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.

The $400 advantage ... itrade / Questrade

I see that Scotia Bank has absorbed itrade and is up and running, not sure how long they have been. I am a BNS client for mortgage, credit and a couple of accounts including my US dollar account so I thought I might take a look at their trading platform and fees. Perhaps there is an advantage in having everything in one location...perhaps not.

I like Questrade as they are cheap, $4.95 trades (a penny per share with a cap of $9.95), the pro platform needs 25 trades to be "free" and is reasonably flexible and the active account minimum is $250 with no additional fees or tiered commissions.

So looking at the Scotia offering, I was surprised that it did not really compare as I though that it might.

A quick glance shows the tiered commissions. $6.99 per trade looked good but I would have to have 150 trades per quarter. Sounds big, at 50 per month it is substantial. Their is no mention of trade size that I saw but there were a few restrictions based on share pricing and minimum trade size, it was not terribly clear exactly what that entailed though.

Comparing my activity levels I may qualify for the $6.99 trades in some months but I transact 30 plus trades per month, not always 50. Due to my small startup account being less than $50,000 I would typically get nailed for the $19.99 trade commission (2 cents per share after 1000) as I would need to have between 30 and 150 trades per quarter AND $50,000 to qualify for tier two.

Options trades follow the same pricing structure plus $1.25 per contract compared to the $9.99 plus $1 at Questrade. My current volume and account size puts me in the $19.99 plus $1.75 per contract though...and I consider myself pretty active... the second tier is close but, again, no $50,000 or I would see $9.99 plus $1.25, a little pricier yet but not enough to make a real difference.

Now, the real kicker comes in with the platform. The pro level software IS THE SAME SOFTWARE as Questrade uses. I should not be surprised though as this is a common theme with onine trading.

Pricing is a little different though:

For 150 trades per quarter it is free (50 trades per month), 30-149 per quarter it is $99 or greater than $250,000 in assets. The base price is $200 otherwise.

This compares to Questrade's pricing for Pro at 20 trades per month or $30 per month.

I like Questrade's simple commission and platform pricing structure and the fact that it is just plain cheaper overall. I have not had an opportunity to try out Scotia's itrade for customer service as I will not open an account just to test run it...I considered it though but it just didn't make sense to through the money away to satisfy my curiosity.

So, the bare bones comparison for my monthly fees given my account size and activity now is:

Questrade: $4.95 stock and $9.95 options commissions, zero account fees, zero platform fees...zero any other fees except ECN, margin rates and other probably comparable fees. $300 or more due to commissions. Nice.

itrade: $19.99 stock and $19.99 options commissions, $99 platform fee, other fees seem the same. $700 or more due to commissions and platform fees.

So, I will continue to use the $400 advantage of Questrade.

I must mention the one advantage in favour of itrade... which I likely wouldn't use at all anyway... Virtual Trailing Stop Orders. They track the VTSO actively them selves and execute the market order on my behalf. Questrade only uses the orders that are available through the market they are trading in. This may mean that a true stop loss order is also available through itrade as well. This begs the question about execution of these trades though. They explicitly outline that they are not responsible for losses due to failure of software and whatnot. I know that a VTSO or stop loss placed with a market will be honoured and executed, what happens in the case of a volume load and platform problem where the itrade VTSO cannot get through...I am not as comfortable having an order another "step" away from the market.

Having said that I am trading US markets that do support the VTSO and stop loss and I am not using stops, generally, for my option orders so the whole issue may be a moot anyway.

For any interested I have links on this blog for Questrade and the Scotia stuff can be found by just entering "itrade" in the search browser, it will show up near the top of the search.

Jeff.

Cross checking the trading

I have been running some manual backtesting of the last 30 days or so of trading Global Gold using Horizons Betapro Global Gold bear and bull leveraged ETFs to give me more confidence in my trading plan. Although I know that it can work I felt I needed a little nudge to get me more motivated to get trading for real. It certainly helped. I'll post more about that once it is completed.

Today's performance was not so hot though as I think I over traded a bit and made a couple of calls for entry and early exits that cost me some profits as I was down about $70, (about 1/2 of my trading costs.)

This tells me that my trade setups and calls were mostly on the mark, the execution was a little lacking. I did get in at good and predictable prices so at least that was going for me.

Doing the back test for today had me making 12 trades, surprisingly the same number that I actually traded. Three were washes as the price did not move as anticipated shortly after the entry. I just applied rules not trying to make judgements based on anything else.

