For Directional traders

update for the week ending 8/12/2005:

i'm down about $80 from last friday's closing prices. considering all the whipsaw movements i saw this whole week, i'm happy to just end the week almost flat!

position updates (bid prices used):

DWA Dec 30 calls - doctor, we have a heartbeat! still down $980 on risk capital of $1820 but it's ok for now. stock movement has gone to positive for now.

KSS Jan 50 puts - closed-out. see mini-update. i think KSS is too strong a stock. it's got too many long-time shorts that have been caught and they are providing support for the stock. i'll revisit KSS puts later when the stock has broken down.

NFLX Dec 22.5 calls - closed-out yesterday for a profit of $675 (minus comm.) that's the good news. the bad news is i could have gotten an extra $750 for it if i waited until end of day, today. this position was based on 2 criteria, stock fundamentals and market opinion. one is no longer valid (market view) and it was time to close it. i should have waited today, though, because today marks the 2nd friday that nasdaq has closed lower than previous week's close. oh well...

AMZN Jan 40 puts - up $75 on risk capital of $2400. same reason for the position as the closed-out position on NFLX. bearish on the stock fundamentals and bearish on the market (for the short term). will close-out the position if significant news comes out on the underlying or market changes direction (imo).

only 2 positions for now: DWA calls and AMZN puts. next week is expiration week and time for my expiration-week option play. if goog (or another highly-volatile stock) is up significantly on monday and tuesday morning, then i'll open a small put-position around 9AM PDT tuesday. and vice versa (calls if down, blah...)

i have a really bearish view of the markets for the short term. if everything's still the same after expiration week next week, i'm gonna double-up on my AMZN puts and/or open another put-position.

Good Trading to everyone...
 
Well, i tried but i just can't do it...buy straight calls and puts...too impatient, too freaky about the effects of leverage when the position moves a point against you. this morning I bought RIMM Sept 70 calls for 2.65, watched it chop around with the rest of the market, and...finally, I couldn't resist, and sold the Aug 70s against them for .85. Ahhh, it felt like a jumping into a crustal clear lake on a hot summer day. I have no idea what RIMM will do next week -- go to the moon, plummet to the basement, chop around aimlessly for a week of opex games -- but with a potential cost basis on the September 70s of 1.80, I can sleep tight for the weekend, at least.

I guess when it comes right down to it, I'm just not a directional trader. too bad, 'cause i really wanted to be one
 
Quote from eagerbeaver:

Well, i tried but i just can't do it...buy straight calls and puts...too impatient, too freaky about the effects of leverage when the position moves a point against you. this morning I bought RIMM Sept 70 calls for 2.65, watched it chop around with the rest of the market, and...finally, I couldn't resist, and sold the Aug 70s against them for .85. Ahhh, it felt like a jumping into a crustal clear lake on a hot summer day. I have no idea what RIMM will do next week -- go to the moon, plummet to the basement, chop around aimlessly for a week of opex games -- but with a potential cost basis on the September 70s of 1.80, I can sleep tight for the weekend, at least.

I guess when it comes right down to it, I'm just not a directional trader. too bad, 'cause i really wanted to be one
More...

Interesting. Could you elaborate in theory what should happen next week?
If the stock stays flat you sell the Septs back and keep the income of the sale ?

What would your stop loss be on the long calls, in case the stock falls next week ?

Wouldn't buying the September 65 @5.70 with a real cost basis of $ 1.70, then selling the Aug 70 against them be a better deal ? (1.70 - 0.85= 0.85)

At present your calls are OTM $ 1.00 plus $1.80 costs basis = $ 2.80

The way I mention your cost basis would be approx $0.85

Please fell free to correct me, I am only getting into the "selling of options" I have always been a purchaser.

Thanks.
 
I guess it's all about how you want to play it -- do you have convictions as to direction, or not? For example, if you bought the sept 65s for, say 5.80 and sold the aug 70s for, say, .80 your cost basis would be higher (which would be $5.00, I believe -- I'm not sure I'm following on your numbers there) but your upside risk would be eliminated, as the delta of your long call will, for the most part, be higher than the delta of your short call, until such a point as both your long and short are so deep in the money that their deltas are zero, in which case there's no time premium left in the option, in which case you're just left with intrinsic value, which means your long will always be worth than your short as it is deeper in the money (of course, there would be the risk of your short being exercised, but that's a different story...)

On the other hand, the downside risk is increased, for the very same reason -- the delta of your long is much greater than that fo your short (until, of course, the extreme case, where the underlying crashes to near-nothingness, in which case the deltas of both would approach zero). Which means your long strike will lose value faster than your short strike, which means your spread will lose its value more quickly than....

