Live Options Trader

Vol Risk: Strangles Before Earnings

2006-10-18T10:25:00.000-04:00

The title really says it all and most of the traders who have lost enough money in the game know how vol risk works. However, it is nice to be reminded of it every so often.

Case in point being last night's IBM earnings.

As the sentiment was so upbeat and the stock quite overextended the obvious thing to do was to buy the 85/90 strangle. Historically, post-announcement the stock would either pop a lot higher or drop like a stone. Either of these things tended to happen quite reliably when the stock ran up or down into earnings and peaked on volume.

Since I like scalping gamma we put on a synthetic by buying Nov 90 calls and selling the stock. With the stock trading at 87.50 towards the end of the day, buying 30 calls per every 1000 shares sold short resulted in a perfect delta neutral position. So, any appreciable move in the underlying would result in long or short deltas automatically banking us a profit. Simple, naive and actually workable.

Of course I looked at the vol of the calls prior to buying and found it at 21 - above the mean of 17. So, the vol risk was there and it was quite probable the vol would implode post-announcement.

I just didn't think it would implode to 16.

So, when IBM opened at 90.60 the strangle should have resulted in a nice profit - had the vol stayed near the 19-20 level. Instead it actually lost money - not a lot - but enough to be reminded that vol risk is very real and is to be respected. Knowing what I always knew about this (trading 101) this morning made me feel like a little boy.

The stock did end up running to 92 and thankfully the strangle made money by the time it had crossed the 91.10 barrier. So, shedding the "little boy" image and turning into a temporary daytrader I scalped the slowly emerging delta as the stock got taken higher.

A nice profit overall, but a sobering lesson nonetheless: making money on this strangle shouldn't have involved my stock trading skills.

Bottom line: if you play long gamma/vega prior to an announcement, don't assume your vega exposure won't do you in. So, hedge it. And if you don't know how then don't put on the strangle.

Cheers,
/Dmitry

Oil Bear

2006-10-11T18:45:00.000-04:00

It's uncommon for me to get bearish after long and quite vicious declines. Goes against my adopted contrarian's grain. But, as a contrarian I look for nuances and while I saw these nuances in earlier price action in Oil (circa Sep 20) - that prompted a series of excellent trades on the long side - they have since disspiated and made the current decline unattractive.

Not that I'd go short right here but I am now bearish enough to sell a rally with an outlook for a few more dollars on the downside. That's what the commodity itself looks like to me today.

Now, let's throw in some equities into the mix and we see our favorites (VLO, TSO, NE, etc.) break down, rally and consolidate below their recent support levels. In addition, OIH managed to frustrate an army of both long and short players within the last six weeks and still stayed in a tough consolidation below its support.

In general, as dictated by our directional model, when support breaks and the price stops falling, it is a cause for alarm. Pretty contrarian, eh? The basic reason lies in the fact that if support break were fake, an immediate rally would ensue that should carry the price back above the broken level. When this does not happen, two things can follow: either the price continues to fall (naive but often true) or it stops falling and moves sideways.

When the latter occurs, the odds for a continuing move lower are quite high. Naturally, random events will alter any particular scenario but the overall odds over a large enough sample certainly favor negative price action.

Following this digression into trivialities of chart reading I no longer have a reason to be an Oil bull. And I have several to turn myself into a bear.

So, I change my mind. I change my mind because as a trader this is what I do.

Cheers,
/Dmitry

P.S. Does this mean I should be a bull on non-oil equities? Good question!

Selling Pain

2006-10-10T10:53:00.000-04:00

Another one of my infrequent posts comes in what I believe to be an opportune moment currently borne by the waves of the U.S. equity markets.

OK, that wasn't too poetic. In fact, the recent events are anything but - for us, contrarians, that is. However, when pain sets in and then gets worse, my battle-worn senses tell me that opportunity is very near. Just like in all the other times when an urgent need to spit blood prevailed over any other feelings.

So, I hear all this talk about the Dow setting a new high and the "educated" crowd crowing that inflation-adjusted, it is actually down 15%. Hence, the exhuberance is driven by ostensibly "fake" numbers.

Eh, maybe.

However, that's not what makes me an almost net put buyer. I see a few other things from my technically driven astral plane:

1. Put vol on many stocks, especially the leaders like GS has collapsed. In fact it collapsed (as in, below its mean) on many issues and that in itself gives a buyer an edge.

2. I see lots of parabolic rises often ending on higher than normal volume. If you don't know what that means, read one of Jesse Livermore's studies. You'll learn something trivial but also irrefutably true: trends tend to end after a prolonged move accentuated by a rise in volume.

3. I see no long opportunities from a contrarian standpoint. Meaning: if you like chasing things or buying breakouts, there are a plethora of setups. However, consider that one of my core put selling strategies is to sell puts in exactly these situations ... when put vol is high. See number 1.

4. I see nothing going down in a way that would make a value play attractive. I look at the markets all day long and I see waves of things running up. It's like an ocean with a huge tide consisting of waves that try outrun each other. The tide edges higher and higher. We all know what happens to tides.

Ultimately, I am not calling a big top. As a trader I am only good at calling trades and here I am calling a tradable correction.

BTW, having this view I think the best way to exercise it is via buying puts on individual issues (watch the vol) or selling stock if puts aren't available. Selling call verticals right here isn't a bad idea either. For example a GS October call spread (185/190 strikes) will yield 10%. Not bad for two week's worth of work.

Trade 'em up and watch your risk. The best way to make money is to make sure you keep it.

Cheers,
/Dmitry

Natural Gas - The Amaranth Signal

2006-09-23T19:20:00.000-04:00

We've all heard about the trouble and Amaranth and I won't regurgitate the news. My point is not to rant about the fund but to deliver a short observation:

It's the same thing as Oil. Looking at the technicals I see absolutely no reason to sell here and all the (technical) reasons to buy. Like I said in my previous post, we'll see these prices again.

It's a strong buy signal for a trade and Amaranth's "blowup" just made it a whole lot stronger.

Cheers,
/Dmitry

Oil: Capitulation?

2006-09-20T16:12:00.000-04:00

This is a big question and by the sound of it it seems to require a big answer. I am sure that with enough research of the sector's and the commodity's fundamentals, analysis of market order flows, comparisons to the past, etc., several strong, "big answer" views can be formed.

As a trader and by no means a well-equipped analyst, I will offer a small one:

December futures are trading at 61.70 and we are betting a large sum of money that we will be seeing this price again.

"Great!", you say. "You call that a view?"

Well, from my perspective, which has an extremely shallow, admittedly singular basis called "making money", it absolutely is. If I told you that there was at least a 95% chance that 61.70 was a price that we will be seeing in the future, would you consider that information as a tradable view?

To be fair, this really boils down to your trading methodology. One of the methods sometimes applied at Cadence is bottom fiishing (feel free to read my recent article posted at tradingmarkets.com that describes the strategy). In a nutshell, when an asset falls hard and fast after a prolonged decline (I am oversimplifying) chances of a near bottom being formed are very high. Obviously, a glace at the Oil chart that includes today's close will show a nearly perfect example of such scenario.

Now, knowing that the bottom is near, how is my trading view relevant?

It's less than immediately obvious. The easy part is of course that I am dead on right and Oil will go higher from here. If you believe me then you'll run out and buy a pile of Globex futures right now and enjoy your profits as soon as you decide that you've made enough. Now, the not so easy part is that I may be wrong, at which point the issue of risk management comes into play.

Well, here's the clue: I said that I have a high degree of confidence that 61.70 is a price we'll be seeing again. What I didn't say was that most likely, we'll be seeing it on the way up from below. Your profitability will be determined by how much lower we go before we revert to (and likely above) the 61.70 level.

This means that as long as your cost is not much higher than this price, you have a very high chance of being "safe". So, while you may not necessarily make money in the end, the truth is that you're very unlikely to lose much, if any. And, on average, you'll make ok profits.

Word of caution: there is that 5% chance that I am completely, obnoxiously wrong and we won't be seeing 61.70 any time soon. What to do?

The answer is simple if you reaize that this 5% chance quantifies an outlier. And, as all outliers go, the best you can do is cap it with a stop (just like you would with a long leg of a short options spread). Just keep in mind that your stop should respect the increased volatility levels.

Overall, I do happen to think that Oil is capitulating in the short term. I am also fairly confident that once it bottoms somewhere near here it has an upside of $6-8. But this particular statement is just for fun, because we won't be there waiting for the $6 profit to materialize.

That's just not how the game is played.

Cheers,
/Dmitry

Contrarian's View

2006-08-17T09:06:00.000-04:00

So bullish out there... And it was just a few days ago when the entire market was screaming "Inflation! Rising rates! Declining house starts! War! Terrorism! Deficit! National debt!"

Then suddenly the tone changed to "Well, we're not in the clear yet but this looks really, really good. The Fed is done. Earnings are great. Screw Middle East. Oil prices are lower."

Yes you've all heard all of this before. Why talk about this banal stuff?

Simple: for a contrarian trader this "stuff" is essential for spotting reversal points. The above are simply sentiment reads and, while admittedly very broad, are very indicative of imminent reversals. I don't want to beat a dead (actually, not so dead at all!) horse, but look at the Housing sector as an example. Mid-July was the perfect buying opportunity amidst trumpteted horrors of collapsing real estate and falling earnings. As crazy as it may sound but buying into that precipitous decline was the only way to trade the sector and those of us who have, have been greatly rewarded.

Going forward, a few things strike me from a contrarian standpoint:

The market is toppy overall but not toppy enough to get short. However, once a flurry of bulish retoric emerges, buying cheap index puts would be the perfect play. This is the only time I would actually warrant buying index options.
The Housing sector isn't done and the latest dip was an excellent re-buying opportunity. There is still a massive overhang of negativity which will produce more buyable dips. By the way, according to Adam, public has been buying calls in the sector in volume. By public I mean non-sell side such as hedge funds and individuals. Weird, huh?
Oil is being quickly forgotten and is nearing at least a temporary bottom. Look to get in below $70 (Sep Crude).

Cheers,
/Dmitry

Directionally Challenged

2006-08-09T22:07:00.000-04:00

We've been glued to the Housing sector. I admit, it's a bit of a marriage at this point - maybe not positionally (we're small long calls at these levels), but definitely trading-wise. I have a lot of reasons to like the sector and any "fell swoop" selloff is attractive. All the dips this far have been excellent buys with vol keeping its levels and even rising (I love owning calls and making money both ways)

Today's selloff is definitely attractive but I have to say that I got spooked by the trading volume. Our favorites, RYL and LEN sold off on nearly double the normal volume. The actual selling in and of itself was fine - the levels that were reached are very buyable, but when I look at the sector overall and bring the volume into the equation, I get excited about selling OTM call spreads.

So, here I am, bullish on the sector (especially at this level) and thinking to sell calls. Directionally challenged? Absolutely.

So, what do we do?

Two posts ago I made a recommendation that right now looks promising - buy gamma. One thing I am willing to bet a lot of money on is that this sector is going to keep moving and as long as you're willing to sit there and flip stock, you'll make money.

But, a little problem: RYL vol ticked at 52 today. That's the same level as it was when RYL made a big bottom in mid-July. Why a problem? Because two days ago the stock made a top. So, either this vol signals the end of the two day selling spike (which means it's about to implode), or it's going higher, which means we'll see lower levels in the stock.

So, taking that into account, gamma doesn't look so good.

Two things left on the table:

A sudden move lower in the morning on volume will make for a quick play to the upside. I recommend just buying stock if you willing to play at all.
If this selloff gets rejected by a sustained rally, further dips will become buyable again.

Sanity rests with option 2.

Cheers,
/Dmitry

P.S. I promise to get off this Housing topic soon as there are plenty of other things to talk about. But there is so little insight into this sector beyond the boring, regurgitated fundamental views and earnings report that seem to be carbon copies of each other, that I hope that my technical insight brings at least some new value.

Top Tick in Housing?

2006-08-04T12:46:00.000-04:00

If you're in the Housing sector, you are seeing a massive technical reversal on bullish news (supposedly the rate hikes are nearing the (at least intermediate) top, according to briefing.com). The top tick must be in place.

I think not.

If you bought this morning you're bleeding to death and hating it. Granted, that was the wrong time to buy. But given the slightly longer timeframe (days), this dip is an excellent buying opportunity. Maybe not today (actually if you're buying premium, definitely not today), but given a bit more downside (look for a breakdown on Monday morning), it's a dead giveaway.

Reasons:

The uptrend isn't over. Why do I say this? It's a tough questi0n and I don't have a full, satisfying answer. Let's just say, I've seen this situation (ala Housing) before and I'd loathe to bet against it. My best answer: uncouncious competence. Go ahead and laugh.

Technical reversal at this point is likely to be a headfake. It's just too book-obvious and every TA guru has got to be calling a top. Plus, housing sentiment and fundamentals are terrible, aren't they? To most people it will "feel" right to sell this thing - the odds seem to favor it. (BTW, the "seem" part is an excellent subject for discussion - I recommend reading Victor Niederhoffer's "Education of a Speculator" on topic of deception)

The crowd hasn't really caught on the exiting uptrend and any buying done up to this point had to be "quiet". Remember, just a couple of weeks ago the sector threw up all over the low bids, these bids got filled and the stocks stopped. After the initial bounce every down-leg was met with massive flows of new bids. Today these bids turned into offers and the first wave of the crowd bought. This "first wave" is key.

Caveat: I am not calling the bottom in the sector and I don't have a long term view. All I am seeing is that the trend isn't over and the next dip will be very opportune.

What do we do with options? My recommendation is to buy September calls that became OTM as of this afternoon. For example, this morning RYL 45 calls were ATM and gave back about 40% of their premium due to the dip. HOV 30's, BZH 45's all fit this category.

Additionally, if you're uncomfortable owning too much delta, convert it into long gamma and race the vol (which isn't pricing in imminent action). I think these stocks aren't stopping here (even if I am dead wrong on the direction) so, gamma will give you a more conservative, higher odds trade.

Cheers,
/Dmitry

Randomness Revisited

2006-07-26T12:17:00.000-04:00

Any seasoned trader will tell you that things in the market, as much as we don't like to admit, are mostly random. Don't believe me? Not a problem, I won't try to convince you and will let the market do that instead (that beast is far better at it than I am anyway). In the meantime I'll share two tidbits of information for your consideraton:

Read Nassim Taleb's book "Fooled by Randomness". Please read all of it, not just the first two chapters. I won't say it's an eye opener, but I will say that it throws a very healthy doze of reality into the trading game. It does this by quantifying some daunting facts and by disqualifying several persistent myths. This isn't the "top ten cardinal rules of trading" - there are so many incarnations of these "rules" that it's probably safe to fade them. No, this is a book about reality. I'd prefer you read this book and become disillusioned by the reality as a result, rather than remain blinsided and get hurt by it.

Below is a an interesting set of charts that show 100 trading days of two stocks. Here's what's fun about them. One of them is a real chart. The other is a purely random depiction of a random-number generator. Experienced chartists among you should be able to tell the difference but once you do, admit that the random chart does throw you a little. OK, maybe more than a little - in fact I am personally amazed by how "real" it feels. Granted, it is missing many nuances that we would find tradable, but the common patterns (straight out of the "Analysis of Stock Market Trends") are right there staring you in the face.

Frankly, after I generated a few of these I have to confess I felt a momentary wave of discouragement. Very momentary though! :) After all, I could tweak the code to generate even better "looking" charts - at random - and fool just about anyone. Heck, some of the charts look so real that I could count Elliot Waves and defend the count with the utmost, nearly frenetic conviction.

Then I calmed down and smiled. Yes, things are quite random and that explans the difficulty of it all. That explains the angst and high cost of entry.

But best of all, it tells you that once you're in you're not leaving any time soon.

Cheers,
/Dmitry

Chart 1
Chart 2

Housing Death Throes

2006-07-14T12:10:00.000-04:00

After our last foray into Housing options we decided to leave the sector alone as the action we had been seeking had not materialized. Namely, the sector imploded on high volume after a prolonged downtrend. The implosion came on June 6th punctuated by almost double the normal trading volume. Technically (and accordng to our model) it was a perfect buying opportunity. We got long a substantial number of calls (we chose RYL as the main vehicle) and even though we did see some upside, marginally profitable action, the real move we had envisioned never came. Those calls are paper now.

Today the sector is blowing up again. And we are doing the same thing.

Hadn't we learned our lesson? Yes, as far as risk management is concerned (or rather, our risk management approach was yet again validated). No, otherwise. This is precisely why we're buying calls again. Today the sector is not just oversold, it is utterly obliterated by the sellers throwing up their hands and screaming
"get-me-out-I-don't-give-a-rat's-ass-where-it's-going-from-here-it-hurts-too-damn-much!"

Some technical/sentiment facts:

The sector is through or at its weekly support levels.
It is blowing off on super-high volume after a non-stop downtrend.
This morning it reversed at a critial level (LEN) and stopped falling in face of overall market weakness.
It's got so much bad news that any more isn't going to make this swampy outlook any worse. (What, declining orders? Falling prices? Excess inventory? Higher rates? Too many ARMs? Wait, we know all of this already.)
The overall market is nearing an intermediate bottom and even if it decides to implode much further, the oversold stocks won't get that much more oversold. When markets collapse for the second time, it's the high-flyers that get thrown out for sale.

