How Option Orders Can Mislead You – A Case Study with SYMC

• Posted by: stevenplace, July 29th, 2010 at 11:18 am
• Comments: 0

SYMC reported earnings yesterday, and the Street did not like what they had to say. The stock currently is trading down about 9%, and the options market was pricing in a move of about 5%.

The options activity, taken in a vacuum, was very bullish yesterday. The SYMC board saw calls being bot on the ask. Specifically, there was a trader that bot >18000 Sep 16 Calls on the ask (thanks @optionradar).

Source: Livevolpro.com

However, on closer inspection of the stock movement, we saw that the big order was tied to stock– about 560k shares. This made sense; the Sep 16C had a delta of about .30, and someone putting on 18550 contracts would have a directional exposure of about +560000. So instead of this being a screamingly bullish trade, this was a bullish trade on volatility.

At least that’s what I told reuters, you can see the article here.

The trader who put this on is currently at a profit of about 360k. Not bad in a day’s work.

Gold is Not Inflationary

• Posted by: stevenplace, July 28th, 2010 at 10:43 am
• Comments: 0

At least not right now.

The demand for GLD as a portfolio hedge can bet split into two sets of “crazies” — the risk aversion crowd and the hyperinflation crowd. The assumption gold bugs make is that at some point these two crowds will converge and GLD will be at some ridiculous number. But for the time being, we see GLD oscillate between the two. So when GLD was breaking out a month ago, it wasn’t due to inflation, it was due to the sovereign debt crisis and some euro voodoo.

Here is an easy way to see which camp has higher demand:

Source: assetcorrelation.com

This is a correlation between two etfs: GLD and DBC. GLD the most popular etf to gain exposure in the asset, and DBC is a commodity etf that has exposure in heating oil, crude, gold, natty, zinc, and others. Basically, when GLD and DBC are highly correlated, that means there is more risk of inflation, and when the correlation breaks down, it means we are in a “risk aversion” mode.

This can actually make for a nice long term timing of the market, and we’re coming down to levels in which I feel the risk for reflation could be coming back into play (maybe). A confirmation would be a drop in demand for treasuries.

So next time you hear someone trying to justify a position by the price action of gold, make sure to see if their thesis lines up with this chart.

July 2010 Results

• Posted by: stevenplace, July 16th, 2010 at 2:34 pm
• Comments: 0

Performance on closing trades, Jul opex cycle

My TraderInterviews Chat

• Posted by: stevenplace, July 8th, 2010 at 3:45 pm
• Comments: 0

I was recently interviewed by Tim Bourquin at traderinterviews.com– here’s how he describes the interview:

In this interview he talks about exactly what he looks for in great option trades. The essence of his strategy, which he discusses in detail, is to find options that have “mis-priced premium.” He simply finds options that are overpriced and sells them or underpriced and buys them. Easy enough, but how can he tell? He explains it during our discussion. Steven also uses chart pattern setups to find breakouts in equities and indexes and then trades those patterns using the options. I ask him specifically how he decides which options to buy or sell (which expiration, strike price, etc.) and how he decides his profit targets and stop losses. We also discuss a specific trade he executed – a bull put spread – which will give you a clear example of how he finds all his trades. Finally, he’ll talk about why he wants to take the other side of your trade. It’s an interesting ending to a very specific interview on trading options for a living.

You can listen to the interview here.

You Nailed the Bottom, Now What?

• Posted by: stevenplace, July 7th, 2010 at 1:59 pm
• Comments: 0

Let’s assume for the moment that you’re one of these stock market gurus who just happens to be able to buy at the exact bottom of a market turn. This doesn’t happen, but I want to show a method of taking profits that cuts your risk, your directional exposure, and nearly guarantees a profit.

The most recent low on the SPY was 101.13– for the sake of the argument and this lesson, I will say that I bought 100 SPY at exactly 101.13, because I’m a genius. The question is, what do you do now? Obviously, you could take a profit, but that would eliminate further profit potential. Luckily, you can do a call conversion, where you sell your stock and convert it to calls.

Let’s look at our initial risk profile:

Clearly, “Max Risk” is a little unreasonable, unless you pull a Prechter and expect the collapse of the equities market; however, it’s going to be useful in a second.

