Trading Diary: Dec 12th – 16th

by Dan December 18, 2011 7:09 pm • Commentary

OK, bear with me here as this is a bit of a long one, I am on a 4 hour flight and have a little time so I thought I would go into some detail on thoughts that are on my mind as it relates to my recent trading. Also, I will be traveling/on vacation alot for last few weeks of the year, so while I will definitely be on duty for most mornings, my commentary may be more brief than usual.

Last week saw a fairly muted movement in world equity markets which helped the VIX go as low as its been since the beginning of the volatility spike in late July.  As the final expiration of 2011 came and went, many investors are in a holding pattern in anticipation of any news (positive or negative) out of Europe as their central bankers and politicians struggle to agree on the way forward to stem their sovereign debt crisis.

The real story for the week, in my opinion was the apparent unwinding of some popular hedge fund trades, Long GLD, Long Crude and believe it or not Long Euro vs the US dollar.   All three saw significant moves mid week that could be telling for price action in crowded trades as hedge funds struggle to meet redemptions and look to raise cash in their most liquid, yet concentrated holdings.

As for my trading last week, I meant to kept things fairly tight avoiding any disasters heading into year end but there were a few single stock stories that grabbed my attention and I felt the need to play.  As I said last week in one of my morning comments, I lack strong conviction as to the direction of the equity markets in the final couple weeks and any trades that initiate in this time period will be with defined risk  and generally smaller in size than has been the case for the last few months.

As most of my existing positions were set to expire Yesterday on Dec expiration, let’s look at a few trades that came down to the wire and how I managed them.  In the week of Dec5th, I initiated some shorts in MS, C and DB for a one week or so bet that the stocks would sell off 5-10%, retracing about a third of the their recent rallies since Thanksgiving.  My thinking was that investors were too enthusiastic heading into the ECB and EU meetings of Dec 8 & 9th and that no new news would not be good for equities.

With bank stocks down 5-7%  since initiating the prior week I took my initial cost of the table in my MS Dec 16/15 put spread and DB Dec 37.50/35/32.50 .  In both of these spreads with less than 3 trading days to go to expiration and both spreads flirting with the intended strike in which I hoped the stock to settle, I sold half for more than double what I paid.

Let me break away from the trades and expand on this for a minute or two:

Many successful traders slightly disagree with this strategy as it avoids the potential for big winners if you are taking off half of the position all of the time once you have a double, but I have some thoughts on this.

I don’t disagree with the notion that to be successful as an active trader you don’t exactly have to have a massive batting average, you just have to make sure that you cut losses quickly and that you let profits run. If you do this consistently then you should be able to more than make up for a bunch of small losses.  So some may say that if you are disciplined on losers and routinely cut losses and book many small losses, but you don’t let your winners run than you will have problems compensating.

My strategy is a little different as it relates to directional long premium option trading, and especially as WE (me and you) get up the curve together on certain concepts/strategies.  The main goal of is education and we truly hope through my “trading diary” and my daily commentary that you learning from what I do well and not so well.  I am not a one man research/sales & trading department, and like most of you, have limited resources when it comes to my trading (time being one of the biggest) and in this endeavor one of the most important paths to profitable trading is to book as many winners as possible. If I do this consistently and take my cost off of the table on the quick winners, then with what I would call my new “risk budget” I can let the balance run for the attempt at a home run, something that is very difficult psychologically with all the chips still on the table in a trade. I also can place chips on the table (with defined risk) on certain trades that I think have the potential to be big winners (names like HANS, GMCR, LULU etc).  But I can only do this with positive performance and disciplined trading in less volatile names.   Please feel free to email us on these sorts of things, we are happy to expand on this philosophy.

OK, back to the trading…..By Friday with just hours to expiration and MS, C and DB somewhere either in the middle or to the low end of my long and short strikes, I had to make decision on how I thought they were going to close on the day….and frankly by late morning and the diminishing potential for any macro news to move things in a meaningful way,  it was really a market call, of which I lacked conviction. So, I closed the second half of the MS spread for almost 2/3 of the width of the spread and I closed the C dec 27/25 put spread for a modest gain that equaled a little more than 50% of my initial premium outlay.   With just a few hours till the close, the risk reward is not really in your favor if you have gains, while you maybe able too eek out a bit more, the thought of losing the gains plus some initial premium wasn’t that palatable.

