Commentary
No breaks caught today. The bright side is that the market could have been
worse in that it wasn't as bad as Friday. <groan>
Three more of the NLV's positions were stopped out today for expected but
nonetheless unwelcome losses. There are still two more positions (AKAM and
MS right on the cusp of their being stopped out tomorrow).
Everybody's waiting for a boatload of economic data to be released over the
next couple of days, not the least of which is Fed Chairman Bernanke's
general assessment of the economy on Thursday and the level of interest
rates soon to be set (or not). Which brings me up to the following tweaks to
my trading methods.
While I'm somewhat satisfied with how the profits come in when the market is
bullish, I'm not happy with the size of my losses when it tends to be
bearish. Therefore I reviewed my philosophy and policies and came up with
the following facts:
* I sell options to buyers. Options are a wasting asset, that is, all
other things being equal, a portion of an option's value disappears each day
(like the value of an auto policy) and that disappearing value inures to my
benefit as the seller. This means that at expiry the option will have wasted
away to zero and I get to keep the entire premier collected up-front.
Meanwhile, if I decide that it's propitious to cash out earlier, I get to
buy back the option for more than zero but somewhat less than the amount
originally paid to me.
* Each day that we get closer to the expiry date, the option wastes
away faster and faster. For example, if the option lost four cents in value
yesterday, today it might lose five cents, and tomorrow another six cents.
* Therefore,, the longer I hold an option, the more advantage this
accelerated wasting value accretes to me.
* Right now, I've been placing time-stops on my options anywhere from
21 days to 30 days, but in reviewing my STOs, I find that most of them have
expirations from six to 12 months out.
I conclude from the facts that if I were to hold my options a while longer,
I may be able to profit more by allowing the natural course of accelerating
option price erosion to attach itself back to me. Further, there are
transaction costs to consider like broker commissions and slippage. Slippage
arises from the fact that in the market there are two prices on any product
(stock, option, bond, etc) at any one time; the bid and the ask. The bid is
the price that a buyer is willing to pay (think of the bid as the wholesale
price while the ask is what a seller wants for his or her holding (think of
the ask as the retail price). The bid price is always the lower of the two
prices!
The dynamics of the markets are such that when you're a buyer you're faced
with the prospect of having to buy at retail, and if you're a seller you're
facing the prospect of selling at wholesale. This means that if I STO an
option now, I get the bid (wholesale) price, and if I want to turn-around
and buy it back (BTC), I have to pay the ask (retail) price. So not only do
I have to pay commissions on the STO and BTC, but I've also got to absorb
the slippage, which is difference in the bid and ask price, before I can
realize any profits.
If I'm to keep fully-invested and I have a short term time stop of say one
month, then I'll have to turn over my portfolio at least 12 times per year
to stay fully invested. This means I take a hit of 12 round-trip commissions
and 12 slippages. Poof! But if my time-stops are increased to, say, three
months on average, then I only have to suffer four hits per year (12 months
/ 3 turns). The downside is that my return (AROM) will probably be reduced a
little because I'll have my money tied up a little longer per position.
Here's how I acted (or am going to act) upon the facts while compensating
for the negatives just put forth:
* For starters, I'm going to increase each time-stop to 1/2 the time
between the dated entered into the position and the drop dead date to get
out of it. For example if I STOed PCU on 2/6/2007 (which I did) and its
expiry date is 6/16/2007 (which it is) then the time to expiry then was 130
days. Half of 130 days is 65 so I'll put a time-stop on PCU to bail out by
4/12/2007 (2/6/2007 plus 65 days).
* Then, in order to take advantage of PCU's accelerating time erosion,
I'm going to reduce the target BTC stops. As of this moment, I'm not sure by
how much but I should have a percent in mind by the end of trading tomorrow.
The lower BTC gives me greater profit potential.
* Finally, I'm going to reduce my stop-loss BTCs in order to take
smaller hits on losses like I did Friday and today. This probably means a
little more turnover in my portfolio but I'm hoping that it will be minimal
especially when compared with the vast decrease in turnover that extending
the time-stops will bring.
As always, everything I do is experimental and subject to change. But
changes should not be introduced willy-nilly. They should be the result of a
thought-out strategy that takes into account facts, desired outcomes, and
tactics to achieve that strategy. We can't eliminate risk and guarantee
profits. No one can! Not even Dr. Bernanke, unless he wanted to break the
law. But we can sure as hell try to optimize on both ends and I'm hoping
that's what I did a little bit of today.
Paper Profits Table
You look at the table. I was hoping today for a small bounce in the market
but it didn't appear. Maybe tomorrow. That should bring a little apple back
to my cheek!
Closed Transactions Table
Not only did the two options that I thought would stop-out today do as much,
but so did a third <ugh>. As mentioned earlier, there's still two more
positions in critical condition. But a market rebound tomorrow could take
them off the critical list.
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 S/L Tgt Sell By Date
None
I figured I wanted to see where the markets might be heading before I made
any more commitments. (Never try to catch a falling knife). A third day of
trouncing would not bode well; might indicate that we are entering into a
bearish phase of the market. This would make me consider lightening the
portfolio and remain in cash while the market sorts itself out. (Patience,
grasshoppa, patience!) <g>
Buy to Close (BTC)
Symbol Expires Strike STO BTC Profit/Loss
Days Held AROM
LM 05/19/07 $90 $0.77 $1.20 -$0.43 5
-322.0%
LVS 06/16/07 $65 $0.80 $1.30 -$0.50 6
-412.4%
ICE 06/16/07 $90 $0.90 $1.35 -$0.45 5
-263.1%
Administration
None
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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