V is for Volatility

More names

2008-06-09T22:09:00.002-05:00

Vol *did* act as a short-term leading indicator - more precisely, when I showed lots of attractive names, the market was ready to start moving.

This week, there are 4 more additions:

1) DUK
2) EIX
3) EXPE
4) VIP

Vol as a predictive tool

2008-05-25T16:15:00.002-05:00

Over the last year or so that I have been tracking the performance of my vol picks, I have found something interesting - I find more ideas when the market is about to make a significant directional move, and less when it is about to quiet down. For instance, in late Jan, I could not find any names of any profitable significance, and the set of interesting names has been sporadic since then.

Well, imagine my surprise, then, when today I find a veritable bonanza of vol names. Here is the list:

1) TEVA
2) PBCT
3) BIIB
4) TXN
5) ANF
6) NOVL
7) GT
8) ADCT

That's a lottery, so to speak. Not to mention the various ToTY's that have shown up every once in a while.

Here's to more volatile markets in the days and weeks ahead, when, ostensibly, the markets really should be quieting down for the summer!

Biotech bonanza

2008-05-21T21:04:00.004-05:00

2 more excellent candidates for profitable option investing are BIIB (Biogen Idec) and BMRN (Biomarin Pharmaceutical).

BIIB is likely to exhibit a $10 move, and BMRN about $6. On a percentage basis, these moves are quite large relative to the implied vol, so the options are a buy.

ToTY 3

2008-05-06T22:23:00.002-05:00

yes, its early, but good, liquid macro volatility trades don't show up too often. Bovespa vol was a winner, because the index moved up strongly in a short period of time. This ToTY, however, will require a slightly longer timeframe (possibly 3 months or slightly more), but the rewards should be pretty good.

And the idea is - Buy GBP (British Pound) vol. Implieds are near 10%, and over 3 months, we need only a 4% move to breakeven - the likely move is a minimum of 6.5%, and a maximum of 11%, by my work.

Back of the envelope, then, the likely fair vol is 16 at a minimum, or a gain of 6 vegas. Enough to qualify as a ToTY.

TEVA

2008-05-05T14:41:00.001-05:00

is reporting tomorrow. Either tomorrow, or within the next month, TEVA looks ready to move to new highs or to as low as 38. The downside potential is measurable - the upside, less so.

QCOM

2008-04-22T08:59:00.002-05:00

Intermediate term volatility in QCOM is cheap, and the stock is ready to move to either 56 or 32ish - a big move from the current 42 level.

Since this trade may take somewhat longer than usual, I am going with July vol.

Bovespa

2008-04-22T08:57:00.001-05:00

The ETF for Brazil - EWZ has made a new all-time high. The ToTY has done reasonably well, and its time to unwind the entire position into this spike.

ToTY update

2008-04-18T09:07:00.001-05:00

Bovespa Vol has been a winner. We have had a 10% straight up move in less than a month. Whether there is more room to go or not is debatable, hence, its time to take partial profits.

MIR update

2008-04-11T12:45:00.002-05:00

MIR has slowly inched up to above 37.50. However, the move has not been "impulsive", which means that a large, gap move is possible and even likely.
Hence, I am doubling my position with May options.

ToTY 2

2008-03-27T18:20:00.002-05:00

with ToTY 1 almost done, and the end of the quarter near, its time to look at ToTY 2.

And that is...

Bovespa Vol.

Bovespa is the name of the Brazilian Equity Index, and there's an ETF that is convenient for trading it in the US - EWZ.

I still have to study the potential moves likely in this trade, and decide on strikes and maturities, but it is clear that this will likely be ToTY 2.

ToTY 1 is officially a winner

2008-03-27T18:13:00.002-05:00

Live Cattle vol is a winner. I own 97-92 June straddles that I bought for around $3.75. With the continuing selloff in Live Cattle, the straddles are now worth nearly $5. I think there is still a little more room to run before a delta hedge is necessary.

The premium has increased by nearly 33%, worthy of a ToTY designation!

MIR is ready

2008-03-27T18:10:00.002-05:00

to blast off into space...but whether outer space, or lower space - I don't know.

It moved up about 3.5% today, and in doing so, it has indicated that it is ready to move to either below 32, or above 39.

Amazingly enough, with a potential move of that size, BOTH April and May vols are worth looking at.

I don't think this will be a huge winner, but it should be a winner nonetheless.

Update on recent vol adds

2008-03-25T19:00:00.002-05:00

In my post here, I mentioned that CEPH and GLW were showing cheap vols relative to the potential moves ahead.

I had been guessing that CEPH would move lower, but instead, it has moved 10% higher. Wrong direction, but the big move did indeed happen. Picking directions is risky - buying vol is low risk, but also proportionally less reward than picking a direction and getting it right.

GLW has also moved up fairly dramatically after spending a long time waiting to explode.

Of course, so has most of the market. The difference is that with the above, the risk AND reward could be measured and exploited. That's not necessarily the case with the rest of the market, which, oftentimes, is a crapshoot.

New Vol position

2008-03-24T10:37:00.002-05:00

LLL Communications has very cheap vols, and is close to its all-time highs. I think either we exceed the all-time highs and scream higher, or we drop down to 92ish within the next couple of months.
For now, I am buying Apr vol, knowing full well that the company does not report until after Apr expiry. I am leaving room to reload again with May vol if I am not successful on my first attempt.

More vol!

2008-03-13T17:09:00.002-05:00

Its been quite insane lately, with the market making manic depressive moves to the upside and to the downside.
In such an environment, it is tough to buy new vol, since vols are obviously quite elevated. This increases the risk manifold, relative to the potential reward.
The best course is usually to manage existing positions, and to unwind them for good profits when appropriate.

