2010 Jan 17 - Sun

Option Trading Scenarios

Most option trading books discuss the mechanics and mathematics of option trading. Rarely do they offer up any sort of in-the-trenches useful guidelines for doing what when and how. Some recent reading has enlightened me on some useful option trading scenarios.

The first one provides the dual mechanism of obtaining income and optionally paying for protection on an underlying which is already in one's portfolio. The process involves selling a kind of straddle: selling an out of the money call and an out of the money put. For example, with TSL, as of Friday's close, is at $49.50. The Feb 55 Call is at $1.75 and the Feb 48 Put is at $3.25. Selling this results in $5.00 premium. If TSL stays within the range of $48 and $55 till Feb 19, the full premium is kept. If the price goes above $55, the underlying will probably be exercised to result in a $5.50 profit, which is the premium plus the amount the underlying goes to get to the strike price. If the price goes below $48, the Put will go into the money, most likely causing it to be exercised, and you'll end up buying the underlying at the Put strike price, which may be a good thing if you are expecting the price to rebound. On the protection side, the premium earned on the put and call sale could be use to purchase twice the number of puts at the next out-of-the money price, which in this case would be Feb 45 Put. This provides protection on the original underlying plus the shares gained when the buyer exercised the puts.

Another strategy requires maintenance of no underlying. For a stock that you think will go up due to some upcoming good news, such as an earnings announcement, one could sell an out of the money put and use the funds to buy and out of the money call. By careful selection of put and call strikes, the money gained by selling the put may fully cover the price of buying the call. The downside of this is if the price of the underlying goes below the put strike price. You may end up owning the underlying in this case, but at least it was obtained at a lower price.

[/Trading/Options] permanent link

They Who Have The Money

Sometime this last week, someone made the observation of the fact that there was a 'hidden buyer' buying a large amount of treasuries during the weekly US Treasury auctions. There was speculation it might be the Chinese operating through private proxy parties.

The US government has a problem with all the money they are spending. Some one has to loan it to them. Hence the regular treasury auctions.

A couple figures came to mind. I believe I recall seeing that the Chinese have over one trillion US dollars due to trade imbalance between the US and China. Another figure has to do do with the fact that the US government has added over a trillion dollars to their defict through recent spending.

If you put those two numbers together, and tie them together with the 'hidden buyer' observation, perhaps it could be said that the Chinese are converting their US dollar currency holdings into US Treasury holdings. That way, not only have they made money through their exports, but they make additional revenue through the yields on the treasuries purchased.

[/Trading/MarketNotes] permanent link

Short Interest, Solar, Lithium

Many commenters have been discussing Peak Oil, with Peak Oil being the fact that we've found all the easy supplies of oil, most of which has been pumped, and that our supplies, regardless of type, are dwindling... the peak has come and gone. To be more specific, the supply of oil, of which we only have a finite supply, is decreasing, while world demand for oil is increasing. The first day of Economics 100 teaches us the supply / demand curve and the effect on pricing. Oil prices can only go up, and up until the last dropped is supplied and consumed.

In the meantime, alternate sources of energy must be found to supply the world's unending requirement. For sourcing some fraction of our energy needs, some are turning to the nearly non-ending supply of sunlight. One way of converting sunlight into energy is through the utilization of solar panels. Solar panel technology has improved recently, and has resulted in it becoming economically viable to generate electricity via these sunlight receptors.

A number of companies are in the business of producing solar panels. In a sideways fashion, I came across TSL (Trinia Solar) yesterday. Someone had run a stock screener with the settings similar to:

• stocks with high put/call ratio
• minimum stock price of $10/share
• minimum put & call open interest of 10k contracts
• minimum average daily stock volume of 100k shares traded
• trading above its 20-day moving average
• near a 52 week high

TSL has risen briskly but has some pessimism from investors based upon puts easily outnumbering calls. If the negative sentiment unwinds, it could rise further. Another area of measuring pessimism is through monitoring short interest. The web size Short Squeeze offers up information so one can see how many shares are sold sort for a company. Short Interest can also be found within the Fundamental Record of the DTNIQ data stream.

In looking at TSL on Google today, Google shows that all similar solar stocks took a decline today. It turns out that the German government will cut its solar financial incentive schem by 16 to 17 percent.

