Spy going forward.

Chart:

The latest arrows are the current strikes for minimum target spreads for me now. Note that the price is in the middle of the current linear regression channel. had the price been near the top, about $2.50 higher, the best strike may have moved up 2 or 3 points to match. That puts me at the prime point to enter a call spread... 119, 120 would feel a whole lot better to me.

Same deal with the puts, more or less. given a price drop to the lower side of the channel I might expect the premiums to jump to place my minimum target strike another $1 lower... just due to the relationship between increases in volatility as the market drops and the premium on put options.

I have two trades expiring Friday and these may free up some capital for me to place trades next week so I have to wait, but I would have waited anyway.

I did February expiry's out of curiosity. Calls would be 119 and puts at 106...not the best even though the puts are well outside of the technical resistance. The call certainly are not.

Jeff

"...but I digress"

I scanned through a few blogs and found one that looked interesting and that was supposed to follow this guy on his journey to get rich through investing. I read the post from March 25, 2007 that outlined initial purchases and the plan going forward was to include some sort of DCA strategy to enter into a few index ETFs. Buy and hold.

The blog petered out as the market dropped out. March 07 was near the peak...there was no index money to be made past that point, in any long term long only method. Market euphoria was still firmly in place and everyone and their dog thought they could make money in the market.

Rather than chronicling his utter failure and attempting to plan an alternate strategy he must have considered the failure as a sign that he should not attempt to dabble in the market at all.

This is typical of the majority of traders, according to the 90% plus that fail at trading, no secondary plan, no diversity in strategies and no wider vision. Jump in, lose and jump out.

I was starting my journey late in 2007 and cashed out all of my mutual funds in December and January. Nicely timed even if it was not designed to capture the peak... but I am not trying to blow my own horn here, but my timing was bang on if only because I recognized that shorter term trading with no or lower MER products was more likely to work out. I was just looking at things at the right time.

A few days ago I talked to a fellow about trading and investing, he was the investing sort. Through the drop he lost, on paper, the typical 30% of his portfolio. His portfolio has returned to an 8% loss to date. Not too shabby of a return, given the circumstances. The trouble I would have is that, in his case, this was his retirement plan. He has had to move hie retirement plan back a number of years.

Jeff.

Timelines and cashflow

I was putting in a bit of time while making sure that all was clear at work for the Holiday and I let my mind wander. The title does not tie two related topics together but addresses two important ones for me.... and neither should be long enough that I feel compelled to create two posts.

First, a comment by a professional trader who is starting to get in to the teaching side of the game. Fellow by the name of Ray Barros. Unlike a lot of the teachers he is looking at teaching his methods and providing insight into one of his chosen indicators as well as one that he had developed. He is successfully managing client's accounts as well as his own trading account and has been trading since 1990 or so.

The comment was that it took him 10 years to become consistently profitable.

Ouch!

I should ask him what that meant for him to quantify the idea of "consistently profitable".

Any of us that seek to become consistently profitable in any short order need to take pause and consider this. Now, I will admit that it may be easier now than it was then with the proliferation of online information, online brokerages and easier direct access to markets but still, 10 years. Don't be in a hurry to quit the day job.

My goal is to be able to rely solely upon trading and investment income as soon as possible... whether I do or not is beside the point. The "as soon as" is a fluid concept even though I have targets and goals. Some of those just have not worked out exactly as I would have liked for a number of reasons, and not all do to missed profitability. The need to continue to hold down a real job has shifted my idea of the timeline for both attaining my primary goal and shifted me into a less time consuming method of managing trades.

Basically I determined that I cannot day trade my way to wealth.

Now, the cashflow issue... I keep re-working my spreadsheets for call and put spreads to include certain target levels and I am finding that they shift easily depending upon the position size. Due to my small capital base the commission makes more of a difference on the bottom line that I would like. If I consider $10 per day based on a $5,000 trade size an acceptable Return On Risk then I can scale that accordingly as long as I leave in the commission factor as it varies with position sizing.

0.2% per day of the trade net commissions. Setting up a sheet to represent this over various timeframes and credit amounts was easy enough, if a bit tedious. I left out commissions but used the risk as if there were no credit applied due to the trade execution...it gets me very close. The rest I work out on the call / put check sheet where I put the bid asks over the OTM option chains.

Rather than get into the particulars, this means that no matter the size of the trade 0.2% ROR after commissions will always yield $10 for every $5000 of gross risk. A 6 contract trade on a $1 spread will need a slightly higher credit off the start than a 25 contract trade with a $2 spread but either will yield my target considering the combined concurrent trades.

Jeff.

Optioneer / Strikepoint Trade Expiry

I forgot to mention that I had my first Optioneer / Strikepoint trade expire on Friday past. I could have closed it a day or two early and still made the full target but decided to just let it expire.

ROR = 8.62%
Annualized = 98.38%

ROI for the entire account even considering my latest deposit is 18.5% annualized... that is one trade of the five trade capability. 5 trades x 18.5% = 92.5% without factoring in compounding. Every 13 trades I can add one more, roughly.

Just spinning the numbers.

Jeff.

S&P 500 SPY spreads vs scaled trades.

I got lazy and just used the same chart here.

Last post I mentioned diversification in trade type, price levels and timeframes. It reminded me that I could scale into a trade to try to effect some sort of similar idea, not really DCAing as I am looking to grow a core position by adding to it at key times.

I can make a general assumption that the spreads were all profitable, as they all would have been based on the price moves and trade entry points.

In order to fudge against me I will use my minimum $2.40 per day yield based on a $1200 risk trade. Even though I already see that a SPY spread even at today's low VIX numbers can be much higher than that I would choose the safe trade as $2.40 per day lets me run the spread strike farther away from the price. This is 0.2% per day ROR or 6% ROR based on a 30 day trade.

So a quick 22 trades at 30 days per trade calculation leaves 660 trade days at $2.40 is $1584. I would want to optimize my trading to allow for certain overlaps depending upon my capital so I might run $2400 trades here and there. Regardless, this is for a comparison only anyway.

At most, four overlapping trades which uses up my $5000 base. That is a 31.7% return on the account base and I can add one more trade capability into the mix to start the compounding effect.

Scaling into this through purchasing shares directly in SPY in 10 share chunks. Buy at the good bottoms and hold through the top.

Buy at $70, $80, $90, $90, $100 and 6 shares at $104. Average cost is $87.93 for 56 shares. Current price is about $110 so $22.07 per share gain for $1236....if sold now. With a tight stop during this uncertain period it might get sold... maybe not. I can only make money as the price goes up and can only compound if I sell and catch a drop...if the drop reverses when I think it ought.

Meanwhile I am trading spreads and seeing profits while the price wallows each month as expiry dates pass. This way there is a cashflow. Buying and holding has no cashflow...although there is a slight tax advantage when it comes to capital gains

Jeff.

Closing more long calls and the going forward TFSA plan

I closed another long call today for somewhere near a 110% gain. I took it out based on an early morning surge in the underlying price that seemed to peak. I had decided to take any 100% gains this week and close others on strength if they were profitable as the week progressed. So this is a little bonus...particularly after Friday's expiration as four positions closed for 100% losses.

Overall, I am 22 winners out of 36 losers which is not a bad win rate, 61%, and I am still profitable. It just is not good enough to continue paying for a service for that kind of rate. Particularly as I will have more 100% losers come January expiration I expect. My overall rate of return is between 12 and 13% and that is for a period of about 3 months.

The trouble with the win rate is that a loser is likely to be a 100% loser which means a winner must always be a 100% gainer, and they are not all that at all.

I will be removing any extra cash from my TFSA this week as it will free up TFSA contribution room for next year. If I wait until January it will not. This allows me to add to my spread trading account which I would rather be working for a far more secure return without relying on any services to provide entry and exit guidance.

The grand plan is to run a sector rotation style trade setup out of the TFSA using ETFs for long and inverse ETFs for short plays against the respective sectors. While I am saving some cash for this I will likely run a live paper trading model to see how it works in "close to real life". I will look at switching back to Canadian ETFs in order to lower my trading costs in the account, even though I know I cannot set stop loss orders... I may find that access to the same information is not readily available for what I am looking for though and the TSX makes poor proxy for NYSE indices and securities.

Jeff.

The Other Side of Diversity

I have read tons about having a diverse portfolio and I always wondered exactly what it would take to be diversified appropriately. I have never seen a clear and concise answer, nor have I ever come up with one myself.

Earlier I alluded to over diversification being a bad thing, at least stifling gains and possibly even creating it's own series of loss factors. I consider diversity to be a form of insurance, insurance is a cost. Rather than belabour the negative side I am looking at a positive way to diversify ...not in the typical sense.

In the interest of being accurate I figured I would pull a dictionary definition for diversity and found that there are many variations of the use of the word and it's derivatives. These from thefreedictionary.com

The definition that seems to apply to the typical idea of diversity as it applies to the stock market and investing or trading might be:

"the quality of being diverse and not comparable in kind"

This leads to buying different stocks within a sector to provide a moderating effect and in different sectors to provide a hedge or safety with a varied and dissimilar portfolio. Key words that I don't much like here are "moderating", "hedge" and "safety".