However, the market is now offering up a few goodies:
a) CEPH - Cephalon is ready to move again, and most likely to the downside. Given the break earlier this year, the downside potential is limited to roughly 54.

b) GENZ - Genzyme had a big move towards the end of last year, and amazingly, it is set to move again. Like WLP, could this move too be in the direction opposite of the previous break?

c) GLW - Corning is set for a 25% move. Vols are low relative to this expected huge move.

d) EP - Again, a great vol pick - the market is disbelieving of the potential for EP to go anywhere. It has done nothing for so long that the market is tired. That's a wonderful opportunity for me.

e) Otheres - these are not quite yet ready, but in a month's time, I think they will be excellent.
1) ORB
2) HSIC
3) VPHM
4) MIR

The risk with these is that the market moves unexpectedly during the supposed "waiting period". The only way to avoid that is to have partial positions while waiting, knowing full well that losses are potentially more likely than gains.

Happy Hunting!

After two weeks

2008-03-04T22:45:00.001-05:00

there's something of interest to report - and that is that ToTY1 is doing what it needed to do.

Live Cattle futures have gotten smashed in the past week, so much so that my puts (from my strangle) are now in the money.

However, since I think this move is just getting started, I intend to let the position ride without any hedging whatsoever, at least for now.

After all, its a ToTY - it needs to generate big returns.

ToTY done

2008-02-15T10:25:00.001-05:00

There's still upside potential of about 15%, but the downside potential from these levels is much bigger, and hence, I am out of ToTY 0 (buying Sugar Volatility).

I think we'll have a chance to revisit Sugar later in the year.

ToTY 0 just about done

2008-02-13T21:06:00.002-05:00

I am generally early in my profit taking, so I intend to try and push this one at least a little bit further than my comfort zone for usual profit taking. I will look to unwind a large piece of my position near 13.75 (as the price action dictates around that zone, call it 13.60-13.75). There's a shot that sugar could rally up to 14.25, and at that point, I intend to unwind everything.

ToTY 0 did its job. On to to the next.

ToTY 1 redux

2008-02-13T13:17:00.002-05:00

I didn't do a good job of hanging on to the old ToTY 1 - buying Biotech vol - the index *did* get clobbered, but as the market hit a low on Jan 22nd, I unwound all long vol positions, except for my ToTY - Sugar.

Well, I still need a ToTY 1, and I found it today - but it's off the beaten track, and not too liquid either. Drumroll.....

Buying vol in Live Cattle.

I expect a large move in Live Cattle. Commercials are long, and speculators are short, so I would have thought that it would be to the upside. But, the positions are not at an extreme, so I do not have a strong feel for which direction the move will be in.

A delta neutral strangle, June maturity, seems to make the most sense at this point to me. Let's see how it goes.

CEPH blows up

2008-02-08T17:03:00.000-05:00

I had mentioned it as a top pick on Jan 11th but unfortunately, I wasn't on board when it finally blew up. I unwound my vol positions after the spike on Jan 21st.

However, look at my ToTY - Sugar. It exploded to the tune of 6%, and is en route to becoming a home run.

V is for (very HIGH) Volatility

2008-01-22T21:02:00.000-05:00

Vols soared today as the markets looked poised to meltdown, and then, were "saved" in the nick of time by Bold Ben.

If was the perfect opportunity to unwind ALL vol positions at good profits. Except, of course, for ToTY 0, which, although it has given back its last leg up, still appears set for massive upside.

In fact, I don't show a single name where vols are low as of this writing!

ToTY 0

2008-01-17T12:23:00.001-05:00

And sugar is flying today - soaring, up 5%, with the broad equity indices getting pummeled.

Ride the bull for what it is worth - there's more to come, I think. Around 13.5, we'll have to re-evaluate.

ToTY 0

2008-01-16T22:00:00.000-05:00

had a good day with a 2% move higher. It continues to rock and roll - now hitting overbought territory. But, this move has legs, in my view, and so overbought will get more overbought. I am staying with the move until it exhausts.

Morever, inspite of the down move in the markets, ToTy 1 (Biotech) actually had a solid 1.25% up day. Is that the "direction" of the move? I don't know. We will need to wait and watch.

ToTY 1

2008-01-15T23:02:00.000-05:00

I didn't expect a ToTY to show up so soon, but it looks like we might have a winner. Well, let's call the leftover position from last year in Sugar as ToTY Zero. Then this becomes ToTY 1.

And the trade is: (drum roll....)

The Biotech Index BTK.

Its not so easy to trade this, because there are no futures. However, since I do not intend to delta hedge daily, that is not a big problem for me. Moreover, one could hedge with a proxy (like the BBH or IBB).

Vols are implied at around 22. By my estimation, we will have a 16% move in the index, either up or down. Buying ATM straddles gives up a breakeven time of roughly 1 year. I think we'll get the move within 3 months. That is double the move that is implied by the vols.

In an environment where fear rules and vols are sky high - these are cheap vols. Ideally, we can wait a week or so (after expiry) to initiate the position.

Gingerly stepping up to the plate

2008-01-11T09:33:00.000-05:00

The downdraft since the start of the year has elevated implied volatilities, and made good entry points difficult to find. I have been waiting for some stability before entering into new positions. We've started to see some the last couple of days, so here are names to watch:

1) CEPH - Cephalon
2) LNCR - Lincare
3) A - Agilent
4) CVH - Coventry Health Care - this is and old pick that still hasn't done its thing, so its time to double up.

Not a home run (yet), just a double

2007-12-29T21:45:00.000-05:00

I'm referring to my 4th ToTY (Trade of the Year). Sugar vol. Sugar did explode, and by about 12%, so it already favorable, but if I believe that the move is just getting started. We are headed at least another 15% higher, and potentially up to a 100% higher.

I guess we'll just have to call it 2008's FIRST ToTY.

How's that for an early start?

I'm baaaaaaaaaaaaaaaack!

2007-12-24T18:15:00.000-05:00

and with a ton of new ideas for the New Year.

Meanwhile, in my absence, two of my picks went berserk - DNA to the downside, and WLP to the upside.

