I Come From A Land Down Under

If you haven’t already caught this, there was a nice little exchange on Fast Money last week. Here’s the video for your comedic enjoyment (turn up the volume)

And We’re Off!

Existing Home Sales came in above expectations at 5.24M (5.03M expected) and Bernanke said that the “Economy could grow soon“. The SPX skyrocketed above the 1013 prior highs and is now at 1023. The VIX dropped, temporarily crossing under my bullish line of 24, currently at 24.50 (down 2.31%). My bearish inclinations are dropped and I’m back to temporarily bullish.

Week Market

A little under a year ago, we were bombarded on a daily basis with “record” everything and “I’ve never seen this before” from wizened old traders who used to read smoke signals as ticker tape. Now, we are in the midst of a bounce many have “never seen before”. That leads me to view any indicator with added incredulity, even my own. But this one has stood the test of time. It’s been backtested back to the creation of the S&P500. And the results? A ridiculous amount of money. (I have the stats saved somewhere…maybe I’ll post them later)

What I’m referring to is my bull/bear market indicator. It’s nothing more than the 13 week EMA compared to the 55 week EMA. I originally posted this back in Feb as part of my million dollar contest writeup. If you followed it, you would have gotten rich on the dot-com craze, then gotten out (or even better, gotten short) when the party was over, caught the following recovery, then gotten out (aka shorting more than an oompa loompa) the 2008 financial crisis. Where do we stand now?

Allllllmost…but not there yet.

Yes, maybe following this indicator for the prevalent trend would make you miss out on the sharpest of moves, but in the long run, it has been right more often than wrong.

What do you think, Old Turkey?

 

Ideas of what might be in our future. 70’s crash and monster bounce…

…led to this

 

Or will it be this? 40’s crash with a 51% bounce…

…which led to this

Bull-oney

Them bulls is resilient, I’ll give ‘em that.

So we broke through diagonal resistance, but we’re overbought (as usual) and have yet to breach the prior lower high at SPX 1013. So with tomorrow being options expiration day, Bernanke speaking at 7am PST, and existing home sales at the same time, there’s a lot of uncertainty at the moment. Depending on what the bearded one says about our recovery, it could send the markets in either direction.

The point is, be ready for anything tomorrow, and be especially on guard a half hour after the market open. Here’s the 2hr chart of the SPX before I crash for the night

 

Also keep an eye on the VIX. If it pushes above 28.50 – bear mode; under 24 – bull mode.

Stereotypes

So I just got back from the gym I normally work out at, which the clientele happens to be predominately Asian. I drove home in my Honda, and then cooked up some rice and edamame for dinner, just because that’s what sounded good to eat. Then I finished it off with some tasty mandarin oranges for dessert. Who says that stereotypes aren’t real?? Oh wait…I’m white. Never mind…

Lower High

So today we’re bouncing higher but I recently warned of the resurgence of the bears? What gives, Celticaces?? “Can’t see the forest for the trees”.

As I’ve mentioned before, the market rarely (if ever) moves in a straight line. It jumps and meanders and zigzags along, leaving us to marvel at its randomness and watch the movie Pi to uncover its secrets. One of the fundamental tenets of Dow Theory is (and this is about as simple as it gets) higher highs, higher lows in an uptrend and lower highs, lower lows in a downtrend. Since the high on 8/7, we have since made a higher high and two lower lows. Today we are building up to what I believe will be the 2^nd lower high.

Watch the area of 1005 to 1010 on the SPX for a bounce or breakthrough. If we bounce down, I’m getting heavily bearish, but on a breakthrough, I’ll admit my error and flip the script. No trader is 100% accurate, and the most successful traders are those that can quickly throw aside their personal biases when they are proved wrong instead of stubbornly holding on to a dead theory to convince the world that we are all-knowing all-powerful, and most importantly, right. Write that down, xTrends.

Here’s a quick chart of the 2 hour SPX that I’m watching and some other good examples of “lower highs”

Focus!

Most trading blogs out there seem to have their little niche in the trading world. Dr. Brett over at TraderFeed focuses on trading psychology and quantitative analysis, Tim Knight over at Slope of Hope and mole over at Evil Speculator focus on technical analysis and trading ideas, the e-mini addict over at eminiaddict.com focuses on…well, trading the e-minis. You get the point. Though they occasionally cross genres (and in evil speculator’s case, cross dress), they typically stick to their main area(s) of focus and don’t stray too far.

