Calendar Strangle

This is an illustration of a Calendar strangle trade made in Feb 2008 2 days before earnings and closed immediately after earning was released.

Even though the price went against the direction of the trade, it ended making money.

Calendar

o LC and LP at different months
o Reduce cost in trade
o Hedged directional for the short term ( protection if wrong direction )
o Place 14 –20 days before earnings or important event
o VIX should be reasonably low
o Choose stocks that move violently with earnings ( RIMM, FSLR,etc )

If bullish:

- Buy short term call
- Buy Long term Put

If bearish:

- Buy Long term call
- Buy short term put


Feb 11th 2008

o Trend was going bearish. So structured trade aligning with the trend
o Earnings coming in 2 days
o Structure a Calendar strangle for a downside

- Short term put
- Long term call

BTO Jun 180 Call at $37.6
BTO Mar 175 put at $22

( If I am bullish, I would have structured a Longer term put and short term call )


Feb 13th 2008

Results was out in 2 days and trend went AGAINST the trade

o STC Jun 180 Call at 68.4
o STC March 175 put at 8

Gains on call : 68.4- 37.6 = 30.8
Loss on put : 22 – 8 = 14

Despite guessing WRONG on the trend, there was a profit of 30.8-14 = 16.8

Positive Cash Cycle - PCC

This is a cycle on how some basic option strategies can be used. If applied properly, the cash portion should continue to increase. You get increased in cash from the following:

1. Bull put credit if expired
2. Cash from selling Long Put
3. Expiration of SC
4. Closing of Covered call

The increased cash can be used again to invest into a bull put and start the cycle again.

DHI - ITM bear call trade placed Sept 9 2009

This is an out of the box trade. This trade was made on Sept 9th 2009.

It is a speculative trade and should be used sparingly - < 10 % of portfolio should be dedicated to this kind of trade.

Instead of a standard bear call which normally calls for OTM and front month short option, I used a 4 months call spread and ITM.

Application of this kind of trade is when you expect a stock which is fundamentally weak. It has also rallied and reaching a technical top.

Anytime the SC goes ITM, you will start to make money. You have to allow time for the trade to work

The trade offers good credit because it is ITM. Risk is minimal and probability of hitting the target ROI over time is high because of the fundamentals.

Fundamentals:

This is the most important reasons why I choose to place this trade. DHI is one of those companies which are deeply in debt. The company faces a huge series of debt maturities over the next nine years: $550 million in 2009, $360 million in 2010, $400 million in 2011, $300 million in 2012 and 2013, $500 million in 2014, $300 million in 2015, $400 million in 2016, and $800 million in 2017.They are selling assets to finance their debts.

It is selling off its inventory and assets at a loss to generate cash. In the last year, reductions in inventory produced about $1.5 billion in cash. It looks like nearly all of the money went to repay debt: Total liabilities fell by $1.1 billion. But the company still is owes $5 billion. Technically, it can't even make a top-line profit – it spends more to build a house than it earns selling it. So, without a sizeable appreciation of housing price, it will never repay its debt.

Over the last few months, the market has gone from de leveraging to re leveraging. So saw over the last few months, companies which were hugely in debt were doing very well. These companies includes COF, MGM and DHI. It is the belief that this re leveraging and access to credit is very short term. Very soon, once the pool of cash is dried up, these companies will come crashing down again.

Technicals:




As seen from the charts, the stock had tried to hit $14 thrice beg May, first week of August and third week of Aug. MACD was showing a negative divergence and had crossed over negative.

The market had gone up >40% since March. So any correction will bring the price easily down below 11.

Trades:

Bear call ITM

Buy Jan 10C strike 12.5 for 2.11
Sell Jan 10 C strike 11 for 2.77
Credit or Reward = 0.78
Risk: Spread – credit = 1.5-.789 = .72

10 contracts were placed.

Reward is slightly higher than risk. ROI is more than 50%

PE: Exit on 50% of maximum reward or credit of 0.36

SE: o If market really show signs of strong recovery by Dec, exit at 50% loss
o If prices remain stagnant and market shows no sign of recovery, roll the call up another 3-4 months to allow this trade to work


Status: With last Friday decline, the trade is hitting about 40% of maximum reward. I will get out when it hits 50%. When I exit, I will place a comment on this trade.

DBA trade by CH Wu

Please click on image to enlarge.

Current Price: 25.46

Technical Analysis: Uptrend - Buy signal (MACD crosses up, RSI crosses 50, 5ema crosses 20ema, Break down trendline)

Expected price movement: Price reaches 27 in a couple of month.

