Summary – Wednesday, 2008.III.12

A rather boring day, I think, in the markets, with some more steers led into the rally in the morning and some profit taking in the afternoon.  The market finished down, pretty significantly, in fact, if you look at the S&P 500 (-0.9%).  Airlines, along with healthcare, were major winners today on the short side.

Personally, I’m tempted to call it a week after yet another monster day.  The major bull positions from yesterday made some more money today, and my opening puts on [[ALK]] turned into my largest realized gain ever (400%)!!!  The only things not working seem to be the long straddle/volatility plays (large swings in both directions; no decided direction), although the short straddle in [[TMA]] is settling nicely into profits as the underlying looks to consolidate in the $2.50-3.00 range.

DP Buys:

• OTM puts in [[ALK]].  See previous post for details.
• Puts in [[CWST]] – (had pulled back to downtrend line @ $10.50).
• Calls in [[TUP]] – (held support yesterday while printing a very bullish candlestick).  Limit order filled just above yesterday’s high.

DP Sells:

• The remaining calls in [[MON]] were stopped out on the 30% trailing stop.
• Same was true for [[VPHM]] puts.  This was a small position and booked a tiny loss. 
• Sold ALK puts on market close, as mentioned in the intro.  They were well ITM at this point.  The largest gains in options will always be booked when they go from OTM->ITM, which was once again proven here.
• Sold all [[PCLN]] calls at market close for another 100%+ gain.

Thanks to the friends at JP Morgan, the airlines are dying a thousand small deaths, all at once. JPM downgraded no less than 7 of the sector’s components, including most of the big boys: [[ALK]], [[AMR]], [[LCC]], [[NWA]], [[UAUA]], [[DAL]], [[CAL]].

“J.P. Morgan told investors they should sell on any rally rather than commit more cash because of the uncertainty behind sector consolidation and signs of a recessionary economy.

“While a boon for sentiment, the high-risk uncertainty surrounding 2009 deal closure can’t offset the near-term risk of 2008 losses measured well into the billions,” said analyst Jamie Baker in note.

Baker said that that in prior recessions, demand trends consistently reverse by around 10%, and therefore forecast a 6% to 7% decrease in industry revenue, beginning in the second quarter.

“Airlines have been raising fares to offset higher fuel prices, and were able to do so very successfully through most of 2007,” the credit rating agency said. “However, we expect that this trend will stall across the industry in the face of softer demand, likely first on domestic routes and then in international markets.” (source)

I had been watching ALK for technical reasons. It’s been hovering at resistance/support and was considering going in for a trade.

Saw the downgrade this morning along with a surprising non-reaction to it in the pre-market. With oil making new all-time highs every other day, undecided technical direction, and a fresh batch of downgrades, it stock was ripe for some speculation. Bought a basketful of March 20. Puts at the open, which are now up over 200%. Boo-yah!

If you read today’s summary, you may be wondering why I sold almost all my big gainers. Well, besides not being entirely convinced in this rally (as Woodshedder points out, volume was nothing special), I also wanted to book as much profit off the options’ time value as possible.

Time value is a unique concept to options and is an important factor in determining the premium that has to be paid per each contract. Whereas a stock’s value is simply based on its price, an options’ premium is the sum of its intrinsic value and time value.

Intrinsic value is simple to see; it is simply the difference between the options’ strike price and the current price of the underlying stock. Intrinsic value cannot be negative, thus only in-the-money (ITM) options can have any. (So ITM calls have a strike price that is below the underlying stock’s current price, and, conversely, ITM puts have a strike price that is above the underlying stock’s current price.) Options that are at- (ATM) or out-of-the-money (OTM) do not and cannot have any intrinsic value. This must not be forgotten, since at expiration, all that is left is intrinsic value. (Consequently, intrinsic value can also be referred to as ‘real value’.)

Time value (aka. ‘extrinsic value’; its rate of change is denoted by the Greek letter theta) is the trickier part of the equation. It depends on 2 main factors:

1. Time until expiration
   The more time remains for the options to become ITM, the higher the likelihood will be that it will actually do so. Option with a high(er) chance of becoming ITM will command higher premiums. So options that are 1 strike out of the money will be more expensive than the ones that are further out.
   This value decays exponentially, so the closer it gets to expiration date, the more value it loses. For the mathematically challenged, here’s a picture of the exponential decay (credit: Illuminati-Trader):
2. Volatility of underlying stock
   This essentially embodies the risk inherent in the option, whether it is implied or historic. Higher volatility comes from larger than normal swings in the stock’s price and/or momentum. This results in higher risk for both sellers and buyers (sellers risk the option expiring ITM, while buyers risk expiring OTM), thus premiums increase.

