GalaTime - Where Time is Money!

Options Trader Magazine: July 2005 Issue

I strongly encourage readers to check out the "Options Trader" magazine; it focuses purely on options, and is free until April '06! Once you sign up here, they'll email you links to PDF copies of the current (July '05) and past (Apr - Jun '05) issues.

The latest issue features the following:

Contributors: Keith Schap, Jim Graham, Steve Lentz, Peter Stolcers, Brian Overby, and others

News: M&A activity expected among the options exchanges, triggered by the NYSE-Arca merger;

Options Strategies # 1: Using butterfly spreads to reduce the risk while selling volatility.

Options Strategies # 2: How long straddles (and LEAPS) can buy you time on directional bets

Trading Strategies: (Cash-secured) naked puts are equivalent to covered calls! [How many times must I have mentioned this in the past.]

Strategy Lab: Using a short strangle to trade the monthly employment report

Basics # 1: Understand the volatility index VIX

Basics # 2: Using spread strategies to offset losses due to time decay and volatility fluctuations

Basics # 3: Finding options that best suit the needs of a particular trade

Go sign up. It's worth your time.

]]> Here's an image-grab from the Basics (Spreads) article, mentioned above.

Pacific Exchange To Trade Options In Pennies

Following the Boston Option Exchange's PIP initiative, the Pacific Exchange announced this week that it will "begin quoting and trading all listed options in penny increments". The Exchange will submit the necessary rule filing soon, and hopes to receive expedited approval from the SEC so that it can begin trading options in pennies in the fourth quarter of 2005.

This is great news for options traders; by routing your orders to these exchanges, or using "smart" routing features offered by some brokers, you can significantly narrow the bid/ask spread on option trades. For option strategies involving 2 or more legs (e.g. spreads, butterflies), the move to penny quotes will result in a huge improvement in returns (expectancy)!

I look forward to the day when this is offered by the larger options exchanges (ISE, CBOE), so that we can take advantange of the liquidity as well. On this note, its interesting to see the BOX steadily increase its market share every month. Deep discount option brokers, fully electronic exchanges, and narrow option spreads are the way to go!

CotC, Taylortree, Option Strategies for Buyout Candidates

The weekly Carnival of the Capitalists (CotC) is up at Business Blogcasting. Posts that cover trading/investing include: Why Politics Matter to Investors, Bullish Trends in Commodities, and the Islamic Gold Dinar.

Mike at Taylortree writes about his experiments with different position sizing strategies; a must-read for anyone developing a detailed trading plan!

And finally, there's a Smartmoney/Barrons article on how option strategies can be used to profit from buyout candidates. Excerpts:

Most speculators will buy calls on potential targets. But another alternative is the "risk reversal," where one sells at-the-money puts to buy slightly out-of-the-money calls. This allows traders to "simultaneously participate in the stock's rise and to capture the volatility premium generated from a flattening skew."

Covered call-writers scouring for announced deals with "some juice left" tend towards stocks trading at a discount to the offer and whose options look pricey.

SFOMag July '05 Issue: Options & Trading Psychology

The Stocks, Futures & Options Magazine, SFOMag continues to give out FREE online and regular subscriptions - go sign up!

The July '05 issue has an excellent set of articles pertaining to two of my favorite topics: options and trading psychology; check out the summary posted recently by Trader Mike. The cover story "WHAT’S IN YOUR HEAD? Becoming a Trader" is co-authored by Brett Steenbarger, who publishes a must-read blog with daily market updates, trading psychology research, proprietary market indicators, and such.

Here's some excerpts from the "OPTIONS OVER EASY: The Incredible Versatility of the Credit Spread" article, authored by Boris Schlossberg:

There are almost as many ways to use a credit spread in options as there are ways to use an egg in the kitchen. :-)

A trader who puts on a credit spread can make money if prices move as he anticipates or if prices simply stand still. The ability to win in two out of three possible scenarios is a tremendous edge that often trumps the poor risk/reward ratios credit spreads offer.

Time decay is the credit spread trader’s best friend.

Precision is not necessary for success, being close is good enough. What is absolutely vital is good execution.

To successfully trade the credit spread, a trader need not be deadly accurate on direction, but he should be very precise in price.

