OK, I get weekly updates on this particular strategy.  If you're not familiar with the idea, the dogs are the "worst" stocks within the Dow Jones Industrial average on any given year.  I postulated that the reason why the dogs "outperform" is because you're simply taking on more risk in the way of volatility. The idea here is that the DoD outperform the greater DJIA each year, but I assert that this is because the components selected are highly volatile. I proved it on several occasions within the last year when the market was tanking. I further asserted that the dogs would significantly OUTPERFORM when the market recovered and subsequently rallied up. Well, I wasn't entirely right this year. The larger DJIA is up 18.4% as of this writing. The dogs are up 10.9%.

So what does this mean? Well, my lesson learned here is that outperformance is interesting when put in the context of timeframe. I know our dogs haven't outperformed for the year, but I bet they've been up significantly during the upward swing. And as things have recovered, the dogs have probably outpaced the market as a whole, but this doesn't make up for how much they've fallen over the bad times. So when we take the dogs timeframe over the "bad" times and the "good" times we see that they're still lagging overall.

So what does this mean? To me, it means that limiting volatility is just as important as limiting losses. Each bear has a lesson to teach.

This just in from the holy shit department.

http://www.etfexpress.com/2009/11/17/kelly-capital-launches-100x-leveraged-etfs

100x leverage is insanity. This product is just looking to give ETFs a horrible name.  Now you're going to hear the news about Johnny Investor going broke because he used ETFs as a vehicle.  Naturally, the particulars of the ETF will be left out giving the whole ETF industry a bad name.  I suppose we all know that ETFs aren't going away and people who take the time to understand the products and avoid crap like this will come out ahead.

UPDATE: This appears to be a hoax.  http://www.jasonkelly.com/2009/11/first-100x-leveraged-etfs.html

Funny.

I've been selling puts and calls around GE for awhile now. I got assigned sometime last year on some puts and have spent a lot of time sitting. My cost basis (not including premiums collected along the way) is $17.50. I wasn't real interested in taking a loss, so I've been waiting for the $18 strike to show a little premium. Ideally I wanted about 1% this month, but I took a little less and sold calls for $12 at the DEC 18 strike. I'm not going to be terribly disappointed if GE is called away, the premium + profit wasn't horrible all things considered, and I may start writing puts against it for JAN.

My long term MSFT double calendar is getting a bit interesting.  The short NOV 30 call is within range. The position is showing a pretty good profit, but I'm going to try and stick to the plan. If 30 is breached after expiration, I may hold the long call and sell another strike up to make a diagonal. We'll see, but I really didn't expect any of the options to be in the money at this point. If MSFT stays below $30 this Friday, all short options will have expired worthless, which means another good month.

So we bring in supposed "experts".  People who trade the markets every day, Nobel Laureates, economics professors, billionaires and more. These people come on the air as if what they say is any more or less valid than what you say or think with regard to the future. I'm not sure why these segments continue to air or the articles continue to be written. This is noise and nothing else. No one knows the next tick let alone what's going to happen next week, month, year. I've griped of it before and I'll probably bitch and complain about it again, this is nonsense and should be ignored. Reputable (if there is such a thing) outlets are the means of distribution. Your CNBC, Bloomberg, and Marketwatch blow this crap out as if it adds value. If you ever base any buy/sell decision on this, you're a fool. No exceptions.

OK, there, now I've taken my medication and will get back to my nightly reading and research.

I'm guilty. Yesterday while things were falling, I attempted to lower my strikes on IWM from 49/51 to 48/50 and get the same credit. I was close, but not close enough to get filled. I knew what I was doing, but tried to "outsmart" my trading anyway. This is usually a recipe for failure. That failure usually comes in the form of missed opportunities. This time I may be lucky, the market looks like it's going to head lower this morning and I may get a fill after all, but this was a stupid risk. It is simply psychology that must be dealt with. It is no different than a drunk refusing a drink and a fat guy turning down cake. It will forever be a challenge and there is no "cure".

The SPY trade is still on the table as well. I will evaluate those strikes after I right the wrong on IWM.

So far it's almost been like clockwork with this new trading system.  I mentioned that it averaged about a trade a month, and so far it's done that almost on the nose. Since this is a mean reversion system, the recent downdraft has flagged buys across the board. The averaging part of that statement should be paid attention to. Sometimes when the market is dive bombing, the system will flag a couple of days in a row as opportunities. Then in straight up mode, none for months. So I would consider this luck, so far. It could flag a trade or two this month.

