Am I addicted to trading?

Well, I made several trades today, even though I was going to try to avoid over-trading this month. I bought a couple of the short-squeeze plays Cramer mentioned in Realmoney.com today. I bought some CIEN common at 2.35 and MLNM Jul $5.00 calls at 3.61. I was kicking myself after the MLNM calls. I noticed that there were august calls were offered at the exact same price...it seems like I should have bought the august calls and given myself an extra month for the trade to work, or attempted to split the bid/ask on the July calls.

RIMM is on my watchlist. Remember I have been trying not to pay close attention to the markets lately, lest I be tempted to overtrade. Well, about 4 minutes before the bell, I noticed RIMM was down a couple bucks and change. I ran the July $60.00 puts through my spreadsheet and they looked like a great risk/reward to sell them at $0.85. Then after I sold them short, I noticed that I had the June expiration date in the spreadsheet instead of July. No wonder they looked so great! I can't remember the last time I traded so closely to the end of the bell, when I didn't make a stupid mistake like this. It always happens. I always tell myself I won't do it again too. The last stupid trade I made near the close was also a RIMM trade in like February I think. The options still are a decent trade. If I allready didn't have a mostly full position for June...I would be interested in selling these for the July expiration. But considering that I allready have a good portfolio almost a month from the next expiration, I would have wanted to hold off for better oportunies.

I guess I was premature in declaring ONXX at a bottom the other day. It has sold off quite a bit and is now near the 25 strike. DY also continued to cause problems for the portfolio today, and closed below the 20 strike.

A Down day

Most all of the stocks in the June portfolio were down a fair amount today. The only one that is really hurting me now is DY. What a stinker. That one gapped down and sold off all day. It's down like 19% or so to 20.34. My breakeven point for this one is 19.62. I'll be watching this one.

Fighting my own greed

I know I said I would work on a synopsis of the May trades. I didn't get that done this weekend. One preliminary conclusion I have about the May trading is that I need to avoid over-trading. Over trading and impatience, turned what could have been a profitible month into a losing month.

The June portfolio is in excellent shape. Every position currently shows a profit. I'm more diversified then I have been in the past. Not only am I more diversified by holding more positions, but my positions are spread out over a wider variety of sectors. Typically in the past they have been concentrated in the internet and tech sectors. Furthermore I am currently using just a little under 50% of my margin. This represents a little under 2:1 leverage which is where I like to be.

Switching to naked puts from bull credit spreads is working beautifully. My one worry stock ONXX illustrates the benefit of the current strategy over the previous strategy. The stock took a huge plunge, but because I didn't pay for the insurance of a vertical spread I was able to be 20% out of the money, and I have not taken large losses. In fact I currently have a profit on that position. The price of the stock has stabalized, and IV has plunged.

I took profits in MOVI and NVDA today. They were both trading 5 dollars on the offer so I took it. I don't like paying the bid/ask spread twice, but when my options are allready almost worthless it would be a poor risk/reward decision to keep my capital tied up and at risk for another 28 days just to make another $5 per contract. This is the lesson I learned from my INTC position earlier this year, when I could have gotten out at $5 but waited and ended up getting out at I don't know $40 or so?

These stocks are another illustration of how the new methodology is an improvement over the old. Profits on MOVI were $33 a contract. Profits on NVDA were $43 a contract. If I had been in bull-put spreads, they would have been closer to in-the-money and would still be too wide to take profits this early. Even when the underlying moves in your favor strongly, vertical spreads tend to reach full profitability slowly. Furthermore if I was in bull spreads, and the spreads had narrowed enough to consider taking profits at this point, I would potentially have to pay double the transaction costs to close the spread...which makes it even harder to get out early at a good profit.

I want to put the capital that was in these positions to work in new positions. The loss of NVDA takes away tech exposure. I actually want tech exposure this month. I am tempted to put the capital to work right now by selling INTC June 25 puts, especially if I could get $0.20 for them. These puts have high theoretical odds, but yield a smaller return than I would normally like, but the money made from NVDA and MOVI probably exceeded 50% annualized return on capital (I haven't computed the exact numbers yet.) so putting that money to work at a smallerROI for the remainder of the month wouldn't be to bad, since I've "allready made my money for the month" with that capital so to speak. Any more returns on that capital would be gravy.

However, one lesson I learned from the last expiration period was to not over-trade. I recognize that I am starting to succomb to greed. The portfolio is in great shape, and I have benefitted from a strong rally, and yet I'm thinking about putting more capital to work to squeeze out even more returns. This feeling of greed, reminds me of how I felt in late December and January, when I had large gains and I became more agrressive buying more and more stock and calls as the market rallied hard, and then took some of my largest losses ever. I need to be ever vigilent against my own greed.

