November Soothsaying... Or Not.

As October trading is over it's time to look forward to the next month with reference to our new monthly pivots now set in stone, with the last trading day in October adding a fair bit of interest to the equation.

The monthly pivots have been very influential on the resistance side of the equation, but with scarcely any relevance at all on the support side. This is fairly expected in a stong uptrend.

click to enlarge



First line of resistance is 1085 and my guess is that that would well and truly contain this market based on the last few day's action.

Maybe we see the support pivots coming into play... maybe. First support at 1003. Anyway, they're my points of reference to watch out for.

The 20dma of the equity only put/call ratio is still dragging it's ass along the lowest levels of the last 3 years and that still says to me that the market is toppy.



But those low readings can and do drag on.

VIX is the interesting one having hit 30 on Friday. VIX gave a pretty reliable short term buy signal that manifested itself on Thursday of last week, but that all turned to crap on the Friday. The VIX is about 50% higher than current realized vols (on a 20 or 30 day lookback basis); I don't know whether that means options are a sell, because realized vols could just pick up a canter from here... perhaps even gallop off into the sunset.

All in all a pretty interesting week and month ahead. No soothsaying from me at this point apart for not expecting new yearly highs in the month of November... but I don't really think the market is ready to sell of in a major way just yet.

Discuss this and other topics at International Stock Forums. Help our new forum grow with your input.

Cashing In My Chips

The big news of the day in optionstraderblogoshere is the VIX pumpage.

Usually I would try to come up with some insightful market maxim, or a chart with pretty lines highlighting some statistical gobsmacker.

Today I offer none of that. The only thing that mattered to me was that VIX HIT 30!!

...and I won the bet. :)))

Perhaps I should gloat, or give Mark a digital hard time and poke fun ad nauseum. Instead, it is relief that it got there first and saves me some embarrassing payout on my bet with Mark.... fear of loss or some such psychobabble.

It was a bit of a hoot, but I'm cashing in my chips and quitting while I'm ahead.

High Stakes VIX Bet

The story of the day from the options trader's perspective is not the crimson red condition of the stock indexes, it is the VIX pumpage into extremely oversold levels as detailed by Bill Luby.

Adding poignancy to the situation I have been lured into a wager with Mark over at Option 911. The bet is that VIX will hit 30 before it hits 17. Convinced I would have my ass handed to me, I obtained very favourable odds; the payout, something moderately embarrassing if I lose compared to something really really REALLY embarrassing if Mark loses.

Right now, I'm feeling quietly and unexpectedly confident. :)))

N.B. - Neither Mark nor I are likely to be fooled by the randomness of such a wager, just a bit of frivolity folks.

Whither Gold?

Although gold option volatility has settled into what looks like a base of around 20%, it is still usefully above realized vols at around 15-16%... useful depending which side of the trade your on and presuming realized vols don't startle us all into a dither.

Aside from what has become the normal 4 or 5 points premium, there doesn't seem to be a lot of buying interest in gold options (specifically calls), despite the gold-bug's scaremongering and ramping.

Price action on the other hand looks to be approaching an interesting point at the old resistance becomes support observation and this is still in a technical uptrend. Countering this is a few voices such as Roubini who have been talking Gold down.

I've exited my option trades now, so nervously contemplating my next move. I don't want to miss a good party thrown by the gold bugs, but on the other hand, I can't help feeling a bit skeptical about $5,000 gold or whatever number get pulled out of people ass.

Short gamma doesn't excite me right now.

So, whither gold?

VIX Stirring From its (Relative) Slumber

Do I detect just a modicum of concern of this market via the VIX?

Yes we are off a few points today and this invariably causes at least a bit of a rally in the VIX. Nothing startling there. But watching VIX over the last few days I was beginning to wonder whether they were going to plough volatilities into the mid teens, come what may.
We all parrot the standing wisdom that VIX is mean reverting and I certainly think that's true. The nature of volatility and how it is measured makes it deterministically so... with an infuriatingly chaotic dualism so we can never really time volatility except by accident.

('cept when I nail it right on the day. That is unquestionably skill )
What is this mean VIX must revert to anyway? Having not really paid attention during may statistics classes, I never realized there was more than what type of mean. Sparing me the embarrassment of intellectual incapability of calculating other sorts of mean, I am quite sure it is the arithmetic mean of some defined lookback period, AKA a simple moving average.
Easy enough to work out, but even that simple task has been wrested from us via software.

But it begs the question, what lookback period should be used to determine the mean? In other words, what length moving average?

There is a school of thought that uses the 10DMA. Fair enough... whatever. But the lookback period used can deliver vastly different "means". Also the mean is a moving target. The mean today scarcely resembles the mean 8 months ago. By the ten day measure, VIX is probably already overbought (whatever that means). By other measures, there is still some reverting to do.

Whatever the case, the VIX mean is heading lower, unless Roubini's 2nd crash scenario unfolds; and don't see that happening in the near future.

What I'm basically saying in an extremely convoluted way is - VIX has finally bounced, but I have no idea where it, and the market, is going next. But my guess is some degree of retracement.

Discuss this, and other topics at International Stock Forums.

The New VIX Reality

An excellent post over at VIX And More about anchoring and expectations etc, anyway, Bill talks about the new VIX reality at it tanks towards 20%.

Previously, I've spoken about using technical analysis on the VIX, so long as it is only about creating boundaries of prove and disproof. Well, a solid break below what seemed to be a base of around 23% certainly disproved the 23% base hypothesis.

The new one is to expect declining average VIX levels. Despite every bit of negativity in the real economy - green shoots or not - stocks just want to grind upwards.

Some are prompted to predict a multiyear bull on that basis... whatever. But right now, folks are comfortable with buying stocks.

Selecting Condor Strikes - A Study

As I have outlined in another thread, people who trade iron condors are usually taught to select short strikes at one standard deviation from the current price action.

As I am developing a conversation elsewhere, I think extrapolating option volatility to "monthized" levels is not optimal.

What I want to do in this thread is select hypothetical strike levels, assuming that an iron condor is put on on the expiry Friday of the previous cycle. Some people like to initiate ICs with 2 months to expiry, so we'll have a look at that too.

I'll be using historic volatility, just so it can be automated.

I'll report on how these strikes are threatened or not as time goes by, to test how well this selection process works.

