CVA, recent profits in this stock trade

One of my recent trade targets hit was in CVA, Covanta Holding Corp.

I had targeted entries at $14.00 and $13.50 to open long positions which were both hit on Aug 12th. A double position. I know I could have watched the intraday and had a better average entry but that is not the point with my trading plan.

Keeping it simple and to not be required to do any chart watching during the day is my goal. I have done a lot of daytrading and the like and, while it can be lucrative, it can be stressful as well.

Exit profit targets were at $15.00 and $15.50.

The first was hit in a few days for the $1.50 per share goal.... 11.1% in 5 days, nice but trades this short are not not always typical, although there were a number that were less than 10 days. I like those for obvious reasons.

The second target was hit on September 24th with an intraday high of $15.52. Another $1.50 profit and 10.7% gains.

The entire trade lasted 43 days.

Over the entire study period this stock was not a great performer using my plan but it was consistent, and that is the primary goal. More consistent stocks over the longer term leads to more relaxed and profitable trading.

STATS for CVA:

9 first entry trades 8 winners

2 second entry trades 2 winners

$12.50 per share gains (using 100 share trades that is $1250 for the period from June1, 2009)

Total days in any trade 325 of 483 possible

I ran the trades at $1,000 per trade initially and rolled the profits right back into the next trade to provide compounding returns. Allowing for the commission structure at Questrade of $4.95 per trade (I just rounded up to $5 for ease of math) the $1,000 would now be $1,931.

That is a 93% net profit. While consistent, it is well below the average.

Having said that, had I just bought and held the stock on June 1, 2009 at the average daily price of $14.24 it would be at $15.41 now. The gain of $1.17 represents an 8.2% profit.

Jeff.

The allure of cheap ATM options

Risk.

An option risks only the price paid for the option...no more.

Comparing the two options from today's purchases:

CMC risks $510 and CVA risks $290. Take it one strike closer to the money and the overall cash risked is less. Buying the CVA ATM option right now puts $140 at risk and CMC ATM at $200 (and it is 50 cents OTM).

That makes these ATM options look enticing, but is it just because they are cheap?

Let's think about this for a moment.

Considering that they have no intrinsic value unless the stock price climbs AND the Extrinsic Value will most likely decline as the stock price comes up (Delta is usually around 0.50 for these so the IV goes up by $1 and the EV goes down by 50 cents).

Given this and assuming that I am willing to risk $300 per trade I have three choices:

1) buy stocks (100 shares) and set the stop $3 down
2) buy ITM options (1 contract) and set the stop roughly where the $3 stock price drop would be
3) buy ATM options (2 contracts) and set no stop

WAIT A MINUTE....SET NO STOP?

OK...Let's take CVA as an example, mainly because the closing price today was at the strike price of $17.50...or very close.

I bought one contract for $290 with an IV of $2.35. If the stock moves aginst me by $2.35 I lose all of the IV and some of the EV...total loss of perhaps $255 and I had to have had a stop in place to catch this. If it moves in my favour by $3 I gain $3 of IV and the EV may not change much as it is low already. So slightly less than a $300 gain for the position. Figuring out where to place the stop is tough as it is a moving target for a variety of reasons.

The current asking price for the ATM option for CVA is $1.40. I could buy 2 contracts for $280, slightly less than my loss allowance and slightly less than my actual ITM purchase. With the near 0.5 delta 2 contracts can produce the same option price move relative to the stock price move as 1 contract deeper ITM with a delta of 0.8 or greater.

If the stock price moves against me I lose no IV as there is none, only EV. As an example the next strike for CVA is $20...or $2.50 away but the option is only down by about $1. So the same $2.35 move against me would lose less than $1 overall per contract. About $200 for the entire 2 contract trade...less than the single ITM contract loss. Worst case is still $280.

Here is the catch. If the price moves in my favour by the $3, and I have the two contracts, the total IV for the position is now $600. The EV will likely drop but it cannot drop any more than the $280 it had in the first place, likely somewhat less...but let's take worst case. Lose all EV and the IV alone is still $600, I paid $280 so the gain is $320. Seeing as the $2.35 ITM option still has an EV of 55 cents it would stand to reason that the new option price would have close to that under similar circumstances...so the real number will be $110 more...that's $420 gain.

When we enter any position we do so with the expectation that the price will move in the direction that we anticipate, otherwise why make the trade. This means that having built in Intrinsic Value, by itself, is not as important as it may seem. Once the price moves in our favour the IV will move along with the price.

So taking a trade with no more risk and slightly better upside and not having to worry about anything other than a profit protection stop loss looks like a better all around trade to make.

The trick is finding those stocks that are ATM or slightly OTM that are poised for the next move and have the options priced accordingly. In hindsight I would have made those two trades today using this option thinking instead of what I did... so back to the charts to see what I can scare up for tomorrow... or with the long weekend this weekend, I may just wait until Tuesday.

Jeff.

CVA and CMC revisited with options

I keep looking at the options that I am trading now and consider that what I am doing is the best method for the style of trading that I am pursuing... but those cheap ATM or OTM options look awfully tempting.

I bought two new option contracts this morning, CVA and CMC...both of which I have trade stocks in my new plan recently and both are using the Point and Figure entry method.

In CVA my entry trigger for the stock was between $17.25 and $17.50, and I even entered a stock order at that limit initially as I wanted into the market at that price. This gave me time to investigate the options. The price hovered around $17.30 for a while, I entered the option data into my spreadsheet, decided upon the option, cancelled the stock order and placed an option order. Strike was $15, expiry Jan '10. In at $2.90 after playing with $2.80 and $2.85 for a while.

Option cost $2.90, $2.25 ITM so 65 cents Extrinsic Value, 22.4% of the price was EV.

CMC was, more or less the same deal. $16.75 to $17. Option was the $12.50 strike, Jan '10 expiry.

Option cost $5.10, $4.25 ITM so 85 cents Extrinsic Value, 16.7% of the price was EV.

Looking at my sheet comparing the various strike prices with their EV based on paying the asking price (which I didn't) makes these look like the best deal as the Deltas are high and the EV was relatively low.

Then I consider the element of risk. Options reduce risk in the sense that they are somewhat unaffected by some attributes of the stock activity...CAH example as I would have lost over 50% of the value of my stock only position where I did better holding my own in the options.

Let's just see where these trades take me going forward.

Jeff.