Because of this, I am intentionally trying to avoid watching the market and to avoid searching for new positions. When I am allreay almost fully invested and when the market has been rallying is not the time to put more capital to work. I need to be patient and wait for a good pull back.

Quiet expiration so far.

There's not much to write about. I'm not looking to take on any new positions right now. I'm hoping to let Tol,ATK,UNH to expire worthless. Preliminary numbers look like May is going to be a push. I'll write up a postmortem later...maybe this weekend. It does look like I did sell GS at the absolute low @#$!@##$! When will I remember not to panic? If I sold today for example, I'd have gotten out even or a slight profit.

The June portfolio allready has considerable profits, despite onyx which looks like it may have bottomed. I'm looking to close the NVDA position at 5 cents if I can. If that happens I may start looking to add another June position. I feel very well positioned for June.

Sold at the low?

Friday I blew out of the May GS position at a sizeable loss. I haven't computed the PnL yet because I've been too busy, but it's safe to say that that one loss will keep me from being profitable in May. I noticed that GS was up today (which was happy considering I have a June GS position.), I wonder if I sold at the absolute low between now and expiration? I guess we'll see in a few days.

The June portfolio is going well so far. ONXX is my worst position. That thing was down over 4 dollars today, but becasue my put was sold so far out of the money I'm not hurt to badly and still have another 2 to 3 bucks to go before it's in the money. I have high hopes for the change in strategy I mentioned in an earlier post. I'm selling naked puts now instead of bull put credit spreads. I would have been killed today on ONXX if that had been a bull spread becasue it would have had to have been closer to the in-the-money strike. I'm not out of the woods yet for onyxx. Another drop like today, obviously would cost me dearly. The June portfolio is actually slightly profitable at this point. I sold some MOVI puts. I actually opened this postion on Wednesday, but hadn't noticed until late Friday, that my offer was actually taken because it was on a different page in IB's Trader Workstation. I was mainly paying attention to my page entitled "May Position" due to the action in GS lately and ignoring my page "June Candidates".

Could you pass me some panic please?

I sold NVDA 20 puts this morning for $0.50. Tech stocks have sucked for so long, and it seems like they've been getting stronger lately. I just thought I should get some exposure to these for the June portfolio. The stock has been trading down for the past few days, and it was up today. I felt a little bit like I was chasing the stock up a little, but I still wanted these options . Apparently NVidia had earnings today after the bell, and they were good. The thing is up another 2 bucks, since I bought it. I feel stupid for entering the position without checking out if there were earnings announcements coming up. I had no idea. But hey, if I made money, I'm not stupid...I must be brilliant right? right? So I guess will just call this a great call on my part!

GS on the otherhand....oh man...GS. Most of the day I was working, and didn't pay much attention to the market. Then, near the close I browsed the quotes and noticed GS was down 4 bucks! I couldn't find any specific reason for this and I believe you shoudl buy panic so I calmly sold the June 90 put. Shortly thereafter I saw on Realmoney.com that there was a rumor that GS has some bond problem unrelated to the GM situation. Now I changed my mind and decided that one should sell into a panic! I immediately began entering an order to close out my May 100 puts...but the closing bell rang just then and so I couldn't enter my order. We'll see tomorrow if that saved me from making a hasty decision or prevented me from cutting my losses...

GM, Convertable Arbitrage, and Rumors

One of my friends asked me about GM today, so I said I'd write about it in my blog. Here's the deal. A lot of hedge funds use a strategy called "convertable arbitrage". Basically what they do is buy convertable bonds and sell the common stock short. If bad news hits the company (like bankruptcy for example), both the stock and the bonds will go down, but the bond will not go down as much as the stock, so they will make a profit if news is bad because the short stock position will make more money than they lose on the bonds. If news is good and the stock goes up, the hedge fund can always convert their bonds to stock to cover their short position. In the meantime in either case, the hedge fund collects interest on the bonds. (I'm simplifying things a little.) So it looks like a strategy where you can't lose money right? Sometimes weird things happen though. It had long been expected that GM's credit rating would be lowered to Junk status. At that point GM bonds and stock would both go down and as I wrote above, you still make money in the convertable-arb trade in that situation. Unfortunately for them shortly before that, something unexpected happened. Kerkorian made a tender offer to buy GM stock at a higher price than it was trading. People have a lot of confidence that Kerkorian will get involved and be able to turn GM around, so GM stock shot up. To make matters worse, GM hasn't cut it's dividend like everyone expected. This represents the worse case scenario for the converable-arb hedge funds. The stock is shooting up like a rocket while at the same time the bonds are going down do to the credit rating downgrade. So Monday a rumor was spreading that some big hedge fund blew up on this trade.