With a price correction like this, it might be interesting to look to getting into solar at this level. But the real moral of the story is that a news service which tracks a portfolio's stock symbols is probably worth its weight in gold.

Moving along with the alternate energy theme, collected energy needs to be stored. Currently technology appears to be focussing on Lithium as the mineral of choice. A common play appears to be WLC (Western Lithium). An upcoming player as mentioned in Industrial Metals magazine might be GXY (Galaxy Resources).

[/Trading/MarketNotes] permanent link

2009 Oct 26 - Mon

Machine Readable News and Algorithmic Trading

A-Team Research has released a special report called: Machine Readable News and Algorithmic Trading.

I've writing some code to accept a news release feed from DTNIQ/IQFeed. This report comes in handy for supplying some ideas on how to analyze and make use of the news feed. Here are some examples:

• When generating trading signals for high frequency traders and other alpha-seekers, it can be used to build sentiment measurement applications, stock screening applications and back-testing systems for trading algorithms.
• It can be used in support of market surveillance systems.
• This translates into simple stock-screening applications for individual securities or lists of stocks.
• It can mean the analysis of macroeconomic data to identify trends, correlations and other relationships.
• It can involve scanning key parameters to measure market sentiment.
• It could predict potentially volatile trading days, indicating which stocks or types of stock may be most affected.
• It can also be used to quickly derive directional signals from the marketplace, and set in play appropriate trading algorithms.

[/Trading/AutomatedTrading] permanent link

2009 Oct 17 - Sat

Trader Urgency Indicator

In the LinkedIn Group Automated Trading Strategies, Alpesh Patel posted a Trader Urgency Indicator:

• Fix no. of ticks based on market traded( Let's say 100 ticks chart for S&P 500 Emini)
• Monitor the time taken to finish the bar
• You will notice that most successful breakout bars will finish in significatly less time showing trader urgency
• At trend exhaustion you will notice significantly more time taken to finish the bar

I think I wrote about Range Bars at one point in time. This is probably a variation on that theme.

[/Trading/TechnicalAnalysis] permanent link

2009 Aug 29 - Sat

Options as Indicators

Optionetics has an interesting article called Using Options to Predict Stock Prices. The author, John Jeffery, writes that, in addition to the usual fundamental analysis and technical analysis methods of 'stock direction prediction', options can help indicate trade direction. Three useful indications include:

• Put/Call Ratio
• Implied Volatility
• Option Volumes

Put/Call Ratios: The most popular Put/Call Ratio is the one used for monitoring the sum total of option trades at the CBOE (Chicago Board of Trade). The same technique can be used for individual stocks as well. It is basically the ratio of the number of open call positions relative to the number of open put positions on a given stock at a given expiry. With experience, it can be used as a bullish/bearish indicator of the underlying stock. Street Authority has some further information on the Put/Call Ratio. Schaeffer's Investment Research indicates the general market is strongly bullish. They have a series of stock screeners.

Bullish Stock Screeners
• Stocks with a high put/call ratio
• Stocks with high short interest

Bearish Stock Screeners
• Stocks with a low put/call ratio
• Stocks with low short interest

A reference is made to an article by Pan and Poteshman called The Information of Option Volume for Future Stock Prices where they say that they "performed daily cross sectional analysis on 10 years of CBOE data to reveal that doing nothing more than buying stocks with low put/call ratios and selling stocks with high put/call ratios generated a return of 1% per week." You have to read the full abstract for some caveates though:

We present strong evidence that option trading volume contains information about future stock price movements. Taking advantage of a unique dataset from the Chicago Board Options Exchange, we construct put-call ratios from option volume initiated by buyers to open new positions. On a risk-adjusted basis, stocks with low put-call ratios outperform stocks with high put-call ratios by more than 40 basis points on the next day and more than 1% over the next week. Partitioning our option signals into components that are publicly and non-publicly observable, we find that the economic source of this predictability is non-public information possessed by option traders rather than market inefficiency. We also find greater predictability from option signals for stocks with higher concentrations of informed traders and from option contracts with greater leverage.

One of the authors has another paper entitled Investor Behavior in the Option Market. One of the interesting points from the abstract is the remark "none of the investor groups significantly increased their purchases of puts during the bubble period in order to overcome short sales constraints in the stock market." Taken the other way around, puts are an easy method of getting around short selling restrictions on equities.

