Friday, May 24, 2013

Active-Trader - The Gap, Freeze and Slip

Welcome back Active Traders.

If you have been following my blog for any length of time, you know I am a fan of day-trading delta 7 or higher options on big, popular high-priced stocks. And a key part of this strategy is to limit losses to $100 or 1 point when trading a single lot.  These are pretty tight parameters for an option trade since a delta 0.7 option will move 70 cents for each $1 move in the underlying.  This means that a move of about $1.30 in underlying will cause a stop-out in this type of position.   And that's nothing for a high priced stock such as GOOG or AAPL.

Add on top of that the fact that the bid-ask spread for these options can be 1 point or more, and its easy to see how this strategy can make me easy meat for the market makers.  That said, I have had a pretty decent record thus far and my $1 stop loss has resulted in a loss of at most $130 or $150 on a 1 point stop.

Well all that changed this past Tuesday when was trading the GOOG 895 call which I entered on Tuesday at 18 with a target of 20.5 and a stop-loss of 17.   I watched the stock shortly after entry and at one point I was up about 1.2 or $120 or so within a few minutes.  At this point, there was nothing left to do but just sit back and let the trade play out.  GOOG had briefly tagged $920 on Monday and I figured a retest could be in the cards.

A few minutes later, GOOG pulled back to just about break-even, then gapped down about $2.2 or $2.5 points.  At first, it seemed like a bad tick, and the options did not immediately follow. Instead, they sort of froze and waiting to see if the price in the underlying were just a bad tick or what.  I expected the options to catch up within a few seconds, but instead they just froze.   And I sat there watching the price bounce around, have traded well below my stop price yet the option prices were not updating, nor was I stopped out of my position.

Now this is the type of moment when time just stops as a trader.  You are in a position, and you have a stop, but the market is not letting you out.  And it moments like this when you hearken back to the all the fine print in the account agreement when you sign off on the fact that you can incur financial losses based on failures in technology, servers, the Internet, bla, bla bla.  I get all that, but the market maker has an obligation to maintain a fair and orderly market on the underlying if its trading right?

Well all this went on for 2 or 3 minutes but seemed like an eternity. Tradstation continued to update quotes, but a slower pace than usual.  Its hard to say whether the slowness was real or imagined, but it seemed clear that either the market makers were not updating their quotes, or the Tradestation stop server was hung.  Some time after that, the options caught up, and I was stopped out at $15.70, a full 2.3 points instead of the 1.0 point stop I planned upon.

At this point it occurred to me that stops are just a promise, and promises are not always kept.  It's not that we can't trust the Options Clearing Corporation.  Its more that the options market maker can cease to make a market at any time based on their inability to price the underlying.  And this could happen in a a flash-crash or other adverse market situation. It could also happen if trading in the underlying is halted based on news pending or any number of other unexpected events. It doesn't happen often, but its part of doing business in the wild world of financial markets.

All this makes the case for doing a more time-based methods of trading such as credit spreads, condors and other trades which benefit from Theta decay. I have come a long way in my journey as a trader,  but in many ways, I'm just getting started.

Enjoy your weekend and get some rest.

Saturday, May 18, 2013

Meta-Trader - Fading the Gap

Welcome back traders.

In this post, let's delve into John Carter's excellent book Mastering the Trade.  It was interesting to find out that this book contains many ideas which can be tested programmatically.  And I find that to be more than a bit ironic since John Carter himself doesn't do any automated trading.  But he does follow defined setups, and this was the first one in the book and it goes like this:

- Use this system on the broad market indices, either the stock index futures or the broad market ETFs such as SPY or DIA.  I tested it against DIA which is the ETF for the Dow Jones Industrial Average.

- When the market opens with a gap greater than 10 Dow points and less than 70 Dow points,  fade the gap.  In other words, if the market gaps up, sell short and if the market gaps down, go long.

- Close the trade when the gap is closed (as in the example on the left) otherwise close at the end of the current day at the market price.

