July 2009


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From sigmaoptions, this post appeared discussing mental competencies. In a first part response, I’ll look at the Greeks component. In the second, I’ll consider the actual neurological pathways involved, and why in this example, unconscious is a misnomer.

An illustration of this point came up on a discussion forum recently. The question was asked, can you be successful without regard to the Greeks? Various points of view were put forth, but the one that interested me was from an ex-institutional trader with decades of high level experience. He thought that Greeks were not necessary for simple directional strategies.

The Greeks in Options delineate mathematically characteristics of Options as they respond to the underlying asset class from which they are derived. Unless you are a pretty competent mathematician, they are not really intuitive, which is why prior to the Black-Scholes-Merton model, they were traded seat-of-your-pants style, as there were no Greeks

I had an interesting [now] experience with AAPL Options and their earnings, that was entwined with IV. In short, the IV rose prior to earnings, and dropped after earnings, which limited [seriously] the expected return.

Returning to the quote. Yes, an experienced [decades] trader would realize that IV would most likely ratchet higher, as MM sought to insulate themselves [gouge the retail trader] from a positive response to an earnings announcement, but calculating that jump in IV without a model would require some serious cognitive gymnastics.

From this trade you can calculate the IV was 44% on purchase [Black-Scholes model] The day after, I sold at approximately $158.00, IV had crashed to 27%, hence the selling price

This was a simple directional strategy. The strategy and direction both turned out to be correct, yet, the payoff was sub-optimal, due to the Greeks being manipulated. I was aware that it may happen, I knew the IV prior to taking the trade, and still got hosed after the MM dropped the IV.

Would our trader know, or expect a 50% drop in IV? Would he calculate mentally the fair price based on the Greeks for the Option? Would he have known that at purchase price, that gamma was at it’s peak, and would decrease? That vega was also at it’s peak and would decrease? Possibly. By looking at the bid/ask spread, you will get an idea. But he [trader] would be advised to consider historical volatilities in contrast to the current volatility. He might then consider, based on earnings being a one hit affair, that volatility being currently elevated, might well fall back to HV after the event. HV is not a calculation that can be visualised on a chart however. You can look at two charts and observe that one is more volatile than the other, but quantifying that difference is not visually possible. Therefore, consideration of the Greeks becomes a necessity.

How about Gaussian distributions? ITM at 48.7%? Probability to expire worthless at 51.3%? Probability price between $155/$160 at 13.8%? Which is counter-intuitive to the high IV.

My point is this. It is unlikely that even trading a basic directional strategy, that knowledge of the Greeks is not required. Additionally, calculating the Greeks is hardly mental math. Thus, trading without consideration for the Greeks which seems likely, can be successful, but you may take trades that are potential horror stories waiting to happen unless you perform some analysis.

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Obviously I have a death wish, selling SHORT Gold @ $91.83

gld

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Gold has been a very frustrating asset class to try and trade. Almost invariably, I’ve been wrong. So, in a fit of pure optimisation, I’m switching to a different timeframe [12mths] to try and time Gold more successfully than I have been. Therefore, on any strength, I’ll be looking to get SHORT at least into the dog-day’s of August

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flippe-floppe-flye has gone to Disney World [how apt] His blog however has been taking a real shellacking.

The Fly
■Setting Up For a Beatdown
(2 days ago) · 27 comments
■More Cash
(2 days ago) · 20 comments
■You Will Die Without “The Fly”
(3 days ago) · 51 comments
■You Are Cordially Invited
(4 days ago) · 34 comments

This is MASSIVELY down to third tier levels. I know flippe-floppe is inordinately proud of his stats, as he boasts of them periodically. The proletariat seem to have deserted him for ChartAddict who executes the hindsight trading thing even better than he does.

Featured Blogger: Chart Addict
■Ascending Flag on the SPX (4 hours ago) · 107 comments
■Extensive SPX Timeframe Analysis (2 days ago) · 125 comments
■CASH MONEY YA’LL (2 days ago) · 124 comments
■SOMX Kill / SPX is up +44.3% from March Lows / New Consolidation zone (950-1000) / ETF Sector Analysis (5 days ago) · 115 comments

This is a development that I’ll keep an eye on as there could be a putsch in the making here.

