Class
If you can learn one thing from Mark Cuban it is that cash is an asset class. You don’t have to be 100% invested in the market at all times. Cuban stresses that you have to have cash to take advantage of opportunities. The more cash and less debt you have the more likely you will be to take advantage of a tremendous opportunity that could come your way. While Cuban is a billionaire and doesn’t have to worry as much as the rest of us about getting a return on his money, what he says makes perfect sense. Sometime, whether it’s tomorrow or three years down the road, you will get an opportunity to deploy your cash. It could be a market crash or a stock specific crash that presents that opportunity to you. It could even be a business opportunity that comes along that had it not been for hold some cash, you would’ve missed out on. I’m not advocating sitting in all cash but just be mindful that cash is an asset class that could pay big dividends down the line when you need it the most. As Buffett says, wait for the right pitch and then swing. While Warren Buffett was the best investor of a past generation, Mark Cuban is one of the best of our generation. Read and listen to everything he has to say. You will be surprised at how much you learn.
I bought 10 Feb weekly 30 Straddles for $3.50. I bought 10 Feb 30 Calls for $2.25 and 10 Feb 30 Puts for $1.25. So my breakeven on this trade is $26.50 or $33.50. So if the stock sells off under $26.50 I will be profitable, but I can either buy stock against my position to lock in the Feb 30 Puts that will expire into short stock after today or I could sell the Puts out. Since options close at 3PM and stock trades until 7PM CST I bought stock against my spread. So, last night I bought 30% of my stock back, or 300 shares at $26.50. As the learning process is, when I buy Puts and buy Stock I create a Call. So, I converted 3 on my Feb 30 Puts to Calls by buying stock. So, going into today I am long 13 Feb 30 Calls and long 7 Puts. Today, APKT was off to the races and I sold stock against my Calls on the averaged price of $32. So, lets look at a breakdown on expiration:
Bought 10 Feb 30 Calls for $2.25, Selling Stock at $32 is the same as selling the Calls at $2 after expiration, so $.25 loser 10 times= Loss of $250
Bought 10 Feb 30 Puts for $1.25, these will expire worthless= Loss of $1250
Bought 300 shares of Stock at $26.50 and sold it at $32= +$1650
This trade ended up as a $100 winner for a 10 lot, by “scalping” stock in afterhours made this trade from a loser to a winner. Hope this helps for Options 101
Chart of the Day – Gold Here is an excerpt of the The “A Game” Market Intelligence Report which came out Sunday evening: I initially wrote about the high probability bounce, within 3 points, in gold to end a precipitous fall here: http://northingtontrading.com/2011/12/30/gold%E2%80%99s-connecting-flight-it-just-landed/ Since then, Gold has rallied over 10% and has now reached a significant multi time framed level of resistance. Significant volume is also confirming large players are acting in concert at this level. This will be an important level to watch. The take-aways are:•The trend outlook is mixed and choppy•Multi time framed resistance is being tested oThis will be very bullish and serve as support if broken.•Trend compensated momentum is neither extremely overbought nor oversold•If this MTF level holds, you could see significant more downsideoFirst down to 1600 which is volatility-based support (daily), then down to 1500 which is transactional and volatility based support (weekly). This is interesting because it would have direct effects on many other markets, including ours, just as in the case of the USD scenario aboveTo find out more about The A Game Trading Letter click here http://metaswing.com/site/a-game-trade-letter/