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Marco is a trader of stocks, options, currencies, and futures. He has been fascinated with the financial markets ever since he bought his first stock at 11 years old. Marco entered the business world at the age of 13, with the creation of an extremely successful retail website... More
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Hot Trading Strategies for a Cold Market
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  • Financial Stocks Over Heated? Using Diagonal Put Spreads to Hedge
    Many financial stocks have been in the spotlight in the past week, as rumors have caused them to sky rocket. I am sure you are quite familiar with them, as you've read about or watched their ticker symbol scroll by, but to mention four of them they are: American International Group (NYSE:AIG), Citigroup (NYSE:C), Fannie Mae (FNM), and Freddie Mac (FRE). Citigroup has not rallied nearly in step with the other three mentioned over the past week, but has had a much later rally than many of the other large financial names.

    I am very skeptical of these names climbing so fast recently, and although I don't usually purchase and hold put options overnight (or call options for that matter, I use them frequently but usually trade out of them by market close), I have made an exception as I have purchased put options for American International Group (AIG) for the September 45 strike. I am bearish on the financial stocks in the short term, but extremely bearish on AIG. I am expecting a continued sell off, and I think a sell off will hit the financial sector the hardest as mentioned in Are Financial Stocks Especially Overpriced? Some Protective Ideas.

    Financial stocks; too fast, too soon?

    Looking at the first Heatmap below, we can see that financial stocks are up more on average than any other sector in the past month (and the most since the market bottom in early March - not shown). The majority of the box is the brightest level of green (the brightest level green indicates a 6% or greater increase in the stock, and the brightest level red indicates a 6% or greater decrease in the stock. See the Heatbar below the first Heatmap to get a detailed definition of colors % gain or loss). I have highlighted one of the larger market cap stocks JPMorgan Chase (NYSE:JPM) to give an idea of how to read the Heatmap. The map is comprised of many different stocks, the larger the box the greater the market cap. As you can see JPM is just one of many stocks which traded higher than 6% in the past month from the financial sector.

    (click all images to enlarge)


    The second Heatmap below is a zoom in of the financial sector, and although it may look like only a few different financial stocks (due to identical colors), it is the entire financial sector (stocks included are the financial stocks which which have options available to trade). I have highlighted Bank of America (NYSE:BAC) to show just one stock which is up greater than 6% in this period.


    We can see the financials are extremely over heated on a 1-month basis, so if the market continues to sell off, I believe the financials will suffer the most. The strategy below will certainly help hedge against any financial positions or can be used as an all out speculative play if one is very bearish on the financial sector. The strategy below requires the knowledge of stock options, to learn more about this strategy, risks, pricing, calculations, other strategies, and options in general click here.

    The Trade:

    I have opened a diagonal put spread using the Direxion Daily Financial 3X Bull (NYSEARCA:FAS). I purchased the December 70 strike put options and immediately sold some October 50 strike put option against them. The December 70 Put option contracts were $1,800 a piece, and the October 50 strike put option contract was trading for $265 per contract (at the time of sale) making this spread net long $1,535 per contract.

    Possible Outcome:

    If the financial sector continues to sell off resulting in FAS to be at or below 50 at October options expiration, this position will help hedge my financials by returning 30.3%. If FAS does not trade below this level at October options expiration I will sell a similar put contract for the month of November. I have some December put option contracts which I have not completed a diagonal put spread on, but will look to do so on continued weakness, perhaps even for the September options expiration.

    I am long several financial stocks, therefore using this strategy will help me hedge against a sell off. I feel this is a much better strategy than going long the the Direxion Daily Bear ETF's such as the FAZ or BGZ, as increased levels of volatility cause these funds to decay over time as blogged about here. The FAS is a very hard ETF to sell short for this reason (decay), therefore premiums may be a bit overvalued at times. Longer dated put options on the FAS tend to hold their value compared to longer dated call options on the Direxion Daily Financial 3X Bear (NYSEARCA:FAZ), once again because they decay with increased levels of volatility.

    The ideas outlined above involve the use of stock options. The reason option volumes have surged in the last 5 years is because they are a great way to hedge your portfolio as well as create income off of your shares (see option volume chart)

    These are just examples and are not recommendations to buy or sell any security; if you're more bullish/bearish, you’ll want to adjust the strike price and expiration accordingly.

    Disclosure: Long AIG September 45 Put options, BAC, C, FAS December 70 Put options, Short BAC September 19 Call options, C September 5 Call options, FAS October 50 put options
    Sep 02 2:01 AM | Link | Comment!
  • Market Rally or Correction Ahead? Use an Option Strangle to Profit from Either
    It seems like yesterday when I was attempting to do some last minute studying for an Environmental Economics test but could not concentrate, because I was very distracted by the nightly news... Yes it was the Sunday night that Lehman Brothers expected to file bankruptcy the following morning, and Merrill Lynch was acquired by Bank of America (NYSE:BAC). I remember thinking how will this affect the market over the next day, week, month, year, decade, etc..., and will I ever get the job of my dreams on Wall Street?