The one that I found to more accurately represent my idea was not even a primary definition:

"The relation that holds between two entities when and only when they are not identical; the property of being numerically distinct".

This idea very seldom gets any screen time with the exception of the use of Dollar Cost Averaging (DCA) which is really a form of price diversification... buying a stock at numerically distinct prices to provide diversity within the same security.

The trouble with DCAing is that all trades become one trade as it averages the initial cost of the position. This makes the position still susceptible to volatility losses even if the DCA was lower on each successive trade. The other issue is that exiting the position in a profit provides a gain but buying back into the same position requires close to the same dollar figure unless timing is done well...which DCAing is supposed to eliminate. That makes this a buy and hold strategy only.

Here is a chart of SPY for the last 10 or so months:The red arrows indicate rough areas to sell spreads and the green lines are rough levels and duration to sell spreads. The indicator on the bottom is an ADX oscillator and has no real bearing on what I am doing here...yet. The black lines are trend lines that would have been established along the way. I would have had linear regression lines serving this purpose day by day.

The call spread strikes are 90, 95, 99, 102, 105, 107, 110,114, 117, 116

The put strikes are 73, 76, 83, 84, 85, 84, 83, 91, 94, 95, 96, 102

First, diversity by trade type. I run call spreads to bracket the upside and put spreads to bracket the down side. In this case no matter which way the SPX goes at least one direction of the trades will profit. Technically this does not make a true iron condor but it amounts tot he same thing, just with a greater yield due to the optimized entries.

Second, diversity by price level. The calls are all distinctly different even if only my a dollar or two. The puts tended to hover in the middle as the price moved sideways a bit. I expect that I could have gone wider as the put premiums likely headed up a bit due to the uncertainty as to the market direction. Some calls could have been put on along this point as well and given my thinking at the time I would have done so... I was bear minded.

Third, diversity by timeframes. All of the trades are of a short duration and due to that they will be staggered, overlapped and just expiring on 3rd Friday's and end of months depending upon when the price sets up. Longer term trades may be taken if the $2.40 target can be met and there is not too much volatility in the market. There is not one single trade for the whole duration or even a scaled in or scaled out trade. Many multiple profit takings.

Jeff.

Specialization, Diversification, Yield and Perspective

For anyone reading, keep in mind that the purpose of this blog is more for my own "thinking out loud" so some of what I write is repetitive or obvious or just dribble. This may ramble about as I mush out some thoughts and direction.

I updated my sector performance chart.

Comparing it to the Dec 11th one

The same sectors are under performing and over performing against the S&P500, but this is only 5 trading days later.

I am finding that this is giving a good relative performance indication and I could likely run trades based on this, buy the over performers and short or buy inverse ETFs on the under performers in line with the overall market trend. The trouble is trying to use this for spreads on the ETFs. There is not much to capture in the difference in option premium vs the spread size or risk. I mentioned just plunking my cash into Optioneer as they are able to see trades that average in the 8-10% Return On Risk whereas I am starting to see perhaps 4-5% ROR. I thought that perhaps it had to do with Optioneer using iron condors, taking both the call and put side simultaneously but I determined that doing so would only serve to reduce the ROR as call and put premiums vary depending upon the price point of entry (top of the trend channel is best for calls and bottom for puts). Legging would be best but still yields are small.

Of course there are the largest considerations:

Specialization
Diversification
Yield
Perspective

I actually went looking for dividend stocks today out of curiosity, I wanted to get something to stick in the TFSA to be left to grow until I remembered that yields are in the 5-10% for good dividends...per year. Here I am worrying about losing a few percentage points per MONTH.

That looks after the perspective issue for me.

Specialization is easy enough to consider as being able to trade one stock profitably is a good thing, if it can be done relatively consistently.

Diversification is easy as well. trading one stock sounds like putting everything in one basket until I consider that trading the SPY which is tried to the S&P500...500 stocks altogether. It doesn't get much more diversified than that, which provides another interesting problem.

Yield, well, the yield will be the yield and will beat all dividend producers even over the long haul if I just manage to double them, let alone possibly stepping up returns by an entire order of magnitude.

OK, so trading one ETF is diversity but if it is SPY then it can be OVER DIVERSIFIED...huh?

Sure. Trading one over or under-performing sector allows diversity when using ETFs but allows exceptional performance due to specialization. This is the key why SPY can return a better yield in spread trading than most sector ETFs...because it is over-diversified as it represents ALL sectors it cannot help but perform in a rather mediocre style. Just look at the above charts and see that the SPX is consistently ranked 5, 6 or 7 in all categories.

This is the hallmark of a great vehicle to trade a method that works best with relatively non-volatile securities. This allows wider margins and tighter spreads to both give a lesser risk profile over all while still providing a decent yield. Finding the right security to match a preferred method of trading is like curve fitting... but even that has it's advantages.

Next up... diversity through S&P500 price levels.

Jeff.

Reviewing the stock option spread trade issue

I mentioned being a little disappointed in one of the first stock option trades that I placed last week. While that is true I figured that I shouldn't discount the whole idea based on one potential loser. It may have been a fluke with the options expiration as I mentioned so I should maybe consider that entering such a trade immediately before options expiration might not be a great plan.

I did some checking on one other stock that has a deep option chain and is very liquid, AAPL. While I have not doen a sector study to determine if the sector is in the right point relative to other sectors I think that AAPL is one of the drivers of the tech sector.

The interesting thing about the AAPL options is that the price is at $195ish, all of the OTM calls are in $10 strike increments and the ITM puts are of the same denominations. A put credit spread has some money to play with while the call credit spread do not. Indicative of the volatility and higher potential for the stock to drop fast I suppose, which is why put spreads can be more lucrative and more risky.

Running a put spread at 170 strike with 165 as protection runs the best payback but the yield is lower than I would prefer, 4.6%. This would be where I would need to decide upon a cashflow and not be concerned with the yield so much.

Risk wise AAPL has not dropped $25 in 25 days if traded off the low side of the linear regressions or trend channels except in a few cases during the meltdown. Of course that doesn't mean that it won't do just that before Jan 15th this time.

The thing about cashflow and yield is that I would be better off taking my $5,000 and sending it to Strikepoint as I can see a 8-10% yield per trade if I cannot do at least as good as that. I think I will still go back to sector ETFs and see what I can stir up again. I have SPY and XLE on the go right now. I need to update my sector performance table now and see what I see.

I would like to be posting charts and studies now but there is not much of that with a premium selling strategy unless it is run with tight strikes that make more use of support, resistance and trends based on technical chart analysis.

First few days off the board of a spread trade

Those first few days in a spread trade are the worst as it is hard to see through the initial loss to the far side, particularly in a full iron condor.

A regular spread has a built in immediate paper loss. Selling one option at the bid and buying the other at the ask puts both the bid/ask and ask/bid spread in the road on top of the commission costs.

ie, selling a close call at 50 cents and buying a long call at 20 cents looks like a 30 cent credit, but that is not correct. The close call might be quoted at 50 bid and 55 ask and the long call might be at 15 bid and 20 ask. if I turned around and closed the trade immediately after opening it I would be buying back may short call for 55 cents, 5 cent loss and selling the long for 15 cents. A total of 10 cents lost. over a 6 contract trade that is $60, plus commissions.

Then is the initial move. If it moves towards the spread strike both options appreciate, the close call faster than the long call creating an imbalanced loss just like having it move away would create an imbalanced gain...the whole idea of a spread.

Taking the initial bid/ask spread loss and commissions out of mind for a moment it is easy to realise that none of this matters one little bit as long as the stock or ETF price does not hit the inside short call. The commissions will always be a loss but the initial difference in the sale and purchase prices are all that matters if the options all expire outside of the spread.

Jeff.

Stock Option Credit Spreads

I am not liking the stock option credit spreads very much right now.

I knew that stocks can be more volatile than an index any day and more sensitive to news fluctuations AND move in ways that are totally inexplicable at times... so why did I think they could work out exactly?

Well, they can. I just need to work on it a bit.

I took two trades based on a service recommendation due to it being suggested to sell a put against a long call. A rather bullish sentiment trade for certain. I placed my credit put spread $2 lower on the chain than the recommended put figuring that at that point it still meets my target and exceeds their suggested lowest possible price.

The price is within striking distance now. I started out being almost 11% lower than the price and today, after three days, I am within 4%. This trade will expire on Jan 15th, a time to go yet. Considering that the recommended expiry was March or so...

Well, I should know by now that forecasts are not necessarily right, or even close sometimes. That is why I set up trades that look good to me. Rather than going in blind I was planning on using the recommendation as a suggested trade idea. I did a few "just place the trade as recommended" for long options trades and have found that to not work out so well. It is partly due to a possible shift in market trend but if I am paying for a service I would expect it to accommodate that shift and at least not lose lots of money.

