Blue Horseshoe Loves This Finance Blog

"IT'S THE END OF THE WORLD AS WE KNOW IT... AND I FEEL FINE" It's the End of the World As We Know It, R.E.M. The  moments in history when our view of the world has changed suddenly and dramatically are so etched into conscience that they are recalled solely by date: September 11th, November 22nd, December 7th. Markets are dynamic and constantly changing and sometimes that change is dramatic and can be recalled by a year: 1929, 2001 or 2008.  However, unlike moments in history where the gravity and significance of an event is immediately apparent, market events tend to distill more slowly until a collective consensus is reached that leads to a watershed move. The last couple of weeks, domestic markets have begun to react to the stress that's been rocking Asian markets for months.  Now, there is evidence that there has been a shift in thinking about market risk going forward.  I've previously written about the scenario known as 'contango' where docile vo...

"IF YOU THINK THIS IS OVER THEN YOU'RE WRONG" Separator, Radiohead Welcome volatility, we've been expecting you! The markets have gotten their first taste of volatility since 2011 but these moves we've seen these past few days felt more like this time of year in 2008.  1,000 point swings on the Dow and the VIX spiking up to 45+... it's enough to make a grown man cry... and that likely happened too. For anyone who has followed this blog, this all comes as no surprise... the only surprising thing was how long it took to finally get here. Where we're at now, from a technical standpoint anyway, is in a pattern I call the 'reversion trade.'  When prices exhibit large variances from their moving averages, they will almost always do so with spikes in momentum factors.  Once those momentum factors settle down, prices have a tendency to revert back toward their moving averages. A large variance for an index ETF like the SPY would be a reading of 2.00... th...

"INNOVATION IS TAKING TWO THINGS THAT ALREADY EXIST AND PUTTING THEM TOGETHER IN A NEW WAY." - Tom Freston It's been a couple of weeks since I built out the optimization model and now that market volatility has finally arrived - as I have been predicting - we can take a good look at how it has performed. The optimization model was built out of a curiosity I had about how to best structure trades and it produced a bit of an unexpected result... http://tancockstradingblog.blogspot.com/2015/08/optimizing-equity-returns-using.html http://tancockstradingblog.blogspot.com/2015/08/follow-up-on-qihu-short-trade.html First, let's review how some of the original trades - that used options as protective overlays - posted on here have performed. 6 Trades; 4 winners & 2 losers Average return of positive 0.9% Average position life of 20.8 market days Average winning trade is up 6.9% on underlying moves of 9.8% Average losing trade is -11% on underlying moves of 14.9% Now, let...

If the support level on the S&P holds, then this will be a good opportunity to buy on a dip... if it breaks down then the positive convexity of the trade should kick in and limit losses... plus other shorts should continue to run. Implied volatility has ticked up a bit, as would be expected, but it's still within a decent range on this name... the projected vol for the life of the option is 23% vs an implied vol of 32.5% for the at-the-money call. Here's the trade: Short 55 shares CELG at $125.78 Long 9 September $135 calls at $1.18 Upside breakeven:      $136.58 Downside breakeven: $106.18 Expected value range: $250 - $700 Max Loss to Trade Cost: -19.6% Trade Convexity: 10%:       6.7 12.5%:  15.9 15%:     19.1

HOW STRONG IS THIS LEVEL?... Just six days after last testing the 2,050 support level, the S&P is back to try to crack it again.  Here's a look at the SPY whose corresponding level is roughly 205... Over the past six months this level has been a rock solid floor for the broad market.  However, the subsequent bounces have been getting progressively weaker.  I fully expect a technical market correction (as I've written numerous times in this blog) but I'm not 100% certain that the market will breakdown on this test of the support level.  The 50 day moving average is definitely moving lower and it has made all of the requisite 'death crosses' for a bear market but the S&P has a bit of variance to this average.  Whenever there's variance to moving averages there is always a probability of a pullback. More and more factors are pointing to a broad market selloff and my trade proposals on this blog have been designed to take advantage of that... but don't b...

IT'S DEJA-VU ALL OVER AGAIN... -Yogi Berra After writing the piece on hedging theta, I realized that there is more that can be - and more importantly should be - covered.  So here comes part two... hopefully, it's better than most sequels. First, here's a link to the original... http://tancockstradingblog.blogspot.com/2015/08/hedging-theta-decay.html Anytime you are long an option you are also long volatility; regardless of whether it's a call or a put.  As I've written before, being long volatility automatically makes you short theta... or you could even say that you're short time as the value of the option has an inverse relationship to time... but let's not get too philosophical. In the previous piece, I wrote about one strategy that can be used to hedge short-term theta decay... the vertical bull-put or bear-call spread.  However, especially in relation to the optimized positive convexity strategy, there is another strategy worth exploring... the butte...

Last week, I posted a piece titled, 'Calculating the Convexity Effect...'  For whatever reason, it was never posted to my Google feed so I'm posting the link below in case anyone is interested... http://tancockstradingblog.blogspot.com/2015/08/calculating-convexity-effect.html

THE BEST LAID PLANS OF MICE AND MEN OFTEN GO AWRY... -Robert Burns, 'To a Mouse' 1785 The last few trades I've detailed on this blog have utilized options as the return drivers and linear equity as the overlay protection.  This transformation was brought about by a seemingly simple question of how to increase efficiency.  However, I am now faced with a new challenge as a result of being short the market and - now - also short theta. So what happens if my best laid plans for a technical market correction go awry?  If prices move against me, my positions are protected by equity exposure which will hedge the loss on the options, so I'm good there.  But what happens if equity prices don't move?  Even if equity prices stand still, time most certainly does not.  That's when time becomes your biggest enemy. THETA - EXPLAINED & VISUALIZED... Theta is the price an option holder pays to own an option every day... if there is no change is any of the other pricing...