Note that this does not represent any trades I may be doing, it is just an exercise.

On the chart the red lines are 1 standard deviation (68% theoretical probability of staying inside).

The Blue lines are 1.28 SDs (68% theoretical probability of staying inside), which you would probably never get enough premium to trade.

The Green lines are at 0.6 SDs and represent what a low probabilty condor trader might select. It is presumed this trader is prepared to adjust more aggressively.

The top chart with heavier dotted lines is to represent a trade initiated 16 Oct with Nov expiry. (1 Month)

The 2nd chart with lighter dashed lines is to represent a trade initiated 17 Sept with Nov expiry. (2 months)

The 3rd chart lighter dashed lines is to represent a trade initiated 15 Oct with Dec expiry. (2 months)

I have also posted this at http://www.internationalstockforums.com/index.php/topic,29.msg64.html#msg64 That will be an easier place to follow allong as time goes by. Comments most welcome there.

Click to expand image.

S&P500 Soothguessing

(Also posted at International Stock Forums.)

As we head into the new week, once again I pull out my crystal ball (which I'm thinking of sending back for a refund) and look for signs of a top in this market. Ahhhh life is so tough for bearish prognosticators. Once again I'm going to have a look at those leading indicators than markets are so adept at ignoring.

Firstly, VIX. As I said in a previous post, I have no challenge with technical analysis on the VIX, so long as it is about creating boundaries of proof and disproof. My thesis was that VIX had bottomed for now at ~23%. This has now been disproved with Friday's close at around 21.4%. VIX watchers are postulating that it is now oversold on whatever their favourite basis is for such opinions. I'm inclined to agree.

Even if we get a mean reverting bounce in the VIX via a retracement in the Spooz, you'd have to think there is generally lower levels in the VIX's cards as the market grinds upwards.

My old favourite, the 20dma of the put/call ratio is still dragging its ass along some of the lowest levels of the past three years. Clicking down a couple of gears to the 5dma of the put/cat ratio and we are at new lows as of Friday's close.

Nobody wants to hedge their portfolio any more.

This gives us a picture of complacency and this is generally regarded as a contrarian signal. It should be noted however, that complacency can last for some time.

The case for resistance can be made by the monthly pivots. These have shown areas of interest in the past few months and as we are at R1, I'm looking for some genuine signs of resistance. We've had a bit of a pause there during the latter part of last week, but I've yet to be convinced we don't grind higher. Markets have opened up a tick or two as I write, so waiting to see definitive signs of direction for this week.

Good luck

Gold Volatility 14 Oct '09

Gold volatility went into the tank today and with gold not far off those all time highs one has to wonder why. Below is the Chart of GLD with CBOE's $GVZ (The gold VIX).

The $GVZ plonked to 20 and a bit and while that is still a fair way above 30 day historical volatility at 16%, it represents a fall to close to the "normal" premium of IV over HV in gold options.

You'd have to suspect at least a pause/retracement from here if that means anything at all. Perhaps the talk is some quarters of a bottom in the dollar is easing concerns, though the dollar is still taking it where it hurts.

Countering that is the seasonal tendency in gold which resumes an upward bias right up to Christmas (depending whose dodgy data you use).

I'm still bullish after some sort of pull back. Markets just want to go up right now, but option traders seem skeptical.

The Intel Torpedo

The bulls will be feeling all warm and fuzzy this morning as it looks as though Intel earnings will be giving the Spoooz a leg up over resistance and to a new high for the year, if the futures right now are any guide.

Of course it means my double top scenario has taken a torpedo to the magazine case... a direct hit. Never mind, I'll keep my guru robes in the bottom drawer just in case I get a market call right one day. I should have just taken the Abbey Joseph Cohen line and basked in my correctness.

This also means the VIX will sink below the 23% water line, in fact has already closed below yesterday.

Man the lifeboats and board the good ship PollyAnna LOL. I give up, I'm turning bullish.

(Which could just be a great sell signal).

However, worry not for my finances. Realizing how crap I am at market calls, I continue to be delta neutral on the indexes. All this stuff is for amusement only.

I love options :).

(VI)X Marks the Top?

So the S&P500 just about touches the high of the year from last month and slowly backs away. At this point I'm not going to remind you of my top call from September 30, just in case it blows straight through to new highs and trashes my reputation as market soothsayer and guru. LOL

The point of focus for me is now VIX. The finer points are expertly covered by Adam Warner and Bill Luby (and others), but I'm looking at the 23% level and wondering whether that is the base level for right now.

Which begs the question. Is the VIX predictive or reactive... or both. I lean on the side of reactive, but the mean reverting characteristics are well known, hence indicating as least some predictive implications.

The next question is "can technical analysis be used on the VIX?"

I say why not?

I say you can, so long as you're not trying to make predictive assumptions with pretty coloured lines and purely mathematical constructs. To me TA is about create boundaries of proof and disproof. This fits in with VIX analysis for me.

IOW a break below 23% disproves my basing hypothesis. A bounce above supports it.

Adam and a few others use the "10% above or below the 10dma" method to spot potential points of over/undersoldedness (to invent a new word). I'm far too lazy for that so I've tacked a 3,10,16 MACD on the bottom to essentially arrive at similar conclusions. It works adequately for that purpose.

Do we see an oversold VIX? Yes. Does it mean anything? Who the hell knows. But there is that divergence on the bog standard MACD.

The upshot is that I'm trying to convince myself of the chance of a double top right here.

Yes, I'm fighting for my guru call's survival...

...somehow I fear it may be in vain. This market just wants to go up.

Making Plans For 2013

It seems the lucky ones amongst us will be graced with a few more years past 2012.

Yep it seems that the end of the world has been postponed and not going to be in 2012 after all, LOL. That's according to Mayan elder Apolinario Chile Pixtun.

Bugger! I was going to party hard until then, now it seems I'll have to nurse my liver for a bit longer.

2012 is not the end of the world, Mayan elder insists

The year 2012 will not bring the end of the world, a Mayan elder has insisted, despite claims that a Mayan calendar shows that time will "run out" on December 21 of that year.

Published: 9:49PM BST 11 Oct 2009

Apolinario Chile Pixtun is tired of being bombarded with frantic questions about the end of the world. "I came back from England last year and, man, they had me fed up with this stuff," he said.

