Commentary
We're not out of the woods on this one, yet. There's a lot of waffling among
traders as to whether this market "correction" is a precursor to "the big
one" or if it's even a correction at all; just a "normal" hiccup. So unless
there's another catalyst type action somewhere in this wide, wide world, my
belief is that after the weekend, after we've all had a chance to catch our
breath, things will start settling down. Meanwhile, I'm not setting up any
new positions as that would be a pure gamble, not reasoned speculation.
This is my first time as a "portfolio manager" so I'm learning a lot under
fire. One of the things I learned today is that many of the professional
fund managers haven't undergone any 3 1/2 % one day corrections either under
their watch. At least they've probably undergone some vetting in past drops
under the wing of a mentor. That helps but its small comfort when you're
watching your portfolio disappear.
How Stocks and Options Differ in Each of the Market Phases
One of the things I've noticed is that stop/losses do not act the same when
they're placed with options. I think the reason is that options behave
differently than stocks do in almost every market phase. You'll recall that
stocks, assuming that you've bought them long, can only make money when the
market is up and lose money when the market is down. When the market moves
sideways (called basing, in market jargon) a stock neither makes nor loses
money.
Options, on the other hand, profit when the market is up a lot, up a little,
goes sideways, or even is down a little. The only time options lose big-time
is when the market loses big-time as well, like we've been experiencing this
week. I use a palm tree metaphor to help me picture this concept in my mind.
It's original and it's not a perfect picture but it helped me visualize the
concept when I first started actively investing in May of 2005. Without
going into all the gory details, imagine how a palm tree moves depending
upon the wind. If there's no wind, it stands straight and goes about its day
growing coconuts. It bends a little when the wind blows a little and it
bends a lot when the wind blows a lot. Usually that's all there is to it.
After the wind dies down, the palm tree snaps back and continues growing its
coconuts.
But every once in a while, a hurricane wind comes along causing the palm
tree to bend severely, approaching 90 degrees maybe, ripping away at the
fronds and coconuts, and at times even uprooting the palm tree. But after
the storm, most of the trees snapped back to the upright position; with
nothing but a few torn fronds and a few missing coconuts. A few of the trees
were uprooted or broke so they will never come back while the surviving
trees will eventually regenerate the missing and damaged fronds and regrow
new coconuts.
So what's all this got to do with Stop/Losses? This is what the palm tree
picture suggests to me. Assuming the fundamentals of the underlying stock
are ok, options are like palm trees in the wind. I know that I will
eventually make money so long as I'm not hit by a hurricane. So if I'm only
going to lose money in a hurricane, why do I need stop/losses short of a
hurricane?
Further, as I learned so emphatically in this downturn, stop/losses are
almost meaningless in a downturn as the price of the option gaps right
through the stop/loss settling, if at all, at a price far beyond what we had
planned on from the beginning. So just when I need the protection of a
stop/loss the most, that's when I get that protection the least.
I also noticed that short of the big, big wind and short of a company's
fundamentals going south, I can usually ignore the day to day price changes
as options by their nature head toward profitability absent those negatives.
In other words, I have to think of options on a longer term basis than just
a quick get in and get out, although if those opportunities arise, I can
still take them, thank you very much.
But even if I don't use traditional stop/losses as they're promulgated
everywhere I've read about them, I still have to have a way to determine
when to exit a position short of the expiration date. Here's where a few
ideas are formulating in my head. Yesterday I got an idea which I'm going to
try to formulate into numbers over the weekend. It'll be an indicator or
combination of indicators that alert me when prices seem to have gone too
far in the wrong direction according to some preset marker, preferably
deriving from probability theory.
If I can pull this off, it'll be as if some palm tree engineer came in, did
his measurements on each tree and then predicted just how strong a wind must
blow before the tree breaks. Remember, unlike stocks, which break the moment
it's price falls, options only lose if the underlying stock's fundamentals
break or the market's bottom falls out. I'm going to concentrate on the
latter this weekend. I'll tell you more with Monday's report.
Paper Profits Table
Closed Transactions Table
Put Trading Activity for Today
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
No point opening new positions when I don't know where the market's going.
Account Balance less Margin available to invest: 51.9%
Account Balance less Margin and Voluntary Reserve requirements available to
invest: 21.9%
Buy to Close (BTC)
Symbol Expires Strike STO BTC
Profit/Loss Days Held AROM
None
Comments or Questions?
If you have any comments or questions, please direct them to Leonard
leonard@irsdehassler.com
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. I also
reserve the right to cease publishing this missive, or change its publishing
frequency at any time without further notice or liability to you.
Copyright (c) 2007 Leonard Mednick, MBA, CPA (Ret); Managing Member LIME
Holdings LLC
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