And today, TEVA exploded higher as well.

All in all, the progress continues to be satisfactory, and profitable.

Back later in the week, before the New Year, for some outstanding picks for the next couple of months.

Last post for a while

2007-11-21T00:55:00.000-05:00

I'm going on vacation for a few weeks. Before going, the last new idea - buy TEVA vol.

The stock will move about 15%, up or down, in the next 2 months or so. Vols are dirt cheap, and buying strangles should prove to be profitable.

Elsewhere, I have closed out most of my existing positions - Gold, GRP, NOC etc. Still have MRK and AFFX, which will be closed out soon. I am still hanging on to new positions DNA, EP and CVH, because they have too much potential, and don't need active management until they explode or implode.

PETM oversold

2007-11-14T22:37:00.000-05:00

There is potential for PETM to drop to 23.50, but in the short term, it is severely smashed up. I have therefore taken profits on the trade, and have decided to revisit it later after a bounce materializes.

As it turns out, the company reported earnings, and the stock was modestly up after market.

Doubling up

2007-11-13T23:43:00.003-05:00

in El Paso (EP).

The vol crush continues, and the market, I think, is offering me a gift. So I am taking it. I expect a move above 20, or below 15 by Jan expiry.

An old favorite revisited

2007-11-13T23:40:00.000-05:00

Back in May, I had mentioned DNA (Genentech) as a favorite pick.

DNA moved about 10% lower almost immediately, and I unwound that position.

Interestingly, DNA vols are extremely cheap yet again, for an expected move of north of 10%.

Even more interestingly, Cramer picked DNA as one of his 2 favorite biotechs (Celgene being the other).

It should be an interesting couple of months in this pick.

AFFX implodes

2007-11-13T23:36:00.000-05:00

I had mentioned here, that I expected AFFX to move 25%, most likely down.

Today, AFFX got crushed when it announced a convert deal. An extremely cheap convert deal, in fact.

We are down almost 20% already, and my estimate it that when all is said and done, the total move will be my previously estimated 25%.

Another notch on the V.

Huh?

2007-11-13T23:31:00.000-05:00

Of all the stocks I have listed as good vol plays on this blog, SBAC is the only one that REALLY has me confused.

It has turned out to be an EXCELLENT vol buy, but for all the wrong reasons.

When I buy vol, I am looking for "absolutely" cheap vol. This means that I buy straddles or strangles that are priced cheap to the likely future "trend" move. My value added, really, is to identify stocks that are likely to trend, and to measure the likely size of the trend, using my proprietary indicators.

Well, SBAC doesn't seem to have made up its mind yet. It first trended higher. Then, it reversed directions and trended massively lower. And then today, it reversed directions yet again, and moved higher in a frenzy, such that, net net, we are unchanged from where we first visited this stock.

That's not supposed to happen in my book.

No harm done, but something definitely to think about - is there a way to recognize and capitalize on such a trend "reverser".

The Tower of SBAC is falling

2007-11-12T23:36:00.000-05:00

A couple of days ago, SBAC exploded higher - I then opined that we would see 43 within a few weeks.

Then, all of a sudden, LEAP wireless reported all sorts of bad things, and all the tower stocks reversed hard.

The nascent uptrend morphed into a full blown downtrend.

So, now I think that we will see 29.5 very soon.

This is why this blog is about "V for Volatility". I don't usually know the direction of the "Trend" move. However, as long as there is a trend, and a big one at that, I can profit from it. This is a perfect example. As SBAC exploded higher, my options made me long. As the stock plummeted back towards ground zero, I gave up my profits from the initial big upmove. As it plummeted below ground level, I became short from my puts, and as the stock has continued to drop, I have gotten shorter and shorter via my puts, and the trade has worked out just fine.

Volatility in motion.

Airlines "die"

2007-11-09T07:15:00.000-05:00

Well, I got the direction of that trend move wrong - it was to the downside. The original break was to the downside, and the market has continued lower.
The fundamentals, however, continue to point to this being an "ending" move. Hence, I think it makes sense to look to cover shorts, and wait for an equivalently large move back up.

PETM, it is your destiny

2007-11-07T22:05:00.000-05:00

PETM continues its downside run. I last mentioned this name here. It has taken nearly a month, but this is par for the "volatility" course.

I think that PETM will drop much further, down to 23.5 before this downtrend completes. Follow the trend, PETM, it is your destiny!

Oops

2007-11-06T23:14:00.001-05:00

EP reported earnings today, and the stock dropped slightly.

Implieds had rallied smartly ahead of earnings, and they got clobbered post earnings.

Nonetheless, the trend move likely remains intact, and I expect to see $20 by year end.

Similarly, I have been expecting the trend move in airlines to be to the upside, but today, they broke down hard. The trend move appears to be to the downside right now. Tomorrow should clarify matters - follow through to the downside will mean that we're headed another 10% lower. A reversal would put the downtrend in doubt, and suggest that the breakdown was a "fake" down.

SBAC explodes higher

2007-11-02T20:38:00.000-05:00

on earnings that the market deemed better than expected.

It therefore appears that it will trend higher - my guess is that we will see 43 in a few weeks. From its close yesterday, that would be more than 25% move higher, for a stock where implieds are quite low relative to the large move I expect.

A Semiconductor Vol Trade

2007-10-31T21:28:00.000-05:00

Fairchild Semiconductor (FCS) has vols that are cheap relative to its impending move. This might take some time, so I am focusing on options that are relatively longer dated.

2 new potential cheap volatility candidates

2007-10-30T21:06:00.000-05:00

are Wellpoint (WLP) and SBA Communications (SBAC).

SBAC reports earnings on 11/1. Wellpoint has already reported.

Obviously, then, vols in WLP are cheaper than they would otherwise be, and SBA vols are a tad higher.

Nonetheless, they are both ready to move, and I am buying vol in both of them.

Merck achieves its upside target - almost

2007-10-29T19:00:00.000-05:00

I was looking for Merck to rally up to 58.50.