So, if the above sounds like I am trying to convice myself why the sector should be bought, then I just did.

Like it or not, that's what the price charts tell me.

Cheers,
/Dmitry

Good Scary

2006-07-13T09:21:00.000-04:00

Well, not too scary, but scary enough to sell tail vol and look for long index delta. The NDX-100 has equality at 1475 and the SPX is already in the buyable area. We're long some S&P futures and will look to get longer with the morning's dip.

The interesting thing about this morning's dip is that it appears to be a high-odds play to buy a 10 or 10:30 low. This of course will only come into action if the morning gap runs further down and has all the gap faders dump their short term holdings.

What does this have to do with options?

Well, if the NDX does get to 1475 or thereabouts, selling tail vol via front month OTM puts will have the right odds for a trade. The VXN will be up a tick or two and that will help pump up the fast decaying premium. Essentially this is a good example of trading on price extremes: the odds are actually quantifiable.

We're also looking to buy long calls on individual issues as/if they drop through round numbers. NTAP, BBY, CSCO (imagine that!) are good examples.

And for the short put spread types - hang on to your hats as we near the strikes and look for through-strike reversals. That's the last bullet (silver-tinted though) you have in your arsenal.

Cheers,
/Dmitry

Magic Number is 1255

2006-07-12T14:15:00.000-04:00

Nothing really majical about it - it's just a Fib confluence on the SPX. However, this level will result in a bounce and, more importantly, by the time it is reached the NDX-100 will be overstretched far into oversold levels.

BTW, the VXN is much "cheaper" than what it was when the Nsdaq made its previus low. Lower vol is generally regarded as less bullish, but I read this completely the opposite. We're "post-crash" and the anxiety jsut isn't going to get to where it was. Thus within the context of "exhausted anxiety", VXN spiking up to this level is actually bullish.

What we are doing:

Buying a bunch of oversold delta. The likes of NTAP, BBY, WHR, etc.
Looking to get long SPX futures for a trade.
Covering short deltas on previously overbought names (CVX, PG, etc.)
Selling vol on uptrending, but overextended (to the downside) issues.

No sector view, except that I do think Semiconductors are a probable play to the upside.

Cheers,
/Dmitry

Back From the Slumber

2006-07-06T23:13:00.000-04:00

Just like our wins and losses tend to run in streaks, so do my posts. A few people asked me recently about why I have a blog in the first place. After all, shouldn't an active fund manager keep his stuff to himself?

Short answer: No.

Long answer: I can tell the world exactly how we trade and it isn't likely to matter that much. By the way, the reason I say this isn't because I don't believe somone can't erase our "edge" - I think in fact they can. It is mostly because a player who is large enough to be able to do so isn't interested to trade this way.

After all, for example, catching falling knives with "unlimited" risk isn't going to hold up well with a prime broker's VAR model. Granted, I am a strong believer that standard VAR models are at best an indicator of potential risk. But, by that very virtue they often provide little value as to the real risk at hand. Since very few understand this (and this is only axiomatic to my own brain only), I bet VAR models will keep the larger players away from short tail vol/gamma strategies.

Now, as to why I have the blog - well, I like to share my views, my emotions, my successes and my failures. I also like to say things outloud (I often converse with my monitors) and execute my blabberings with real money. Trust me, when you broadcast to the world that you're going long Housing delta and then get your behind publicly handed to you, it's a doubly learning lesson. I don't like looking like a fool (and paying dearly just to enjoy its questionable pleasure), but I do like to get value out of every action I take. So, when I am wrong and the whole world knows it, I learn that much more.

BTW, yeah, Housing was a bad play. :)

We've done a lot of churning over the past few weeks and a few good things came out of it. One observation that I can make now is that the market feels "not so gloomy, and actually kind of happy" - a strange sentiment given that the NDX-100 is just 40 points away from its "crash" low. The S&P, Dow and Russell look a lot better though, so maybe that's where the sentiment stems from. No directional call here, although my gut tells me that we're going to make all-time highs on the Dow.

What we are doing here is buying deltas in beaten down issues that have good rolling trends. I think any downticks in things that have been hit (think MRVL, AZO, CHS, etc.) are good opportunities from the short term perspective. Also, any sharp corrections off strong, volume-driven moves up (LVS, CMI, FORM, etc.) create good short vol plays.

I won't do a breakdown of sectors here as I usually do as I currently don't have an opinion that I am willing to execute. For now I recommend treating this market as a basket of radom stocks that have their own behaviors. Of course, correlation is still there, is hardly avoidable, we all know that, so damn the torpedoes.

Good luck tomorrow!

Cheers,
/Dmitry

Market Crashes and Liquidity

2006-06-13T17:13:00.000-04:00

VIX is at 23.81 - more than double it's recent "normal" levels. Emerging markets are discounted by 30, 40, even 50% (Turkey, Russia). Inflation is a real threat, interest rates are an unstoppable freight train, the last outpost of income - real estate - is agreed upon as inevitably "doomed", Oil shortages, etc., etc., etc.

Question: In the backdrop of all these wonderful things, why haven't we crashed?

Answer: With all due respect, I think we have.

The reason it doesn't "look" like we have is liquidity. If we contrast today's sentiment to that of August 2000, when then Nasdaq bubble whooped out of existence, it isn't all that different. The only difference is the degree of maturity of the U.S. markets and ensuing liquidity. In short, no matter how bad the sentiment gets, there is still a continuous flow of bids out there. That's markedly dfferent from the dot com era when things imploded because noone was around to buy them.

Contrast this yet again to the newer "hot" markets like India and Russia and you get the familiar implosion effect: remove liquidity and the bids dissappear. This simple mechanism has everything to do with the amplitude of the resulting moves.

Bottom line: I don't think we'll witness a real "crash" in the U.S. indices. There are too many players on both sides of the fence and unless the whole world goes to war, they are likely to remain. That's why I still feel that treating emerging markets as an exaggeration of today's sentiment is proper; U.S. is really the same - we are just "saner" because we have more hands in play.

So, I think a point can be made that we did in fact "crash": the world did a real 1987 and the U.S. did a "mature" version of it.

Granted, in the longer term this will probably get worse before it gets better. But I think at this point you can bet on the "worse" part not being all that terrible.

Cheers,
/Dmitry

Concussion Morning

2006-06-13T09:56:00.000-04:00

Feels like a big concussion grenade went off overnight as this morning has a lethargic, jittery, hung-over feeling.

Overseas markets opened way down with Gold and Oil contributing to the carnage. Since the open the markets have been trying to rally, but the action is this sort of unsure, shaky, "I know I should buy but I am too hurt and bone weary to do it".

All this with no real bad news out. Granted, we have all this inflation talk, the Fed, this and that, but in reality, what's actually new out there? We knew about inflation for some time now and we knew about Housing for just as long (BTW, whatever they say, but in NYC area where I live the prices aren't budging. Whle am a bear on real estate I don't see ANY technical (price) confirmation to the whole "bubble" hoopla.)

So, either the bad news is there and it's simply not in print, or what we see is what we get and there isn't anything else coming. If so, I doubt this is going to get a lot worse. Judging by the looks of the emerging markets (I am specifically referring to India, Russia, Turkey, Japan and Brazil) it already has for them. And if we can view these markets as exaggeration of the U.S. indices (after all, they are much less mature and liquid - thus the 40% moves) then the U.S. will bottom out along with them.

The synchronicity is there - the world "collapsed" on 5/11. Could it be that it "finds the bottom" on 6/13? Possibly. After all, we have the world discounted by roughly 30% in just one month. Yes, it's a crash, yes, it's brutal and yes, it is constructive.

I'll probably speak for most of us when I say that we're "too hurt and bone weary" to trade this potential bottom. But recognize that you'd sure hate to miss it. And as you know, when the going gets tough...

Best of luck, folks.

Cheers,
/Dmitry

Throw-up Action

2006-06-08T20:37:00.000-04:00

This morning I felt I was going to throw up.

We're long a bunch of stuff and short a bunch of vol. Well, vol wasn't so bad since most of it (except for Oil) stayed out of the money. Long delta was another story.

Why are we long in this terrible mess? Because I know this is an opportunity that cannot be missed. It isn't every day that the whole world pulls a Y2K on us.

A lot of technical details can go into this, but the bottom line - the world is way oversold and according to any theory, buying this market right now is a high-odds game favoring longs.

However, regardless of my conviction, a wave of selling this morning made me literally sick. Now, I am not a puny guy and I can hold my water any day. Today I almost lost it.

Two things came out of it:

I felt sick watching money evaporate right under our noses. The money wasn't being lost, it was EVAPORATING. If you have any serious amount on the line, that is a sickening sight to behold.
I walked away, cursed in Russian (I rarely do these days - it's really vile) and came back to buy. We bought more Homebuilders and we bought Russia via RTF. And now I am looking to buy India.

Observations:

Risk managment is a wonderful, necessary thing. However, when the opportunity of this kind is here and the money goes against you, it's hard to get out no matter what your risk tells you. Reason: because when you're losing and about to throw up the opportunity is still there (and it's bigger than ever) and you #%^@^ know it. This does not by any means apply to every trade, but this does apply when you know exactly what's going on around you. You just have to have the balls to recognize it, face it and stick with it.
When long term charts show strong technical alignments (look at Fib ratios on Russian and Indian ETFs) and your long, time-tested methods underline an opportunity, you take it, and you take it big. As a trader you literally can't afford to miss it - especially if you've incurred losses leading up to it (most of us would, and we certainly have).

I don't know whether this is the bottom, but I know this needs to be bought for a trade. These are the odds, I may be wrong and I may still end up throwing up.

But, this is the game and as traders that's the one we chose to play.

Cheers,
/Dmitry

Enter the Reign of Chaos

2006-06-06T10:42:00.000-04:00

It's been a while since my last post as we have made a conscious decision to step back and reevaluate the current market environment. A big part of me is very excited about this market - as said on numerous occasions, this is the perfect trader's market and the opportunity that's in front of us is on par with year 2o00.

Now, when I say "year 2000" I don't necessarily mean that we should sell the world short. The reality is that noone knows whether the world should be sold short, but in all likelihood, there is going to be more pain followed by relief, repeated a few times over and followed by a steady recovery. That's what the history says. Of course, if you subscribe to the Elliot wave theory, then we are in the middle of leg "C" on the way down which should take us to all time lows in the coming years. The sky will fall, fire will rain and the seas shall engulf our peaceful existence forever. Enter the reign of chaos.

As a trader I don't care which scenario works out in the end (except for that falling sky bit) as long as we make money. Here's what on the table:

NDX-100 has rejected a very strong long signal with yesterday's sell-off. Unless we have any sort of reversal today, we have an opportunity to sell the index short. I fully expect it to take out the low of 1554 set on 5/24 and reach 1520. A couple of ways to play this: for income, sell 1525/1515 June put spread (you can get 15% on right now); for a directional play, sell the futures. I won't recommend buying options here as I don't have faith in vol keeping this level.
The Housing sector completely blew up and there are markings of a bottom all over it. I do feel there will be a serious reversal coming within the next few days and the recommendation here is to get long calls. Granted, Housing has been our bane, but consider the fact that we're going to be right at some point :) Joking aside, RYL July 45 and 50 calls are our vehicle of choice. Other stocks like PHM, DHI show very similar formations.
Energy sector has seen a lot of volatility and the way to play it here is to put on a few gamma trades (BTU, APC, KMG) and flip the stock. I doubt there are any directional odds in this sector worth considering. But you can bet on realized vol outpacing implied.
Gold has been in a steady, almost picture pefect downtrend after its big top. Whlie I have no idea whether this top will get taken out, I do think there is a trading bottom coming up close to 600 level on August contracts. We are looking to start buying it below 615.

Last but not least we need to consider the global picture. We track Japan, India, Russia, China, Turkey and Brazil. I won't go into particulars but will say that a lot of these markets have experienced classic crashes: Russia is down 30%, India is down 33%, Brazil - nearly 20%, Turkey - over 40%. China and Japan fared better and while down substantially, don't qualify for "crashes".

What this tells us that the emerging markets of the world had their first "wide" sell-off. It seems that with the overall global sentiment being strongly negative, the less mature markets took the largest hits. If history is any guide then we have a clear macro buying opportunity. Certainly I don't expect a U-turn and as I said before, more pain is likely ahead. But at least tactically, buying some of these markets will pay huge dividends down the line.

We live in interesting times folks. Again!

Cheers,
/Dmitry

Not a U-Turn

2006-05-24T13:36:00.000-04:00

Whatever reversal has occurred up until this point is now over and done with. NDX-100 posted a very promising rally at 1580 level and the brutality of what followed carried a truly ominous undertone.

We've sold most of our NDX calls into that rally and into yesterday's decline. The sales were not pretty and I have to say we're still reeling from the unforgiving and relentless blows dealt by the market.

Housing sector favored a bit better where several spikes gave decent exits to our long call positions but even then none were anything to write home about.

Something wicked this way has come and while I am as convinced as ever that this is a massive opportunity, I think it pays to take a safe stance and trade new lows as opposed to acquiring large lots in anticipation of a prolonged rally. The rally will come, but the idea is to remain at least solvent, if not outright profitable, until it does. :)

Currently we're cautiously selling credit spreads in Oil equities and some Housing names. Our long strategy is gaming new NDX lows for a trade.

Stay on your toes folks. This is a tough environment so don't let frustration cloud your judgment. Emotions aren't helpful in any market. And they are deadly in this one.

Cheers,
/Dmitry

1987 - Learn and Live.

2006-05-19T11:26:00.000-04:00

I'll bet that this week every serious trader is scrambling for historial charts. More and more so with every down day. The news is out, it's bad (even though we all "knew" this all along and it's not really news) and we no longer care because the "fundamentals" are known and priced in. We now just want to know what the hell to do next.

A corollary to the above could be that spotting market bottoms can be made easier by correlating load levels on historical tick servers to severe price action. I'd love to run a study on this if I could.

As our readers know our fund is quite long in this market via long calls and short puts across several sectors. Short puts are not bad at all; granted, some spreads are in the money but on those we want the stock anyway.

Long calls is a different scenario. We're huge on NDX and a basket of issues in several sectors. We're getting huger as our models tell us to do. And in general, looking at the technicals that's the only way I know how to trade this.

As I type this Marty Schwartz's quote from "Market Wizards" comes to my mind. When asked what he would do differently in the crash of 1987 if it ever came again, he responded (I am paraphrasing): "Nothing. The market was way oversold and the only way to trade it was to get long." Then he proceeded to lose a sizable fortune.

At the bottom of the crash he then recovered and made a larger fortune.
There is a lesson in this. Both in 1987 crash and Marty's trading.

The S&P right now (or as of last night) looks strikingly similar to how t looked in 1987. Same sort of right-off-the-top, relentless action that made the market look very oversold right near support levels. All of that happened during the expiration week preceding October 19th. Friday's down bar looks huge and even though I don't have volume data I can tell that it was a "blow-off" looking day. I'll bet a lot of people bought into that one. Marty did. And, the way I trade, I would too.

At that point the market was off almost 50 S&P points off its nearest peak in a non-stop free fall. We all know what happened on Monday. Specifically, the S&P fell an additional 60 points and ticked a few points below longer term (two year) support levels. Following this crash a rally of about 40 points followed.

Today, the S&P is off about 60 points in the same fashion as back in 1987 and we are near support levels. We haven't had a big blow-off day but the volume on 5/17 was double the norm so maybe that can qualify. At any rate, there is a clear possibility of a much larger decline dead ahead and if 1987 is any model then an aditional 60-70 point drop is possible. That takes us to 1170-1180 level which happens to be a significant support level.

By the way, I am using 1987 in nominal terms, not percentages. That may be wrong, but I am looking at what's similar about the markets. The scenario of 1987 is technically fitting and that's how I choose to look at it.

Now, we are surely not betting on a crash (see above), but we are very cognizant of that possibility. The way we're playing this is the following:

We are long and getting longer, but only to a point. I do think the probaility of a reversal is very high and we'll have a big spike up after the reversal. That's basically why we're long now.
If the market decides to crash then I suspect that 1170-1180 levels will be a zone of a massive buying pressure where it will be necessary to buy a highly leveraged position. I think the bounce there will be fast and agressive, followed by more downlegs. All of them will be buyable, even if new lows are made with every move down. What we intend to do is get a large futures position right after the open with intent to blow out of it after the immediate rally. Then, smaller portions will be averaged down on every move lower to accumulate a core position to capture a more sustained move higher.

If (2) happens it won't be pretty and large losses will occur. However, these same losses will spell a much larger opportunity and that's why powder must be kept dry for that occurrence.

Make no mistake, this is hard. So, prepare for a bloody one.

Cheers,
/Dmitry

Pin Risk

2006-05-18T13:20:00.000-04:00

For long players it's a real thing - having your underliers pinned to strikes. Happens all the time and I think that some of our holdings are experiencing the effect.

The point here is - if you want to buy here, wait till Friday close - there is no reason in paying theta (and vega with new shorts hammering the vol) by getting in at today's levels that are likely to be here tomorrow.

We're looking to pick up more size here but the above is keeping us away. Surely not a strategic decision but this close to expiration tactics prevail.