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I’m not a big fan of China, their products tend to be cheap and nasty, and it’s really difficult to get any form of consistent data. When there is a lack of transparency, I tend to assume the worst. China has built it’s boom, now and then on a lot of inflation.

With China’s market taking a tumble, take a look at this video this news-story this analysis and this from GMO

The 14 million square feet of empty real estate space has been mentioned before. So has the lack of writedowns at Chinese bank’s who are carrying all these toxic loans.

China may well be an emerging economy, it obviously is mordernising and eventually will become, or remain an economic power, however, they are doing a large part of the lifting via inflation, and inflation always bites you in the end.

fxi

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Sell Gold @ $91.38

gld

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GRANITE CITY, Illinois — In one of the first signs that key markets of the battered steel industry have bottomed out, U.S. Steel Corp. this month recalled about 800 workers at its huge flat-rolling mill here.

The steelmaker also plans to restart an idled Minnesota operation that makes iron-ore pellets used for steelmaking next month.

The company says that prices are firming for some steel products in the U.S. and Europe and it expects shipments and operating rates to increase in the current quarter.

CEO John Surma didn’t say which markets are strongest, but other industry executives and analysts said …

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Buying GLD @ $91.91

gld

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Why bother wasting paying Mr Lee $4K when for a fraction of the cost, namely $0.00 and $50, you can avail yourself of legitimately successful traders and specialists in a variety of trading styles, finding the one that suits your psychology best.

From Dr Brett

One of my favorite blog sites over the years has been The Kirk Report. Charles Kirk does a yeoman’s job of finding informative material on the Web. He also tracks market action and offers members to his site considerable insight into his own stock screening and trading. One particularly valuable feature that he offers members are Q&A sessions with well-known traders and investors. When you see people with a mere fraction of Charlie’s insight and experience offering “education” and “training” at hundreds and even thousands of dollars, you can’t help but feel that, at $50.00 per year, membership in his site is one of the screamingest bargains around.

So one way I can recognize and pay a little back for all that good work is to offer members of The Kirk Report a free live chat tomorrow (Wednesday) at 11:00 AM ET. Members not only participate in the chat, but suggest questions for me to address. The markets will be trading then, of course, so I may make some comments about those in real time. Here is the URL for the session; you can also sign up for a reminder.

Should be fun; hope to see you there–

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A couple day’s back I ran some weekly charts to question the validity of the Bull Market call based on daily charts. From Richard Russell there has been an expansion of his analysis.

For four frustrating months or ever since the March lows, this writer [Russell] has been in a state of perplexity, better known as confusion. Now, at last the picture has clarified. I would like my subscribers to study the following explanation carefully. I’m going to explain why the trend of the stock market has turned clearly bullish under Dow Theory. The fooler was that this pattern did not occur immediately off the March lows – but it took place part-way up the rally and four months after the March lows.

“Please, refer to the charts of the Industrial and Transportation Averages below.

(1) The Industrials (top chart) recorded a low in May at 8230.

(2) The Transports also established a low in May at 2971.

(3) Next, both Averages rallied to June peaks, the Dow to 8877 and the Transports to 3434.

(4) Both Averages then turned down, with the Dow breaking support and declining to 8087. But important – note that the Transports held support and did not confirm the Dow weakness.

(5) After the Transport non-confirmation, both Averages rallied, and both Averages broke out above their June peaks.

“This was a classic Dow Theory bull market signal! To review – we saw the two Averages decline with one Average (Industrial) breaking to a new low while the other Average (Transports) refused to confirm. Next, we witnessed a rally with both Averages breaking out to new highs.

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The trend of the stock market is now bullish. But this is where interpretation is critical.

“Nowhere during 2008 or 2009 did we see anything typical or characteristic of a major bear market bottom. However, recently we witnessed a Dow Theory bull market signal. My interpretation? We are now in a cyclical bull market as opposed to a secular or primary bull market. In effect, we’re in an extended bear market rally. The true bear market bottom lies somewhere ahead.

“There is no way of knowing how high this bear market rally might carry. The question – is it worth playing this cyclical bull market? My answer is yes, but play it very conservatively and carefully.”

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