    I am sure I'm not alone when I say, I never expected it to start the chaos it did on Wall Street. Luckily at the time I was very hedged, not because of my expectation for the entire banking industry to nearly collapse, but because I figured the high price of oil would slowly strangle the consumer and could cause a recession. I expected to see the market sell off causing the Volatility Index [VIX] to increase, so as a hedge I purchased out of the money October 30 strike VIX options for $25 per option contract, while the VIX traded below 20 in August. I never expected less than a month later my VIX options would increase more than 30 fold, but they did and I sold half of them while the VIX traded near 32. Selling half of my options resulted in a huge profit, and I couldn't lose my initial investment, so I decided to keep my remaining VIX options until expiration or sell them into strength. Over the next month I sold many of my VIX options for huge premiums helping to keep my entire portfolio profitable, and actually sold my final contracts the day before VIX expiration on October 14, 2008 for more than a 15,000% gain ($3860 per VIX contract), which if I let the options expire and settle for cash the following day (or traded them mid day) would have been even more profitable.

    As I noted in my blog post here, I believe the market is due for a pull back this fall, not because we are approaching the one year anniversary of that "study free" Sunday night, but because I believe we are too overbought on a short-term basis. I believe so much as a 5% correction will cause the VIX to spike, but VIX options are very expensive due to this speculation and due to the implied volatility being so high. Even far out of the money VIX options seem expensive (mainly because VIX above previously unheard of levels is now known to be possible).

    The strategy I have decided to outline today will profit if the market sells off like I expect, but will also allow for a profit if this market continues to rally through September. If we do get a rally which is very possible, the VIX options would most likely expire worthless. So, I will take a different less risky (in my opinion) approach to capture a large market sell off, while also being able to profit from a continued market rally.

    Examining the mean for the 25 Delta Call and 25 Delta put on three very active index ETF's we can spot which one is trading for the cheapest premium based on volatility.
    • PowerShares QQQ NASDAQ ETF (QQQQ) is the highest with the current mean at 23.40%
    • SPDR Trust S&P 500 ETF (NYSEARCA:SPY) is the second highest with current mean at 22.99%
    • Diamonds Trust DOW ETF (NYSEARCA:DIA) is the lowest with the current mean at 20.50%
    I chose to structure my option trade around the DIA as it is the cheapest based on volatility, and although the DOW is less volatile, if a significant move occurs in the market the DOW is sure to track closely to the other major indices give or take a few basis points. The trade outlined below requires the knowledge of stock options. To become more familiar with stock options check out my stock options trading E-Books here.

    The Trade:

    I opened a delta neutral strangle position for the October Dow Diamonds ETF (DIA). As the stock crossed 95.50 Friday, I purchased October 94 put options (Delta -0.429) and October 97 call options (Delta 0.419). I opened this position for $440 per option contract, and I strongly believe the Dow Jones Industrial Average will move lower by October options expiration by more than 5%, meaning this position will likely result in a profit. If I am wrong and the market continues this rally to the upside, a move greater than 5% to the upside over the next 45 calendar days will also likely result in a profit. Note that if the market moves sideways and the DIA ETF expires between the two strike prices indicated, the position will result in the maximum loss of 100% of the premium paid (in my case, $440 per option contract).

    This strategy should only be considered if one believes the market will experience a great move (either up or down), and should never be considered if a sideways move is to come.

    I believe the market will correct to the downside by 7%-10% before going higher into the year end, therefore I am long this option strangle for October. The optimal case for opening a long strangle option strategy like this would be a sell off, this is because as a sell off occurs, volatility increases [historically], causing option premiums to be priced even higher (all other things equal). Technically if volatility increases sharply without the market moving too much in one direction or another anytime soon, this strangle could also become profitable, but that is very unlikely and I am not opening it for that reason.

    If profitable I will look to close out of 25%-50% of my strangles Thursday before the unemployment numbers are released Friday morning. Although the contracts don't expire in September, it should cause increased volatility levels on the underlying, pricing these contracts slightly higher. If I can take a profit before the unemployment rate for August is released, I will do so and purchase them back on decreased levels of volatility.

    The ideas outlined above involve the use of stock options. The reason option volumes have surged in the last 5 years is because they are a great way to hedge your portfolio as well as create income off of your shares (see option volume chart).

    These are just examples and are not recommendations to buy or sell any security; if you're more bullish/bearish, you’ll want to adjust the strike price and expiration accordingly.

