OptionPundit

Tag: option trading

  • Put Diagonal Spread- An Income Startegy to Play Downward Move

    The Dow has still been unable to regain the important resistance of 11,750 (few points here and there). It danced around that level for a while before falling like a hard rock. In this post, while I shall be sharing about Put Diagonal Bearish startegy, I shall also briefly touch upon current market state.

    Dow is around 11,100-200 and the next level of key support is 11,000 followed by the July 15th low of 10, 827. As I mentioned earlier, the real important area to watch is 10,697 or so which is almost a 50% retracement of the bull market that started Oct’02 on and peaked in Oct’07.

    I had earlier mention on how one can survive such a market. One of the key things I would like to highlight is that one needs to be very nimble in decision making these days. You can’t prolong the decision making. For instance- I mentioned that Gold was oversold, it bounced for a very short period but look at it now, it has turned bearish and now it is to test the level it took over 20 years to cross. I booked some gains, some losses (a lost vertical spread even for OPNewsletter) but since then I am in bearish trades for this.

    How do you play bearish moves while protecting for any potential upward move?

    Put Diagonal Bearish spread is one such a strategy that enjoys some excellent benefits and can be used when your analysis indicates that the price of a stock, ETF, index, or commodity futures contract has strong probability of going steadily (not abruptly) lower over the next month (s).

    This Put Diagonal option strategy, can be a debit or credit spread and can be done in multiple ways depending on how aggressive you want to be. This is a good trade to do with LEAPS in combination with short-term options. In the conservative strategy, buy an OTM (Lower strike price, e.g. DIA $105) Put with 60 days or greater to expiration, and sell an OTM (higer strike price e.g. DIA $110) Put with at least 30 days until expiration and at most 30 days less until expiration than the purchased Put.

    Here are some of the key features of a Put Diagonal spread-

    1. Because diagonal spread is essentially a vertical spread+ calendar combo, in most cases it is a vega positive trade. I’ll keep it simple and won’t into IV smile curves etc. With the fall in underlying, the average IVs generally rises. So falling markets are Put diagonal’s friends.
    2. As this is a put diagonal spread with bearish bias, it’s delta negative. Falling markets will general profits due to short delta.
    3. Since you are selling short options and buying the long option, this trade is theta positive. So as the time passes by you are making receive checks from theta every day.

    All key Greeks are in this trade’s favor. But one needs to be watchful. Watchful because even though it will make money when underlying is falling, it may lose money for that day. It only gains because of IV increase and with theta accumulation accompanied by partial short delta.

    When to enter– You have bearish expectations for the underlying asset, but you do not expect the asset price to fall too quickly. Pay as close to $0.20-$0.50 for debit/credit (excluding margin). But do note that there should not be a big IV skew between sold Puts and purchased Put. IV skew exist for a reason and implies that a big move probably is on the way. One also need to look at the risk/reward of the trade and selecte short strike where you expect the underlying to be at expiration.

    Decide when to exit- Set your exit rules in advance so you don’t have go through the emotional gyrations during panic hours. I generally prefer 15% gains for exit and 12% for loss exit but it also depends on where the underlying is in relation to expiration date. IV also plays an important role. If IV keeps falling spoiling the risk/reward, there is no point in continuing to keep the trade unless I think IV is about to rise.

    Adjustments-
    You may roll the short options to next month if you are using leaps/longer term options for back month. You may convert it into a calendar, vertical or double diagonal. There are various options which will be applicable depending upon the time to expiration, underlying position and IVs in addition to your outlook about the underlying move.

    Key watch-out– It’s an excellent startegy and allows lot of flexibility. However, the success if this trade depends upon selection on underlying, selection of short strike, IV profile and risk management. A sound trading plan is required before executing this.

    Continue to watch this space, I may share some trade ideas as we are going through this bear market. Feel free to add your comments or question to know more about the strategy.

    Profitable trading, OP

  • POT (+54%), CF (+28%)

    Before market opened I talked about Fantastic Four (POT, MOS, MON and CF) and to keep an eye for bearish strategy. Here are the intraday trading results of the two bearish play I used for my intraday trading set-ups (POT and CF). Though these fell even further, but double digit gains for less than 1 day holding aren’t bad by any measure.

    Few month’s back I had written about where we were headed and what were the key points. Those I still consider to be valid and something that my readers should be watchful. These are tough times and hence careful trading and due dilligence is of utmost importance.

    Profitable Trading, OP

  • Is It a Bear Market or a Bull Market?

    What kind of market we are facing these days? One day it is up, but to give-up all the gains next day. 200-300points daily move seems like a norm for Dow Industrial. It is a good market for directional players, yet it is a bad market for directional player. Delta neutral seems a good idea but with such large moves, at one point or other, your adjustments might be triggered that will be useless the next day. Though it is volatile, the Option implied volatilities are not showing panic to that degree yet. Is it a slowdown, recession or deflation (Yes, I am talking about deflation not inflation).

