HOT TRADING STRATEGIES FOR A COLD MARKET
Daily Stock Market Equity and Options Trading Commentary

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Saturday, August 29, 2009

Bull or Bear Market Ahead? Who Cares, Profit from a Rising or Falling Stock Market

It seems like yesterday when I was attempting to do some last minute studying for an Environmental Economics test but could not concentrate, because I was very distracted by the nightly news... Yes it was the Sunday night that Lehman Brothers expected to file bankruptcy the following morning, and Merrill Lynch was acquired by Bank of America (BAC). I remember thinking how will this affect the market over the next day, week, month, year, decade, etc..., and will I ever get the job of my dreams on Wall Street (which I am still looking for)?

I am sure I'm not alone when I say, I never expected it to start the chaos it did on Wall Street. Luckily at the time I was very hedged, not because of my expectation for the entire banking industry to nearly collapse, but because I figured the high price of oil would slowly strangle the consumer and could cause a recession. I expected to see the market sell off causing the Volatility Index (VIX) to increase, so as a hedge I purchased out of the money October 30 strike VIX options for $25 per option contract, while the VIX traded below 20 in August. I never expected less than a month later my VIX options would increase more than 30 fold, but they did and I sold half of them while the VIX traded near 32. Selling half of my options resulted in a huge profit, and I couldn't lose my initial investment, so I decided to keep my remaining VIX options until expiration or sell them into strength. Over the next month I sold many of my VIX options for huge premiums helping to keep my entire portfolio profitable, and actually sold my final contracts the day before VIX expiration on October 14, 2008 for more than a 15,000% gain ($3860 per VIX contract), which if I let the options expire and settle for cash the following day (or traded them mid day) would have been even more profitable.

I believe the market will sell off this fall, not because we are approaching the one year anniversary of that "study free" Sunday night, but because I believe we are too overbought. I believe so much as a 5% correction will cause the VIX to spike, but VIX options are very expensive due to this speculation and due to the implied volatility being so high. Even far out of the money VIX options seem expensive (mainly because VIX above previously unheard of levels is now known to be possible). Not to mention if the market continues to rally, VIX options would most likely expire worthless. So, I will take a different (less risky in my opinion) approach to capture a large market sell off, while also being able to profit from a continued market rally.

Examining the mean for the 25 Delta Call and 25 Delta put on three very active index ETF's we can spot which one is trading for the cheapest premium based on volatility.
  • PowerShares QQQ NASDAQ ETF (QQQQ) is the highest with the current mean at 23.40%
  • SPDR Trust S&P 500 ETF (SPY) is the second highest with current mean at 22.99%
  • Diamonds Trust DOW ETF (DIA) is the lowest with the current mean at 20.50%
I chose to structure my option trade around the DIA as it is the cheapest based on volatility, and although the DOW is less volatile, if a significant move occurs in the market the DOW is sure to track closely to the other major indices give or take a few basis points. The trade outlined below requires the knowledge of stock options. To become more familiar with stock options check out my stock options trading E-Books here.

The Trade:

I opened a delta neutral strangle position for the October Dow Diamonds ETF (DIA). As the stock crossed 95.50 Friday, I purchased October 94 put options (Delta -0.429) and October 97 call options (Delta 0.419). I opened this position for $440 per option contract, and if the Dow Jones Industrial Average moves by greater than 5% in either direction over the next 46 calendar days this position will likely result in a profit. Note that if the market moves sideways and the DIA ETF expires between the two strike prices indicated, the position will result in the maximum loss of 100% of the premium paid (in my case, $440 per option contract).

This strategy should only be considered if one believes the market will experience a great move (either up or down), and should never be considered if a sideways move is to come. I believe the market will correct to the downside by 7%-10% before going higher into the year end, therefore I am long this option strangle for October. The optimal case for opening a long strangle option strategy like this would be a sell off, this is because as a sell off occurs, volatility increases [historically], causing option premiums to be priced even higher (all other things equal). Technically if volatility increases sharply without the market moving too much in one direction or another anytime soon, this strangle could also become profitable, but that is very unlikely and I am not opening it for that reason.