Speaking of losses I have a number of options expiring today...I will need to go in and calculate those into my P&L over the weekend.

Anyway, total risk is only $540 if the trade goes 100% against me and runs down the protection put. I could close the short put and cash in on any gains in the long put but I always run the risk of second guessing my trade as if the stock does take back off I can compound my losses easily enough. Perhaps today is just a shakedown due to this being the dreaded "Quadruple Witching Day" with all options expiry's happening today.

I will probably drop the stock option idea altogether for a while and concentrate on sector ETFs as I can. That makes life easier. If it does not work out as well as I anticipate then I can always just chuck the capital into Optioneer to add a trade or two capacity.

On the other hand, Optioneer trades are sitting easy. Wider margins here.

Jeff.

Quiet day

Today was a quiet day for trading for me. Having one account entirely committed is good and saves farting about with some of the complications involved in the discount brokerage positions...although I did take some small profits on a long position this afternoon.I decided t start closing out some of these on relative strength, the shorter expiry options anyway. I am disappointed in the overall performance of the option advisory service that I stuck with lately, the one I decided to drop.

I started looking at the older trades that these fellows setup to see if trading spreads would have been a better strategy to use. Being that I cannot sell options in the TFSA or RRSP account I was tied to covered calls only or long option positions... that ties my hands more than I realized while trying to use someone else's plan. When they were creating credit trades by buying long calls and selling naked puts for profit I could only buy the calls... without the credit of the puts I was hobbled off the bat and many trades are expiring or being closed with a 5 cent profit...with the naked put. That puts me in the red more often than not in those cases.

I am now investigating the possibility of having had placed spread trades on the same securities at the same times as their recommendations. Rather than getting fancy I will be using current option chains to see if there is enough yield now and extrapolate that into past performance. It is rough but as long as the stock price remained ahead of the strike for the duration of the trade to inside month expiry and I apply the $10 per day per $5000 (0.2% daily ROR) I can get a sense of the value of perhaps continuing the service going forward.

In cases where a solo naked put was recommended I might just place a bull put credit spread. Other times when the put was sold to cover the cost of the long call I might trade a bull put credit spread in a large enough ratio to pay for the long call up to a maximum risk level. The odd time a spread that I can trade comes up or an iron condor. I think I may find that 1/3 to 1/2 may have been workable as many do not have great chains with depth.

Looking at some of the trades that they took it looks like this may have been a promising venture... only I am starting late. I'll think on this over the weekend and see what I come up with.

I have an Optioneer trade expiring Friday, nice to see the spreads expiring, another on the 30th with them and two SPY spreads as well.

Jeff.

All in... once again

Well, I have filled my account with credit spreads now. I threw in two stocks that pulled back sharply on news and placed put spreads well under the resistance levels. These are smaller trades, 2 and 3 contracts but still pretty lucrative overall. I may investigate this sort of trade closer as well. As much as stocks can be more volatile than the sector ETFs this volatility can be made to work in my favour. Trading immediately after a sharp move takes advantage of a bump in the premiums and allows me to use a much farther strike and therefore create a less risky spread.

My effective yield of the account overall is exactly 10% should all positions expire. Considering that the longest trade was for 33 days, if I can keep the averages up and I have no losing trades that should work out well.

I may send my Optioneer money for January into this account instead as this is much more fun and, so far as the numbers look right now, at least as profitable. I can always take this money back out and send it along should I desire to do so afterwards.

I think that optimizing credit spreads is an overall fixed income machine as there are no huge single payoffs, just regular plodding along to take advantage of yields.

The best part...or maybe not for someone like me who likes to play... is that there is nothing to do until Dec 31st when two of my trades expire freeing up an increased buying power. My SPY iron condor expires then. The rest of my positions expire Jan 15th.

My SPY spreads are actually degrading quite nicely. The long options have lost the majority of their value which reduces the value of my positions BUT the short options are outlosing them by a healthy margin which is securing profits.

Jeff.

Quote spreads and slippage

I was looking at the cost of trading spreads this morning as I lamented the loss of the quote spreads. On today's trade there was 4 cents left due to the bid ask spreads on both the buy and sell legs of the spread order I placed.

$16 for the entire trade.

Well, so what?

When I buy at the ask and sell at the bid and if I have to turn around and close the trade by selling my long option at the bid and buying the short at the ask, I double this cost of trading.

Considering that the commissions are $17.95 for the 4 contract spread, the opening bid ask spread is $16, should I close the trade another $17.95 and another $16 for the bid ask spread again...that makes $67.90 to open and close the trade in direct and indirect losses.

That certainly needs to be considered in the mix when it comes time to think about how to close. Letting the trade expire is obviously the best most cost effective method as it cuts this cost in half but is not always going to be an option.

Considering that the total possible loss of a spread trade is much higher than the value of the trade by about one order of magnitude taking this additional cost is a small price to pay to exit a potentially losing trade.

This is why I am concerned with the space I allow between the stock price and the spread strike. The more space that still allows me to see my minimum profit target, the better.

Jeff.

XLE Put Credit Spread

I placed the put spread in XLE as I mentioned earlier. Seeing as the S&P 500 opened higher and XLE also opened higher (pre-market trading made this easy to notice) I went with the lower credit spread of 25 cents or better.

Sell to open 4 Jan 52 strike puts, XLE MZ
Buy to open 4 Jan 49 strike puts, XBT MW

They opened today giving me about 26 cents...but I haven't seen any trades executed so I am not sure what is up. I think that my order didn't get placed immediately so may be stuck in line somewhere. 26 cents seems to be holding so I should see a fill.

There we go, 0943h sold for 50 cents and bought for 22 cents for a 28 cent credit. The worst is it looks like I could have held out for 30 cents and got that also...not to get greedy though.

Aim for the targets.

Daily return is $2.85 for an total 8.5% ROR.

So far my average daily return is $3.27, higher than my $2.40 target but that first tight trade is at $4.06 which skews the result due to the small sample so far.

3 active trades, two expiring Dec 30 and one Jan 15. I'll be watching for a fourth and lining up two replacements in the new year to keep things rolling along.

Jeff.

Selling Premiums vs Buying for Gains

In my last post I mentioned a bit about sector rotation, among other things, and it got me to thinking some more about relative sector performance among themselves and against the market in general.

Sticking with the S&P 500 as the index and the ten basic sectors.

Trading ETFs or stocks to take advantage of outperforming sectors was where I was headed with the Bullish Percent Index charts... trying to determine when to get into a sector security and when to switch. The trouble came in when I realized that I was splitting my efforts between two conflicting ways of thinking about making money in the market.

Selling premiums and buying for gains are pretty much opposing in there ideology. This goes against my plan to specialize and get to know one method and to be able to execute that method very well. This has been my greatest downfall over the last two years as I see potential in one system only to see potential in an alternative idea... skipping about until something felt right.

Enough already.

Selling premiums is where I am at and I will not lose sight of that plan now.

So, back to topic at hand, sector performance vs market performance.

Two plans, two methods of study

First, a basic premise. The market can do one of three things in varying degrees of amplitude.

1) the market can go up

2) the market can go down

3) the market can go sideways

All three are subject to duration and amplitude or volatility.

Buying for gains requires a sector to outperform the market toward the bias of the trade, up for long and down for short. In order for a plan to also outperform that market money needs to be in play on that sector or group of sectors for most of the period of out performance. Of the three basic premises one must be chosen and be relatively correct to beat the market. This does not necessarily mean it is profitable, just better than the underlying index.

Of all of the factors direction, duration and amplitude, there are 12 possible combinations. For buying, getting 1 in three of the major ones right is necessary. Profitability is determined by amplitude and duration which, if the first premise is correct, still have a huge affect.

Exit strategies are important as well as stop loss protection. While trading ETFs the whole trade is at stake but it is unlikely to be all lost in one trade. Capital needed may be large as some ETFs are expensive.

Trading options can skew the results in my favour and reduce cost and exposure as a down move may not be as damaging to the account. Even so, options become more sensitive to the duration even with the correct direction.

Choosing one of the three possibilities when only two can produce gains without range trading, which is pernickity.

Selling for premiums does not require any particular sector to outperform the market. This saves making the first selection the most important one. Amplitude is a factor but can be mitigated by a decent exit plan.

Unlike typical buying, selling can be right for two of the three basic premises and even all three if the amplitude is small. Duration is not really a factor if time to option expiry is kept short. The only case that can be wrong is if the amplitude is large and faster than the term of the trade and even then profit can be managed later into the trade. I would have to be really wrong and right off the bat by a large margin to lose a lot of quickly.

Of the 12 combinations any with duration are eliminated due to the short time to expiry, basically the trades are short enough that duration does not affect the profitability. This cuts it down to 3 major premises, up down and sideways and one other factor, amplitude. Choosing a correct combination is made much easier as only 1 of the remaining 6 combinations will work against the trade. Wrong direction with a large amplitude.

It boils down to comparing two basic methods

1) Making a buying decision where being correct is a 2 in 6 and profitability and complexity are issues. Exit strategies are often more important than entry strategies.