Total profits after commissions assuming some slippage was $176. Compared to my backtesting days even this was not a great day, that makes me feel a bit better, but not too much.

Applying my 30% fudge factor puts me at about $122 and if I took off my top two trades I would have seen $92.

Considering that today was my first real full run of this version of the plan for the entire day I don't think I did too badly. If I produced a gross loss (net loss greater than my trading costs) then I would be disappointed.

As it is, I still think there is a little tweaking to be had but the plan is sound.

Jeff.

Exchange Traded Funds (ETF)

Here are four charts that might be examples of what I would be tracking at once.

This first is the Horizons BetsPro S&P/TSX Capped Energy Bear Plus ETF for last Friday afternoon trading. This tracks the TSX capped energy index inversely.

This second chart is the same period for the Bull version of the fund as it tracks the energy index directly. Note that the price is not in the same range.

This is the S&P/ TSX Capped Energy Index itself.


This last chart is Suncor Energy.




The correlation of Suncor and the TSX Energy index is more obvious when looked at in better detail but the pattern is pretty obvious.

The volume of the two ETFs is substantially lower than SU. The volume is not a factor in the ETF's though as they are tracked to the index with some variance due to the bid/ask spread of the ETF. I need to watch these ETFs to see how they behave and it will be different trying to trade a derivative that is not driven by the traders trading it directly.

It is worth noting that ETF's can be traded using all the normal order types available to use with regular stocks, limits, stops, shorts, probably VTSOs and I understand that there are even options on these as well...although I don't anticipate using those.

There are a number available for most of the popular indices, gold, natural gas, oil, financial etc.

Jeff.

Dec 31st and a new toy, TLM

Talisman Energy.

True to form I cannot leave well enough alone. I want options and to see what else works. I have proven my strategy workable for AEM, now SU and I would like to test it on one or two more so I have a total arsenal of four of varying prices to choose from.

I ran a new scan today for stocks between $10 and $30 with a volume over 500K per day. I ended up with about 40 stocks to choose from, cut out all the ishares and ETFs as well as small movers to pare it down to about 5. Then I concentrated on only the ones that had patterns that mimicked AEM, Suncor and the realted indices.

Cameco Corp (CCO) and Talisman Energy (TLM) were the only two that exhibited the qualities that I was looking for. CCO is about $20 and TLM is around $11 so I chose TLM for the ease of trading small if I so decide to really scale it back. Both are energy related, TLM more so...but enough of this boring research, they follow the indices in the intraday and daily scales and that tells me as much as I need to know.

I checked the pre-market posturing for TLM at 5 minutes before the bell and decided that it sould start down and best to concentrate on long positions today...so long as soon as it looks good. Rather than playing the quotes as hard as normal I decided on a technical entry based on the primary pivot point (horizontal blue on the chart) as that looked to be where the price was going to head for very early. I was not disappointed. Long was the play so I ended with two trades, but only because I didn't hold for the whole long move when the price wallowed.

Of course the targets were the 200sma and R1 but I didn't think the 200 would hold. The R1 was at $12.15 so this was the real target for the morning. I set my limit for 400 shares at $11.70. Keeping with the more technical trade I exited on the pullback when it was just above $11.93...volume was very high and the price hovered, usually a good sign to bail if it is on my mind I find.

Trade 2 was a no brainer as the consolidation at about 0950h was getting ready to break. 400 shares at $11.85. I kept in the trade and waited for the 10sma to break or the R1 line to be hit...although the volume dropped off to nothing between 1025h and 1030h...1029h was the best exit. I wasn't paying much attention to the quotes so I was not sure what my exit would have been exactly so I just took the low for the minute I exited at $12.11

These were bigger moves than I was really thinking I was going to get.

Results:

3.74% return on trade

The 400 share trade is part of my plan to have the whole portfolio on each trade, or as close to it as can be managed with even lots...which is why a smaller price stock is actually a better play while the account is small. It lets me play smaller if I need to, scale into and out of questionable trades and take advantage of smaller moves.

So, let's compare this with the possible trades with SU.

This day was not tracking the pivot points as PP is on the chart and R1 and S1 are no where in sight. The same opening was expected though and this is a typical gap fade style of trade. So long off the bottom based on the pre-market quotes. I half expect that I would have missed the first nice trade of the day though so the rest were a fight for pennies and at best 10, 10, 15 and 10 cents per trade. 200 shares is the only reason these were profitable as the commission is $10 per trade (round trip).

Results:

1.2% return on trade...with the fighting for pennies I would have stopped at 4 trades.