It got to 58.17.

Close enough?

I think so.

I took off half of my position here, since the risk-reward is no longer as attractive. If I see any serious weakness, I will unwind the balance quickly.

This trade also has turned out to be a triple, if not a home run.

Update on the Third Trade of the Year

2007-10-29T18:57:00.000-05:00

I had mentioned that I thought that Gold would move 15%, and then revised that estimate up to 22%.

Well, today, gold exceeded 790.

There is some resistance here. However, I still think that we will see 850 before this uptrend exhausts itself. Of course, a largish correction should be no surprise after a near parabolic move to recent highs.

This trade has lived up to its billing.

2 movers, but losers

2007-10-25T19:43:00.000-05:00

Affymetrix and Grant PrideCo dropped sharply today, but, inspite of solid gamma gains, were net losers due to drop in the implied volatilities of the options.

This is what makes buying options into earnings announcements tricky - the events are "visible", and the move required is rather large compared with that which is implied in the prices of the options.

However, if the move is a trend move, as I fully expect it to be, the end result a couple of days is still likely to be win. This is because unlike daily delta-hedged options, these options are hedged only once the trend is complete, the move is by then large enough for the trades to be profitable.

NYX becomes a member of the S&P

2007-10-24T19:21:00.000-05:00

and in the process exceeds my "then-outrageous" 88 dollar target.

NYX was added to the S&P500 at the close today. Nearly 40m shares changed hands, as arbs sold to indexers, and in the process, the stock rallied to north of 92.

This show of strength, now, implies that the upside target shifts to NORTH of 113, which was the previous all-time high.

I haven't taken any profits, and now won't do so until the new upside targets are achieved.

Earnings coming up in some choice names

2007-10-23T20:53:00.000-05:00

Flextronics, Grant Prideco and Northrop Grumman, three of my cheap vol picks are reporting earnings tomorrow.

One that I deemed too risky is Lam Research.

There should be some fireworks in the next few days in all of these names.

Adobe update

2007-10-23T20:51:00.000-05:00

Adobe has achieved its first upside target, so I have unwound more than half of my position.

I expect a correction, followed by further upside. The move down will crush all near dated upside strikes, so I am getting rid of all near dated options in Adobe, and leaving only the far months.

Merck, Merck, Baby

2007-10-23T20:49:00.000-05:00

Now that's more like I was looking for.

Merck continued where it left off yesterday, with a 3% followup upside move.

The gamma of my position is so large, that I am suddenly massively long Merck.

I might need to trim some of my delta purely from a risk management perspective. At 58.50, I will cut down at least half of my position, if the stock gets there.

At that price, the trade will be a home run.

Merck moves up

2007-10-22T19:02:00.000-05:00

but in a slow, muted fashion.

I think there's a lot more where that came from. Regardless, the position is already profitable - though not hugely so.

Merck double up

2007-10-21T22:53:00.000-05:00

Merck reports tomorrow, and since the stock has done nothing since I first mentioned it, it is time to double up - which I did on Friday toward's the close. Let's see how the earnings are!

General Comment

2007-10-21T21:41:00.000-05:00

There's been a lot of interesting names that are trading with "cheap" implied volatility. The last time this happened was in June-July, and we know what happened then. Immediately after the market swoon in August, I had written that there was very little cheap volatility - obviously that has been corrected.

Interesting names that I am studying right now are:

1) Lam Research
2) Grant Prideco
3) Flextronics
4) Chesapeake Energy
5) Titanium Metals

In fact, in the very short term (few days), even the SPX is showing volatility as being relatively cheap, inspite of implieds that are elevated relative to the recent history.

Interesting times, indeed.

Northrop Grumman

2007-10-16T21:45:00.000-05:00

started what might be a new uptrend today. The implied vols are cheap at 20+, because the stock is likely to move up or down about $10 (based on today's price action, the direction is likely up). The only issue is time - it reports in about 10 days time, so that might be the catalyst for the move.

El Paso

2007-10-16T21:44:00.000-05:00

is ready to move, and its volatility is still cheap relative to its move potential. I expect it to move up or down about 25% in the next couple of months.

GENZ soars

2007-10-15T21:37:00.000-05:00

As I mentioned yesterday, GENZ had the potential to move, and move big. It did so today!

GENZ meets some upside estimates

2007-10-14T19:51:00.000-05:00

There was so much going on this past week, that I completely forgot about the massive move in GENZ. It has run up from 60 to north of 70, meeting its minimum upside potential.

Now, we will either go on to new highs above 77, or, crash below 60. Earnings are after expiry, so it should be an eventful name to watch.

COGN continues to fly

2007-10-14T19:49:00.000-05:00

and is now quite overbought. Thus, it is time to take profits by selling at least half of the position.

This one worked out better than my initial estimate of its move potential. Its good to be lucky sometimes.

PETM blows up

2007-10-10T20:23:00.000-05:00

Vols in PETM have been underpriced for a while, as I mentioned a couple of months ago.

Today, PETM blew up, but rebounded nicely. This might mean that the eventual move is going to be to the upside, not to the downside! Tomorrow should clear up the situation a bit more.

Airlines ready to fly

2007-10-09T19:38:00.000-05:00

I had mentioned that airline vol was cheap.

After the 10% sky dive, I mentioned that the drop might be a fakeout that might be reversed.

Well, the move was reversed.

What is the implication? Well, it means that the odds have improved that the move will be up 30%, not down.

The stocks are cheap, and the stocks appear to have put in solid bottoms.

Clear skies ahead? Time will tell. But that's how I am betting.

NYX nears its upside target

2007-10-09T19:34:00.000-05:00

of 87, that I had outlined a little while back.

Good stuff!

NDAQ also continues to fly higher, making that vol trade a successful one as well.

Cognos soars

2007-10-08T20:54:00.000-05:00

Many many moons ago, I had created a list of stocks that I thought were good candidates for the purchase of volatility, because volatility was cheap.