A significant time period for the Mayans does end on the date, and enthusiasts have found a series of astronomical alignments they say coincide in 2012, including one that happens roughly only once every 25,800 years.

But most archaeologists, astronomers and Mayans say the only thing likely to hit Earth is a meteor shower of New Age philosophy, pop astronomy, internet doomsday rumours and TV specials such as one on the History Channel which mixes "predictions" from Nostradamus and the Mayans and asks: "Is 2012 the year the cosmic clock finally winds down to zero days, zero hope?"

2012 is likely to be an interesting tear on the stock market however... just like every year.

Guru S&P500 Prognostications

In the absence of anything notable to report re my current obsession with gold, I'll have a look today at my guru call from Sept 30. (N.B. all the guru stuff is tongue in cheek and a bit of self derogation.) as you will recall I Went Out On A Limb and called a medium term top on the S&P500.

Well the bulls are putting that call under some serious pressure after some smugness inducing down days immediately succeeding my call. As of now, the yearly highs still have not been taken out, so I haven't cancelled my guru robe order just yet. I'm speculating on a double top and that divergence (for whatever that is worth) in the MACD does its freakin' job of psyching traders into a sell-off.

The 20day MA of the put call ratio I keep posting in the hope someone takes notice, is still highlighting extreme complacency.

So I'm sticking to my guns for now. Still no money on the outcome here, just managing a delta neutral trade. That means that don't want be toooooo right, sideways consolidation would be good.

Gold Volatility 8 Oct '09

OK, so I have a thing about Gold at the moment. There is nothing unusual about that as half the universe has a thing about it at the moment. With gold grinding out new all time highs every day, there is nothing to be surprised about.

For me it is more about finding option opportunities, hence the prelection with gold option IVs.

I had an idea that with new highs in the underlying, we'd see new highs in implied vols as punters bought calls with their ears pinned back. This is not how it's playing out at this stage. This IV peak is lower than the IV peak in early September, even though the "actual" volatility of this move is slightly greater than the early September one. So, what this tell us?

Probably nothing.

But if any delusions can be derived from this, it is that option traders are toning down their expectations of more upside in gold. It should be noted that implied is still miles higher than realized with 20 day HV at about 17.5%, but this seem to be a chronic situation. IVs have consistently been higher than realized for quite some time.

The standard wisdom says that either IV drops or realized increases. It ain't necessarily so with gold.

No ideas for a trade *right now* but a few ideas depending on how things pan out

Gold Volatility Popping Again

As we all know gold is breaching all time highs right now and leading on from my post yesterday http://www.internationalstockforums.com/index.php/topic,4.0.html there is some interesting developments from an option trader's point of view in that implied volatility (vis a vis option premium) is spiking well above current realized volatility.

Here is the last three months of volatility history on GLD (Gold SPDR)

As is obvious, implied volatilities are well over the odds. As you would expect, most of the meat is in the higher strikes as shown by this skew graph:

This means call option buyers, particularly OTM call option buyers need further dramatic rises to turn a profit, whereas on the face of it, writers would have an edge here. That's on the face of it. Who you be game to write call options here? Not this little black duck; not yet. I've got some naked put shorts I wrote at the end of august in anticipation of the seasonal gold bull, plus trading the moves with various strategies, but would I write more puts here?

Well I prefer to write puts at potential pivot point lows and that ain't here. (With the caveat that it has to make statistical sense to do so)

This situation is still developing from my point of view and worth watching for a nice writing opportunity. The $64,000 question is whether realized volatility catches up with implied, or whether gold bugs are just having another "Gold to $5,000 oz" party, are wrong again and IVs collapse back to current reality. We would need some very strong moves, relatively, to justify this IV.

Stay tuned.

Too Far, Too Fast

So says Nouriel Roubini in an article in Gloomberg today. And even though everybody has already read, and just to display some confirmation bias (with my "top" call of last week), I think it's important enough to post here.

Roubini Says Stocks Have Risen ‘Too Much, Too Soon, Too Fast’

By Shamim Adam and Francine Lacqua

“Markets have gone up too much, too soon, too fast,” Roubini said in an interview in Istanbul yesterday. “I see the risk of a correction, especially when the markets now realize that the recovery is not rapid and V-shaped, but more like U- shaped. That might be in the fourth quarter or the first quarter of next year.”Oct. 4 (Bloomberg) -- New York University Professor Nouriel Roubini, who accurately predicted the financial crisis, said stock and commodity markets may drop in coming months as the gradual pace of the economic recovery disappoints investors....

Actually, I'm a bit surprised at his relative bullishness (or the reportage of the same) of late. This more moderate tone is a bit more of what I'd expect from him.

The Thing With VXX

I'll bet you didn't know it, but the VIX has an ETN too

And if you'd care to take a dare I'll make a bet with you

Now the VXX is a pretty good fiddle boy, but give the VIX its due

I'll bet a fiddle of gold against your soul, that the VXX has negative roll too.

...with humble apologies to The Charlie Daniels Band.

Yep, just like some of the commodity EFTs. Bill Luby at VIX And More highlights the problem with VXX as both a hedging instrument and a longer term play. Anyone thinking of having a play with VXX should read his post.

The bottom line is that when you need it most, VXX is at its worst in tracking the VIX.

Read It Here.

For a bit of true poetry and some amazing fiddle playing:

The Creaking Limb Holds

The sellers have come in to save my call. Phew, my campaign for gurudom is intact. Of course, having an iron condor to manage, I hope I'm not too blinkin' right.

Some consolidation right about here would be nice.

The greater question is the medium term prospects for stocks. We've come a long way and there is a lot of euphoria about, mixed in with some stubbornly pessimistic outlooks.

I'm doubtful that many of the problems which caused the financial cesspit we're in have been resolved in any way, and the real economy is still struggling. So the question is to what extent stocks will start to reflect reality - or some future version of it?

Which begs the whole gamut of existential and related questions. What is reality? What is value? Inflation or Deflation? etc etc etc

More importantly, when will the dip buyers step up to the plate?

The Limb I Went Out On Is Cracking Already

Amazing market we're in at this time. There is dip buying, then there is dip buying.

Going Out On A Limb

No, I'm not embarking on a mission of McLean-esque spiritual discovery, but I am taking the unusual step of publicly calling a medium term top on stocks.