Cheers,
/Dmitry

Shadow of Death

2006-05-17T12:45:00.000-04:00

Scary, crazy, painful, but not-quite-jump-out-of-the-window (yet) action. Enough said. Two points I'd like to make this afternoon:

No matter how bad the news is (I don't know how bad it actually is as I rarely read it) or how bad the catalyst is for a move of this magnitude, the market always overreacts. So, technically, we are going to reverse and the revesal will be significant. This is what we are betting on right now. Now, whether the reversal will be lasting is a completely different question and as a trader I don't care to answer it.
The Dow and the SPX finally sold off after the Nasdaq made its headspinning slide - a tell that everthying is getting thrown out for sale. It's a good, bottom-forming fact. However, it's tough to time it correctly - just know that when "beta goes out of the window" it's a "crash" scenario and as we all know (or at least should), crashes are good. No, make that great.

At Cadence we're continuing to leg into this slide. In fact our prop long model tells us to buy new lows at this level agressively. So, we're sqeezing the trigger at NDX June calls, Homebuilders (RYL, LEN and others), Financials and a host of others. Anything quality will bounce hard and you want to be averaged close to the money when it does.

Homebuilding sector may be a bit of a misnomer when I say "quality". The play here is pure sentiment - so much bad news at once when the sector is so low without ay retracements is a dead giveaway (there is more to this, but even what I said is enough). So, there it is on the table -we're long a massive call position on the sector and we're getting longer. This is not a recommendation so do what you like with this tidbit. I am just putting our money where my mouth is (or is it the opposite?)

I should comment on Oil and Gold and will do in due time. Ammo for the next post. :)

Parting thought - no matter how bad this looks, please recognize that this is a huge opportunity. Let the fear not veil your logic. Something like - "... though I walk through the valley of the shadow of death ..." - basically, stick to your guns and shoot to kill.

Cheers,
/Dmitry

Scary, eh?

2006-05-15T14:23:00.000-04:00

Another down day and we're through support in a very meaningful way. Volume isn't there to make it a bone-rattling breakdown and thus I am still a buyer. Besides, (thankfully) we haven't bounced this whole time.

An interesting observation from the portfolio level view: many of our OTM put spreads are now ATM an the equities had to stretch to move the prices that deep. I think this is an important fact as I often see that when a large number of OTM spreads get brought at the money a reversal has good chances of occuring.

Before it begins to seem like I am really trying to reach for a bounce let me say that I'd be buying even if the above weren't true. However, having made the observation I have reason to get more aggressive.

Finally, the VIX is above 14 and if you follow Adam Warner's logic (I agree with him) this relative number is high - too high.

We're getting deeper into NDX, Homebuiders and Semiconductors. The reversal is near but I doubt it will manifest itself as a simple U-turn. So, hang on to your hats... and pants.

Cheers,
/Dmitry

Blood, I Want Blood!

2006-05-12T10:01:00.000-04:00

I am not as blood thirsty as I sound (well, I do have Viking beginnings) but the 10 o'clock reversal isn't satisfying. Two things:

The fact that the market bounced so easily means more pain is in the cards.
It would be a lot better if it hadn't bounced at all. As I said yesterday, NDX-100 running right through 1640 would be phenomenal.

Maybe it can redeem itself by stopping this rally and dropping right through the magic level. One can hope. However, a significant rally from here, will be foreboding and my "catch the knife (no, make that a sword)" mantra will change on the dime.

Trade 'em!

Cheers,
/Dmitry

With Chaos Come Clarity. So, Don't Blow It.

2006-05-11T18:32:00.000-04:00

So, the Nasdaq makes its second biggest downmove on the year and I immediately come across alarmist articles like this one (Next LTCM?) and this one spelling all kinds of horrors.

My analytical side looks at this and says, "that's why I don't read news". My cynical side (I like it more and more these days) says (with a big, toothy grin), "Damn, lovely!"

Regardless of the commodities explostion, oil debacle, Fed, debt crisis, phases of Moon and Venus and pagan gods of thunder, it is business as usual, folks. The charts are oversold, they are running at support levels at the speed of a freight train and as far as I can tell nothing has really changed in the world from yesterday. So, if you plan on selling once the support is broken you will achieve three things:

You will lose money. The more you sell, the more you lose. (I know, this is brilliant)
More importantly, you will lose confidence in your ability to play the game. The irony of "of course it came right back after I sold it - the damn thing is random!" will ring true and you'll reach for the proverbial towel.
You will blow the biggest opportunity of the year (this far) available in the U.S. equities market.

While you're busy hitting the evaporating bids (I honestly hope not), at Cadence Capital we'll do the following:

We'll be buying (actually, already are) June NDX 1650 calls. We're long just a few now and plan to buy more lower. A break below 1640 (especially if it happens tomorrow) will be a massive buy signal. Every low will be bought aggressively.
The housing sector is nearing buyable levels and we're beginning to accumulate RYL June 60 calls. LEN 50's will follow shortly.
Oil stocks should be sold here and we'll do that via put purchases. None initiated yet but we'll sell upticks.
Gold is done for now. Nonethelss, going short here is a tough call and as crazily aggressive as I am, I can't pull the trigger. However, we'll sell any new highs via long ATM puts.
Semiconductors - be discriminate here as the sector isn't as unified as it used to be. We like MXIM and KLAC. I think MXIM is a huge trader and KLAC is right behind it. Long calls on both of them. LLTC, SLAB to follow.
Japan and Russian markets had a nice sell-off from their tops. I like Japan more than Russia from risk-adjusted returns standpoint. However, if you have the nerve, buy Russia here and smooth it out with a portion of long Japan.

You'll find it funny that the above "to do" list comes from an almost net premium seller. I have to tell you, I've learned to like being long. There is something about making money at supra-normal rates of return. I found that I don't mind the (sometimes crazy) risk, the drawdowns and occasional fits of anxiety (ever felt nauseous after making money?). Hell, we're traders and it's a part of the game.

We take our lumps and deal with the pain. In the end it pays off. Big time.

Cheers,
/Dmitry

Not For the Weak

2006-05-11T15:41:00.000-04:00

Far too busy to write a detailed post on what's going on, but in a sentence, this is an amazing opportunity. While I am not screaming "buy!", I think we are nearing a level where not buying will be both strategically and tactically the wrong thing to do.

Specifically, if NDX breaks 1640 in one fell swoop, a properly controlled cost averaging long NDX call strategy will make a lot of money.

Our fund is already leaning long on the index, but only a little - I think more downside is in the cards and this really isn't going to be easy. Regardless, the opportunity is here and the strong hands are going to make a kiling.

More on this later.

Cheers,
/Dmitry

Will the Dow Make a New High?

2006-05-05T14:53:00.000-04:00

Observation 1: Of course it will. Observation 2: Who cares?

Having satisfied my cynical side, I think the Dow making a new high will be an excellent newspiece and if anyone should care it would be us, options traders.

From one point of view, the index is meanigless to my style. From another, a new high will mean more realized volatility (and maybe even lower implied) and the break higher will inevitably be followed by a tradable breakdown and then yet another rally higher. All of these moves will have implications on individual issues and create a lot of exploitable price extremes.

Contrarians will have their field day.

This market is positively giddy. TOL said Q2 will look bad. Fortune said construction landscape looks bad and the builders are up. Gold and Oil are screaming and the S&P is up.

Giddy about what? See Observation 2.

Buy those dips and leverage into breaks. There is money to be made.
A whole pile of it.

Cheers,
/Dmitry

Big Oil

2006-05-04T10:06:00.000-04:00

If you want a perfect gamma trade, we have one right in front of us. I am convinced that the spot is going to move violently from these levels and while I can't call a direction (yet) there is definitely an outsized move brewing. So, a synthetic strangle on the futures is the game in town.

But I think there is even a better way. While I am an options guy, I am hell-bent on playing direction. In fact as I mature and accumulate battle-hardened emotional scar tissue I become more and more direction oriented. Because even though it's a tough, damnably tough game, that's where the real money is. Damn the hedge.

Watch the spot to rally from here and stall around 73.5 level (June contract). That's the inflection point (yes, it's a 5/8 Fib node). A slide from there is a short signal. An aggressive rally above is where you get long. Also, for super-aggressive types, it would be at least probabilistically correct to get short right here (71.44) with a quarter size. The reason I won't do that is that my gut tells me that this is situation is actually going to end up a long trade.

Or, sell the future and buy the options. Much less risk and a highly probable return. That's money too.

Cheers,
/Dmitry

Long Options: The Realm of High-Multiple Return

2006-04-30T17:16:00.000-04:00

I've been talking more about long options lately. Maybe it's because the vol is so knocked down that short premium is tougher to find (at the same time I am a firm believer that as long as options exist there will be a reason to sell them) but more likely it is that the long side of options has that unbeatable advantage: high-multiple return.

To avoid any confusion, let me immediately state that when I talk about long options I always talk about naked calls or naked puts and I always put that into the context of directional trading. Other well-known ways to trade the long side exist, such as long gamma and long vol. Those are rich with their own merits (sometimes long gamma is such a good trader that I shun any other method) but in retrospect, from both personal and historical perspectives, the most money on the long side was made betting on direction.

Admittedly, the most money lost was the same way.

There is a lot to be said about playing direction. One thing I won't do is go into details of a winning strategy (I made a foray into that a few weeks earlier and found it to be a non-rewarding experience. Giving someone a fish really is a fruitless exercise.) and would rather talk about the necessary ingredients of coming up with and executing a successful one.

Generally speaking, a trader is very rarely right. If you don't believe me then you haven't traded seriously or long enough. You may also have been incredibly lucky (long runs of being "right on the money" indeed happen and are completely in line with randomness, given enough of a sample space - something that we certainly have if one considers the number of financial deaths paving the steps to greatness). Now, since successful traders do exist, being right obviously isn't a necessary requirement.

So, being wrong is acceptable but it bears to consider how wrong a trader is allowed to be. Let's consider a standard cost-averaging strategy where being wrong is allowed (and in some cases even encouraged - yours truly is a practitioner of one such case): some amount of an asset is purchased at some cost with the outlook of further prices rising. The expected rise does not occur and the prices drop instead. An additional amount of assets is purchased. Shortly thereafter the tape prints a limited rally and then leads even further. A third lot is purchased. Another decline. The asset is now showing a sizeable unrealized loss.

Immediate observation: If you haven't been in this situation, you probably haven't traded enough and certainly have not made any serious money. Reason below.

Necessary question: What does a trader do?

The answer is not simple and it depends on two things:

The percentage of total capital in jeopardy.
The integrity of the existing trading context.

It's really a balance of these two. Other factors such as fear, heart palpitations, dry mouth and visions of doom don't enter the picture. If they somehow do, please get a lot more money and continue trading. It makes my (non-writing) job a hell of a lot easier. And if this suggestion upset you (because you think I am a pompous asshole) then financial world has a better place for you - behind a desk as a stock analyst.

My "black book" says that the amount of total capital in jeopardy should not exceed 25%. To most of you this is going to sound crazy since we're taught to never risk more than 2-5% of our accounts. The reason 25% is my choice is that this number factors in the fact that a strategy (consistently executed) loses very rarely (this is a trivial function of mathematical expectation based on frequency of wins vs. losses and average dollar amounts won or lost). So for my strategy an occasional 25% loss isn't at all terrible. However, it should be rare that a 25% unrealized loss is even a reality - mainly because of the second point - the integrity of trading context.

This point is fundamental. As you buy into a situation you must be absolutely assured that the context leading you to buy has not been compromised. The minute it is, you will blow out of the trade and move on. To make sure the context has not been compromised you must have it defined as concretely as possible. This is never an easy task and it is very often extremely subjective. So, test your strategies well. The main point here is that your trading context should dictate whether to get out of the trade or stay in (or get bigger) way before your money does. So, if you're seeing a 15% loss of your equity it is well if your definition of a proper trade is compromised by the market. That way you know you're getting out for the right reasons and not because your bank account can't stand it anymore.

From the above it follows that if you trade on the long side, be prepared to withstand substantial swings in your unrealized P&L. If you trade a $100K account, you should have no problem in seeing a $10-15K unrealized loss and staying with the trade - so that you can make the expected amount. Obviously, the bigger the swings the more you'll make. Again, this is a function of your strategy.

As a parting thought, as you progress always be respectful of ruin (study it and understand it), but don't be afraid of it (put your money on the line like you mean it).

Cheers,
/Dmitry

BBH: What a Mess!

2006-04-26T10:52:00.000-04:00

BBH opened down over 7 points today. After the initial shock it became crystally clear that we were hit with yet another contract adjustment. According to CBOE:

"Biotech HOLDRs Trust [...] has announced a cash distribution resulting from the merger of Chiron Corporation ("CHIR") and Norvatis AG ("NVS"). The distribution will be $7.66435 in cash per BBH share held of record April 28, 2006, payable May 2, 2006. The ex-date for the distribution will be Wednesday, April 26, 2006."

So, BBH closed yesterday at 181.40 to open this morning at 173.08. That's the per share "cash" adjustment (more or less). All the old options are priced off the "fake" underlying modeled after BBH+$7.66. Fine, fair enough.

Now here is my gripe: Forget the options, but the chart is now broken! We have a huge (and totally meaningless) gap between Tuesday's close and Wednesday's open and I'll bet most quote vendors won't "fix" the chart - because there's nothing to fix! After all, BBH is priced correctly.

What to do? Get your own charting software. Build it if you have to. Because you're in the business of making money, not giving it away.

Cheers,
/Dmitry

Oil Puts Overpriced. Totally.

2006-04-25T14:36:00.000-04:00

Doesn't take much analysis to figure this one out. Granted, alot of Oil companies are reporting earnings within the next two weeks and that pumps the vol. However, does the market really expect a bad Oil quarter?

HYDL is a decent case study. Good earnings and the stock is off about 8%. Common with earnings driven by a commodity sector. My bet is any further decline will be driven by Oil prices (I am a temporary bear) and any such decline will be short-lived at best (I am long term Oil bull).

Look at EOG 65 line. Front month puts are offered at 0.65 with the next strike down covering your short for 0.20. Lots of other examples as well.

Having said all this, I'd be much more excited if a long call opportunity presented itself. I think it will, but not just yet.

Cheers,
/Dmitry

What You See is not What You Get

2006-04-24T22:40:00.000-04:00

I have gone out on a limb and called an Oil Top a few days ago. Today I still stand by this call. In fact, I stand by this call not only because our fund's money follows my mouth but also because we are at a high-odds inflection point in commodities and equities markets.

And when such points occur, being wrong is almost as good as being right. You make money either way.

More specifically, the Oil market rejected a massive short signal on a monthly timeframe and ran up an at accelerating (nearly parabolic) pace into a new high, where the 75 or so area was achieved on a significantly increased volume. Since my call of the top we had two big reversal days confirming the blow-off. The right way to position here was to up-average long puts on most things Oil. Today you should be sitting with a nicely sized position at cost with minimal, if any loss showing for it. BTW, in case you're curious, Victor Niederhoffer, if he were trading these days (he probably is), would be doing this exact thing.

Now, with the Nasdaq recently putting in a new 5 year high (BTW, this is technically as good as an all-time high) and failing to follow through on it twice (failures on 04/07 and 04/21) we have a double top in place.

So, Oil is at a new high (naively bullish) and the Nasdaq has a double top (naively bearish). A perfect contrarian setup. Naturally, my expectation is to see the Nasdaq refute the double top and the Oil to tank. This scenario would generate a very strong commitment to further direction (equities up, Oil down). If case this does not occur and the Oil continues higher then the Nasdaq's double top will likely prove true (sadly) and commitment in the opposite direction will become a necessary choice.

Patience, once again, is a virtue.

Cheers,
/Dmitry

Alert: Oil Top

2006-04-18T13:48:00.000-04:00

According to our model June Oil Spot is right near (72.30) its intermediate top. This is a technical short signal in an overall uptrend that we expect to continue on a longer time frame.

What we are doing:

We're short ATM April put verticals on many Oil names with expectation of pinning and dip buyers coming in with every new opportunity.
We're buying May ATM puts on select names such as our favorite (APC) and several others.
We're looking to sell QM May NYMEX futures near these levels. In fact, every new move higher should be met with selling.

This is super-aggressive and extremely contrarian. According to all the hoopla surrounding commodities, this feels right.

Cheers,
/Dmitry

Weird Options: Dealing With Spin-Offs

2006-04-13T11:31:00.000-04:00

Market blurb: Given the recent break the indices have held up well and my get tells me there's strength in them. That strength is likely being held down by the usual expiration factors, so even though I am bullish on the broad market, I'll hold any move suspect. After the slide we sold a set of put verticals on NDX-100 and OEX and left it at that. I am also putting our fund's money into long OEX May 585 calls on downticks with a view at a run higher after the expiration sorts itself out (as described in my Sunday post).

Here is a bit of trivia: what do you do when you hold options on a stock that does a spin-off (meaning, restructures a part of itself as a different company)? As a member of a market making operation some years ago I had to deal with sort of thing (and other kinds of annoying corporate actions) all the time. However, after having founded Cadence I luckily haven't run into this sort of a situation for a long time... until now. Here is the gist of it:

I sold some KMG (Kerr-Mcgee) 105 calls a while ago and a few weeks later found these same options in my portfolio under a different symbol than I remembered (the root used to be KMG and now it's KMO). More importantly, these options suddenly became much more expensive than what I paid for them, even though KMG (the underlying) hasn't changed in price all that much. Or so it appeared.

