My Life My Trade

You might recall that last night I posted my plan for Monday’s trading – it involved getting out of all short positions if ES 919 was breached. Additionally, it involved adding more short positions if ES heads to 908-909 region. This was based on the assumption that my most likely scenario of gap down OR small gap up and then go down, plays out.

However, the overnight reversal in ES from being down 8 points at one point to being up several points made it clear that no big down move was coming. At the same time, there was hardly any upside pressure – so it suggested a range trading day for Monday. So, the plan was to get rid of shorts at low end of the range and get into new short positions at the high end of the range, which is what I did. In general, one must plan for all four scenarios (at the very least)

• trend up
• trend down
• ranging day with down first and then up
• ranging day with up first and then down

This is something that should be obvious, but a lot of new traders (myself included) would forget. Till few months back, I would just plan for one scenario which was largely dictated by my portfolio and when that wouldn’t play out, then I would do some stupid moves in panic – be it due to fear or due to greed. Then, some one (I think it was Pike Trader at TK’s blog) asked me what my plan was if the market did not gap down and instead spiked up and kept going up.

Yes, when you are massively short, just the mere thought of a market ramping up and only up is very painful. But it is best if I bear this pain today in the evening – this would mean much less financial pain for me tomorrow if that ramp up scenario indeed plays out. I have two choices:

• I can either deny the possibility of a ramp up and then get taken to the cleaners tomorrow if it indeed ramps up.
• Or I can live/walk through a possible ramp up today itself and plan out what I would do if faced with that scenario – this is what makes or breaks your account.

You must have noticed that some of my trade related posts today were titled MANAGED. There are many ways in which one can manage positions. I will share with you two techniques that I have used today.

A range trading day like today when the market goes into both, red and green territory is a wonderful day for managing positions. Of course, there is nothing better than the market heading in the direction that would benefit my portfolio the most. But that doesn’t happen always. So, one has to adapt and make the best out of what is offered.

Averaging down/Scaling in: This is something that most of you would already know. At the beginning of the day, I purchased some contracts of USO Jul $39 puts @ $1.20. Subsequently, USO moved in a direction away from what I predicted. So, I added more positions at @ $1.03 to give me an average price of $1.13. This is why it is critically important that one “scales-into” a position and not buy the entire position at once. Scaling in gives you a chance to refine your position in case the initial entry was a bad one.

Buy-low Sell-high or Vice-versa: On Friday, I purchased QID Jul $32 puts @ $1.50. Today, at the close, these puts were priced at $1.30. If I just held onto them, then I would be looking at a loss of $20 per contract. Instead I used the down move in the beginning of the day to sell my puts @ $1.55 and then get back in near the highs of the day again @ $1.25.

So, what is my current cost per contract – $125 minus $5 (profit that I made by selling Friday’s purchase) making the cost to be $120 per contract. So, even though from Friday to Monday, QID Jul $32 puts went down $20 per contract, I am still looking at $10 profit. This is the magic of managing positions.

Today it was easy to sell my puts near the lows of the day because the move down clearly lacked momentum, and the quick reversal last night only confirmed that the move down was a fake out/bear trap. Of course,  one has to balance this out with letting the winners run.

I will also take this opportunity to point out that this is how Atilla who has been short since SPX 720 has probably not lost a dime, and probably even made some even though SPX today is 200+ points higher.

In summary, two key elements that are critical for success in trading:

• Good entry (if the entry is bad, managing positions can only do so much).
• Good position management (seldom will your entry be perfect, but you can take advantage of the up-down gyrations of the market to refine your positions).

Folks, if you found this useful, some love shared would be very much appreciated

For past couple of months, I finally got over my stingy mentality and subscribed to the Zero Indicator, that Molecool has put out on his EvilSpeculator blog. It costs just $50/month, but has been a live saver and money minter, both at the same time.