Long: 82 shares @ $89.12 Long: 2 September $90 Puts @ $5.1 Long: 2 September $85 Puts @ $2.8 Capital allocated:    $8,900 Max Loss:               $1,498 Down Breakeven:   $81.92 Up Breakeven:        $108.32 Expected Value:      $400 to $700 Price Shock         Convexity 10%                      -1.44 15%                      3.76 20%                      4.59                      ...

This is another follow-up on the QIHU short trade that was generated through the optimization model I recently built. In yesterday's post on the QIHU follow up, I noted the leverage gained by using options as a return driver.  I've talked about option leverage before but now I want to view it in the context of a multi-asset position - like the short QIHU trade which has 4 components... 1 stock and 3 options. I started my career in traditional fixed income asset management doing portfolio analytics and risk reporting.  One of the key risk concepts of fixed income is convexity.  Convexity is the second derivative of the bond pricing model that accounts for the non-linearity of returns for changes in - mostly - interest rates (duration and convexity on non-investment grade debt tends to be more empirical).  Convexity is a major benefit to the holder of an asset... being long convexity means that you're making more as the value of your investment increases than you lose ...

This is a vertical bear call spread... Sold August 21st 209 Calls for $1.37 Bought August 21st 212 Calls for $0.25 Proceeds: $1.12 Potential Loss: $1.88 This trade has a positive expected value of about $30.

The S&P looks to have a well defined support level that the market bounced off of again today.  It's roughly around 2,045 to 2,050 on the S&P or 205 on the SPY. Here's a look at the SPY over the last 6 months: It will be interesting to see if the falling 50 day moving average applies pressure for the market to break past this barrier to the downside or if it holds.

In working with the new optimization model, I've definitely noticed some interesting things as I mentioned in yesterday's post detailing the QIHU short trade. First off, I had originally intended on setting up QIHU as a long position as it looked to be in a bullish pattern and that's what I used when describing the new model.  However, when calculating the expected return to the September options expiration, the exponential return model produced a significantly negative projection of -4.68%. In seeing this, I ran the model to short the position using both a traditional equity approach - with an option overlay as protection - and as a traditional long.  However, I used a constraint in the long model that gave me a short position using options as the return driver and the stock as the overlay protection.  The contrast between the model outputs is definitely worth examining. Here's the output from the traditional short position: Expected values from this trade ranged betwe...

Here's a new position that I built out using the trade optimization model.  There are quite a few interesting things to note with the model that I'll follow up with later. It's also important to note that I built this trade out earlier in the day and the stock has moved quite a bit since then. The trade: Long:  112 Shares @ $63.87 Long:  3 September $65 Puts @ $3.80 Long: 3 September $62.50 Puts @ $2.75 Long: 2 September $60 Puts @ $2 The breakeven on the downside is roughly $59 and just less than $85 on the upside.  With a max loss of $2,200, the expected value is +$760.

SOMEWHERE BETWEEN A THREAT AND A PRAYER During the height of the Cuban Missile Crisis, just hours before the United States was scheduled to invade the Soviet satellite nation, President Kennedy used a back channel communique to deliver a last-ditch offer for peace to Secretary Kruschev.  The Russian leader's first reaction was to call the letter 'somewhere between an threat and a prayer.'  In this blog, I detail trades that use option overlays to manage the risk of the position.  However, as I have been analyzing these trades (and countless others that have preceded this dialog), I have admittedly found myself indecisive as to the most efficient way to apply the hedges.  While the ramifications aren't nearly as dire as those in the fall of 1962, I have felt like my judgements were somewhere between a wish and a prayer.  To remedy this, I have spent the last few days building an optimization model so I could replace the iterative process with one based in math...

Continuing in the direction of adding short exposure given my personal market views (which have been strengthened by exponential trend projections), here is a short trade on DeVry Education Group.  DV is a for profit education company... the for profit education sector has been hit hard lately (APOL, STRA) due to increasing regulatory curiosity into the business practices of many of these companies.  Whether DV falls into that category or not is not yet fully known or even the impetus for the trade. The stock went through a dramatic draw-down during the first half of the year, losing approximately 1/3 of its market value before consolidating at its current range of $30 - $35 a share.  From a technical standpoint, it looks to be breaking down through this level and this represents a breakout trade (or breakdown if you prefer).  The company reports earnings on August 18th which gives the trade a nice catalyst at that time. Here's the trade: Short -75 shares DV @ $30 Lo...

A RIDDLE, WRAPPED IN A MYSTERY, INSIDE AN ENIGMA Speaking in a 1939 radio interview regarding a British alliance with Russia, then First Lord of the Admiralty, Winston Churchill said "I cannot forecast to you the action of Russia.  It is a riddle, wrapped in a mystery inside an enigma..."  Present day Russian actions could be described in much the same way but that's for a whole other blog all together.  Rather, more fitting to the context of this discussion is the riddle of forecasting equity prices. Let's be clear at the start... equity prices are impossible to predict. .. people far smarter than I have tried and failed on countless occasions.  Despite this fact, traders and academics alike continue in the pursuit to predict future prices for motivations far less noble than those of our grandparent's generation. According to the Black-Scholes-Merton options pricing model, equity prices follow a lognormal distribution known as Geometric Brownian Motion.  This ...