If profitable I will look to close out of 25%-50% of my strangles Thursday before the unemployment numbers are released Friday morning. Although the contracts don't expire in September, it should cause increased volatility levels on the underlying, pricing these contracts slightly higher. If I can take a profit before the unemployment rate for August is released, I will do so and purchase them back on decreased volatility levels.

The ideas outlined above involve the use of stock options. The reason option volumes have surged in the last 5 years is because they are a great way to hedge your portfolio as well as create income off of your shares (see option volume chart).

These are just examples and are not recommendations to buy or sell any security; if you're more bullish/bearish, you’ll want to adjust the strike price and expiration accordingly.

Disclosure: Long DIA October 94 Put/97 Call Strangle, VIX October 30 Calls

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Thursday, August 27, 2009

Most Active Stock Options August 26, 2009

The top ten most traded option contracts for August 26, 2009 are listed below:
  1. Citigroup September 5 Call Option
  2. PowerShares QQQ (NASDAQ:QQQQ) September 38 Put Option
  3. Citigroup September 4 Put Option
  4. Blackstone Group January 5 Call Option
  5. S&P 500 SPDR ETF (NYSE:SPY) September 100 Put Option
  6. S&P 500 SPDR ETF September 103 Put Option
  7. S&P 500 SPDR ETF November 85 Put Option
  8. PowerShares QQQ October 39 Put Option.
  9. Citigroup September 5 Put Option
  10. S&P 500 SPDR ETF November 95 Put Option
It may seem unusual that Blackstone Group (BX) options traded among the most active, but that is simply because they are spinning out a dividend on August 27, 2009. As stated in my mid day most active contracts blog post, it looks as if someone is very bearish and opened a November 95/85 put spread on the S&P 500 SPDR ETF. Citigroup is the most active option contract again... I am surprised a Bank of America contract isn't right up there with the Citigroup ones, or at least the Financial Select Sector SPDR ETF (XLF). I opened up a strangle position on the Direxion Financial 3X Bull today; purchasing call options for the September 84 strike, and put options for the September 75 strike. Each contract cost roughly $1,030 after commissions. Sphere: Related Content

Wednesday, August 26, 2009

Mid Day Most Active Stock Options August 26, 2009

I am a little late for mid day, but as of 1:30 PM the top ten most active option contracts traded today are:
  1. Citigroup September 5 Call Options
  2. PowerShares QQQ ETF (NASDAQ:QQQQ) September 38 Put Options
  3. Citigroup September 4 Put Options
  4. S&P 500 SPDR ETF (NYSE:SPY) November 85 Put Options
  5. PowerShares QQQ ETF October 39 Put Options
  6. S&P 500 SPDR ETF November 95 Put Options
  7. S&P 500 SPDR ETF September 100 Put Options
  8. Citigroup September 5 Put Options
  9. S&P 500 SPDR ETF September 103 Call Options
  10. S&P 500 SPDR ETF September 103 Put Options
November being a few months away it is unusual to two of them in the top traded contracts; I am guessing someone has opened up a 95/85 put spread on the SPY. It also looks as if someone is expecting increased volatility to come and opened an at-the-money option straddle on SPY for the 103 strike price. Sphere: Related Content

Banking on the Banks to Move: Detailed Option Strangle Strategy

With banks continuing to demonstrate strength throughout the month of August, many have been anticipating a sell off to come soon. I too have been anticipating the banks to sell off, but lately they've made a fool of me. Let's face it, this rally could continue for quite a while with all the money sitting on the sidelines. In this article I will outline an option strategy which I'll be opening for the September options expiration, as it returned a great amount of profit for the August options expiration (and I was anticipating a rather calm stock market).