In visiting a related author, there is a recent paper called Dynamic Trading with Predictable Returns and Transaction Costs which discusses some portfolio optimization with a mixture of short, medium, and long term mean reversion based trades. This has nothing to do with options, but is an interesting article in itself which I wanted to keep.

Implied Volatility: Implied Volatility is the expected volatility of an option's underlying asset up to the option expiry. This tool can be used for inter-day and intra-day trading calculations. In the article's example, where the underlying is moving sideways, an increasing Implied Volatility could indicate some major move in the underlying. Various other relationships can be established as well.

Option Volumes: When looking at option volumes across the whole series of an underlying's strike prices and expires, look for unusual activity in volume. This means comparing current traded volume with average daily traded volume. It may be possible to see where traders are seeing resistance or support levels, with the interpretation being whether the volume is in puts or calls. If there are no related news, earnings events, or government announcements, then someone may know something.

[/Trading/Options] permanent link

2009 May 16 - Sat

High Performance Messaging

The most mention I hear of low latency trading is from data vendors who say their market data feeds are 'the best' because they are nearest the data source, and that their infrastructures have been designed for high availability and performance.

I've always thought though, that market data source adjacency forms only a portion of the overall delay budget. It seems to me that 'closeness' to the execution side of things is just as important, if not more so. This is confirmed through some articles I've recently seen that discuss some colocation facilities situated to optimally provide this 'betweenness', aka Smart Proximity Hosting.

The third aspect of low-latency trading resides within the compute engine, the engine that receives market data, calculates the trades, performs risk management, sends out the execution requests, and receives the execution confirmations. Copying data from and into packets as well as receiving and transmitting them can be a time consuming processing. Buffer management is a serious consideration in high frequency trading scenarios (the concept of high-frequency trading being intimately intertwinded with the concept of low-latency market data feeds).

I came across Topics in High-Performance Messaging in relation to someone's generic question about how to test throughput on links. Buffer sizing is one of many important topics in optimizing throughput and reducing latency. This paper makes obvious many of the hidden gotchas for the compute engine, the links (how many, what kind, and how they are joined), the feed types, and the supporting L2/L3 infrastructure. Even though I came across it as a generic response to throughput testing, I see it is written by a group that has spent much time on investigating low-latency issues in trading. I see the article as being very usful for optimizing additional milliseconds/microseconds out of the execution cycle time.

Another view on this low-latency issue arises in a blog entry from The Blog of James: Does the need to process volumes of data prohibit lower latency?

There is a news site dedicated to news regarding low latency trading issues: low-latency.com.

[/Trading/AutomatedTrading] permanent link

2008 Dec 28 - Sun

Modern Day Vikings

I don't have access to the paper, but the abstract looks interesting: Looting: The Economic Underworld of Bankruptcy for Profit. Sometimes I think that some companies do a business plan around this, or implement it through 20::20 hindsight. Back a few years ago, companies were laying fibre like crazy. Over capacity resulted. Many went 'under' and resurfaced with the assets but less debt overhead after writing investors off.

[/Trading/ReadingMaterial] permanent link

2008 Nov 23 - Sun

Seasonalality Timing System

In Mark Hulbert's November 17, 2008 article called The long-term reasserts itself, he mentions the Seasonality Timing System (STS) designed by Norman Fosback of the Fosback's Fund Forecaster Newsletter.

The STS is designed around the fact that "the stock market has a bullish bias around the trading sessions immediately prior to each exchange holiday as well as those at the turns of each month." He indicates that "STS followers will not get back into the stock market until the close next Monday, so as to be fully invested for the sessions on Tuesday and Wednesday, the two trading sessions prior to the market's Thanksgiving holiday."

According to those remarks, trading for this upcoming week should give us a rebound.

The picture turns less rosy with Paul Farrell's November 19, 2008 article 30 reasons for Great Depression 2 by 2011. Basically he says more spending with little or no increased income is a recipe for further disasters.

Peter Brimelow in a November 20, 2008 article called Bears' glass half empty or half full?, writes about Dow Theorist Richard Russell indicates that the primary bear market has been reconfirmed, and things are headed lower, perhaps to around the 7286 (the 2002 Dow Low) and 7470 (half the bull market peak), which we touched Thursday and Friday, but were saved by the news of Timothy Geithner, now president of New York Federal Reserve, would be Obamas's Treasury Secretary.