    What’s going on? Is it a short-term correction in an on-going bull market or is it a primary bear market? It is a trillion dollar question and whoever thinks they have the answer may want to have a reality check.

    So far, smart funds have been selling into the rallies and I think until there is institutional buying there won’t be any sustained upward move in the markets. According to John of Hussman Funds, the US market is trading on theme that largely overlooks the potential of a significant US recession. At the point of recognition, we may very well observe abrupt weakness in both stock prices and the US dollar. He mentions a “Jaw of death” between USD 5-Year swaps spread and VIX, indicating that stock market is too comfortable with the situation and there is no panic while credit investors are very nervous. And be mindful though, the official arbiter of the recession decision-the NBER- has marked the economy’s peak publicly an average of 7months following each contract’s start which means we are in recession, will be declared when then meeting in few months time and markets may not like it. Read more.

    Liobor-OIS spreads are warning another round of trouble and based on market actions it doesn’t seem that’s it’s going to settle anytime before 1st half of 2010. Former Fed Chairman Alan Greenspan said in June’08 that this spread, which is the difference between the three-month London interbank offered rate for dollars and the overnight indexed swap rate, should serve as a measure for telling when markets have returned to normal. A narrowing to 25 basis points in the so-called Libor-OIS spread would be viewed as a positive, he said. Forward markets signal that won’t happen until sometime after June 2010. The premium averaged 11 basis points in the 10 years prior to August 2007. Read More.

    Linked to same topic, Caroline Baum of Bloomberg is questioning “Are bond investors crazy or waiting to exhale”? According to her, Inflation expectations are so weighted down that investors are buying 10-year Treasuries yielding 3.8 percent with inflation running at 5.6 percent and great de-leveraging might be unfolding. She is further examining that business are not able to pass all the costs to the consumers and hence margins are being squeezed.

    According to Investech, this is the worst performance (decline by >11%) of S&P500 since 1940s for any pre-election period (till mid-Aug) when S&p500 fell by 19.9% (isn’t there an existing belief, that markets have smooth sailing in he pre-election periods?).

    There is also data available that says markets rallies leading into the election months. So let’s see if we are going to see that. The summer season is almost over, big traders will be coming back to the market and it remains to be seen if volume will pick-up? and in which direction? Other bullish argument can be made that in spite of barrage of bad news, day after day markets haven’t fallen apart. It has been absorbing all the bad news.

    There is no one answer. I shall cover more on the bullish argument in the coming days, stay tuned.

    I covered options expiration here. I shared POT with OPN members. POT was pinned at $170 and some members made profits to the tune of >50% in few hours time. These are bonus trades to the OPNewsletter subscribers.

    Profitable trading, OP

  • The Week Ahead

    A very important week is ahead that might set tone for rest of the quarter. Fed Chief Bernanke will be announcing on Tuesday via FOMC announcement that he has decided to keep interest rates same (my guess) as US economy can’t handle any hike at the moment. Rate cut it out of question.

    Though a lot of companies are going to announce earnings this week, here are few name that might see some significant movements- OTTR , OEH, HURN, BIO, NILE, PCLN, SNCR, WFMI, FWLT, KALU, AIG, COGT, CROX, DECK, HANS, INT

    PIMCO chief Bill Gorss says “This deflating supply of credit is in effect the financial market’s version of Mad Cow disease.” Read more. On the other hand, John Hussman thinks that once market recognizes that we are in recession, we may observe abrupt losses-

    The stock market certainly has experienced weakness year-to-date, but one of the important features of this weakness is that it has not been tied to any broad recognition of ongoing recession. Rather, the predominant source of weakness has been concern about financials and the mortgage market.

    This suggests that there remains an important layer of risk to peel away: presently, the greatest threat to the stock market is not the potential for further mortgage writedowns, but the risk that enough evidence will emerge to remove the lingering doubt about an ongoing recession. Once an ongoing (and in my view, probably deepening) recession becomes broadly recognized, we may observe abrupt losses as the likelihood of more sustained earnings disappointments and much broader default risk becomes reflected in one fell swoop.

    Whatever your perspective maybe, play it cautious. No single direction is a clear winner except that bears so far had upper hand. Whether it is a correction in the on-going long term bull market or it is a primary bear market, that still remains to be seen. I have shared my thoughts earlier and I am still holding on to those levels as primary indicator to tell whether or not tide has turned. At the same time, I would encourage my readers to read Adam’s perspective about bottom calling.

    Read this if you are looking for understanding impact of high IV on options’s greeks. OTB has complied some good lessons on options. If you benefit from the posts, don’t forget to support the blog via visiting sponsors.

    And of course, Olympics starts this week in Beijing China. A lot is on stake, national pride(s), sporting companies, travel companies and many china tickers are counting on business from Olympics. If those doesn’t materialize, we’ll see a show down on the likes of NIke (NKE). Stay tuned.

