Thursday, April 30, 2009

Trading Lab Recap - Breakouts

Market has been a tough nut to crack! Why?
Has shown signs of a top, but has never followed through- stresses the importance of price confirmation. This is the drawback of taking anticipatory trades (which I sometimes do!)

Mixed Signals between Indices. They're out of sync:
$RUT broke out above resistance today
$NDX has been leading the entire time, but is now testing its 200 MA
$SPX hasn’t broken above 875 yet, but is close
$INDU weakest – hasn’t yet reached Jan / Feb highs
When market is out of sync, what could we do?

Treat it as a stock pickers market- Find relative strong stocks to go bullish
Could find relative weak stocks to go bearish (if you dare! – obviously hasn’t really worked recently)
B/c markets are out of sync, I would put more emphasis on the merits of individual charts.

Top Down Approach Finding Trades:
Does the $SPX have a definable pattern (bull retracement, bull breakout, ascending triangle, etc…)
Find a sector or stock with similar pattern (if SPY has consolidation- don’t look for retracement)
Recently the SPX has had a sideways consolidation (bullish breakout pattern)- Consequently you’ll have better luck finding bullish breakouts (GS, JWN, TGT) than bullish retracements recently.

Bullish Breakout Pattern

Trade Identification:
1. Stock is in an uptrend
2. Stock basing sideways close to a resistance level (tighter the consolidation, cleaner pattern)

Buy above resistance

1. Sell after stock rises 1 ATR
2. Sell at resistance

Trade Management:
1. Original stop could be placed beneath prior day’s low
2. Original stop could be placed beneath the base

Beta = measure of relative volatility. How volatile is the stock relative to (or vs.) the broader market (SPX)
SPX Beta = 1 SPX goes up 3%
XYZ Beta = 1 XYZ goes up 3%
ABC Beta = 2 ABC up 6%
MNO Beta = .5 MNO up 1.5%

Bullish on Health Care
Naked Put play
April 27th
Sell May 45 put for $4.50

I want the chart to confirm the trade. CELG was in a downtrend, thus we could have found better candidates for a naked put. Price Pays!
When selling Naked Puts, I Always sell OTM puts! (May 40)
It’s nice to have a support level between the current price & short strike, to decrease the odds that the stock falls to the short strike causing the put to move ITM.

Outlook: Bullish
Bull Call Spread (vertical debit spread)
Buy Sept.30 call
Sell Sept. 35 Call
Net Debit $2.45
Max Risk = $2.45
Max Reward = $2.55
Target: Exit when achieve 30% of max profit

Using September options is more conservative b/c you have 5 months for the stock to reach $35.
By going 5 months out, it also requires you to wait longer to make your money
A more aggressive approach for bull call spreads is to use less time (2 months or so)

Question: Do I have to have a net delta of +25 for a bull call spread?
Answer: Not necessarily- The most important variable is whether or not you believe the stock has the ability to reach the higher strike by expiration. If the net delta is less than +25, you’ll just make money a little bit slower.

INTC put calendar Neutral to bearish outlook on INTC, Implied Vol relatively cheap.
Strategy: Put Calendar spread (profits from neutral to bearish move & an increase in IV
Buy Jan 2010 17.50 puts
Sell May 15 puts

Revisit next week on managing put calendar & delta hedging

Earnings Announcement – Option premiums get juiced up prior to earnings (IV increases)
Allows me to do a much wider Iron Condor than usual
AFTER earnings – option premiums get smacked – volatility crush (IV decrease)
Placing Iron Condors presents a limited risk way for entering a short vol trade into earnings.
If after the earnings announcement the stock gaps up or down less than the options are pricing in, then Iron Condors can be profitable.


Anonymous said...

on entering the IC prior to the ER sounds good, but in practice, you are taking on the risk of stock moving fast (maybe gap up or down). If your short strike happens to get caught in this gap play, then what?

Can you talk about how you will choose the strikes for your play prior to the ER?

also a q: would you monitor the greeks on overall portfolio or by individual security? This gets tricky as some securities may move faster than others on any given day and may throw off the net delta. but if you monitor the security movement such that it doesn't touch the short strike then how would you monitor the delta/greeks for that security or for the portfolio? would you monitor it on a daily basis or only if some security moves against you?


Tyler Craig said...


The trades I reviewed in today's post were from traders that joined me on the lab. I was merely giving them my feedback. I don't typically play earnings, but if I wanted to place a short vol trade into earnings, IC's aren't a bad way to go.

In choosing strikes, I would go as far OTM as possible, but still bring in an acceptable credit (this is the same mentality I've mentioned on individual credit spreads). I believe they used 180-190 and 130-120 as their strikes.

If the stock gaps into my spread on earnings, I would either exit or delta hedge if I really wanted to stay in and thought the stock was going to retrace. I'll answer the Greek question in a bit...

Tyler Craig said...


The answer on the Greeks is yes & yes. You are correct in asserting that not all Deltas are equal (1 GOOG delta is not the same as 1 SPY delta). Some brokers offer the ability to Beta Weight your deltas. This feature gives you the ability to set all the deltas to a specific underlying (such as the SPY). So that you can determine how many shares/contracts of SPY (or whatever else you set it to) you need to buy to hedge your entire portfolio.

I monitor Greeks on a daily basis (but that doesn't mean every trader has to). I don't base my trade management decisions only on the Greeks, I also take into consideration what the underlying is doing (tech analysis).

Lastly, it depends on what strategies I'm playing. If I'm trading an Iron Condor where I'm trying to stay delta neutral, then monitoring the Greeks is crucial. On the other hand if I'm playing a directional trade, then I'm usually not as concerned about monitoring the Greeks as much.

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