So back to the trade at hand, SPY, QQQQ, IWM and DIA are all flagged. I reviewed all four and the credits on SPY and IWM were the best even though they weren't necessarily the most volatile. In fact, I would say QQQQ is probably the most volatile of the bunch but it yielded the worst credit. The second thing to consider is that the SPY NOV trade is still on, so do I want to expose myself to additional SPY risk? Well, IWM and SPY are pretty tightly correlated and the SPY has a little less volatility, so this becomes a pretty tough call. My plan is to take the IWM trade today and maybe the SPY trade tomorrow if we continue lower. Here's how they look.

 First IWM.

iwm-vertical-spread-dec-2009.png (43.70 kb)

And now SPY

spy-vertical-spread-dec-2009.png (45.00 kb)

Hopefully you're getting used to seeing the P/L structure of verticals. Each of these yield about the same credit and the distance between strikes is $2.00, which puts about $1.67 at risk.

Now the next trick is getting filled. The futures are pointing up slightly this morning, so a gap up may put these credits out of reach, but hopefully the market will rattle around enough today to fill. Things are changing rapdily as volatility has come back.

Will keep you up to date on the progress.

DISCLAIMER: This is not a recommendation to anyone to buy or sell.  I'm not a professional and I don't have much sense, so following me is hazardous to your finanical health.  The point of the post is to share ideas and hopefully get some feedback so that we can all improve our understanding of the subject.

A regional idea.  Georgia was under a "severe" drought over the last 2 or 3 years.  Yes, I put the severe in quotes because I wasn't a believer, but that's another debate for another day.  What was serious is that a mini-war amongst states began.  Alabama and Florida started bitching and complaining about Georgia not letting enough water down the Chattahoochee River which is their fresh water source.  This went to court and became front page news for many months until the ruling came down against Georgia.  We could not withhold water from the downstream states.

Fast forward to the last few months where we've seen floods and we're close to setting an all time rainfall record for the month of October.  Now we're talking "negotiations" and other civil means for dealing with neighboring states and water.  This was less than civil just a few months ago.

Rainfall averages are just that, averages.  Like the market, from time to time, they will deviate, sometimes wildly, but eventually the snapback will happen.  When the news here was that Atlanta could possibly be a desert, I wanted to be long rain.  If that were possible, I would be talking of my windfall at this point.

However, what if the trend changed permanently.  What if fresh water or water supplies were severely crippled or cut off in a region.  How could/would that be remedied? What sort of companies could provide relief in a serious situation? I know the water angle isn't new, but the water angle in the US is.  This has my eye on Claymore's CGW ETF.  Unfortunately, this is "global" in nature, but I suspect that a US water ETF is an idea for the future.  The next time there is a regional water crisis and the discussion turns to ghost towns in a major region of the United States, a good speculative play might be water.  High risk / high reward, for sure.

So we're back to arguing politics in the Atlanta area, not whether or not we're going to have to abandon our homes in search of H2O.  Forecast in Atlanta, rain showers, maybe some thunder, just in time for the weekend.

I have not initiated any new trades from the speculative account, but the recent down turn has allowed me to close the short XLF calls out at 0.09 (original credit of 0.31).  Also, I wanted to update a wildly speculative position I put on with MSFT.  I called it Long Term Double Calendars.  In a nutshell, I hold way out of the money long puts on the downside and long calls on the upside.  MSFT was about $25 when I opened, so $20 puts and $30 calls were my strike choices.  I bought APR options and sold NOV options at the same strikes.

MSFT earnings last week apparently made the street quite happy and MSFT shot up past $28 (briefly touching $29).  The NOV short put went way out of the money and I closed it for 0.01.  The APR puts are big losers, but they've lost much less than what the long calls have gained.  I did not expect MSFT to shoot up this fast and my plan at this point is to close the call side if MSFT stays around 28-29 by NOV expiration.  I may or may not keep the long put, depending on IV.  It's worth so little, I may just keep it as free insurance.

As I mentioned, the recent down draft hasn't allowed me to write any calls yet, but I am looking to write some puts.  There are some new faces I've had my eye on and they are indexes that I might like to hold, so whether I'm going to do spreads or run naked has not yet been determined.

