As a follow up to my post about last Friday’s closing of my QQQ puts – – in green is the buy point, in red is the sell point, and the face indicates how I felt this morning when my $2,500 profit was “coulda been” $19,000………..
Anyway, I’m not going to chase my QQQ screw-up, so I’ve started legging into an IWM put position with a pledge to myself not to royally fuck it up this time (that’s fancy technical analysis talk, in case you’re confused).
I mentioned a couple of times earlier this week that I had done something which I hadn’t done for years – – bought an options position. Specifically, I bought a big slug of $143 QQQ puts, expiring July 21st. Well, I just sold ’em, and it worked out nicely (I did this screen grab a little earlier; I actually got out at $3.00, higher than shown here).
I know most of you are fancy-pants options traders that do sophisticated positions, but I’m just a dumb old bear.
Oh, and one other tip – – now that I’m out, I can assure you that the NASDAQ is going to completely crash sometime between now and July 21st. God has a riotous sense of humor.
Before we discuss the basic of options parameters for trading, we need to understand the concept of volatility. This is not simply an observational number, thought it can be used as such. In general stock investors want to avoid volatility. They want to minimize the standard deviation of their investments, as large drawdowns can be petrifying to some. This is a reaction that encompasses more than trader psychology; when the broker taps you on the shoulder with his margin call, it really is game over for you. This can be unfair, but those with the gold set the rules.
This is a more difficult topic, but one which demands attention from all investors, not just option traders. Much ink has been spilled on the topic of portfolio diversification, wherein it is said that those who trade in multiple different underlyings, can be said to “spread off their risk”. In other words, rather than having all of your eggs in one basket, say, by just investing in Google, you try to invest in multiple symbols at the same time, so that the risk of one symbol is spread off by investing many symbols. But does this really work?
Part of Tim’s shorting strategy relies on investing on many underlyings at once (sometimes), and I assume investing small amounts like $1-2000 at a time so that the gap losses, when they happen, will be small (intraday losses are minimal because of tight stops – when they are employed). However, as we shall see, this is partially a false sense of security.
We see in one study that up to an n of 30, increasing the number of instruments in one’s portfolio does indeed reduce volatility and risk. Standard deviation (risk) initially might be 49% with one instrument, but only 20.9% (a reduction of about 60% of the risk) with up to 30 instruments. However, beyond 30 there are limited returns.
So as I’m sure everyone noticed, price sped up a bit this past week. It might have taken some of us (including myself) by surprise, but in the bigger picture, ever since Nov 9th kicked this rally into full gear, price has been fairly relentless ever since. Just take a look at the 100MA deviation envelopes.
The Pareto principle, and the true distribution of the market
The Pareto principle is one of the most important empirical properties in nature.