One of the names on that list was Cognos (COGN).

Today, Cognos exploded upwards due to the purchase of its prime competitor, Business Objects, by SAP.

Interestingly, before flying, Cognos first dived lower into July.

Through intelligent gamma hedging, it was therfore possible to first profit from the large move to the downside, and then, ride the move all the way up beyond the initial entry point, to the opposite breakeven point.

A doubly "intelligent" win (pun intended).

Interestingly enough, it does not look like the move is done yet. There seems to be more behind this move, possibly as early as tomorrow.

AFFX

2007-10-03T20:45:00.000-05:00

hit temporary resistance today. A pullback is likely.

If, however, the pullback is vicious, then the odds of a break below 20 increase.

Either way, my previously mentioned 25% move is still a high probability.

NDAQ, GENZ and NYX

2007-10-03T20:41:00.000-05:00

NDAQ and NYX appear to be trending nicely towards their targets.

GENZ today took launched into the stratosphere. What's more, it happened on no discernable news.

The stock has been constrained by the $70 sellers for so long, that short dated vols actually FELL even though worthless options suddenly became valuable. This is because people have been conditioned to lean against the stock at the $70 level. If, for any reason, the stock breaks above $70, then, all hell will break loose with the implied vols.

Or so I believe.

Affymetrix update

2007-10-02T20:42:00.000-05:00

As I mentioned here, I expect a 25% move in Affymetrix.

How does one take advantage of such a move?

The easiest way is to buy a strangle. That is, buy calls and puts in a ratio such that the position is delta neutral.

The question is, what strike and what maturity?

The strike is easy - buying options where the total premium spent is less than where you expect the stock to be if you are right.

The timing is more an issue. In AFFX, for example, one could buy Nov, or Jan options. The Jan options obviously have a higher premium, the Nov's less. If one is confident that the move will happen very soon, the Nov's are better. If the move will take time (e.g. just prior to Nov expiry), then, the value gain on the options will be too small since the options will lose their "vega". If the move happens after Nov expiry, then the Nov options will be worthless.

In this case, I have chosen to buy the Jan 30 calls and the Jan 20 puts. The option combo (1x3) is roughly delta neutral. As long as prices are higher than approx. 32 or lower than 18, I will make money. Since I expect a 25% move (roughly $7), I expect to at least break even by expiry. IF the move happens soon, then, the deep out-of-the-money options will become at-the-money (either the 20 or 30 strike), and their value will soar. That's where I expect to make the money. Once that happens, I will get out.

What is this blog all about

2007-10-02T20:22:00.000-05:00

Trading volatility is difficult.
Let me say that at the outset.

The investment community at large has learnt to think about volatility as the standard deviation of daily returns. When someone talks about buying (or selling) volatility, what they mean is that if you were to buy an option and delta-hedge it systematically at the close every day, your P&L will be the sum of these daily delta-hedges, offset by the cost of the options.

Thus, if you are long volatility, you will be buying low and selling high, and the profit from a myriad such trades should equal the cost of the option, if the volatility is fairly priced.

The problem, however, is that the profit from delta hedging is entirely PATH-DEPENDENT. It matters what happens to the stock between here and maturity. If the stock moves 10 up one day, and 10 down the next, and does this with regularity, then, the P&L from delta hedging an option on this stock will be more profitable than if the stock moved 1 up and 1 down every day. This is the case, even as the stock ends up unchanged between the option purchase date and expiry. PATH DEPENDENCY is the bane of accurate measurement of volatility, and inferring whether it is cheap or rich. Cheap and rich become relative terms. Vol is cheap or rich relative to its past implied, or its past realized. But for an ABSOLUTE measure, one needs to be to forecast the exact price path in the future. Since forecasting prices 1 day ahead is "impossible", forecasting the exact price path is more so. And thus, one can never say (except in hindsight) that vol is (or was) absolutely cheap or rich.

This lead me to think outside the box. If I cannot measure whether volatility is cheap or rich, how can I ever hope to make money trading it?

This blog is the result of work that solves a subset of this larger problem. I have found ways of identifying cheapness and richness for a subset of the universe of "names" that have options trading in them. And that is what I share with you here, as and when I identify them.

The wonders of doubling up

2007-10-01T20:28:00.000-05:00

There are two ways to manage risk:
1) Invest 100%, and employ a stop-loss
2) Invest on a scale, scooping up more as the investment goes against you.

The first is a momentum trader's modus operandi. The second is the lifeblood of a value investor.

One of the reasons I like my strategy is that it appeals to a value investor's mindsight. By construction, I have created a process that identifies cheap volatility. Every day that goes by with the underlying remaining quiet makes the implied volatility cheaper in relation to the future realized.

Thus, if a 50% position ends up losing money, one can start fresh with new capital allocated to that underlying, and put on a 100% position.

In a previous post, I mentioned that it was time to double up on options on Walgreen's and Adobe.

Today, we saw the payoff to that portfolio construction.

Walgreen's imploded to the tune of 15% in a single day. When implied vols are below 30, a 15% move qualifies as a home run.

That's what we had in Walgreen's today. A veritable HOME RUN!

This one turned out to be more profitable than all my previously listed Trade of the Year ideas!

Affymetrix

2007-09-28T20:38:00.001-05:00

is a new name, where implied vols are dirt cheap. We should get a minimum of a 25% move either way.

And gold continues to fly...

2007-09-28T20:36:00.000-05:00

at this point, a move to $800 becomes a very strong likelihood. I am still hanging on to a third of my original position, and enjoying the ride!

NYX continues to fly

2007-09-24T20:24:00.000-05:00

today's move firmed up the probability that the trend move will be to the upside, to a minimum price of 87. A 10% move in a week is definitely a good start, but there is a lot more to come.

Airlines move, BIG

2007-09-24T20:21:00.000-05:00

albeit to the downside. Still, a 10% move in US Air (LCC) is an excellent outcome for the trade highlighted merely two days ago!