Of course after a minute of gazing at the price I realized what happened: KMG spun off a new company effective (ex-date) March 31st. In this case, the newly formed company (Tronox Inc.) was listed under TRX.B symbol on the NYSE and "took" $0.20164 from KMG's original stock for every dollar of its new share price. This is otherwise known as a "distribution". When TRX.B opened on March 31st the price was $17.75 per share which meant that $17.75*0.20 (roughly) was the amount by which each share of KMG had to be reduced. Doing the arithmetic, the reduction comes out to be $3.55 per share. On March 30th KMG closed at 99.51 to open the next day at 96.00. Close enough. So, as of March 31st, KMG had a newly spun-off company, TRX.B trading along its side with bunch of KMG's "money" invested into it via this so-called distribution.

Great, so what happened to the options? Well, since the options I held were the "original" KMG options (pre-distribution), they were tied to the original KMG price. Now that KMG got chopped by $3.55 per share because of the spin-off, the options needed to be adjusted accordingly. One of the ways to do this was to create a new "synthetic" underlying priced according to the combination of the "new" KMG and TRX.B. In essence, the new underlying price would then become KMG+0.20*TRX.B. Trivially, this synthetic underlying would reflect the old price of KMG, pre-distribution, but be tracked under the new KMG and TRX.B, reflecting the behaviors of both stocks, as intended.

That's exactly what was done. The only (minor) issue is that now you, the trader (or me, in this case!) have to create the synthetic price all by yourself. In my case I was negligent to do so and only noticed the change when the options went from the original price of about $0.95 to over $2.00. You'll probably realize at this point that the options went up in price because KMG rallied back to 100 and even higher. Of course, since the options were now tracked by the synthetic underlying, the actual underlying price was close to 105, which put the options at the money and inflated their price.

The lesson here is to watch your corporate actions carefully. Whether you're a die-hard technician or not, looking at stock charts certainly isn't going to be enough (I mean, we're short KMG calls, the stock drops 4 points, that's great, right?). So, add "spin-offs and acquisitions" to your list of things to track, right next to dividends and splits.

Tongue-in-cheek: By the way, KMG's retracement up to 103 from its March 10 low is exactly at 0.618 Fibonacci level (off the high of 110). That does not include the $3.55 "discount". So, Fib traders out there, explain that one! :) Just more evidence that things a lot more random than we choose to believe.

Have a great long weekend!

Cheers,
/Dmitry

Now, THIS is Exciting!

2006-04-09T17:40:00.000-04:00

Awesome wipeout last Friday. At the risk of going out on a limb, I have to say that I am tingling with excitement about this (S&P) market. Here's why:

We made multi-year highs and sold off.
We then re-tested the highs and sold off again, HARD.
Looks like a double top, doesn't it? Better yet, a double top with a massive headfake (we fail the breakout)?

So, given this context, what's next?

Well, keep in mind that I am bullish about the market overall. In fact I still very much think that it is heading quite a bit higher. Given this bias, there are two very profitable ways to play this setup:

Wait for the market to sell off more and watch for OEX approach 580. As it get closer (preferably in a single day) start buying May ATM calls. It the weather gets really bad I can see the index dropping as low as 570. In that event you will be cost averaging calls and will end up with a whole load of them at that overextended level. Naturally, I fully expect the market to correct up and head higher from there. If I am wrong, blowing out of those calls will be painful but not at all destructive (assuming you use a decent allocation strategy): remember that the lower the underlying goes, the slower the price of calls will decrease.
If the market does not sell off and rallies instead, wait for OEX to close (it really must close, not just trade) above 592. Once it does, you'll get long delta from there on. This is a less risky (actually, not less risky, but defintiely less gut-wrenching) play but it is also less profitable as your upside will be limited and you won't have the opportunty to accumulate size (unless you go all in right away). I am planning to position our fund net long SPY stock in this scenario.

Finally, if I am dead wrong and the market tanks and never looks back we'll have a great opportunity on the short side after an inevitable rally. But, we'll cross that bridge when we get to it.

Cheers,
/Dmitry

What We Are Doing

2006-04-05T12:31:00.000-04:00

A lot of columnists are saying that the market is still "range bound" but I beg to differ. I'll skip the fluff (my apologies for terseness, but I am swamped) and get right to the meat of it:

The market is heading for new highs and I have taken a positively bullish stance: We're buying dips (by cost averaging May calls) and selling rallies (on select issues). We're also scaling into long OEX calls, a strategy that I don't really like but given the VIX levels it actually makes sense to buy index options here.

On the sector level I am excited about three things and my readers already know what they are:

Oil. What a trader! Our long futures positions are fluctuating a staggering amount of dollars every day but overall, every dip has been byable. In fact I am still a very aggressive Oil bull. Oil equities look great (APC, KMG, NE, etc.) and OIH has been a decent proxy as well (althrough it does feel "heavier" then separate issues).
Housing. The rally finally came and being overloaded with long front month delta we're not only breathing a sigh of relief but are also reaping profits. I think the stocks are headed higher from here, even though a single day "wipeout" is likely. So, if you'd like to get long, the right strategy is to put on some size here and that way for a scary dip to complete the position. Note that I am saying this in the context of being a longer term Housing bear and the short signal on the sector is still intact.
Gold. Nothing new to say here. The spot has been an amzing performer and equities held up well. I continue liking the spot itself over the equities. We've been adding long GLD stock with every opportunity.

Other things of interest:

Miners. I think a few things are overdone here and buying puts on PD will work well (for the patient types). Again, use scaling to put on that position.

Biotech. It's a mixed bag. We're short BBH call verticals and at the same time short put verticals on select names. I am not really a bear on biotech but I see no technical catalyst in the sector. "Languishing" is what comes to my mind.

Semiconductors. We're short SOX put verticals. We also liquidated all long delta on stocks. Feels weird but that's probably good. :)

Retailers. Nothing to write home about but we're short put verticals on RTH.

That's about all, folks. I'll be posting our performance update for Q1 sometime soon, so stay tuned for that.

Cheers,
/Dmitry

Gold Options on ECBOT

2006-04-01T20:35:00.000-05:00

Just read a bit of news that CBOT listed electronic gold options on 100 Troy Oz gold. Option root is OZG.

This is a really good news. I only wish I'd found out about this earlier. The recent Gold runup would have been that much more interesting for us.

Cheers,
/Dmitry

Bought The Dip

2006-03-31T20:53:00.000-05:00

Things are working out as expected. Oil gave us a nice, buyable dip and Gold held it's "sold off" levels. Our stance is unchanged.

The only disappointment is the Housing sector with KBH, RYL and other names printing weakness. Well, we can't be right all the time... :) Adding some calls here (we're getting a big overleveraged on long positions) and staying with them for the next few days.

Have a great sunny weekend!

Cheers,
/Dmitry

FYI: We Are Buying This Dip

2006-03-31T09:06:00.000-05:00

Oil and Gold both are lower this morning. They are weaker on some (irrelevant) news which makes this an excellent opportunity to add to our long positions via futures and long GLD stock.

I'll post an update on this later.

In the meantime, the equities markets are holding up well with a few ticks higher here and there. I do think the strength will continue, for now. I am looking for Housing to perk up higher even through technically the stocks look terrible. We're long calls on a bunch of issues here.

Cheers,
/Dmitry

Trivial Yet Baffling

2006-03-30T19:45:00.000-05:00

I'd hate to use the word "predictable" but the market was pretty much that - predictable. Huge rally, followed by a 10 am reversal breaking through the day's lows and leading into a flatline. A bull case may be made of that. Generic.

So, what's interesting about this market?

Well, Gold, Oil, Interest Rates and Equities are all in rally mode. I am probably not old enough to say that this is weird and unusual, but you know what? It's unusual. Our fund is delta long all of these things in one form or another and while we have many technical reasons to be long (we don't question prices, we trade them), there's still that persistent and somewhat apprehensive "Why?" inside of me. The persistent part of it seems to be telling me that "something wicked this way [still] comes" and the apprehensive one prevents me from going on a shopping spree (no matter how bullish I am I have a healthy respect for risk).

I am no economist (do they actually know how to make money anyway?) and thus don't have the ability to concoct a believable (but not necessarily correct) answer. Nonetheless, it is still baffling that a few inversely correlated (so history says) markets are all heading in the same direction. I read this as a sign of increased volatility approaching, and likely not in the most positive way. With VIX trading at its ever-low levels of pre-teens owning some is a good idea.

Damn those bulls, even when I run amongst them.

Cheers,
/Dmitry

Japan Bull

2006-03-29T23:08:00.000-05:00

Forgot to mention that my stance on Japan has found footing with ITF heading higher and posting a new long signal. My ITF position is not related to our fund (I am long in my own account) but I thought I'd mention it as I feel Japan is heading a whole lot higher.

For those with interest, compare long term Gold charts with those of Nikkei. You'll see why I like the latter.

Cheers,
/Dmitry

Wall of Worry

2006-03-29T22:43:00.000-05:00

Finally, something worthwhile to talk about. Without resorting to rehashing the obvious, here is what we are doing with Cadence money:

I am an official Oil bull. We own Oil futures, Oil stock and Oil OTM call options. True to my word, we got long the futures contracts once June crossed the 66 mark. Everything else followed in response to bullish formations on individual equities.
I am an official Gold bug (for now). We are long Gold miner and GLD stock. We're also selling put verticals on dips (if there are any). Note that I am more excited about Gold than Oil here as Gold has put in a major long signal that has a potential do return more explosive, directional move. And no, I am no a vol player here.
We've sold a large number of vertical put spreads in the Semiconductor sector via SOX. Not super-bullish here, but I do think the sector will stabilize and guide higher. If the Nasdaq is to keep the "new" highs, Semi's won't stay down, or at least won't guide lower.
Not excited about Homebuilders. Unless the sector wants to "rotate" higher, selling calls here is right and is our strategy. I do want them higher but every spike will be met with selling. I'll reiterate that a long term short signal is in place on the entire sector and this uptick is our opportunity to get in. Buying puts into rallies is ok as well as I expect vol to pick up.
The Nasdaq (Composite) looks great and I like NDX-100 even more. We're selling put verticals with a doze of cautious optimism. I have to say that I don't like selling index spreads and the fact that we "simply had" to do a number of them tells me that the market is heading a lot higher. By the way, let it be known that I hate chasing runs. The funny thing is, today, putting on bull trades after the index is up 30 points doesn't feel like chasing at all. Yes, weird. That's ok - I let my human self feel anyway he likes as long as his trading counterpart makes money.

The above are the big movers in our book. We also have mild interest in GOOG (that's a market of its own). Interestingly, GOOG is off more than 10 after-hours. Naturally, the overall market is off as well and that presents a perfect bull case. See, GOOG is off on technical news, and with the entire universe buzzing about the Nasdaq making a 5-year high the opportunity to buy is almost unprecedented. Shabby analysis, I know, but my trading gut tells me I am right.

Climb a wall of worry? The evidence speaks for itself.

Cheers,
/Dmitry

Back From Slumber

2006-03-27T09:42:00.000-05:00

The first week of April expiration cycle gave us the deadest market ever. Of course now that there are only four weeks left the market is antsy to make a move. Only problem: tomorrow is the big "Bernarke unknown". Granted, we all know a hike is coming but given a 100% probability of a quarter raise, the question becomes:

What if it's a half?
What will the Fed have to say about the future raises?

While I don't have the competence to answer the above, the important observation is that the market doesn't either, so again, we wait.

BTW, on a sidebar, the compulsive speculator inside me (I ignore him most of the time) thinks that rate hikes are far from over. There are lots of reasons for this (and we all know them), but besides the obvious I just get the uncanny feeling that it would be far too "easy" to end them now. Funny that - given the emerging problems in the housing sector and other interest-rate sensitive industries.

So, the bottom line is, whatever happens, it's going to happen tomorrow, not today. Regardless of the outcome here is our stance going into this:

Gold has become a major long candidate. We are buying stock right here. I like GLD as the vehicle and I am advising our fund to sell put verticals on individual issues.
Oil is at a major inflection point. While I am still an Oil bear a break out higher from this consolidation (over 66 on June contract) will turn me into a cautious bull. I do believe the breakout is going to happen very soon now, so owning vol here is OK. BTW, I am talking about the spot, not the stock sector. Stocks are more difficult here as I see both bullish and bearish action, depending on the issues.
Housing turned higher as I expected. The irony here is that while selling call verticals is the right strategy I do feel that this sector is capable of climbing the "wall of worry", given all the negative press it has received. So, don't go "all in" here and scale in slowly. Regardless, on the longer term scale I am definitely a bear.

Given the lack of action last week, I'll stop short of talking about any other sectors. We are not doing much in them here (this means that we have only minor commitments with short term prop strategies), but we are expecting to see action at least in Biotech, Semiconductors and Retailers this week.

Cheers,
/Dmitry

S&P Freeze: Day 5

2006-03-22T14:48:00.000-05:00

The world has fallen asleep. Or, the world fell asleep right before expiration (normal) and then forgot to wake up (less normal). Regardless, the S&P has been in a mindless, tight range for almost 5 days now succeeding in frustrating just about any strategy.

To comment on my prevous stance on "break out higher to re-initiate put positions", the long put strategy is unchanged. The market did break out higher as I expected and then reversed sharply. Buying OEX 590 puts was the right play into that rally. The challnge now is to stay with them until the market proves that it wants to go higher. That proof needs to come in before time melts our premium. Doesn't look like the best odds out there, but we're sticking to our guns. Now, if the proof proves the opposite, then there's money to be made.

In addition, our views on Housing, Oil and Metal Miners have remained the same, - again until the market shows its hand.

Outside of that, this is the right time to do nothing. Think about this: most options traders have five (well, four and a half now) weeks to April's expiration. Normally they only get four. So, given this "free" time, traders are unwilling to take on any significant positions until they "have to". So, combining this fact with an absence of any other catalyst, it is quite understandable that the market isn't willing to make any headway.

I realize that the whole universe is thinking the same thing. Well, don't run in front of the universe unless you want to get run over. It's always better to make a lot less then to lose a lot more.

If there is anything to be exercised in the options world today, it's patience.

Cheers,
/Dmitry

Down Action

2006-03-20T14:14:00.000-05:00

As non-exciting as the indices look, the underlying picture is quite telling. A few things worth noting:

OEX is printing a classic range-bound, "run-the-stops-and-turn-around" type of action. I see traders religiously dedicating themselves to selling at the low end of the range and buying back at the higher band. And then they reverse and do the opposite. While this is clearly observable and often downright funny (another proof that people, as an aggregate complex, never learn), the useful corollary is that once the breakout does occur, the fade is where the actual money will be made. I prefer OEX to break higher for a few points to re-initiate our long put position (we've covered our OEX 90 puts until a better trade signal is generated). A break lower will work as well, but I don't like going long in this market and thus will have to commit less money than usual to this scenario.
Metal Miners, Oil and Housing are all selling off rather hard. Surprising to see this underlying current with SPX behaving so mildly. I am especially interested in Oil as it is presenting an amazing short oppotunity. BTW, if you'd rather not play direction here, getting long vol is nearly as enticing. Oil looks so bad that I am contemplating selling April futures instead of employing any other instrument. As far as this commodity is concerned, I specifically like the spot itself. Oil equities are fine but I'd rather sell verticals on them then get short outright.
Housing started a new leg down and we're short a set of calls here. I do feel that the sector may lead a bit higher before selling further. So, while we are net sellers, I am not deploying full trade size at this juncture. Up-averaging our call sales seems to make sense here.
PD and CLF are our Metal Miners favorites for long puts. We have about 30% of our trade size deployed now and we are looking to buy some more. I am not an outright bear on these as I am on Oil or Housing. I simply think the sector is overbought and needs to bleed off a bit. It is also likely to be entering a trading range and I think it is currently at its upper band.

Now, on another note, do I still feel that QQQQ's will break below 40 in the near term as I suggested last week (I stated that QQQQ was going to break 40 with 80% probability within the next few days)?

Answer: I no longer have a view. My reasoning behind the original opinion was that the well-known head and shoulders pattern on NDX was NOT going to work, but in order for it to fail, it had to break its neckline and then produce a rally from there. Ironically (how else?), that's exactly what happened, except that the neckline break was much less prominent than I expected. So, basically I was right, but to no use because being right in this case made us no money. I suppose more people were watching the pattern unfold than I expected.

That's one of the reasons I rarely trade patterns. Another reason is more fundamental: random events tend to cluster and create observable patterns. Thus, patterns invariably accompany randomness. And, as far as I know, randomness is a tough vehicle for generation of money.

Cheers,
/Dmitry

Aiming At April

2006-03-17T10:23:00.000-05:00

Expiration is almost over and unless you're still playing ping pong around the pinned strikes (I see NEM, WTW, APC in our book rubber-glued to round numbers) you should be considering the next long (5 week) expiration cycle.

On the broad index level, the Nasdaq is still in a range sitting right at its 50 day MA. Notably, the 50 day MA is flat as a pancake (it has been for almost two months now), which leads me to have absolutely no view on this index. If I were to bet money on it today, I'd sell a strangle. However, there are better plays out there.

