Archive for July, 2011

Today I would like to walk thru a trade I made using TD Ameritrade’s Think or Swim platform. I entered into a calendar spread on FAS, a triple leveraged ETF that tracks the Russell 1000 Financial Services Index. I bought the July 30 Put @ $3.40 and sold the Aug 30 Put @ 3.90. This resulted in a credit to my account in the amount of .50 per contract.
I entered the trade as a limit order which means that my order would only be filled if it met my requirements which in this case was that my trade result in a .50 net credit to my account.
My outlook on FAS is neutral to bearish in the short-term as it is trading near resistance in a downward sloping channel.

Moving Averages: The 5, 10, and 20 day are bullish.

MACD: Fast MA is bullish, while the slow MA is somewhat neutral.
 Stochastics: The 9, 14, and 20 day are all above 80% which is strongly bullish.
Relative Strength: The 9 day RSI is bullish. The 14 day RSI is technically bullish but is indicating weakness. The 20 day RSI is strongly bearish.
Money Flow Indicator: The 9 and 14 day MFI is still technically bullish but is indicating weakness. The 20 day is still bullish, but given the weakness in the shorter time intervals we can expect the 20 day to follow the trend.
Volatility: The Average True Range for the 9 and 14 day are identical while the 20 day is a little lower but they show bearish sentiment.
In total the technicals are slightly bullish but show weakness. For that reason I chose not to get into a trade that was extremely sensitive to direction.
Fas is trading in a range of $22.26-28.65 in the past 30 days and doesn’t look like it will break out of that range . It looks like FAS is headed toward the lower end of that range.

By entering the calendar spread I was looking to benefit from a near term increase in implied volatility, the benefit of time decay and price movement with my July put having a higher sensitivity to price movements due to the likelihood that my option expires at or near the current price.
My risk on the trade is limited to the credit I received ($500.00) as long as I cover my short before expiration of my long contract. My profit on the trade is dependent on how I decide to unwind the trade. I can choose to get out of both trades at the same time or I can cover my short and let my long ride. If I were to do that then time decay stops working in my favor and starts working against me. I also increase my risk to  the price action of the underlying.

With calendar spreads you should always cover the short option prior to the expiration of the long option. This is just simple risk management. And depending on your account type your brokerage may not allow you to do otherwise. I plan to close both contracts by Friday. I have a near-term price targets on the downside of 25.50 and 24.21. On the upside I will exit the trade if FAS crosses 28.41.


Very interesting blog on a topic relevant to all traders.

Gambling and Speculation One recurrent topic in trading is differences and similarities between gambling and speculation. After having reads quite a few ideas on this I came up with the following definitions that work fine for me. Both gambling and speculation share the same common ground and this is risk. Risk in turn has to do with the uncertainty of the outcome of future events so basically both gamblers and speculators have in common that they take risk with the obje … Read More

via Piedmont Trader

Cover of "The Black Swan: The Impact of t...

Cover via Amazon

I am going to touch on a topic that has been made popular over the past few years as a result of the wildly successful book by Nicholas Nassim Taleb “The Black Swan“. I found his  fooled by randomness to be much more interesting, but both are must reads to anyone interested in the market and how we perceive everyday events. The author has a few detractors in finance, academia and the media. You shouldn’t let these deter you from what he has to say as he has yet to  experience the failure that some of his most vocal detractors have.

Nicholas Nassim Taleb must be thought of first as a pursuer of intellectual truth and knowledge, second as a trader and financial commentator. I share with him a desire for independence and freedom from authority and believe that trading can offer that. His most profitable trades have arisen due to misconceptions about risk and chance. Two topics of vital interest to traders.

A “Black Swan” event is the occurrence of a highly improbable event that has extreme implications. Black Swans are the outliers on a data set. If you were to ask where a black swan would show up on a Bell-Curve it would be to the extreme left or right. The two tails of the curve. They are often times the most ignored, yet most important aspects of a data set.  So a black swan trade would be to trade an event that is highly improbable of occurring, but in the case that it does, results in a large or even immense payoff.

The exact opposite of a black swan trade would be to trade an event with a high chance of occurring with a small payoff. An  example of this is given in another great book When Genius Failed by Roger Lowenstein in which he highlights the implosion of Long-Term Capital Management. LTCM was a fund created by some of the most elite and revered names in finance. Their trading style was to find high-probability, low payoff events, leverage the trade by on average 20:1 and hope that the black swan never crossed their path. Well as is often the case in matters of trading, the black swan decided to make its presence known. What resulted wasn’t on the scale our most recent economic crisis, but the fed had to step in with its strong-arm tactics forcing Wall Street’s major players to bail out a group of academic legends.

If you chose to become a black swan trader you will experience bouts of depression and self-doubt as most of your trades end up as losers, if you are able to withstand the psychological assault that this style provides then at the end of the day you will have achieved the independence and freedom from authority that we all pursue. If you chose the LTCM path and many of you will, you will experience a life of satisfaction, but be forewarned that it is a life lived on borrowed time.  For the Black Swan comes swiftly and witthout warning.

Isoalpha isn’t the proper forum for me to offer advice on trades that you should make, my goal is to make you aware of mistakes that can be made. To become a successful trader you have to be aware of your biases and how they affect the decisions you make while trading. You must be willing to look at the data in a different light and constantly question your rationale for making a trade. Just because you can backtest a strategy and found that it has been successful using historical data, doesn’t guarantee that it will be successful tomorrow. It doesn’t mean that you shouldn’t execute it, just be aware of the consequences that will occur if your theory isn’t valid in tomorrows market. If those consequences are bearable then by all means make the trade.