GS was down over 2 bucks on Monday. I think people were worried that GS might have some exposure to the GM convertable-arb trade. I was somewhat concerned. One more day like that and my short puts would be in the money...potentially causing me to lose serious money. Now, I didn't believe that GS would actually be hurt by exposure to the GM conv-arb trade, but I was worried that the fear might not blow over prior to options expiratoin. At that point it wouldn't really matter as far as I'm concerned. I'd still lose money.

Apparently the fear subsided. GS was up almost 2 bucks today (Tuesday). In retrospect, I should have sold GS 95 puts for the June Portfolio at the time. Unfounded fear is the ideal time to get long. I think I was so shell-shocked by the huge sell-off in GS that I didn't even bother to check June GS options out. Other than that Monday was uneventful.

Today was a pretty active day. First of all, I finally got my price for the June MO 60 puts. I wanted at least $0.70. This morning I sold them short for $0.75. I possibly could have gotten $0.80 if I had been more patient...but I had been waiting for days to get my price. I was tempted many times in the past few days to sell for $0.65. I'm glad I waited.

I also sold ONXX June 25 puts for $0.75. Normally I would kind of avoid selling naked puts on a biotech. I see them gaping up and down more than 50% all of the time. Cramer wrote an article about how there's some sort of cancer symposium this weekend and a bunch of biotechs including ONXX might make positive announcements at the conference. He liked ONXX because it hadn't run up, while the others had. I looked at the options, and these ones looked attractive. It's not like there is an FDA announcement coming out this weekend, so I don't see any potential for some huge gaps. The options are 19% out of the money, and the chart kind of looked like it had some support above that strike so I felt like there was enough safety to enter this position.

I feel like I have sold the minimum number of options for June expiration now. I would like to find more positions to enter, but the market is getting over-bought and will be max overbought around may expiration probably. It is becoming a time to sell not buy. I need to be careful not to chase the market up.

I tried to enter the GM convertable arb trade today. James Altucher wrote on Realmoney.com that this could be a good time to enter, because you'd be taking the other side of the hedge-funds that are supposedly being forced to liquidate. He writes in his book Trade Like a Hedge Fund, how to do this using prefered stock. In this case I wanted to buy GMS and sell GM at a 2:1 ratio. Of course I couldn't get any GM to short. Do to recent SEC regulatory changes, it is often very difficult for retail traders to short stock lately, but if there are massive liquidations of the GM conv-arb trade you'd think that there would be some shares available to short? Maybe this is a sign that the rumor wasn't true.

GOOG Profits

I'm still looking for Summer premium to sell. I sold June 25 puts on CBH today. They are ~8% out of the money. I've been watching this stock as a candidate for several months. It was down today because some of their former executives got convicted or something. This was a pretty good price but not as much "edge" on them as I would have liked. Apparently Cramer says to wait a day to buy this stock. I might have been a little jumpy on the trigger finger today because I've been watching this stock for so long...maybe I should have waited.

I needed more capital for opening positions in summer options so I also closed out the May GOOG position for a profit of $93/spread.

It is looking like I was premature in closing out my TWX position last week. That thing has consistently stayed above the strike and I think it most likely will until expiration.

Doubling up on LU common for the longterm portfolio a little while ago, appears to have been a good idea in retrospect. LU is up big because they announced a buy back for some convertable prefered shares.

I worked on the earnings volatility buying system this weekend. I think my earnings data downloader is done, and I am currently testing it the background while I work. In a few hours when I've confirmed for sure that it works I'm going to start on step 2, by purchasing options data.

Am I an insurance salesman?

I was pretty active today.

While I was looking for options to sell for summer expirations, I notice that TOL May 70 puts were selling for$0 .55, which is a pretty good return on capital for 14 days of risk. I don't feel terribly bullish on Toll Brothers. Toll brothers is a homebuilder, and homebuilders have run up big this year. The great jobs report today can't be very good for Toll Brothers, either. With the job market booming, the fed is more likely to continue to raise rates to pop the "housing bubble", but is there any pending events that could drop TOL 9 points in 14 days? I looked around on the net for news on TOL and didn't see any events coming up, except for their earnings which isn't until after expiration. I don't need to be terribly bullish on TOL to think that it won't drop 9 points in 14 days so I sold those options short. I am a little concerned that there is something I'm missing here, though.

