After charting the S&P 500 ($INX) the past couple of times I moved back to the Dow Jones Industrial Average ($DJI) again this weekend. The charts are very similar as you’d expect. The triangle I had drawn for the S&P 500 a couple of times broke higher one day and then back lower with a vengeance. I didn’t bother drawing it here since it is past its usefulness.
What really stands out still is the trading range we’re stuck in. This is great for option sellers. Sell calls at the top and buy at the bottom or sell puts at the bottom and buy them back at the top. The reverse could work too for option buyers. I’ll post my February account summary tomorrow, but in short I was up due to this pattern although the major indices were all down.
The upside ceiling seemed fairly firm with the horizontal resistance around 12,750 and the declining trend line of lower highs coming together. (I might have cheated the lines a little there as I didn’t draw it off the tops of the December highs, but used the level just below that.)
The downside floor is interesting. The DJIA stopped at the recent short trend line of higher highs. I’m curious to see if that short line holds next week or if we continue down to the longer lines of 12,000 and 11,640. I’m expecting the 12,000 line to hold, but will keep some money to the side if it breaks to get in deeper should it go back down to the mid-11,000 range again.
This is clearly a market for the patient. Trades are there as I showed with my late Friday afternoon limit hitting. I think it’s a matter of finding a stock that has the fundamentals you like and charting it to see where you should get in. Set your limits and let them sit for at least two weeks. No matter what, we are not going to see a sustained surge to new highs any time soon, so there’s no rush to get all your chips on the table for fear of missing a new bull rally from the first day.
I hope you’re right. If there’s a bounce, it’s easy money. Otherwise, I am going to get margin calls. I need to reevaluate my risk management strategy for when everything goes against me. My models do not currently take into account that owning shares in industries leading the decline and high beta can give you an effective 2-3x on top of the options leverage.
If you are going to sell naked puts you MUST manage your risk. What basis are you using now to limit yourself from getting too far? I don’t let the total of my underlying stocks get to more than 2x the value of my account. This doesn’t take into account the decline in account value in a bear market, but still leaves a cushion big enough to avoid margin calls.
When I first started selling puts I had a few margin calls before I figured this out. I sold and sold until Amertrade would say I had no more money. That’s like writing checks until the bank says you have no more money and you’ve bounced a check.
I use the if assigned cost basis times the probability of expiration to calculate cash needs for the front month options expiration. This is supposed to prevent draws on the margin loan line.
I use the historical volatility and correlations to calculate what the 3 sigma level of price swings will be and use that to calculate margin needed. For example, if the monthly standard deviation of a security is 10%, I figure a 30% loss for margins.
I believe that the problems I am having can be traced to two things: Ameritrade does not have real time buying power and I sometimes forget to account for trades done in the day and effect of today’s market movements. The current market is showing correlation higher than historical data (e.g. commercial and residential real estate both being squeezed) and the current market is showing higher volatility than recent historical data.
Basically, I am having the same model problems that the investment banks are having. They are having problems with marking down MBS. I am having problems with the market marking WB down to 0.85 book value.
I tend to use excess margin to sell out of the money puts on stable companies (e.g. JNJ). When I get a margin call, I just buy those back. I also keep reserves outside of Ameritrade due to the low interest rate.
How much commission do you pay to trade NPLXX? If I could consolidate my reserves into the account, I’d probably eliminate all the margin calls.
What’s your current view on volatility? With all this sub-prime stuff continuing to brew, volatility could easily spike, hurting those with short positions.
Volatility spikes don’t hurt you if you hold an option to expiration. Generally, you try to sell options with already high implied volatility. While the VIX may spike, the options I am selling with IV of 40-60% will not spike that much. If you think that volatility will spike, then buy VIX. If the time premium of VIX is too expensive for you then that clearly means others are much more worried about volatility spikes then you are; the market is telling you that a volatility spike is priced in.
I can’t find it now, but I remember if you hold NPLXX for three months there is no fee. The fee to go in and out would be about break even after 45-60 days I think. I had to start with $25k and then after that I eased in until I got to $40k which seems to be as much as I can keep liquid now. After March I plan to up that when some of my “junk” gets called away.
I agree with Opt Strat’s comment on Volatility. Overall VIX is fun to watch for a contrarian angle, but I play the same game of looking for stocks that are already spiking individual IV or I set my limit orders to take advantage of it on a stock dip that scares people.
The sub-prime stuff is baked in with a lot of the stocks that were trading with lower IV a year ago, so some of the risk is reduced (not gone) from those on spikes. The bottom line is what he said just above this comment, if you don’t get a margin call and can hold until expiration volatility is only there to help make us money since the moves after you’ve sold short don’t matter.