Well, then a "neutral" spread, where longs and shorts are at the same strike, such as the one I legged into today on RIMM. As for what I plan to do with this spread...yes, you're right, assuming the august's expire worthless, I can then sell the septembers, or I can use the septembers as the basis for a new spread...a bearish or bullish vertical, for example, if I care to call a direction, after all is said and done. If, for example, Rimm closes next exp. Friday at exactly where it is today (it won't, of course, but for the purposes of this discussion, let's pretend....) my sept. 70 calls will be worth approx. 2.50 (assuming other factors, esp. i.v., remain the same, which they won't, but, again, let's just go with it for now...). If I thought RIMM was coiling to rise, I could then sell the sept. 75s for 1.00. Since my cost basis on the Sept. 70s is 1.80 and I'm selling the 75s for about a buck, my cost on this spread would be .80 cents, and my potential profit would be 5.00 - .80 = 4.20. In other words, I'd be risking eight cents to make $4.20. Not bad. Similar logic applies to a bear call spread. Or I could ratio the thing, blah-blah-blah, the fun never stops!

And, speaking of stops...my stop here is a little different than what it might normally be for a calender as I legged into the spread at such favorable prices (I would never have been able to open this spread for $1.80 in one swoop). Basically, I'll close the spread the moment the mid hits $1.80 (at today's close the mid was $2.00) With time decay really kicking in for the short strike during the final week, this stop isn't quite as tight as it seems, and provides reasonable cushion against moderate oscillations. Beyond that, my breakeven points at expiration are 67.52 on the bottom and 73 (approx.) on top.

Having said all this, I should add that this is a pretty lousy calender spread. Why? Two reasons. One, my long call IV is substantially greater than that of my short (37 vs. 31 percent) and negative IV skew is not a desireable thing when you're looking to buy cheap and sell dear. And, two, the current IV for both strikes (but especially my long strike) is substantially higher than RIMM's H.V. (100 day average was at about 21 today). Yuck. The problem is that I run the risk of IV regression to the mean sucking the premium out of my long strike (a bigger risk for slightly OTM strikes, like my 70). The only reason I don't feel like a chump for being in this stupid spread is that I lucked into a very favorable leg-in, at prices that provide some insulation IV vagaries, and during expiration week to boot, when rapid time decay can cover any number of sins...

Remember, I didn't get into this calender by design but by default. I'd bought the Sept 70s naked, felt buyer's remorse, and wondered what I could do to extinguish the gnawing regret I felt for entering the trade. The juicy premiums for the Aug 70s were too tempting to resist, under the circumstances.

If Rimm rockets next week, obviously, this will have rurned out to be a none-too-swift move. But, really, I don't care. I turned what I felt were lemons into...well, a calender spread with a lousy IV skew but a very decent chance of turning a nice profit -- in other words, I turned a high-risk, high-reward position that left me feeling queasy into a low-risk, moderate-to-high reward position that permits me to have a happy weekend watching my kid play Little League. All-in-all, I'm content with the trade-off.
 
...or i could have just closed the damn long call in the first place..

Palawan, how do you do it? How do you stomach the 50 % drawndowns in your position, all the while knowing that time decay is slowly gnawing at your equity? What kind of money management do you use? How do you determine stops, both in terms of price and time?

I am genuinely curious as I like the idea of buying straight options -- it's clean and uncomplicated and, as I've said before, with premiums so low, it is, in some respects, the contrarian play -- but I have yet to figure out a way of doing it that comports with my psychological profile.
 
Eagerbeaver:

Thank you for your clear explanation reg this trade.

It's funny how our own individual personalities affect the way we trade.

From your point of view it makes complete sense to do what you did. You make money as long as the stock stays flat or goes up a little.

As a directional trader we only make money if the stock moves up in a short period of time. Sellling options into a long position even though caping your profits is a very sensible approach.

In my replly earlier I meant the cost of the Sept 65 @ 1.70 because the option has $4 intrinsic val.

I am reading Natenbergs book, hoping to see the light. Will I change my perspective? I don't know. But this cal spreads make a lot of sense.

Thank you again for your input.

Good luck to you !
 
Yes, first law of trading, as in life, know thyself.

And good luck to you, too. Hey, I'd love to hear your take on my questions to Palawan, as well, if you're up for it...
 
