Trading Rules/Plan

As mentioned in my introductory post, I’ve had a set of ‘trading rules’ that I’ve tried to follow to the best of my discipline. However, as they were my first attempt at creating such rules, I knew they were nowhere near perfect. They were thus expected to evolve through daily application, with the overall intention of arriving at a ‘consistently profitable‘ and ‘perfectly suited to my style’ set of rules.

So I spent some time tonight reviewing the old set of rules and adjusting them to fit the patterns of my latest successful trades. While a couple got thrown out, most were either reworded or made more specific. Here, then, are the results:

RISK

• Never more than 2%/trade, regardless of position size
  • Standard: 2% = 30% loss in position
  • “All-in”: 2% = 100% loss in position
• Enter trades at support/resistance/trendline
• Buy breakouts only after re-test/consolidation
• Never hold through earnings
  • Unless the trade is on volatility rather than the underlying stock

REWARD

• Hard Rule: Sell 1/2 of position at 100% gain.
• Always have a stop – trailing; line-in-the-sand; ‘written down’ – never just ‘mental’
• Set targets; if reached, sell to guarantee breakeven
• Sell on weakness in Stochastics/price action.

ROUTINE

• Enter new trades in the morning (before work)
• Use day limit orders for rest of the workday
• Work permitting, keep an eye on the market
• Examine all positions ~20-30min before close (lunchtime)
• Go through watchlist nightly; identify trades for next day
• Always look for ways to improve; learn from others’ mistakes

STICK TO THE PLAN!

• Excellent food-for-thought: brands that may soon disappear! (@ 24/7 Wall St.)
• There are still some stocks out there making new 52-week highs. Buy the strength?
• Review some basic ‘shorting’ candlesticks for catching the top of the next bull-trap rally.
• Lots of data to explore here. I’m sure most of them are scary.
• Politics I’m usually not interested in, but I do enjoy quality science fiction. For those familiar with Frank Herbert’s Dune, this may be somewhat funny.
• One more funny link – cracked.com at its finest.

BONUS LINKS:

• Ainkurn starts reviewing his trading probation.  (@ 10kThrownAway)
• A personal story on re-learning to trade.  (@ Trader Eyal)

Very busy day; opened quite a few new positions, several of the non-standard variety. Went from 70% cash to 35%.

DP Buys, at the Open:

• Calls in [[CYMI]] – (support @ $26) and [[TTEC]] – (support @ $20.50).
• Puts in [[VPHM]] – (breakdown from downtrend).
• Sold short a straddle in [[TMA]], as highlighted the night before.
• Bought straddles in [[GOOG]] & [[RIMM], expecting large moves due to the payroll report, and the upcoming Fed meeting/rate cut.
  • Surprisingly, both of these stayed essentially unchanged in what otherwise was a wild day in the markets. But I have confidence they’ll both be making large moves soon.

DP Buys, Limit Orders:

• Long straddle in [[NG]] as it hit $10. This level has provided support since January. Earnings are to be released this weekend and should provide a $1 move (10%) in either direction. Possibly more, if support is broken.
• [[CPO]] calls at $37.50. Looking for uptrend/asc. triangle to continue.
• Back into [[BIDU]] with some puts at $240. This is where I was originally going to take this trade (at the beginning of the week).

DP Sells:

• CYMI got stopped out on the intra-day 30% trailing stop. Booked a small profit.
  • It eventually held support, so may be worth a revisit.
• [[CTRP]] calls stopped out; uptrend did not hold.
• Sold [[APH]] calls at the close as it finished below support.

Angelo Mozillo thus reaffirms his deserving of the Asshat of the Year award.

A good day so far, with most positions going in my favor. These include short straddle in [[TMA]], long straddles in [[NG]] & [[GOOG]] & [[RIMM]]. Puts in [[BWLD]], [[GME]], [[PBR]], [[VLCM]] continue to make money. Even some long calls seem to be working, such as [[CPO]] & [[CYMI]] (both new as of this morning).