Out of curiousity had I managed to get into the first trade where I might have...had there been more technical indicators lining up to make that decision, $23.10 to $23.40, roughly another 30 cents per share. I expect that I still would have stoped at four trades so that is only another 20 cents per trade overall. Still not a bad day and it would have met my goal.

All in all I am looking forward to trying my hand at TLM for about a week as I apply and wait for my tax free trading account to get set up and funded.

Jeff

VT - buy and hold vs CTP

OK, So the comparison looks like the buy and hold crowd have me beat...but do they really? Let's de-construct the final numbers and see what we see. Keep in mind that I am working with a $5,000 initial capital investment.

I am on a bit of a bandwagon here as I have had some online discussions with active traders and investors and everyone tells me that I cannot produce the returns that I say I can. I don't generally spew inflated numbers, on the contrary, I will always fudge the trades against me and understate the figures. For the trades I have listed here I believe that I likely could have pulled another $25 - $75 per trade ($200 - $ 600 or an extra 4 - 12%) while watching the stock price action and placing the trades. I only used the chart that you saw in the previous posts so it is rough.

This stock is uptrending so well that it actually is in favour of the buy and holders' numbers...so I thought it might be a good example.

Buy and Hold results

There could be two buy and hold methods applied here. The first being the addition of shares along the way which would appear to minimize the risk somewhat and make it easier to get started as only 100 shares are bought up front. Final cost is higher though.

• Start with 100 shares
• 6 trades
• 600 shares today, average cost of $11.58
• yesterday's close = $14.73, paper profit = $1890.00
• capital used for this = $6948.00, the entire capital plus some margin (borrowed money)
• Return on investment...on paper = 37.8% over 10 months, annualized that would be 45.36%
• Potential loss at the start = $150 and it remained so until right near the end.

Buying 600 shares right off the bat would have gained = $2838 BUT the potential loss off the bat would have been $900.00. It would have also required $6000 up front.

• Start with 600 shares at $10.00
• 1 trade
• yesterday's close = $14.73, paper profit = $2838.00
• capital used for this = $6000.00, the entire capital plus some margin (borrowed money)
• Return on investment...on paper = 56.76% over 10 months, annualized that would be 68.1%
• Potential loss at the $900 or 18% of the initial capital. the break even time would have been about late December.

CTP Strategy


I used the same buy in numbers for both styles and for the shorts I applied, more or less, the same fudge factor. This makes it as even as you can get when comparing different strategies.

• Start with 100 shares, and only ever trade 100 shares of this stock
• 8 trades
• yesterday's close = $14.73, paper profit = $173 (only 100 shares still active)
• Realized gain = $1075.00
• capital used for this = $1450.00 at the most
• Return on investment...on paper = 24.92% over 10 months, annualized that would be 29.9%
• Potential loss at the start = $50 and it was only ever that at the beginning of each trade

Ok, so they have me beat unless you consider that I could have bet the farm just like the buy and holders did...plunk $5K down and run the numbers again. I will do one trade and then just give the numbers for the entire run.

• 1st trade - 500 shares @ $10.00, stop at $9.50
• P/R = 4:1 still, potential loss = $250.00
• stop out at $11.50, realized gain = $750.00 (that's already a 15% return)
• the previous gain can fund the next trade at $12.50 without using margin
• final total gain of the trades = $5375.00
• Return on investment = 107.5% over 10 months, annualized = 129%

Hmmmm....makes one wonder.

I am not a gambling man so betting the farm is not in the books so instead I know that I can afford about 4 active trades of 100 shares each. The return might not be stupendous per trade but it's the percentage return that is important. Even if half of those trades had gone wrong, and not the small ones, I would still be up $2500.00 or 50%. I like those odds better then having the one single trade go wrong and loose accordingly.

The other advantage is that this stock is going up...buy and holders either lose money or sit on cash while the stock goes down...I trade it and make money even in the rough times. So a downtrending stock can be at least as profitable as an uptrending one.

Had the buy and holders used only the 100 shares to invest like I did then the numbers are much different. Something like a 10% gain overall. Even spread over the 4 or maybe 5 active trades if they all went in their favour might produce 50%....I think it unlikely though as the stock does not consistantly move like this one has over the very long term. That and I may have a few bad trades but they are less of an impact as there are profits taken often.

Having said all that there are some stocks that are real gems and they are super performers...trying to pick them is the key ...and a very elusive one at that. So I do not try to pick them, just trade the charts, take some profits and maybe keep my eye out for a stock that might take off to concentrate on.

I hope this was, at the very least, entertaining.

JD.