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The Deliberate Trader
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We are semi-professional traders. By that we mean that we are accomplished professionals in other fields, who have gained knowledge, skill and experience at trading the markets almost as a matter of self-defense. We were dissatisfied at the way fund managers, investment “professionals” and/or... More
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The Deliberate Trader, LLC
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  • Using Option Implied Volatility To Enhance Probability, Control Risk

    Trading is about two principles: probability and risk. This largely consists of identifying scenarios that put you on the right side of the probability part of the equation, as well as formulating and managing contingency plans for mitigating the effects of adverse development in order to control the risk of loss.

    Using options as a tool to enhance probability and control risk gives many traders who use them an edge over traders who do not or cannot. However, the successful options trader must understand the impact of implied volatility, a key component of option pricing. Without this understanding, options can be misused like any tool; and if misused, options can contribute to the risk of loss.

    On October 15th we attempted to do this trade:

    Buy AEGR stock at 16.00 or better with half a position. Sell AEGR November 17.50 calls for 3.35 to cover the stock. Sell AEGR November 12.50 puts for 2.65 with half a position.

    This was the scenario:

    • The stock had traded in a sideways, coiling $5.50 range for more than a year, narrowing to an even tighter 3.00 range in the last several months;

    • Two days later, on October 17, 2012, the FDA would hold an advisory committee meeting for AEGR's drug Lomitapide. The drug is intended for the treatment of genetically high cholesterol levels. During this meeting, a panel of medical and scientific experts would vote to consider the benefits of Lomitapide, along with associated issues and concerns;

    • It was widely expected that this meeting would be favorable (or at least not unfavorable) for the prospects of Lomitapide's eventual approval;

    • Technically, the charts for AEGR showed strong support in the 13.50 range with higher highs going back six months;

    • Most importantly, the anticipation of the October 17th meeting contributed to extremely elevated option implied volatility levels, making the sale of option premium clearly favorable.

    Accordingly, we structured a trade that took advantage of the probability that the stock would continue to rise, and took further advantage of the opportunity afforded by the stock's very high option implied volatility to enhance the probability of success, and importantly, to control the risk of loss.

    Attempting to purchase the stock at 16.00 put us in position to take advantage of the anticipated favorable news. While selling the 17.50 calls capped our potential profit, the premium was so highly elevated that if the shares were called away, it would have been as if we had sold them at 20.85. This would have been a stunning 36% profit in one month.

    More importantly, selling the 12.50 puts protected us from the risk that the stock might sell-off due to unexpected adverse developments, or the possibility that the favorable news might already be fully baked into the stock price. Combined with the 3.35 call premium, the 2.65 put premium would protect our share purchase at 16.00 all the way down to 11.25, well below the trading range of the past year.

    In the event (nothing in trading turns out exactly like we plan or expect), on October 15th AEGR opened higher with a 1.89 gap. This put the stock at 17.85, well beyond our planned entry point. Instead of giving up on the trade, we decided to make an adjustment to the plan. We purchased the stock at 17.50 and also sold the November 17.50 call for 3.50. Again, while this capped our potential profit in the trade at 20%, this was still a trade well worth doing, as the annualized called return is 240%.

    In order to provide additional protection from the risk of loss (selling the calls protected us down to a price of 14.00), we expected to sell puts under support in the event the stock price quickly retreated to previous levels. Of course, the stock price has not retreated, so we missed out on this potentially valuable leg of the trade. However, we will happily accept our 240% annualized return when the stock is called away tomorrow.

    Disclosure: I am long AEGR.

    Additional disclosure: After option expiration tomorrow, our shares will be called away and we will be flat as to AEGR. With the FDA approval event coming next month, and the market anticipating approval as evidenced by the recent rally, exiting the market at this time is an excellent technique to control risk.

    Tags: AEGR
    Nov 16 2:28 PM | Link | Comment!
  • UXG: Can We Buy It At A Better Price Than Rob McEwen?

    UXG: Can We Buy It At A Better Price Than Rob McEwen?