Actually, I don't give a rats, I'm delta neutral and really would love some sideways consolidation ( a top of sorts I guess). I'm really just about managing whatever this ludicrous market throws at me. I just think that if that rich mental map that we traders think we have is worth a cracker (probably not), this really "feels" like it wants a decent retracement.

The $64,000 question these days is - what constitutes a decent retracement? Dip buyers apparently are cashed up and are all over any divot, never mind actual dips.

Lots of sentiment indicators are screaming "complacency", none more so than that 20dma of the put/call index I keep pulling up in the hope of a guru-like market top call. It's still entrenched at around it's lowest level of at least the past three years.

As mentioned in an earlier post, this is a pretty blunt tool, but usually manages to bludgeon the market into some sort of pullback. Add to this the "October Meme" and I think there is a reasonable case for a little bearishness.

N.B. For amusement value only, there is no money riding on this.

Coughing Up For Gold Options

The recurring theme in stock index options over the last few months has been the chronic overvaluation as measured by implied volatility over the eventual realized volatility. Theoretically, this has been an excellent time for index option writers, except that the indexes have been running a long way from their mean. Any sellers writing fairly close to the money (like moi :-0) have been as busy as a one armed taxi driver with crabs, making adjustments.

We've had to work pretty hard for our money.

Index options haven't been the only ones in more or less chronic overvaluation. Gold options have been in a similar situation. I like the futures and their options, but the gold ETF, GLD and its options pretty much mirror the futs.

Check out the IV/HV chart for the last six months.

Even ignoring the IV spike earlier this month, those buying options have been paying well over the odds. Writing options here seems the no brainer. I liked the idea of selling premium with some long delta with a couple of different ideas leading into September, due to the pretty reliable seasonal tendency. That's worked out pretty well, but who's game to write unhedged on the call side in this market?

Not this little black duck!

Runaway gold markets don't happen that often, but the bulls can go berserk if *something* happens. Nevertheless, there is a bit of short gamma fun to be had here in this market... just cap the risk IMO.

The Big O(s)

There was an interesting article floating around a few of the trading message boards on Friday regarding OptionsXpress, Optionetics and George Fontanills.

I wanted to post the excepts then but couldn't find the source. Thanks to Don Fishback who has posted on the same subject with correct attribution, I am doing likewise today at last...

From Barrons:

There is reason to be skeptical about claims made by Optionetics, a trading-seminar outfit that optionsXpress hopes will lure customers.

A cracking read for seminar skeptics.

Homeless

As of the weekend I am officially homeless as we start our exodus to a new country. I am still in the UK for a few weeks, but staying with family. My trading desk is now a makeshift affair consisting of... well, never mind, use your imagination. lol

Posting may be sporadic, but I'll try and keep the blog idling along so-as not to lose my three readers completely.

An interesting point about trading businesses is that I am able to keep my trading business ticking along during this period of travelling... not exactly in a hammock at the beach in the Bahamas like some of the seminar clowns like to portray, but nevertheless possible to do so on the move.

A nice advantage.

I must admit that I prefer my own cave to trade from however. I'm looking forward to settling down again.

More on That Oil Option Skew

The Bloomberg oils option article I mentioned yesterday has caught a couple of other options bloggers attention today.

Don Fishback has a closer look at the directional implications of the downside skew and concludes it doesn't really mean a lot.

Adam Warner makes substantively the same points as me and takes a swing at Bloomberg clichés, but is also skeptical of any directional signals.

Looks as if Bloomberg has been pwned by the blogosphere on this occasion.

Bloomberg Option Blooper

There are no end of erroneous statements regarding options that appear in financial publications. Today I'm going to pick on an article in Bloomberg, because I just happened to do something I don't often do... and that is read Bloomberg. (Nothing worse about Bloomberg than other Wall Street Cheerleaders, I don't often read much of any of them).

This is what they had to say:

Oil Options Hit Highs as Verleger Predicts 44% Plunge

Sept. 21 (Bloomberg) -- Oil traders are paying more than ever in the options market to protect against a plunge in crude prices.

Oil options are something I follow pretty closely, so fearing a volatility spike that I had missed, I immediately pulled up $OVX (The VIX of oil options)

Hmmmmm IV near recent lows, no spike there. What could our B'berg author be on about here. Reading further:

The gap between prices of options betting on a decline and those that would profit from a rise in oil widened to a record 10 percentage points, according to five years of data compiled by Banc of America Securities-Merrill Lynch...

...Options granting the right to sell, or put, oil in December below current prices have a so-called implied volatility of 54.3 percent, compared with 43.3 percent for the equivalent options to buy, or call, data from the New York Mercantile Exchange show.

What's this? The arbitrage opportunity of the century? As I pulled up the option chain for December crude, I was multitasking and transferring every cent of spare cash in my trading account for mountains of reversal margin. Alas, I was disappointed as both ATM calls and puts were priced equally in terms of volatility.

What the f*** were they on about?

The subtle clue is what I have retrospectively bolded in the above quote. The author was comparing the IV of WOTM puts to WOTM calls. This is nothing more than a downside price skew. Skew is common in all sorts of markets; in fact it would be a little unusual for a market not to have some degree of skew to one side or another.

It's true that event sensitive commodities usually have skew to the upside and therefore skew to the downside in oil is noteworthy. The hypothesis that oil probably will experience some downside pressure is a fair one. But I wish they would call a spade a spade rather than dishing out erroneous bullshit on on options like this article has. Options are confusing enough for the neophyte, without inaccuracies from supposedly authoritative sources.

Give yourself an uppercut Bloomberg.

Options Spuikers Under The Spotlight

Choice Magazine which is a consumer magazine down in Australia has done a bit of a spiel on options trading seminars, featuring "The Big O" and a local spruiker. Read the article here.

They took quite an even handed approach, but there are some interesting quotes:

One company, Optionetics, says if you don’t make 300% on your tuition fee in six months you’ll get your money back. Another, Traders Circle, recently said at a free seminar that if you start with just $4000, its options “mentoring program”, “recipe for success” and trading recommendations will teach you how to earn $1000 per month for the rest of your life.

I suppose enough has been said around the traps about Optionetics refund policy, but Traders Circle claiming 25% per month? For life? Hmmmmmm. Excuse me a second while burst out laughing.

We attended free seminars and spoke to other experts to find out if options are really the best way to profit from volatile market conditions. We found options to be highly speculative, with a very real chance you’ll lose everything you invest. We also uncovered some dubious get-rich-quick claims that downplay these risks.