2) Making a selling decision where being correct is 5 in 6, profitability is known beforehand and complexity is no longer an issue. Also, being wrong that 1 in 6 time does not necessarily mean a loss unless the amplitude of the move occurs very early in the trade and the exit strategy is to just let the trade expire normally...easy as pie.

While this is an overly simplistic way to look at the issue and there are other factors that can affect trading plans of any style, this covers the major ones.

Keeping it simple is the best plan in any case.

Jeff.

S&P 500 sector weighting and some other thoughts

In my wanderings on the internet I ran across the Stand and Poors website. I learned some interesting and unrelated stuff.

There is a www2 now as well as a www online. "Therewith" is also a word...I thought "therefore", "thereof" and "thereto" was about it. Does that mean that "therewithout" is also a word?...perhaps that is "not withstanding"?

Anyway. I also realized why the financials can make or break the market so easily.

Sector weighting as of Sept 30, 2007.
19.82% - Financials
16.18% - Infotech
11.68% - Energy
11.64% - Healthcare
11.51% - Industrials
9.52% - Consumer Staples
9.23% - Consumer Discretionary
3.75% - Telecom services
3.44% - Utilities
3.23% - Materials

The top 10 stock holdings make up 20% of the index as well. That leaves 80% to be divided up amoungst the rest of the 490 companies. Also, the top ten do not have a representative top ten company for each sector...Info Tech, Energy and Financials each have two...Utilities, Consumer Discretionary and Materials are not represented. Explains a lot.

Financials were lower by the end of 2007 to 17.64% and I didn't go looking right now for up to date numbers.

Just buying the SPY still leaves you open to market crunches even if individual sectors do not do as badly. It's fine to say that it has performed reasonable over the long term but what about having to get out after a severe rundown? Sometimes market timing is forced by circumstances not by choice. I wonder if there were no overall attempt at indexing would the market "crunch" have been as bad as it was? This index, and many other similar ones, seem to give the media something to be able spin.

The rest of this is not new, just sort of starting as if I hadn't looked at this stuff already...a fresh perspective looking for the edge that I know is there while preparing to setup my next trading plan with some better rules. Timeframes seem to have me locked in trying to predetermine trends. The BPI charts are locking me into a particular mindset and I am just breaking my latest thinking pattern of performance based on looking for sector gains.

Running a quick comparative performance chart over a rolling 1 year period results in ALWAYS one sector outperforming the 500, sometimes by a large margin of 50-60%, usually for longish periods of time, usually multiple sectors and in a few cases by all but perhaps one sector.

I studied sector rotation in the past but prediction was not as good as just riding an existing wave. Active management seemed to be the key but using a no-brainer approach to ETF selection and re-balancing amoung only the top two or three sectors is best for diversity, not necessarily performance.

The things that I do not study are the various existing methods of trying to take advantage of any of these trends as I prefer to play with this stuff myself...part of the fun and part of the fully understanding of how best to take advantage of the information that is available out there. Pre-boxed plans may work but when they don't there is a vacuum of knowledge. Not a good plan in my books. Besides, I have tried a number and they just didn't really cut it.

Due to my plan of using spreads and preferring to use both put and call spreads I think that looking for the median performers is actually my best plan. Market volatility can bump option premiums but using a not so volatile sector can benefit from the resulting quick erosion of price over the last short term to expiry given the inflated premiums overall.

Jeff.

Walking through a Monday spread trade, XLE

Let's see if I can use all free tools to figure out my trade for Monday, I have space for two more in my margin account with Questrade and I am considering liquidating the TFSA positions and transferring the cash left into that account as well. Seeing as I really don't want to have to track those leftover positions that are from the previous advisory service and with year end nearing I will have that room to add to next year if I choose. If I withdraw it after December 31st then I cannot put it back in next year if I decided to.

So, Stockcharts.com for free P&F charts, annotating candle charts, relative performance charts, the CBOE site for option chains...that should cover it. I will use esignals for the candle charts as it is easier but I wouldn't really need to.

First up, the overall S&P 500 Bullish Percent Index (BPI) as a P&F chart.

I used a wider chart to get a feel for past years here. The BPI has only been in this range twice in the last 7 plus years...very overbought. The last time it immediately preceded the consolidation and drop into the 2008 year. This would lead me to consider wider ranges on puts or just selling calls to play the pending downside. I looked at these BPI charts some time ago but never got around to using them... options make these much easier to play I believe.

OK, looking for a trade in SPY is easy and I already have two in, one tight call spread and a wider put spread both meeting or exceeding my target credit. Let's look at another sector and see what we can scare up elsewhere...for diversity.

Putting all of the ETFs on a relative performance chart and jotting down the 30 day period performance (30, 60, 90 etc) results in Energy being the poorest performer over the last 200 days. the trouble is that the BPI in energy is in the low 40's so it is heading into oversold territory already...not necessarily the best time to concentrate on call spreads... the P&F chart indicates that the price is set for a support test on a current bull trend.

This is the trouble with relative performance. As much as it has been the poorest performer it does not mean that it is heading down, just not up as fast. So this leaves me sitting on the sidelines if I were looking to trade the ETF but I am not. It is not trending hard, the S&P is overbought, energy may wallow a bit while the S&P decides what is up. The dollar and oil are doing a dance right now as well. So let's get into the options.

Lots of options here. The January calls put me at $59 strike to meet my minimum target. Seeing as the price is at $55.53, about $3.50 difference, and is on the bottom of the linear regression channel and lower than the recent high in October this would put my call strike inside the upper channel area. I should look at the puts instead right now.

Much better. I get down to the $52 strike, still $3.50 difference but from the bottom of the channel which is around the low for September. Seeing as the strike is also near the 200sma, typical support.

Here is the XLE chart for reference

The way the short term trend is setting up it might appear that the price may head down. Given the last few down moves I think that the trade level given the timeline (red arrows) should provide enough of a buffer. If it does then I would watch for the longer term regression channel to level out and widen. This will give me the setups I would look for to set a call spread at an upper channel price.

Due to the nature of a spread, in that I am playing the difference of two strikes as opposed to the options prices themselves, I can afford to wait to see if an apparent support level ends up being support before placing the trade without too much worry of missing a good price. Of course if it takes a long time to do so them I will lose as the difference does get smaller as the prices depreciate.

The trade is to sell the Jan 52 strike. My spreadsheet gives me values for $1, $2 and $3 spreads. In this case the $3 spread provides the largest difference between the long and short quotes.

My trade:

Buy 4 Jan 49 strike puts, XLE MW
Sell 4 Jan 52 strike puts, XBT MZ
For a net credit of 30 cents (I can go as low as 25 cents and still hit my target, seeing as my goal right now is to get some trades filled and working I may go for the largest lenience)

Jeff.

Credit Spreads vs Buy and Hold, a Comparison in Principle

BUY AND HOLD

The goals of buy and hold are long term appreciation and dividends taking advantage of the premise that stocks go up over the long run... blue chip large caps anyway. Perhaps some shorter term "investing" which is really longer term trading for some straight speculative gains plays.

Canadian and US registered accounts are a benefit in allowing these gains and dividends to grow tax free. Taxation only comes into play when the positions are sold and/or the resulting funds are removed from the registered account.

The idea that a long term holding does not have to be monitored and a that a drop in the portfolio will aways come back over time seems to be the mindset of most B&Hers...time frames not of the investors choosing though. Using stop loss orders or put buying, these positions can be protected. The issue becomes market timing to get back in at lower prices. Not many seem to be able to do this.

DRIPs alleviate some of the holding issues as dividends are re-invested in additional and partial shares. Over time this creates a compounding effect and the plan is to have the dividends produce an income stream sometime in the future. I find the time frame too long for my style.

The latest popular plan is to buy ETFs in place of stocks in order to provide some level of diversity. Some even promote buying index ETFs in order to gain the historical 11% per year of the general market. Fine if your time of capital needs lines up with the time of market strength. Sector rotation or sector relative strength are becoming know now as well. While decent strategies these are not strictly buy and hold plans as portfolios require re-balancing over time

CREDIT SPREADS

The goals of a credit spread strategy are income generation and risk aversion.

While not able to be executed in registered accounts the gains are realized monthly and taxed annually as income.

One major idea behind this style of plan is to take profits regularly thereby eliminating the chance of having a position drop below a predetermined loss allowance without having to set stop losses. Compounding is handled by increasing position sizing as profits accumulate to an additional contract size. Buying back into a position differs from stocks as each month a new set of options are available and buying back in is at the then price of the options given the strike prices chosen. Buy an option pair this month, letting it expire by month's end, turn it back into the next month's option pair at a similar price.

Selling high and buying low is, essentially, taken care of automatically.

Sector rotation or relative strength can be used to increase the already high probability of taking full profits from these trades with exposing the portfolio to undue risk. In fact, these additional strategy adjustments can allow a greater position sizing opportunity. Something that is not as easy to do with stocks unless using up margin.

COVERED CALLS?