Stay tuned.

I have a trading system that I retired right about the time the downturn started.  It was in the final phases of live testing, but I decided that I didn't like the actual results enough to continue committing capital. It also had a lot to do with the fact that another trading system I was testing was showing better results. It operated against individual Dow components, so before too long, I found myself holding 1/3 of the Dow.  Then whoosh, the bottom fell out.  The trading plan didn't have a stop loss, only a bar time out.  So I decided to "outsmart" the trading system and hold on to these guys because I was certain the market would bounce back.  Well, it has bounced back (although I didn't expect to be sitting on these positions for over a year).  Like most, I'm a little nervous about being excessively overweight in equities, so this has provided me with a great opportunity to unload some of these speculative equity positions from market cycles past.

So two things are accomplished here, one, I get to fix mistakes from the past and second, I get to lower my equity exposure.  Another win/win.

October expiration has passed, so it's time to analyze closed positions and think about new ones for November and December strikes.

Position Recap

The GE calls @ 18 expired worthless.  So I keep 100% of the 0.15 premium.  Not exactly juicy, but not too bad considering the stock hasn't done much but bounce around since I sold the calls in the middle of September.

The IWM trade flagged on September 2nd and taken on September 4th, brought in an 0.18 credit.  These options also expired worthless allowing me to keep the full credit.

November's SPY 92/94 vertical spread is well out of the money.  In fact, I tried to close this on Friday for 0.04, but didn't get filled.  With the original 0.31 credit, that would've been a fast move.  Usually things have to get way out of the money (since it's a spread) to be closed this quickly.  Well, the SPY has done so, but not enough for the market makers to give me 0.04 to close the position.  If there is another decent move up, I should be able to close it out, which would be nice.

The DEC XLF calls are showing a profit, but I'm getting less comfortable with these as time passes.  These calls were essentially a way for me to lock in some gains on my underlying XLF shares.  I felt pretty strongly that the financials were in for a set back.  Due to earnings, volatility shot up on the XLF and for a short time, the position was at break even.  The original credit was 0.41 when the XLF was around 15.35.  The XLF is now around 15.15 with the calls trading around 0.18.  I'm going to look to close this out around 0.10 and see if I can't catch a wave up and write some calls at 17 or 18 for December.  Stay tuned on that.

Looking Forward

Writing calls against GE is my top priority.  I don't like the credit offered for November at this point, I think the numbers weren't as bad as the market thought and shows some stability in the company. Maybe it won't happen this year, but I think people will slowly begin to buy up GE again. Hopefully it's next week and I can write a call or two.

The trading system that I write the verticals with isn't on a calendar, it's a mean reversion system, so it could flag trades at any time, but gets triggered on pullbacks. I'm comfortable enough with the wider strikes as I did with the 92/94 put credit spread on SPY. I'll stick with a 2 strike distance and see how that goes for awhile.  So far the trading system is 3 for 3.  Bill trying outguess the trading system is 0 for 1.  Imagine that.

And I'm still paying for the sin of writing puts against C back in 2007. If you weren't with us, my puts were exercised @ 22.50. That's not a typo. So with credits since, my cost basis is still somewhere around $21 which is obviously nowhere near the $4.60 C trades at today. I never bought any more C because I had little faith in the price and my original take was that Citi was big enough to absorb the losses without too much of a hit.  I was wrong and have been paying ever since. I decided that since I was wrong that I would not average a loser and held true to that. Now I feel that Citi is stabilizing in price and it's time for me to get some premium. I'll be looking at the $4 puts on another move down or a spike in implied volatility. The worst case is that I'm assigned at $4 which will lower my cost basis for C substantially and possibly get me out of this hole. It will be a happy day seeing C out of my trading account.

I spent a portion of the weekend getting caught up on older issues of Futures & Options Trader magazine.  If you're not a subscriber, you should be (it's free).  It can be downloaded from http://www.futuresandoptionstrader.com/.  Current issues are free, back issues are not.  I'm going to be referring to the May 2009 issue, so if you don't have it, I'll summarize the relevant bits.