Possible strategies:

1. Bull call:

BTO November 09 strike 26 call at $0.8
STO November09 strike 27 call at $0.35
Net Debit: 0.45. Position delta: 14.92
Maximum risk $0.45.
Maximum profit: 0.55
ROI 0.55/0.45 = 120% in 50 days
Break Even: 26.45
PE: Stock above 27 at expiration or at 20% gain.
SE: Stagnant – close position at loss.
Bearish: close position at 50% loss.

2. Bull call II:
BTO November 09 strike 25 call at $1.25
STO November 09 strike 26 call at $0.65
Net Debit: 0.6 Position delta: 16.63
Maximum risk $0.6.
Maximum profit: 0.4
ROI 0.4/0.6 = 66% in 50 days
Break Even: 25.6
PE: Stock above 26 at expiration
SE: Stagnant – Close position around break even
Bearish: close position at 50% loss.

3. Diagonal

BTO April 10 Strike 27 call at $1.4
STO Oct 09 Strike 26 call at $0.2
Net debit : $1.20 Position delta :8.38 , Theta -0.5
PE: Oct 09 call expires worthless, sell November call
SE: Roll short call up and out when short call is ITM
Maximum profit:
ROI:?

4. Calendar:
BTO April 10, Strike 27 call at $1.4
STO Nov 09 Strike 27 call at $0.35
Net Debit: $1.05
PE: Nov options expired worthless, sell December call
SE: Roll short call up and out when short call is ITM
Maximum Profit: ROI: ?

5. Call:

BTO April 10 Strike 26 call at 1.40

6. Naked put:
STO Nov 09 Strike 25 at $0.65
PE: options expired worthless
SE: own stock at cost basis 24.35

AIG "reversed" collar

This is an out of the box trade. It is not the standard application of a collar. There are additional risks to this trade. You can lose a lot of money if you fail to apply the protective discipline promptly. Also, the trade is very volatile and it whipsaw on your trade and wipe out any profits.

Fundamentals:

It is lousy stock! Without the government support, it should have gone bankrupt. People are buying it because they believe that it cannot fail because they believe the government behind it. They are too big to fail. Also, another irrational argument is that the stock was $1400 two years ago. I have not seen any improvements in the company to justify that it will resume its former glory. On the reverse, I do not respect the management and I think the insurance industry and financial industry are still very vulnerable.

There was a stunning omission from the government's latest list of "problem" banks, which ran to 416 lenders, a 15-year high, as of June 30. One outfit not on the list was Georgian Bank, the second-largest Atlanta-based bank, which supposedly had plenty of capital.

Georgian's clean-up will be unusually costly. The book value of Georgian's assets was $2 billion as of July 24, about the same as the bank's deposit liabilities, according to a Federal Deposit Insurance Corp. press release. The FDIC estimates the collapse will cost its insurance fund $892 million, or 45 percent of the bank's assets. That percentage was almost double the average for this year's 95 U.S. bank failures, and it was the highest among the 10 largest ones.

It failed last week.

What this latest failure reveals is that (a) whatever methodology the regulators are using in their bank reviews, it is disastrously flawed; (b) without mark-to-market accounting, the nature and scale of what actually lurks in the loan portfolios of banks is unknown and unknowable.

The FDIC is now bankrupt, and the $46 billion it hopes to raise by having its member banks pony up their dues for three years in advance is not likely to last out 2010

I think very soon Obama will run out of ammunition and AIG will run out of excuses.

Technicals:

Please refer to the graph below ( Please click on image to enlarge )




o IV can be very high during certain days. Very good for creating credit trades
o Broke support today. Although it bounces back, but no bullish signal.
o MACD and Stoch are negative
o Exhaustion with 3 tops over the last 8 months

Strategies:

My strategies are:

Because this was an ongoing trade, I am not going to give you a detail plan but will articulate my strategies as the trade moves along with time. I will give a summary of the current status and will update as I put in my adjustment. This is an actively managed trade.

I open a synthetic put 2 weeks ago on 31st Aug 2009. ( 300 short stock at 46.82 and a 3 Nov Long call at 47. Since then, I had been able to take advantage of the volatility 3 times by selling a SP when the price dived below 38. I bought the SP thrice and sold it twice before it expired. Current holding an Oct 38 SP. I have captured about $900 in credit.

I am waiting for the stock to fall to <20 before I will close the whole trade.

If it is being called out by October at 38, I will make around $1000. But I may roll down the put to keep the Oct SP at 38 intact. If it is not assigned, I will continue to short put to reduce cost while holding the long call and short stock. Once the stock reaches below 20, I will close my trade if there is support.

IF the trade goes against me, I have my protective call. I can still close it at breakeven or a slight loss. My bet is the probability that it will collapse before end of November.