The bit in blue might not be necessarily true, but Choice probably couldn't help arriving at that conclusion from what was presented. Re the green bit - Indeed.

We contacted Traders Circle to confirm what we’d heard at their free seminars. They clarified that profits are before costs described in the company's financial services guide including trading fees (up to $82.50 per trade), education fees ($7000-$13,000) and monthly subscriptions ($349), and before losses from unsuccessful trades.

Holy Shit!!

While the risks of options trading are described and the company (Optionetics) proposes to teach people how to set predetermined entry and exit points for trades as a way to cut their losses when markets move the wrong way, there’s far less focus on the losses that customers must also be experiencing.

We’re not the only ones sceptical about the potential profit claims. “While it may be possible for such returns to be achieved, it would only result from adopting risky strategies,” says the SDIA’s Doug Clark. “The risk of loss from trading in options can be substantial. In all investments, high returns usually mean high risk. A good options adviser is invaluable to help you understand the market and give suitable advice.”

Rod Peters of ABN AMRO Morgans uses options for private clients, but mainly for capital preservation and to earn an additional income, rather than to speculate on big profits. He says 1.5% profit per month, or even double digit figures in a year, would be “a phenomenal return” from options, even for someone prepared to accept some investment risk. “I don’t believe the higher returns being quoted by these options education companies are sustainable,” he says. “Any astute investor would realise that to achieve those returns you need to get lucky, take extreme risks, or both.”

Good comments.

My biggest eye rolling moments come from the "it only takes 20 minutes a day" assertions. Here's what one client had to say:

"I attended an options seminar in 2002 and, while I thoroughly enjoyed the program and felt I learnt a lot, I believe that the instructors give a false impression in relation to both the amount of time and effort required to trade properly. It was stated during the seminar that, provided we put alerts and stops on our buys, we would need to spend no more than 20 minutes per day to trade successfully. However, I do not believe this to be true and feel, particularly if you are working in a full time position, that it is simply not possible to monitor your trades effectively enough to be successful." Fran

Lastly, something anyone that's been around options longer than 5 minutes knows about these seminars:

"The biggest problem I've found with a lot of these training companies that offer 'free' seminars is that the courses they spruik are expensive (probably to cover the HUGE of marketing that they must incur) and the content of the free seminar is purely a marketing vehicle to build hype for the product." - Paul

It not a bad article and a good read. It bags out these companies with reasonably accurate information, but unfortunately perpetuates a few of the pernicious myths about options trading if someone was seriously considering going about it the right way. Lots of good quotes to pull out of it too.

Read.

PutCall Ratio - A Blunt Tool

This is a bit of an update to the Put Call Ratio post of 26th August where I thought it could be signaling a toppy market. This is what I wrote.

The interesting thing for me is that the 20DMA of the equity only put/call ratio is now at its lowest level in the three years of the plot. That in and of itself probably means zip in the predictive sense, but if one wanted to make a case for a pause/consolidation/retracement in the indices sometime very soon, this indicator certainly would add some weight to that hypothesis.

Lots of bears are talking another major down leg, and generally I'm still a bear too, but I doubt we'll see too much downside in the medium term. But I'm making the case for a short term top somewhere around about here.

I'm claiming a minor hit with that guess. We did get a short retracement soon after that post... of course dip buyers were all over it like a rash and the bulls have pushed us to new highs.
However, that put/call ratio is still down at those extreme lows:

It's still raining greenbacks dropped from Uncle Ben's Helicopter, so there is nothing to stop this market continuing upwards. We're in pollyanna mode here, ignoring all the shithouse news coming from the real economy and pumping the "positives".

Maybe the recession IS over. I'll let time decide whether that's true, but we still have this extreme P/C reading. Tops are notoriously harder to pick with leading indicators than bottoms, and they're hard enough, but Holy mother of Mary we have to see some sort of retracement soon...

...don't we?

The truth is that these leading indicators are blunt tools, they need a bit of time to be right... just like a bear I guess. :)

On The Lack of Posts

Your humble options blogger is moving far far away from his present location and will be travelling a bit for a while, so with organizing things, postings will be lean and sporadic.

But stay tuned.

PutCall Ratio Divinations

The put/call ratio: Is it it predictive or reactive? Maybe a bit of both, just as I think VIX is. But like VIX and volatility in general, it tends to be mean reverting. Extreme readings don't often last a hell of a long time and are often the harbinger of a reversal - or at least a consolidation or retracement in the prevailing trend.

For the medium term view, and the P/C being a very volatile figure, I like the 20DMA of the equity only put/call ratio to find extreme readings.

Here is the last three years of this figure in green, plotted against the SP500:

A close examination highlights the inverse correlation.

The interesting thing for me is that the 20DMA of the equity only put/call ratio is now at its lowest level in the three years of the plot. That in and of itself probably means zip in the predictive sense, but if one wanted to make a case for a pause/consolidation/retracement in the indices sometime very soon, this indicator certainly would add some weight to that hypothesis.

Lots of bears are talking another major down leg, and generally I'm still a bear too, but I doubt we'll see too much downside in the medium term. But I'm making the case for a short term top somewhere around about here.

Some nice sideways action would do my spirit (and my index position) the world of good.

Futures Options - Part 3

Judging by my site stats since starting on futures options, it doesn't seem like there is a lot of interest in them. That's a bit of a shame in my opinion, because there are some great opportunities to trade in the futures/commodities markets.

While there is nothing at all wrong with stock options and I will continue to trade them, commodity options can be far more suitable for some investors/traders, particularly if you like writing options.

The seasonal tendencies in commodity markets offer some unique opportunities, not just for speculating on direction via direct futures and/or long options and option spreads, but I think the most reliably profitable trades are the so-called "non-seasonal" option write as described in Stuart Johnston's "Trading Options to Win".

This is basically writing options on the opposite side of a seasonal tendency, or even just a seasonal non-tendency. This is a trade that has history and statistics on it's side and with discipline, is an excellent way to trade.

One of these to follow in the near future that I have alludes to already on the blog, is the seasonal bull in gold which begins around the 9th of Sept and continues to the first week in October.

I'll wrap up this "difference between stock and futures options" theme with a couple more points and then it's DYOR.