The S&P and Dow Jones broke out to significant highs and that is generally considered bullish. However, I am far from being convinced. If S&P is to sustain its advance it will need the Nasdaq to support it. That has not occured and that's why I advised out fund to keep OEX April 590 puts that we've been buying on the way up. Keep in mind that I am not calling for a reversal here. I am just observing that the index will turn lower if it is to successfully realize its plans to move significantly higher. (it must get worse before it gets better, if at all)

Now, here are my thoughts on the sector level:

Metal Miners are taking the spotlight today (I am surprised that PD is above 75). In the very short term (next few days) I expect prices to turn lower with implied vol remaining at these (healthy) levels. We're buying CLF and PD puts on the way up and are looking to sell OTM call verticals.
Oil spot is currently in a neutral position with the spot having spent the necessary time to consolidate after its relentless move from top of January. I am bearish on Oil all over again but I'd like to see June contract to break below 64 before any money is committed.
Gold spot is at a major inflection point of 560 (June contract) and any reversal to the downside will be considered bearish. Watch NEM and AU for action on Monday as their moves after pin release will be indicative of the future direction.
Housing has posted a major retracement and I strongly believe that this is a rare opportunity to sell call premium. KBH, CTX, RYL are the short vehicles of choice. Any prices higher will trigger our call sales. Yes, I am a bear :)
Semiconductors have been abysmal and the bounce from their oversold levels (circa 3/10) was not the type of money maker I really expected. Regardless, I am still not a bear on the SOX though and I feel that SOX 455-460 level will hold (sell put verticals) even in face of the S&P and the Nasdaq potentially heading lower. Granted, the sector is a clear underperformer. But the cynic in me likes it for that.
Retailers are range bound on the longer term scale, but the latest breakout in RTH through 98 tells me there is a catalyst that should move the sector higher. Dips will be buyable and the strategy here is to get long RTH calls on dips and sell put premium on individual issues.

Other sectors we'll be watching are Defense, Biotech, Brokers and Hotels. I'll be sure to cover them in the near future - assuming actionable events take place.

Have fun cotra-hour and enjoy the weekend!

Cheers,
/Dmitry

Married To Money

2006-03-15T21:25:00.000-05:00

Anyone experienced in premium short selling is familiar with the curse of "marrying money". And, if you're not, here is the story:

At the risk of sounding trivial, when an option is sold short, the proceeds are applied to the seller's account. Now, assuming the seller's strategy is to collect the proceeds (via the option expiring worthless), a normal, human tendency is to treat these proceeds as unrealized profits.

Of course that's wrong, but consider the context:

You're selling "worthless" options and you watch your account increase in equity from $20,000 to $22,000.
This selling has impacted your margin and you have much fewer bullets to fire.
You now can only sit and wait for the expiration bell to ring. Besides selling some (increasinly smaller portions of) additional premium before the time runs out, that's the only way you'll make money.

The time is ticking and the clock is grinding away at options prices. The closer to expiration the less opportunity you have to make trades to increase your equity. And as the time squeeze curves your portfolio's theta into an exponential drop you realize that what you see is the most you're going to get as far as account equity is concerned.

And this is when you experience the moment of fear. That's when you start to pray that your option deltas don't increase and put your positions in the money and wipe you "profits" out.

You become married to money.

The funny thing is that being married to money is at least just as bad as being married to a position. Actually it's much worse. A position that you're married to is already losing you money and you are experiencing pain. Pain is good because you have a threshold and once it's reached you are going to act.

However, the money you married is there in your account. It isn't painful to have it. But it is scary to lose it. And therein lies the problem: fear is the mindkiller. You do nothing when things go wrong. You do nothing because you are afraid.

I prefer pain to fear. The former gets you to act. The latter gets you killed.

Cheers,
/Dmitry

Here We Go!

2006-03-15T15:40:00.000-05:00

OEX is at 592.50. It's a green day and we're starting to make our first OEX put puchases at these levels.

Folks, I'll repeat, it's a tough thing to do - fading this much optimism feels so wrong. But, as a trader I am a machine and I can't buy this, no matter how much I want to.

If you're long, good luck. I am sticking to my guns and I am taking our fund with me.

Cheers,
/Dmitry

Momentum Fade

2006-03-15T09:57:00.000-05:00

Expiration is upon us so there are two things we are looking to do:

Fade realized volatility. This strategy should have 70-80% of focus dedicated to it.
Sell April premium. 20-30% of activity is allocated here.

The biggest trade we're looking to put on is a fade of the OEX rally by buying April 590 puts as soon the index starts ticking above 590. Also, I think the recent advances in Housing and Metal Miners can also be faded - but this time by selling OTM call verticals. Since we are six weeks out from April expiration, it is possible to collect around 10% in premium per spread with lots of margin of direcitonal error built into it. However, while this is certainly game-able we don't recommend being aggressive on this strategy.

The reason we recommend to lighten up on our staple of selling premium this week is due to the fact that most directional moves won't have follow-throughs that are actionable over the next six week term. By actionable I mean the type of a move that creates a probability distribution that deterministically affects forward pricing. So, while this week is the wrong week to develop a directional view, it is the right week to be a short term contrarian.

... And the cynic inside me rejoices!

Cheers,
/Dmitry

Trade OEX: Buy Puts!

2006-03-14T14:25:00.000-05:00

OEX is at 589.37 as of this writing. We are short 590/595 March call vertical. Yes, it's painful. Here's why we're keeping the position:

As soon as OEX gets through 590, we will be buying April 590 puts. I still maintain that this rally won't hold with the Nasdaq in the bear trend. So, the headfake above 590 (or higher) is sell-able via cost-averaged put premium.

And, with the VIX at 10.59. I want to be long vol anyway. This is a scary play and that's how I know it's the right one.

Cheers,
/Dmitry

Rolling Corrections... Up

2006-03-14T11:01:00.000-05:00

Our fund's focus on the Housing, Oil, Gold and Semiconductor sectors seems to be bringing in dividends. Combining our long premium strategy with oversold conditions in these sectors is paying off handsomely, despite the fact that these same sectors are still in bear trends.

Before I go off patting myself on the back, the point I want to deliver is the following: these sectors have corrected up in their bear trends and that's the only reason we are long. Since our focus on them was due to their technically strong position, it bears to note that this technical position has been weakening with the prices rising.

Context:

We have a bearish divergence on the indices. Say what you will, but I am sticking to my view of Qubes going below 40.
We have Housing, Oil, Gold and Semiconductor equity sectors in confirmed and sometimes, severe downtrends.
We have Gold spot at a very important inflection point. (As I said earlier, I see a strong short signal)
We have Oil spot in a similar position to Gold.

What this means is that we have a series of rolling corrections to the upside in an overall bearish trend (or backdrop) of the respective markets. For a closer look:

Housing: KBH, LEN, RYL, HOV are up between 5 and 8% off their lows.
Oil: OIH, APC, AHC, RIG, PTEN, etc. are up between 4 and 6%.
Gold: NEM, AU, ABX are up around 6%.
Semi: starting to bounce here. I am treating this sector as a tell for the top in the overall market (meaing, once it rallies 5-6%, a short signal will be in place).

I know, with the S&P itching to break out to new multi-year highs it's a tough pill to swallow.

But realize that this scenario is the same as a series of rolling corrections to the downside in a strong bull market. Everything gets sold out and we go higher. Well, turn this upside down and we get "everything gets bought out and we go lower".

And, with VIX close to an oversold level of 11, selling call premium or even buying puts is where the odds are.

Cheers,
/Dmitry

Make 10% By Friday?

2006-03-13T11:39:00.000-05:00

It's a lucrative proposition. How can it be done?

Last night I wrote about the bearish divergence between the Dow Jones and the Nasdaq. What I did not mention (those who care would see it as obvious) that S&P 100 and the Nasdaq have that same divergence, which leads me to believe the following two things:

Most like the markets will fall into a bear trend for the foreseeable future.
S&P 100 won't break out to a multi-year high without the Nasdaq's help. And even if I am wrong and it does, it won't stay there.

Now, S&P 100 is trading at 585.29 as of this writing with the 590 strike marking that new multi-year high. So, we sell the 590 and buy the 595 for a net credit of $75 per spread. Given the margin outlay of $500 per contract, we rake in 15%. This assumes that we get filled at mid-market. However, even if we hit the bid and the offer, we still take in $65.

So, it's actually better than 10%, but when we make that much on our money in four days, let's not split hairs. :)

What are the odds on this?

I can't quantify them in a solid number but I do feel they are in the 9o's. The obvious question would be "how often does the S&P make a new high without the Nasdaq's support"? While this is a legitimate question it isn't that interesting. A more enlightening question would be, "how often does the S&P make a significant move (given it's realized volatility) during the expiration week and remain near the attained levels?" The reason I think this question is better is due to many idiosyncratic factors that come into play during expiration. Strike pinning would be one of them.

I'll look for the answers. In the meantime, I am putting our fund's money to work.

Cheers,
/Dmitry

Bearish Divergence

2006-03-12T23:42:00.000-05:00

This isn't the first time I am seeing the Nasdaq and the Dow Jones present such differing reads of mass sentiment. While I can't exactly quantify why I think they are so different (aside from the generic 50 day MA point of view - one is below, the other is above, and the "lower lows vs. higher highs"), every time I've witnessed such divergence, the market corrected in a significant way.

By "significant" I mean more than just a couple of scary down days. Such diveregences have at least empirically shown themselves to be trend makers, where the resulting trends were negative and lasting.

That's pretty bad news because as I pointed out in my earlier post, broad downtrends tend to be slow, grinding and very frustrating... even to the bears.

So, what's a decent recipe for trading in such envornment? Pretty much what we've been doing all along: sell rallies and buy new lows. To most, selling rallies is fairly obvious. However, buying lows is only so to some. If buying a low in a downtrend feels "weird", I recommend reading my two-part article on buying premium for an idea of why buying in a downtrend can be a correct strategy.

Market sectors we're are presently focused on are the usual suspects:

Housing: we're seeing a short term retracement higher in an overall downtrend. Long call positions should get richer here. We have long delta exposure in this sector.
Oil: similar action with the smaller names (PTEN, GMXR) recovering much less than their bigger counterparts (SLB, APC, etc.). We're looking to sell more call premium into April.
Miners: undecided. Even though they seem to tag after Oil equities, I don't feel there is an edge there (minus the correlation). Watch this sector though as the vol has maintained healthy levels and a drastic move will get us long gamma in a second.
Gold: the stocks have bounced and even at their "bounced" levels they still look overdone. We have long call/short put exposure here but we are also short Gold June futures as I feel that the spot will do worse than the equities going forward.
Semiconductors: we're looking for the sector to grind lower as it is very correlated to the Nasdaq (I very much expect Q's to punch through 40). As SOX gets closer to the 480 level, selling put premium will become lucrative. At this point we're staying away.

Good luck next week everyone. Expiration time is upon us!

Cheers.
/Dmitry

Friday: Not What You Expected?

2006-03-10T15:51:00.000-05:00

Well, not exactly what we expected either. From one point of view, Friday was a great day of respite - our long call positions got better and our short put positions got more chance to remain profitable. From another - I really thought we'd get a negative day with a Monday follow-through that would create a blow-off bottom.

Since this didn't happen, I think things may be worse than I originally imagined.

Naturally, I am going out on a limb here, but since the markets did not continue the bleeding it may mean that we're in the kind of a steady downtrend that doesn't get anyone excited but does get everyone very frustrated. This is the worst type of action - especially for the newer players as they are very prone to be stopped out on every rally.

As a trader, I like quick, stabbing sort of action that creates visible probability pockets. A slow grind is a mind killer and a bore, but more importantly, it is much more dangerous than a fast, bloody (or peachy, depending on whether you ever look at your charts upside down) move that culminates in opportunity-generating agony. Slow, grinding trends tend to last until everyone throws in a towel and by the virtue of being slow, the "towel" event takes a bit of time to occur.

Now, regardless of the type of action, the probability of Q's breaking through 40 remains unchanged and if anything, any coming rallies should be used for sizing your positions bigger. Having said that, the context of this trend dictates that it is important not to chase any prices - all moves lower have been showing to reverse quickly and if you don't realize this, your short positions will cost you a lot more than it should.
And if they cost you more, then you may not be able to afford to be wrong as is often neccessary.

As far as what our fund is actually doing in respect to the Nasdaq and our favorite market sectors, I'll post an update this weekend. Until then, enjoy the early spring weather!

Cheers,
/Dmitry

QQQQ Taking Aim at 40

2006-03-09T17:56:00.000-05:00

Here is a trade that's in the cards: QQQQ should break through 40 wthin the next few days with a very high certainty. Are we betting this way? Most certainly - a good portion of our fund's money is parked in long April 41 puts. If we get another rally, we'll park more.

Why are we so certain?

Two reasons really:

Technically, the market is developing a severe downtrend which is currently in the midst of making. It is being confirmed by many sectors and many other markets.
More importantly, breaking below 40 will complete a much-awaited head-and-shoulders pattern. Just so you know I personally don't believe in this pattern (or most others for that matter). That's why I think the pattern will in fact occur - I've witnessed this sort of self-fulfilling prophecy ( this sounded far too much like a cliche but I had no better way of saying it) far too many times. That's also why I think that covering our short positions right below 40 will be the perfect trade.

In sum, I think NDX-100 is heading lower, but will it reach a new decision point above 1600 level. As far as I am concerned, QQQQ @ 39.75 or so constitutes a point of a random outcome. To make this perfectly clear, right now the action is non-random and should be traded with proper odds built into your risk management. Below 40, all aforementioned probabilities get thrown out of the window and a new game begins.

Before my readers point out that I am contradicting myself (I did say a "severe downtrend" above) which can't possibly imply a mere 1 point of decline in the Q's, understand that I am only talking about the probability of an impending break below 40. Given the context, my read is that this probability is in high 80's. However, after it plays out, future moves will have a different probability profile. - dictated by the function factoring the magnitude of the decline and elapsed time.

Today, I don't care about the future that far out. But in a few days I will.

Cheers,
/Dmitry

Housing, Gold and Oil, Redux

2006-03-09T12:22:00.000-05:00

A few notable things this afternoon:

One, the Nasdaq-100 stalled after the 25 point rally (from yesterday's low to this morning's 10 am reversal) and sold off. The painfully obvious level of resistance is 1672. The reson I say "painfully" is that such obvious levels rarely work outright. However, the reason I am pointing this level out is that this time I think it really is important and needs to "work" in order for the down leg to continue. If we close significantly above it, I will scale back on our bearish positions.

Two, Housing is looking worse than ever. Even the rally barely helped. With RYL breaking 65, BZH breaking 60 and CTX free-falling towards 60, this sector looks so oversold that regardless of me being right or wrong in the end, the only way to play it here is to aggressively get long calls. We're already long in KBH and a few other names, but here's where we're going to get longer.

Three, Gold bounced as expected and now we're scratcing our heads as to whether to use this rally to get short outright. Not enough evidence here but do stay tuned. I think the best outcome for this commodity is to move sideways as I suggested a couple of weeks earlier. I doubt it's got upside right here, right now. So, why not sell calls? Because, the short signal that's in place now may get rejected, and if it does, we'll get the kind of a rally that negates all of the above. So, back to scratching heads. (Isn't being a trader fun? :)

Finally, Oil is acting as expected. Selling April call premium here looks right.

Cheers,
/Dmitry

World Markets Top?

2006-03-08T23:13:00.000-05:00

I am not an expert on macro views as far as the world's markets are concerned, but poring over my charts tonight I saw something that stood out like a sore thumb:

Indices around the world don't look so good. The indices I am talking about are represented by listed funds (ETF's) on Amex and Nyse. These funds concern the new "leading emerging" economies - the spotlight of economic developments and, if I may say, "precipitous" hype:

India: IFN
Russia: TRF
China: FXI
Brazil: BZF
Turkey: TKF
Japan: ITF

The notable thing about all these tradeable funds is that not only they just appear to be "toppy", but that most of them (with exeption of Japan) present very prominent tops followed by two down days with an expanded range and an unusually high volume (in some cases volume was almost triple the 10 day SMA). To me, this looks like an ominous combination, even though I don't see much of a catalyst behind it.

But then again, most events never have catalysts - until after they occur.

What to make of it? Well, as I mentioned, I am not an expert on foreign markets but this does look like some sort of a top with possibly worse things to come. Some of these tops show strong sell signals on a longer term scale, and as I look at them I get a familiar feeling of "have-to-get-short-now-don't-care-how", which usually resulted in profts. Having said that, please be careful to not read this as a deliberate forecast of some doom and gloom scenario - I am merely pointing out something that may "click" when you witness a seemingly unrelated situation in the US markets. Given the proliferation of foreign influence on our market indices, the globe is really worth paying attention to (it always has been, but now it's simply a must)

The way I am advising our fund to game this is to continue the mode of selling rallies in the broad indices. If anything, the above gives me a stronger (or more confident) bearish bias, which will be parlayed into our trading.

It's odd. I am not a forecaster and I (mostly) don't believe in it. Most of the things we trade seem to show a trend of anywhere between "blah" and "bad", and if I had to get on CNBC and try to make a "prediction" I'd have absolutely nothing good to say, except that the VIX will probably be a lot higher in the coming months.

All of this may well amount to nothing, but my gut tells me it does. So, I advise to keep this in mind, trade accordingly and hope that the bottom does not fall out.