Each month, the magazine has a feature entitled Options Trading System Lab.  The major players for the software OptionVue are the main contributors.  The feature takes a relatively well known strategy and runs a back test on historical data using the OptionVue software.  The results are usually disappointing. I don't mean that in a disparaging way.  If you've done backtesting for any length of time, you'll know that most of the ideas put forth are real stinkers.  In fact, I'd say over the course of many years, even before my days of working on RightEdge, I'd tested hundreds and now thousands of trading systems.  To this day, I use about 3 trading systems out of thousands tested.  There are some systems that have shown signs of promise in the lab and some that just plain stink, but I took an eye to May's Iron Condor results.

Strategy Summary

If you're not familiar with iron condor strategy, it's really just a fancy name for two vertical spreads put on in tandem.  It's basically an out of the money bear call spread and out of the money bull put spread. Both are credit spreads.  The P/L structure for an iron condor is below. 

spy-iron-condor.png (47.83 kb)

Most iron condor traders are looking to put the short strikes around one standard deviation.  In the P/L structure above, you can see that one standard deviation is marked by the vertical red dashes.  As a result, I put the short puts at 99.00 and the short calls at 115.00.  The long options can be placed anywhere you feel comfortable.

Risk

Now here's the catch on iron condors, my maximum reward is 0.44 less commissions.  My maximum risk is 4.00 - the credit.  This puts the risk/reward ratio at around 1 to 10.  That's not 10 to 1, that's 1 to 10.  This means that 1 losing month can wipe out 10 months of winners.  Couple this with the fact that one standard deviation means that it's probable the price has a 68% chance of staying within your shorts on either side, it sounds like a mathematical loser all the way around.  You need 90% winners in a case where statistically the price will only stay within your boundaries 70% of the time.

Backtesting the Strategy

Normally, this idea would be discarded especially with the pitiful risk/reward ratio.  Admittedly, it's not one of my favorite strategies, but let's see the results anyhow.

The test period started in January 2001 and ran through April 2009.  The starting capital is $10,000 and each month an iron condor was opened one standard deviation out.  They used 5 call and 5 put spreads. The system is always in the market and cycles the position (i.e. closes the current month and opens a new one for the next month) on the second Friday of each month.  The system had a 75% win rate with an average win of $763 and an average loss of $1,314.  What's noteworthy is the annualized return of 28.7%.  This would give you a return of 236% for the time period tested.  The S&P 500 had a negative return over the same time period.  Wow.

Discrepancies of Note

OptionVue constructs positions based on historical data.  I find the further out of the money the spread, the harder it is to get filled.  At best, the bid/ask spread on these positions is pretty lousy.  This probably wasn't accounted for.  Even dividing the bid/ask spread in half usually won't get you filled.  Second, the authors list the risk/reward ratio of 1 to 4.  I think that's generous.  I've seen in real life the ratio as poor as 1 to 12.

My Take

Given the discrepancies noted, if you were to consider putting on ICs, I strongly recommend using 1 contract positions and also putting them on the SPY ETF and not the big S&P 500 futures contracts (which are leveraged instruments).  Of course, never put on anything until you know what you're doing. Even in light of this impressive test, I'm still not very interested in iron condors because of the horrible risk reward.  I do, as most readers know, put on bull put verticals on the indexes when my trading systems flag them as a buy.  This has turned out to be successful so far in my first phases of live testing.

Now that I've had a few minutes to digest a bit more about last week's trading sessions, I've made what I think are some interesting observations.  First, the VIX had a hell of a down week (probably releasing some earnings anxiety) and second, long term treasuries were socked pretty hard on Thursday and Friday to end the week down over 3%.  Meanwhile, the overall market continued its steady climb upwards with the S&P 500 up over 4%.

Why this struck me is because it looks "normal".  The market is up, the VIX is down and bonds are down.  Gold went in various directions (mostly up because of the worldwide speculation of de-dollaring) but seemingly uncorrelated to both stocks or bonds.  This is a pretty normal market 1 year after everyone in every asset class lost their minds.

I've had the feeling that all asset classes that I hold were short term overvalued.  I felt the inverse one year ago and I bought with reckless abandon.  I've been holding cash on the sidelines waiting for something to crack and the first thing was bonds.  I snapped up some TLT this week and I have my eye on some TIPs probably when they crack below $101.00 and some more at $100 and so on.  If the inverse movements between bonds and equities continue, I may even sell some stock and beef up on bonds.  This will hopefully hedge against the snap back that may or may not occur.