- Stop loss is 50 Dow points, however John Carter recommends a stop at 1.0 to 1.5 times the gap size.  I didn't find the results to be much different when using Carter's formula versus a fixed stop.

Coding this system took some trial and error but I have to say its a complete pleasure to work in this environment versus Meta-Trader. TradeStation by default will evaluate systems once per bar.  When I tested it against the hourly bars, it would not enter a position until 10:30 AM.  So I ran it against the 5-minute bars and TradeStation had no problem pulling up and executing the system against 5-minute bars for the past several years.  This was a major relief vs Meta-Trader where you could not trust the results of 5-minute bars due to the bar interpolation issue.  Also, getting reliable data inside MT4 is a challenge to say the least. What an amazing tool TradeStation is and I am so glad to be done with MT4!

Code for the system is pretty simple and looks like this:

{* Index Gap Fade down *)

var: bool GapDn(false);
var: double DistanceInPoints(0.0);

{* Did we gap down?*}
GapDn = Open < CloseD(1);

{* How big was the gap, will always be positive *}
DistanceInPoints = closeD(1) - Open;

{* Greater than 10 and less than 70 Dow Points and 9:35 AM *}
if GapDn and DistanceInPoints > 0.1 and DistanceInPoints < 0.7 and time = 0935 then Buy ( "FadeGapDn" ) at next bar at market;

{* Stop a stop of 50 dollars, we are trading 100 shares *}

Results for the system are shown in the table in percentage return of invested capital. 

- For the past 8 years, returns ranged between -0.55 and +1.16% per year. 

- Against the entire 7+ year test period, the system returned 2.56% with about -0.38% drawdown.

- Percentage profitable was just over 63% showing the system definitely does have a positive statistical bias

JC references an analysis where he shows that gaps are less likely to fill on Mondays than other days of the week and some other conditions (last day of the month etc) which I did not include in my analysis.

One weakness of this system that it loses money on days where the market gaps up and does not look back.  Since the stock market has a positive bias over time and certainly over the test period, the system fights the trend in that respect.  We can see that in the results where buying the gap down makes twice as much overall as shorting the gap up.

Overall results from this system are not stellar.  To make a living in active trading, we want to make about 1% per day on our assets at risk. But this system is just one of many tools in our arsenal of money making techniques.

I will upload the TradeStation code to my Yahoo Group and notify the list.

Have a great weekend and week ahead.

Saturday, May 11, 2013

Meta-Trader - Just go with it

Welcome back Meta-Traders.

It was another spectacular week in the stock market with Dow Jones Industrials breaching 15,000 for the first time.  Taking a look at the daily chart of SPY, we had new, all-time highs on 5 of the 6 previous trading days. And it all started with a gap to the upside after better-than-expected jobs numbers last Friday.

To say the markets are extended at this point it putting it mildly with the SPY way above the 8, 20 and 200 day moving averages.  Everyone expects a pullback, but we are not getting it.  John Carter recently advised that in situations like this, you don't want to fight the action, you just want go with it until it stops.  Its the kind of simple mindset that comes so naturally to JC that at the same time would cause the head to pop-off of someone who is trying to view the markets from a complely rational perspective.  And since we are managing swing or day trades one at a time, nothing should happen in any one day that causes much financial damage ensuring that will be around to capture the money-making opportunities when they arise.

And speaking of opportunities, we had a beautiful breakout in Regeneron (REGN) this past Friday.  I was watching the markets in the first 30 minutes of the day and spotted a breakout.  Checking the daily timeframe, this was a clear breach of the recent trading range that formed as the stock based between the 255 and 265 area.   I picked up a half-size long position at the 266 level right at the orange bar shown in the chart on the right. From there the stock screamed upward.

I was able to point this out to the other traders on the Simpler Options trading room and some other traders got on board and even John Carter put a position on (believe it was 270-280 call debit spread) as the stock reached the 270 area.  The stock made it as high as 274 then based for the remainder of the day and closed at 273.57.  I went out long the stock in both my cash and retirement accounts and I am going to try and stick with it until $300 which I think is an entirely reasonable target from here.  The logic being that if a stock makes it to $270, why not $300 since its the next big round number.

