This is the second of an occasional series where we will post some Q&A with readers. We’ll also open up this post for comments for more questions and answers. Please keep the comments on point and remember that we are not registered investment advisers so will only try to answer questions on general option strategy, trading advice, etc. Risk Reversal is a trading diary and is intended to be used as an educational tool to help you in your own trading. We feel the Q&A is a good forum for that purpose.
(Questions and answers below have been edited for privacy, clarity, grammar and spelling, and specifics are sometimes left out because they don’t matter)
Thanks for all of your help. I am learning a lot and trying to get my brain around things. for instance, your CSCO and INTC trades seem inconsistent to me. aren’t they in “connected” industries – networking and pcs? moreover, when i look at their charts, i see that they pretty much move together. so, how do i explain to myself that i am looking for csco to rise while looking for intc to pull back? is it just a timing thing? a catalyst thing? or an analysis paralysis thing? – K
INTC is extended and up 16% on the yr and has run since its positive earnings announcement in oct…CSCO while it is up a lot off of its 52 week lows is still down 10% on the year and has yet to report earnings…I think earnings could be a decent catalyst for a stock like CSCO to play catch up to some other large cap tech names like INTC. So INTC is a sentiment play while CSCO is a catalyst play. But the point of the site is not to have readers follow me into these trades, it is to watch my thought process and learn from my mistakes and my winners…..I hope that helps. -Dan
I own the AAPL Nov19 $395 calls for $18.33. Today they are at $11.25…. But Dan thinks APPL is going south in the short term. Not good for me. Last time over shot with one of these “top” tech stocks I chickened out and bailed on AMZN on Oct 27th and took a bath … only to have them rally on October 31…. Ouch. I like Dan’s latest AAPL trade… but I don’t want to lose all $18.33… or sell today unless necessary and lose money. –
As for my AAPL trade, as I stated in the post this is not exactly a high conviction idea, more of an inclination and to this point the stock hasn’t done much…..but also, like I said in the trade that any stock specific news could clearly break it out of its funk…I do want to buy appl on a pull back setting up for what I feel will be good buzz around their holiday sales……as for your trade…obviously owning AAPL calls gives you long exposure, but when the stock is not moving, as it isn’t at the moment, those calls which are meaty are doing nothing but decaying, that is a large reason why I normally suggest call spreads to lower your entry cost and risk. At this point you could sell a higher strike call to help mitigate some of the decay but you will also be limiting your upside if it does what AMZN did. – Dan
Define ‘Edge.’ I need to know what this consists of, or could be. The cynic in me can think of a few, but they aren’t usually available to the unwashed masses… – MO
Yeah, thats not what I meant, I never have that….often times traders at banks or hedge funds use that term to refer to their conviction level which could arise from a whole host of inputs from fundamental, to technical to something they are seeing in the math of the options……I basically use it as I dont think the options market is pricing in an event properly…..so basically I make an assumption of what i think the probability of something happening and then what I think that will do to the stock and then I assess what the options market thinks….so if I have a ton of conviction on an idea after that process then sometimes I could mean I feel I have a bit of an edge. -Dan
‘Edge’ also has a specific quatifiable meaning amongst professional options market makers. It means the net ‘edge’ in options’ theoretical values that have been bought and sold in a portfolio over time vs. what they are currently trading. In an options portfolio traders will see 2 numbers every morning, their realized profit and loss based on mark to market and their theoretical ‘edge’ based on mathematical assumptions of what those options will be worth over time. This ‘edge’ is hardly money in the bank and is mostly ignored by good traders unless they are having a bad day. -CC
Aren’t there tons of companies–even large multi-national’s–that this little mess will essentially have no impact on? Only reason this is moving things, is because of the herd mentality of hedge funds, and computer algorithms? I mean is it even gonna damage large financials that much? Does anyone even know. Traders just trading the fear? -MO
Correlation in the market is unlike anything most people have ever seen. Every day every company in the world is essentially moving with the latest rumor out of Europe. So you’re right that it should be that way for every company. But it is what it is and you can be on the wrong side of a 2 day 10% move in the market basically every single week. So people stay out of the way, stocks are thin and volatility high as a result. As far as what would happen if things do go to hell over there, I think what you have is a situation where ’08 is so fresh in people’s minds they won’t stick around to find out. So sort of a self fulfilling prophesy. People won’t want to be stuck with the French or German version of Lehman Brothers and they will sell first and do the math later, and as we know from ’08, the whole thing is a house of cards where that kind of run doesn’t differentiate between who should survive and who shouldn’t. -CC
But you guys are still trying to trade around it. i.e. quick earnings plays “define the risk”. I guess you figure you put on the earnings trade. If it blows up the next day, it’ll probably come back in 2 or 3…. the market risk is short, day-to-day…? -MO
It is funny, I mentioned that to Dan the other day, that even if you’re wrong in a position all you have to do is wait 3 days for the entire market to reverse 10%. Sort of like that old joke about if you don’t like the weather, wait 10 minutes. But the challenge with this market is really being disciplined about not chasing the ends of these rallies and selloffs. I think we’ve been pretty good about that on the site, not pressing lows when everyone thinks the world is ending and not buying into the hype that all is clear. -CC
To CC’s point about correlation, I thought this was interesting -Dan
On the QCOM trade you did. If QCOM is above 55 on Friday I assume you will have no trouble selling the spread. Question who would want to buy it or is that part of market making operation by the exchange. Thanks. -B
On Friday if the stock is below 55 the Nov weekly 55 call will not likely be worth much and you will be lucky to get more than a few cents for it….to do this sort of trade you have to believe that the stock will not go up more than 7% this week and that the stock could rally into the analyst meeting in Mid Nov. -Dan
To the market making part of the question, yes, usually there is another side to a trade, even when a line is near worthless. If it is so far out of the money that there is no bid to take off part of a spread, the market is essentially saying there is no need for that line to be traded out of and it will expire worthless. -CC
I am new to opotions trading and just love your site. I find it a great resource and this may sound stupid, but I was looking at the AMGN trade and was wondering how the math worked to reach your break-even of $57.50? -GM
Thanks for the kind words and the email…..basically we are pricing what the jan 60 call would be worth on dec expiration if the stock was below 60 and what price it would take to break-even. Keeping implied volatility at the same levels, that break even price would be around current levels, so that the jan call would not lose money…the problem with calendars is that many people at home don’t have the ability to price options themselves or know how to make the proper assumptions about vols. -Dan