Tick Size

Each commodity future has its own minimum tick size that will relates to the price per bushel/tonne/bale/whatever and they are all different. As an example, the grain complex is quotes in cents per bushel (contract size is 5,000 bushels) with a minimum tick size of 1/4 of a cent. This means each cent movement on a contact of , say corn, is worth $50.00, while the minimum tick size is $12.50.

One would think the options would be quoted the same way. Nope. Grain options have a minimum tick size of 1/8 of a cent, not 1/4 cent. No big deal, but something to be aware of and something to research at the relevant exchange's site before trading them.

Margin

If you like writing options, you can leave Reg T behind with futures option. Futures options margins are calculated using a ludicrously complex algorithm called SPAN, which is short for

Standard Portfolio ANalysis of Risk and better known to stock option traders as portfolio margin.

As a general guide, short option premiums on ATM or OTM options will generally be less than their corresponding futures margins, which is quite generous.

There's enough there for folks to be aware that there are significant differences between stock and futures options and my best advice is to aways refer to the exchanges website to be sure of contract specs and expiry.

Futures Options - Part 2

This is Part 2 of our look at futures options.

Contract Size.

Whereas a stock option is a right to buy or sell a parcel of a certain number of shares, a futures option is the right to buy or sell a futures contract. This is quite easy then, one option = one future. As a futures contract it is the right to buy or sell another derivative contract, this explains some of the various nuances of futures option.

Expiry

Stock options all typically expire on the same day in the monthly cycle. In the US, this is the third Friday of the month and all stock options are on a certain expiry cycle as per THIS LINK. It's all pretty easy to work out once you know how it works.

Futures options are different. While the US stock index options expire on the same day as stock options, commodity futures options all have there own expiration nuances that can take some time to get used to. Many commodity options actually expire the month before the contract month. For example, The December 2009 cocoa future expires on the 15th Dec, but the December 2009 cocoa option expires on the 6th November. The reason for this in this particular contract is that the option expires before the first notice day, where holders of futures contracts are required to notify their intentions for delivery of the physical commodity (Speculative traders will have exited this contract before then).

Every futures option is different and the exchanges website should be consulted as to the exact expiry of the option concerned. For a handy 2009 expiration guide for futures and their options, have a look here at Daniels Trading have put together.

Exercise

This is another nuance which is different for each commodity.

A stock option relates to the physical delivery of a parcel of shares. When you exercise or are assigned, you deliver or accept delivery of the number of shares in question.

As stated above, a futures option is an option on a futures contract. That is where the certainty ends.

Firstly there are regular expiry contracts and then there are serial expiry contracts. A regular exiry is an option whose expiry correlates to the futures expiry (even if it expires the month before). An example is the cocoa option mentioned above; the December option correlates to the December future, both are Z expiry.

However, futures options may have expiries between futures contract months. For example, if you look at our cocoa options example, there are options which are V (October) and X (November) expiry that do not have their own futures expiry. These are called serial expiry options. These are options on the Z (December) contract.

Confused?

It doesn't stop there. In some commodity options, the regular and serial expiry options may be settled in different ways. In some cash settled futures, the regular expiry options are settled in cash, whereas the serial options are settled with the futures contract.

The key is to always refer to the exchanges website to make sure of the expiry date and the settlement terms.

Enough for now, stay tuned for part 3

Future Options - A Bit Different

With Liberty trading Group running all over the shop promoting the writing of commodity futures options, I thought it would be a good time to highlight some of the differences between futures options and stock options.

This first post is on pricing.

Anyone who looks at payoff diagrams will notice a slight difference in how futures options are priced. The most obvious diagram to look at is a straight out ATM long call and the corresponding long put.

Supposing you have two instruments with all things being identical, i.e. all inputs into the model are the same, but one is a futures option and the other a stock option. You will notice that stock option calls are more expensive than the futures option call. Likewise, the stock option puts will be cheaper than the futures option puts.

Also, if exactly at the money, the futures options call and put prices will be virtually identical.

Furthermore, again if exactly at the money, you will notice that stock option calls will have a delta of greater than 0.5, with the negative delta of puts less than 0.5 (the absolute values of both should add up to 1), whereas the futures option will be very much closer to, if not exactly 0.5 each.

The reason for this is the cost of carry priced into the options. Stock options make the assumption that someone is holding stock and is entitled to be paid carrying costs in lieu of risk free interest, whereas a futures option is an option on another derivative contract. This means that carrying costs priced into futures options are negligible.

There are a few other differences which I'll be going over ion the next few days - stay tuned

Stocks Good, Options Bad

How many times have you heard someone pontificate on the subject of "stocks are good, options (or futures) are bad with the contention that:

1. Options (futures) are a zero sum game, for you to win, someone has to lose. They do not create any net wealth.
2. Stocks are a positive sum game. When you buy shares you are assisting the company to raise capital to build infrastructure, employ people and create value and wealth.

Anyone who's been around markets longer than 3 days will have heard this, or some variation of it It's a very persuasive argument used by many civic minded folk to avoid derivatives as they must be the spawn of Satan, stocks are virtuous. There is only one problem with this argument.

It's bullshit!

If one buys stock on the open market, not one dram, not one iota, not a jot of that capital goes to the company in question at all. While it's true that stock and bond markets are mechanisms for companies to raise capital, the vast majority of investors probably never contribute to this process at all. Or if so, it is a pittance.

Why? Companies only raise money through the issuance of NEW shares or bonds. Unless participating in an IPO or bond offering, the company will never see a cent of your money.

These are a miniscule proportion of transactions, with the overwhelming majority of transaction being the exchange of existing shares between specialists, marketmakers, institutions, traders and investors. The actual company whose shares we are trading is outside this loop, apart from you actually removing capital from the company if they pay you a dividend.

That means that for the most part, share trading is also a zero sum game (actually negative sum because of tranaction costs), capital profits come as opportunity cost for the seller.

The wealth creation bit is performed by the company itself, not the owner of shares purchased second hand on an exchange.

Ergo, the trading of options (or futures) or shares are equal in virtue, none have any moral advantage over the other.

Synthetic Equivalence - What It Ain't.

I've posted a bit on synthetic equivalence a few time in recent months, both here on the blog and on some message boards. Some people have a few trouble with this concept even when proven mathematically, so thought I would talk a bit on what it is and what it isn't.

