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spxtimer
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I’ve traded stocks since I was 16, and have gained and lost more than I am willing to admit. Twelve years ago, a friend asked me to develop a computerized trading system for him. He supplied me with trading software, piles of books and hundreds of articles. After mastering the software, I... More
My company:
Primata Funds, LLC
My blog:
Two Outstanding Stock Strategies Enhanced by Options
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  • Planning for an Earnings Report – a Protective Trading Strategy
    You have a nice profit after a great entry and a steady rise. However, you want wait to sell the stock until after the trade qualifies as a long term gain. However, the stock’s earnings report date is approaching and you are apprehensive. If the report is disappointing your stock could be downgraded easily. This short article describes a trading strategy for protecting your profit and increasing it in case the stock tanks.
     
    Let’s consider Check Point Software [CHKP]. Assume you bought 100 shares of it on July 30, 2010. That would have been a great entry because the price was $29.48 and it’s now $51.35. Your gain is close to 75%, $2187.00. For tax reasons you do not want to sell now. However, on this coming Friday, April 14, 2011 its earnings report is due before the open.
     
    You are concerned. While it’s a great stock, what if the report is disappointing? What if the run-up prior to the reporting date has made it over evaluated? Even worse, what if as a consequence Check Point is downgraded over the weekend? A downgrade could easily result in more than a 10% price drop on Monday, the 17th. A 10% price drop would be over $500 and would take away about 25% of your profit.
     
    At this point you should sell an Out-of-the-Money July 52.50 Call. It would convert your trade to a Covered Call and bring in $225 with the sale. This is inadequate for providing the necessary protection. Insurance, in the form of a $50 May Put will cost $137. The income from the Call will pay for this insurance. The purchase of the Put converts the Covered Call to a Collar.
     
    As long as you keep the Collar, your profit will be limited to $2380 no matter how much Check Point rises. But, your concern doesn’t relate to giving up additional potential profit. It’s focused exclusively on a possible downgrade. But, with this Collar, your profit cannot fall below $2130.
     
    If the earnings report is good and you feel Check Point has further to go, you can remove the Collar. This might cost $400-$500, depending on how well Check Point price responds to the report. However, the real opportunity arises if there is a downgrade.
     
    Assume its price has fallen 10% to $46.21. The Put you bought has gained in value. At the same time, the Call you sold has dropped from $2.25 to $0.46. You can buy an additional Put, the May $45. Its cost will be about $110. Your net option expense would be near $25.
     
    If the price stays at $45 or higher, your maximum profit would be limited to $2020. With the downgrade it’s much more likely the price will continue to fall. But, with this additional Put, your income would start accruing at a rate of $100 for each $1.00 in price drop below $45.
     
    With this not-so-rare scenario, maybe bad news can be good news.
     
    Let’s recap. When you hold a stock that you don’t want to sell and a situation arises that could threaten your profit, a Collar provides an inexpensive trading strategy for protection. If the threat materializes, you do not have to bail out. An additional Put allows your profit to grow further if the stock reverses.



    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Apr 10 10:23 AM | Link | Comment!
  • Why Trade Leveraged and Inverse ETFs
    This article aims to explain the what, the why, and the how-to-trade of leveraged and inverse ETFs.

    What are Exchange Traded Funds?
    Exchange Trade Funds (ETFs) are cousins of mutual funds. They correspond to baskets of stock that are bought and sold like stocks. Generally, there is a one day delay after a sell order is placed on a mutual fund; ETF sell orders are executed immediately during hours. During a market crash this difference could be significant. There are other advantages. Except for brokerage fees for trading ETFs, there are none of the maintenance fees associated with mutual funds. Also, there are no loads [penalties] associated with opening a mutual fund account.
     
    What is a Leveraged ETF?
    Over the past few years, a new class of ETFs has emerged - leveraged ETFs. To help you to understand leverage, let’s use an example: Let's say we have two equities, ABC and XYZ. For every change in the price of ABC, the price of XYZ changes double the percent move in the price of ABC.  If ABC were to change 5% then XYZ would change 10%. Notice this does not imply if ABC were to change by one dollar that XYZ would change by two dollars. It’s the percent change that matters, not the dollar amount.
     