Some would argue for a covered call strategy but it has it's downfall in that the underlying stock could drop substantially. While premiums collected by selling calls against the position can mitigate this problem it does not eliminate the issue altogether. It also requires more capital and risks having the stock called forcing the purchase of another position at a probably higher price.

While any strategy has it's benefits and drawbacks that must be taken into account I have found that credit spread trading fits my particular style and time requirements. I have run numbers to get a feel for what is needed to produce an annual money doubling strategy and they look very good and attainable while taking conservative risks and starting with small positions.

While I have gone on about various points and strategies in other posts I just felt a need to summarize to myself a few points drive the final nail in the coffin of buy and hold investing for me.

Jeff.

Another Spreadsheet for Reference

I setup a spreadsheet similar to the one that I use for Optioneer minimum targets at various timelines between 30 and 45 days. With the spread trading through Questrade I would consider going as low as 10 days IF I could get enough of a credit at the outset to still produce my $2.40 per day per $1200 risk capital...just in order to keep the money working for me. Trades at this short a timeline have a good chance of staying profitable. The only drawback may be that at this point premium may have eroded such that I will not get that credit...so 10 days may be an unreasonable short end...maybe 15 might be the minimum.

Having said that a quick glance at my sheet indicates that a credit trade of 8 cents with 6 contracts traded will produce $2.61 for each day of the 10 day trade. Small absolute dollar figure but doing that over and over again, assuming that 10 day trades are frequent amounts to the same thing as running 15 cent credits over 26 days. It is a shame that I will barely make more than the broker even though the $2.40 is net commissions. Going with higher position sizing AFTER using a minimum size for the calculations is in order for these.

Note that these are my absolute minimum targets.

With Optioneer I went from 5 for 5 trades not filled over two weeks to 3 of 4 filled over about two weeks again. Better selection of trades as I have a target in mind when placing them and the lenience is allowed accordingly. The better the trade credit beyond my minimum target the more lenience to get the trade filled. With Questrade the lenience works a bit differently as it is a straight up limit order but it will still let me get trades filled for minimum risk at my target or greater without guessing where to sell and buy the strike levels.

I should note that this ignores the actual value of the legs of the trade as long as the difference in my selling price and purchase price meets the criteria the options could be 15 cents or $5.

Also, my formulae allow me to change the risk capital on the fly, adjust the colours for the indicators and bump the position sizing very easily to compare various setups.

Jeff.

The last of the services bites the dust.

Well, tonight I decided to cancel the last advisory service that I subscribed to. This was a $2000 per year setup and the refund is pro-rated. I have, over the last couple of months, realized the downfall of the "as advertised" claim. I made decent money initially but the style of trades they provide do not fit my trading style at all now. I only have to decide how to manage the trades that I have left.

If I traded everything exactly as they recommend I could see a decent return with two main exceptions.

1) I cannot sell naked options... and likely have no intention of doing so, this would make the difference in performance as at last every second trade involves selling a naked put in conjunction with a long call. Usually this is for a credit which makes taking the call trade alone questionable. Lately every trade has been a naked put sale... I don't think so.

2) Their recommendations are no better than playing the trend using a relative sector method of trading. They happen to have some insight into things "options related" that I can never hope to in the near future. That does not mean that I cannot make decent profits in options trading.

The long and short of this whole exercise is interesting.

For anyone wanting to trade, be ready to absorb and try as much as possible. Get familiar with the execution, the feel of loss and gains and be prepared to realize that anything that looks good on paper may not work in real life... paper trading is for the birds.

The final word on the various services that I have tested is that, seeing as none worked as advertised, or did but there was far more to the story than meets the eye, I cannot recommend anything that I have looked at or tested... none. That is why I have not bothered to mention any names here as none worked out well enough to get any credit to.

If anyone is still reading and happen to be interested in finding out what I did test and why it didn't work out, drop me an email. I believe that "no publicity is bad publicity" so mentioning them here only attracts attention that I do not intend. Questrade as a broker and Optioneer as a service are exceptions... along with Esignal and Stockcharts.com. There are a few other free services that I am using here and there that I might mention in future.

Jeff.

"...but I digress"

I have always held to my tenet of writing this blog for me first as a method to journal some of my trading forays and to, perhaps, entertain a few who might be reading along. Nothing here is meant to be taken as advice on trading decisions even if I think they may be valid theories. I will do all the playing so I will be the one making or losing. I would still write it about the same if I had made it completely private.

I read other blogs and a number of newsletters and I am always surprised, or at least I used to be surprised, when a blog or newsletter would go commercial. Pushing advertising or affiliated sites, blogs or services with little more than a thin film of prose that may be interesting but mostly meaningless. I know that there is a desire to have an audience. While I would like to have lots of readers I also understand that I am not likely to go there as that would require me to refine my writing and start writing toward an external interest rather than for my personal desire.

Like everything in my trading I like to try out various things. I put an Adsense on my blog, I put a couple of Questrade ads in but that is about it. I think in the last year and a half my Adsense account is up to $15. Obviously I am not maximizing my potential as an online hack.

I suppose this is a little rantish, oh well.

There was one blog that I frequented for a while and I even found some decent information. I returned a few times over the last months and it has gone commercial. Affiliated links and little "reviewish" writeups along with a "premium lesson" link and a "subscription services" link. This means that the free blog is just a bunch of fluff with lots of hooks now.

I guess that I am disheartened after having tried out a number of paid services only to find a bunch of re-hashing of stuff that is available for anyone for free online or for a few bucks at the book store.

This is where the truth of "where's the money" shows through. Pumping services cannot help but take away from a genuine interest in trading and is reflected in the content of a commercial blog aimed more at making money than any real desire to enlighten or disseminate information.

I suppose if I streamlined my blog and gave some opinions on market direction and some tidbitty pieces of chart analysis I could pass it off as "premium" as well...right.

Off my soapbox for today.

Jeff.

SPY, the Chart, the Trades

Green arrow is the trade date and sold level for my initial bear call spread.
Red is today's bull put spread.

I am feeling somewhat better about the call spread as the index seems to be topping out, the yellow lines are the original linear regression channel (one standard deviation) and the black are the current lines. the top is lowering and the slope is flattening out enough that the new price projection is lower, but still could intersect my initial call spread. I feel pretty good about the put spread though. It is a better trade even though it is worth a little less than the calls.

Looking at the call spread I wonder about where it might have ended up had I been using my current spreadsheet and thinking...$10 equivalent days ($2.40 days per $1200 risk).

It is going to hit $3.95 per day with a 12.58% yield (Return on Risk) so I had far more wiggle room than I thought...I was fixated on a 10% yield at the time...which may just inttroduce more risk that I would like. I may have been able to tighten the spread to $2, raise the short strike by $1 and bump the contracts up to by 2 and created a safer trade for the same risk and met my $2.40 target.

I would love to setup a spreadsheet tool that could import quotes and run these numbers quicker but this at least keeps me focused on one security and therefore focused on the plan.

Comparing the first trade to today's numbers, SPY price is close to teh same level. If I use Jan expiry it is about the same timeline. The relative call quotes are very similar but might result in a slightly higher net credit.

Plugging in the numbers gives me my target by trading at the 117 strike level instead of the 115. So I guess I was a little greedy. I need to always remember that I am aiming for cashflow, not returns.

Jeff.

Questrade and the Credit Spread, some comments

I have placed two spread trades with Questrade now. One bull put credit spread and one bear call credit spread...basically an iron condor style trade if taken together as they are both expiring on the same EOM timeline. My execution could have been better timed, although the put spread is where I would want it to be the call spread is a little close due to my just wanting to place a spread trade to try it out.

Unlike a regular trade the spread trades CAN rack up a larger loss if let go if the underlying stock or ETF price goes through the spread to the other side.

I already noted how Questrade calculates the commissions for these. Both side of the spread are treated as one trade therefore the commission is $9.95 plus one dollar per contract. So my 4 contract call trade is $17.95 ($9.95+ 8 x $1).

I expect, but did not ask, if closing the trade costs the same commission. Letting it expire is the best method of retaining as much capital as possible as closing a trade should only be done as a risk management and loss control measure.

I have to place orders through the trade desk, easy enough. The desk brokers are helpful and knowledgeable and quick to pick up the calls. I do not have to pay the additional $25 trade desk fee for these trades...I wasn't sure about that originally.

The latest curiosity has been the closing of one leg of the spread. If I have sold a 110 strike and bought a 112 strike call and I want to control risk by closing the short side, the 110 strike, due to a price move in that direction can I close the short call?

The quick answer is yes, I did not ask how the commissions get calculated though.

I can call the order desk and they will close it for me or I can do it through the platform. If I do it myself my buying power is not adjusted until the end of the day so if I want to place another trade and need the room I would have to call the desk to advise them. No big deal.

All in all I must say that I am pleased with the options trading through Questrade. I thought the order desk was going to be problematic but it appears that I was mistaken.