I also took a similar half-size long position in Biogen Idec (BIIB) at about the 211.5 area.  This was close to the bottom of a recent consolidation and I expect the stock will get back into the 220 area next week.  Some members of the Simpler Options Trading room consider BIIB to be an "Elephant" with much higher price levels expected ahead.

As for development work,  I have started to code TradeStation strategies for some of the swing trading setups mentioned in John Carter's excellent book Mastering the Trade.  More to come on that when I'm ready to share.

Enjoy your weekend and be sure to do something special for the Mother's in your life since Sunday is Mother's day.

Looking back, so far 2013 has been an incredible year in the markets. There's no way of telling how long it will continue. So for now, we're just going to go with it.

Saturday, May 4, 2013

Meta-Trader - Apple Trendline Break

Welcome back Meta-Traders.
It was another spectacular week in the markets.  Gains were broad and across the board with SPY +2.1%,  DIA +1.82% but QQQ leading the pack up +3.78% for the week.   We also had healthy gains in Europe and Emerging Markets with EEM +3.39% as the ECB finally dropping interest rates for the first time since July of 2012. 

Those who subscribe the "Sell in May and go away" theory missed a monster rally on Friday May 3rd.
But the big story was AAPL where we finally had a break of a huge 8-month trend line set from the top at 700 set back in September of 2012.  This came on some big fundamental developments which i'll cover below. 

But first, why do we care?  We care because AAPL has a larger capitalization of any stock in the US Market.  So AAPL has a huge impact on the markets themselves.  We also care because AAPL is such a big point mover, about 30 points this past week and the week prior.  So we can make good money trading delta .7 options on this stock. 

And we care about this move because history has shown that trend line breaks often signal the beginning of long-term shifts in price action.  There's a tendency to think that you have to be super-smart to make money in the markets, that to have to be looking at something that nobody else is looking at.  I would argue the opposite - that the big money is make on the big, obvious changes in character like this one here.

Well at this point, the stock is clearly extended, having gone straight up almost 10 days straight.  So I am  not saying that AAPL is a screaming buy here.  Its just that we have clearly switched from STFR (Sell the F'ing Rally) to BTFD (Buy the F'ing Dip) in John Carter parlance.  Now what fundamental developments have occurred here that we need to know about?

Well on Tuesday afternoon, AAPL released earnings along with a number of moves to redistribute part of its huge cash horde to shareholders.  In fact, at the beginning of the conference call, you could here the relief in Tim Cook's voice that he was finally bowing to some of the relentless pressure he has been under to do something about the 40% loss of Market Cap the stock has seen in a mere 7 months.  Here's what they came up with:
  • Increased repurchase authorization to 60 B by the end of 2015.  With a current capitalization of 418 B, that will reduce the number of outstanding shares by 14%, thus increasing the per share performance of the business for existing stockholders. 
  • Increased the dividend 15% to $3.05 per share per quarter
  • Accessed the debt markets in the largest single corporate debt offering in history borrowing 17 billion dollars!
This last item is pretty significant since AAPL has traditionally avoided financial engineering of any sort, and almost ignored its huge cash position and instead, focused on just making great products.  With this move, AAPL is borrowing at record low interest rates to retire stock and avoid having to pay taxes on income earned overseas.  They are clearly listening to their shareholders, and activist investors. 

I would not consider buying the debt, since it pays only slightly better than US Treasury securities.  And I am not a debt investor anyway.  What it does say is that APPL thinks they can provide a better rate of return on the capital borrowed from these investors than they are paying them to borrow it.  Phrased another way, they are selling puts on the cash to the bond investors and buying calls on their own stock.  Which side of that trade would you take?

As for the stock, its going to have a long road back to the all-time highs at $700.  For active trading, I also have an eye on Google (GOOG) which on Friday took out its all-time closing high.

That's enough for today.  Go forth and enjoy the fruits of your labors.  And enjoy your weekend.