wisdom from mike on the ctm condor

John,

 

If you follow these threads on the CTM IC back to January you can glean more of the thought process that goes into trading the CTM but I will summarize some of them quickly here.  From your email I think you already "get" the main reason to trade this CTM from my viewpoint, less/more controllable risk.  Note what Vikas and others have stated there really is no "right or wrong" way to do this.  There are however, some basic premises that I go into the trade with each month.  I know that if I collect about 40% of the spread width in premium: $4 on a $10 RUT spread I have the ability to make certain adjustments if the trade goes against me.  The most basic way to adjust/protect the CTM if your trade is going against you is to BTC the endangered short vertical when the index reaches that short or actually trades past it a little.  If you look at your TOS option pricing for verticals you will see that the ATM verticals trade for about $5, give or take a little.  If you do nothing after collecting your initial credits but sit and wait for the index to attack your short verticals you can always pull the trigger and pay the $5 to buy back the endangered vertical.  You took in $4, paid $5 to close so you are down $1 with no more risk on one side.  Note you still have risk in the other direction and you will have to decide if you want to BTC that side based on cost, time to expiration etc.  These are all round numbers but you get the idea.

 

Your next step will be to decide if you want to sell another vertical further out to bring back in some credit and eliminate your $1 loss zone.

 

Note that to BTC your short vertical for $5 is usually a last resort type of adjustment.  It often pays to close your trades early for a profit, make other adjustments like buying calendars, verticals, butterflys, roll out or up etc.  I am of the school that believes that you try and make as few adjustments as possible.  When you put the trade on you have a certain probability of success, if you sell your IC for $4 you have a 60% probability.  If you leg in and get a wider spread width and still get $4 premium you have a higher probability (you can estimate probability of your legged in verticals by pricing them as an IC, say they are only worth $3 as an IC, that would give you a 70% probability).  Generally when you are short premium you want to delay/minimize adjustments to take advantage of your probablity and time decay. 

 

As others have stated you really need to have a plan of what you are going to do when your position is threatened because as we saw this week crazy things do happen and your position will be threatened.  Up 300 Dow points on Thursday;  down 400 on Friday and we are trying to trade a market neutral strategy????  Are we crazy????

 

Time will tell on the crazy part but if you control your risk and manage your money properly you can make money trading.  No matter what trading strategy you use you have to ask yourself what is the max loss I can stomach/afford?  What is your personal burn rate before you go out of business?  Adjust your trade size and portfolio risk accordingly.  As an old friend of mine kindly told me once when I was trying something pretty dumb and risky;  "People in small boats should stay close to shore".  I still use my friends advice to temper my "enthusiasm" when I get a little ahead of myself.

 

Happy sailing!

 

Mike

10/9 john n to marketstudent

10/8 John N  to marketstudent: As far as the risk graphs go, I generally don't use them.  I calculate the risk I'm taking when I plan the trade in my head using the simple math (planned credit received subtracted from the difference between short and long strikes).  And I don't like to go that far OTM...so I don't need to see where the one std dev point is.  I just look at the chart and try to determine S/R (or the formation of a lower high, higher high, lower low or higher low - all depending on the trend) and then sell the strike just beyond that high/low (or maybe two strikes, depending on the premium).
Generally speaking, if I need to see the risk graph to understand what's at stake with my trade, then it's getting too complicated. :-)  I try to keep things as simple as possible.  I realize that if the underlying begins to move a little too close to my short strike there are a number of defensive plays I can do, such as buying one strike closer than my short strike to turn that side into a butterfly, or add an additional long position to the long portion of the credit spread that is threatened, or buy the same strike that is short but an additional month out to turn that strike into a calendar with the long strike from that credit spread just below it.  The list goes on as we know.  But that gets too complicated for me.  I just sell a credit spread beyond S/R and if that S/R is violated enough that the basis for which I entered the trade has then been proven incorrect, I buy the whole spread back and wait and look for a point to reenter that side at a more strategically advantageous point.  And the second part of that previous sentence is where the trick lies. :-)
I'd be very interested to hear your thoughts on all this. I'm sure you (and Vikas as well, LOL) have many.
- John
---
Greg,
I have read Dudella's book so much that the binding is almost worn out.  But it's been awhile and I need to go over it again.  And your assessment is spot on!  I entered too early...that was flaw #1.  Flaw #2 though is that I set my stop at the right place, but just a little too tight, so to speak.  I always try to set a point, down to the penny, at which if that point is breached, then the basis for which I entered the trade has been proven incorrect.  Then I establish some "leeway" around that point and set my stop beyond that.  And I try to make it as random and arbitrary as possible.  I do this for the specific purpose of not being caught on a fishing expedition (whether it's legit or just the market doing what the market does).  For example, if you look at the chart and see the spinning top that formed right at the 100 SMA ($56.20), I set my stop, I believe, at $55.87.  The low of that spinning top was $55.33.  And considering my short strike was $54, one could argue that my stop was too tight.  However, I think I can also argue that the stop was set right and that I was legitimately taken out and that's just the way it is sometimes.  If you really look at the candles on a day by day basis from that spinning top on, there really isn't a good reentry because ideally, one could have had a great reentry if the day following that spinning top was an "up" day where the close was higher than the high of the spinning top.  I actually think the reentry trigger came on Thursday, but I had no internet so I couldn't take advantage of that.  Plus, with it being late in the opex cycle, the premium may not have even been worth it to sell a spread with the short strike just beyond the low of the aforementioned spinning top.
Thanks for your response!
- John