The algorithm behind this indicator is of course a proprietary one, but what I have understood so far from using it and observing it is that it tries to measure the momentum/pressure/push in the moves. A lot of times we have a big move in ES, say 10 points up in half an hours… but the zero indicator would show no signal, thereby implying that there is hardly any buying pressure and that market is moving up on fumes.. This suggests that a turn is just around the corner.

I used it in April – did really well. I opted out in May because I was going to be busy at work and not be able to trade much. I jumped back in June again, this time for good. Every week, on at least two to three occasions, I am able to make some trading decisions that I would not be able to make without using the Zero Indicator. Check out daily wrap posts at Evil Speculator blog that describe how the zero indicator did that particular day.

http://evilspeculator.com/?cat=124

PS: Mole has not asked me to post this. Nor am I getting any referral fee or any kind of kick back from Mole if you subscribe to it. I am posting this out of my free will. The only reason I am posting there here is because I like it and use it, and it might benefit some of you out there. I just want the readers of this blog to know that there is a tool out there, which costs just $50/month and can really improve your trading performance.

DISCLAIMER: Nothing contained anywhere on this site constitutes any investing advice or recommendation. Any purchases or sales of securities are solely at the discretion of the reader.

Every now and then you must have heard that a certain company is added to a certain index. Usually this announcement is accompanied with an instant pop in the stock prices of that company. Back in the bull market days, 7% pop is what used to be the norm when a company got added to S&P 500 index.

Russell shuffles its indices at one time, towards the end of June. There are a whole bunch of companies that get added to the Russell indices and others are removed. Friday, I believe was the last day when the mutual funds had to buy shares of the newly added companies (I might be a bit off here, but this is not the whole point of this post). I subscribe to Real Money (from The Street.com website) because I have a lot of respect for one of their commentators, Rev Shark. He wrote an article yesterday about the kind of farce that is going on. Here, I am going to share the essence of that article with some charts to illustrate some points and then present my ideas of how we could have and can trade this going forward.

My understanding of this process is as follows: There is a phase in which mutual fund managers are required to dump the shares of the companies that are being evicted from Russell indices. This would create a downside pressure on Russell indices. And then there is a phase when the managers buy shares of the companies that are added. When a whole bunch of money managers around the world are scrambling to buy shares of some of the thinly traded companies, here is what happens:

The question in your mind is how can I trade this. Here are some ideas that come to my mind (Note that I haven’t back-tested any of these). If you can think of something else, please feel free to leave your thoughts in the comments section and I will update the post (giving due credit to the commenter) with relevant ones.

• One obvious thing would be if we could figure out when the money  managers are going to dump the shares of the companies that are being removed from the index, one could short these shares. Very likely, however, the stock prices of these companies would have already taken a dump the day this list was published. However, in thinly trades stocks, the prices can really take a plunge when a lot of money managers around the world are trying to liquidate their positions. A better way to play this is to actually short the actual Russell index since one knows that the components that are being removed will go down… creating a downward pressure on the index.
• The graphs above suggest that there is an upward pressure on Russell indices as the deadline to purchase the shares of newly added component comes close, which was Friday end-of-the day.
• Come Monday, the Russell (micro-cap) index consists of holding ZN at $13, when it could have had ZN at $7 the previous day. (very) likely ZN will soon go down to $7, there by creating a downward pressure on Russell indices. I did buy TZA calls (see the trade posted here), but turns out that the timing was off – the pop in Russell came much later in the day
• You can short the individual shares like ZN, CHBT etc – but unfortunately they are non-optionable and are “hard to borrow” at this point.

I had been hearing about Russell rebalance for a while, so I knew it was coming. But never really gave it much thought to see how I could trade it. Having seen all of this now, I will definitely plan something out when we come closer to this event next year and will share it on this blog.

You can read more about the Russell Rebalance process here. For those of you who have the Real Money subscription can read the original article by Rev Shark here.

UPDATE: Found more such examples here.

Found something useful. How about share some love

DISCLAIMER: Nothing contained anywhere on this site constitutes any investing advice or recommendation. Any purchases or sales of securities are solely at the discretion of the reader.