By capping losses, the credit spread protects the trader from runaway risk like takeovers to the upside or fraud to the downside.

Forex market provides the retail trader with an opportunity to trade exotic options like the “no-touch” option, which states that the trader will receive a predetermined payout in return for the premium paid if the currency never touches a certain price point before expiration. Since this option is far cheaper and often offers a better risk/reward ratio, it can be an effective substitute for the credit spread in the FX market.

Managed Options: Kawaller Fund

The Kawaller Fund ranked among the top-10 managed options programs (CTAs) during the April '02 through March '05 period; such rankings are regularly compiled by the Barclay Group. The fund was also featured in the top-100 CTAs list, compiled by IASG (a site that provides data on hedge funds and managed futures), based on 60-month performance prior to April '05. The fund had a terrible run when it launched in July 1999, and its year-over-year performance is very volatile (+262% in '02, -23% in '04). But then again, the annualized 3-year & 5-year returns are in the 30-50% range!

Trading Philosophy:
The fund limits trading exclusively to buying options on futures contracts. The premise of the trading activity is that futures prices – particularly futures prices in fixed income markets – are notoriously poor predictors of prospective spot prices; this view is supported by a preponderance of academic evidence, and the long-term track record of the fund.

The Fund takes directional positions using only long options on futures contracts, where (a) the choice of puts or calls is determined in such a way as to benefit from the convergence of the spot and futures prices and (b) the time value of the option is smaller (in absolute value) than the spot/futures differential. This condition fosters the outcome that if the spot price remains unchanged over the life of the option, the option will appreciate in value. For a long option portfolio, any and all invested option premium can be lost.

Also, check out the excellent collection of finance articles on Kawaller's site, especially the "derivatives" section.

]]> Program Details & Performance Statistics:
* IASG profile
* Min. investment = $25K, Fees: 2% mgmt fee, 10% incentive fee
* No. of winning months: 38
* No. of losing months: 33
* Maximum Drawdown: 57% (July-September 1999, immediately after inception!)
* Sharpe ratio: 0.6
* Correlation with S&P 500: -0.3

Here's a snapshot of the fund's returns, 3-year and 6-year periods::

Optionetics: Selling Covered Options on S&P 500 futures

[Monday morning link-fest: Bill Cara's weekend review, Carnival of the Capitalists at Blog Business World, Barry Ritholtz's Around the World.]

Optionetics has an article that looks at how S&P futures differ from commodity futures; and how covered option spreads on S&P 500 futures (bull/bear, call/put) can be used to add another dimension of diversification to a properly balanced trading plan.

S&P futures options offer the same benefits as other futures options, such as highly attractive margin requirements, the ability to sell far out of the money strikes and excellent liquidity.

Problem: Selling naked options on S&P futures only yields a tiny (comparatively) return on capital invested. Also, the trader takes the risk that even a mild fluctuation in the value of the S&P could increase margin requirements substantially.

Solution: Covered option spreads allow a trader to enjoy the benefits of collecting option premium while limiting risk and reducing margin requirements simultaneously.

The downside to spreading is that it takes time to reap the profit. To take the full profit, the investor must generally remain in the trade through expiration, or at least close to it.

Interview w/ Tom Sosnoff at Real World Trading

In the past, I've written about options broker ThinkOrSwim, and their options advisory RedOption; both offer quite innovative services at reasonable prices! A recent interview with Tom Sosnoff, conducted by Dave Goodboy of Real World Trading, explains how he co-founded TOS and where he thinks the options market is headed. I recommend reading the interview in its entirety, but for those of you with short attention spans, here's some excerpts:

TOS was the first firm to introduce single click trading functionality for complex spreads, with access to six different equity option marketplaces.

TOS is a dynamic front end trading platform, Option Planet is an educational service that offers free seminars, Red Option is a very low cost option advisory, and Liquid is an institutional (more complex) trading platform.

Expect consolidation among exchanges: AMEX and PHLX may merge or be acquired. The Pacific Exchange is going to be hard to judge because of its relationship with Archipelago. CBOE and ISE are the two main players.

The BOX is very interesting because they have introduced price improvements - it's basically pennying the marketplace.