Quote from eagerbeaver:


Palawan, how do you do it? How do you stomach the 50 % drawndowns in your position, all the while knowing that time decay is slowly gnawing at your equity? What kind of money management do you use? How do you determine stops, both in terms of price and time?
More...

very easy, actually... years of experience.... of blowing-up the account :D seriously speaking, though, i've had some very nice gains over the years, and i've had some... well, let's just say, the past years have always ended up with a loss that i claimed on my taxes :) at this point, my psychological profile is able to handle paper losses and paper profits at bay and to follow through with my trading plan. money-management is what i rely on the most, now. my plays have been on the conservative side (eventhough they don't look like it to everyone else) as i'm trying to not to blow up the account and end the year on a positive for once.

to me, what i'm doing is safer than buying or shorting the underlying outright. this is true if i can stick to plays that involve 4 months or longer options. not always the case, but i'm aware that when i go for shorter-term options, i am taking on much more risk and i usually think in my mind that the rewards would be worth it.

let me see if i got this right:

call = long the stock + put
put = short the stock + call

let's analyze my play on AMZN Jan 40 puts:

The only thing I'm concerned the most is my delta. It says delta is -.26 which on 15 contracts translates to being short 390 shares.

If I was shorting 390 shares of AMZN, i don't think i can sleep at night. the beauty of options is that the more it gets ITM, the more delta i have. it's kinda like the more i'm right, i'm adding to the position. the more i'm wrong, the delta gets lower and my rate of loss lessens. IV is of course something that can change all that, but since AMZN already reported earnings....

well, someone who's long the stock or short the stock will argue that when the position goes agains them, they can hold on. with straight out options, if i'm wrong, fine, i have an automatic stoploss that will kick-in when the premiums are lost and the options have expired. all the while, i have 4 months to sell it for a loss or gain.

the bottom line to my strategy is that i'm a speculator and not an investor. i'm happy to have the time limits imposed by options coz i only plan to hold for a short time.

for now, i'm comfortable with my strategy and the consequences... i don't necessarily recommend it to anyone else, because as you've noted, those swings are a b*tch.

Good Trading...
 
Palawan, looking at the charts, NFLX looks good for some more, KSS looks like it's just cresting another one of its characteristic cup patterns, but, just coming off E.R., who knows?

You've made some good calls, good trading.

How do you arrive at an assessment of a stock's direction? All I have is Yahoo Finance and I don't know how to interpret the right data. Are you bullish when P/E rises and stock price has been declining? Where do you find guidance - I see it mentioned often?

What does it imply to sell a call or put outright? Is one liable to sell stock for the former and buy stock for the latter, at a certain time? And what happens if I let my calls expire ITM? Do they get exercized, or sold at market?

Such green questions...
 
Quote from Rob on Business:

Palawan, looking at the charts, NFLX looks good for some more, KSS looks like it's just cresting another one of its characteristic cup patterns, but, just coming off E.R., who knows?

You've made some good calls, good trading.

How do you arrive at an assessment of a stock's direction? All I have is Yahoo Finance and I don't know how to interpret the right data. Are you bullish when P/E rises and stock price has been declining? Where do you find guidance - I see it mentioned often?

What does it imply to sell a call or put outright? Is one liable to sell stock for the former and buy stock for the latter, at a certain time? And what happens if I let my calls expire ITM? Do they get exercized, or sold at market?

Such green questions...
More...

i'm not done with NFLX... it's just at this time, i'm quite bearish on the markets and even if NFLX goes up, i think it'll be an uphill battle. maybe later when my opinion of the markets change.

each stock, each position is different. i try to have multiple reasons before going in, and sometimes i'm right and sometimes i'm wrong.

i don't give that much importance to PE, as much as the other stuff. free cash flow, market cap, quarter over quarter growth, year over year growth, debt, cash, institutional buying/selling, stock's price in relation to the trading range of the past month, significant news, upcoming news/catalyst (EA, FDA decision, etc.). almost all of the info, you can get from yahoo finance (if they're accurate) and inst buying/selling at nasdaq.com when all is said and done, you just KNOW whether you're gonna buy calls or puts. how you handle that position after you've put it is the hardes thing. one day or one week, you could be up so much, and the next thing you know, you've given up all gains and then some. and then you start rationalizing that it's not that you're wrong, it's just the market was going down (or going up if you're holding puts). that's when you have to step back and analyze. sometimes, holding on is the right thing to do.

those last questions indicate that you need to read up some more, Rob. options are hard enough even when you know a lot. they're even harder if you don't know the fundamentals.

when you sell a call/put, you're giving the "right" for someone to buy/sell the stock at a specific price within a specific time.

say you sell a 40 call on xyz and the stock is 45 at expiration. the owner will exercise because it's in the money and the stock can be turned around and sold for a $500 gain. since you were the one that sold the call, you have to sell 100 shares of xyz for 40/share. if you don't own the shares, you have to buy it or be short 100 shares at 40. that's the risk you took when you collected the premium at the time you sold the call. reverse all that for the put.

how are you doing with your options? you really should play longer-term options... with longer term options, you'll find out that many times, your position will be positive at some point in time. whether you cash out when the position is positive is another story.

Good Luck...
 
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