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Saturday, January 25, 2014

Trading Thoughts --- Week Ending January 24, 2014

Hello Fellow Traders! 

I know that it's been a very long time since I last posted on this blog... with Stocktwits & Twitter I am able to post most of my trading activity there, so please give H2Options a look. These social media sites are pretty cool as they give me an opportunity to both journal my trading activity and keep me honest on the decisions I make both good and bad.  Hopefully most of my decisions will be good ones as my livelihood depends on it!  This blog is nothing more than an extension to this... the main and obvious difference is I have the opportunity to express my thoughts in greater detail here on my blog. 

So, with that in mind, I want to begin by stating that 2014 has gotten off to an interesting start to say the least.  The weather, for one, is currently at extreme cold temperatures, with even colder temperatures on the way… –25 below!!  In contrast, the stock market has been on quite a roll and to many it’s been too hot to touch.  

That sentiment may have begun to change on January 24th, seeing the Dow drop over 300 points closing below 16,000 to 15,879.  According to various news reports I’ve seen, many investors have been waiting for a pull back in the market before “pulling the trigger” on their funds. These folks have remained in disbelief that the market is for real ever since the 2008 financial meltdown.  On the flipside, there are those who have participated in the market run up, and are getting nervous and have been looking for reasons to sell.  For me personally, I’m somewhere in between these two schools of thought.  I have steadily taken money off the table throughout 2013 in my stock portfolio, as I was an aggressive buyer in mid 2009.  At this point I continue to hold a well diversified portfolio of dividend paying stocks (~65%) and cash (~35%).  My cash allocation is much higher than I use to have before I became more knowledgeable about options.   I use the cash portion for all of my option trading activity as I believe options provide the most efficient use of one’s capital given the leverage and flexibility it provides.  

As I gain more knowledge in trading options, I am more inclined to allocate funds to these instruments.  This way of thinking has become even more apparent after the stock market sell-off the past two days. I’m convinced even more the important role options can play in hedging one’s portfolio.  Sure, my option portfolio took a hit, as it is “net long”… however, the losses would have been much greater had I invested my money solely in a stock or mutual fund.  As you probably know with stocks and mutual funds, you can only make money on these instruments one way… they all must go up in value.  However, with options you have the ability and flexibility to make money if the underlying stock goes up, down or sideways.  They really are fascinating instruments if constructed WISELY.  

As I say on my Stocktwits profile: “I emphasize hedging ALWAYS.”  I say this because there is option strategies out there that are quite risky… for example, selling naked puts or uncovered calls can be quite lucrative, but can be disastrous to one’s financial health if the market moves against them severely.  I would assume this scenario played out for some on Friday!  All of my option trade strategies are “hedged”. This simply means that each strategy has defined risk parameters built in to ensure that I know what the maximum loss will be on any given trade.  That gives me great comfort, and I can sleep at night.  The drawback to options is that in most of the trades I implement caps the upside or downside potential I can make.  To me, this is an acceptable “drawback”, as the leverage feature of options in terms of the amount of capital needed and the time frame involved (usually 20-90 days) is very rewarding.  

Current Open Option Trades
19
Unrealized
Underlying Equity
Option Strategy
Date Opened
# Days in Trade
Current Profit/Loss
1
Apple (AAPL)
Iron Condor
01/24/14
0
$22
2
Akamai Tech. (AKAM)
Double Calendar
01/21/14
3
-$160
3
Akamai Tech.#2 (AKAM)
Double Calendar
01/21/14
3
-$90
4
Celgene (CELG)
1-3-2 Put Butterfly
01/13/14
11
$13
5
Dow Chemical (DOW)
Double Calendar
01/08/14
16
-$49
6
Ebay (EBAY)
Double Calendar
12/31/13
24
$105
7
Morgan Stanley (MS)
CIS Collar w/Put Butterfly Hedge
12/20/13
35
-$495
8
Russell 2000 (RUT)
Iron Butterfly
01/15/14
9
$30
9
Russell 2000 (RUT)
Iron Butterfly
01/22/14
2
-$126
10
Scherwin Williams (SHW)
Dbl Diagonal Calendar
01/03/14
21
$69
11
United Airlines (UAL)
CIS Collar w/Put Butterfly Hedge
12/12/13
43
$332
12
Yahoo (YHOO)
CIS Collar w/Put Butterfly Hedge
11/20/13
65
$151
13
Yahoo (YHOO)
Double Calendar
01/08/14
16
$112
Current Open Options Gain / Loss:
-$86
2014 Closed Option Trades Gain / Loss:
$463
Total Open/Closed Option Trades 2014:
$377