In the world of super low 11.5% volatility, there is a good side to things. True, you can't make as much, but you also can't lose as much.

Eventually, I want to become the house - I am not a premium buyer, I like to sell premium with a defined risk and I don’t care what current volatility is.

Market Meltdown: Cherniawski at Financial Sense

Keep in mind that today is June options expiration:

Last month, Anthony Cherniawski published an article titled "Market Meltdown" at the Financial Sense website, that argued for a global stock market downturn. In addition to Ellitt wave counts, the author looked at the volume of open interest for out-of-the-money puts on the SPX and the dollar volume of short trades that should be placed in order to adequately “delta hedge” the exposure of the sellers in the June put contracts.

The author proposed that automatic delta-hedging trades, commonly used by hedge funds, could lead to a cascading effect, should the S&P violate the 1175 and 1160 support levels, and lead to a drop below 1100.

And yet another scary thought: One of the talking heads on CNBC stated that one of the largest brokerage houses was recommending that retirees sell naked puts to increase their income from their investment portfolios.

Of course, with the S&P trading above 1215 today, the market meltdown didn't materialize.

PS: In Market Meltdown Part II, Cherniawski reports on why portfolio insurance was deemed to be reponsible for the Oct 1987 crash. For those of you (us?) selling naked puts, this is a worthwhile read!

Hamzei Analytics' HOTS: May 22 Issue

Here's a summary of the May 22^nd Issue of the HOTS options newsletter from Hamzei Analytics; it's edited by Dennis Leontyev, a hedge fund manager and options trading expert. Note that the newsletter is made publicly available after a delay, so its useful only as an insight into option strategies.

Market View:
- Bullish outlook in the intermediate term, for all equity indices

iShares Russell 2000 Index (IWM):
- Break-out of inverse head & shoulders pattern
- Bull Put Credit Spread strategy

Bowater Inc. (BOW), Kimberly-Clark Corp. (KMB):
- "Statistical arbitrage mean reverting trade utilizing options"
- Stocks are highly correlated on long-term basis, but BOW has under-performed KMB recently
- Expectations: BOW to outperform KMB (regardless of direction), hence buy BOW Calls, KMB Puts

Market Views, CotC, etc.

I've been quite busy on the home front, hence the lower frequency of posts.

LBR Group's Night Owl session: There wasn't one this weekend, but they do post a few charts (S&P, Dollar, DAX, etc.) daily.

Bill Cara's Weekend Review - Gets you up-to-speed with recent market action! Bill talks about the spam annoyance, his long-term outlook on equities, US bond yields, and the usual sector/ETF analysis.

The weekly Carnival of the Capitalists (CotC) is up at the Byrne's Marketview blog. Posts that cover trading/investing include: 5 common investor errors, investing in China, technical analysis, Greenspan's conundrum, and similarities between the US & UK economies.

Options Trader Magazine: June 2005 Issue

The latest issue features the following:

Contributors: James Bittman, Boris Schlossberg, Don Fishback, Thomas Stridsman, and others

News: CME's efforts at increasing option trading volumes; the Option Industry Council (OIC)'s “Profile of the Options Investor” study. [Note: I talked about the study results in a previous post.]

Options Strategies # 1: Using vertical spreads to sidestep the complications of changes in implied volatility, and reduce risk.

Options Strategies # 2: Matching option strategy to market conditions - an excellent overview, by Thomas Stridsman, of various option strategies and when to use them!

Trading Strategies # 1: Forex options require traders to learn exotic option terminologies, e.g. no-touch options, double one-touch options, etc.

Trading Strategies # 2: Option spreads - The reinsurance approach; how credit spreads let you play the odds à la casinos & insurance companies

Basics: The role of options as insurance/hedge for your portfolio

Strategy Lab: Using a long straddle to trade the monthly employment report

Resources: Option analysis tools at Hoadley.net

Go sign up. It's worth your time.

PS: Here's an image-grab from the Stridsman article mentioned above.

Managed Options: LJM Partners Fund

Yet another top performing managed options program is the LJM Partners Fund; its averaged annual returns of 30% since 1999, with a standard deviation of 32%. That might seem a tad risky, but the fund's recent performance has been spectacular: +68% in 2003, +54% in 2004, and +16% YTD in 2005.

