Sunday, December 4, 2011

AGU Roadmap

 Luca Giusti posted a seasonal pattern for AGU and this looked pretty good on my seasonal projection studies for a Nearly Naked Put Diagonal trade. So I am documenting here the why and how of this trade which I shared on MyTrade.

First of all I have 'splaining to do on my seasonal projection studies. That mess of blue, magenta and green extending into the future are my seasonal projections. These are a graphical digest of the last five to seven years of seasonal behavior that I find to be relevent to trading. To build these I take the fractional price changes of the underlying equity from the same anchor date in previous years and average them together and then multiply the average fractional move against the closing price of the anchor date. This is done repeatedly for each future date to build up a projection line of average seasonal performance.

The top edge of the green mess is 0.3 standard deviations below the average projection and is only displayed when it falls 2% or more higher than the flat line. This multiple of the standard deviation means that 62% of the individual season projections fall above the green mess - a better than even chance for where the future price will go when business is usual. Also, the fact that the green mess tracks so consistently close to the projection through April tells me that AGU is strongly seasonal. After April it falls away from the projection when I anticipate the season to end.

Moreover, my seasonal projections help to indicate whether business is usual or not. In the roadmap above I show two seasonal projections: the blue line (a seven season projection) is anchored 10 trading days back and the magenta line (a five season projection) is anchored on the most recent day. The fact that these two projections converge and move together into the future is a strong indication to me that business is usual for AGU, otherwise any recent trader knowlege of unusual business in AGU would show its existance by separating the seasonal projections because AGU would be off-track wrt the earlier projection.

This all suggests to me a bullish trade in my preferred style: the NND (Nearly Naked Diagonal.) In my formulation of the bullish diagonal, I sell a put in the front month at the first strike ITM and I use this value as a budget to shop for a backmonth strike to buy (usually a goodly number of months back, like 5 or 6, so we have plenty of roll opportunities.) I like to outlay between $1 and $2 for these trades or whatever I feel I can cover in the first roll of the short option. The April 62.5 Put fits the bill and I can put this -Dec70P/+Apr62.5P trade on for a debit of about $1.50 as of Friday prices. This would set my max loss to $9, which is well within my small-acceptable-loss tolerance but keep in mind that this max loss would only be realized if AGU were to go "Lehman" in the next two weeks. Barring that unlikely extreme event I will roll the short option for a credit and thus whittle-down the max loss exposure.

The roadmap says that AGU could rally up to the descending trend line of a symetrical pattern by the first week of January, where it might then fall back to the ascending trendline before finding support for a larger breakout. If I do see precisely this kind of behavior it may pay to buy back the short option that first week of January and complete the roll by selling February closer to the Jan expiration. However, it is of little concern if I don't see precisely this kind of behavior due to the power of the roll as there is wide latitude in the underlying equity price for which a short option can be rolled profitably. NND's are very forgiving in this respect.

Well that's the plan and I will keep you posted as to how reality measures up.


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