To begin I will show the change for ten of the major financial stocks since the stock market bottom in early March. The table below shows the % change for three time periods following the market bottom: 1 month following the market low, 3 months following the market low, and market bottom to August 25, 2009 (Bottom to Date)

Date used for market low was March 6, 2009.

Company Ticker 1 Month 3 Month BTD
American Express Company AXP 46.75 141.53 217.71
Bank of America Corporation BAC 135.96 274.12 459.93
Citigroup Inc. C 166.66 139.21 365.68
The Bank of New York Mellon Corporation BK 43.31 43.6 49.57
Morgan Stanley MS 26.64 72.25 67.9
Wells Fargo & Company WFC 87.81 204.4 236.58
JPMorgan Chase & Co. JPM 69.87 108.12 162.53
Goldman Sachs Group, Inc. GS 42.74 82.34 101.84
KeyCorp KEY 41.78 -3.04 15.71
Regions Financial Corporation RF 36.45 29.03 88.06

As you can see the rate of acceleration has slowed (not only for financial stocks but many stocks). Most of the financials experienced their largest gains during the first month following the market bottom (March 6, 2009 - April 6, 2009). However from the next table below, we can see financials were not asleep during the month of August.

Company Ticker August % Gain
American Express Company AXP 15.84
Bank of America Corporation BAC 20.01
Citigroup Inc. C 49.84
The Bank of New York Mellon Corporation BK 7.50
Morgan Stanley MS 5.92
Wells Fargo & Company WFC 11.73
JPMorgan Chase & Co. JPM 12.75
Goldman Sachs Group, Inc. GS 1.00
KeyCorp KEY 12.10
Regions Financial Corporation RF 31.89

I strongly believe increased activity will return to the stock market after labor day, causing a large move upward or downward, so I assume financial stocks will either continue to rally greatly or sell off sharply. With this date approaching, I am anticipating a big move again either lower or higher. The strategy I will outline will profit if such a move happens. The way I plan on capturing a move in either direction is by using the option strangle strategy. I plan on doing this by opening a strangle on one of the most volatile financial ETF's available, the Direxion Daily Financial Bull 3X ETF (FAS). To learn more about option strangles, risks, pricing, calculations, other strategies, and options in general click here.

The Trade:

I am anticipating a drop in the financials by September options expiration, but as stated before they could keep rallying; if they do continue to demonstrate great strength this option position will also profit. To make this trade I will choose a near the money option put option. I am thinking the 75 strike Put option (delta -0.389). In case the financials continue to strengthen over the next 24 calendar days, I will also purchase a call option with a similar delta. This happens to be the 84 strike call option (delta 0.40). This strangle would cost me roughly $1000 per option contract.

In order to break even from this strangle, the FAS would need to increase by 20.95% or decrease by 16.37% from close price Tuesday August 25. Anything above or below those levels will result in a profit. Note that this is an extremely risky strategy and should only be used if one believes financial stocks will experience a great amount of volatility, resulting in an increase or decrease above or below these levels. 100% of the position will be lost if the FAS expires anywhere in between the two strike prices ($75 - $84). I opened a similar strangle on FAS for the August options expiration on July 31, 2009 and the FAS increased by 34.5% by options expiration, however as I rarely wait until expiration, I closed my position within one week (August 7) for a very nice profit.

I will be looking at opening this position on decreased levels of implied volatility, one of which I assume will be sometime after the new home sales data is released on Wednesday August 26 at 10 AM.

The ideas outlined above involve the use of stock options. The reason option volumes have surged in the last 5 years is because they are a great way to hedge your portfolio as well as create income off of your shares (see option volume chart).

These are just examples and are not recommendations to buy or sell any security; if you're more bullish/bearish, you’ll want to adjust the strike price and expiration accordingly.

