Monday, March 19, 2012

bull signs

i am bullish on this market. i think we are about to see some shock and awe. here's why:

firstly, it is just the season for putting money to work in the markets. people are getting tax refunds and seeing good results as this quarter draws to a close. here's a seasonal projection of SPY:

the dark blue projection is a seven year seasonal average and is anchored 10 bars back. the purple and green projections are 5 year seasonal averages. the purple one is anchored on monday's close, while the green one is anchored 10 bars back. these 5 season projections are right on top of each other and trading above the 7 season projection. this tells me that the season is trending to higher values and we are on track for a repeat performance.

now the other signs that are figuring in my thinking are that utilities got whacked pretty hard last week. here's my favorite utility, ED, sucking wind:

there was a high-volume exodus from ED last week and the same pattern for utilities in general. utilities are where people hide out from the market in bad times because they are relatively stable and pay decent dividends (4.2% yield.)

furthermore, the treasuries took a drubbing last week too:

this all says to me that there is an exodus from the safe/defensive investments in these final weeks of the first quarter. i am placing my bet that this is a rotation into risk-assets. so hold onto your hats people.

Sunday, March 11, 2012

butterfly stroke

at the li swimmers meeting this saturday i initiated a discussion about a strategy that is called broken-wing butterfly. so i just wanted to rehash that here briefly.

first of all it is necessary to understand what a butterfly is, so here's the basic recipe: buy an option at strike 1, sell two of the same kind of options at the next higher strike, and, lastly, buy an option of the same kind at the next strike above the options sold.

here's how the standard butterfly looks on the equity we were referencing, gmcr:
standard butterfly on gmcr

you can see that this is a low risk/high reward kind of trade but with low probability. one should expect to see these go out with a small loss most of the time. at the peak of the sweet spot centered on 60, there is the potential for profit of $228 and the more likely loss limited to only $17.

now to break a wing, we replace the most out-of-the money option purchased with the next further out-of-the money option. in the example above that would mean buying the APR12 65 CALL instead of the APR12 62.5 CALL. here's how this transforms the trade:

broken-wing butterfly on gmcr

breaking the wing transforms this trade from low probability to high probability. at the peak of the sweet spot this bwb will produce $268 of profit and the flat area below 57 is a $22 profit. the trade off is that there is now a higher risk to the trade with max loss of $228 occuring for prices above $65.

these bwb's only tend to price for a credit like this when implied volatility has spiked. in this case news was released that starbucks was coming out with a single-serve coffee maker and this caused gmcr to gap down.  that you can trade these bwb's reactively like this is what appeals to me. the strikes were chosen to place the sweet spot at the top of the gap, the theory being that that this is where gmcr is likely to find resistance. furthermore implied volatility is likely to decline as gmcr rises into the sweet spot which helps develop profit in this trade. for this reason, i am not sure it is wise to trade the opposite, a broken-wing put-fly, in reaction to a gap up. it is likely that they would not have the IV spike to be initiated with a credit and the tendancy of IV to increase with declining prices would work against it.

Friday, March 9, 2012

a high-class problem

those of you who signed up to tastytrade via my referral link - i thank you greatly. however, this creates a high-class problem for me because tastytrade does not share your information. if you would kindly email me at i will reply back with the import files i promised.


Thursday, March 8, 2012

nearly naked stock

one of the objections people have to selling calls against their stock is that if the stock starts to run-up then they get left spectating. this is unfortunate because equities only trend about 20-30% of the time. if you are not selling calls against your long stock then you are leaving money on the table and are most likely frustrated with the lack of profitability in range-bound trades.

i now have a new strategy, along the lines of my other nearly-naked strategies, that makes it so you can have your covered-call cake and eat it too by participating in up-trends.  the idea is simply this: buy a few more shares than you're selling calls against.

for example: purchase 150 shares of a stock you like and sell one 30-delta call option against it. now if the stock starts to move strongly above the strike of the call you still have 50 naked shares profiting in the run-up. you can let the 100 shares get called away thereby scooping profit off the table and manage the 50 naked shares as a runner, perhaps trailing a stop against it.

 i am now doing this with the few equities that i own the shares of. usually these are high-dividend paying life hedges, such as ED, VZ and XOM. now you have no excuses - sell some covered calls.