    Looking for a potential long term investment in a junior gold miner at this stage of the game carries significant market risk with gold trading near all-time highs, and the stock market perched precariously near highs not visited in nearly three years. Managing risk is the key to successful investing; and there is not much better endorsement for the future success of a company than a CEO who has a proven track record, reportedly takes no salary from the company, and owns a full one fifth of its equity.

    US Gold (UXG) is engaged in the exploration of gold and silver in Nevada and Mexico. The project in Mexico now has a resource of over 60 million ounces of silver; and the company recently released a preliminary economic assessment targeting production of 5 million ounces silver and 50,000 ounces gold per year by 2014.

    We consider insider buying as one of the best leading indicators for the future performance of any company. Impressively, the Chairman and CEO, Robert McEwen now owns more than 20% of the company after he acquired almost $20 million of its stock at $6.50 a share pursuant to a public offering that closed last week. The company obtained net proceeds of more than $105 million pursuant to the public offering. The company intends to use the proceeds from the offering to bring the project in Mexico to completion. Normally, a dilution of stock is the bane of mining company shareholders; and this time may be no different. However, McEwen's substantial transparent stake taken at $6.50 a share is a signal to shareholders that the risk may be well worth taking.


    McEwen has been the Chairman, CEO, and largest shareholder of US Gold since July, 2005. Previously, McEwen was the founder, former Chairman and CEO of Goldcorp Inc. U.S. Gold's website states:

    “During his tenure at Goldcorp, McEwen transformed the company from a collection of small companies into a mining powerhouse, growing its market capitalization from US $50 million to approximately $8 billion. More importantly, the shares of the company produced a compounded annual growth rate of 32%.”

    We think that the combination of leadership, participation in the risk by management, no debt on its balance sheet, and assets in the ground make UXG a compelling long term investment. But how can we accumulate its stock and get a better deal than Rob McEwen?

    Try this:

    1. Buy UXG stock at $7.20 or better;

    2. For every 100 shares you buy, sell 1 January 10.00 call for .75 cents;

    3. Additionally, for every 100 shares you buy, sell 1 January 5.00 put for .55 cents.

    Here's how this may work out:

      • UXG trades between $5.00 and $10.00 between now and mid-January 2012, the options all expire worthless and you're left holding your UXG shares at an average price of $5.90; or

      • UXG trades above $10.00 in mid-January 2012, the calls are exercised and your stock gets called away at a profit of $4.10, including the option premium; or

      • UXG trades below $5.00 in mid-January 2012 and your stake in UXG is doubled at an average price per share of $5.45.

    In each scenario described above, your net entry price per share is less than that recently paid by Rob McEwen. Of course, in the first scenario above, if the stock trades between $5.00 – $5.90 at option expiration, you would be holding at a loss. However, it would be no more than .90 cents per share. Similarly, if the stock is put to you in the third scenario, you would be holding at a loss of at least .45 cents per share; and the real risk to the trade is if the stock price collapses.

    Under the second scenario, your $4.10 profit on an investment of up to $12.20, assuming your put sales are fully covered by cash, is an annualized return of about 36%. Therefore, we like the risk/reward profile in the event the stock gets called away..

    The implied volatility on the option premium, while not irresistibly high, is acceptable. The chart picture for UXG is mixed. On a point and figure chart, the stock is performing relatively well against its peers. On a candle chart, there is a band of Fibonacci and chart support between $6.50 – $6.00. The next area of Fibonacci and chart support is at $5.30. If we do not take a full position with the initial trade, an adjustment can be made at the $5.30 level to reduce the average entry price to below $5.45 per share. You can also make adjustments to the initial entry points to suit your risk tolerance as the market moves up and down. You just have to be nimble.

    Without the recent position taken by Mr. McEwen at a share price of $6.50, the suggested trade might be considered aggressive. While there are more conservative ways to trade this, including sitting on the sidelines awaiting a retracement, it fits well within our strategy to control risk.


    Mar 01 10:40 AM | Link | Comment!
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