Disclosure: Long AXP, BAC, GS, FAS, Short BAC September 18 Calls, GS September 180 Calls, FAS September 85 Calls

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Monday, August 24, 2009

Mid Day Most Active Stock Options August 24, 2009

As of 1 PM the top ten most active stock option contracts traded are:
  1. Citigroup September 5 Call Options
  2. Citigroup September 4 Call Options
  3. Citigroup September 5 Put Options
  4. Citigroup September 6 Call Options
  5. SPDR S&P 500 ETF (SPY) September 103 Call Options
  6. Citigroup September 4 Put Options
  7. PowerShares QQQ ETF (QQQQ) September 40 Put Options
  8. SPDR Gold ETF (GLD) December 75 Put Options
  9. SPDR S&P 500 ETF September 100 Put Options
  10. Bank of America September 18 Call Options
Nothing too unusual except the GLD December 75 Put options (volume currently at 41,093 contracts traded today). Sphere: Related Content

Sunday, August 23, 2009

16 Breakout Stocks on Big Volume: Week of August 24, 2009

In this post is a fresh list of stocks to watch for the week of August 24, 2009. All of the stocks mentioned in this post are stocks which have broken out to the upside on unusually large volume. The table below shows the company, ticker, Friday's per share % increase, and Friday's volume increase (% increased compared to 50 day average).

Company Ticker Price Change Volume Change
Aeropostale Inc ARO 10.23% 213.11%
Comstock Homebuilding CHCI 93.75% 3496.55%
Fronteer Development Grp FRG 12.27% 278.62%
La-Z-Boy Inc LZB 9.38% 39.17%
Mentor Graphics Corp MENT 13.51% 498.31%
Maguire Properties Inc MPG 22.77% 462.50%
Mueller Water Products MWA 13.13% 219.63%
Opnext Inc OPXT 18.50% 746.22%
Republic Airways Holdngs RJET 11.80% 97.84%
Sinclair Broadcast Group SBGI 32.56% 753.20%
Smucker J M Co SJM 4.28% 130.32%
Meridian Resource Corp TMR 31.25% 241.30%
Veeco Instruments Inc VECO 13.93% 113.27%
Wet Seal Inc WTSLA 10.54% 125.15%
Exide Technologies XIDE 21.24% 297.79%
Sirius X M Radio Inc SIRI 3.24% 183.79%

Many of these stocks are up big on earnings announcements, therefore it may be a good idea to wait for some profit taking and purchase the stocks on weakness. The stock which is most attractive to me is Aeropostale (ARO). Below are some trade ideas which I may be using in the weeks to come. To learn more about the risks, pricing, calculations, strategies, and options in general click here.

Aeropostale, Inc. Option Trade Ideas: The first trade is very simple and involves purchasing the stock and writing a call option against it. I would purchase the stock and immediately write out a call option for the September 42 strike price. The theoretical price for the option is $90 per contract which will lower the cost per share by 2.3% (as of Friday's close) and would give me a potential return of 8.5% if Aero stock is at or above $42 at September options expiration (26 calendar days).

The second Aero trade I would be looking at is much more risky and a bit more complicated. I would look at opening a diagonal call spread. With implied volatility down after their earnings release, it would be much cheaper to open this spread today versus one week ago ( a similar spread, not identical strike prices). I would purchase the October 38 call options and sell the September 42 call options against them. The position would cost roughly $270 per option spread and assuming Aero's stock is at or above $42 on September 19, 2009 this position would return 48.1%. If the stock is below 42 at expiration, a vertical call spread can be formed using the October 42 strike calls (assuming Aero's stock is within range and the October 42 call option is bringing premium). It is important to note that if Aeropostale stock is below $38 a share at October options expiration the entire position will expire worthless. I am also looking at ratio call spreads for the upcoming months, but will not be going into details in this post.

The ideas outlined above involve the use of stock options. The reason option volumes have surged in the last 5 years is because they are a great way to hedge your portfolio as well as create income off of your shares (see option volume chart)

These are just examples and are not recommendations to buy or sell any security; if you're more bullish/bearish, you’ll want to adjust the strike price and expiration accordingly.

Disclosure: Long Sirius

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