I also purchased some HON common stock for the weekend. Cramer wrote on RealMoney.com that there was unusual call option buying in HON, so I bought some on the rumer that there will be a take-over bid...apparently a lot of other people had the same idea, as it was reported on extensively by CNBC today. I'm not terribly thrilled to be part of the herd buying a stock on a rumor, but I've made money before from what I consider to be similar Cramer calls, and the risk isn't large for this position....Oh great THIS JUST IN! Cramer just said on Mad Money that he would have sold the HON at the end of the day...He didn't outright say this on RealMoney.com...I kind of got the impression that he was saying to buy it for a few days. Oh well...and I was tempted to take my gains today....

Anyway I was looking for stuff to sell for summer expiration months. My favorite candidate is the MO June 60 puts, but I need to get at least $0.70 for those puts, a price that was unavailable today. I did sell DY June 20 puts for $0.40 today. In this stock I have slightly changed my approach, in several ways. Usually I take positions in stocks that I have been following and know something about. I had never even heard of this stock before yesterday evening. In the past I have rarely been able to find even 5 stocks to sell puts on. I would like to establish more positions going forward so I haveto cast a wider net, and am now selling puts on stocks I don't know as much about. This is for two reasons. First of all, I want to be more diversified. Secondly, I mostly follow stocks like GOOG, EBAY, QCOM, INTC, CSCO, LU etc...those are yesterday's stocks. Those stocks belonged to the 1990's (except GOOG of course). Going forward I need to start learning about other types of stocks, because I don't believe the nifty ninety's stocks are going to be the best stocks for the 00's. We'll see how well this turns out I guess.

The biggest change in approach is that I am selling naked options again, instead of selling only bull spreads like in March, April and May. For those unfamiliar with the term "bull spread", let me explain what I mean. If I sell a put short, I am entering into a contract that says I have to buy the stock at the options' strike price from my counter-party at his whim. Essentially I am selling insurance against losses, and my underwriting fee is the option premium. So for example if a stock is trading at $55, and I sell a put with a strike of $50 for say $0.45, I am now exposed to losses of around $5000 for a contract of 100 puts. So I am making 45bucks and being exposed to a risk of losing 5000 bucks. That doesn't seem like a very good deal does it? But that is what I do...I'll make a longer post some other day and explain why I do this.

Now it is unlikely that the stock will drop to zero, but what if the stock drops to say 25? That would still be a sizeable loss of around $2500 dollars. Since I am usually margined, that could very well be a 100% loss on the position. After reading Telab's Fooled By Randomness, I became less comfortable with naked put selling. Telab warns about the so called "Black Swan" events...Rare unexpected events that come along and wipe out traders like me who expose themselves to unlimited losses.

So what I have been doing is this. When I sell that 50 put short for $0.45, I also buy some insurance of my own in the form of purhcasing a 45 put for say $0.15. Now for this position I am only making $30 profit but my maximum downside risk is clearly defined at around $500. This is what I meant by the term "selling a bull spread". Note that even though I am making less money, my return on capital is actually higher. Before using %50 margin instead of the aproximately %25 margin I'm allowed on a naked put sale, it would cost me around 2500 to cary that position, so my return on investment would have been 45/2500 = 1.8%. But now I only need around 500 to cary the position so my return on investment would be 30/500 = 6%.
Another important reason for buying insurance was that I typically didn't have very many positions. Ideally I would need to have 20 to 30 positions to be well diversified instead of only 5. With my capital divided among only 5 positions, I'm especially exposed to extreme price moves which are common in any individual stock. If I had my capital divided among 30 positions then I would have less need for insuring each individual position. Instead I could just buy puts on the S&P to insure the whole portfolio, against an extreme market move, and absorb whatever individual stock risk I suffer on any individual stock since the capital in an individual position would be small.

So why have I decided to go back to selling naked puts instead of bull spreads? By not buying the insurance I can go down to a lower strike, increasing my chance of profit. For example let's look at this month's TWX fiasco. I sold TWX $17 puts for $0.20. I then insured myself by purchasing $16 puts for $0.10. This left me exposed to a maximum of $1.00 per spread for a 10 cent profit per spread. Now this was a stupid spread to enter, because transaction costs are too large for such a small profit...but I'm using it as an extreme example. Well if I had just sold the 16 puts naked for .10 I would have been making the same amount of money, but I would have a lot less to worry about because the risk of TWX dropping below 16 is much smaller than the risk of it dropping below 17. By giving up protection against rare events, like say TWX dropping to say 10 dollars in one day for example, I give myself more protection against common events like TWX dropping a buck maybe. I still plan to insure the whole portfolio against large market drops by purchasing index options.

