Theta Positive - Option Trading

September 30th

The end of Q3 marks and up day (at least around 3:30).

My blogging and trading is going on the back burner for the next couple of months.

Non directional trade starts with the presumption that calculated Standard Deviation is obeyed by the markets. Of course we allow for bigger moves, in one or the other direction. Currently we see big moves in three direction up, down and back up again. Not very helpful of a non directional trader.

Part of a traders skill is to recognize when his trade style is applicable and in which situation it is not. For me it would be pitfall to toss non-directional trading to the sidelines and to trade more directional - as said earlier - which direction? I am better off to sidestep this ordeal and come back with proven methods when the environment is more supportive.

I will use the VIX as an indicator for market conditions, in 2002 it took a couple of month for the waves to settle. So maybe I am back for December - the Vix will tell.

Thank you for all your support over the last months.

September 29th

No comments - a dark day- hope we live to see the consequences.

20 days to October expiry

What can you share on trading blog after a day like this.

Just amazement that some politicians were advocating reduction of Capital Gains Tax for companies as part of the bail out. When you are about to spend 700 billion why would you want to reduce your tax base? Why would you advocate for deregulation? A high school kid can see that the absent of regulation got us in this mess.

I have been listening to a lot politicians the last couple of days. You get the impression that companies, government and American Families are made up by three different kind of species. Species with different interest and goals. Let's please realize that every company employee and the end of the day is part of an American Family as is a governmental official.

We need successful company tax paying companies and we need functioning Tax Paying American Families. Government needs income to take care of services which we as individual can not organize by ourselves. We all appreciate life in America - I sometimes wonder why we think it needs to come without a price tag.

In my opinion the Wall Street bail out is not a bail out of banks and other financial companies. It is a rescue of the world as we know it. A just a couple of hundredth thousand people have been able to bring the financial world on the edge of a ravine. Fueled by self interest and Xmas bonuses. Some anger towards them would be appropriate.

Enough politics.

For my trading position let's hope this weekend will end with a "surprise" announcement and a jump up. This morning the opening left me below of my lower Expiration Break Even, normally you would start peel off some debit spread (from the butterfly) - but anticipating a jump up, there was just one logical choice - endure the pain and hope for the best. A horrible feeling when "hope" enters your trade plan.

I entered a little naked put position on BAC - if the bail out comes through BAC will benefit being able to off load some toxic stuff from MER and CFC. Toxic assets they acquired for a discount.

I truly hope most you followed the advise to stay away from trading October. Don't forget Oct 7th Q3 earnings season will start - more volatility to come.

Enjoy your weekend

21 days to October expiry

I am still hanging on the finger nails trying reduce the damage done by the excessive moves. With the Bail Out on the threshold, the market is looking to the upside. Can you imagine Jerry Immelt's surprise when he looks at his stock price at 4pm. Bad news is good news - normally you would say these are the very characteristics of a bull market.

This market is driven by fear and news - someone suggested to me to set market neutral trading to the side for awhile and to make more directional trades. I have only one answer to that suggestion - Which direction?

I added to my RUT mess a butterfly a 710-750-790 this trade is ready to accept a run up and can endure some pain before it becomes non-salvageable.

This morning I started to swing my position towards positive delta's. I reduced for a profit some naked calls I had on the DIA OCT 119 and took some more profit on other covered calls. If we get a run up I don't want to loss the upside by having to many covered calls on my positions. When I say swinging towards positive delta's - I mean with moderation - always make you adjustment in small steps - never commit yourself you one direction. When the thought "I am hiting the jackpot if we go down" comes up, then you are at risk!

I am not saying we get a run up, as a perma bear I just want to be prepared. The only real indication we have is the RVX dropping 2.5 points.

22 days to October expiry

The SEC update the list with companies which are on the no short list. Strangely enough IBM is added.

Enough reason for me to get some short delta's on IBM. I am long JAN 115 PUT and short the OCT 110 PUT. I paid 5USD. If it works I can profitably roll the OCT 110 to the next month. If it doesn't rolling to the next month will reduce the cost of the little play.
I like making directional with debit diagonal. The downside risk is very limited - if we stay at this level I can roll to November for approx 2USD, reducing the cost of the trade to 3USD. After Nov I will still have two more rolls Dec and the closing roll to Jan. If the stock runs up, without any risk I can start selling the NOV 115. Of course safety comes with a cost - IBM falling overboard will not give me the jackpot. The question is how often are you right in you directional plays and how often do you get the jackpot when you do a directional trade.

The market is waiting for the results of the discussion in Washington. The VIX and RVX are staying very high. We are quite sure the Washington rescue will come - but traders seem not to be selling a lot of put spreads.

With a RVX in the high thirties - be careful the next move can be huge.

One more thing - like to see a good youtube video with George Bush (not a joke)

September 23rd

Sometime you come up dry, no inspiration for the blog, no inspiration for new trades.
Risk/reward is not in balance. We move down, we break important levels, but sometime this week Washington signs off on the deal and we are up 40 points. Not a market for a Theta Positive traders.
I wish I had know it in advance, I would have stayed on my Island in the Carribean.