So, in order to make the most of my ridiculously limited schedule, I’m paring down my focus from “everything in the world of finance” to the following major topics

• General (like this one)
• Market commentary
• Technical Analysis
• Futures trading
• Options trading – with a focus on theta positive income strategies
• System trading & backtesting
• Indicator programming
• Things that are freakin hilarious

My twitter account will be used for live commentary and trades

That’s it for now. But on a quick “Market commentary” note, today’s drop was a significant sign of weakness. The bears are done hibernating…be ready

This video came up on a random google search for “Focus”. It would definitely fall into the freakin hilarious category

High Frequency Trading Video

Here’s a great video I caught about high-frequency trading. Hat tip to Tyler Durden (who someone just told me I look like…the guy from Fight club, not the blogger) over at Zero Hedge

And on a side note, I’m not going to spend much time explaining how busy I am and why I can’t post all the time. It makes for some lame reading, and well, there’s not much I can do about it. I’ll just drop in a nice little post when time allows and hopefully the internet world will get something good out of it. Ok I’m out. Enjoy the rest of the weekend!

High-frequency trading from Marketplace on Vimeo.

Post Office Box

After a long hiatus for the regular reasons (too damn busy!), I saw a video that was so immensely compelling that I had to post it right away. It’s tough to tell what network this is from, but if I had to guess, I’d say CNBC.

Opposite Day

Remember opposite day when we were kids? When everything you meant the exact opposite of everything you said? We would say with a twinkle in our eyes, “you’re the smartest person I’ve ever met.” Only to follow with an overly enthusiastic, “too bad it’s opposite day!” and then giggle uncontrollably as we ran away. That pretty much sums up what the market decided to do today. Stocks have been going up? Today they were down. Oil up? Not today! Gold rising. Negative. Dollar falling? “Too bad it’s opposite day!” Tee hee!!

Now, everyone knows that markets never move in a straight line. They breathe in, and out. Higher highs, higher lows. Or the reverse, lower highs, lower lows. From my perspective, this was a reasonably predictable “higher low” day. Towards the close, we had a nice little bounce which happened to coincide with the 200 day MA on the S&P 500 (which is now support). The overall trend is still up, and no major trendlines were broken with today’s pullback. Now, we fall below 910 on the SPX and I’ll start to reevaluate things. But for now, my bias is to the upside

Fortunately, I had picked up some puts on the breakdown in PCS the other day, which helped offset the losses on my long positions.

Here is a cool feature over at finviz.com. It’s a map of all the ETFs and how they performed on the day.

 

In other news, I went to the trader’s expo up in Pasadena today. Some of the presentations (ok…practically all of the presentations) were dull / about things I already knew / story time for the presenters. There was, however, one glaring exception. Lawrence McMillan, famed options guru and author of Options as a Strategic Investment (which I just finished reading by the way) gave a phenomenal presentation about how to trade $VIX futures and options. Now these are vehicles that even the pros on Wall Street shy away from because they are very complex and don’t behave like normal futures or options do. $VIX options are basically a derivative of a derivative of a derivative. Obviously that leads to some confusion and complexity. And the thing that makes McMillan the master that he is, he saw this fear and inefficiency in this new product as an opportunity to make money. It’s like if you were to find a perfect waterfall in the woods. When it is just you and a few people enjoying it, it’s the best experience in the world. But then after everyone else discovers it, you got 3 year olds peeing in the water, fat rednecks spilling their beers, and prepubescent teens making out behind the falls, all the magic is gone.

But forget about my abstract analogies. Here are some pictures from the day and my notes from McMillan’s presentation for your reading pleasure. Or at least whatever you can get out of them without being there for the presentation.

Lawrence McMillan – Options Guru

John Person – Technical Analyst and futures trader

Tom Sosonoff – Founder of ThinkOrSwim

 

 

How to Use Volatility in Your Trading with Larry McMillan

• Using volatility derivatives
  
• Implied volatility
  
  • A guess at volatility
    
  • The major unknown in optinos prices
    
• 1973 first options
  
• 1983 index options
  
• 1993 OEX index invented – volatility index
  
  • Created by prof whaley, duke university
    
  • Now uses first 2 months, all options in those first 2 months (a strip) – $VIX
    
  • OEX renamed VXO
    
• Volatility as a contrary indicator
  
  • Implied volatility tries to predict the stocks volatility
    
  • At extremes, they are usually wrong
    
• Spike in VIX and reversal is buy signal for the market
  
• Use a bull spread to lower price of options
  
• Follow the trend of the vix
  
  • More important than the spikes
    
  • Inverse to market
    
• Seasonality of volatility
  
  • Avg from jan to march
    
  • Drops from april to june
    
  • Spikes hard from july to october (peak)
    
  • Drops sharply from oct to dec
    
  • 2008 followed the model
    
  • 2006 was the opposite
    
    • He thinks the market was rigged during that year
      
• So, how do we trade volatility?
  