During the day, I just have 4 charts open on whenever I am trading. These four charts are ES, NQ, $TICK, EUR/USD.

Those looking to trade VIX options need to know what they are trading. VIX options are very different from equity options in many many ways, some of which are:

• They do not expire on 3rd Friday of the month. They expire on the Wednesday at open – sometimes it is the 3rd Wednesday of the month, sometimes it isn’t…
• They are priced off of VIX futures and not the cash VIX index
• The calendar spreads work very very differently, and one can be burnt badly if one doesn’t understand how calendar spreads would work

ToS did an article on VIX options back in the February 2009 edition of their quarterly magazine. The article is on the pages 36-39 of that magazine. Click here to access that magazine.

Even those who have been trading since eons might not have seen the kind of volatility we saw last fall. Just to highlight how crazy things were, I will use two examples.

• Oct 9, 2008 to Oct 10, 2008: SPX range was 167 points (highlighted in GREEN)
• Nov 21, 2008 (Friday) to Nov 24, 2008 (Monday): SPX range was 124 points (highlighted in BLUE) – Note that the two shaded regions overlap

To put the craziness of volatility in perspective, I have posted 12 year daily chart of SPX. One can see that the SPX ranges that took almost a year to traverse were covered in period of 2 trading days – crazy isn’t it. This is not the norm – this was the exception AND will be an exception going forward as well.

A normal trading day looks more like what can be seen in the intra-day 5 min ES chart for Jun 17, 2009. How does one trade this – after seeing what we saw last fall, this just looks like random chop. Once you put on the Cumulative VWAP study onto this chart, things do not look that random anymore. One can see that for most part the ES price bounces between VWAP +/- 2 standard deviations. And the best way to trade this is to fade the moves to the extremes.

Now, the key question is when the price hits the outer envelope (VWAP + 2dev or VWAP – 2dev), when does one enter the trade. I have paper traded this for a while and have found that as the price approaches the outer envelope, if the volume declines, then the price will bounce back towards VWAP. On the other hand if the volume is not declining (as in example labeled 2 in the figure), then the price might not come back to VWAP. The exact entry timing and stop loss setting is based on personal risk profile and comfort level. Now that you are done reading this, how about some good love shared

NOTE: This might not be for the advanced traders amongst you. So, feel free to skip. If you feel like going ahead and reading it, it will take no more than 2 minutes.

Here is the daily chart of SPY (as of Jun 19, 2009). Let us dial the time back to March 19, 2009 the day on which the stochastic looks like rolling over OR may be even a week later, when all three, the stochastic, MACD and the RSI were looking to roll over. What most of the bearish minded thought was that… we have had a 150 point rally on SPX from the bottom … more like a “big dead cat bounce”. It is time to go short this market again.

Now below is the weekly chart of SPY. The day on which the daily oscillators were looking to roll over, the weekly ones had just cross the 25% line and were just gathering speed and momentum.

The million dollar question then becomes, what the hell do I do? Do I go short or Do I go long on March 19, 2009. Well, the good thing is that we have had 2 full months pass by since then and we have the answer in front of us.

Those who are short term trades, should have looked at the daily oscillators and gone short… but keeping the weekly oscillators in mind, they should have known that the downside is limited. Instead what a lot of us did was to go short (indeed it was a good entry to go short), but did not listen to what the weekly oscillators were telling us and kept insisting that the market will go down to new lows and test the March lows. I will admit there in front of every one that I was one of them and missed a good chunk of this long rally to the upside. But I have learnt my lesson and am here to share it with you:

Those who are intermediate term trades should have looked at the weekly and said that we will go long, but should have waited for a good entry by looking at the daily chart.