DB was a different story, and with the stock about 1% away from the 35 strike that I was short and my desired settling point for max profit I was willing to hold out a bit. This was also the trade where I had the most bang for my buck from the initiation point.  Remember a little more than a week before I paid .30 for the hope to make 2.20 if the stock settled at 35.   This is a great example of how taking some quick profits lessens the overall profit potential.  Remember earlier in the week I sold half of the Fly at .75 for a .45 gain, so Friday afternoon on Expiration, just a few days later, I sold the balance at 1.80 for a 1.50 gain, the average gain for the initial position is far less than had I just waited……But here is the deal, I, like you, don’t have a crystal ball and in a volatile market like the one we are in  you have to take what you can get, and keep some capital exposed to your best ideas.

So, on to those more speculative trades……On Monday I bought a Dec call spread into BBY’s earnings report Tuesday morning……As I wrote on Tuesday, I outsmarted myself on this one and some ways I pulled a “Costanza,” doing the opposite of what I normally do.  This one lined up right in my wheelhouse, with the opportunity to short near-term overbought name into an event where sentiment might have gotten ahead of the fundamentals.  I guess all you needed to hear was my answer to CNBC’s Melissa Lee on Options Action Friday Dec 9th, when she asked me where I think the stock was going longer term, my answer was much lower…..This was a dumb trade because I ignored my gut about the company in general and wanted to be a bit contrarian for the sake of it, this was clearly my worst loser in a while…..

Then there was HANS, this company I don’t get, it is a natural drink maker that has a valuation like a hot new internet IPO.  My track record hasn’t been great on trying to play this one from the short side, but I will use some of that “risk budget” earned from some of my less speculative trading to stick with it……Heading into Friday’s expiration the Dec 85/80 put spread I was long was becoming worthless and quickly with the stock well above my Long strike.  With another high-flying consumer name DECK down 10% on Thursday on an analyst downgrade and the action earlier in the week from GMCR (down 20% in 3 days) I thought this was as good of time as any to get in front of the name.  My timing wasn’t great in front of their addition on Friday’s close to the Nasdaq 100 (as Nasdaq Indexers had to buy stock) but I am going to stick with this one as It is only a matter of time before it breaks.

The most extraordinary thing that happened in my trading in a long time was GMCR’s 20 plus % move lower that salvaged my DEC 50/46 put spread, which was basically worthless then swung to a quick profit…..again with just a few days to expiration I sold half at .80 on Tuesday for a .75 loss with the stock down about 10% and then on Wednesday with the stock down another 11% closed the balance at 3.00!!! for an average profit of .70 on the whole position…….wow.  I guess the lesson here is that we don’t sell teeny options, meaning when the spread was basically worthless it doesn’t make a ton of sense to sell it to recoup just a few bucks…..this one situation financed keeping these sorts of long shots on for a while.

OK, back to a couple of losers……ADBE, also one where I lacked a ton of conviction and clearly stated that. Now some would ask why play without conviction and the truth is, as stated above I played in a size and with defined risk that if the position was a zero, as it ended up being it would not change my life. Into their earnings I bought a Put Fly that had a 5 to 1 payout in the event of a 10% move lower….I like those sorts of plays and after doing some work on a name into an event, as I did in this case, I will usually put something on the sheets.  I paid .39 for the Dec 26/24/22 put fly with 1 days to expiration, this was a very binary situation and one where I wanted to define my risk and use as little premium as possible to express this low conviction view.