    Disclosure: Long BAC, DIA October 94 Put/97 Call Strangle, VIX October 30 Calls


    Sep 01 1:18 AM | Link | Comment!
  • Bull or Bear Market Ahead? Who Cares, Profit from a Rising or Falling Stock Market
    It seems like yesterday when I was attempting to do some last minute studying for an Environmental Economics test but could not concentrate, because I was very distracted by the nightly news... Yes it was the Sunday night that Lehman Brothers expected to file bankruptcy the following morning, and Merrill Lynch was acquired by Bank of America (NYSE:BAC). I remember thinking how will this affect the market over the next day, week, month, year, decade, etc..., and will I ever get the job of my dreams on Wall Street (which I am still looking for)?

    I am sure I'm not alone when I say, I never expected it to start the chaos it did on Wall Street. Luckily at the time I was very hedged, not because of my expectation for the entire banking industry to nearly collapse, but because I figured the high price of oil would slowly strangle the consumer and could cause a recession. I expected to see the market sell off causing the Volatility Index (VIX) to increase, so as a hedge I purchased out of the money October 30 strike VIX options for $25 per option contract, while the VIX traded below 20 in August. I never expected less than a month later my VIX options would increase more than 30 fold, but they did and I sold half of them while the VIX traded near 32. Selling half of my options resulted in a huge profit, and I couldn't lose my initial investment, so I decided to keep my remaining VIX options until expiration or sell them into strength. Over the next month I sold many of my VIX options for huge premiums helping to keep my entire portfolio profitable, and actually sold my final contracts the day before VIX expiration on October 14, 2008 for more than a 15,000% gain ($3860 per VIX contract), which if I let the options expire and settle for cash the following day (or traded them mid day) would have been even more profitable.

    I believe the market will sell off this fall, not because we are approaching the one year anniversary of that "study free" Sunday night, but because I believe we are too overbought. I believe so much as a 5% correction will cause the VIX to spike, but VIX options are very expensive due to this speculation and due to the implied volatility being so high. Even far out of the money VIX options seem expensive (mainly because VIX above previously unheard of levels is now known to be possible). Not to mention if the market continues to rally, VIX options would most likely expire worthless. So, I will take a different (less risky in my opinion) approach to capture a large market sell off, while also being able to profit from a continued market rally.

    Examining the mean for the 25 Delta Call and 25 Delta put on three very active index ETF's we can spot which one is trading for the cheapest premium based on volatility.
    • PowerShares QQQ NASDAQ ETF (QQQQ) is the highest with the current mean at 23.40%
    • SPDR Trust S&P 500 ETF (NYSEARCA:SPY) is the second highest with current mean at 22.99%
    • Diamonds Trust DOW ETF (NYSEARCA:DIA) is the lowest with the current mean at 20.50%
    I chose to structure my option trade around the DIA as it is the cheapest based on volatility, and although the DOW is less volatile, if a significant move occurs in the market the DOW is sure to track closely to the other major indices give or take a few basis points. The trade outlined below requires the knowledge of stock options. To become more familiar with stock options check out my stock options trading E-Books here.

    The Trade:

    I opened a delta neutral strangle position for the October Dow Diamonds ETF (DIA). As the stock crossed 95.50 Friday, I purchased October 94 put options (Delta -0.429) and October 97 call options (Delta 0.419). I opened this position for $440 per option contract, and if the Dow Jones Industrial Average moves by greater than 5% in either direction over the next 46 calendar days this position will likely result in a profit. Note that if the market moves sideways and the DIA ETF expires between the two strike prices indicated, the position will result in the maximum loss of 100% of the premium paid (in my case, $440 per option contract).

    This strategy should only be considered if one believes the market will experience a great move (either up or down), and should never be considered if a sideways move is to come. I believe the market will correct to the downside by 7%-10% before going higher into the year end, therefore I am long this option strangle for October. The optimal case for opening a long strangle option strategy like this would be a sell off, this is because as a sell off occurs, volatility increases [historically], causing option premiums to be priced even higher (all other things equal). Technically if volatility increases sharply without the market moving too much in one direction or another anytime soon, this strangle could also become profitable, but that is very unlikely and I am not opening it for that reason.

    If profitable I will look to close out of 25%-50% of my strangles Thursday before the unemployment numbers are released Friday morning. Although the contracts don't expire in September, it should cause increased volatility levels on the underlying, pricing these contracts slightly higher. If I can take a profit before the unemployment rate for August is released, I will do so and purchase them back on decreased volatility levels.

    The ideas outlined above involve the use of stock options. The reason option volumes have surged in the last 5 years is because they are a great way to hedge your portfolio as well as create income off of your shares (see option volume chart).

    These are just examples and are not recommendations to buy or sell any security; if you're more bullish/bearish, you’ll want to adjust the strike price and expiration accordingly.

    Disclosure: Long BAC, DIA October 94 Put/97 Call Strangle, VIX October 30 Calls, BAC September 16 Puts, Short BAC September 18 Calls

    Aug 30 2:24 AM | Link | 1 Comment
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