Bad things happen when it does.

Cheers,
/Dmitry

Sell the Rally, Buy the Break

2006-03-08T09:55:00.001-05:00

That's the name of the game as we see it. So far our scenario of Oil, Housing and Gold finding short term bottoms is panning out as expected. At the same time, rallies in the Nasdaq are presenting opportunities to get bigger on the short side.

Oil: Most of our names have bounced (we're looking to liquidate long calls) and the put spreads collapsed. Now we are looking to sell call verticals on this upswing. Oil spot looks oversold and I do think more upside is in the cards.
Housing: Less of a bounce as I am seeing more names reaching oversold condition. I do think we'll see a tradeable rally here as well. Leaning long calls as the sector grinds lower.
Gold: Spot looks terrible. Technically, there is a MASSIVE sell signal in place. Yes, it looks that bad. However, equities seem to have priced in a substatial drop in the spot and are near their short term bottoms. Leaning calls here as well.

My order of short-term bullishness on these three sectors is: Oil, Housing, Gold.
At the same time, Oil and Housing are in longer term downtrends with Gold at a big decision point. Watch the Gold futures very carefully here - I can't bring myself to get short, but the indications are definitely telling me to do so. (Am I a gold bug?)

Biotech is also bouncing smartly but I haven't figured out my stance on it. I am putting Cadence money is BBH and separate names fading directional moves.

Finally, Metal Miners look terrible and that tells me that buying vol is a good idea. We're eyeing CCJ as an interesting candidate. At the same time, PD and CLF look close to a near-term bottom and we're selling put verticals here.

Caveat: I just re-read all of the above and it feels like a hodge-podge of trading ideas. Well, it truthfully is. There is a lot going on and I owe it to our fund to not leave anything on the table.

When markets move we have to trade them. That's what we do.

Cheers,
/Dmitry

Heavy Metal

2006-03-07T13:29:00.000-05:00

In the midst of all this action I almost overlooked the Metal Miners sector. First off, I absolutely love the volatility here. At 45 vol underperforming realized volatility in major names (PD, CLF, PCU, etc) we can be buying April premium to take advantage of the oversold condition and sell near-term premium because with downside becoming more and more limited it is so darn overpriced. (Yes, I did say overpriced, even though implied vol is actually below statistical)

So, we're selling CLF March 80 puts and looking to buy April 80 calls once the stock trades lower. PD March 150 calls are similarly expensive and we are legging into short vertical with every uptick we get.

This is the sector to be aggressive on. Get in there and trade it.

Cheers,
/Dmitry

Action: Oil, Gold, Housing, Biotech

2006-03-07T10:55:00.000-05:00

Listless action in the indices. Even though I always heed the old saying "don't short a dead market", I read today as bearish. Reason: if yesterday's drop was unimportant then I fully expect it to be bought aggressively. Well, so far today is anything but aggressive.

We did not add to our short positions this morning as the rally we got was just ... small. Instead, we'll either expect a stronger rally or just wait to cover lower. It's just me - often I can't stand to add to winning positions. Something to ponder. Glad I don't make all the trading decisions! :)

Now, other sectors are moving nicely with Housing, and Oil hitting oversold levels.

In Housing we're leaning long calls in KBH, RYL and BZH. I do expect this sector to grind lower, so these puchases are initial position builders.
Oil looks terrible and that tells us to sell OTM vertical put spreads. Basically we are legging into an "iron condor" position with short call spreads sold higher and puts spreads being sold lower. Names: HYDL, SFY, and of course, APC.
Gold spot looks bad here but the stocks (NEM, ABX, AU) paint a different picture. NEM punched through 50 and we have a consensus that buying April 50 calls is a good thing with the stock trading below strike. We did miss a good entry at around 49.50 but I think we'll get another opportunity. Too many hands in the pot...
Biotech BBH "breakout" was a headfake but I don't expect the Holders to break below 185 any time soon. Excellent premium there and we're selling it on downticks.

To sum it up, we are bottom fishing by either leaning long calls or selling overpriced put premium in these sectors. Note that there is considerable risk in doing this as short gamma exposure this close to expiration can get worse very quickly.

But risk has two sides. More on that later.

Chers,
/Dmitry

A Tick Lower

2006-03-07T09:26:00.000-05:00

The markets ticked a bit lower (Nasdaq, Oil) with Gold a tick higher.

Look out for a rally this morning and if it does come, we should be able to add to our positions at around 10-10:30 am, when early reversals tend to occur. Personally, I would love to see a rally because down-down-down action gets oversold too fast.

Our stance is unchanged. Best of luck today.

Cheers,
/Dmitry

What We Are Doing

2006-03-06T16:00:00.000-05:00

A quick recap of the day with some parting thoughts:

I am putting a portion of our fund's money into QQQQ puts and NDX-100 credit verticals. I am becoming a bigger bear in this market and I am putting our money where my mouth is.
We're doing similar things with Oil by selling more near-term verticals. However, I am also looking for overextended names to buy April calls. I do expect the action to grind lower with a tradeable snapback. Read my "Buy Premium!" article on how to game this.
We are also deploying long calls (April) into the Housing sector. I like KBH the most out of the lot but I expect more long delta/vol exposure to be added to our books in other names as well. Not calling a bottom here (especially if SPX decides to collapse) but Housing, being as oversold as it is now, will be less vulnerable (almost overlooked) if things get bad.

That's all for today. For those wondering why I haven't said anything about RIMM, here is a quick answer: it's pure alpha and is really tough to game. We sold some puts on it but we have no serious commitment. However, if it moves above 85 (quickly) we'll be looking at it again.

Finally, I expect the market to uptick overnight and maybe try a rally tomorrow. If you're with me on this trade, you'll be selling it.

Remember to manage your risk. In the end, that's the only thing that will keep you alive.

Cheers,
/Dmitry

1666, The Number of the Beast

2006-03-06T14:09:00.000-05:00

NDX-100 is at 1666 as of this writing. We're selling call verticals and holding on to our long puts on the Q's.

I fully expect this move to be faded by gamma scalpers in the very short term but it does look real once the program pressure is gone. If the scalpers do come in, use the uptick to size up.

Stay on your toes.

Cheers,
/Dmitry

Slick Top!

2006-03-06T12:18:00.000-05:00

Our model tells us that we just saw a top in Oil. June contract reversed at 66 and our bet is, it's not going anywhere above it.

It's a big statement, I know.

At this time we're selling call verticals and looking to buy lower OTM calls after the leg takes us lower. No, I don't think it's Armageddon in the Oil market. In fact I still think that while we saw the top and we are ways off from the bottom, the action that gets us there will be volatile. If you're ready to hit the market like we are then play both ways with a negative bias.

If it sounds like I am talking from both sides of my mouth, I am. But recognize that I am an Oil bear and I will sell rallies and buy blowoffs - all while staying a bear. You want to trade the S&P and the Nasdaq? Fine, but as far as I am concerned Oil is THE market.

Get in there and trade it.

Cheers,
/Dmitry

What I Saw Last Week

2006-03-06T08:46:00.000-05:00

Had I been a stock trader I would now be finding fewer and fewer things to buy long. In fact, in this low vol environment, owning index puts doesn't sound like such a terrible idea. My only problem: I didn't see enough of an extreme reading on the upside to start scooping them up.

However, I did see this: past Tuesday and Friday were down days for the broad indices. Notably, both days had an above average volume when compared to the other three days of the week (where the market ended higher). Plus, last Friday the market rallied within fractions of a multi-year high (SPX) and then reversed at around 2 PM to give all the gains back and close in the red.

So, whlie I am not reading an outright short signal I think the play is the following (let's take QQQQ as the vehicle):

Watch the 42 level and look for a close above it. If you can't wait for the close then get in on a retracement once it is punched through intra-day. Then make sure we close above it. My rationale here is that if the market indeed breaks through, it will reject two big-volume down days and will also reject Friday's reversal.

Now, if the weakness continues, then become a cub and start selling the rallies (via buying puts, for example) and grow to become a bear as the market guides lower. 42 becomes your stop loss point. Now in this case don't take "42" too literally. My point is that if you've seen enough reason to get short, you don't want the market to get even close to 42 because it will then mean that it's just not weak enough to continue selling.

Why buy puts and not short the Q's outright? You want to pick up the spike in VIX.

Cheers,
/Dmitry

P.S. BTW, if you still don't think that 42 is important, consider that 42 is the meaning of life, according to Douglas Adams.
:)

Buy Premium! (Part II)

2006-03-05T11:12:00.000-05:00

In the first part of the article I talked about the virtues of buying options and expanded on employing volatility view as the basis for a long strategy.

While vol trading is a good reason to get long options, there are a few drawbacks:

Often you have to continuously flip stock against your long gamma. This creates non-negligible transaction costs.
Every time you flip the stock you have to make a decision to limit your profit running in one direction. That's a tough thing to do, time and again.
You often have to keep your positions on for many weeks so that your stock profits outrun the time decay of your long options. So, besides constantly having to trade around your position (that takes focus away from other things), you also have to commit your capital for extended periods.

In spite of these drawbacks, I still do vol trading all the time, but more often than not I look to buy options in order to capitalize on a highly probable directional outcome. Before I go into this let me state for the record that directional trading is a very tough game. In fact I think it is by far tougher than any other game in town.

Why is it tough?

It's the most level playing field for traders. Everyone has pretty much the same level of access and thus, unless you are a specialist or an institution filling a massive order, there is no inherent edge available to anyone.
Directional trading has been around for much longer than any other type. Thus every imaginable method has been developed and tried in every market that goes up and down. You have to assume that they were developed by a lot of very smart people who have tried very hard and then failed miserably. Notably, a few winners do stand alone. Very alone.
The data needed to run strategies and evaluate new directional methods is readily available. The facilities needed to grind this data are equally ubiquitous. Again, no mystery there.
There is more randomness in the evident directional moves that most traders choose to believe. That's their choice but the reality is that most of the time the markets are chaotic and have very low odds of showing a particular direction (the one that agrees with yours)

Other factors, too numerable to be listed, exist. The point is, if you're going to play this game, you'll need every imaginable advantage you can find.

My advantage is using options, and not the underlying, for directional positions. There are a lot of reasons for this but the two most important ones are below:

If you're long an option and you're wrong about the direction, you lose money at an ever slowing pace. This is due to delta curvature (gamma) where as the underlying moves away from you your delta exposure automatically drops off. So, if you started with an ATM call with 50 delta, you end up with 25 delta after a couple of points against you.
You can afford to be wrong. This is basically an elaboration of (1). Let's say you want to buy 10 calls. You know that being right at the time of purchase is unlikely. So, you buy 3 instead of 10. Then as you end up wrong, you buy more. Yes, you cost average. And here is why it's not an evil thing to do: you buy options at lower cost and with lower delta exposure. This last fact is crucial. The more and lower you buy, the slower is your rate of loss. And as your rate of losing slows down, your odds of making a profit on a reversal are increasing.

Caveat emptor: I have completely factored out time decay. I chose to discount it because I generally buy options with at least 10 weeks to expiration and my directional setups have an expectation of working (or not) within 5-7 trading days. Thus, theta is minimal.

Other reasons exist but, contrary to popular belief, are not nearly as key: the most frequently cited ones are limited risk and greater leverage.

Now, if you consider (1) and (2) carefully it is obvious that cost averaging should be done close to turning points of the underlying. Naturally, those points exist at substanstially extreme levels. Without giving too much away, let's quantify "substantially extreme":

Two or more standard deviations away from some average or mean.
Maximally short in terms of elapsed time.

These two points are not to be taken literally. They comprise the basis for the directional model that has a respectable level of probabilistic outcome. The actual parameters and numbers with respect to the magnitude of the move and the time factor depend on the underlying, the sector, the market and, ultimately, the trader.

Cheers,
Dmitry

Performance Update (January and February)

2006-03-03T14:45:00.000-05:00

Two months into 2006 and here are our fund's results on pure trading basis:

Best account: +7.4% YTD
Worst account: +5.7% YTD

These figures are net of commissions and exchange fees. No adjustment has been made for management and performance fees charged to the accounts. So, this is trading P&L only.

Why does our performance vary between accounts? The short answer is: it depends on the size of the account which affects our ability to diversify across strategies. Since diversification can lead to better or worse results, depending on market environment, the returns will vary. In general, all of our managed accounts will post very similar results by the end of the year, regardless of their size.

Cheers,
/Dmitry

Disclaimer: The above is not a solicitation or offer of any services. This information provided is for educational purposes only.

Buy Premium! (Part I)

2006-03-03T12:18:00.000-05:00

Unsurprisingly slow Friday. I don't have much to report as far as our fund's activities are concerned and I'll use this opportunity to share an educational post. Below is the first part of the article:

As some of my readers know one of the key strategies at Cadence Capital is premium selling. I love the strategy for many reasons but one of the drawbacks that always leaves a bitter taste in my mouth (even after making money) is its capped return. Granted, you can be the best options seller but 5% a month on your capital is probably the best you can hope for - with any sort of consistency. By the way, before I get bombarded with "I can do 15% a month, no problem" type of emails, keep in mind that this 5% is calculated on your entire account capital, not a particular monster trade that you did that month.

So, how does one position for a higher return? The only answer I have is "buy premium". I realize it may be funny that a net seller is recommending to buy options but there is really nothing strange about this: you have to diversify across strategies (read my earlier post on this topic) if you want consistent returns with a high Sharpe ratio (volatility of P&L your client can stomach)

Naturally, being long options can be for two basic reasons (aside from more exotic ones):

You have a volatility view
You have a directional view

I like to buy premium for either reason but ultimately, it's best to do it for both.

If you're going long vol you'll buy options and stock (assuming puts) and scalp gamma in either direction. Your bet here is that realized volatility of the underlying will outpace theta of the options. You'll make money if the underlying moves up and down in a proximity of the strike. You'll make money if the underlying moves strongly in one direction (here you'll have to exercise staying power to not "cover" too early).

This strategy (by the way, this is often called a "synthetic strangle") works well with implied vol being on the downside and technical positioning of the underlying spelling a high probability of movement. Recently, Oil stocks served as excellent examples for this sort of play.

If you going long direction then you'll buy options the way you'd normally buy stock. Naturally you'll still have to pay attention to implied volatility (you don't want vol crush to decimate your profits even when you get the direction right). However, there are several other key considerations that need to be taken into account (and they are the ones that make long options so much better than stock) before initiating a long premium position. Yes, leverage is one of them, but it is by far the least significant one on my list. We'll cover the art of buying premium in detail in Part II of this article.

Cheers,
/Dmitry

Capture The Bounce

2006-03-02T10:46:00.000-05:00

Down and up and down action - in sum, we are nowhere index-side but we are certainly seeing action in specific sectors. Often, a mindless grind in the broad indices will bring out definitive action in beaten down or overbought parts of the market. Today it appears to be working and we're seeing the following:

Oil is bouncing smartly and near-strike long April exposure is paying off well. As an example, one of the things we were doing to take advantage of this was buying into 27.5 April call strike in PTEN on the way down. Today is the right time to liquidate this sort of position as the oversold condition is being worked off.
Housing is doing the same except that it is trailing Oil in its bounce. I feel that another day or two of upward retracement is in the cards so if you're long (we like RYL, KBH and LEN) give yourself a chance to gain some deltas.
Semiconductors sector is the final example of this. The difference is that it was never really oversold (unless we decide to judge the oversold condition but the likes of KLAC a week ago). Since the sector is rallying strongly my feel is that it is going to continue may even lead the tech market higher. (CSCO is through 20 and that means quite a bit)

Keep in mind that Oil and Housing are in an overall downtrend so while capturing the bounce is where the money is at the moment, it is just a moment nonetheless.

Stay on your toes!

Cheers,
/Dmitry

Cub, Then Bear

2006-03-01T11:08:00.000-05:00

Today's rally is really frustrating the bears. The rally really shouldn't be, so it angers them and the bears cover their positions to wait for colder weather. But the bears are wrong!

What's a bear?

A bear is someone with a distinctly negative outlook for future prices. A bear is someone who backs up his outlook with money and gets short the instrument. A bear is someone who is going to get really hurt if his outlook proves to be wrong.

So, why are the bears wrong?

Contrary to the obvious, it's not because we have a rally. The bears are wrong because they can't afford to stay right.

It's really simple: You want to be a bear? Become a cub furst. Then grow some claws and teeth and gain some size. With time you get bigger and you become more like a grown bear. By the time you reach maturity you're growling and likely collecting dividends for having grown up.

And if you don't make it to full age, you shouldn't have been a bear to begin with. No harm done.

Lesson? Position sizing, risk management, asset allocation. You don't make money only when you are right. You make money when you can afford to be wrong.

Cheers,
/Dmitry

Analysis: MACD/RSI divergence?

2006-02-28T22:14:00.000-05:00

It's 10:30 pm and I am agonizing over SPX. Normally there are greater things in my life than worrying about the next tick, but right here, right now is a point of potentially outsized profits - only if we get the direction right.

So, how does one get it right?

Often, traders use indicators derived from price series, such as MACD and RSI, to estimate future direction. One of the more common and allegedly reliable "setups" implying high odds for the directional outcome are represented by divergences between the oscillators and the actual underlying price series.