Next question will be can I place GTC spread trade orders? For some reason I doubt it unless I placed the short option trade order independently in the platform and then just placed the long order after execution...or just let it expire as it may not be worth the commissions or could actually end up ITM...another day.

Jeff.

SPY Credit Put Spread

That was quick.

My order was filled in the first 60 seconds as the difference in the 102 ask hit 49 cents and the 104 bid hit 36 cents for the 13 cent credit. I likely would not have got my full 15 cents on this one due to the price jump in SPY...it may have come in later but I decided that I will work my minimums, not get greedy and aim for easier fills as a result. I will end up getting fills in future at better than my minimums. I already see the effect of that over at Optioneer as I have one order that hit my target and two that exceeded them. Also, my other Questrade spread was filled above my minimum but that was just arbitrarily picked at the time the order was placed.

The trouble, not really trouble I guess, with Questrade orders is that they are just limit orders and will be filled at the very first opportunity. Optioneer orders are worked a bit to get better than limit order fills if it can be managed...they also have some volume of orders to work with whereas Questrade is just placing my order by itself...more or less.

I will need to double check my numbers for January expiry's now so I know what trades I will want to take. I think that I will plan to have all my margin capital in spread trades by the end of December... with the one December EOM expiring to be applied in early January.

I guess my sector plan may take a back seat for a while. I may still try to get it rolling but more in a manner to allow me to trade spreads based on sector performance rather than trying to trade for stock appreciation. It may be enough to spread trade SPY.

Looking at the greeks for a moment. As much as they are talked about when it comes to trading options I think that often they are overrated depending upon the strategy being applied.

The 102 strike put has a delta of -0.104 and a Theta of -0.029
The 104 strike put has a delta of -0.151 and a Theta of -0.034

Taking the differences makes this trade have a combined delta of -0.047 and a Theta of -0.005

In theory that means that when SPY moves $1 the trade should move 4.7 cents. Because I am working from selling premium the delta is important in that as the price moves away from the 104 strike it indicates the DEPRECIATION of entire spread trade...depreciation is my friend as it means that the trade, should I decide to close it, would cost me 4.7 cents less for each dollar the SPY moves up...the reverse is also true. But I do not plan on ever closing these trades as I want them to expire.

On the Theta, for each day the value increases 0.5 cents. This really means that the trade becomes cheaper therefore increasing the value to me, the seller. Adding the theta and delta together can give me an impression as to the future movement of the total cost to close the trade.

Higher Theta means that I will see premium retention quicker while higher Delta means that there is greater risk in underlying price moves and there may be greater depreciation as well, that one works both ways.

Rather than really getting into the greeks I find it easier to just look at the actual prices of the options as time progresses. My long protection option depreciates slower than the short sold option and I see the difference in rates and values as money in my account. That is much simpler.

Jeff.

SPY and the Bull Put Credit Spread continued...

I did some more thinking about this last night and decided to check the historical odds of getting a 102 strike put hit from a $110 level...basically an $8 drop in 36 days as that is what my trade would be for the January puts.

Other factors include the fact that the price is already at the low end of the trend or linear regression channel, even using the price at a peak this happened once in June...very close anyway and in the steep drop earlier in the year. During the drops I would be putting my energy into calls spreads so puts would not make it to the table very often.

So, rather than go on about it here I will be placing some orders, one and maybe two, for either Dec EOM or January expiry.

Order placed for Dec EOM, 6 contracts meets my target for $1200 risk. I went as low as 13 cents or better as SPY is going to open up this morning, maybe 60 cents, which may depreciate the put options...15 cents was based on yesterday's close prices. So we'll see what happens this morning.

It would be nice to be able to sell naked puts and keep all of the premiums, I could go lower on the strike as well and still come out ahead. I know I take the risk of the trade really going against me but it is an ETF tied to the S&P 500, that in itself creates a ton of diversity. The only downside is an ETF valued at $110 needs to have $11,000 free cash to back it up.

Jeff.

SPY and the Bull Put Credit Spread

I modified my spreadsheet to include put calculations today. I was concentrating on the call spreads just because I needed to start somewhere.

Seeing that the call spreads would benefit from having the SPY price closer to the top of the current regression channel I figured that it would be a good time to check the puts...I was not disappointed.

I chose to check the January expiry's first but the timeline is too far out to be comfortable as I would like the trades to be in the 30 day range or shorter if I can manage it. So I also ran the December EOM.

Based on my range finder the calls at the SPY $110 level should be at 115 strikes sold for EOM and the puts 105 strike sold. For some reason I look at the chart and I don't like the call level still... perhaps I should add a trend factor in there. I did add an adjustment for the price position in the trend or regression channel. Time will tell how much I may have to adjust these factors.

Anyway, back to the puts.

I decided a while back that $10 days for trades risking $5,000 are my minimum target, (Optioneer), breaking that down to smaller trades puts me at $2.40 per day at the $1200 mark assuming that I can keep my money working for me regularly. This is roughly what I expect to use in my SPY trading as a risk allowance. This doesn't convert very well to an overall ROR as it depends upon the timeframe...as long as the daily dollar target is met the rest looks after itself. It is a 0.2% daily ROR though so a 30 day trade should return 6%.

Using that as a minimum guide I ran the various strikes at the various spread values and I can now just scan down the chart to see what the minimum credit trade would be to accommodate my minimum target. As of today's close prices a 104 strike put sold and a 102 put bought would provide $3.09 per day over the balance of the month...22 days. Seeing as the premium collected is based upon the difference in the prices of the two options a longer expiry should have provided a similar result.

Using the chart for minimum targets allows me to assign a better risk model as I can use the absolute farthest strike from the price and I don't really need the whole range calculation at all. Now trial and error can be very expensive in this so I will have to be nimble if this puts the spreads too close and they start coming under pressure form a larger price move than I anticipate. All I need to do to adjust is lower my daily minimum target and the trade moves farther away on it's own.

A quick comparison of the SPY puts.

December EOM
Sell to open Dec EOM 104 strike and buy to open the EOM 102 strike for a 15 cent credit.
21 days left, $3.24 per day, 6% overall.

January expiry, 3rd Friday
Sell to open Jan 104 strike and buy to open the Jan 102 strike for a 28 cent credit.
36 days left, $4.06 per day, 13.86% overall.

Sell to open Jan 103 strike and buy to open the Jan 101 strike for a 24 cent credit.
36 days left, $3.39 per day, 11.32% overall.

Sell to open Jan 102 strike and buy to open the Jan 100 strike for a 19 cent credit.
36 days left, $2.56 per day, 8.31% overall.

Jeff.

Option Spread Optimization and the $10 day

I slightly reworked a spreadsheet to provide a comparison between varied strike spreads at various strike levels and incorporated position sizing, Return On Risk, daily returns and the average ROR for the entire spread strike listing that is usable (ie all $1, $2, $3 and $4 spreads from 115 to 121 strike).

The result, the best bang for the buck is for the $2 spreads by a 0.5% margin.

With my Optioneer/Strikepoint trades I look for $10 per trade as a minimum target and that is based on a $5000 (less premium sold) risk profile. With my spreads I might feel comfortable with a 117 or 118 strike spread...go with 118 so safety.

A 118 strike with a $2 spread yields 3.27% based on $1200 gross risk.

This nets about $1.09 per day of the trade (January expiry) if I trade 6 contracts, $1200 total risk. Comparing against the same risk profile as Optioneer I would put $5,000 at risk and yield 3.95% and $5,50 per day.

117 strike the yield jumps to 6.72% and $9 per day
116 strike the yield jumps to 9.65% and $12.50 per day

Considering this is with the price of SPY at the low end of the trading channel now these numbers would look much better with a higher SPY price as the strikes would be that much closer...although the volatility would be lower and would depress the option prices a bit.

Thus the issue becomes how much to risk and how far out to place the strikes to lower the chance of taking a larger hit and meeting a $10 per trade per day target or the equivalent.

$10 per day at $5000 risk
$5 per day at $2500 risk
$2.40 per day at $1200 risk

Today that target could be met with a trade at 116 strike yielding 8.9% and a $2.80 per day profit.

Considering that there is no margin available for these trades and my account is just over $5,000 I would feel better placing more smaller trades so I will have to aim for the "equivalent to $5000" trades. I think that I can find combos to provide this particular cashflow without undue stress.

I also am aiming to be able to do any number crunching after market hours in order to place my trades before the market opens the next morning and not have to worry about intraday chart watching...I either get my target price or I don't. This certainly gives me a feel for what the Optioneer/Strikepoint guys do. I knew it would be fun.

Jeff.

SPY and January Expiry's

I was considering putting a SPY bear call spread in for January expiry this morning but got looking at the chart first. I was liking the spread between 115 and 118 strikes again, the same spread that I have now for Dec EOM (which is doing nicely given the market wallowing of late).

Here is the chart:

Given that the Jan options are only 15 days later than my current trade and there are holidays to suck up some more of the time value it looked good, a 40 cent credit spread. The trouble comes in when the price position on the trend is taken into account. It is at the low of the channel (similar to gold in my other post today) and, if a decent rally occurs to follow the trend my trade would be in jeopardy...as it is the Dec EOM could be.