The market is feeling a little "text book", which has me nervous.  [grin]

I still have some GE short calls open for OCT.  These are well in the money and are on the verge of being closed.  What's going to push the issue is when GE reports earnings before the bell on Friday, which happens to coincide with the expiration date of the options.  However, there's an entire session to be had.  Given the current tone of earnings season, they'll probably exceed the low bar and move higher.  My ideal case is to buy back the calls sometime before Thursday's close next week, wait for the earnings pop for a boost higher and sell some NOV calls either at a higher strike than last month or at the same strike but for a juicier premium.  Will it play out that way?  Probably not, but that's the way I see it at this point.

If I don't talk to you before, have a great weekend.

I like to watch old stalwarts with high volume in boring ranges. This is why I pick symbols like GE, MSFT, etc.  Another one that's been on my radar for a couple of years is WMT.  Actually, it comes and goes on the radar screen because it is extra boring.  A recent article at the Beating Buffet Blog piqued my interest again.  Had I been keeping on an eye on WMT like I should have, I would've already made this play.  The position is a simple short put.  The P/L of a short put is shown below in case you forgot.  It is limited gain with stock risk.  Stock risk means that I am insuring the buyer of the puts from the strike down to $0. 

wmt-naked-put.png (42.59 kb)

When do I write puts as opposed to a vertical spread?  I invite you to read my article entitled Having Problems Buying?  Consider Selling Puts.  In a nutshell, I only write puts against assets that I don't mind holding.  Writing puts should feel like a win/win situation because if the asset goes up, you keep the premium (score!) and if the asset falls and you get assigned, you own the asset at the lower price + you keep the premium to lower your cost basis even more.  Win!  So bottom line, if you don't want to own it, don't sell puts.

Looking at the stock price, I'd like to write November 45's for a 0.30 credit.  They're currently trading around 0.28, so that's not a big move to get filled.  We'll see what tomorrow's session has in store.

Usual disclaimer: This is not a recommendation to anyone to buy or sell.  I'm not a professional and I don't have much sense, so following me is hazardous to your finanical health.  The point of the post is to share ideas and hopefully get some feedback so that we can all improve our understanding of the subject.

I started something new a couple of weeks back that I thought I'd share.  My idea here is that folks think the market is bound to move in the next several months.  Will the bulls continue to trounce the bears or will the bears finally have another day in the sun and the pullback "everyone" has been waiting for will finally become reality?  Who knows, or at least, I don't know, and I don't really care a ton.  To try and capitalize on a big move, I picked a stock that I watch frequently that seems to be in the middle of its long term range.  That stock is MSFT.  Between 20 and 30 for the longer term, I think feel it can hit either one of those targets in the next few months.  So how to capitalize on that move?  Well, buying long dated options is expensive and time decay (theta) will slowly chew away at your profits.  Also, the further out of of the money, typically means higher premium because of volatility skew.  As you may have guessed from the titled, I've opted for out of the money calendar spreads.  My put strikes are at 20 and my call strikes are at 30.  I have purchased April 2010 calls and puts at the strikes mentioned.  I have helped "finance" this purchase by selling calls and puts at those strikes for NOV.  I received on average an $8 credit and on average paid about $45 per spread.  My thought here is to continue getting on average $8-10 in credits each month which, if MSFT goes nowhere, means I break even.  If MSFT makes a move (and hopefully doesn't shatter through the strikes), the profit will exceed the other options loss and I will close at a profit.

This is going to be tricky for three reasons.  First, imagine that MSFT makes a move up to $27, not a big enough move to take a profit, yet, I'm going to lose a lot of credit on the put side.  Will that be made up on the call side?  I'm not sure.  Second, volatility risk.  Calendars are long vega, if the volatility drops, my credit shrinks and I'm once again, not getting enough to finance this trade.  Third, a massive run up that puts either side in the money.  The short option has more gamma than the long options and may chew up profits fast should there be a fast run into the money.

This Is Only Test

I'm testing with real money, but only using a single contract.  The reasons above leave me enough doubt not to put anything significant into this. I firmly believe that I'd have to try this several times with single contracts to feel any sort of comfort throwing real money at this idea.  Even then, that doesn't mean that it's going to work every time or ever again.

If you've tried something similar, I'd appreciate sharing the pitfalls and nuances that go along with this.