The time value is thus determined by combining the premiums from these 2 factors*. They are both important, but at expiration, time value always equals 0, regardless of volatility.

So when an underlying stock goes through a large price swing, volatility goes through the roof (relatively speaking) and the time value increases accordingly. This extra/added value is lost as soon as price action settles back to a normal range.

Since large up or down days in a stock are more often than not followed by consolidation/smaller swings in price (during which time volatility decreases), I tend to sell (at least part of) a position, to capture that added time value.

*It’s a bit more complicated than a simple summation of course, but that’s beyond the scope of right here/right now. For those who like differential equations, feel to read up on the Black-Scholes Model…or check out the Binomial Method, or the uber-complicated Monte Carlo Sims.

What an amazing day! Unless you’ve been hiding under a rock, you know by now that we posted the largest single day points gain in 5+ years and the 4th largest in history. Here’s a detailed recap from the good people of briefing.com.

I had one of my busiest days ever in the market, with several daytrades and lots of position flipping. Woke up to find an extremely bullish sentiment reigning in pre-market, amazingly coinciding with my bullish charts from the day before.

There was thus only one way to proceed…sold almost all my puts and bought calls in every single one of those stocks highlighted. Then, at the end of the day, following one of my unwritten rules, I sold almost all these newly bought calls after monster gains. This was done in order to cash in on the higher time values associated with options during such large moves.

DP Sells:

• Sold at the Open: [[AMGN]], [[BIDU]], [[PBR]], [[TUP]], [[VLCM]] puts. All but BIDU ended up profitable, despite the gap up.
• [[BWLD]] was looking to open weaker than the general market, so I left that on the usual 30% trailing stop. It didn’t actually get stopped out until the last surge at the end of the day.
  • This was only a half position that remained from yesterday’s profit taking. Overall gain in position came out to 75%.

DP Buys:

• Calls in all 5 stocks from the previous post as well as [[HES]].
  • To be on the safe side, all but [[MON]] were strictly minimum positions, that is the entire position basis equaled the 2% risk allowed/position.
  • Sold half of MON at 100% to guarantee breakeven.

Market-on-Close:

• Closed out entire position in [[CLF]], [[GBX]], [[HES]], [[ILMN]].  Profits ranged from 55% – 150%!  Left with half position in [[MON]] and a min. position in [[PCLN]].
• Bought straddles in [[JCG]] and [[TTWO]].  Both were due to report after-hours, so the idea was to take advantage of the resulting volatility.

Should you have, in your possession, the following 3 items:

• Steel mesh or Kevlar gloves (to catch the titular knife)
• Cojones grandes (to not scream like a little girl when said knife slices your hands off)
• Gambling mentality (to bet on a brief respite from widespread selling)

…then you should consider going long on the stocks represented by these here charts. They all offer attractive, low-risk entry points at oversold conditions.

STEEL & IRON: Cleveland Cliffs – [[CLF]]

RAILROADS: Greenbrier – [[GBX]]

BIOTECH: Illumina – [[ILMN]]

AGRICULTURE: Monsanto – [[MON]]

INTERNETS: Priceline – [[PCLN]]

Anybody who is a regular reader of this here site made all kinds of moneys today.

And while I’m getting tired of the media’s constant badgering about ‘increasing’ financial/economic concern (can we just finally say “we’re in deep shit” and get the whole ‘increasing’ part out of the way??), there’s no real reason to think that we can actually still avoid recession/financial meltdown/food lines.

Personally, I had about a 5-diamond day, banking and amassing unrealized gains of devalued dollar at an alarming rate.  It was not perfect due to some misguided longs and continued asshattery at [[TMA]].  I’m also mad at myself for not shorting [[MOS]] this morning after it broke its uptrend on Friday.

DP Buys:

• Puts in [[AMGN]]-(broke support @ $44.50) & [[TUP]]-(broke support @ $35).
• RC sold me on some of his solar bullishness, so I’ve taken a gamble on [[CSUN]] with a sprinkling of OTM calls.  Support around $6.50?

DP Sells:

• Got rid of calls in [[CPO]] & [[TTEC]].  CPO should be worth a revisit in better market conditions.  TTEC was a small position gamble, so the loss booked on it was only about 1/3%.  Not a good time to put on such a trade though (and now I’m doing the same with CSUN).
• Booked profits in [[BWLD]] by selling half of my puts for 100% profit and guaranteeing a breakeven in the position.

I have a feeling we’ll be getting a ‘dead-cat’ bounce soon, so I will be looking to book profits on the rest of my puts soon.  The [[GOOG]] and [[RIMM]] straddles finally saw some action today, although the [[TMA]] short straddle is looking precarious as the selling continues, almost driving the stock below the profitable range.