Corey Rosenbloom has confirmation of the Interesting Fibonacci Development. We have a level of support at about 7500, and a trading range up to a level of Fibonacci and psychological resistance of about 10,000.

But then more bad news could be around the corner. Lots of interesting Economic news coming this week: Existing Home Sales on Monday, Tuesday with GDP and Consumer Confidence, and then the day before the US Thanksgiving we have Durable Goods, Personal Income, Jobless Claims, Consumer Sentiment, and New Home Sales.

[/Trading/MarketNotes] permanent link

2008 Nov 14 - Fri

Receding Recession Indicator

The last time the Dow was at current levels looks to be back in May of 2003. But going back a bit more, it was May of 2002 that the Dow dropped below 10,000. It hit a low of 7600 during the beginning of October 2002. December and January were relatively 'happy' months before the Dow retested 7700 in March 2003. It took a steady rise till December 2003 to cross back above the magic 10,000. The year 2004 saw a few minor dips below 10,000, but nothing serious. October 2007 seeems to have been the recent peak at around 14,000. It declined bit by bit until September/October of this year when it bit the dirt.

In the last few weeks, it hit a low of 8451 around Oct 10, another lower low October 27 of about 8175, and retested with a mid-low at 8282 on November 12.

All this to say that we haven't made any recent lower lows. Yet. Leonard Novy says a symmetrical triangle is forming prior to a head and shoulders finalization at a still lower level. We shall see.

And if history offers any pattern for the future, we could stay at this level for six to twelve months. Things could improve over the next bit. Come next year, there are supposed to be more mortgage resets, which may cause another economy/financial hit, more people losing homes, and as a result jobs. After that, hopefully people's eternal optimism will start to kick in, and it is possible we could see a 10K Dow by the end of 2009 or first quarter 2010.

According to Donald Luskin, the bear market will be over when "stocks have rallied at least 20% from any given low point, over at least two calendar months". The pattern in December 2002 almost but not quite made the 20% criteria. It wasn't till after March 2003 did things conform to pattern.

Perhaps 2008/2009 may hold a similar pattern to 2002/2003.

[/Trading/MarketNotes] permanent link

2008 Oct 27 - Mon

Interactive Brokers TWS on Linux

Installing Interactive Brokers Traders Workstation on Linux is relatively painless. It is probably best to stick with Java Runtime 1.5 rather than using 1.6. The IB forums mention problems with 1.6, and Think Or Swim does not like 1.6 either: apt-get install jre-java5-jre. This will require non-free and contrib in the /etc/apt/sources.list file. After installation, 'update-alternatives --config java' will get the right version set.

The IB suggested command line has problems with hsqldb.jar. I use the following command line as an alternative:

java -cp \
jts.jar:pluginsupport.jar:jcommon-1.0.12.jar:jfreechart-1.0.9.jar:jhall.jar:other.jar:riskfeed.jar:rss.jar:/usr/share/java/hsqldb.jar \ 
-Xmx256M jclient.LoginFrame . &

[/Trading] permanent link

2008 Aug 06 - Wed

Market Notes for August 6, 2008

This article really isn't about today. Nor is it about yesterday. It is about Monday. But becuase I only read Mark Hulbert's colummn today, which he penned yesterday, which is about Monday's 332 point gain, I've dated my article for today.

Mark's point of the day revolves around another rule of thumb: the day was not a 9-to-1 up day. This type of day is when 90% of the volume of shares that rose or fell in price was in shares that went up. The term was coined by Martin Zweig, who used to publish several investment newsletters. On Monday, for the NYSE, it was only an 8.1-to-1 day.

According to his 1986 book called "Winning on Wall Street", Zweig states "Every bull market in history, and many good intermediate advances, [has] been launched with a buying stampede that included one or more 9-to-1 up days".

In Mark's article of yesterday, he mentions that valuations are still a little high. As such, a bull market may not be in the offing yet. So far July 15 is considered our low of the current bear market.

I think because of additional mortgage resets happening later this year, we may not be completely ready for bullish thinking. Maybe a nice little volatile rally, but we may see some more lows.

[/Trading/MarketNotes] permanent link