I watch the senate hears this morning. I seems to me that some of those gentleman have really no clue how big this thing is.
The CDS market is like us "playing with option" but then in a system that doesn't hold margins and with only a few issueing counter parties.

In the CDS market it is possible to make good on one end of your spread, while losing on the other end of your spread. Sounds familiar doesn't it. The difference is we option traders, by the rules of the CBOE, are sure the counter parties have the moneys to pay us out when we close the winning side. In the CDS market there is no such thing.

So Company X is in the money for a couple of millions with counter party A and down a couple of 100K with counter party B. Next morning they wake up counter party A is in liquidation. Profit gone and they still hold the IOU for the losing trade to counter party B. If this happens to often company X will fall and here goes the house of cards. Leh could fall, AIG had a lot of naked CDS contracts on the books. To many companies X would have seen their trade go wrong.

Be carefull, no adventures

24 days till October Expiry

Spent this weekend on analyzing my butterfly, the trade rules and how they worked out in this volatile market. I came to the conclusion that in the first week of the trade, the butterfly ( with exception of exceptional market drops) does NOT need any adjustment.

The butterfly is essentially a credit spread and a debit spread.

Going down the credit spread will make money; max profit is the credit received
Going up the debit spread will make money; max profit the width of the spread minus debit paid.

The underlying needs to run so far down or up that closing the losing side creates a bigger lose than the max profit on the other side. This is hardly possible within one week. The second week you will have already received some theta, which will help to off set market moves. In the third and in the last week Gamma will start to play a more major.

My main conclusion I can be more relax with the butterfly in the first week of the trade then I initially allowed.

I have decided against putting on extra trades as in additional butterflies. The market needs a little time to settle. November will be soon enough. The remainder OCT Rut trade has integrated into one big position. Today was a good day to recoup some of Fridays losses. Tomorrow this market can jump in any direction, so I very tight with Risk Management, keeping my Greeks under control. Without adjustments my profit zone is @ expiration between 690 - 740. Still 3 weekends to expiry a lot can happen :) Although I heard Paulson is expected to play golf this weekend!

27 days till October Expiry

troubled times for a market neutral trader.

What did I do today - till 2pm nothing. The damage was done. The market was coming to my direction.This gave me time to assess the situation and consider coarse of action.

My butterflies and Iron condor have become unrecognizable in my account. The final adjustments have melted these position into one. Currently my delta are -5 and I have gamma of .53 and Theta has become NEGATIVE. The last means that I am outside my Expiration break evens. My position will not change significantly on Monday between 640 and 800. So what ever Uncle Hank throws us over the weekend, I will not pay the price.

Over the weekend I will do some more analyzes on my positions. I am seriously considering another butterfly on the 760 level. I need some time with myself to fight about that one.

My position size is less than 40% of my normal position. I am not yet in my 30 days trades and I have only half of the butterfly on. So result on an cash-flow basis are not good, on a average per month basis they are still acceptable.

My directional bias is up; I can't imagine Bush and Co coming out with 'BAD' news on Sunday.

In closing one thought for everyone with children: "Use the weekend to find a good reason and explain why we gave them an extra Trillion USD of deficit to pay off".

28 days till October Expiry

Hoisting a second red ball.

sorry that is all for today - no adjustments made to the butterfly - I need a long work out in the gym to get over this.

29 days till October Expiry

As you can imagine, struggling is the best verb to describe my trading.
Based on the /er2 futures yesterday low was 676, the 1AM high of this morning was 721. Currently we are retesting yesterday's lows. (and while I am writing yesterday's is gone)

This is a difficult market for market neutral traders. I hoist the RED BALL for anybody but the extreme experienced traders. If you want to make a small "Las Vegas" style bet up or down, be my guest. Don't enter the market right now and expect the standard deviation rules to be applicable.
Normally you would say selling any spread with a short strike of delta smaller than 20 should be safe.

I would argue you can't bank on it these presumptions right now;
- Our Uncle Hank or his cousin Uncle Ben speaks and we are up.
   (We are lucky that cousin John is silent; "The economic fundamentals are solid". Thank you McBush!)
- The CFO of an insurance company you never heard of confesses that (s)he played with the cash reserve in the CDS market and we are down
- The biggest shoe to drop; a big pension fund has to admit that all their investments are gone. They used to have a well diversified investment strategy. They owned GE, LEH, BSC, GS, FXI, EWZ, RSX, COH, FNM, AIG, WM, WB, F and GM. With the spare cash they owned some bonds and CDS'es. They just recovered from Enron and Tyco. Now they have to ammit that they come short x,x00 Billion.

Enough politics and pessimism.

Without regret I rebalanced the butterfly - I will get creamed if we turn around and go up from here (especially if we imitated yesterday's speed). Cost of yesterday's decision $535 for each 5-10-5 unit.

In these situation I keep an eye on the following 'last adjustment' and check if I make the final directional decision what would my p/l be. Currently that is $2300 which is close to 50%. We don't aim to make 50% so we still have time to peace meal the last three steps into the trade.

Late night edit::

Check this video interview with George Soros.