RIMM is another one where I was swimming against the tide a bit…..A name that I have been so right in for a while that with the stock pounded into oblivion I have wanted to be a bit contrarian….not because I believe there is any hope that the company can salvage their ever declining smartphone positioning, but because exiting management or someone external will come to the conclusion that there is value to be unlocked….Rather than throwing premium at a trade that the stock would bounce on earnings, I actually wanted to fade the move in DEC as the company had already pre-announced but implied volatility in Dec was still fairly elevated.  My conclusion was simply that nothing was likely to happen after the print so I wanted to sell Dec options to buy Feb which would give the company some time to find a partner or a potential buyer…..Thursday night after the company again lowered guidance for the out quarter and pushed out their new QNX based phones, the stock was down 11% making new 8 year lows.  Thursday I had bought the DEC23rd weekly $16/ Feb $16 call calendar for .75.  I sold Dec 16 calls betting that the stock wouldn’t trade above that level by next Friday’s close and then used the proceeds to help finance the purchase of the Feb 16 calls….This trade worked out OK as the Dec options were almost worthless Friday morning (covered them for a nickel) and then I was just long the Feb 16 calls (that has lost more than 50% of their value) so I was down about .15 on the trade….to further reduce my risk on this trade I then went and sold the Feb $18 call at .30 to now own the Feb 16/18 Call Spread……RIMM is kind of on my banned list for new trades and in some ways I am hoping the stock will now go to zero, not that the shareholders or employees deserve that, but senior management certainly does.

Back to booking gains I took some profits on INTC Jan 24/22.5 Put Spread that I paid .35, Sold half on Wednesday with the stock below my long strike at .71 more than a double, now I can’t lose on the position.

A I sated above, Euro weakness was one of the big stories for the week, breaking down below support at 1.32 and hovering around 1.30 for the balance of the week back within about 1% of the 2011 low made back in early Jan.  A few weeks back I bought a Jan 130/125 Put Spread making a bet that the situation in Europe would cause their currency to make new lows by early in the new year.  With such a massive move in such a short period of time ,and technically looking like it is holding a the next support level, I sold a bit of this position for a decent gain, and will look to put some more out on a rally, if we get one, either way you guys know the drill, book gains when you have them……

And finally, few little things. I had some long premium trades expire worthless, WMB Dec 29/25 Put Spread, stock hovered around 30.00 for most of the time I had this trade on…..AAPL Dec 375/360/345 Put Fly, this trade worked out too quickly, the stock went quickly down towards my short strike and I sold half of this position for a .70 gain, and I almost had it again as the stock was trading south of 380 just this week and probably could have salvaged a bit more, but decided to keep it on in the chance that the stock  saw further weakness.  I have had some good ones in AAPL of late and modest losses on a position like this with the potential profit potential seemed OK to me…..

On Friday with ZNGA’s IPO falling flat I wanted to go back to an ol’ friend, LNKD….this company is a bit of a joke to me, and there are couple significant events in the coming months that could cause some downward volatility….first, is the overhang coming from restricted holders, at some point in mid Feb 55 million shares should come unlocked for sale to the public.  Remember their IPO was only for about 8 million shares back in May and then they just sold another 8.75 million shares in a secondary at $71, some $26 above their May IPO price, with some intial VC investors cashing out entirely…..also as Facebook IPO comes closer and closer I think this will make the valuation of LNKD look worse and worse.  I bought a Feb 55/45 put spread for 2.00 playing for a move that re-tests their IPO price….

Also, I did one of my little black swan trades in GRPN, where I bought the July 10 put and sold 2 of the July 5 puts….this trade is not for everyone and playing for disasters with real premium commitment is not a disciplined way to make money consistently, but I can’t stand this company and think this single vendor online coupon crap has the potential to go the way of the DoDo bird as everyone gets into this space.

Finally with the VIX closing below 25 I think there is a great deal of complacency and with rumors that S&P may downgrade some European Sovereigns I thought it prudent to buy some VIX calls…..In particular I bought the Dec21st 27.50/30/32.50 Call Fly (so this move I am looking for has to come in the next 3 trading days.  This is definitely a bit of punt but paying .25 for the chance to make 2.25 if the VIX goes back to technical resistance just based on rumors, so definitely not for everyone…..but I do think things have gotten a bit complacent.