To Battle!

I've always believed that my ancestors had Viking blood running through their veins as I often find myself deeply affected by the lore of Rus. So, every time I get knocked down, a strong desire to rise and do battle infuses every inch of my being.

I have to tell you, we were quite wrong last week. Not wrong enough to really get hurt but wrong enough to turn a very healthy 6% return on capital for the last expiration cycle into a paltry 2%. Yes, we're up 2% for Jan cycle (we track our results in expiration cycles, even through our official reporting is on a standard monthly basis) , which is better than most money managers, but 2% is really the low end of things for our standards. The most painful thing isn't making less than we expected, it's making that much less because of one day that happened to be the last one!

However, this needed to happen. And looking back, I am very glad it did:

1. Days like that remind us of market's frequent vagaries.
2. Days like that reaffirm our faith in our strategy.
3. Days like that create excellent opportunity for the near future.
4. And, best of all, days like that wake up the warrior in all of us.

Lots of traders will take a step back here and let the dust settle. Sounds fine, but our strategy tells us otherwise. This is the time to be aggressive because this is where money can be made with high probability.

Why?

Several reasons:

1. Lots of fear on the street. VIX is through 14 in massively overbought levels.
2. Dow, SPX and NDX are down too far too fast.
3. Dow and SPX are at strong Fib support and "agreement" levels (when reached this fast, the probability of a strong bounce is very favorable).
4. The whole move was likely affected by expiration (indices plunged through several "worthless" strikes) and is likely to be overdone.

So, while I won't make any predictions as to where the market is going to go in the intermediate term, our fund is betting on a strong bounce early next week. Selling premium (vol) into this and getting long stock (this is the time where our model will condone down averaging) is the strategy of choice and it will take some nerves, but in our view this is the only way to game this situation.

Can the market break much lower? No doubt it can. Because that's how the game is played.

Cheers,
/Dmitry

Ask And Ye Shall Receive

Dow is trading at 10683 - exactly where the year started. We got what we called for sooner than expected, which again spells opportunity.

At this point we're begining to lean long 575 Feb OEX calls.

Cheers,
/Dmitry

Bloody Expiration

As of this writing, OEX is through 575 and Dow through 10750 on the way down.

Quadruple witching or not, I admit, we did not expect to see this much red today. The DIA 109-108 short spread looks terrible here and the only consolation we have is that we lightened up a lot on it at the down open.

Most of our short gamma positions are holding well into this slide even though many of them are getting close to the strike. This surely puts a bit of a damper on our performance for this expiration cycle, but since our main strategy is short vol/short gamma, that's the nature of the game. You take in lots of premium and then you give up some.

The most disturbing factor about this action is that OEX and NDX are through several major strikes - a possibility that the whole market didn't seem to be pricing in. I personally find this overdone in the very short term as it is a rare occasion for the indices to get so severe on an expiration following a long cycle of very benign action.

From a near term perspective this feels like a normal continuation of the Wednesday's leg down, which in our view currently amounts to an extended correction. Having moved this far it would be constructive to see the market trade just below the levels established on Jan 3rd (For the Dow and SPX), where a high-probability long signal would be triggered (in our prop model).

Overall, our stance is unchanged - with a market long bias and vol spiking, selling Feb put premium is warranted and as we wade through the bloody streets, that's our order of the day.

Cheers,
/Dmitry

Rhetoric Bias

Humans are easily swayed. That's why most of them will lose money in the game of uncertainty.

Case in point: lots of rhetoric lately on this move lower. Most of it will set a backdrop of apprehension to the current situation. We've felt a wave of it and honestly, it makes one feel twice.

Except that "feeling" is exactly where we all go wrong.

I'll make this simple, and I'll bet that I will be no more wrong than any other trader who digests news, gossip and company numbers for breakfast, lunch and dinner:

The market rallied, broke out and corrected. The correction is strong and scary, as it always should be to be deemed a correction.

As I said before, get longer.

Cheers,
/Dmitry

Yahoo! Armageddon

VIX is at 12.43 as of this writing. Funny that I mentioned just a few days ago that a level of 13 would be significant.

YHOO blow up wasn't altogether unexpected (even though we did get annihilated on YHOO spreads) and the ensuing market reaction wasn't unexpected either. In fact, YHOO in itself is not at all significant. Now, YHOO's impact on the market is far more interesting as the entire universe somehow perceives YHOO's news as the next Armageddon.

I respectfully disagree with the universe.

I am not a fundamentalist so I won't go into whether YHOO's report was in fact good or downright bad. But I am a "sentimentalist" and regardless of the underlying numbers it is clear to me that the market pays far too much attention to that company.

Which creates an opportunity.

First of all, VIX is "overbought", so statistically, this is definitely a buy signal (I don't care about if's, contexts, etc. Analysis paralysis is not my game.) However, from a fully proprietary standpoint, I'll say that the NDX-100 is down too far too fast, given the recent rally.

So, my bet is, we're going higher from here - at least for a while. I'll even add that it's a rare opportunity to make 10% in the next three days as theta decays at super-exponential rate.

Cheers,
/Dmitry

Action: Off The Highs

People are scratching heads here wondering what this action means. Old fear reemerges and erases the recent exhuberance. I love smelling the fear - after all, a big rally gets forgotten quickly when lots of buyers come in at the top and hold through a gritty drawdown.

So, how big a drawdown?

Well, if you are holding long deltas from the top I bet that you're beginning to feel real pain here. Here at Cadence we are holding long deltas from the bottom to mid-move and are experiencing a measure of mild discomfort. For example, we're short DIA 108-109 put spread many times over and as I am writing this, DIA is trading at 109. Of course, we collected lots of theta over the last week and a half so from P&L perspective there is nothing to complain about. However, regardless of where you got in, the point is that right now is when you have to make a decision to stay long or get longer.

Why?

Because had you no position at all, you'd be itching to get in. But because most people do (at this point), they are itching to get out as it is becoming painful to stay in.

Analogy: In the ubiquitous (isn't that amazing?) game of Texas hold'em you raise when someone calls your good hand. You raise because you believe to have a better hand (other reasons as well, but I am simplifying). That raise, by the way, could put you all in and will usually generate a palpable amount of fear. That's how you want it because you are probabilistically a winner when you make that play.

You just have to do that many times to realize the gain.

DIA is 108.90 now. My bet is, it will end up above 109 by this Friday's expiration. So, I raise.

Cheers,
/Dmitry