Daily Archives: August 2, 2010

More Money Than God

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I just finished reading More Money Than God, which is a wonderful overview of the history of hedge funds. It's a really entertaining read – right up there with Market Wizards – and I'd describe it as a combination of financial history, amazing market anecdotes, and a bird's eye view of the 2007-2008 financial crisis. I genuinely enjoyed this book, and if this kind of subject matter interests you, I'd encourage you to get it.

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Speaking of books, thanks to those of you who have ordered my book – – it popped up to the #1 spot of Online Trading Books on Amazon yesterday.

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As for the present market – – groan. The bulls have been punching the bears in the face since Independence Day.

I've drawn the various lines in the sand below on the /ES graph. As each of those levels are crossed – – magenta, cyan, and yellow – – the prospects of any decent down-move get weaker and weaker. It's going to take a violation of last week's low, tinted in somber grey, to give the baton back to the bears. Until then, the bears are going to continue to be the losers in equity markets. It wouldn't take much – – just a cross above that 1130 level – – to give the bulls another turbo-boost to higher prices.

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Crash Course in Trading $VXX (by Chicago Sean)

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Let's call this week that just ended:  Week 1 of the "Education of a VXX Speculator" (a polite nod to Victor Niederhoffer).

I took some long positions in $VXX and, frankly, I was less than
enthused with the results. Would I feel differently if my trades were
wildly profitable? Probably. However, I certainly did not like the way
the product moves. It feels as though each positive chart candle has a
dead weight around its waist. Rallies quickly run out of steam with just
the slightest pause or hesitation in the S&P. I realize much of
this is due to the current contango environment. However, I don't see
this environment changing anytime soon. And when it does, it probably
won't last that way for very long.

The inescapable fact that I can't ignore is that $VXX is essentially a
decaying product. It's natural tendency (all other things being equal)
is to drift lower. And if a product just wants to trade lower, then I
should be short it, right? Yes and no.

A Long Walk for a Short Idea

A Brown Line train crosses the north branch of...With
my long $VXX position not putting out the way I was hoping on Friday
morning, frustrated, I decided to go for a walk. I'm one of those geeky
exercise walkers. No, not the speed-walking-hip-swinging kind.
I just like to walk. It's good, safe exercise and it is where I often
do my best thinking. Plus, it was a beautiful morning on the northside
of Chicago today. Not too hot.

Stopping for a sit along the north branch of the Chicago River, an idea
began to take shape. If I'm going to continue trading $VXX I need to
have a strategy that will profit when volatility explodes (as per my trading thesis);
meanwhile, protecting myself against the unstoppable drift lower in
$VXX share price. I can accomplish this by being short $VXX shares to
take advantage of its naturally tendency to melt away, while protecting
myself during the difficult-to-predict explosions in volatility which
eventually come by being long at-the-money calls (2 calls per 100
shares), thus giving my risk profile chart the look of a long straddle (see below).

In
this position with $VXX currently trading at $22.57 and utilizing Aug
23 calls, if $VXX continues to drift lower, my position will be
profitable at expiration anywhere below $20.00 per share. If, however, volatility explodes, this position is profitable anywhere above
$26.00. My max loss is hit if $VXX closes at expiration at the strike
price of $23. The most I can lose is the cost of the options. In this
case, $260 per 100 shares of stock.

However, these previous numbers only hold true if I don't make any
adjustments along the way. I plan to make adjustments and therefore
expect my true risk to be significantly lower.

The plan that is taking root in my head is to short $VXX stock on
significant rallies above $23. When these trades are made, I will short
enough stock to get my position back to delta neutral.
I will hold on to the newly accumulated short shares and ride them all
the way down (hopefully) to my new downside breakeven point which will
have risen thanks to the additional stock sales. When this point is
reached, I will cover my short stock and then will effectively have a
free ride on my remaining open long calls. They could expire worthless,
but my worst case is a scratch on the entire operation. However, if we
were to have another period of rising volatility, then these calls will
retain some value, and it will be pure profit from here.

Meanwhile, once I've "roundtripped" that first operation in August, I'll
then immediately begin again in September options. And then October,
etc. My thinking is, after several months of successful operations,
there is a good chance I'll accumulate a good inventory of "free" call
options that I'll be able to liquidate into any volatility spikes. And
this is where the occasional homerun will be hit. But most importantly,
losses will be minimized during unfavorable markets.

I'd love it if some of you option geeks out there would chime in on this to give your two cents.

A Couple of Changes to Comments

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The new comments system is going to be in a constant state of improvement, but as an “emergency fix”, there are two changes right now:

(a) Comments will only be suppressed with a very substantial number of Dislikes

(b) Any given user will only be able to use Dislike a limited number of times, so use them sparingly.

It’s unfortunate to me that some trolls – – probably those childish morons from IBC – – choose to spoil things for everyone else. I’m going to smoke out who the clown(s) were.

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Next Rising WedgeTarget (by Springheel Jack)

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ES bottomed very close to the 1084.5 ES target that I gave near the high
last Tuesday, poking slightly through the bottom of the rising wedge to
reach it. Over the weekend declining resistance from that high at 1109
has been broken and a move to the top of the rising wedge, near the
level of the June high, now looks likely, though if the strong support
level at 1104.5 ES is rebroken with conviction then it would probably be
best to abandon ES longs today:

100802_ES_Daily_Rising_Wedge

It seems likely that having reached that level we will then see a
significant retracement. EURUSD is close to the last significant declining
resistance level now:

100802_EURUSD_Daily_Declining_Resistance

Oil appears to be forming a bearish gartley pattern. The target for the
current (and last) leg up within that is in the 82 area, which is also
the obvious rising channel target:

100802_Oil_Daily_Bearish_Gartley

Gold broke the lower trendline of the longstanding rising channel last
week, but only slightly, and looking at the channel, the low Gold
reached fits with an alternate lower channel trendline, so I have
altered the rising channel slightly accordingly. Gold still looks an
attractive buy here on the basis of that channel, and it will not be an
attractive short IMO until that channel is broken convincingly:

100802_Gold_Daily_Rising_Channel

UPDATE:

EURUSD and GBPUSD have both hit my targets since writing this as ES hit 1115.50.
This may be where USD starts a serious bounce and if so, it may well be
that equities will pull back with them. If EURUSD does not make an
interim top here then my next target is in the 1.335 area.

Completing A Wave?

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It's Brian Johnson again and here's a video on the current state of the markets and what to look for as we move forward. Both the DOW and the SPX appear to be in bull pullbacks but they're not confirmed until we break out of them to the upside. Lots of overhead resistance at the 10600 (DOW) and 1113-1125 (SPX) areas but coming into a new month of trading should give us some great opportunities for those who are patient.