For what it is, I'll leave the explaining to Charles Cottle, from The Hidden Reality:

There is the raw (actual)position consisting of the exact options that contribute to an overall strategy. For every raw position there are a number of alternative positions called synthetic positions (synthetics). A synthetic position has the same risk profile as its raw position and achieves the same objectives.

What that means is that the risk profile of an option strategy can be duplicated via different combinations of options and/or stocks. A few examples:

A covered call is a synthetic naked short put
A married put is a synthetic long call
A collar is a synthetic vertical spread

There are dozens of combinations that can duplicate the risk profile of different combinations.

The problem seems to be that some people feel that the positions must me identical in every respect to be synthetically equivalent. The most common objection is that of different capital/margin requirements. - that if one position needed more money to trade than the other, they can't be synthetically equivalent.

One fellow didn't feel that a long call/short corresponding put wasn't synthetically equivalent to long stock, because he could get the option combo on margin, whereas the stock required the full investment of the value of the stock. That *may* be true for some traders. But it is certainly not true for others due to different margin rules, haircuts or whatever.

The logical extrapolation of that logic would be that stock bought on margin is not the same as stock bought for cash.

In any case, capital/margin requirements are not relevant to synthetic equivalence. What is relevant, it the risk profile... the payoff diagram adjusted for cost of carry and dividends if necessary.

Capital/Margin is not considered when looking at synthetic equivalence.

How to Trade VIX

There seems to be more and more interest in directly trading the VIX lately. I've not succumbed myself, but of course am a keen observer. The most sensible commentary does not come from Bloomberg or the clowns on CNBC, but from Adam Warner's Daily Options Report and Bill Luby's VIX And More. These guys do actually trade, contrary to what on suspects with the MSM pundits.

There is a good post today over at VIX and More on how to trade the VIX - worth a gander if interested. How to Trade the VIX.

A CNN Bearfest

In the absence of anything worthwhile to say today, how about this bearfest from a couple of weeks ago.

Niall Ferguson, Nouriel Roubini and Mortimer Zuckerman revive the Apocalypse.

Gold Doldrums

A few days ago I highlighted the rising implied volatility of gold options. That seems to have been the high for gold IV for now, as IVs have settled back to the high teens.

Nothing more than a short term IV spike which has been fairly typical.

Meanwhile, realized volatility remains low, much lower than IV but as discussed before, there are good reasons for this.

Gold seems to be rooted in the doldrums, but there is always that September seasonal tendency to look out for and then there is the inflation hedge argument... QE and all that.

My purely baseless guess is that gold dribbles along for a while; until it doesn't.

Credit Spread Myths

So a few posts back I started on a bit of a rant on the BS being passed off as information on credit spreads and gave up about half way through. As the fashion for option bloggers is to do the odd video these days, I decided to finish the job in a video.

I've picked on the same article, because it encaspulates most of the nonsense out there in just two or three paragraphs and a few bullet points. I don't have anything to sell, so no need to be wary about any marketing at the end.

Options Profits Reportage

Those folks that have been around options for any length of time, might have noticed the way in which options newsletters and course sellers report profits (but never losses :))from options.

The first trend goes something like:

...top-performing 2009 trades scored 844%, 416%, 390% and 227%

Is it possible? Of course it is. It might be true, it might accurately reflect the facts, but is it appropriate to report it in this way?

Firstly, big wins are nice, but on their own say nothing unless in context with a string of trades taken by the trader. The bottom line is that the sum of winning trades must exceed the sum of losing trades for there to be a profit at the end of the year. This is what's never reported on. This big outlier wins are important of course, but what is more important is the number and scale of losses in comparison. Mathematical expectancy is what's important.

The second point is the capital allocation to these option trades. If a stock trader allocates a $10,000 position size to each trade, how much capital should the trader allocate to a long option trade?

Anybody that buys $10,000 worth of options in place of $10,000 worth of stocks, probably should be committed; particularly if they are out of the money option punts.

Obviously if the trader uses some sort of position sizing algorithm based on capital at risk (fixed fractional or similar), the capital used in each trade will be commensurately smaller with the option trade.

Put these two points together and those huge percentage wins take on an entirely different perspective. The question should be: What is the return on capital with reasonable risk control in place?

But that doesn't make for good advertising copy does it?

The second trend is the practice of annualizing profits. For example:

Net Premium: 2.70

Net Return: 3.8%

Annualised Return: 87%

If the trader could guarantee similar net returns with no gaps and possibility of losses, it might be a valid way of reporting losses.

But this is the real world, traders must deal with the reality of losing sometimes. Once again sums of wins versus sums of losses (AKA expectancy) applies. How many times does the trader win 3.8% and how many and what percentage losses does the trader suffer over the course of the year.

And on the niggly point of losses, should they also be reported on an annualized basis? That wouldn't make good advertising copy would it.

Imagine a 7% loss on a 4 week covered call annualized. That doesn't look so good. :(

The only thing important to any trader, whether trading options, stocks, or tiddly-winks, is the bottom line at the end of the year. That is, the return on the entire account. We trade options to hopefully improve that return over other methods of trading and investing, but there there is more to it than many vendors let on and more to it that what is reported in some blogs and options advertising.

I'm probably "preaching to the converted" mostly; obvious stuff to anyone who trades options seriously. It's still worth putting out there once in a while for new people coming in to Option Land to consider.

Volatility? What Volatility?

In option land, volatility has a specific mathematical definition and is used in the various pricing models (Black Scholes et al). That definition is as follows - the annualized standard deviation of logarithmic daily change in price. I have highlighted "daily" because that's what it measures, the daily change of price.

Option volatility takes no account of the trendiness of the underlying instrument however.

Let say instrument (a) moves 1% up and 1% down alternately for 20 days in a row, but instrument (b) moves up 0.5% every day for twenty days. Instrument (a) finishes very close to where it started, hardly any nett movement at all, yet (b) is up over 10% higher after the 20 days.

According to the option volatility formula, the volatility measured over this time frame is much higher for (a) than for (b).

But depending on your precise option positions (b) could probably *feel* a lot more volatile than (a).

This is the feeling some may be having at the moment if trading delta neutral strategies on index options (or just about any stock option actually). Realized volatilities have been trending down for months, with 20 day historical volatility sitting at just ~16% as I write. Yet anyone with short gamma wing spreads or (gulp) short strangles is going to be *feeling* like they are in a volatile market.