nov investors intelligence ideas

Equities – Technology

In November 2008, the NASDAQ 100 (NDX) was one of the first major US indexes to bottom. Others had to wait until March 2009. Leaders in a rally are often the leaders in a decline, so this index is an important one to follow.

During early October the index tested 1773, an important Fibonacci level as it represents a 61.8% retracement of the whole decline from the 2007 high. The level also coincides with a resistance level just overhead at 1800. The next Fibonacci retracement level stands at 1978, a level that also coincides with a lateral chart level, the top of the August 2008 level.

The uptrend still remains up as the series of higher highs and higher lows still stands. That series came close to an end with the drop in the final week of October but the last pivot low at 1656.57 from Ocotober-2 looks to of survived by the skin of its teeth. Providing there is no sustained break of that low, the trend is expected to continue to test the target of 1978 proposed above.

Finally, note the lower chart window which shows the performance against the broader market. The NASDAQ has been outperforming impressively and for those who like to cherry pick their stocks, the technology area is where the tastiest fruits are to be found.

Commodities - OIL

We looked at front month NYMEX Crude Oil (CL1) in the September report. At the time oil was trading at $69 and here is what we had to say:

“This (momentum) should provide the slack for another attempt towards the 38.2% Fibonacci level at $76.28. Fib tests are rarely perfect so there could even be a price spike up to $80”

The price did manage a spike up to $80, occurring last month, hitting $82 on October-21, but where does Oil go next?

Fibonacci retracements tell us the next levels to watch are $89.83 and then $103.39, 50% and 61.8% retracements of the sharp 2008 decline. To achieve those levels the uptrend needs to hold. A strong indication that the uptrend is holding up would come from no sustained move beneath $75 over the next few weeks. Providing that happens, the up trend should resume into the year end.

The Chinese Renminbi - the first great trade of the next decade?

With the benefit of hindsight, just one good trade a decade would be enough to make us all wealthy men..... buy gold in the 70’s, Japan in the eighties, tech stocks in the 90’s and property this decade. Of course, you would have to take profits at the right time in all of these asset classes - so that’s getting it right twice!

However, these trades look relatively easy to identify when looking back through the mists of time. Frequently, the best entry point would have been just before the turn of the decade, so are there any "obvious" trades staring us in the face as we roll into the next ten year period?

Colleague Jackson Wong thinks that the Chinese Renminbi (also known as the Yuan) fits the bill. The currency continues to be pegged against the US dollar, with only minor revaluation over the last few years. But can this last? The economic fundementals for a RMB revaluation are compelling. Here are Jackson’s arguments:

GDP: China is racing ahead (expanding); US is slowing down (contracting). Implications: Chinese economy is inflationary; US deflationary. Thus, theoretically, the RMB should go up against Dollar, as both economies adjust. For example, higher inflation -> higher interest rates. Attract capital inflow.

But, the RMB is pinned down. Because of the peg, when USD declines, RMB declines. To shed some light on where the RMB might trade at if not controlled: the Brazilian trade weighted exchange rate is up almost 30% against USD this year.

For the US, a depreciating USD is logical since the country needs to increase exports and reduce imports. So Bernanke prints like mad. However, for China, to maintain the peg results in massive credit creation (via stimulus). But does China really need so much stimulus? Excessive credit creation creates one big problem: Inflation. In China, inflation is taking place in both assets (property and stocks) and consumption sectors. Also, excessive credit lowers returns on projects and increase bad loans.).

To control inflation, China may well need to revalue the RMB at a higher level over the next few years.

So how might one play this trade? The plan is to harness the appreciation of the Chinese Renminbi against the USD, but how can a US-dollar based investor achieve this? Luckly, there is an ETF that can offer this exposure. In our ETF portfolio this week we opened a long position in the WisdomTree Drefus Chinese Yuan Fund (CYB).