    Trade carefully, Trade profitably, OP

  • OPNewsletter (Aug’08) : +3.0% (Open)

    Another profitable week for OPNewsletter; both for income as well as speculative directional trades. Even though we increased out investment by 17% (to 48.3%) since last week, our returns also increased from +1.24% to +3.06% this week (including commissions). Considering what happened in the broader markets past week, I am pleased with these results. On a big picture basis, we didn’t make any significant adjustments to any of the portfolios since opening. No adjustment are expected for any portfolios till next week too.

    Other then income portfolio, all the directional trades also proved money maker with exception on ISRG intra-day. AMZN and AAPL both delivered > +20% for 1 day holding periods. POT 230 Put directional calendar is also profitable. In fact I shared a list of expected “Big Movers” that I was analyzing and POT, AMZN, WFR, AAPL, CMG, BIDU and many more moved huge %.

    Few testimonials from OPN current subscribers-

    I have been an OP Newsletter subscriber for about 3 months. I’ve been trading options for 2 years.

    I am extremely Happy with my subscription. I have taken most of OP’s suggested Income Strategy trades and they have been overwhelmingly profitable. The ones I did not take, due to travel or just plain second guessing, ultimately turned out to be profitable as well. LOL.
    Most of the spec trades that I’ve taken have been overwhelmingly profitable as well.

    OPN differs from other Newsletters in that OP provides timely, suggested adjustments for his Income Strategy recommendations. He, or other subscribers, are quick to answer my questions. This keeps you in the trade with an expert assisting you, and teaches you how to trade these strategies at the same time. In addition, I have found OP to be very responsive to questions as well as feedback.

    I’ll be happy to answer any questions you may have.
    Feel free to contact me at smrusso@aol.com.

    Sam Russo
    Boynton Beach, Florida

    Thank you for the vote of confidence Sam. It’s members like you who keeps the community growing and learning from each other.

    Hi OP,

    I find it hard to put into words the value of the service you (and the whole OP community) offer the individual retail trader and investor. In my opinion, this style of options trading is the only path to consistent and repeatable profitability. I also have not found another service that puts all of these strategies together the way that optionpundit.com does. It feels like a true group of friends and peers that are learning and growing together, not just someone taking our money and throwing out trade ideas. I sincerely appreciate the time and efforts you put into your service for your members, especially at the price you offer it for. True knowledge is priceless.

    Thanks Again,
    David Castello
    Ormond Beach, Florida

    Thank you David. I appreciate your feedback. I hope OPNewsletter continues to deliver rather exceed the expectation that members have from it.

    Another interesting learning happened while I was playing WFR earnings with a bullish perspective. I landed in the worst case i.e. Stocked gapped down hugely vs my expectations. To add to pain, I was also assigned on WFR 55s. Keep an eye on the blog posts for strategy concept and on the forum postings for specific trade with prices (OPN subscribers) where I shall share with you how I turned that worst case into a profitable trade.

    Profitable trading, OP

  • Pre-Market and Apple Update

    Even though the markets have been rallying recently I am not yet convinced. But I don’t fight with the markets and cautiously follow the turning points. Oil is down, Gold is down, financials are up and so is the transport. REITs are also starting to show signs of strength. Whatever you make out of it, be a little more cautious on every rally.

    Here are some names for pre-market activity-

    Gapping Up: NIHD, ISRG PHLY, CNH, WYE, GD, ILMN, WHR, WLP, and MCD

    Gapping Down: COST, CHRW, ZMH, VMW, BJ, ABFS, ADCT

    Apple had quite an amazing show. Before markets opened, here is what I mentioned to OPN subscribers for a bullish speculative scenario-

    AAPL- A Bullish trade. This is not for everyone. This is purely speculative and you my lose all your investments and hence capital allocation is extremely important. Nothing more than 2-3%.

    AAPL is down nearly $16 in the pre-market activity. Overall market futures are down as well, so expect it to be a bearish day…(except something interesting surfaces). I have generally observed that AAPL is good in guiding very conservatively and beat those nicely when the actual reports are shared. There is nothing majorly wrong in the results they have reported except the outlook and some concerns on margins. Which is what taking the stock down with it.

    I however think, $148-$150 area will prove to be a support area and within a few days it should recover some grounds and don’t be surprised if it fills the gap. (It may not results this way and that’s why I call it speculative).

    so a call diagonal, or a bull put spread or a bull call debit spread or bullish calendar maybe something good to look so that the risk is contained. BUT don’t do anything especially in the initial 30mins as you wouldn’t know if you are paying the right price (unless you are very very clear on the price you are paying is correct one). IV will also be tricky, it will be down but I don’t know when and how, specially for initial 30mins. Logic wouldn’t apply.

    So here we go, look for a bullish opportunity once AAPL finds a bottom today. And if you do make profits, book it, don’t leave for next day …profit taking never hurts.

    And rest is history now. After hitting a low of $146.5, it closed at $162. If you are an OPNewsletter subscriber, check out the “Directional (Non-OPN)” thread for my current holding on Apple. This was not part of OPN but a bonus one as part of speculative alerts. I shall update it when I close it today. We shall reapply similar strategy for some underlying in the up-coming days.

    Profitable trading, OP