Trading Philosophy:
LJM has developed a market neutral trading strategy with a belief that the S&P 500 market is always efficiently priced. LJM does not attempt to forecast market direction, rather LJM derives profits as a function of the “time decay” of options by managing changes in underlying volatility. The basic principle of LJM’s trading methodology is to simultaneously write (sell) deep-out-of-the-money call and put options, and profit when the price of the options that have been written (sold) declines such that the options can be purchased for amounts less than the price at which those options were initially sold. Profits are also realized when options expire worthless, providing full profit on the original option premium sold.

What's more, the fund provides clients with customized investment profiles:

Negative Correlation to the S&P market

Conservative: Annual target of 8-10%, 2 year timeline

Moderately Aggressive: Annual target of 24-30%, 2-4 years timeline

Aggressive: Annual target of >40%, 3-5 years timeline

]]> Program Details & Performance Statistics:
* IASG profile
* Min. investment = $500K, Fees: 2% mgmt fee, 20% incentive fee
* No. of winning months: 65
* No. of losing months: 12
* Maximum Drawdown: 46% (In July 2002, Quite severe!)
* Sharpe ratio: 1.0
* Correlation with S&P 500: 0.1

Here's how the fund's returns compare with those of the S&P 500, since the former's inception in 1999:

Closing TXU Corp (TXU) Bull Put Credit Spread

My option trading has been light as of late; there's only one position for June expiration - the bull put credit spread for TXU Corp (TXU). The stock moved up from $78 to $80 since I initated this trade; it's time to close the position as follows:
Open: Sell Jun $75 Put @ $1.5, Buy Jun $70 Put @ $0.5
Close: Buy Jun $75 Put @ $0.15, Sell Jun $70 Put @ $0.05

P&L: This trade generated a profit of $90/spread. With maximum risk of $400/spread, this translates to a 22% return over 15 days.

Monitor my trades at http://www.galatime.com/portfolio.

Carnival of the Capitalists - June 6th Edition - Hosted by GalaTime

As your host, let me first share how I've compiled this CotC. I started out with Brian Gongol's template, but noticed that several posts (e.g. topics related to blogging, environment, etc.) didn't fall into any of the typical CotC categories. Hence, I've assigned (one or more) keywords to each entry for better categorization & navigation. There were 48 entries, all of which have been listed below, in random order. Given my own blogging interests, I've asterisk-ed those blogs and/or posts that talk about investing & trading in the capital markets.