It does appear that there is a non-trivial probability that this breakdown might be a fakeout, so I will be monitoring the stock to get back to delta-neutral at the first sign of strength. The sector has been absolutely trashed, is fundamentally cheap, and hence, I have a hard time seeing it move 30% lower.

Update on the home run Third Trade of the Year

2007-09-20T20:46:00.000-05:00

Gold shone yet again, today, rallying to new 52 week, 52 months, and 52 quarter highs. No, not 52 year highs. It will happen some day. Just not anytime soon, I think, although we are only about 15% below all time highs.

There is still potential for upside to 800. In the near term, though, the market is extremely extended, and this means that it needs a rest. Whether that rest takes the form of a consolidation, or whether it involves giving back a substantial portion of the recent gains is the real question. I took another round of profits on my position today, with only a third remaining. I intend to trade this with a trailing stop.

I expected marginal new highs in the worst case, and a rally up to 800ish in the best case. What I did not expect was a straight up move, with no pullback or correction. Oh well, you can't get every nuance, but you still gotta try.

Interestingly, the new highs in gold were accompanied by new highs in the HUI as well, so, it is likely that this confirmation bodes well for the intermediate future.

Sweet sugar's causing a breakout

2007-09-20T20:38:00.001-05:00

The breakout in sugar yesterday saw some follow through today. This might be the real deal. A move to $11.25 is my minimum expected upside target. But there is a chance that a move to as high as $23 may be in the works as well.

Exchange Day

2007-09-20T20:36:00.000-05:00

Just like NDAQ, NYSE also exploded up today. Importantly, it KEPT its gains, and this suggests that my expected move to $87 or higher is under way.

NDAQ explodes

2007-09-20T20:30:00.001-05:00

NDAQ announced a three part deal today, which caused the stock to explode nearly 8% today, before closing up only 1.5%.

I had mentioned that buying vol made sense here just two weeks back.

NDAQ has been stuck in a triangle pattern for the last year and more, and today's rally took it to slightly above the downtrend line. It persisted there for half the day, before falling apart and closing below the line.

If this is not remedied quickly, we will see a big breakdown in the stock down the line.

Knowing what to watch for, I liquidated half my position the moment we started dipping below the resistance line. This brought me back to delta neutral.

If we cannot rally back above the line tomorrow, it will be time to bet on a complete breakdown in the stock (similar to BEBE earlier in the year)

Its time to fly

2007-09-19T20:30:00.000-05:00

Yes, US Air vols are underpriced.

US Air (LCC) came out of bankrutpcy, and rallied all the way up to north of 60. From there, as oil rallied up to new highs, LCC dropped all the way down to 24ish.

It is now at 30.

We are headed down to all time new lows below 20, or at least to 40, and possibly beyond, starting soon.

With a 30% move waiting in the wings, vols are cheap, and I am loading up on them.

Its time to fly!

The Sugar train is running away

2007-09-19T20:27:00.000-05:00

without me...

Well, I got the idea right, but did not get to execute upon it.

That's as bad as not having the right idea in the first place.

Nevertheless, if I am right (and I believe I am), then, there is still time to execute the 4th Trade of the Year. The economics still work.

What I did is to skew the trade a little bit such that I am net long delta, instead of delta neutral. In doing so, I am exposing myself to the risk that the break-out is a fake out. That's the price to pay for tardiness, though. Increased risk.

More on the 4th TotY

2007-09-18T21:54:00.000-05:00

The markets absolutely exploded today upon hearing that the Fed was lowering Fed Funds by 50bp.

Most of the soft commodities exploded up as well.

Sugar was not one of them.

We also got some updated data on the positioning of the commercials. They are net long, but only modestly so.

I also studied the demand/supply structure of the market over the past few months using tools that I have developed.

My conclusion is that sugar will act similar to gold - there should be a scary fall towards the old lows.

Whether this scary fall is a breakdown, or a feint before a massive upside breakout, will be the critical question. For now, I am leaning towards the possible breakdown as being a feint, but we're getting way ahead of ourselves here. Let's take things one step at a time!

The fourth Trade of the Year

2007-09-17T17:32:00.000-05:00

is not quite ready yet, but I'll disclose it anyway.

It is yet another commodity trade, after Treasuries, Natural Gas and most recently, Gold.

Similar to gold, this commodity moves big when it moves at all. And it is on the verge of a BIG move.

That commodity is Sugar.

Sugar went berserk in 2005 when it rallied from about $8 to about $20 early last year. Since then, it has been in its own bear market, falling right back down to about $8.50ish.

Now, I don't (yet) expect a move of such proportions, but still, a move to about $11.25, or down to about $7.75, from its current $9.60ish level, is defintely in the cards.

That's a move north of about 17%, and that's something I am willing to buy volatility for, specially when it is priced at a low 20s implied level.

To put things in perspective, for a 3 month straddle, you need to pay about 10%, and if you get a 17% move, that is what I consider a winner!

I intend to wait a few days/weeks before getting involved, but am excited about the trade nonetheless.

And thar she goes...

2007-09-17T17:28:00.000-05:00

as gold keeps going, and going and going...

Today, Gold made its highest close of the last 20+ years. The third best trade of the year is certainly living up to its billing, although one needed to be willing to let the profits run. As I have previously acknowledged, I am too quick to take profits - I hate losses, and that is the downside of such a mentality. It is something I need to work on.

Two new names

2007-09-13T21:28:00.001-05:00

Its time to buy vol in two new candidates:

1) Merck (MRK)
2) NYSE Euronext (NYX)

MRK has been a star the past year, and NYX has been a dog.

Maybe their fortunes reverse here?

Vols are not as low as I like them to be, but the move I expect is large enough to offset my concerns. I expect a $6 move in MRK, and a $17 move in NYX.

Double up!