Full update later today.

Looks like we’re ready to start tanking back down. Will need another spectacular rally to hold 12,000 on the Dow.

Tomorrow’s great idea is brought to you by the wonderful ‘fucktards’ at [[TMA]].  It sure takes special talent to lose over 85% of your stock’s value in a little over a week.  And while I have no idea where the stock’s going next, I do know that implied volatility of 500%+ is egregiously high, especially when it used to average about 60%.

So how to profit from this?  Short the volatility!  (Thus assuming that 500%+ IV won’t last long.)

One way to accomplish that is to sell a straddle, that is sell both a call & a put of the same strike & expiration date.  This creates a (close-to) delta-neutral position, which, as long as the stock’s price stays within a certain range, is profitable.  Here’s a pretty picture to illustrate:

The high volatility helps out tremendously when entering this kind of trade, since the profitable range is determined by the premium paid for the options.  High volatility creates expensive options, thus resulting in greater initial credit and a higher probability of reaping profits.

Back to [[TMA]] for a concrete example:

• Mar 2008 2.50 options:

  • call (IV = 561%):  $0.55 ask

  • put (IV = 475%):  $1.30 ask

• Selling both creates a credit of $1.85/option, $185/contract, with a slightly negative delta (-0.09).

  • These equal the greatest profits that can be gained from such a position.

• As long as the stock’s price stays within $0.65 – $4.35, the position is profitable (either at expiration, or closing out ealier).

Just to compare, take a look at [[SANM]]:

• Mar 2008 2.50 options:

  • call (IV = 74%):  $0.25 ask

  • put (IV = 79%):  $1.15 ask

• Selling both creates a credit of $140/contract, with a higher negative delta (-0.17), in this case (we want to be as close to zero as possible).

• Profitable range is reduced to $1.10 – $3.90.

So if TMA does nothing but sit right where it is now, assuming IV reduces and the premiums behave as for SANM, we should make ~$45/contract (30%).  Those would be profits due to implied volatility only.  Rest of the potential profits come from time decay, as the options move closer to expiration.  Max. profit could be booked if the options expire worthless, although the chance of that happening is fairly small.

The downside risk of a short straddle is significant, if the stock falls or rises outside the range.  In fact, much like short-selling stocks, the potential losses are unlimited.  Stops are highly advisable.

What we’re betting on, however, is that the underlying stock stays within the profitable range, volatility falls, time-value decays (on near-term options), and profits are booked.

It’s a bit grim out there, to say the least.  Yet we’re still holding 12,000.  Should we break that tomorrow (on the heels of non-farm payroll [25-30k expected] & unemployment rate [5.0% expected] data), than the real fireworks shall begin. 

I’m not 100% convinced that we’re going down tomorrow, even if the data sucks…mostly because almost every stock on my screen is oversold!  Of course, that may not matter a bit.  Instead of picking a direction, I will be looking to use some neutral/bi-directional strategies, taking advantage of the wild swing that is sure to occur.  I would be very surprised if we don’t see another triple-digit day up or down.

DP Buys:

• Saw some success yesterday with long calls (more on _that_ later), so I went long [[CTRP]] calls at $55.  Several percentage points lower, the uptrend is still holding…barely, if I squint just right.
• [[PBR]] – was watching this in the morning and bought some Apr 115. Puts when it failed to break through $118.  This was a rare trade in that it was neither limit/stop nor at open/close, since I had the time this morning to actually watch the price action.
• Took the [[GME]] bear put spread trade highlighted last night.  Bought Apr 45. Puts and sold Apr 35 Puts as GME dropped past $45.  Straight puts were the more profitable option, in retrospect, but I still held my false belief here that calls were generally a good idea.

DP Sells:

• [[BIDU]] puts and [[DRYS]] calls were both stopped out on the -30% trailing stop.  Both are worth getting back into under the right circumstance, especially BIDU.  DRYS support is also still holding…
• Sold [[ALK]] calls when they dipped below yesterday’s low.  Slight loss.