Ask Us Anything

by CC May 29, 2012 12:45 am • Education

May 19: I’m looking for a move in gold and I am thinking about a 160/170 or a 170/180 call spead. I was wondering if you could look at the option chain and see if anything jumps out at you. -TL

The one thing that always stands out to me on GLD for the options surface is what options traders refer to as “inverted skew.”  That just means that the implied volatility for higher strike calls is higher than for lower strike calls and than for some lower strike puts (the ones closer to at-the-money) as well.  For example, in GLD December options, the 160 strike call is a 22.6 implied volatility, the 170 strike call is a 23.25 implied volatility, and the 180 strike call is a 24.32 implied volatility.  For most stocks, the implied volatility for the 160 strike would be higher than the 170 strike, which would be higher than the 180 strike.  Why?  Because people usually buy lower strike puts or sell higher strike calls when they want to protect their long stock positions.  But with GLD, people buy high strike calls for protection, in case gold goes parabolic.
This matters because I always prefer to buy lower strike options and sell higher strike options when I’m trading GLD.  Your call spread idea does that, which is a benefit.  I am ambivalent on GLD, don’t have much of a directional opinion, but purely from an options standpoint, I would prefer the 170/180 call spread over the 160/170 call spread because the implied volatility difference is greater, and your risk/reward seems more favorable as a result.  -Enis


May 21: Just wondering what your thoughts are on your IBM put spread that you did a few weeks ago? -GM
Since putting this trade on a little more than 2 weeks ago, the stock is down about 3.5%. in that same time period, the SPX is down about 4.5%. so the stock has outperformed the market which is obviously a decent sign of relative strength. But on a day like today when the SPX is up about 1.4%, IBM is under-performing, only up about 75bps, so about half of the index’s gains. This is not exactly that surprising given the general defensive nature of the stock. With the stock about $197.35, the spread is worth about 4.90, I paid 3.40 for it, so a decent gain so far.

I have covered most shorts on the site, as we have been getting a little worried about this sort of rally that we are getting today, and that could last a couple of days. But I didn’t take the IBM put spread off because I still have a lot of time, and it should capture the companies 2nd qtr earnings announcement, and frankly given the stocks out-performance for the last year or so, the stock is not very oversold at current levels. I think we have this one right where we want it. -Dan


May 25: I’ve been frustrated on the euro trade until recently. I’ve been using calls on the EUO, do you think put spreads on the FXE is a better way to go? -LK

As for the Euro, I’ve been using either UUP long calls or FXE long puts. The UUP is a separate trade because it depends on the Japanese Yen and British Sterling (other currencies are minimal in the basket), but the implied vol is cheaper, and it is still 57% Euro composed (and I was expecting more weakness in the Japanese Yen, which has not happened).

But the cleanest way to express just a Euro short position is FXE puts in my opinion. Be careful on your strike and maturity selection because you don’t want your option to decay too quickly before the Euro makes its move. -Enis


May 24: Question on risk management: as an example for the TLT call spread, if we are wrong where do you stop it out? 50%?  On the upside of a trade when a trade moves quickly like TLT call spread did the other day do you ever take out the quick profit or let the thesis play itself out. – KS

I like to use situational stops (meaning I get out when the reasons for my trade seem to have not gone my way) most of the time to inform my own trading, but it’s all dependent on each traders personal risk appetite, style, and personality.

For the TLT specifically, my thesis has not changed much and there are still more than 3 weeks to expiry, so I did not take any off yesterday, but there is no harm in taking profits when we are trading options that have expiry in one month or less. The main thing is to size your trades correctly so that you feel comfortable with your risk of losing your premium. -Enis


May 22: I have a question about one of my trades. A couple of weeks back I put on the 750/730/710 June put fly on pcln. Since I put on this trade the stock has tanked. I noticed that the value of the spread has become a credit? Which means if I decide to double up my position I would get a credit for it?? -MT

First, a general rule of thumb on butterflies. The butterfly will always cost you a debit because you cannot lose money on being long a butterfly (the max loss is 0). When I eyeballed your PCLN butterfly, the bid/offer is wide enough that if it might look like a credit, but if you went into the market and tried to double up your position with a credit, or even at 0, you would not get any done. The market making systems (and even manual market makers) would not sell you a butterfly at 0 or for a credit.

In any case, your hope at this point of course is that the stock has a very sharp rally above 710 by June expiry. -Enis


May 20: Unfortunately I bought into the hype of Facebook and got some shares at $42. Since the stock closed at 38 and change the IPO day, where do you think it is going to go in the next month or two? I am happy to double up my position if it drops to 35 but below that i d be concerned. Even at 38, the stock is trading 100 times the earnings.

In correlation with Facebook, I bought some ZNGA @ 8.20. This position is bleeding really bad with stock down a dollar from where i bought it Thursday. I think I’d get out under $6. -BG

As for FB, it is a tough one here, the underwriters obviously supported this deal or the stock would have closed lower than 38. So if i had to guess the stock goes below 39 this week. I have no clue where it goes but I would be surprised to see it in the low 30s unless the market totally melted down, which it could definitely do. But if you are looking at FB long term i have to assume that the stock will be over 42 at sometime again….this is not recommendation as I think this stock is a very special situation, while it is growing users so fast, I have not heard a rational argument how they will be able to make a lot of money of them to support this valuation. The other thing is the accelerated lock up in the name, there will be tens of millions of shares coming off lock up in 3 months and then again in 6 months, this could keep a lid on the stock.

As for ZNGA, we took a hard look at it a couple weeks ago and were thinking of playing for a bounce into the FB IPO and didn’t because we think it is a bs company. I have no idea where the floor is, especially if FB were to keep going down. I will say this, they have a $5.2 billion market cap, and trailing 12 month sales of 1.15b, not egregious and they have 1.5b in cash. So if the stock was 20% lower at 5.75 with about a market cap of 4b and 1.5 bil in cash i would suggest there would be good support there….but again their future is so tied to the success of FB, and as a stated contrarian i can’t tell you that is an interesting proposition to me. -Dan


May 9: In your tweet you referred to IWM being on top of  VWAP. What is that? -KH

VWAP refers to volume-weighted average price. It’s a bit of a technical measure that’s used mostly by day traders as a reference point for where the average market participant bought or sold on a given day. So in IWM, the average trader today bought or sold at $78.40. Through my day-trading experience, I learned that VWAP is usually important intraday support if we are trading above it, and important intraday resistance if we are trading below it. In today’s case, the $78.40 level acted as support, and we eventually bounced, I pointed it out because IWM tends to lead the bigger indices like the S&P or DOW since it is a measure of more names (2,000 stocks).

Here is the technical explanation. – Enis


May 8:  I would love to learn more about the types of options screens you use. – CP

The more useful screens that I use are based on relatively simple historical comparisons of realized volatility to implied volatility. It is actually rare that you will find large discrepancies between stocks within sectors, but once in a while it will occur, and offers good opportunities. We also would run more complicated screens based on term structure and skew, but those were usually more difficult to trade anyways.

We recently developed the implied move calculator for earnings, a widely used tool by professional options traders. Our hope is to develop a similar tool for general volatility screens, so you can eventually use the site for screening whether volatility in a name is rich or cheap. -Enis