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