My best strategy is to wait until the price rises to at least the median of the regression channels which will allow me to select a higher strike to sell which allows me more margin for fluctuation.

Worth noting that the blue old gap levels are providing an interesting bit of activity as the S&P levels hover on the upside of them.

Patience.

While I am waiting for that to set up I placed and filled a trade yesterday with Optioneer at my minimum target for a January expiry. I was actually surprised it filled as I allowed no lenience, I figured if I got it I got it.

Should the SPX fall another 15 points I will place another trade and perhaps get a nice close to 30 day expiry.

Jeff.

Gold, some comments

All I see about gold...going back a few days... was how $1200 was just s launching pad and it is going higher. Very few were looking at the real picture though, the technical side of the equation.

No matter how you cut it gold was overbought...which just means that it is on the topside of it's trend channel. I pulled up chart after chart for gold indices, gold companies and they all look identical.

Keep in mind that I was not really watching gold anymore so the only real reason I did not see the drop was I was not looking for it.

Here is a chart...CBOE gold index, not the price of gold. Why anyone would have expected it to go any higher after the latest run-up is beyond me.


The 80 and 40 day linear regressions and the trendline are indicating the same thing....there is no break in the trend yet, just a typical linear regression. There is still approximately 4% of the peak price in room left before the price is at risk of breaking the trend and actually heading down. The current trend has been in place since the end of 2008 and each of the minor corrections back to near the trend line have all been normal.

While it might be a good day to buy gold I'm not jumping in. Other fish to fry right now.

I find it odd to talk about charts as if the technical stuff actually determines what is going to happen next. Can it predict the next move? Not really, but it gives a trader something to work with as a starting point. Seeing as trends are repetitive it certainly can indicate a high probability next move...as long as it is not this late in the game in a trend.

Jeff.

Breakin' it Down

A quick overview of where I am at now.

Trading by the BPI with sector ETFs

Bull trading - Use the S&P 500 trend based on the 30/20/10 BPI entry rules for bull trades
- the over sold condition cannot remain oversold for long

Bear trading - Use the S&P 500 trend based on the 70/80/90 BPI entry rules for bear trades
- unlike the over sold condition, over bought can remain in force a lot longer so entries need to have tighter stops and stricter trade management overall

Compare sector performance at each point to determine which sector is leading the charge, or is losing the least ground if it is early enough
- this is a relative measure to determine which sector to focus on

Compare the ETFs within the leading sector to determine which is performing the best overall
- this is the same relative measure to determine which ETF to trade or focus on

Trade the sector ETF based on the S&P500 trigger
- assuming good liquidity or, if options, enough selection and liquidity in the option chains

Alternately compare constituent stocks within the ETF to trade
- this might be due to an expensive ETF, a desire to only trade options or an attempt to boost returns by using the stock that is driving the ETF that is driving the sector that is driving the market

This can mostly be set up ahead of time to make life easier. Stockcharts.com uses strings of ten symbols for it's performance chart, free or otherwise, so setting up strings to be able to cut and past will make life easier. Tracking the market to be ready for a change in trend and tracking sectors for the same reason is a good daily practise while waiting for the initial trade setups. Checking ongoing trades in order to maximize earnings by perhaps selling one ETF/stock/option in order to play a better performer can be done monthly.

Jeff.

BDH and TTH with Options

Let's see what options can do for these trades to get the capital down, eliminate stops and increase the ROI.


BDH has two options, maybe, for the first month and very little open interest... 4 and 5 contracts and huge spreads...not worth looking at...no LEAPS either.

Rather than shifting to the second string ETF I looked at the underlying holdings that represent stocks from the sector in this ETF. About 20. I picked 6 that were priced around $5 to $20 just to keep a larger range of possible options and to stay out of the penny stock range.

ALU, SWKS, QCOM, GLW, CIEN, BRCM

Running these on a performance comparison yields SWKS as the clear winner.

SWKS closed at $13.84 today, in mid-March it was under $8 ($7.75). For interest sake running a single trade on March 12th to September 27th again would yield a $13.25 price... $5.50 gain or 71%. Not bad... running four scaled trades is an ACB of $8.88, $4.37 at 400 shares makes $1748 or 49.2%.

So it is a cheap trade on it's own but I want to get it even cheaper...so into the option chain.

At today's price the options are at strikes of 2.5 to 25 in 2.5 increments. The open interest is between 5K and 15K, lots of liquidity near the money. Buying close to the money but still out of the money today would cost 35 cents at 15 strike and $1.70 at 12.5. As the price is near the mid line I expect that ATM might be in the $1 range.

Assuming that back on March 12th puts the ATM calls at 7.5 and the stock price at $7.75. The call is only 25 cents ITM so make it a $1.25 option for the next month... 40 or so days to expiry.

Buying the options a month at a time and only counting intrinsic appreciation (extrinsic becomes a cost) the first option (April expiry) would be worth $1.50 at expiry. After costing$1.25 that makes a 25 cent gain... Considering that the ROI on that is actually 20%. Not bad but no commissions are counted AND if the stock price does not go up the $1.25 is a loss.

I think that these sector BPI moves are pretty long term so I would need to go way outside to be able to hold a single option trade for this time frame.

Enter the LEAP.

January 2011 expiry today would cost about $3 for ATM options. Seeing as my stop loss for a stock trade is likely to end up being $3 per share this is in line for a Maximum Loss Allowance. Had I bought a LEAP in March at that price...or so... the intrinsic value would have been up by $5.25 and I would be down by about $1.20 of the extrinsic value. Total gain of about $4 ($400 per contract). Total ROI of 133%.

The key for LEAPS would be to roll them over while they still have some extrinsic value, 3 months out, and take the gains, buy the next LEAP in the same or perhaps in a better performing stock or ETF.

The cost is always going to be the lost extrinsic value but the ROI on a per trade basis is large and profits can be taken while buying back into the same stock options at a cost similar to the very first trade... that is something that cannot be done with a stock or ETF.

A side note worth mentioning is that at a $3 initial option cost and a 1 year plus timeframe on the LEAP I could set a stop loss at $1.50 in order to keep my MLA lower and allow me to double my position sizing. Using the example a 2 contract trade costing $3 per share would put the trade at $600 stop loss at $300. End profits at $800. Scaling in I won't try to figure out but it would increase the absolute dollar return and depending upon how it all gets executed, realized gains will be had along the way.

I really just need to get working on a live trade for this. The only trouble is that, while I can have trades on all the time, I was not planning on starting with bear trades AND I am not at a prime entry point on any one sector that I have prepared. I also am torn between trying to keep it simple by using only S&P500 sectors vs using the Investors Intelligence 46 sectors...even though it makes sense to do, it will take more work.

Jeff.

BDH and TTH, Histrionics

I figured a little more historical testing was in order so, using the S&P sectors (smaller list) and related ETFs the following was the ideal trade setup according to my BPI trading rules so far. I did the total S&P 500 already and ended up using the QQQQ ETF and would be showing a single trade gain of 56% over the last 9 months. Seeing as that is a good return and it was using the general index I figure it would serve as decent benchmark.


Using the same dates from the S&P study I applied them to the sector study.


Major sectors are: (with the stockcharts.com symbol)


S&P500 total - SPX
Transport - GSPTRN
Consumer Discretionary - SPCC
Consumer Staples - SPST
Energy - SPEN
Financial - SPF
Health Care - SPHC
Industrials - SPI
Info Tech - SPT
Materials - SPM
Telecom - SPTS
Utilities - SPU


March 11, 2009 the S&P500 breaks 20% BPI on the way up and Telecommunication Services is the overall best performer over various timeframes with Information Technologies a close second.


Take Telecom. The two ETFs that were front runners were BDH and TTH as of March 11th. BDH did spend more time outperforming on up moves on a larger scale but as TTH spent less time underperforming in the downturns. Comparing only the two leaves no clear long term winner but BDH is a short term outperformer.


BDH on March 11th close at $8.46, buying with a limit at that price on the 12th. Using a $1.50 stop puts me still in the trade today at $12.41. A 47% gain on a straight all at once purchase.


Using Williams %R as an oscillator during an uptrend can give decent buy signals for additional lots to scale the position up...


May 14th at $10
July 8th at $11
August 18th $11.67...although this entry is questionable as the sector BPI is highish


This sector often does not reach 70% of late so that is the target to watch. September 27th the BPI in this sector hits 70%, time to tighten up the stop or just take profits. Sell for about $12 either way actually.


So, even lots makes three purchases of $8.46, $10, $11 for an ACB of $9.82 and a gain of $2.18. An overall 22.2% gain.

Putting the exact same timing and execution into TTH results:

Trade 1 = $20.69
Trade 2 = $22.12
Trade 3 = $22.00
Trade 4 = $22.86
ACB = $21.92
Sell at $24.30
Gain of $2.38 or 10.9%

While the returns sound low the absolute dollar value of the trades are $654 and $952 if each trade was 100 shares... although that puts about $12,000 to work for an overall 13.4%. This is OK and can just add to the trading options available to me.

