Slope of Hope Blog Posts

Slope initially began as a blog, so this is where most of the website’s content resides. Here we have tens of thousands of posts dating back over a decade. These are listed in reverse chronological order. Click on any category icon below to see posts tagged with that particular subject, or click on a word in the category cloud on the right side of the screen for more specific choices.

Another Speculative Options Bet

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In previous posts, I've mentioned a few guidelines I've been keeping in mind when making speculative options buys (the first three of which are mentioned in Tim's book, Chart Your Way to Profits):

  • + Start small (since options often expire worthless).
  • + Avoid out-of-the-money-options (instead, try to get ones with some intrinsic value).
  • + Avoid nearby expiration dates (to avoid theta burn and give positions more time to work out).
  • + Buy options at a discount to model estimates of their fair market value.

I've been making bullish and bearish bets to increase the chances that some bets will make money whatever direction the market takes over the next several months. I've also been trying to take advantage of relatively low volatility when buying options.

On Tuesday night I placed limit orders for a few small bullish and bearish bets. I got a fill on one of the bearish bets Wednesday, puts on BCRX. More on that below. First, a recap of my M.O. here, and a reminder about the difference between speculative options buying and hedging.

Looking for Speculative Options Bets

For the bearish bets, I’ve been starting by scanning for relatively lightly-traded (average daily volume over the last month of < 250k shares), optionable stocks that look weak technically and fundamentally. The idea behind looking for relatively thinly-traded stocks is that the options traded on them are more likely to be thinly-traded, which increases the chances that they might be inefficiently priced. Then I look for in-the-money puts on them several months out, and compare the current bid-ask prices for them with the estimated fair market value of them via the Black-Scholes model.

If I find one where the most recent bid is significantly below the Black-Scholes fair market value estimate, I’ll place a small limit order for it, with the limit price set at a ~20%+ discount to the fair market value estimate.

For the bullish bets, I’ve been doing the reverse: Scanning for stocks that look strong technically and fundamentally, and looking for in-the-money calls priced below the Black-Scholes estimates of their fair market value.

Prior to today, I used this M.O. to purchase puts on JOE, NAK, MOTR, TNDM; and calls on HMC, HIT, COHR, SUP, and ASMI. I noted these purchases (and sales, in the case of HMC, HIT, and MOTR) at the time on the Short Screen message boards.

Hedging vs. Betting

If I were hedging, I would enter the symbol of the stock or ETF I was looking to hedge in the “symbol” field of Portfolio Armor (available as a web app and as an Apple iOS app), enter the number of shares in the “shares owned” field, and then enter the maximum decline I was willing to risk in the “threshold” field. Then Portfolio Armor would use its algorithm to scan for the optimal puts to give me that level of protection at the lowest cost.

On rare occasions (I’ve seen it happen once, so far) the optimal puts Portfolio Armor presents might be in-the-money; in most cases however they will be out-of-the-money. Since I’m making a directional bet in the cases below, though, and not hedging, I bought slightly in-the-money options. This makes sense for directional bets (when you are willing to pay more to reduce the odds against your bet) but would be sub-optimal in most cases for hedging (when you want to get a certain level of protection at the lowest possible cost). If you'd like to read more about hedging, you may want to check out my latest article on it, "How not to insure a stock portfolio".

A Bearish Bet

Biocryst Pharmaceuticals, Inc. (BCRX) is a biotech company that develops small molecule drugs for the treatment of cancer, viral infections, and autoimmune diseases. As I've mentioned before, these are the kinds of stocks I generally prefer to bet against with puts rather than by shorting them, because they can spike on news of an FDA approval, or a partnership deal with a big pharma company.

BCRX

Short Screen shows an Altman Z-Score of 0.86 for BCRX (recall that scores of 1.8 and lower indicate financial distress, according to the model).

I got a fill on a few of the $4 strike December puts on BCRX Wednesday.

The Trouble with Hedging

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The market simply cannot make up its mind. Perhaps the powers that be simply want to bore traders to death so they don't have to worry about what will happen once the QE2 program, dreamed up by that colostomy bag of a man, Benjamin Shalom Bernanke, runs dry in a few weeks.

I have recently kept things pretty simple in my portfolio, with:

+ An absolute mountain of small short positions (dozens upon dozens);

+ One or two large long positions to balance things out

My hedging has done nothing but harm lately. Because of the whipsaw nature of the market lately, the only meaningful losses I've suffered are – ironically – from the very long positions acquired to protect me. Today was no exception.

Take a look this this chart of recent activity on the ES…….

0525-frustration

You can imagine market participants reacting at these movements in real time:

(1) The bears are excited that the market is starting to steadily move lower;

(2) Then the bears get shoved aside, and the bulls get energized that the market is forming a beautiful basing pattern, preparing to launch higher;

(3) And then the bulls get kicked in the teeth while the bears thrill at recent lows being taken out and a wonderful late-night drop (which regular equity traders really can't exploit, since only a tiny percentage trade the ES markets);

(4) Then the bears get smacked upside the head as the entire drop is reversed and the market explodes higher, thrilling the bulls;

(5) And then the bulls have their eyes poked with a limp-wristed selloff near the day's end, giving the bears some renewed hope.

Suffice it to say, this market is pissing everyone off. I'm no exception. If putting up a sign saying "Price Pays" near your trading workstation could save you from the above, well, God bless you.

My core disposition toward the market is based upon the marvelous topping formation in the Euro, which I think will provide the badly-needed wind at the bears' backs in the coming weeks.

0525-eur

 

Of course, the distinction between the FOREX and equity markets is quickly becoming meaningless, as correlation approaches 1.0. We might as well just all become FOREX traders and not bother with anything else.

0525-eurcompare

In any case, I think I'm going to give up on large hedge positions for now. If I want to reduce risk, I'll simply lighten up, which is precisely what I did today. My exposure is now only 42% of my portfolio, down from about 90%. Getting jerked around up and down gets really, really old, so I'm adopting a new tack.

That's it from me for the day. See you in the morning.

Eye on UltraShort Treasury ETF (by Mike Paulenoff)

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My near and intermediate-term technical work on the 10-year yield is warning me that the correction in yield off of the Feb 9 high at 3.74% is nearing completion ahead of the initiation of a new, powerful upleg.

Let's notice that all of the action during the past two weeks has carved out a "falling wedge" formation within the lower portion of the larger, corrective pattern that has dominated the price action since early February.

The falling wedge formation usually represents a consolidation prior to one final price plunge that concludes the corrective period (in this case, from the Feb 9 high).

Right now, I am expecting one more bout of weakness that presses yield to 3.03% before its reverses to the upside in a big way. It is with the foregoing in mind that we are bullish the ProShares UltraShort 20+ Year Treasury ETF (TBT).

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Originally published on MPTrader.com.