Options Trader: Weekly Wrapup

by: Philip Davis

12,002.37! We finished the week above 12,000 -- Wow! What a wild week it was! We had a lot of paper pain from our November oil puts, but a ridiculous run on ExxonMobil Corp. (NYSE:XOM) and Valero Energy Corp. (NYSE:VLO) put our covers far enough into the money to save October. We won't be so lucky if we are wrong about November, as I called a top on oil Wednesday, and removed the covers on the remaining puts.

We closed just 27 positions this week for a 22% gain on 14 average days held. That includes 5 total losses on Morgan Stanley (NYSE:MS) (2), Goldman Sachs Group Inc. (NYSE:GS) (2) and a Yahoo! Inc. (NASDAQ:YHOO). That leaves us with 43 open positions that have been open for an average of 16 days with a 27% loss due to the horrendous performance of our oil puts.

This relatively poor week drops our monthly total to a 53% profit on 94 positions held an average of 8 days, but it's all relative as these are very small positions compared to the ones we won with. As I said on 9/29:

"Of course we will watch the Dow, but I'm moving into 85-90% cash over the weekend. If I LOVE a position, I sell 80% of it -- so keep that in mind as we talk about open positions. If we confirm a real rally next week, we still have a good 300 points to go before our next real Dow resistance at 12,000 (still 4,000 behind the Nikkei) and I'm sure we'll find something to trade..."

Just 2 days later, on October 1st, I said:

"Despite my best efforts we still have 35 open positions, but they represent a lot of rolls from positions that topped out and opposite sides of spreads that closed well. By themselves, they are a sad lot of open positions with no profit as a group after 10 average days. Think of them as more of a watch list than positions I recommend."

"My primary signal that the market was turning was our generally optimistic portfolio's performance dropping from a 90% return in week 2 of September to 27% in week 3. We did manage to close out 58 positions at 59% for this week, but those are gone, and just represent numbers on the balance sheet now (get spreadsheet here). As I said, the remaining positions, which are at 0%, could be taken off the table by a smart guy and call it a quarter!"

Why didn't I listen to myself? I could have taken a nice vacation! As I said in September when we closed out 136 positions for a 92% profit -- it was a good time to quit at the top, because you can't do that twice in a row!

I guess we're all spoiled by August's and September's average return of 82%, so 53% for October seems pretty bad, but when I started this blog we were happy to make 20% for the month in what was a very choppy 2005 market.

Oh well, all we can do is resolve to be smarter next time and pay attention to that little voice inside ourselves that lets us know when to hold 'em, know when to fold 'em...

The Dow sure didn't fold 'em, but we're still not sure if it's bluffing with a 42 point gain for the week, quite a slowdown from the 360 point run we started the month with. Think back to 9/22 when the Dow was at 11,500, and this week accounted for just 10% of the recent gains. On the whole I would have to say that earnings are not living up to expectations, not of the analysts, but of the investors who have driven up the market.

The S&P actually lost a point on the week, arresting a 60 point run (5%) that began on 9/22. The NYSE put in a similar performance but did manage to gain .5%, and the Nasdaq actually fell 25 points for the week, never recovering from Tuesday, when Kim Jong II declared WWIII and no one came.

The transports finished flat for the week but the SOX fell through our floor today and I am concerned that one more bad earnings report will push them right over the edge.

All I will say about oil is that when the commodity your company derives its revenues from drops below the lowest measurement on a 6 month chart, you should perhaps consider lightening up just a little...

What's most interesting about gold is the recent lack of interest in futures contracts. Usually volume trends down before a change in direction, but the direction has been up as the volume plunged, indicating the direction may plunge as the volume goes up.

I've little to say about politics this week as I generally root for the underdogs, and that looks like it's the Republicans now! So far Karl Rove's October surprise has been a bit of a disappointment for the party faithful who thought we would capture Osama, rather than catapult Obama to national prominence.

At least we have Fox news to turn to for a fair and balanced perspective... Even Steve Colbert says the whole Foley scandal is overblown.


Trends are what concern me in general, and what has caused me to take a defensive stance for the past couple of weeks. I was hoping to go over our picks and be able to say I am firmly on board with the rally but, sadly, there is much evidence to the contrary -- at least in the short run.

What has been bothering me since September is that we are zooming along hitting all the high points I predicted on 9/29 (above) as well as in my more macro prediction of August 31, but without (so far) a sensible pullback that is bound to come.

The further we go without a small pullback the closer we get to a "major correction," and those can get very ugly! Now I don't want to scare anybody but, as it is almost Halloween, we should at least be ready for something nasty to jump out of the shadows.

