Friday, July 26, 2013

Active-Trader - The Market Maker Move

Welcome back Active Traders and wealth builders.

It was a breakthrough week for my options trading career and I made some pretty decent money trading earnings.  In this post, I will cover how its done so you can do it yourself.  Its not that difficult once you know the tricks which I have learned thanks to the expert tutlage of Henry Gambell and John Carter over at Simpler Options.  Here's how its done:

1) Find companies which are going to report earnings before the next day's open - either today after the close or the next market day before the open.  My favorite source is Yahoo Earnings Calendar. Stick with big, popular high priced and heavily traded stocks if at all possible.

2) Bring up the options chain and calculate the "Market Maker Move" abbreviated MMM as follows:

MMM = Cost of at-the-money put + Cost of at-the-money call

As for an example, with AMZN trading at 300, the 300 Call is asking $9.20 and the 300 put is asking $8.80. Add them together and you get close to $18 so round it up to $20. That means that the Market Makers are pricing just under a $20 move after earnings.

3) Now calculate your upside and downside targets as follows:

Upside Target = Current Price + MMM
Downside Target = Current Price - MMM

In our example using Amazon:

Upside target - 300 + 20 = 320
Downside target - 300 - 20 = 280

4) Next price some options spreads where you are shorting the calls just outside the MMM on the upside and shorting the puts just outside the MMM move on the downside.  In our example:

Short the 320 call
Short the 280 put

For protection, we also want to buy the next further away option for protection since short options have unlimited (or at least very large) risk.  In our example:

Short the 320 call and long the 325 call
Short the 280 put and long the 275 put

So you are basically selling a Call Credit spread above the market and a put credit spread below the market.  Those familar with options parlance recognize that that as an Iron Condor.  The beauty of this trade is that all the price has to do is close anywhere the 2 short strikes and the trade goes out at max profit without even a closing transaction!

5) Calculate the total premium you can collect. For a 5-dollar wide spread, you want to get a credit of at least 1/3 of the distance between the stikes for example $165 for a maximum loss of $335. If can't get a decent credit, don't take the trade. For example, I would not take a $1 credit for a max loss of $400 since the risk/reward ratio is more skewed and not in your favor.

Another cool thing about this trade is that at least one side of the trade will go out at max profit because the price can only have a single closing value.  After all this is trading and not quantum mechanics!

6) If you think you can get a good enough credit, put in a limit order for the side with the bigger credit and see if you can get filled between the bid and offer also known as the natural price.  Once you get filled, on one side, try agressively to get filled on the side since having both legs on actually reduces your overall risk

7) Once filled, sit back and wait for the earnings.

If the stock really pops or drops, you can take off the short option and leave the long on on which I did with some success with AAPL this week.  You can always trade around a position if it moves against you.

Having traded this method several times this week, its uncanny how often the price closes within the MMM! 

Here's a table of trades I did this week and the outcome:

AAPL395/400 440/445+1.90Max profit plus some due to trading around
NFLX225/230 300/305 +2.03Max profit
BRCM29/30 34/35+0.35Max loss but does not expire until August
CELG131/132 139/140+0.35Closed for debit of 90, loss of 0.55
AMZN275/280 320/325+1.64Closed for 0.06 short of max profit

I'm sticking with small volume (1 or 2 lots) until I can get the hang of this.  Also, i'm trying to keep the maximum loss of on any single position less than about 1.5% of the account.

That's all, enjoy your weekend

Sunday, July 21, 2013

Active-Trader - 4 Horseman of Biotech

Welcome back Active Traders and wealth builders.

This past week brought more new all-time highs in the broad market indices which was not at all unexpected given the way we recovered from the 5-week corrective pattern as described in last week's post Ripping Higher.

One theme which has been working this year is biotech, specifically Jim Cramers "4 Horseman of Biotech" which are Biogen Idec (BIIB), Celgene (CELG), Gilead (GILD) and Regeneron (REGN). Together and individually, these stocks have trounced the SP-500 on a year to date basis as shown in the comparison graph above.

 I have traded in and out of these stocks this past year and made and lost some money on these. On Friday, I went out long CELG and GILD on continuation plays, since both stocks made new, all-time closing highs in the prior week. Since I now have a financial interest, let's take a brief look at each of these and see what we can find out about the company, about the stock and how they trade.