Keeping in mind that the $12,000 is a margin account that really means that I could be using as little as $4,000 of my capital and the return based on this is now 40.1%. A much better return. While I don't normally like the idea of using margin to the max I believe that this trading strategy may warrant the risk in order to get more trades in play to add diversity... mitigating the risk.

Jeff.

Current position review...Oh My!

I decided to check all of my current option positions against the BPI for the sectors that they are in and was a little surprised at what I found. Keep in mind that all of these are recommendations by an option advisory service. While some of their recs were quite profitable, and I am still up in realized gains, I would not have chosen the trades myself... they base them on information that I do not have access to. That in and of itself may be a good reason NOT to use a service, not double checking anything.

These are listed in descending order of S&P 500 sector BPI.

Positions - Sector - BPI
12 - Information Technology - 84.21%
1 - Healthcare - 80.77%
3 - Consumer Discretionary - 73.08%
2 - Utilities - 71.43%
1 - Telecommunications Services - 66.67%
2 - Financials - 63.29%

I am a little more than top heavy in one sector and it is the sector that has the most companies in a bull trend according to P&F signals... 84.21%. Considering that this is 14.21% higher than the 70% trigger I would use this does not necessarily bode well for those many positions. There obviously is not a market sector slant to the picks.

Of all optionable stocks the BPI is 66.54% and on it's way down from an 82.08% high in late September. If it had been used as an index trigger, November 2nd the BPI dropped below 70% triggering a bear trade.

Info Tech hit a high BPI of 97.31% on October 21st and crossed down on November 4th, bear trade signal again and I am loaded up with Info Tech.

I knew that there was merit in using Bullish Percent Index charts but at the time I don't think that I was really ready for the application. I did keep all the charts in my stockcharts.com account but I did not refer to them often. Like anything else, just another tool in the trading toolbox.

Having said all that I will not second guess my current trades, comparing one strategy against another using the wrong tools can be problematic.

Jeff.

The Banking Sector

I am going to follow the Banking sector through it's current phase as my most likely future bull ETF trade opportunity. Due to the ongoing banking crisis I am not sure that it will give what I want in the short term but I like that the BPI chart regularly hits the 10% mark which makes that particular indicator a no brainer trade.

In the past year and change it has hit 10% four times and had decent rallies. Even though most are still way down many ETFs have returned 100% from their respective low points. They are still relatively inexpensive which makes them a decent stock style trade instead of options if they are not all optionable... which I am finding the case with many ETFs. I hesitate to start drilling down to the stock level to find underlying securities to trade options on...but I will go there after getting comfortable with this style of trading.

I cannot find a decent BPI for this sector directly so I thought maybe I could substitute the financial sector on stockcharts.com. No luck, that BPI is in the high 60%'s and I will likely watch it as a good short candidate if it peaks above 70% one more time and it likes to hit sub 10% as it has six times in two years.

Tomorrow I will setup my performance comparisons for a few indices that look ripe for either a bear or bull trade.

I cannot easily setup and post charts for the P&F from stockcharts.com and I will not post stuff from Investors Intelligence as it appears to be proprietary indices. The charts that I have been posting in the past have all had information on them that is non-proprietary and not real time so I have never had an issue in the past. Of course I wouldn't really expect anyone to see and have an issue with anything here I still like to keep away from any chance of some sort of infringement.

I suppose I could just keep everything simple for myself and use the S&P500 indices and BPIs as they are mostly available through stockcharts. That and ten main sectors is easier to manage than 46.

Jeff.

Wrapping my head around the sectors

Investorsintelligence has a nice bell curve display which lists the 46 sector categories that they track. It notes their position relative to their Bullish Percent Index (BPI) and their current P&F chart bear or bull status. The trouble is that they do not list the ETFs in the same categories as their are only ten ETF categories.

For example, banks. Banks has 7 sub-categories by US region. I can view the constituent stocks. I would expect that banks and finance might be tied together somehow, they are not as financial has five sub-categories and they are more lending leasing and index tracking funds.

I have a separate listing but it has quite a bit of overlap in vaguely related groups.

Back to the bell curve. Overall the curve is peaking in the 60% range, there are none under 20% and three over 80%. This leads me to believe that the market is nearing a terminal overbought stage. Given the run up we have seen in the last months that would be expected, at least a correction of sorts is due but tough to predict. I would say that the top heaviness at least provides an indication that the risk of a correction is high and anyone long in all but buy and hold plans (although I think even they should be aware) should be setting tighter stops or scaling out of positions about now.

Having said that, if everyone decided to scale out right now that would trigger a massive sell off as the buyers would not offer decent bids knowing that the market was going to fall off. This is why I would rather be trading options or inverse ETFs than short selling stocks.

But I digress.

Selecting the sector on the chart brings me to a P&F chart of the BPI for that sector. Right now there are none under the 30% mark but there are four poised to pullback under for some possible setups. Seeing as it takes little time to setup a sector comparative ETF performance chart I will wait until one or more do head south.

On the other side there are 9 in the 70% - 80% range and 3 in the 80's. I am not sure that I want to try getting into playing the bearish side just yet...but I will choose one of the bunch that is in the most ideal position for a bear trade and at least track it. The trouble is that I cannot do a sector comparison easily with stockcharts.com as they do not have most of these indices available. I don't like using an ETF to simulate the index either as all ETFs are used for possible trading and using one as a benchmark could throw the while study into question.

Jeff.

S&P 500 and the bullish percent chart continued...

I was just sitting in front of the fire as the temperature has started to drop outside, toastie. I picked up the laptop and decided to run a quick historical test using the S&P 500 index as a base to determine entry points in related ETFs. I was surprised to find so many large cap ETFs out there.

I entered them all into Esignal in a quote window and sorted them by 12 month performance as a percentage relative to their respective price at that start point. Taking the top 10 and placing them into a relative performance chart, relative to each other, resulted in the top three. The top one was far ahead of the rest by enough to be a little odd, so I might take the second best but I will test all three.

I started on January 1st 2009 as a starting point figuring that the Bullish Percent Index (BPI) should definitely get low enough to trigger all sorts of entries in the continues spring drop.

Method, seeing as I don't want to enter on the way down I would follow these steps to capture the best possible entry price.

1) When the BPI hits 30% on the way down I flag the sector and check the representative ETFs to choose the top three relative performers in the sector, S&P 500 and large caps in general in this case.

2) If the BPI crosses 30% on the way back up, enter a long trade in one of the ETFs. This could be options or straight ETF units.

3) If the BPI does not recross 30% but heads farther down then use the 20% as the next recross target, again, enter a long trade after the BPI is above 20%.

4) If the BPI does not recross 20% but heads farther down then use the 10% as the next recross target, again, enter a long trade after the BPI is above 10%. Alternately I might just enter a long trade once the BPI is below the 10% mark as this is so low that it almost cannot stay there long.

Using these four entry steps:

Feb 20th, 30% is broken, no trade, check performance, QQQQ, IVW and IWF are the three best performers even though they are losers they lost the last of a few timeframes.

Feb 28th, 20% is broken, QQQQ remains the top performer even with a loss over all timeframes up to 200 days.

March 6th, unbeknownst to any at the time 2009 just posted the lowest S&P 500 level for the year at 666.79 points.

March 9th, QQQQ posts it's lowest for 2009 as well at $25.63.

Mar 11th, the 20% is broken on the way up, QQQQ is still number one and is posting some positive performance over the shorter time frames. Trade entered March 12th at a limit of the previous day's close of $27.75 or just at the open, I am not sure which to go with. 50 shares stopped at $24.75.

March 13th, the 30% is broken on the way up, March 16th (Monday) 50 more shares bought at the previous day's close (limit again) for $28.74. 100 shares with ACB of $28.24. Stop os at $25.24. $3 stops set for now, I will adjust to some ATR method or use the P&F or reversal of the BPI to get out or to help determine how much space to give.

Today, if using a $3 stop I would still be in for a current price of $44.12. A $15.88 gain over the 8 month period. That is a 56% gain.

Also worth noting for today I should be readying my list of potential shorts as the exact same entry criteria and method could be applied on the way down using 70% as the first trigger. 70% with downward recross to short the poorest performing ETF, then 80% recross and 90% recross.

This could be considered a conservative measurement as using other sectors that are performing well against the SPX and better performing ETFs from within those indices. Also, using options could allow for not needing to place stops, provide leverage and using spreads against some of the positions in certain ways could also produce premium income. Then there is playing the downside moves as well which I would most likely do with either buying puts instead of short selling anything or just running bear call spreads to take advantage of the weakness even without a defined drop.

All in all I think that this is a nice workable and easy to execute plan. I may redirect some funds into my margin account in order to run some live trades in this methodology. I might luck out and hit a market downturn soon as the SPX has crossed 70% and 80% on the way up. This should affect my long only option trades heavily, although I am selling a few of them as they show strength right now.

Jeff.