The next question in your mind is WHY AM I POSTING THIS ARTICLE? The answer is “we are again at the same crossroads today”. Look what the oscillators on the daily and the weekly SPY charts above are saying. The daily is saying that there might be a small bounce here, where as the weekly is saying “short”. The lesson here is two-fold:

• For my intermediate term trades, I will look at the weekly chart to tell me the direction of the trend and will use daily chart to get good entries
• For my short term trades, I will look at the daily chart to enter and exit. But I will keep the weekly chart in mind to remind me that the trend is down. So, I will play it small when playing in a direction opposite to the weekly chart trend.

I recently happen to read Trading Options at Expiration: Strategies and Models for Winning the Endgame by Jeff Auen. I highly recommend this book for anyone who is looking to trade front month options on the Thursday and Friday before expiration. I will share some of the things that I learnt from the book, that I found pretty useful. At options expiration, there are three big market forces at work:

Implied Volatility collapse all day long on Friday: The implied volatility profile of a typical at-the-money option looks like this on the expiration Friday. If one is trading front month at-the-money options on expiration Friday, it is useful to keep in mind that the Implied Volatility (IV) is highest at the start of the day and gets a small bump up near Noon time ET.

Pinning Effect: This comes out of Market Makers desire to leave most of the option holders empty handed (a.k.a. bag-holders). 15 stocks are more likely to get pinned to a strike price more than the remaining others. These stocks are the ones in which options are traded most heavily, namely AAPL, APA, DNA (no longer publicly traded), DVN, FDX, GOOG, GS, IBM, LMT, MA, MON, RIG, RIMM, SHLD, X.

As an example, today GOOG was trading around $415 mark.. There is a good chance that it will end the day tomorrow (Friday) near $410 or near $420. Note that Pinning Effect is different from Max Pain theroy. Max Pain theory is a specific case of Pinning Effect which says that the strike to which the stock gets pinned is the one that maximizes what the Market Makers pocket.

Having this knowledge, I will refrain from making myself believe that GOOG might go beyond $420 tomorrow and buy the *cheap looking* $100 costing GOOG $420 call.. hoping that GOOG makes to at least $425 or so, thereby scoring a 5-bagger. Of course, if for some reason the market makes a big move on the options expiration day (as has happened in Nov 2008 and Feb 2009), a lot of this goes out of the window. However, even if there are crazy moves, as the end of Friday is approached, GOOG will have tendency to end close to a strike price rather than away from it.

Rapidly Accelerating Time Decay: You would have seen this in the theta burn of your options as expiration nears. This is one reason why a lot of people don’t go long options that are expiring in less than two week.

The author talks about specific plays for buying options on Thursday to hold overnight into Friday AS WELL AS Friday only option day-trades, especially some that are to be initiated in the final few hours of Friday. Very interesting read. I am going to be paper trading some of those strategies tomorrow, and will report how it goes, along with some details of the strategies. You can go check more details about the book out here.

If you found this useful, please do share some love

UPDATE Jun 19, 2009: I had some RIMM Jun 65 puts and Jun 90 calls (see this link). RIMM was basically flat after the earnings. So, these options were terribly out of money and were truly worthless. There was nothing in this world that was going to move RIMM down 10 bucks or up 15 bucks today. So, the obvious choice would have been to let them expire worthless. However knowing the IV profile from the graph above, I figured that if at all I had to salvage a dollar or two out of these contracts, I had to do so right at the open. So, right before open, I put in market order to sell these. And guess what, 2 contracts of puts and the 2 contracts of calls that I had – they all sold for $0.05. So, out of the 200 dollars that I had invested in this trade, I got $20 back (LOL – which paid for the book). 5 minutes later, those same options were trading for $0.01.

Here is the 5min chart for ES for today (May 22 2009). The pink line in this graph is the cumulative VWAP study on ToS charts.. See how ES has bounced off of that VWAP all day long – we think that the action is random, but it isn’t. In the morning, it touched vwap-2 and bounced back sharply from it. Combine this with TICK (I will do a more detailed post later) and you have a gold mine. For now, all I will say is that you need a very strong positive/negative TICK to push the price across VWAP onto the other side.