2007-09-13T21:26:00.000-05:00

Its time to double up on some non-performing positions, namely Walgreen's and Adobe. I still expect home runs here, but with the theta losses so far, the overall trade might turn out only to be a single!

Gold

2007-09-11T21:13:00.000-05:00

vaulted higher another $10 today, making the trade a home run so far.

As mentioned in the previous post, we need to get near 730 before a significant reaction sets in. We are at that point, or within 1% of that point.

There is a possibility that this breakout is a false breakout (witness the move in treasuries, where the breakout above the 15 year downtrend line was reversed in short order). If that is the case, the reversal will be sharp and swift.

Hence, I decided to take partial profits on my position.

Looking through all my previous ideas, I notice that I am usually early. This is a case of not letting my profits run. However, options are wasting assets, and I feel that it is better to take profits rather than watch them disappear altogether.

Third best trade of the year

2007-09-06T21:30:00.001-05:00

lives up to its billing!

Gold exploded up $14 to a new 52 week high.

Not only that, vols exploded higher as well, from 14 to 17.

A home run all around.

However, this is just the start. We will probably get near the old 730 highs before a significant swing lower, after which, most likely, we will see new 5 year highs in short order.

NDAQ

2007-09-05T21:14:00.001-05:00

Its time to buy volatility in the exchange itself - NDAQ. That's right, not the Nasdaq, but the Nasdaq Stock Exchange!

Vols are cheap, and the exchange is ready to move about 20% at a minimum.

Pullback, as expected

2007-08-28T22:22:00.001-05:00

The overbought conditions that existed Friday had to be relieved. That was a near certainty. What was uncertain was the manner in which the overbought would be relieved. They got relieved in a hurry with two big downside days.

We are now back to neutral. The easy money (if there's any such thing) has been made. What next?

The VIX rallied all the way back up to north of 26.

Since we are sitting in the middle, there's no clarity.

However, my work suggests that a few emerging markets are in possible "break" mode. Breakout, or Breakdown? Not clear. A perfect example is the Sensex in India. It is ready to have a big move, possibly as large as 20%. Up or down, doesn't matter. What matters is, are vols cheap enough to capitalize on such a large move. That's what I intend to study next.

Bingo!

2007-08-24T21:52:00.000-05:00

The market waited till the last possible moment, sort of, before showing its hand. It turned out to be a trend up day, with the various indices closing up a 1% apiece.

In the process, the market has reached overbought as measured by the Summation Oscillator. Thus, a pullback becomes a near certainty some time next week.

Vols continued to "plummet" lower. The VIX touched 20. It seems like a lifetime ago that it hit 35. Can you believe that it was just last week?

So, is the bottom in? Are all the problems fixed? Are we ready to sky rocket higher?

The market certainly acts like this is the case.

But the market is not always right. Time will tell!

Volatile day coming up

2007-08-23T21:13:00.001-05:00

Most likely, tomorrow, we will get a 1 to 1.5% move in the overall market (S&P).

While I felt that it would be to 1485, today's price action casts doubt on that. It appears equally likely that the move might be to the downside.

The only near certainty is that there's going to be a largish move.

Enjoy!

Nice rally

2007-08-22T20:20:00.000-05:00

We got our move, and it was to the upside, not to the downside! So, it appears that the market is ready to go straight up to 1485 without making a detour along the way. Vols and the VIX continue to drop.
In a few days, it might be time to get long vol again.

For now, the only name I am buying vol in is GENZ (Genzyme).

The vol crush continues

2007-08-21T19:15:00.000-05:00

It is amazing to see how badly implied volatility gets destroyed at the first sign of peace and quiet. It is almost as though the market has no long term memory, and forgets the chaos and panic of just 3 days ago.

The good news is that we are ready for another nailbiter, most likely tomorrow. I am guessing that we'll have a run towards the lows, but will hold near 1400-1410 on the S&P. Thereafter, we should get a fast move up to nearly 1485 by the end of the month.

The implications? Its fine to own gamma, but not vega for the next 10 days or so.

That's my gameplan for now.

Vols plummet

2007-08-21T07:30:00.000-05:00

Its been only two days since we hit the lows in the market. Since then, the VIX has dropped from nearly 35 to nearly 25.

Vols have gotten absolutely crushed.

We likely go sideways for another couple of days, and either Thursday or Friday, get a 1% move again.

My guess is that the quality of that move will decide whether its time to BUY already high vols since they're going much, much higher, or whether vols will continue to drop much more.

For now, let's hope vols continue to drop, such that the decision is easier when the time comes.

Blog Name Change?

2007-08-16T16:02:00.000-05:00

"V is for Volatility"

I think as of today, the scariest letter in the alphabet is not a for alpha, b for beta or g for gamma. Its V for Volatility.

Long Live Volatility.

Not so fast. As of today, there are no cheap vols in the US. None. Zip. Nada.

For the first time in ages, I am looking to SELL volatility. Of course, one look at the VIX (above 30) is confirmation that that's the right direction to look at in terms of volatility. Mean reversion.

So for the next few weeks, this blog is going to be re-named - Q is for Quiet.

No, it won't be quiet as in "shhhhh". It'll be quiet as in 3 weeks from today, we'll be at the same level of the market, having gone up, then down, then up again, then down again, basically treading water.

Thus, it is time to SELL straddles.

Of course, the last big trade of the year, Gold Vol, lived up to its billing so far. Gold dropped 3.5% at one point during the day. Let's see how far it goes!

Gold Vol update

2007-08-13T21:51:00.000-05:00

We had back to back 1.5% days on Thursday and Friday, first down, and then up.
Today, nothing.

The market is coming to a head.

In the next few days, we're going to get a resolution to the 1 year plus trading range.

I revise my estimate for the potential move from 15% to around 22% now.

There's still time to buy gold vol (currently priced around 14).