The price of "peace of mind" = $0.16

I closed the TWX position for about a $16 loss per contract. This was probably premature, but I just don't want to deal with it anymore. I had a bad feeling about this position all allong. I chased the stock up the day I bought it. Then to make matters worse, I sold bull spreads, even though the difference in option premiums was very narrow, and the profit potential was small. Hopefully I've learned good lessons from this fiasco. As I look for new positions to enter I do feel a little bit of a temptation to chase stocks up, and enter positions that I'm not terribly excited about. I need to keep reminding myself of TWX as I search for puts to sell. One stock I'm interested in is MO. I will be looking for a good entry into MO tomorrow.

Yesterday I finished reading Options as a Strategic Investment, by McMillan. I've learned so much from reading this book. This is definately the best book on options I've read. I have so many ideas I want to start working on. This motivated me to do a little bit of work on the Maestro's system which I posted about earlier. I'm almost finished with Step 1:"Write routines to import earnings from finance.yahoo.com.

Keep risk per trade constant!

Friday evening I checked out the CBOE equity put/call ratio. It looked really high to me (.78 I think). Normally I would not want to be long puts with such a high put/call ratio. Sure enough Monday morning my SPY puts were down around $0.30. I offered 1/3 of the position 15 cents above the bid. I should have waited for that offer to get hit, because it would have in the next 30 minutes....but I panicked as SPY started to drop a little, so I hit the bid for all of my contracts. That is the problem with bigger positions. I get panicky and impatient which causes me to trade poorly. I probably could have halved my losses to 15 cents per contract if I had been more patient.

This loss erased my previous gains from trading the QQQQ's this month, and will take a good bite out of my profits from the May Portfolio (assuming I end up with any). I think one of the most important rules to follow in trading is to keep the amount risked per trade fairly constant. I didn't follow that rule this time and my % return this month will suffer because of that. It's interesting. I have a bookshelf full of books about the stock market and trading, but I can only think of 2 books that specifically mention this rule, although many implicitly state it when they discuss money management ideas. Maybe this idea is too obvious to be mentioned in most books. It certinately wasn't obvious to me as a beginner, and I frequently changed my bet sizes. I first read this rule explicitly stated in Practical Speculation. I remember reading it and thinking how important a principal that this was at the time. The only other book I can think of that explicitly states this rule is also one of my all time top favorites: The Zen of Gambling. This is kind of a hokey book, and it is written in an extremely simple style, but it is full of profound insights about what it means to be a contrarian. I should re-read these books.

On Tuesday I opened up a position in Pepsi. I bought some out of the money Dec 05 calls. This is a very small position. I'm going to be looking to establish a small portfolio of long term out of the money options in companies I like that have a good theoretical edge. I almost always sell volatility, and I need to get past my phobia for buying volatility. Most of these positions will be total losses. I need one or two to gain enough to overcome the losses on all of the rest. Hopefully I can get a feel for what it's like to buy options it instead of shorting them without losing too much money.

I'm not being exactly truthful to myself. I definately do have a feel for what it's like to buy volatility. I lose most of the time and it sucks. That's why I have the phobia! Basically I think trading methodologies come in 2 types.

Type 1: High probability of profit per trade. Losses are bigger than winners. These are your countertrend/reversal, and option premium selling methodologies.

Type 2: Low probability of profit per trade. Winners are bigger than losers. These are your trend-following systems, and premium buying methodologies.

I'm more comfortable with type 1 systems. Most of the time you are making money, and that feels good. The chalenge with type 1 systems is not to go broke when positions move several standard deviations against you. Fat-tails in the price-distribution curve are the enemy of type 1 systems. If you read my blog much, you've probably figured out that one of my favorite authors is Niederhoffer who is a type 1 trader and he busted his fund! Type 2 systems are harder systems to trade because most of the time you are losing money, which makes you doubt yourself. Type 2 traders benefit from the rare extreme moves. The chalenge with type 2 trading is to keep your losses as small as possible, while waiting for those extreme moves where you make all of your money.

One of the best books I've read this year was Fooled By Randomness, by Taleb who is a type 2 trader. Reading this book caused me to start thinking about buying option premium. I am not sure who is right Niederhoffer or Taleb, but I would like to learn to trade in the type 2 style just to expand my arsenal.

I have never been very disciplined when buying option premium. I think my main problem with buying premium is that many times I've put too much capital in individual positions. Since most of these positions will be losses the position size must be small.

I'm guessing that Time Warner's earnings were good. It was up big today. Now all of my May short puts are in great shape, for the time being. I could close all of my positions for 2/3's of the maximum possible profit right now. Two and a half weeks to expiration... I need to start thinking of some ideas for June/July expiration.