Lurking ahead next week is the GDP report (Fri.) and a Fed meeting (Tues./Wed.), both with the potential to spook the markets, along with the always frightening home sales (old Wed., new Thur.).

So I continue to be cautious, but, now that we have some earnings under our belts, we can get back to picking some stocks -- really my favorite way to play the market as sector bets are just tediously long to play out!

Our sector bet on oil has gone from triple digit gains last month to a bunch of 50% losses as the sector took a little bounce as oil stopped declining. As I've said in comments, I am letting my November puts ride, but won't be adding new positions unless we get a much better turn signal.

The same logic that caused me to stop playing gold on October 1st should have applied to oil, but AngloGold Ashanti Limited (NYSE:AU), for example, was down from $50 to $35 while Chevron Corp. (NYSE:CVX) had only fallen from $67 to $65. AU produces gold, which fell from a high of $730 in May to $609 (17%) on October 1st. CVX produces oil , which fell from a high of $79 in July to $62 (22%) on October 1st. It just seemed to me that CVX (and the rest) had a little more room to fall.

"The market can remain irrational longer than you can remain solvent." -- John Maynard Keynes

My biggest mistakes this week were not sticking with winners longer, but that's what happens when you get behind on some bets -- you need the money from the winners to cover them. This is why it is vitally important to limit losses to 20%; you need to detach yourself from a losing trade

Google Inc. (NASDAQ:GOOG) is one example, as I took 91% and 107% gains off the table on Tuesday's dip, rather than risk them (or at least half) into earnings, as it was just far too much money to leave on the table while I had other positions I had let slide too far.

While I didn't follow my own rules there, at least I did properly take the opportunity to buy out my callers, allowing me to benefit on the actual Google stock. I have refused to even consider how much money I would have made, but I will be forced to, as I have had several requests to do a post mortem on the Google calls this weekend...

I could have held onto Coca-Cola Co. (NYSE:KO) one more day, although 86% seemed good on Wednesday, the Nov $45s did a little better than .65 over the next two days! I think my disappointment with Alcoa Inc. (NYSE:AA) made me a little nervous pre earnings.

Merck & Co. Inc. (NYSE:MRK) was another good call pulled way too early with the Nov $45s closing at $1 (up 33%) on Thursday's dip. This one made sense as the whole sector sold off and I still had GlaxoSmithKline plc (NYSE:GSK) Nov $55s for .90 open and I chose to keep those.

I also got out of the Pfizer Inc. (NYSE:PFE) Nov $27.50s at $1 (up 33%) for the same reason, and those I can still get back for .60, so it's a win-some-lose-some thing!

On the other hand, I got out of the GS, MS and October Yahoo! Inc. (YHOO) positions far, far too late, causing myself 80% more loss than I should have 5 times! This is a very amateur trading mistake, being careful with my profits and careless with my losses, and it brings us down to one of my favorite sayings:

Do as I say, not as I do!!!

Always remember that when I enter a position, I am only allocating 1/10th of my intended purchase. When the trade goes 20% against me early, I either liquidate or wait.


I want 100 contracts, so I buy 10 contracts at $1, and now they are .80.

At roughly a 40% loss, I reexamine the position and make a double down decision to bring my total investment level to 16% at a 25% loss.


The contract drops to .60 and I buy 10 more contracts, now holding 20 contracts for an average of .80

From this point I will endure another 20%-30% drop, down to 60-75% lower than my original investment where (if I still feel VERY strongly about the position) I will double down one last time to bring the average basis to .60 and a 33% loss.


The contract drops to .40 and I buy 20 more contracts, now holding 40 contracts using 25% of what I had intended to put into the position had it gone well.

At this point I have a new rule: If the option goes back to my new basis of .60, I take half off the table, and reset back to position 2. If it drops another 20% from this point, I decide to walk away with a 50% loss on my 25% position (12.5%).

On the way up it's a little different as I will add to the position every day until it's up 20%, at which point I stop and follow the rules in Trading Policies. That's why I'm generally not very happy when I hit a move right on the nose; more often than not I don't have a big position in it if it takes off early.

Managing your cash is important for any stock trader but it is CRITICAL for an options trader. I learned this the hard way!

The most important thing I learned is the value of a good night's sleep and a worry free weekend, which is why a diversified portfolio with a sensible mix of puts and calls is what I always recommend. While you may miss out a little when the markets makes one of their big runs -- in the long run you will live to see a lot more of them!

Have a great weekend!

- Phil

Read all of Phil Davis's articles on Seeking Alpha.