    In the past, it was common for investors to employ margin in their NON IRA accounts. You are not permitted to use margin in an IRA account. Margin let’s you borrow money from your broker at a percentage rate. Once the margin account is opened and operational, you can borrow up to 50% of the purchase price of a stock.
     
    Here's an example. Let's say you want to buy $20,000 worth of Company A stock, 50% of it on margin. That means you need to have at least $10,000 cash in your account, allowing you to borrow the other $10,000. Just like a bank, your broker will charge you interest on the loan. Rates vary between firms and can depend on the balance in your account as well as the current interest-rate environment.
     
    In the past you had to use margin in order to obtain leverage in your NON IRA account. Leveraged ETFs are structured so that no fee is involved. Generally, when you find a leveraged ETF its underlying ETF is a broad-based index.
     
    For example, SPX is an ETF that represents the S&P 500. SSO also represents the S&P 500. However, it is leveraged 2:1 compared to SPX. That means that if SPX goes up 2%, then SSO goes up 4%. You get the leverage you are after without borrowing from your broker. Additional fees are not incurred. Furthermore, buying these leveraged ETFs is allowed in an IRA account.
     
    YTD SPX vs SSOThis chart compares the year-to-date performance of SPX versus SSO. SPX has a gain of 3.77% while SSO has gained 8.13%.
     
    Another example of a leveraged ETF is UWM. UWM moves twice the percentage move of IWM.  By the way, IWM is the Russell 2000. The Russell 2000 is made up of two-thousand stocks and represents a broad portion of the stock market.
     
    Want more leverage on IWM? Buy TNA and get three times the move of IWM. 
     
    What is an Inverse ETF?
    Another new class of ETFs has emerged, called inverse ETFs. An example of an inverse ETF is TWM. TWM represents the Russell 2000 but it moves inverse to IWM. For example, if IWM goes DOWN 2%, then TWM goes UP 4%. Now you can play a down market even in your IRA
     
    UWM and its Inverse TWMThis 3 year chart displays the leveraged UWM with its inverse TWM. When one goes up the other goes down.
     
    Want more inverse leverage? Use TZA. TZA is an inverse ETF that represents IWM, (Russell 2000). If IWM goes down 3%, TZA goes UP 9%. During the market collapse in 2008, those who held TZA made a fortune.
     
    Why Use Leveraged and Inverse ETFs?
    You might think trading leveraged ETFs is dangerous. However, as I mentioned above, they correspond to broad-based indexes. In comparison to trading stocks, these are much better behaved. Even stalwart stocks like GE have lost fortunes for their investors over the past few years. There are dozens of stocks that we all know which behaved similarly. Buying stocks means that you have to be a good stock picker.
     
    How many of us are good stock picker's? I know I'm not. Usually investors pick stocks because of company news. Unfortunately, by the time you learn the news, half the world already knows about it. Of course, you can make a good profit by choosing a winner. Instead, many prefer leveraged ETFs, both for their safety and profit potential.
     
    The government discourages investors from shorting the market. In a down market, those with retirement accounts had only two choices: either staying cash and be protected or hold your investment and watch its value diminish.
     
    Inverse ETFs solve this problem. In a falling market you can close your long positions and buy inverse ETFs like UWM.
     
    Compounding
    The most important reason for trading in bear markets has to do with compounding. To keep things simple, let's assume the market is bullish half the time and bearish half the time. In addition, assume we gain 5% in consecutive periods. The net profit if you had only traded in the bull market would be 5%. However, if you had traded in both periods your net profit would not be 10%. It would be 10.25% because of compounding. Over time, the small difference would become significant.
     
    How to Trade Leveraged and Inverse ETFs
    I use three guide posts to trade these ETFs: a good market timer, an entry condition to ensure the ETF is moving in the same direction as the market and sound money management. Collectively, these three principals have eliminated draw-downs associated with leveraged ETFs. As a result, I've been able to sleep well at night while generating good profits during the day.
     
    You can tell by these charts that leveraged ETFs are significantly more volatile than their underlying broad-based indexes. You will not succeed if you try to apply your trading strategy to them. Instead, keep applying it to the index. Simply trade the leveraged instead of the index.
     