Trade #1 Apple Inc. (AAPL)  Iron Condor Strategy  

I entered this position on late Friday afternoon to take advantage of elevated implied volatility (IV) levels due to Apple’s earnings coming out Monday, January 27th after the close. I initiated the trade with AAPL trading at ~$548.39.   An iron condor consists of selling both an out-of-the-money call and put spread simultaneously so there is only one commission charge.  It is considered a 4-leg option. I like taking advantage of high IV because you can obtain higher premium prices that you sell for a credit.  In this case, I sold 4 contracts for a net credit of 85 cents.  This translates into my money market account receiving ~$340.00 less transaction costs.  This is the maximum profit I can make on the trade.  I can “keep” all of this “up-front” credit if Apple shares remain between $587.50 and $520.00 per share at expiration on February 1st.  Should Apple shares exceed or decline by more than these levels, the maximum loss I would face at expiration would be $660.00.  Below “Return on Risk” box shows the risk/return parameters of this trade.
IRON CONDOR
AAPL JAN5  587.5/590 C - 520/517.5 P
PUT & CALL STRIKE MARGIN
$2.50
 (LESS) NET CREDIT
$0.85
MAXIMUM RISK @ EXPIRATION =
$1.65
x # CONTRACTS
4
x # SHARES @
100
MAX $ RISK =
$660.00
MAX % RETURN =
51.5%
MAX $ RETURN =
$340.00




Trade #2 & 3 Akamai Technologies (AKAM) Double Calendar Strategy

I entered these trades on 1/21/14 to take advantage of expected moves in the stock due to earnings that will be announced on Wednesday, February 5th after market close.  AKAM was trading between ~$48.59 and $48.81 when I initiated the above trades.  The double calendar involves selling near term Feb1 calls and puts and buying the longer-dated Feb same strike calls and puts.  In order to maximize profit AKAM will need to trade near the near term 55 call/42 put short strikes at expiration in 13 days.  The maximum loss on the trade occurs is the debit paid on the trades totaling ~$530.00… this would occur at ~$75 on the upside; $35 on the downside. Maximum gains at the short strikes on calendars are difficult to determine.  The ability to obtain at least some profit is quite wide as the breakeven points are $62.50 on the upside and $37.50 on the downside.  One important thing to consider is that implied volatility typically rises into an earnings event causing option premiums to widen which should be advantageous for the trade.  It will be interesting to see how this trade plays out.

Trade #4 Celgene (CELG)  1-3-2 Put Butterfly Strategy

I opened this unbalanced trade on 1/13/14 with CELG trading at ~$164.65 per share.  Celgene as well as other large bio-tech stocks have been trading at rather high levels.  The 1-3-2 put butterfly strategy takes advantage of situations where you believe a stock is due for a pull-back, albeit minimal.  So, you are in essence neutral-to-bearish on the stock.  The beauty of this strategy is there is no risk for the stock continuing its ascent should it’s bullish ways continue.  I entered the exact same trade (different expiration) back on 12/19/13, where this actually happened: the stock was trading at $163.41 when I opened the trade and on expiration on 1/10/14, Celgene was trading at $169.81… the result: a $26.00 gain.  I only execute this type of trade when you can receive a net credit.  The current trade shows that I received a 45 cent credit… so with 2 contracts, at minimum I will keep $90.00 if CELG trades at $160.00 or greater at expiration in 13 days.  You begin to see greater profit potential in the $155-$160 range. In fact, the maximum profit is the middle short put strike at 155, where you have the potential to receive $1,090 at expiration.  The breakeven point on the downside is $152.30 and maximum loss of $910.00 occurs at $150 or less.  Celgene took a pretty good hit on 1/24 to $161.22, so it is getting real close to the maximum profit range of $155-$160. 
CELG 1-3-2 Put Butterfly
$90 Gain @ $160 or greater

Max Gain:
~$1090 @ $155.00 per share
Max Loss:
~$910 @ $150 or less
Break-even:
 @ $152.30



Trade #5 Dow Chemical (DOW) Double Calendar Strategy


The same idea as with AKAM, is employed here with Dow Chemical.  It reports earnings
before the market opens on January 29th.  Maximum profit occurs at the February near-term short strikes 47 calls and 39 puts.  Currently, DOW is trading right in the middle at $43.41 per share.  So, any movement towards either strike between now and February expiration 27 days from now could result in a decent profit. Losses are again limited to the amount paid for the trade which is ~$400.00.