Joseph's Marketing Blog	Look for Competition LAST	Business Strategy	When planning your business, look at the competition lastly as to not base your business on a foundation built by your competitors.
Secrets of Going Solo	Yes Virgina, You Do Need to Sell	Entrepreneurship, Sales	A direct challenge to solopreneurs to get over the excuse of I don't like selling. If you don't like selling hire someone who does or get out of business.
Upsetting the Balance of History	Upsetting the Balance of History	Economics	Economic lessons of unintended consequences
Freedom's Fidelity	Global Warming or Heated Rhetoric?	Economics, Environment	General Discussion of Environmental Economics.
Weekend Pundit	Waiting For The Bubble To Burst	Real Estate, Investing	Is the real estate bubble really a bubble? If it is, will it burst or just deflate? How can you tell if you are indeed stuck in an overheated market?
BaySense	Mis-representation of 'cap & trade': just like Groundhog Day	Regulation, Environment	Most newspapers like the Sun do a poor job of explaining the concept of cap & trade
Lead and gold	Top down Innovation	Business Strategy	Argues that while established firms might have an advantages in capital and brand recognition, they face huge barriers in terms of diseconomies of scale, procedures mindsets, and inappropriate metrics.
Talking Story with Say Leadership Coaching	Why GTD reminds me of the 7 Habits	Professional Development	This article examines how the productivity teachings of Stephen Covey and David Allen intersect and synchronize: As I see it, Allen is bringing fresh attention (especially in Blogsville) to timeless principles.
Blog Business World	Title tags: Simple SEO	Blogging	One of the fastest and often forgotten techniques, to move a blog or web page higher in the search rankings, is to change the page’s title tags.
View From a Height	Finance Fault Line?*	Investing	Former NY Fed Governor Gerald Corrigan argues that hedge funds have learned from the LTCM fiasco to limit their leverage so as to avoid another meltdown. The problem is, leverage was only one, aggravating aspect of the collapse.
Capital Chronicle	The state of auto-makers: my other car's a Rover	Business Strategy	Medium-sized UK car maker MG Rover went bankrupt in May - just how healthy are most of the other notable auto-makers in the US, Europe and Asia?
You Big Mouth, You!	Work: What I Do For Money	Entrepreneurship	small business case study in finding and developing a niche
Gautam Ghosh on Management	What do you look for in a career?	Professional Development	Sometimes the insight into what a person looks for in a career comes from popular culture, like a Hindi film !
The Entrepreneurial Mind	Assessing Opportunities	Entrepreneurship	Learning to effectively assess potential opportunities is a critical skill for entrepreneurs to develop to increase their chances for success.
The Other Bloke's Blog	NeuroMarketing Versus Internet Marketing - No Contest	Marketing	NeuroMarketing reads brainwaves and is invasive. Internet Marketing uses the electronic footprints that customers leave all around to fine-tune promotional efforts.
Free Money Finance	Net Worth of Financial Bloggers	Blogging	Sheds light into the financial success (or lack thereof) of people who are giving financial advice on the web
voluntaryXchange	Models In This Ad ...	Marketing	Why do advertisers of real estate that features provocatively dressed women have to put a disclaimer in about race?
The Sharpener	Brown’s crusade	Politics, Economics	Free market, sceptical dissection of UK Chancellor Gordon Brown's 'Marshall Plan for Africa'.
Crossroads Dispatches	Are You Blind to the Breakthrough Story Right In Front of You?	Business Strategy	Dietrich Mateschitz, Donald Trump, Sidney Frank typify a new class of billionaires who got rich not by inventing a new product but by selling an ordinary one inventively.
The Prudent Investor	Experience shows that man never learned anything from experience	Politics	President Bush's style of governing and the relaxed mood at the Federal Reserve Bank don't bode well for the future when we remember that the US already went through such a constellation before.
Political Calculations	Graduating to a Paycheck	Professional Development	How much is a college degree worth today?
JSLogan	Are Frequent Visitors to Your Business Better Than More Visitors?	Entrepreneurship	If all things were equal, would you prefer more visits to your business per person or more people visiting less often?
Marketing eYe	Playing to Win	Entrepreneurship	The reason why Detroit Pistons won game 4 against Miami Heat... and the business (and life) lesson behind it.
Roth & Company Tax Update	Treasury Inspector General, Irs Clash Over S-Corporation Employment Taxes	Regulation	The Treasury Inspector General proposes drastic action to collect employment taxes on S corporation income. The IRS disagrees. So do we.
Ideologic L.L.C. - A Blog Process Outsourcing Company	Blogger Code of Ethics - Blog Process Outsourcing Version	Blogging	Blog Process Outsourcing is a business concept where a professional blogger writes on behalf of the Company. Therefore, it is essential that some Blogger Code of Ethics is in place for this category of Blogging.
Retail Store Blog	Retail Trends and the Boomer Convergence	Business Strategy	The retail spending and sensibilities of the huge Baby Boom and Echo Boom generations appear to be converging. If so, then organic, sweat-shop free, efficient, sustainable products will move markets