Having covered the NASDAQ index earlier in the report, we thought it useful to take a look at its internals via the NASDAQ Bullish %. This indicator is a Technical Analyst’s stethoscope, providing a clean overview of market health.

For those who are unfamiliar with the indicator, a bullish % chart measures the percentage of point & figure bull trends amongst an indexes constituents. The mechanics are not just applied to indices but also industries, all of which are available on the Investors Intelligence website.

The NASDAQ Bullish % shows that the late October pull back caused a correction in the breadth. The correction was necessary following the incredible 24 ‘X’ boxes in a row run. Looking back to the period following the 2003 bottom, the bullish % chart reversed in October 2003. It then dropped 4 boxes before reasserting to a new high at the end of 2003. So nothing untoward about the pull-back we have just experienced and if history repeats, the NASDAQ should firm into year end.

etf website

Bernie Schaeffer ETF Center

10/4 dan fitzpatrick assesing the XRT retail rally

more [mc] on adjustments

more mc on adjustments:

[mc]: The more I do this, the more I just wind up looking at prices (of options) as trigger points for adjustment.  When I am in a winner I look for a point where I can turn the trade into a risk free winner (i.e. no downside with some residual profit potential). When the trade is a loser I just put on my “inside out hat” and look for points where someone holding the opposite side of my trade can turn that into a risk free position; if that point is triggered, I know I have to make some kind of defensive move.

Example: let’s say you enter a +45/-50/-55/+60 call condor for $1.00 debit.  if at some point either of the short embedded flies (-45/+2 50/-55  or -50/+2 55/-60 call flies) can be traded for a $1.00 credit, then that is the point to act on sewing up the trade. So if that 50/55/60 fly can be sold for $1.00 you net into the +45/-2 50/+55 fly for zero debit. it makes no difference that for this to happen that the underlying is probably out of the resulting fly profit zone (probably somewhere around 55 strike). What it means in terms of sound trading is that you just freed up capital and left yourself with a reasonably decent core position that might pay off handsomely. You then can redeploy your original $1 risk (or some fraction of it) to start a new component  of the overall position. lather, rinse, repeat.

Conversely, say you are in that same +45/-50/-55/+60 call condor for a $1.00 debit. if at some point the 45/50 vertical can be bought for a buck, then that’s the time you have to make a defensive move. The figurative person holding the opposite side of your condor could thus buy in the risk of the 45/50 wing and net into the +55/-60 vertical for a riskless, zero debit. since you are on the defensive you need to assess various strategies but to give yourself any chance of winning in this position you have to take on some risk. a possible trade adjustment is to add the +40/-2 45/+ 50 fly or, if possible for no additional debit, something like the +40/-2 45/+55 unbalanced fly. These defensive moves obviously add risk but when faced with a losing situation, you need to act decisively. The fact that your virtual counterpart “the market” has been given a risk free trade at your expense is the only message you need to heed the call to action.

[rj] Michael, I am a bit confused by this. Is the essence of the above:
"My original position is now worth less than what I paid for it. Thus
I have to either close it out at a loss or make some adjustment (e.g.,
extend the condor at the risk of losing even more than the original
debit) to stay in the game"?

[mc]: No. I'm offering my personal perspective on WHEN to make an adjustment. What
kind of adjustment to make (and closing the position is one alternative) is
another discussion. My point here is that there are pretty clear times that
the market is telling you that your position is in deep doo doo. The
rationale here is that you don't need to make any kind of exotic or
arbitrary or assumption dependent decision. Based on the pure market
conditions and a rather easily pre-determinable (if that's a word) criterion
- namely the prices of other relative options - you are well prepared for
working through most market conditions. With a winner the it might seem a
bit cleaner but with a loser the same dispassionate approach could, and in
my opinion, should, be followed. Even though the condor in my example would
still have some value, the point I was trying to make is that a proactive
trader wouldn't just sit, wait and hope that things might reverse or
improve. As is always going to be the case with a loser, you have to decide
whether to realize the existing loss and close the trade or seek to modify
the position so that you have a fighting chance for profit. Adjustments with
a loser always involve adding risk either by reducing the reward for risk
ratio or by adding overall risk (or both of these). Whatever you do at the
trigger point is of course what defines you as a trader and what will
ultimately either make or break you. I'm just tossing out a method or tool
that can help very definitively define when that trigger point is reached.

11/3 GBP/USD short

11/2 [shadowtrader] The GBP/USD’s broke below its wedge pattern and has risen to retest the wedge support as resistance. We are going to short this tonight with a slight rise. This is a sell limit at 1.6400, with a target of 1.6050 and a stop loss of 1.6540. We will only take 1 mini contract for the time being.(below). 

11/3 sto 1 @ 1.61418