First up is Biogen Idec which was formed from the 2003 merger of Biogen (founded in 1978 in Switzerland) and Idec Pharmaceuticals which was founded in 1985 in California.  BIIB develops drugs to treat multiple sclerosis AVONEX and TYSABRI.  BIIB also developed RITUXAN which is the world's most prescribed treatment for non-Hodgkin's lymphoma and an effective treatment for rheumatoid arthritis.  The stock gapped out to new all-time high territory back in 4/3/2013 when it announced it purchased the remaining rights to TYSABRI from Elan corporation. 

As for fundamentals, BIIB has been profitable for many years and has nearly a 28% 5-year annual earnings growth rate and a PE of 35 and no dividend yield.  The stock is up 50% for the year so far and earnings are due out before the open this Thursday.   Be very careful going into earnings, but be ready to add longs or sell puts on any gap down in the stock price.

Next up is Celgene which is another global biotech powerhouse founded in the mid 1980's and went public back in 1987.  Similar to BIIB, CELG develops drugs to treat a variety of cancers and other auto-immune diseases.  Most recently the stock gapped out to a new all-time high on 7/11/2013 when the company announced a positive outcome from its Phase III trials of REVLIMID for new indications.  It is already approved for a series of other treatments.  Interestingly, REVLIMID is chemically related to Thalimid which was prescibed in the 1950's as a sleeping pill and lead to a series of limb-related birth defects.  That legacy continues and even now pregnant women should not be exposed to REVLIMID and related compounds.

As for fundamentals, CELG has a 5-year growth rate in the mid 20's but the actual number is missing from TC2000 for some reason, PE is 40 and no dividend yield.  The stock is up 73% year to date and earnings are due out before the open this Thursday 7/25.  I'm almost certainly going to clear out of my long before the close on Wednesday.

Next up in Gilead which was founded back in 1987 and went public in 1982.  GILD produces Flu medicine Tamflu and has been a key player in antiviral drugs to treat patients with HIV and Influenza.  The stock hasn't had any meaningful gaps lately, but is incredibly volatile and traded down to mid 40's in the May/June pullback and is since up 50% to a new all time high breaking $60 for the first time.

As for fundamentals, GILD has 5-year earnings growth of 13%, a PE of 32.7 and no yield.  Earnings are due out before the open on Thursday, so like, CELG, I will be out before the close on Wednesday and look to re-enter on a gap down after earnings on Thursday.

Last up in Regeneron symbol REGN and based in Tarrytown, NY not far from the home of your humble blog author.   Regeneron was founded in New York City in 1988 and has only 3 products on the web site EYLEA which treats Macular Degeneration ARCALYST which treats a rare hereditary condition abbreviated CAPS and ZALTRAP which treats metastatic colon cancer. 

REGN has the least stellar earnings history of the 4 horseman and actually lost money as recently as the 4th quarter of 2012.  So that leaves REGN with a non-existent 5-year earnings growth rate and a PE of 37 and no dividend yield.   Even so that stock is up 60% year to date taking 3rd place behind CELG and BIIB.

Investing in biotech can be more of a minefield than stock investing in general since any bit of news can soar or crater the shares.  Trading the above names, whenever I took full-sized positions with a tight stop, I nearly always go stopped out and lost money.  When I look small say quarter of half-size positions (25 or 50 shares) and took reversals off the daily charts, I did okay.  

As for this week, I need to be out of GILD and CELG by the close of Wednesday, then look to reload on any earnings related downward gaps on Thursday.

Enjoy your Sunday and have a great week ahead.

Saturday, July 13, 2013

Active-Trader - Ripping Higher

Welcome back, Active Traders and wealth builders.

Sometimes what's going on in the markets overshadows any individual stock stories.  That was certainly the case this past week with broad market indices SP-500, Dow Jones Industrials and Russell 2000 scoring new all-time closing highs.  What is even more telling is how this was achieved and the daily chart to the left tells the story.

After peaking back on May 22, 2013 markets went into a corrective pattern as identified back in my post on June 2, Signs of Distribution.  At that point, we started taking profits on many individual stock positions to book some good gains for the year.  You can't go broke taking profits as the saying goes.