The Big Picture*	On Line Trading: A Business Plan for the future*	Business Strategy, Trading	Since E*Trade's bid for Ameritrade was rebuffed, and Ameritrade is now approaching T.D. Waterhouse about a merger, I started thinking about this commodity business.
Half Sigma	The economics of charity	Economics	The author argues against the notion that charity is strictly about altruism, and thinks that it should not be tax deductible.
Revenue Roundtable	Leads, leads, leads	Marketing, Sales	Sales person: Marketing sends us crappy leads. I don’t get enough GOOD leads. Marketer: Sales never follows up on all the leads we send them. We are wasting money generating leads that are never followed up.
ROFASix	The Celtic Tiger: Secret of Success Unveiled	Politics, Economics	Why has Ireland's growth been 167% over the last 18 years? While other European economies were languishing, Ireland boomed. A recent study uncovered the reason.
Chocolate and Gold Coins	The Economics of Wine Tasting	Economics	If you have a winery, should you charge for wine tasting?
Guerrilla Consulting	Getting Paid What You're Worth	Professional Development	This post describes why the hourly billing rate is bankrupting the best professioanl service providers and what can be done abouit it.
The Internet Stock Blog*	Is Amazon the loser from the EBAY-Shopping.com deal?*	Technology, Investing	This post discusses the threat to Amazon.com from eBay's announced acquisition of Shopping.com.
Coyote Blog	Why Do So Many Libertarians Blog	Politics, Blogging	I was asked in an interview recently, after I described myself as an anarcho-capitalist, why so many libertarians blog. This was my answer.
Mover Mike	Copper and Julian Robertson*	Trading	Who is Julian Robertson and what did he say on Ron Insana's show that took the air out of the market on Tuesday May 39th?
The Common Room	Managing from the Heart, Correcting	Professional Development	Even if you disagree please don't make me wrong.
Big Picture, Small Office	The Truck Stops Here	Professional Development	This is story of decent, uncomplicated man, retiring after thirty years with the company. But where is the CEO? Another tale of folly from the large company that thinks small.
Businesspundit	All Marketers Are Liars - A Book Review	Marketing	I review Seth Godin's new book "All Marketers are Liars."
The Mobile Technology Blog	School girl "hostage" phone	Technology	There are lots of reasons to have two mobile phones - here's just a couple of more amusing examples.
Small Business Trends	Hottest Sites to Find Small Businesses for Sale	Entrepreneurship	This post describes why so many more small businesses are being bought and sold today, and contains the six best sites to find listings of businesses for sale.
Ashish's Niti	Leave the culture and the tax-payers alone	Regulation	Argues against government patronage of art as a non-monetiazable thing
Interested-Participant	Swampland Sold on eBay	Regulation	A company that sold swampland to buyers on eBay has been ordered by the Florida Department of Business and Professional Regulation to track down everybody who bought swamp and give all their money back.
EGO	Christopher Cox at the SEC*	Politics, Investing	Thoughts and comments on Christopher Cox as the new SEC chairman.
Alchemy of Trading*	Heart Of Darkness*	Trading	Dangers of leveraged, high-stakes trading
Gongol.com	The Economic Costs of Pseudoscience	Economics	Pseudoscience isn't just harmless fun and games -- it has real economic costs. The more you like markets, the more you should be ready to fight pseudoscience wherever you find it.
Mean Ol' Meany	Treatise on Re-Education of Deadbeat Socialists	Politics	When all of our populace learns the value of a dollar, they can easily be motivated to better themselves and keep their damn grubby, no-working paws off my pocketbook.
Drakeview	Business plan planning	Entrepreneurship	Creating a good business plan is lot of work that must be done by the founder(s) of a start-up. While professionals can assist with some elements, the planning and critical aspects need to be authored by the founder.
The Picket Line	Lucky Duckies	Regulation	A useful summary of the "lucky duckies" kerfluffle that was set off by a Wall Street Journal editorial about how the poor in America don't pay enough income tax and so aren't motivated to agitate for lower taxes and less-costly government.

FYI, next week's CotC will be hosted by Byrne's Marketview. Submit your entries here.

Hope you enjoyed this CotC. Cheers!
-Kaushik

CotC Reminder, Blogger Kudos, Yahoo OptionClub

First, a reminder that I'll be hosting the weekly Carnival of the Capitalists (CotC), starting tomorrow; and would particularly like to see bloggers contribute (here) their posts on investing/trading ideas.

Next, congratulations are due to Bob Arne, of the Hedging Options blog, on passing the Series 7 test. Bob scored 82%, and I'm guessing that's a good score :)

Fellow blogger (and Roundtable contributor) Tom Ott, of the Sixth World blog, also gets our good wishes; he recently graduated with a part-time MBA! I too went through this (full time job + evening MBA school), and believe me, its a lot of work.

And finally, a quick mention of the Yahoo OptionClub; a users group dedicated to collaboratively expanding our knowledge and understanding of stock and option trading strategies, technical analysis, and money management. Its one of the few messageboards free from junk/spam/rants; there's actually good discussion of option strategies, trades and trading resources.