So what we’re going to do here is sell the stock, and buy a call. Specifically, we’re going to buy the Aug 105 Call. Here’s the new profile:

So what happened here? Well, you cut your risk in half (delta went from 100 to 50). You also rolled into a risk free trade, and while you have the risk of giving back all your gains, you also keep the potential for higher reward. The cash required got cut by a factor of 13, and you also get a gamma “kicker” by owning options.

If the market continues to rip and you do manage to pick up some long positions, you may want to consider this conversion as a way to manage risk in this market. After all, everyone was looking for Armageddon just 72 hours ago.

About that Head and Shoulders Pattern

• Posted by: stevenplace, July 2nd, 2010 at 10:26 am
• Comments: 0

One of the problems with purely subjective technical analysis is that it falls victim to all sorts of biases. Hindsight, confirmation and others can skew our perception of what actual market action tells us. And this is normal– odds are if you’re staring at charts looking for signal, you’ve got skin in the game, and you’re looking to speculate on market direction for profit.

Also, the signal is never pure– there are always observer effects. In a nutshell, that means a particular level or pattern or fibonacci retracement can become a “self-fufilling prophecy” if enough observers are acting on the signal. This exists in financial markets and can be measured by, well, subjective TA.

On this particular pattern, let’s look at some actual numbers by people who actually tried to quantify the head and shoulders pattern to see if there was any discernible edge in the signal.

On one hand, you’ve got Bulkowski’s pattern research site, which claims that the head and shoulders top is one of the more powerful patterns out there. You can see the research here. A high success rate, along with a high probability of a pullback to the breakdown level, are some of the stats that are highlighted.

Also in basic TA, you have the measured move off the chart pattern. The basic idea goes that you take the price difference between the high and the low of the pattern, and you get the expected target on the H&S. The target of the current H&S is about 86.

Bulkowski also notes that the odds of actually reaching this technical price target are around half, so the odds of this target getting hit are not exactly stellar– and I feel for this particular pattern, the odds are less as there are big levels of technical support from last year that should hold.

But there are other studies out there with different stats on the H&S. Carol Osler has done some great work objectifying the H&S patterns across various asset classes to determine whether it actually has predictive power. For example, when it comes to exchange rates, the H&S pattern shows great signal (pdf here).

But what about equities? In another paper, Ms Osler finds these results:

The identification of head-and-shoulders traders as noise traders is based on two empirical results. First, I show that the activity of head-and-shoulders traders substantially increases aggregate trading volume. In fact, the total trading generated by a given head-and-shoulders pattern amounts to one quarter of a days’ trading volume. This is important, because a trading strategy cannot serve as noise trading unless people actively use it. Second, I show that head and shoulders trading is not profitable. Like all of the major results of this paper, these are supported by numerous sensitivity analyses.

Source (pdf)

Of course even an objective study, when looking at historical patterns, can be subject to other biases, and the results could be drastically different depending on the execution strategy employed.

For this particular pattern, I’m leaning towards proper resolution of the pattern, but it will be messy due to other technical readings. Looking for a 2008 move, in my opinion, is misguided.

GLD Correlated with other Inflationary assets

• Posted by: stevenplace, July 1st, 2010 at 1:29 pm
• Comments: 0

To be continued…

Put Your Premium Hunting Caps On.

• Posted by: stevenplace, July 1st, 2010 at 11:43 am
• Comments: 0

I’m nibbling on some vol sales here.

June 2010 Trading Results

• Posted by: stevenplace, June 23rd, 2010 at 1:27 pm
• Comments: 0

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Volatility Correlation and Company Fundamentals

• Posted by: stevenplace, June 23rd, 2010 at 12:32 pm
• Comments: 0

One of the more interesting parts of trading options is how perceptions of volatility and stock price movement relate. Generally, when you see a stock move down, vol goes up; the converse happens on a runup. There are exceptions to this rule– for example if a name gaps up big and runs on earnings, the forced covering of option shorts will hold vol up as they have to buy premium.

This volatility voodoo is often labeled as human perception. However, there may be a fundamental factor that comes into play. Consider this exceprt from a post by CSS Analytics:

[...] changes in the stock price, whether rational or not, can have actual financial implications for a company’s cost of capital. But it does not stop there. Like any complex system, this process involves multiple feedback loops, where the drop in the stock price can cause increases in the cost of capital, which in turn can cause further changes in the stock price.

The whole piece is worth a read, and it goes into an explanation of snapback rallies in awful names, and how vol begets vol.