Theta Positive - Option Trading

Jan 14th

Well that was a day! We did break that low of yesterday even before the open. At least it took any doubt away of what the direction was going to be.

I am stopped out of the /6b future (GBP/USD) and I closed the RUT Iron condor. I was in this trade since Dec 30th and the clock was at 2.5% in 2 weeks. I was anticipating another 3% profit - but - my head is still a bit brushed by Nov (hope you forgive me). Seeing the vix move back over 50 - I just decided to play it safe. Between the TLT, /6b and now the RUT I getting close to my month target for FEB! Did not feel like taking the risk.
In addition if and when I have a definit signal that the vix will come down, I will sell (as blogged before) a naked SPY strangle both side delta's 10 approx netting 1.50. With the vix come down that will be a good trade - doing it in a size equal to the 3% profit which I left on the table - will help silence my greed.

You might remember that I am still the proud owner of a RUT JUN/Feb 370 put calender. It start off as a JUN/JAN calendar. The plan is to keep rolling - It works like a spider waiting in its web. Raising IV and a retest of the Nov lows will be its ultimate moment.
For now this trade is marginally profitable, but then I don't look at it from day to day - I know I can still roll 4 times enough to become at least break even.

I hope you did not get hurt to much - keep any on those Greeks

Jan 13th

Just coming back from Starbuck, I swear at Starbucks I heard the same sound as I heard in the market the whole day. A coffee bean grinder, hacking away, going nowhere :)

Again the intraday VIX was a good tell tail for the market condition. Market down vix down - as long as that is true, I relax a bit on the down turns.

Someone asked me if my trade style only allows for butterflies or do I trade anything else.
I trade a lot of different styles - most successfully are theta positive and trend following. With break outs and IBD-style my track record becomes spotty.

With options, theta positive, I will use any appropiate strategy but most experience I have with butterflies, condors, straddles and calendars (no order intented). Double diagonals don't come often out of my bag. Recently I started to practise with Ratio Spreads.

As for trend following, I try to follow the power which steer the world markets.This market is in a dance, currently the dance partners are USD (and other currencies), Gold, Treasuries and SPX.

I am not an expert; but on a day like to day, USD up (compaired to GBP) - so someone is buying dollars. Where is the money going, in the equity market or in the treasuries. Flow the money - it will leave a trail. I closed the TLT trade on the recent strenght - Happy to reenter it when it is ready for the next leg down. Profit on the TLT trade is substanial. Last night I short the GBP with a future (/6b)  - currently I am full of doubt 50% result (based on margin) under 20hrs - be happy, or wait for more.The usual compromise is to move the stop order a bit down.

At times I am on purpose brief - I am on a quest for the holy trading grail - I don't expect to find it - the quest itself is profitable. By tiptoeing onto topics I hope you add some of them to your own "quest list".

Before we close for the day - I think for the short term the market is making a point - this is the intermediate low. check if this fit your model - if so - time to sell some volatility. Break of today low would violate that outlook!

Jan 12th

Big move but not more than one Standard Deviation for one day.

IV * price * SQR (1/252)  = 45% * 87 * sqrt (1/252) approx 2.49

From high to low the SPY shows a range of 2.50; a one SD move; should happen less than 68% of the time. (corrected based on Harold's comment).

Probably just because we fell 'asleep' during the xmas week that we are a bit surprised.

I did added some long delta's in IBM shorting the FEB 85 put and long the FEB 85 calls, for a 15ct credit. Let see if the strength in IBM on a weak day like this is a good tell tail.

Thank for all the support emails and comment over the weekend.

Sorry no inspiration for more !

Jan 9th

Market has a difficult time to find a direction. First up on the job reports then down after the open. While we were down, the vix also had a gap down. The only way that really happen can if someone (big) is willing to sell some puts. During the day the vix moved slowly up, but hardly came into yesterdays range.

The VIX move kept me from becoming bearish when we hit the day lows. I did not anticipated any further break down.

TLT has given me a wild ride gap down, thru the triangle, back into the triangle, out of the triangle on the upside and late afternoon back down. Again difficult to read.

During the day I was lucky with some 'revenge' trades - I took my 2008 PL sheet and started to work my way from the small lose up. Trying to get at least even with the underlying. Revenge trading is definetely not adviseable style - since your mind is not in the right place. But I had some fun today.

Optionmonster has a free video section - daily around 2pm they post a VIX update video report - I have listening to the report for about a month now. I find it very interesting from an educational point of view. Check it out.

A new student of Dan asked me a question on why I trade Butterfly. Since next week Thursday the alarm bell goes off for the Feb. Butterflies - maybe good to answer the question in public.

Why do I trade the butterfly.

Couple of reasons;
1. Risk/Reward ratio
2. Low volatility risk
3. Short time in the market
4. Easy to adjust

ad 1. In a normal market (forget part of 2007) you can book on average 15-20% on the invested capital. Since the trade initially stays nicely balanced there is not to much risk to get whipped out. In the first 10 dys the trade is not very vulnerable.

ad 2. Due to the skew of the strike on the Volatility graph IV moves are rather neutral. Last year I did a separate post with graphs on the topic of vega risk in the butterfly.

ad 3. With a little luck you can be out of the trade in 15 dys - which means less risk - which adds imponderable to the risk/reward ratio

ad 4. What I learned over time that I need to moderate my eagerness to adjust - (do the adjustments later) - but when you need to adjust you can do so easily by reducing the trade on the side which hurts. As long as the market doesnot completely reverse to the other side, you will do great. Reversing to the other side after an adjustment is the big Achilles heel of the butterfly. I am still working on my trade rules to minimize that risk.