Over my years as a stock trader (before options suddenly made a lot more sense) I came to watch these divergences. I saw a lot of them. In fact I saw so many that eventually I saw just as many that "worked" as the ones that didn't.

Today I am seeing both MACD and RSI show such a divergence with respect to SPX and my gut tells me that this just has to work. But, regardless of what it tells me I know one thing: this is a lesson in the making. This is the time to use your brain and do the right thing as a trader, not a compulsive speculator who thinks that MACD, RSI, ROC, or some other squiggly is somehow superior to the very price series they are all derived from. Folks, understand that I don't want to knock these as I know a lot of people swear by them, but if you've seen enough price charts, MACD and friends won't tell you anything radically different from the price itself. In fact, these divergences can be spotted without bringing in MACD or RSI at all!

In case anyone still thinks otherwise, let me state with the utmost degree of conviction that there is no way to tell the future. All one can do is make sensible bets and employ proper asset allocation techniques (or some other form of risk management) to enable yourself to take advantage of this situation. I promise you, noone knows whether this is a top until it becomes (painfully) obvious.

That's why it's a just a carefully measured, calculated bet and that's the only right way to look at it. And so my agony over SPX is over.

Cheers,
/Dmitry

Buying Premium

2006-02-28T12:34:00.000-05:00

To reiterate I am not an official bear but I am putting our fund's money into long SPY April puts right here. To quote a master sci fi story teller Bradbury, "Something wicked this way comes".

Note that I am making a minor commitment here as I don't like selling tops on broad indices. Also, I am looking for a very short term bounce in Oil and Housing that could be actionable from a long call perspective.

Dismal action in Biotech and I am watching 195 level on BBH as a tell. So far it's a retracement among overall weakness, but it easily get worse. If the market gets weaker but this level holds I'll look to add to our short put positions.

Stay tuned.

Cheers,
/Dmitry

Relentless and Right

2006-02-28T10:56:00.000-05:00

Smart action this morning with the indices spiking straight down in a kind of a relentless, unmerciful way. Given the weakness of yesterday's rally this move is welcome and my hope is that it starts a new wave down that takes us out of the range we've been stuck in for the last three months.

I scanned the news this morning (my readers know I don't read news, but I do scan them for a sentiment read) and I find two interesting things:

Everyone is talking about Housing bubble imploding. I think this is now bordering on hype and while I am a Housing bear a bounce is in the cards at these levels. We're still looking to sell more calls in this sector but we'd like to see a rally to make the sales worth it.
There is still lingering bullish sentiment on Oil and that tells me that it's heading lower even at these "beaten up" levels. The vol is fairly rich here so selling calls is excellent from both directional and vol perspectives.

So, am I a bear on the overall market? I know I'd like to be but more action is needed to really get me to growl. For now I am looking for oversold conditions to buy calls into or rallies to sell same. Getting long SPX puts has crossed my mind several times but this morning is exactly when one should be careful about chasing an index.

Cheers,
/Dmitry

What We Are Doing

2006-02-27T15:29:00.000-05:00

My gut feeling proved right and the market moved. Not reading too much into this action as the "breakout" that everyone has been waiting for came on a dismal volume. In fact now Nasdaq-100 looks like it corrected up and is positioned to start a leg down. Not calling anything here - this is merely another observation.

A few actionable things happened today:

Retailers (RTH) are strong and we are long deltas via stock and April calls. I don't think owining vol is great here but I like calls because they automatically get you bigger as the sector moves higher.
Biotech peaked my interest even though I think I missed the meat of the move (somehow I haven't been watching this sector for a while). We're looking to sell puts on BBH with any weakness and are buying calls in a couple of names.
Oil is weak as expected and after selling call spreads on midday strength we let them rest easy.
Housing is all over the news but the action is non-exciting. Regardless, we're sticking to our bearish strategy and are selling calls in KBH, RYL and other names.
Gold seems to have caught the "lack of inflation bug" and that's why people think it's down. To us it doesn't matter. NEM is our vehicle of choice and we're short call spreads here. Again, once the sector sells off, we will be selling puts as well as our view for the next few weeks is neutral.
Finally, we like the Drug sector with LLY and ABT being among the favorites. I broke down and advised our fund to just buy stock.

This about wraps it up.

One last thing - I am personally getting long ITF (Japanese fund) as I like the technicals a lot. This has nothing to do with our fund (for now) but I thought I'd through this out here.

Cheers,
/Dmitry

An Option Trader's View

2006-02-27T10:48:00.000-05:00

I always said to a head trader of an options firm I used to work for a long time ago: "Take a view". Why? Because focusing on just capturing the bid/asked spread in an often illiquid (options) market isn't a worthwhile game. I'll explain this at some point in detail.

Naturally, there are more than one kind of a view. At Cadence Capital I condone either a volatility view (essentially an arb play between realized and implied) or a directional view. Often I combine the two.

Personally, directional views is where I like it the most. Maybe it's because I've done a lot of stock in the past (before my re-incarantion in the options world) or maybe it's because delta is the ultimate money maker.

So, here is where I am putting our money from a directional perspective:

I am a bear on Oil for at least the next month. At this juncture we will sell any rallies that may follow today's action. The reason for us not getting short outright right here is that there is also a great possibility that the spot will consolidate in this range for a while before moving lower. Thus I'd like to sell the highs, not the lows of the range.
I am neutral on Gold in the short term. It doesn't have to break hard, but I do think it's done here. We will sell rallies and buy breaks. From an options perspective a ratio strangle (with the calls outweighing the puts) is the play. We want to sell more calls because I see the buying interest still lingering here with weak rallies giving us better prices.
I am a bear on Housing. KBH, RYL, BZH should be heading lower and we are getting short credit call spreads on any strength. Now, keep in mind that I am not a long term bear on Housing and I don't subscribe to the usual "interest rates/bubble/recession" rhetoric. I just don't care. I am not an economist, I am trader.

I have other views as well but the three above are the most defined. As far as the overall market is concerned, I like the strength today (NDX-100 traded through my majic 1682 number and hopefully stays above it), but I am not finding anything actionable on this level.

I will update everyone later in the day with "What We Are Doing" post as far as our fund's activities are concerned. Good Trading Week to all!

Cheers,
/Dmitry

Gut Feeling

2006-02-27T09:26:00.000-05:00

Oil is heading lower this morning. Not calling a reversal here and not suggesting a trade just yet as I feel the near futures contract can move to 66 before reversing in a meaningful manner. If one is itching to do anything, then a long gamma stance in OIH may be sensible. At Cadence we aren't taking this sort of a position on right now as we don't see the odds we need.

Semiconductors also present an intersting picture with SMH looking ready to breakdown and separate issues such as TXN and LLTC drawing a perfect technical setup to get short. We aren't taking the plunge on this either as the overall market isn't providing a "get short tech" sort of context now. If anything, I'd look to fade any breakdown.

Overall, I have a feeling the market will move today. Yes, it's mostly a gut feeling, but often that's all we have going for us!

Cheers,
/Dmitry

CNBC: Fundamentals and Daytrading?

2006-02-26T13:58:00.000-05:00

I just happened to come across a video of CNBC blurb that featured Barron's Michael Santoli and DayTradeteam.com's Andy Swan talking about the recent Google decline. It's the usual CNBC tactic of stuffing a bull and a bear in the same cage and giving them a story to fight over. What's notable though is that they take Santoli's fundamental view and pit it against a daytrader's opinion, thereby forcing Andy to put on his "fundamental" hat and do his best in combatting Michael's arguments.

CNBC certainly achieves its goal of providing an entertaining show but fails miserably at educating the investor. In retrospect I find it entirely laughable: it's similar to handing a soccer player a hockey stick and throwing him on the ice. Probably just as entertaining and at the same time utterly lacking in any other value.

The above isn't meant to undermine Andy's abilities. Bet let's face it - he is a daytrader and I'll bet he is very good at picking his battles when it comes to short term directional trades. In fact, his bullish view on the stock (GOOG was trading at 344 at the time) proved to be correct (the stock is at 377 as of last Friday). Roughly ten percent up. Excellent call if you ask any trader.

So, does that mean Andy's fundamental arguments (about Google's expansion of product lines, growing ad space, etc) have proven true? Or are we to believe that Google isn't going to 250 as suggested by Santoli?

No, all this proves is that a trader is a trader is a trader. Either the folks at CNBC still don't understand or they deliberately ignore this important fact. In either case, this is just another proof that when taken seriously, the show is dangerously misleading to the investor.

TV is entertainment only, folks. CNBC is one of its best kinds.

Cheers,
/Dmitry

Options Trading: Premium Selling and Diversification

2006-02-24T15:50:00.000-05:00

Placidity continues. Flatlining indices aren't presenting much of an exciting landscape for net delta types. However, time keeps running forward at its inexorable pace and continues to reward premium sellers.

Part of me wants the market to make a big move but at the same time, through diversification of strategies employed at Cadence Capital, profits get generated in any market conditions.
Granted, I like delta moves because that's where serious rate of returns are attained (strongly augmented by long gamma strategies). However, time decay-type returns are nothing to sneer at either - even if they don't give you the same ROI.

It's really a matter of capital allocation. For fund managers the game isn't about just timing the market from vol/direcitonal perspectives. It's also (and more so as fund assets grow larger) the game of picking the strategy with the right payoff profile for a particular stretch of time and allocating appropriate portion of assets to it.

Currently, we're still 70% in cash, but our short premium strategy is by far the most prevalent on the books. As the market keeps on churning we'll get shorter while fully realising that an ensuing directional move can (and likely will) challenge our short premium positions. A big part of our short strategy is to collect enough profit from time decay to offset forthcoming losses due to delta exposure.

Does this work?

It does as long as the move does not come too quickly. Mainly the bulk of this sort of risk is contained by a short time window (7-10 trading days) after premium is sold. This assumes sales in the front month premium as we want the exponential theta to "outrun" delta exposure in the short term. While this works well, often we witness convergence of theta profits and delta losses netting a zero. That being so, it's a small price to pay for a potential (and highly probable) profit.

Of course then there is the issue with outliers.

Assuming that a strategy takes on a reasonable amount of risk (so that a reasonable amount of profits stand a chance of being generated) outliers will inevitably happen. That's why diversification within a strategy plays such a crucial role. If we want to employ a premium selling strategy, we'll sell premium in a large number of issues. While this may be counterintuitive, this has a "self-hedging" effect where the probability of all (or a very substantial part) of the portfolio blowing up is very small.

And how does one hedge that "very small" probability?

Through diversification across strategies. For example, our short premium strategy will get us to sell puts on issue A. At the same time we'll be long issue B through our delta long strategy. Naturally, A and B by themselves aren't enough to offset overall risk, but when there are many A's and B's in several uncorrelated "buckets", this risk gets closer to zero.

But, it's never really zero, is it? That's why we are traders and that's why "past performance is not a guarantee of future results." :)

Cheers,
/Dmitry

Placid Indeed

2006-02-23T15:42:00.000-05:00

30 minutes before the close and another trading day is gone. Our favorite sectors remained in a tight trading range and we stayed away from making any major committments. A few issues in which we found mild interest today are:

RMBS (net long delta)
CTRP (short credit put spreads)
PHM (long ATM puts)

We're mostly in cash as of this writing and besides the above names our portfolio has exposure to RIMM, GR, OSTK, BBY, WTW, APC, RYL, CVX, AEP.

So, we're keeping it small at the moment as the market isn't offering any actionable ideas. Our wish for NDX-100 closing significantly above 1682 doesn't seem to be coming in and that being so, I am beginning to feel that it's a good thing. Frankly, I'd hate to get seriously long this market right now.

Best trade for the time being: do nothing

Cheers,
/Dmitry

Fractals, Dow Theory, Nikkei

2006-02-23T08:57:00.000-05:00

Pre-opening market levels are slightly lower this morning. Aside from Housing and Gold sectors trying to keep strength (a few stocks are ticking mildly higher) nothing eventful is on the radar.

Another placid day? With VIX sitting right in the middle between overbought and oversold levels it's quite possible.

We're looking for actionable items in NDX-100, Housing, Gold, Semiconductors and of course, Oil.

Looking around for items I came across a website that provides long term charts on pretty much anything. So, I looked at the stock indices and noted three things:

The Dow Theory non-confirmation of DJIA rally is glaringly obvious. With a so far 100% hit rate of such non-confirmation having spelled "bad things" in the past, this is something to keep in mind.
S&P 500 looks like it's forming a massive double top. This is too early to say but fractalists and Elliott Wave practicioners out there are terribly concerned. I have to confess that I am too afflicted by these schools of thought and thus tend to align my views with their camp.
Nikkei 225 looks a lot like Gold before it rallied from 250 levels. We'll do more research on this as I'd like to allocate a portion of Cadence Capital money into Asian markets.

Here is the link: http://www.mrci.com/pdf/stocks.pdf

Cheers,
/Dmitry

Closing Bell

2006-02-22T16:10:00.000-05:00

The NDX-100 closed below the 1682 level that I really wanted taken out. Well, that's actually a good thing because now we get to look for strength confirming my bullish view. For example, a strong gap up at tomorrow's open and a failure to fade it would be an excellent indication of strength that I will find actionable.

Housing closed at the highs but we did scale into RYL call credit spreads and also went long PHM puts. We will continue to build bearish positions in this sector. Also, I am looking to put on a long gamma trade in KBH using a combo of long April 70 puts and long stock.

Oil is acting well on the downside. While I am a longer term bear my gut tells me that the sector may base here for a while. Again, selling calls into rallies and nipping on puts into breaks is our strategy. Also, any heavy breakdown should be met with long calls for a trade. Our rationale here is that while the sector may well head significantly lower, it isn't ready to make a big move just yet. It's not just about the price, it's also about the time, folks.

Insurance sector is beginning to peak our interest. The premium here really doesn't pay to take on short gamma risk, but buying vol is not a bad idea. We are looking to position ourselves with either outright long calls or at least long gamma in MET, PRU, MBI and potentially HIG.

Last but not least, Gold is on our radar. As mentioned earlier, we want it to do nothing and so far our wishes have been granted. We have not initiated any position here yet but we are looking at the big names (NEM, ABX, etc) to sell premium.

To sum it all up, opportunities are taking on shape and we are ready to pounce.
And pounce we will.

Stay tuned!

Cheers,
/Dmitry

What We Are Doing

2006-02-22T14:45:00.000-05:00

Interesting action in the Housing sector today. A few posts below I mentioned that Housing looked terrible on a monthly basis. I also said that we'd look for rallied to get short.

Well, today we have the rally. I am looking for selling call spreads on RYL, KBH, LEN and a few others. We may be running a bit ahead of the train here so my recommendation is to scale into the short position as the market tries higher.

While the SPX is attempting to post a multi-month high and the NDX-100 traded through my magical 1682 level (see below) I am looking for the market to keep the strength into the close before selling puts on the indices.

I guess my caution is due to the unconvincing action in the Semiconductors sector - I really would like to see a move lower followed by a stronger reversal than what we are seeing today.

Finally, the Oil sector is selling off and we're looking to add to our credit spreads on the call side on any uptick.

That's all for now folks!

Cheers,
/Dmitry

Good Old Dow Theory

2006-02-21T23:19:00.000-05:00

Anyone involved in analyzing the markets from the technical side has at least heard of the "good old" Dow Theory.
Below is a link that shows it in action - an action that is ominous, to say the least.

I don't forecast for a living. However, reading in-depth analyses of people who do, especially with employment of impressive level of rigor, is at least prudent.

A Dow Theory Primary Trend Warning

Cheers,
/Dmitry

A Few Wishes

2006-02-21T17:34:00.000-05:00

Every time I witness a non-actionable stretch of market activity I ask myself the inevitable question of what would really gets me excited.

Well, here are a few answers:

Oil reversing right here. As I posted earlier, I don't like Oil on a monthly basis. If I am right, I'd like to see a confirmation of a continued downtrend. Soon.
NDX-100 trading through 1682. That would get me short puts on the index in a second. However, it's not just the number, it's also how it gets traded through.
SOX.X trading down to 510 in a single fell swoop. That level is pretty obvious to most technicians, but the exciting part is what happens once the index gets to it.
Dow Jones hit new high. Why? Because it will be the most ironic thing against a backdrop of a deteriorating market. Did I just say "short Nasdaq puts" above? Yep, that's the art of trading. :)
And the final thing that doesn't quite fit the "excitment bill": Gold going nowhere. Yep, I think selling gamma in Gold is ok here. Just be careful to leg into your short gamma at the extremes of the range (We're looking at the recent high and low - 580 and 540 respectively). Actually, breaks above and below these extremes should be faded - at least in the next few weeks.

Cheers,
/Dmitry

Placid

2006-02-21T15:15:00.000-05:00

Welcome to March expiration cycle.

The NDX-100 is down 17 as of this writing but the market overall feels somehow stronger. Semiconductors getting pushed lower must be skewing the action. Overall, nothing to write home about.

This weekend I pored over several hundred charts and came to two conclusions:

The Housing sector looks terrible. This is on a monthly timeframe and even though we are not ready to short sell the equities right here right now, we will look for rallies to get short. Also, selling calls into these rallies will be another recommended strategy.
The Oil spot looks pretty bad as well. It has bounced from its lows of 58 or so but I see a lot more downside. Some Oil sector names need to be sold here and we are offering call premium in APC, CVX and other issues. Just like in Housing, we are not ready to get short outright, but the time will come.