Trade of the Year, the best yet

2007-08-08T17:25:00.001-05:00

I've highlighted a couple of "Trade of the Year" picks. Going Long US Treasury Vol, and going long Natural Gas Vol.
The third in my list, is one I have been itching to pull the trigger on. But I haven't. Its my favorite sector. When it moves, it really, really, really moves. There isn't a more volatile "asset" that I personally track. Sure, some commodities move as much, but they are not very liquid.
So, with that as a prelude, where do you think vols are for such a sector?

Before one can answer that question, its probably reasonable to look at history and see what kinds of moves one has had in this asset over the last 10 or so years.
We've seen realizeds as low as mid single digits (2000), to as high as 40+ at one point in 1999. More recently, realizeds were as low as single digits in 2005, and as high as high 30's last year.

Implieds are currently at 14.

Intrigued? Upside of as much as 20 points, downside of no more than 10 points. You're getting odds of 2:1. The question is, what is our edge? Given my methodology, I believe my edge is greater than 3:1, meaning that I think there's a 75% chance that I will be right. If I am wrong, it will be due to having picked a shorter maturity, and given my methodology, the likelihood of a explosive move AFTER my chosen maturity will explode even higher. My point is, the odds are great, and my edge is even higher.

But back to the trade. I've waited, and waited, and waited, and in the meanwhile, implieds have dropped, and dropped, and dropped, and then dropped some more. The edge has improved, and improved and improved. I'm ready. And I intend to size this one up big. Really big. I'm gonna throw 5% of my capital at it. Usually, I don't risk more than 1%.

The trade - Buy Gold vol.

That's it. Nothing more complicated than that.
Oh, its not that easy either. What maturity? What strike?
Those are issues that I rely on my other tools and philosophies to help answer, and they are constantly evolving. But, the bottom line is, that this is going to be a out of the galaxy home run, and I am excited about it. Let's put it in quantitative terms: the breakeven move necessary is about 6% (cost of a strangle). I believe we're going to experience a 15% move.

So, I will make roughly 1.5x my capital invested, if I am right.

Bring it on!

WYNN explodes

2007-08-07T23:16:00.000-05:00

WYNN exploded higher, thanks to Macau.

I didn't actually have this one, since the risk appeared to be unreasonably high relative to the reward. That said, it went completely berserk to the upside today!

Sometimes high vols are actually worth it.

WYNN is a possible winner

2007-08-06T15:14:00.000-05:00

WYNN is showing up as a volatility purchase candidate - the problem is that it is reporting earnings after the close, and hence, front month vols are quite elevated.

Nonetheless, it is worth a shot in the Sep or Dec maturities.

More volatility ideas and plays

2007-07-31T21:49:00.000-05:00

After the bout of massive volatility we've seen the past 10 days, it is difficult to find attractively priced options. Thus, for once, a case can be made that it is time to SELL volatility.
One place that looks attractive is the XLE ETF. Vols have exploded, at the same time that the ETF is likely to trade in a range. Hence, it makes sense to sell Aug and Sep 65-75 strangles, and leave them unhedged. That's right, the trade is to bet that the index will consolidate in a wide, 10 point range. One can collect about $1 for the Aug strangle (with only 13 trading days left), so it is definitely something to look at.

More interestingly, and in keeping with the focus of my blog, two new names to watch:

1) EBAY - look to buy Sep volatility (not Oct, where the earnings are causing vols to be bid up)
2) PETM - a pet retailer, this has volatility that is also underpriced

Finally, Adobe has dripped theta, and has been a net loser so far. It is time to double up, and if nothing happens for another 2 weeks, maybe quadruple up.

Long vol funds should have massively outperformed this month. May negative carry live on!

Volatility explodes

2007-07-27T22:12:00.000-05:00

The Vix hit a hit of 24 today. Volatilities exploded across the board - there was a glitch with Bloomberg, such that from 3:43pm onwards, no prices for NYSE listed stocks were available. Quite a catastrophe.

Is the market ready for a big plunge?

On the one hand, there is a visible sign of distress on the credit front.

On the other hand, large cap stocks in the US are demonstrably cheap.

The Summation Oscillator has hit deep oversold levels without the major indices doing so. This suggests that the large caps are indeed holding up the market.

Moreover, speculators are record short. They are never right at turning points.

These are the "so-called facts".

Confused?

You're not alone. So's everyone else.

UNH update

2007-07-09T13:33:00.000-05:00

Similar to DGX, UnitedHealthcare has done absolutely nothing for 3 months - it has been a huge theta drip. That is why, I am quadupling the position -
a) Anytime a vol trade doesn't work, I expect to double the position later
b) Earnings are due on the 19th, and that is a visible catalyst

I have no idea whether the break will be higher or lower.

I don't think the July options are a bargain.

But September options look like a bargain to me, and that's where I am adding more exposure.

DGX home run

2007-07-09T13:30:00.000-05:00

I'm back from vacation, and I find that DGX was a home run - not because the stock moved too much (only about 10%), but because rumors of a potential LBO north of 65 have caused the implied vols to move up by 15 vegas.

I'll take it!

Moral of the story - the longer it takes for one of these trades to work, the BIGGER the payoff will be! You just have to have the conviction to keep adding to a losing trade, because these are VALUE trades, not momentum trades.

Vacation time

2007-07-01T20:09:00.000-05:00

I'm going on a cruise till Friday!

Buying Nikkei vol

2007-07-01T20:08:00.000-05:00

The market has created a "George Lindsay" box, and is ready to move to either 22,500 or down to 14,000.

3 month straddles, unhedged, are priced cheaply enough to allow one to profit if either of the above two levels is achieved.

Its time to buy Nikkei Vol.

BEBE breakeven

2007-06-27T21:23:00.000-05:00

BEBE had a move to the downside that allowed the strangle trade to breakeven. Given that the decline did not have impulsive characteristics, I believe that we are now ready to reverse back up, and hence, it makes sense to hedge the delta and bring the position back to delta neutral.

I fully expect to see an upside breakout in BEBE at some point in the not-too-distant future.