Well actually, we are, if you use a different measure of volatility.

Plain old standard deviation, measures the deviation from the mean (and as used in Bollinger Bands) over a set time frame tells a different story. While it has nothing to do with option pricing, it does show how much price is moving around or a longer period of time.

Check out the chart below (NB Stockcharts doesn't have HV as used in option pricing models, but Average True Range is used a proxy, as it also measures the daily range): Over the last three months 30 day ATR has gradually been trending downwards, mimicking HV as use in OPMs, yet 30 day standard deviation is at a high over the time period.

This is telling us what we already know, that the Indices have been flying in one direction. Volatility over a period of time IS in fact high as measured by standard deviation, even though volatility of daily changes has been declining.

It's another dimension to volatility that we retail traders probably need to throw into the mix when making volatility projections. For us, option volatility is important for pricing, but may not tell the whole story when analysing potential trades.

Covered Calls - Naked Puts Redux

About a month ago, I was opining opining that though covered calls and naked puts are synthetic equivalents, there may be valid structural or psychological reasons why a trader might use one over the other.

It might not surprise many that I am impressed by my own profundity in that discussion ;). *Some* other arguments on the merits of one over the other leave me underwhelmed however, most particularly when those arguments are chockers full of non-sequiturs, half truths and plain old BS. These of course are all over the place in Option Land, but I'll pick on a recent article published by an option book vendor.

In the article, the author recognised the synthetic equivalency of covered calls and naked puts (rare), but argues the superiority of CCs based on a load of old cobblers, to wit:

Here are the reasons I prefer covered call writing to naked put selling:

1- Many brokerages want the assurance to know that you have the ability to purchase the shares you are obligated to buy when selling the put. Therefore, they will require you to have an adequate amount of cash in your account to cover such an event. You will then have sold a cash-secured put and set aside the same amount of cash as the CC seller.

I don't see this as a disadvantage at all if the goal is conservative premium collection. As the author acknowledges, capital usage is the same. Therefore, there is no valid reason on this point to prefer covered calls.

2- The seller of a covered call captures all dividends distributed by the underlying corporation, the put seller does not. We’re not talking about a huge windfall here, but the cash is better in our pockets than someone else’s.

Just plain incorrect. Option pricing takes into account any pending dividend and option pricing cum-dividend and ex-dividend account for them. If you have a covered call position, the call premium will be cheaper to the tune of the dividend amount. You get the dividend via the stock, but you lose it via less call premium. I have an article on the effects of dividends for further information.

3- Selling covered calls allows the investor more flexibility. The most profit a naked put seller can generate is the premium on the option sale. A covered call writer can profit from the option premium PLUS additional share appreciation if an out-of-the-money strike is sold. That choice is available to the covered call writer but not to the naked put seller.

There is still no difference in payoff. If an OTM call is written, the *corresponding* ITM naked put can also be written, again with the same payoff diagram as the OTM covered call. Synthetic equivalence is maintained no matter what the strike price.

4- Early assignment is not an issue for CC writers because the option premium is not affected and possible additional upside appreciation is incorporated into your profits if an O-T-M strike was sold. For naked put sellers, early assignment could be a disaster. Imagine a stock gapping down, and the stock “put” to us at the $30 strike. The stock is plummeting and heading for the teens! The put seller wants to sell the stock before it loses more ground but perhaps the shares haven’t even hit his account yet. He may have to wait until the next day to sell the shares. One way of getting around this issue is to sell the shares short (selling before actually owning them). The problem with this solution is that average... investors will have a difficult time getting “shorting privileges” from their brokerage firm and may lack the sophistication necessary to manage such situations. Besides, who needs the headaches?

There are a couple of points here:

a) It's true that the naked put might be assigned early if there is zero extrinsic value, however the short put will have a delta of +1, or very close to it, and will be trading like the stock anyway. This will put the trader in a position of a substantial open loss for sure, but the author neglects to inform the reader that the covered call will be in the identical position of a large open loss. Once again, the positions will be the same.

b) The suggested response of shorting stock is incorrect for the stated goal of exiting the position, as you don't know if and/or when you will be assigned. You may just be flipping your deltas and have an open synthetic short call. That's not what the author intended. There is no law that says you have to hold the put till expiry or assignment. The best response if you want to exit the trade before possibly being assigned is just buy back the written put.

5- Those interested in option investing in tax sheltered accounts, will have an easier time establishing such accounts using covered call writing than any other form of options trading.

This isn't my field, but I am led to believe that cash covered naked puts are permissable in such tax sheltered accounts.

If people really want to trade covered calls over naked puts, fine, there may be valid reasons as I stated in my earlier article. No skin off my nose, but let's not justify it with misinformation and bullshit.

Gold Volatility Popping

Gold volatilities, along with vols in just about everything have been in a steady tankage since the near Apocalypse in the latter part of 2008.

The following image is of 63 day, 20 day and 6 day historical volatilitities on GLD the gold ETF; the varying lookback periods serve as a look at the structural volatility of gold. The general level of HVs have come from ~50-60% down to sub 20%, effectively reducing by two thirds. It does look like HVs are bottoming out however.

This level of HV is not unusual, having visited these levels twice before since the inception of this ETF in late 2004, the observation at those points was that vols stayed pretty low for months before eventually popping.

So does this mean gold stays quiet for a few months? Maybe not. Two things to note going forward.

1/ The seasonal tendency of gold shows that September is traditionally when gold starts flying, because of jewellery demand at this time of year,apparantly. This chart from www.spectrumcommodities.com

Important thing about seasonals; it's a historical *tendency*. It doesn't mean gold WILL run higher during September.

2/ Implied volatilities are popping, with IV a full ~50% higher than the 30 day HV plotted on the following graph.

So are option traders anticipating an increase in realized volatility? Well, IVs have consistently overestimated realized volatility; there's good reason for this with the ever present chance of Gold bugs going ape shit over one or another threat to world stability.

But an IV pop is what it is, it doesn't necessarily protend anything, as we can see from recent history, but reason to sit up and take notice. Perhaps the pop in the underlying a couple of days ago is responsible, perhaps gold bugs are about to party... again.

I think it's interesting juncture. I don't have a position in gold at the moment, but this looks an interesting time to watch more closely.