Counting the daily bars, there were 22 days in the corrective pattern which started on after the peak on 5/22/2013 and bottomed on 6/24/2013. Since then its been almost straight up, and we recovered the entire distance of that pullback (which took 22 bars) in only 13 daily bars - and 8 of those bars were on opening gaps to the upside!   And you know from prior blog posts that when the right side of a correction recovers faster than the time it took to go down, that means the market is straining to move higher and nearly always goes on to make further highs.

Another interesting story to be told is the chart to the right.  This one compares the year-to-date performance of the Dow Jones Industrial s versus the SPY (SP-500 in yellow),  QQQ (Nasdaq 100 in blue) and IWM (Russell 2000 in white).  This shows the broader market Russell 2000 is clearly outperforming the Nasdaq 100, SP-500 and Russell 2000.    This speaks to the broad nature of this rally and also tells me that on dips I should no longer buy DIA, but instead should be buying IWM, SPY, QQQ - anything but DIA contrary to what I noted in last week's post DIA on Dips.

Moving our focus from broader markets to individual stocks, we had awesome performances in individual stocks Tesla (TSLA) and Netflix (NFLX) this past week.  I was able to participate in both stocks along with the other members in the Simpler Options trading room.   I continue to learn a lot from John Carter, Henry Gambell and the other traders in the room.

One important thing I learned from John Carter is that trading nearly 100% a mental game.  Put another way, the state of your mind at the time of the trade determines your actions.  Are you in a state of fear that you will lose money?  Are you more concerned with making money or not losing money?  My behavior is clearly being dictated by my psychology, and my TradeStation account tells the story where I have:

  • 31K in cash buying power
  • 62K in overnight marginable buying power
  • 124K in intra-day buying power for marginable securities

Yet given all that, I won't put on a trade which risks more than $300 or 1% of the account!  I clearly have some mental hang-ups which are preventing me from realizing my full potential as a trader.  So let's just say I have some serious work to so in the area of trader psychology.

Enjoy your weekend.

Saturday, July 6, 2013

Active-Trader - DIA on Dips

Welcome back, traders.

Curious about the long term price behavior of the stock market, I loaded up a yearly chart of the Dow Jones Industrials.  I went with the Industrial Average because its history goes farther back than any other Index.  On the TC2000 platform, they have yearly data all way back to 1915 which was older even that TradeStation whose data starts in 1920.

Taking a look at the data, there were a few times when the index was cut in half, and another time when it was cut by about 90% when the Dow went from a high of 386 back in 1929 to a low of 40 in 1931.  More recently in 2007 we had more than a 50% haircut when the Dow went from a high of 14,198 back in 2007 to a low of 6,469 in 2009 only to bounce back and make a new all time high within 4 years.

Aside from the occasional haircut, the overall direction is decidely positive, from the lower left to the upper right of the chart as Dennis Gartman would say.  Based on a simple analysis, the average gain over the 98 year period from 1915 to 2013 is 7.93%.  So I did a simple estimate of what average would look like into the future based on continuation of the current trend, and came up with these numbers:

This chart shows that the Dow will reach 20,000 before the year 2019, 30,000 by 2024 etc.. until it reaches 100K by 2040.  Some of these numbers look fantastical but its really just simple math and clearly i'm not going to win any awards for this research.  Point is the stock market goes up over time and the Dow Jones Industrials is as tried and true and indicator as there is.
Based on all of this I have added to my ETF holdings in DIA and its now my largest position.  I like the fact that the index is focused on the largest most successful companies.  Also, the index is managed for growth as underperforming companies are kicked out, and new successful companies are introduced.  In fact, of the original Dow-30 stocks, only General Electric remains.

Just to give you an idea of how much the index is changed, here are 11 of the 12 original components from the index when it was started by Charles Dow back in 1896:

American Cotton

American Sugar
American Tobacco
Chicago Gas
Distilling & Cattle Feeding
Laclede Gas
National Lead
North American
Tennessee Coal, Iron and Railroad
U.S. Leather
United States Rubber

With the exception of General Electric, every company has been reorganized or otherwise restructured.  This is downside protection to avoid the situation where you get stuck with a dud of a stock since they generally get kicked out of the Index.  Recent cases are Citigroup and General motors, both of which got kicked out of the index back in 2008.

Plan going forward is to add DIA on dips.  And with a 2.4% dividend yield, its paying you pretty good while you wait.

Enjoy your weekend