Commentary
Have made, and been making, lots of changes to our trading approach. I hope
I'm not destroying our core strengths by doing so -- the point of the
changes is to shore them up. I'm simply not satisfied running, as it were,
about neck and neck with the S&P. The rub is, in order to increase our
returns we have to take on more risk. That's the way it is with life and it
certainly is the way with investing. For example, in life you may be faced
with the prospect of a new, higher paying job but it is in a different
state. How will you and/or your family adjust to your new environment and
will the new job work out?
In investing we face the same dilemmas, only more frequently. As frequent as
each position that we enter and exit. If I increase my time-stops, say from
21-days to one month, I face the prospects of allowing my option to ripen a
bit more for more profit, but at the same time expose it to some sort of
adverse surprise such as an oil-well blowing up in Nigeria, a competitor
announces a break-through making my company's main product virtually
obsolete, or just that the CEO of my company and his secretary have
disappeared. Somehow I have to balance all this and that's where I'm hoping
probability theory helps and that I don't find myself on the wrong side of
the probabilities, abnormally too frequently. Btw: one of the changes
implemented is that I did increase the time-stops to one month. Here's why.
Time-Stops
Since options always expire at a certain date in the future, and since I
write/sell options, this means that if the stock doesn't move much up or
down by expiry date, I will have earned the entire premium that was paid to
me at the outset. In effect we can consider that the option kind of
decreases in value day by day until it reaches zero at the expiration date
and since it is worth nothing, I get to keep the 100% of the premium paid
me. It's sort of the same concept as depreciation on you car, which attempts
to measure the decrease in value it suffers from the moment you drive it off
the dealer's lot. Another word for that decrease could be "Decay". But...
With options, the decay is very small the first day, but increasingly gets
larger and larger each day until expiry day when it becomes 100% of whatever
value remained. Here's a picture of what I just said (double-click icon,
below, for picture):
Notice how QQQQ (ticker symbol for the Nasdaq 100 ETF) chart shows an option
decay line that curves upward.. We're looking at the chart from the eyes of
the buyer of the put option. From my eyes, I would see the chart flipped
along the (imaginary) horizontal line passing through 0.00 in the upper
right hand corner of the chart. Therefore, from my eyes I would see the
decay going downward. In either case, the option was opened on 2/2/2007 and
is due to expire on 2/16/2007 on the chart.
The curvature is small in this example because we are dealing with an option
that's about to expire in about two weeks. The curvature is more pronounced
in longer term options In this example the buyer had to pay me (as the
writer of the option) $0.44 per contract ($44 in real terms). He/she hopes
to make money if the value of the option increases beyond $0.44 faster than
the decay can reduce it. (e.g. he/she would like to see the value go to,
say, $0.88 by expiry date so that their investment would double. This can
happen for assorted reasons not the least of which is that the value of the
underlying ETF (QQQQ), decreases in value by expiry date. But if nothing
happens, or QQQQ increases in value, I can look at the chart like it was
money in the bank. (which it is, in this example, by the way).
Net Liquidating Value (NLV) Portfolio
Changes
First, lets explain a couple of changes in the table. All of the January
rows have been removed except for 1/31/2007. Since end of month numbers
reflect YTD standings, we retain them in the table for comparison purposes.
We change the background color for historical month ends to yellow to help
the eye distinguish a month end set of numbers from a quarterly (background
in orange) from current month numbers (background in white).
Second, I've added a column at the end of the Closed Transaction side on our
actual wins and losses to give us a feeling of how we've been doing YTD as
measured by the "cash register" rather than the S&P. In the longer run, our
paper profits & losses should correlate with the Closed Transactions side.
So we can think of the Paper side as a predictor of sorts of the Close side.
I'd been trying to figure out a good way to summarize our work when I ran
across an article in SFO Magazine (stands for Stocks, Futures, & Options) by
Robert Deel. I'd never heard of him but a quick google check showed that he
had some gravitas in the options field. His article will need a closer
reread by me as there are some other benefits besides the rating, that may
be able to help me pinpoint other areas in my trading approach that need
improving. The only change I made to his numbers is that I translated them
into English so that you don't have to keep flipping back and forth to
another table to determine what they mean.
So the underlying numbers are his but the English translation is mine. Deel
says that "You should strive to achieve a score of at least [Good]." As to
my Rating description of "Rare and 'Cosmic'", I derived that from his
statement about ratings in excess of a certain number when he said: "Over
time a score of [Rare & 'Cosmic'] will be a rare occurrence. Hence I added
the word "Cosmic" to connotate we might break open a bottle whenever (if
ever) we attain that rating again. (but make my bottle V-8, please <g>). To
read the other possible ratings, read the header description, above.
Paper Profits Table
Well, the NLV Return broke the 20% psychological barrier, today (Friday).
But the scampy S&P bolted ahead to 23.47%, a little less ahead of us than it
was Thursday. Frankly, if our tortoise has got to lose to the S&P Hare, let
it be in the 20%+ region or more. But I don't want to LOSE!
Closed Transactions Table
We did fairly well across the board. Our Avg Win, P(win), and Avg Prof/Trade
all leapt forward. Another few days like today and we might just be able to
advance our Rating to Excellent.
Put Trading Activity for Report Date
Generally, we want STO Premiums to be as big as possible and we was BTC
Premiums to be as small as possible. This would give us
optimum profits. In other words, we want to buy low and sell high, but with
put writing its always in reverse order. Note that all Premium, STO, and
Profit/Loss Columns should be multiplied by 100 to get the per contract
numbers and that all positions we enter into will always be for as least two
but probably more contracts per position.
Abbreviations: STO-Sell to Open; BTC-Buy to Close; AROM-Annualized Return on
Margin; S/L Tgt-Stop-Loss Target
Sell to Open (STO)
Symbol Expires Strike Premium BTC Tgt Sell By Date S/L Tgt
None
Buy to Close (BTC)
Symbol Expires Strike STO BTC
Profit/Loss Days Held AROM
PRU 06/16/07 $80 $0.80 $0.50 $0.30 11
118.2%
ANF 02/17/07 $72.5 $0.24 $0.15 $0.09 2
220.0%
ANF 05/19/07 $60 $0.55 $0.41 $0.14 3
228.5%
Administration
In addition to increasing our time-stops, we've loosened our BTC stops. This
means that we'll be waiting for bigger profits per trade but exposing us to
the same surprises described in the commentary, above. But keep in mind, you
must risk more to make more. Want risk-free returns? Get U. S. Government
Bonds. The return? Around 5.0% per annum. About a quarter of what we are
doing to date. The trick is to control risk and that's a trick devoutly
wished by me. <g>
Disclaimer:
This is the fine print and is designed to protect me in these litigious
times, and until I get better wording for this disclaimer, you are under
notice that I am not selling my services nor any other product, nor am I
trying to induce you to trade along or independently, with me. I am merely
offering a journal, so to speak, of my portfolio's transactions and results
with the hope that you will glean information and educate yourselves in the
stock market in general and option trading dynamics in particular. Trading
in the stock market and in options involves substantial risk and much money
may be lost. Beginners, especially those with little or no understanding of
the stock market, lose most, if not all of their capital in a relatively
short time. In other words learn from me and my mistakes and if you want to
risk your money in the markets, that's your business and has nothing to do
with me. I am not your representative, broker, advisor or any other type
agent acting in your interests. As a matter of fact, if you want to invest
your money, I recommend you hire your own advisor other than me.
Copyright (c) 2007 Leonard Mednick, MBA, CPA (Ret); Managing Member LIME
Holdings LLC
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