    SPXTimer.com provides unique strategies for trading leveraged and inverse ETFs. These strategies combine sound money management with a timer based on both market movement and sentiment.
     


    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Tags: ETF
    Feb 28 11:13 AM | Link | Comment!
  • Emerging Markets – the S&P 500 on Steroids
    Trading Emerging Markets is a challenge. Every trading analysis method I had tested was a terrible failure.  I could not eke out any gains without experiencing unbearable draw downs.  Because of the volatility of the emerging markets, represented by the ETF named EEM, the draw downs were much too large for any sane human to trade.   (Draw down is one of the most important factors to consider, in my opinion.  People come up with amazing trading systems that make a good deal of money, but only a computer can trade them.  A human, with his emotions, would never be able to take the next trade after experiencing a huge loss or series of large losses.) 

    Many mutual funds use the S&P 500 as their benchmark. Yet, few of these funds have an historic performance record superior to the S&P 500. This is one indication that the S&P 500 is not easy to trade. Given these facts, successfully trading EEM appears to be an insurmountable challenge.

    However, this article presents a proxy strategy for trading EEM using an already successful strategy used to trade the S&P 500.  The S&P 500 strategy, trading the ETF, SPX, employs money management and market timing to capture excellent returns. An adaptation of this strategy is employed for trading Emerging Markets to achieve outstanding returns without suffering serious draw down. 

    Chart shows the relative percent movement between SPX & EEM.

    5 Year Daily Percent Gain Chart of SPX [black] vs EEM [green]
    SPX is a stock symbol for trading the S&P 500; EEM is the stock symbol for Emerging Markets.

    If you study the relative movement of these two items in the above chart, you will see that EEM [green], moves in the same direction as the SPX [black], but the movement is exaggerated.  However, their peaks and valleys line up relatively well.  It is difficult to predict the extent or amplitude of the relative movement, but the prediction of the direction is solid.   

     In summary, we can say:

    • EEM is much more volatile than SPX.
    • EEM tends to move in the same direction as SPX.
    • The relative price change of EEM is uncorrelated relative to the corresponding change of SPX.

    I use a proprietary market timer based on several factors related to the S&P 500. Other market timers may also work. The key to trading the S&P 500 is the following money management strategy; stop-losses are not employed.

    The market timing strategy is straight forward:

    • When the timer is bullish buy EEM when it starts moving up.
    • When the timer is bearish, short EEM when it starts moving down.
    • When the timer is neutral, stay on the sidelines in cash.

     

    In bear markets EEM is shorted. This is not permitted in IRAs. However, EEM has an inverse ETF, EUM. Rather than short EEM, buy EUM. This eliminates the IRA restriction.

    Here is a brief description of the adapted money management strategy:

    • When the SPX has gained 5% from its start at the market timer signal, sell 25% of your EEM shares. 
    • For each subsequent gain of 5% of the SPX, sell half the remaining EEM shares.

     

    Note: this is the identical money management strategy used to trade leveraged ETFs for the S&P 500. Except in this case, we are substituting EEM for trades of the ETFs.

    This strategy was back-tested 11/22/06 to 11/18/10.

    • $100,000 grew to $356,850
    • Average Annual Rate of Return = 64.39%
    • Maximum Draw-Down = -7.15%
    • Percent winning trades = 84.62%

     

    If you were among the many whose equity suffered in the 2008 market collapse, this strategy should be considered.  If you like a more consistent, less exciting, easier to trade strategy, you should probably look at trading SPX using a timer with the proper money management.

    In summary:  We tame the violent moves of EEM using SPX as a trading proxy.  Using the same market timing and successful money management strategy that we use to trade SPX, we can trade EEM. 

    My web site, SPXTimer.com is dedicated to assisting investors sharpen their investment performance using the SPXTimer linked with proven money management. We aim to achieve outstanding gains while maintaining safety primary. See our ETF Trade Performance.

    Many of our strategies have been developed primarily for IRAs. These strategies show you how to safely profit in both bull and bear markets. Our market timer is unique because it includes market sentiment when calculating the market direction.



    Disclosure: I am long EEM.
    Tags: ETFs, Market Timing, Money Management
    Jan 08 12:43 PM | Link | Comment!
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