Jan 8th EOD

Friendly market at the end of the day.

Vix lower, futures flat or slightly in the green.

I made (hopefully) good use of the spike in the VIX by adding to my FEB RUT Iron condor.
the shorts are 380 and 590. If the VIX indeed comes down - then I can congratulate myself on this trade :).

Analyzing the day then you can see the sell off happened out side market hours. During the day the volume in the futures was to the upside.

As always we will see what tomorrow brings,

Be safe and well!

Jan 8th

Deron Wagner (see recommendation section) was spot on with his call Tuesday and Wednesday early morning that the big boys and girls were selling into strength.
I reduced some delta in my long portfolio - took some profits.

So far TLT is a good trade for me. I have been rather active. As TLT moved down closer to my short 110 puts - my overall delta became less short. As long as the down trend had speed I liked to maintain approx 200 delta (equal to the 200 short tlt I have). To accomplish this I sold a couple of 120 calls and later some 114 calls. Tuesday during the day it became apperent that TLT was taken a little break. I reduced deltas (now 60short) by closing the short calls (for a profit). TLT (on the 15') is now making a little triangle and a break either way will be a good trade entry. TLT (@tos) is at times easy to borrow and at time not. Currently (@10:11AM) it is easy to borrow.

The rest of the week I "played" with some earning plays.
MOS
MON
BBBY

Mos gave a small profit - small due to a horrible trade entry (my fault)
MON run away from me - the ATM straddle/strangle showed a max move of approx $5 - as we all know the move was way beyond.
BBBY - is still on the table, so far so good.

Long Term recession

This graph comes from the daily newsletter Casey Research (they have a free daily newsletter) and depicts perfectly my understanding that the recession is yet to come.

Brush off your; currency trading skills, your trend following skills to trade the adjustment in the credit markets, find ways to lower your deltas in your overall wealth. Be alert - today will be up, and you will be happy with those long deltas and those dollars - but one day in the future we will have to swing them around.
BTW for this graph to continue we don't necessarily need a lower sp500. Larger inflation will also do the trick.

Jan 5th

At 2pm it looked like the bulls were winning - but within a couple of minutes the bears were drawing blood and we fell back in the range.

Volume wise - the bulls not give much of a fight. I don't really know how to read it right now. For now a break over 934 and under 916 will tell more.

I am in the MOS trade - I had to trade it from my cell phone using Think Anywhere. I am not to happy with my fills - I might have roughed  it up a bit. My mistake to have more puts then calls, that just happened - to small a keys to big a fingers.

Earnings play

The coming two weeks I will add an focus on speculative earnings play into my trading.

I like to do earnings play's close to expiration since earnings are events were Implied Volatility gets pumped up. Being close to expiration means that the IV has to subside pretty quickly. The main focus on a speculative earnings play is to pick up the drop in IV. No opinion for the direction comes into my mind - good news can give a drop in price, bad news can give a gap up - the direction is up for grabs.
The drop in IV is a certainty.

Here is a recipe;

Check earnings for a least the prior year;
- what was the average and extreme price move before and after earnings
- did the ATM straddle cover the price move (is the market predicting the earnings move correctly).
- what was the IV drop in the last earnings
- how quickly did IV drop
- Is current IV skew inline with the past
- how big a move does the ATM straddle/Strangle predict

Keep a logbook on all your research and the trade - luckily for us wehave a crazy 3 months earnings cycle, which allows us to play the good trades 4 times a year.

For tomorrow Jan 6th I am focused on MOS.

The first three earnings in 2007 were non-events all nicely within a 1SD move. The Oct 1st earnings gave a 4.5sd move to the down side. Including a gap down, which would have been difficult to navigate. Since Oct 07 the stock has leveled out and volume has been very moderate (accumulation?)

Currently I am look at a double calendar Jan/Feb 35 puts and 40 calls, but I will wait till later in the afternoon to see if any news is tickling out into the price.

The ATM straddle strangle prices in a $4 move. Again lets see how things look like in the afternoon.

Book review

Happy New Year and blessed trading!!!

May 2009 bring a high Vix and low Historical Volatility :)

I spent part of my Xmas break by reading a book recently written by Jeff Augen.
I truly recommend more experienced non directional traders to read this book. Jeff is a very serious, mathematical inclined, pretty smart option trader - just read his bio and you 'll see what I mean. It is not that Jeff's book will teach you a complete new concept of option trading (at least I hope not), but he describes our business verbally and with statistical concepts. In my training I was sometimes more focused on the PL graph, hence the visual side of option trading. Taking a moment and let Jeff explain the inner workings of our strategies has added to my understanding. As the title of the book says - In this book Jeff primarily focuses on Volatility .
Why do I think this book is for the more experienced trader? - because a. the material covered is complex - b. the material covered is the sauce on a option portfolio. The meat and the potatoes can be found in the essential work of Dan Sheridan.

If you are looking for a starters book describing the the theory of Option Trading I still recommend a recent book by Dan Passarelli.