I know my view on Oil is really counter-intuitive but I call them as I see them. And no, I don't care what WSJ or CNBC has to say about the situation with production, supply, operational overheads, margins, etc.

With the market not offering much activity, here is a really interesting read posted this weekend on TheStreet.com:

An excellent article for all market technicians out there.

Cheers,
/Dmitry

Pedal To The Metal

2006-02-17T11:24:00.000-05:00

Welcome to Expiration Friday.

For options sellers this is the day of relief and, at times, vindication. While this is certainly true, at Cadence Capital we like to treat this day just like any other.

Markets are trading, prices are moving and that means there's money to be made.

So, don't get lazy. While you aren't likely to get caught with your pants down on Monday, it's better to wake up with the gas pedal pressed to the metal, as opposed to having to jumpstart your slumbering Ferrari.

Cheers,
/Dmitry

Slick City

2006-02-16T12:06:00.000-05:00

Big Oil morning, if you caught the bottom last night.

Our NYMEX trades proved to be a good bet but being in "risk averse" mode we're booking profits with the QM futures up about $0.70

OIH did better then the spot (I suppose because OIH has an equities element in it and the equities market is up) and gifted us with a nice $2 gap open with a follow-through higer. We're liquidating our March 135 calls at these levels.

Oil stocks individually are probably the best of the bunch and we're either liquidating our long calls here or watching our ITM puts shrug off evil short gamma.

Yes, Oil needed to bounce. I think the bounce isn't over yet but there's likely more downside afterwards. Since I am now talking out of both sides of my mouth we have no money commited to the slick sector (aside from some remaining short gamma).

Cheers,
/Dmitry

CLF Lesson

2006-02-16T10:49:00.000-05:00

CLF is down 8 points this morning after a disappointing earnings announcement.

The lesson here is simple: last night we had to make a decision to cover our 90/85 CLF put spread. We did, while leaving some long puts on the table "just in case it disappoints". So, we gave back $100 per spread in order to avoid a potential $500 loss. Today is that day of "avoidance". Today is also that day when I can afford feeling smug having nailed the trade from both ends.

But most importantly, today is the day when this situation is still a lesson, but no longer a painful one.

I am glad I could share it with you.

Cheers,
/Dmitry

Oil Update

2006-02-15T16:03:00.000-05:00

Just looked at teh March contract chart.

It is too bad I didn't look at it earlier. While I am a short term bull on OIH and family, I am even more bullish on the Oil futures as I feel the contract is perfectly positioned for an outright long position. We're buying these after the market on NYMEX.

Enter at your own risk. :)

Cheers,
/Dmitry

Oil Revisited

2006-02-15T15:21:00.000-05:00

Big action in the Oil sector with the spot down nearly two points on the day. The action is bloody and downright frustrating.

Perfect opportunity for a net long delta position.

We're buying March OIH 135 calls and looking to get int to the following names if they go through the nearby strikes:

WFT, SLB, RIG, PTEN

PTEN is already through but I'd like to see OIH bleed itself to death before I commit any Cadence Capital money to it.

We can be labeled "Agressive Long" here for the very short term.

Cheers,
/Dmitry

Earnings Before Expiration

2006-02-15T12:10:00.000-05:00

If you are positioned with short ATM gamma and there is an event right before expiration you have to make a choice to either keep it and expect options to go out worthless or incur a loss (hopefully limited by a spread).

We had to make such a choice with CLF. The 90/85 put spread is trading at about $100 and we're short a full position. Our risk is $500 per spread with a potential gain of $100 (actually it is less since we entered it a while ago with the stock being much higher).

What does one do in this situation?

Since our current focus is on risk management (as opposed to trying to rake in more premium) we had to make the correct decision to liquidate the position. We did keep a few long 85 puts just in case CLF disappoints but other than that we felt that giving back the $100 premium was more strategically sound than expecting CLF to do nothing.

What went into this consideration?

Well, one can start looking at the earnings history and see how the stock reacted to suprises or disappointments. One can look at implied vol and deduce a potential movement after the announcement. One can...

Hogwash. The stock can and will do anything it wants. Our only consideration was to give back a "known" $100 per spread today rather than look at a potential $500 loss tomorrow - exactly when we wouldn't be able to do anything about it in terms of hedging (this consideration would have been different had the annoucement been at an earlier date).

I've woken up to blowups before - the hard ones came on the third Friday of the month. And they stink! They stink because we know better and they stink for our performance.

And that's why we're flat.

Cheers,
/Dmitry

The Bernarke Wednesday

2006-02-15T10:32:00.000-05:00

I hate gossip. I prefer facts.

Problem is, people are almost invariably ignorant of facts but are well informed of all kinds of gossip.

This is why I rarely read news (too little of it is factual) and I never talk about it. I am sure this is at least somewhat surprising and I'll offer an explanation at some point when I detail my strategy. However, today I'll make a rare exception:

So, the web is abuzz (is that a new word?) with talk about new Fed's chairman Ben Bernarke's speech due out sometime today. I won't go into my feelings about the Fed and its policies - we all have our views that in the end amount to nothing useful. What I will say though is that it is intriguing how much attention this "event" is gathering from every financial mogul.

The interesting fact is that unless he utters something radical, Mr. Bernarke has an amazing lack of control of how his speech is going to affect the markets. Understandably, this has nothing to do with his ability as the Fed chairman. It has everything to do with too many human beings paying too much attention to another human being speak. Consequently, a neccessary observation is that his speech is likely to move the markets in a significant way - at least in the short term.

How do we game this?

It depends on what one is trying to do:

If you are a stock trader then you'll probably fade the immediate move that results from the announcement. I imagine Oil and Housing will be affected the most. Since the downside in both is limited in the short term (I am still a bear cub in Oil - in the intermediate term) a selloff will be buyable. A rally in these sectors will be tougher to trade and I recommend to stay away. If you are a bull and need a reason to get long, this isn't it.
If you're an options trader then you're likely waiting for expiration to "just get here already" and aren't too concerned with making more money right now. Keeping what you've made is plenty. This is a tougher position especially if you're short ATM gamma like we are. Recommendation: do nothing. It's a hard advice to follow but that's the only way you'll have odds on your side.
If you're an options trader and are trying to make money then sell ITM options after the initial move. Essentially you will become a stock trader and collect the most time premium you can get on top of it.

We belong to the second and third category. Good luck all.

Cheers,
/Dmitry

A Good Fight

2006-02-14T11:04:00.000-05:00

Today is a day of much pain.

With housing, oil, metal mining and semiconductor sectors hitting lows and making us bleed at the money gamma in a bright flood of red I stare at the screens, utter a few expletives, clench and unclench my fists and make a decision to blow out our positions and wait for a better day.

Except that it's not really me making the decision. It's just my human self.

A sip of coffee. It's a crisp, shiny winter day and I haven't seen so much snow in a long while. I love snow. Another sip. It's Valentine's day and there is something special I am going to do for her today. And it's not just cooking dinner... Sip.

I turn back to the screens. It's expiration week, opportunities abound and there is money to be made.

My human self goes out for a walk, the trading machine is back and it's business as usual. We keep the portfolio and get bigger.

We like Housing and we're selling ATM credit spreads right into expiration. We like Oil and we're doing the same. We're watching Metal Miners (CLF and PD) to trade lower so we can buy stock. And we're looking to regain our long gamma in OIH.

This is scary stuff but this is how it has to be done. Because humans lose and only traders win. Make no mistake about it.

Cheers,
/Dmitry

Areas of Pain and Opportunity

2006-02-13T14:06:00.000-05:00

Interesting to see NDX-100 down 22 in this quiet, almost placating fashion. Forget panic, I don't even sense any significant degree of fear out there. VIX rallied to 13.56 but it's not reflecting the level of immediate anxiety that should be present in an obviously delfating index.

Do we buy this? Yes, very soon I think. To reiterate, I do think we're range bound and this leg will run into buying pressure at the lower levels.

Most painful areas in our portfolio presently are:

Semi SOX.X index. We're beginning to see short gamma.

Metal Miners: CLF and PD. Major weakness here but I don't think there is much downside left. If we do see a move lower I will position us to capitalize on an ensuing rally.

Internet: GOOG. Of course. Again, gaining short gamma, but also continuing to see a deal in both directional and vol views.

On other fronts:

Oil is heading lower after trying to rally once more in the morning. We're looking to buy some stock lower to hedge short deltas. Again, it's our APC/OIH favorite combo.

Japan (ITF) is looking pretty terrible here. In fact, I am sensing that Japan may be presenting an opportunity very similar to that of Oil. We're are seriously considering a directional play here by shorting ITF (options are too illiquid on the index) and also looking for other vehicles.

Cheers,
/Dmitry

Week Behind, Week Ahead

2006-02-12T18:45:00.000-05:00

There are times when I am deathly afraid of being bored. This isn't because of lack of hobbies (I have several, one of which used to be my fulltime career) but because boredom often spawns an incessant need for action. Action out of fear of not making money.

Well, I haven't felt that way since Jan 06 when the market broke out higher and we were overbought with seemingly nowhere to go. Over the past few weeks the equities market had the chance to negate all of the yearly gains, Gold rallied and sold off, Oil tanked against everyone's expections and the VIX/VXN started to trend decisively higher reflecting a rise in anxiety. In addition, the market keeps hinting at an imminent cliff-dive while managing to frustrate the bears with "nah, I was just kidding" type of a follow-up rallies.

The realized volaitlity over the past few weeks has given us the opportunity to capture healthy profits which we hope to retain during the expiration week. Continued volatility is welcome and ,judging the new levels of anxiety, fully expected.

Specifically:

We will continue to capture long gamma opportunities in the Oil sector. Plus, while I am no longer a growling bear I am definitely at least a cub, so I will make direcitonal recommendations to our fund.
The equities markets overall (NDX/SPX/etc.) may try to break lower, but I think there is too much money on the sidelines and too much anxiety (judging by rhetoric posted all over the net) for them to really break down. So, further "scary" dips will be viewed as buyable.
Gold sector put in a top but I doubt it's a big one. More downside is in the cards but that presents an opportunity to sell OTM spreads.
Finally, we expect VIX/VXN to establish slightly higher levels than what we've been seeing for the past few months. Not looking for VIX to hit 25, but a range between 13 and 16 is quite probable.

See you Monday, bright an early!

Cheers,
/Dmitry

Recap, Recap!

2006-02-09T17:18:00.000-05:00

Another volatile day. As I mentioned earlier Oil rallied in the morning and then sold off throughout the day. We got shorter after the initial rally and flipped stock against our long gamma. At this point, we're flat in OIH (no position) and long gamma in APC with zero delta at 99 level. We are expecting continued volaility in that stock and the overall sector. Interestingly enough, some of Oil stocks are trying to stay in a range (GSF, RFC, WFT) while some others are selling off (APC, AHC, MRO). This tells me that while Oil is clearly topping, it may not be prudent to get overly negative on it.

In fact, we started selling OTM spreads on some Oil stocks for Feb (there is still moderate-risk 6% premium available) and are considering even deeper March spreads.

Other parts of the market universe were relatively stable and the only notable trades we made was getting out of our long BZH/GOOG positions as we expected. Actually, GOOG has been a great trader and we flipped it back and forth several times in the last two days. Not really our style but when a stock makes strong uni-directional moves it creates highly probable situations and there is no reason not to take advantage of them.

To reiterate a point made in my earlier post, I do feel that NDX tends to fall in unison with Oil but for no apparent reason. Granted, NDX is basically at the year's lows but Nasdaq Composite and Dow Jones aren't. Feels like an inter-market divergence with the overall market stuck in a range. If so, I'll repeat that I think NDX dips are buyable. As I am typing this I realize that this is a bit of an "off the cuff" analysis and it is not something we normally game with serious commitment. However, over the years I've become cautiously optimistic about empiricism and my current observation is at least worth considering for the near term.

Cheers,
/Dmitry

Oil Run!

2006-02-09T15:25:00.000-05:00

Short update: we are rebalancing right here right now to DELTA NEUTRAL on oil and maximum gamma.

So far this action has been amazing. I am no longer an aggressive Oil bear (but will still lean short delta after a lift). However, I am a massive long "gamma-er".

This market is going to move... again.

BTW, it is curious to see NDX react negatively every time Oil sector sells off. I think the NDX dips on Oil reaction are buyable.

Stay tuned for more or write us with questions: cadencecapital@gmail.com

Cheers,
/Dmitry

Fast Rally

2006-02-09T10:15:00.001-05:00

A quick update this morning. Our favorite combustible rallied this morning allowing for the last short entry. OIH at 147 is a good place to get shorter if you are an Oil bear like me.

Long gamma types should be flipping stock here and looking to reload lower.

Cheers,
/Dmitry

What We Are Doing

2006-02-08T15:18:00.000-05:00

An interesting day. Make that last three days.

Here is the recap:

We're long BZH at 2/3 of capital allocation. I like BZH specifically because it broke the 65 strike. The entire Homebuiding sector lifted today so that certainly helps. We don't plan to stick to this trade for too long and are likely to be looking for an exit tomorrow.
We're long GOOG at 1/3 of capital allocation. Actually we flipped the stock a few times during the day by buying dips and ended up with a meager long position.
We're holding on to our Semiconductor credit spreads with SOX.X acting like a champ.
We're long gamma in Oil sector via OIH and APC synthetics
I am personally short delta in OIH - I've been selling it all day into strength.
Finally, we blew out of PD - see the story below - and rolled credit spreads to 135/130 strikes.

As a disclosure, the above is not a list of all of our holdings. I am merely reflecting on the day's activities. Sometime soon we'll be posting our fund's holdings in their entirety on daily basis. Stay tuned for that.

NDX/SPX complex is acting strong with VIX dropping through 13. As we expected the markets seem to be stuck in a range with scary dips and rallies rattling everyone's nerves.

And that's a good thing.

Cheers,
/Dmitry

PD Story

2006-02-08T13:29:00.001-05:00

As promised, here is a play by play of our PD trade. As a disclaimer, this story isn't about options, it's about being a trader. Also, there isn't anything special about this story as we go through such situations all the time, but I think I should share this common lesson with you.

On Monday, Feb 6 PD rallied to challenge it's recent new high of 167 on about half the volume of Feb 2nd - the day it opened at all time high and quickly sold off. This particular setup happens to be one of key ingredients for our model's probability distribution of future near-term prices. Directionally, PD had great odds of moving higher.

Seeing Feb credit put spreads at 150/145 strikes paying nearly 10% in premium we legged into the trade at a maximum capital allocation (meainig, we were fully weighted).

On Tuesday, Feb 7, PD opened lower and proceeded to fall nearly 13 points in an almost arrow- straight line to close at around 152. Our spread by then widened to show a significant unrealized loss. This event had a roughly 12% chance of occuring as estimated on Monday.

Today, Feb 8, PD continued its fall to reach 148 by 10 am EST. Right after the open we liquidated the short leg of the spread (150 short put) and continued to hold on to the long 145 put. At 10 am (which happened to be the reversal bottom) we liquidated the long leg.

All of it at a loss.

Every kind of pain has a theshold. It either makes you pass out or you stop the pain yourself when you can no longer handle it. If it's the former, you will either end up in financial death or you'll make good money. If it's the latter, you are guaranteed to experience a controlled loss.

That's an important difference to realize. It think anyone would agree that having a control over one's losses is better than not having one, even if such control always guarantees a loss. Mathematical expectancy of controlled losses points to an overall profit, assuming all other parts of the trading strategy are sound. On the flip side, the expectancy of an "all-in and close your eyes" approach is distinctly negative, and in a very short term.

We chose to end the pain and take the loss. While it may now look foolish by seeing PD tick at 154, it was the only correct thing to do. The other correct thing to do was to exit the trade last night before the close as we didn't expect to see PD down 5, 7 or 13 points at any given point. But that's mostly hindsight.

So, as much as I'd like to be exiting the trade at 154 now, I'd rather exit it the way we did.

Why?

Because even after doing this 100 times I'll still be around to make a trade.

Cheers,
/Dmitry

Traders Are A Fickle Bunch

2006-02-08T10:49:00.000-05:00

Guess what I am going to talk about his morning.

Yep, Oil.

However, before I get into that there are a few other things worth attention:

We are now long initial delta in BZH and GOOG (both of them went through the 65 and 365 strikes and our model got us long). We'll be looking to add into further weakness.
We've liquidated credit spread in PD for a substantial loss. We also rolled PD short spread to 135/130 strikes.

Now, on to Oil. The sector dropped sharply at the open and then rallied just as sharply back. As I am typing this, it is selling off again. Naturally we like the volatility... a lot. Our trades are centered around long gamma in OIH and APC and I am also trading short stock into every rally.

I am still an Oil bear but I make no predictions as to my disposition for tomorrow :) What can I tell you, traders are a fickle bunch.

However, if you do want a prediction from just another guy out there, then I'll say that there is a very good chance that Oil will continue lower in a rolling trend. So, selling rallies (hopefully around a long options position) is a good stance to take. Besides, owning vol in OIH and friends into this downtrend is an excelent idea.

By the way, our PD trade was very frustrating and I'll make sure to write about it in the next blog entry. Lesson learned there.

Cheers,
/Dmitry