If the stock market pushes up another leg to November, I will roll my Nov Call to Feb or March. I may want to keep the synthetic put intact until I reach my target. Unless, the market show real signs of turning around by next year I will close my position. Currently, because of the SPs, I am almost risk free if I continue to manage the trade timely.

I think if the market goes through a correction, this stock can drop to <20 anytime.

Because it is so volatile, you have to very quick to capture credit when the stock is down by selling puts. I may be called out before I can close the trade but that is fine because I will make some money but not my maximum target.

Upgrade in Trading Strategies

Recently, I have made some major changes to my trading strategies.

I have started to use extensively option spreads to bulletproof my trades.

I had been successful with directional trades for many years. My core approach was briefly outlined in an earlier post in my blog.

Many traders because of the following factors have considered options risky:

1. Volatility – prices move too fast
2. Spreads – there is often a wide gap between the ask and buy prices
3. Time decay – options lose value fast especially during the front month

However, if applied properly options can be safe. Actually, spread strategies turn the entire negative factors in your favour.

In addition, spread strategies soundly applied offer the following advantages to your directional trades.

1. It drastically reduces fear and greed and forces you to plan your trades – your risk, reward, entry, primary exit and secondary exits if you trade goes against you. Planning is the key to success in all trades whether you are directional or using options. Plan your trades and trade your plan. The proper use of spread bullet proof your trades
2. It allows time for the trade to work. Very often, I am forced to execute my stop loss even those I know I am right fundamentally. With option strategies you can buy time to allow your trade to work finally. Even if you are wrong eventually, you can minimize your lost if you exercise discipline
3. Very frequently, mistakes are made in short-term timing. It is impossible to perfectly time our trades although many traders try, especially day traders. Adjustment can be used to get back on track. No one can guess the short-term direction perfectly. With the use of combination of long and short options, you cover yourself in all directions short term.
4. Strategies can be used to prepare for explosive movement of stock owing to some companies’ news event. Whether the stock moves up or down, you can profit from the move. The only time you lose money is when the stock does not move.

Thus spread strategies are a great complement to the strategies of my trades. Ultimately, fundamental rules in trading. Option spreads are used to control, leverage,

In subsequent blogs, I will be showing actual trades that were made to illustrate all the comments made above. I have invited a group of traders who are trained in spread trading to comment, show case their new trades and we all learn together. It is our intention to monitor our trades. We will make mistakes and we will certainly learn from it. Note that all trades as stated in the policies section in this blog, are not for investment advice but for educational purposes only.

For those who are not initiated in options spread trading, I apologize. Many of the subsequent threads will not be easy to follow if you are not trained in the methodologies. We are a group of traders who are trained in options spread strategies. Actually, we are all trained by Options Animals. I have personally looked at a number of companies including Optionetics, Option University and Option Planet. Options Animal provides the most complete training at a reasonable price. The key value is the interaction with the coaches on actual live trades. Alternatively, you can get a lot of free training on the web like those from CBOE and brokers like Think or Swim or Option Monster. It takes practice, time and commitment to be proficient. It is worth the effort!

Update

It has been a while since I posted. It seems there may be a recovery in the economy. I am still not sure. At least there will be a substantial correction before things start going up again. Only then can I be sure of the recovery. Meanwhile my bet is that in the longer term things are still down!

It's probably too early to make a call for a bull.

It was strange the way the market moved in the last few days - straight up and no signs of slowing down. Another sign of over-exuberance and a bubble for at least the short term? I doubt the market will go past S&P 935 on Monday morning. If it does, there will be the huge hurdle of 1000.

The Canadian Dollar should do well at least against the US$. Since I am living here in Canada, I converted a substantial amount of C$ last month. I also bought Canadian dollars against the US$ heavily. It was a timely decision. It is a commodity currency and thus should do well eventually. It is my belief that gold, silver, oil and other commodities will be up again.

At least my bets on oil, shorting treasuries and gold, are doing well.

Fundamentally, I believe there is re-leveraging going on. We went from de-leveraging to re-leveraging with help of the massive injection of printed dollars from the US. Last 2 weeks, we saw COF, SLG, MGM - all highly leveraged and highly in debt companies - move up more than 50%. All these companies were expected to be next on the chopping block for bankruptcy this year! Capital seems to be no longer the issue. Also, junior stocks are ramping up by the 100s of percentage points. So are good times back again?

As for me, I will enjoy it while the times are good. I think the massive money supply will continue for a while under the Obama administration. The flip side is the potential collapse of the dollar and also massive inflation. So it is a no-brainer to short treasury stocks. This is my biggest bet, besides oil and gold.

However, I still maintain that we will see a greater crisis that will bring the DJ and S&P below the low of Jan this year.