Trade #6 Ebay (EBAY) Double Calendar Strategy
Trade # 10 Sherwin Williams (SHW) Double Diagonal Calendar Strategy
Trade # 13 Yahoo! (YHOO) Double Calendar Strategy

I thought I would go ahead and lump trades 6, 10, and 13 together since they all are the same types of strategies as discussed AKAM and DOW.  Without question, the double calendar in earnings season is one of my favorite options strategies.  I'll try to explain... With the heightened volatility in the general market environment, coupled with a company earnings report, this generally bodes well for calendar trades.  Volatility (i.e., significant uncertainty/fear) is expected to expand into a company’s earnings report. This should in turn expand my calendar position value to the point that I can possibly close or adjust the positions ahead of the company report. However, in the case of trade #6 Ebay, they just reported on Wednesday 1/22... I've decided to hold the position because volatility has remained high.  Why? I believe there are two primary factors: 1) the macro environment is more uncertain; 2) some lingering stock specific news from Carl Icahn demanding Ebay to spin off their PayPal unit.  I'm hoping for some pop/drop in the shares soon, otherwise any sign of a volatility crush, I will close out the position immediately. Under normal conditions volatility in the option pricing should fall quickly after company earnings and this too can potentially expand closing prices because of the effect of time decay (theta).  Theta also works in my favor as the short options lose value faster than the longer dated calls and puts.

I also want to emphasize the probability of profit on calendars are pretty darn good.  Again calendars take advantage of the underlying trading at or near the strike in the trade and there is also a wide range for the stock to trade which gives a better probability of success especially if there is a significant move in the price of the shares.  Keep in mind that each individual calendar can potentially more than double in value so there is a very good risk/reward situation for a trader. The logic with calendars is to have the shares to be near either short strike in order for the calendar to expand and any rise in volatility will also increase the value of the options.  Below are the double calendar set-ups and current P&Ls:

*EBAY @~ $54.74 EBAY DOUBLE CALENDAR  Open Dollar Value Open Delta 01/24/14 Open IV     Net P&L EBAY Current                Price: $54.30
12/31/13 Buy 5   Mar 57.5 Call $1.68 -$840.00     24 $1.040   24.95% -$320.00         Current IV: 27.45%
12/31/13 Buy 5   Mar 50 Put $1.04 -$520.00  -27 $0.605   28.03% -$217.50      1 σ move +/- to FEB expiry:  $58.51/         $50.26
12/31/13 Sell -5   Feb 57.5 Call $1.29 $645.00   20 $0.500      27.41% $395.00
12/31/13 Sell -5   Feb 50 Put $0.73 $365.00  -25 $0.235    30.93% $247.50
*Underlying Open Share Price Max Loss -$350.00
*Opening IV@ 29.74%      O P&L= $105.00
TOTAL EBAY P&L  = $105.00
FOR ILLUSTRATION PURPOSES ONLY!!!



*SHW @~ $183.15
SHW DOUBLE DIAGONAL / CALENDAR  Open Dollar Value Open Delta 01/21/14 Open IV   Net P&L     SHW Current Price: $190.80
01/03/14 Buy 2   Mar 200  Call    $2.25      -$450.00             22       $3.25          22.                           92% $200.00     Current IV: 28.34%
01/03/14 Buy 2   Mar 155  Put $1.53 -$306.00    -11 $0.600 31.  37% -$186.00      1 σ move +/- to FEB expiry:         $205.61/ $175.75
01/03/14 Sell -2   Feb 200  Call $1.35 $270.00      17 $1.98 23.   50% -$125.00
01/03/14 Sell -2   Feb 160  Put $1.20 $240.00     -11 $0.300 31.   18% $180.00
*Underlying Open Share Price
*Opening IV@ 26.04%   O P&L= $69.00
                                                                TOTAL SHW P&L  = $69.00
FOR ILLUSTRATION PURPOSES ONLY!!!


*YHOO @~ $41.55 YHOO DOUBLE CALENDAR  Open Dollar Value Open Delta 01/21/14 Open IV Net P&L  YHOO Current Price: $37.91
01/08/14 Buy 7    Mar 47  Call $0.84 -$588.00     24 $0.325   34.45% -$360.50      Current IV: 41.36%
01/08/14 Buy 7    Mar 37  Put $0.79 -$553.00    -20 $1.915   34.55% $787.50    1 σ move +/- to FEB expiry:        $42.24/ $33.59
01/08/14 Sell -7    Feb 47  Call $0.47 $329.00     18 $0.085  35.61% $269.50
01/08/14 Sell -7    Feb          37    Put $0.41 $287.00    -15 $1.245  34.16% -$584.50
*Underlying Open Share Price 7
*Opening IV@ 33.54% O P&L= $112.00





Happy Trading!
H2Options










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