  • 2004 – futures allowed on $VIX
    
  • 2006 – options allowed on $VIX
    
    • New options on $VXN & $RVX
      
• VIX Futures: Details
  
  • One point move in VIX is $1000 move
    
  • Margin: $8800 initial ($7000 maintenance)
    
  • Settlement day: 30 days prior to next option expiration
    
    • Always a Wednesday
      
  • Example
    
    • $SPX July options expire 7/17/09 (3rd Friday)
      
    • 30 days back: 17 In July + 14 in June
      
    • June has 30 days, so 13 days back is Wed 6/17/09
      
  • Expire quarterly, march, june, sept, dec
    
• Spikes in VIX and the volatility futures don’t spike with it is another buy signal
  
• The problem with $VIX futures
  
  • Both speculateors and hedgers have sometimes been disappointed
    
  • “Term structure”
    
    • Near term wide scatter of volatility
      
    • Long term, range is more narrow
      
  • Crashes
    
    • $VIX jumps up
      
    • Near term futures jumps, but not as much
      
    • Long term futures move much less than both $VIX and near term
      
• $VIX Futures predict broad market price movements
  
• Look at VIX futures in comparison to $VIX
  
  • Futures trading at “premium” to $VIX, strong bearish signal
    
  • Futures trading at “discount” to $VIX, strong bullish signal
    
• Average $VIX is typically around 15
  
  • Above 30 is typically bear market
    
• Options on Volatility $VIX
  
  • Options on $VIX index (not on futures)
    
  • Launch date 2/24/06
    
  • Section 1256
    
  • Just like options on $SOX
    
  • Expiration date: 30 days prior to next month’s $SPX option expiration
    
  • Prior to expiration, pricing is based on futures
    
• $VIX call options 10/10/08
  
  • Oct > Nov > Dec
    
  • What???
    
  • If you look at the futures prices for each exercise month, then it makes sense
    
  • Need to understand all these things to trade volatility properly
    
• Some $VIX optinos strategies behave differently
  
  • Calendar spreads no longer have limited risk
    
  • Since you are trading options on 2 totally different underlyings, loss can be much more than the difference between the two options
    
  • Now, separate months should be considered totally separate trades. Same month = same underlying
    
• A hedged strategy when $VIX futures are “out of line”
  

$VIX 23.60

May VX futs 26.10

• Could try to short #SPX because of the premium on the futures
  
• Or could hedge: short $SPX, short $VIX
  
  • Buy SPX puts
    
  • Buy VIX puts
    

• VIX/SPY spread concept
  
  • VIX and SPY move in opposite directions
    
  • So buying calls or puts on both is a hedge
    
  • Traditionally a discount or premium of +/- 2.0 points is a good time to put on this trade
    
  • 2 ways to profit
    
    • Convergence
      
    • Either are wildly volatile
      
• How many options to buy?
  
  • (V1 x P1) / (V2 x P2)
    
  • V = underlying historic volatility
    
  • P = underlying price
    
• When to exit or adjust
  
  • If convergence occurs, then exit
    
  • If prifits arrive from movement, then recenter
    
    • Roll profitable side up
      
    • Loss side down
      
• What can go wrong
  
  • Divergence
    
  • VIX decline can hurt SPY calls in a rally
    
  • Failure to adjust can be costly
    
• Other VIX option strategies
  
  • Calendar spread with limited risk
    
  • Instead of buy nov 40 call, sell oct 40 call
    
    • Buy nov 35 call, buy oct 45 put
      
  • Max loss is now limited to what is paid for options
    
  • Use long options on both sides instead of short options
    
  • This is because of the “term structure” discussed earlier (short term more volatile than long term
    
• New product $VXX
  
  • $VIX short term futures index
    
  • Blended average of front 2 $VIX futures months
    
• $VXZ
  
  • Blended of months 4-7
    
• Using VIX option volume as an indicator
  
  • Put/call ratio on $VIX
    
• Variance futures
  
  • Trade the actual volatility of $SPX
    
  • Variance = volatility squared
    
  • $50 per point
    
  • Settles 3rd Friday
    
  • Margin varies with price fo futures
    
  • $RUG = realized volatility
    
• VIX hedging is cheap
  
  • A well known study using 90% SPX and 10% VIX, it outperforms the SPX in up/down/sideways markets
    
  • Some people recommend 20%
    
• Micro: stock option collar
  
  • Buy OOM put and sell OOM call
    
  • Zero cost collar
    
  • Limited risk and limited reward
    
  • Best to use longest term options possible
    
  • Can minimize downside risk and still have upside potential
    
  • If you want to do this strategy, go long term
    
• VIX collar
  
  • Buy calls/sell puts
    
• New – volatility on oil $OVX
  
  • On gold $GVZ
    
  • Euro FX $EVZ
    
  • Next: VIX on rates
    
• Still a lot of inefficiencies (i.e. profit potential)
  
• Option trading philosophy
  
  • Use a model
    
  • Trades all markets
    
  • Use follow up strategies
    
  • Only trade in accordance with your personal philosophy