Monthly Archives: January 2013

The Week Ahead: 1/28/13 to 2/1/13

This week, we’re presenting you with a downloadable Excel file regarding some of the top tickers reporting this week, as well as the economic data for the week.  Every piece of data is from Briefing.com and is completely free, so we take zero credit for the compiling of the raw data – we are doing this to save you the time and effort of screening stocks that have a higher probability of being a name with a lot of tradeable opportunities:

Earnings Spreadsheet (Briefing Data)

Next week, we’ll be adding commentary on some of the companies reporting and the most prevalent economic data for that particular week.

– ZMoose

Tagged , , , , , , ,

Using Options to Profit on Low Volatility Stocks

When investing in the market, it’s not always necessary for the price of a security to move in order to make a profit. There are multiple ways to profit from low volatility stocks. Below I will discuss my two favorite option strategies which will allow you to profit when the price of the underlying security doesn’t move.

Iron Condor

This is by far one of my favorite strategies to use when I’m dealing with securities which have historically low movements in price. This strategy is called an Iron Condor, and is a non-directional strategy, meaning that a profit will be incurred if the price of the underlying security doesn’t experience high volatility. The profit, however, is typically low with an iron condor due to the fact that your risk is limited—unlike a naked call/put, where the loss can be infinite.

To put on an iron condor, a trader must open the following positions expiring in the same month:

1

This will result in a net credit for the trade, which is collected upfront. If you look at the P&L Chart above, to maximize your profit, the price of the underlying security must stay between the Short Put strike and Short Sell strike.  While maximum loss occurs if the underlying stock price is higher than the Long call strike or lower than the Long Put strike.

Iron Butterfly

An Iron Butterfly is similar to an Iron Condor, however it usually offers a higher maximum profit due to the lower chance of gaining the maximum profit. Like an Iron Condor, this strategy also offers limited risk.  With this strategy, the probability of earning some sort of profit is relatively high, compared to other strategies.

To put on an Iron Butterfly, you must open the following positions expiring in the same month:

2

This trade will result in a net credit, which will be collected upfront. As you can see from the P&L Chart above, profit will be maximized when the underlying stock price at expiration is equal to the strike price of the Short Call/Put.  Maximum loss, on the other hand, is realized if the underlying stock price is over the strike price of the Long Call or if it’s under the strike price of the long put.

These two strategies are my favorite to use when trying to profit from low volatile stocks. Like I mentioned above, the profit will be tremendously less than using naked calls/puts, however the risk is tremendously less as well, making these strategies a good way to make a nice consistent profit.

Check back early next week, as I will show you one of my trades using one of these strategies and keep you updated on how it does.

 

Tagged , , , , , , , , , , , ,

Long Caffeine: Dunkin’ Brands Options Trade Review

I had a conversation with some heavy hitting financial professionals (who will remain nameless for confidentiality purposes) a couple of weeks back regarding the recent price depreciation in Coffee with relation to the companies that are affected by the commodity due to their exposure in the industry they reside.  The initial portion of the conversation was made up of discussing the technical aspect behind the Coffee move, eventually leading to a discussion between who had more upside during 2013:  Starbucks (Ticker: SBUX) or Dunkin’ Brands (Ticker: DNKN).  Over drinks, the companies internal structures began to get broken down:  SBUX locks in their commodity prices a year out to avoid any extreme volatility, and DNKN…  Well…  How exactly does that company control their Coffee commodity risk?  The conversation ended, the drinks continued, and the evening was a phenomenal one; it got me thinking, however, about the dilemma we ran into during our discussion about DNKN and how they indeed monitor risk.  Based on this evening and following a simple risk assessment and the known fact that earnings were right around the corner (the initial Whisper Date being February 8, 2013, prior to the official company announcement of January 31, 2013 @ 8:00am ET), I got long eight contracts of DNKN February 2013 37.50 Calls at $0.30 and began delving into the company’s fundamental picture.

Let’s break down the Coffee industry as a whole before we get into DNKN’s specifics.  As a common misconception, many people think that Coffee is a bean when in fact it is a berry that a bean comes from; instead of coming from the ground, it’s actually a hanging piece of fruit that is more like a seed than a bean.  The most heavily picked, produced, and roasted species of this particular fruit is the Arabica coffee bean, which is what many of the leading coffee supplying fast-food joints (including McDonald’s, leaving SBUX and DNKN alone) and suppliers of K-Cup producers (the leader being Green Mountain Coffee Roasters) use.  The Arabica bean is what the Coffee contract on the ICE and CME track (Contract: KC_#), with the second most-produced bean, the Robusta bean, being tracked on the NYSE Liffe.  Both of these particular beans are most popularly produced in Latin America, and similar to fine wines, need a particular soil and climate in order to get the best quality.  Because Arabica makes up 70% of the world’s coffee production, the first thing I wanted to see is how the KC contract compared to DNKN’s percentage performance since the company’s IPO in late July 2011:

DNKN, KC 5yr Percentage Comparison  (1232013)

This is where we can see the clear inversion at the turn of 2012 that took place (denoted by the yellow circle) and two particular inverted price areas that struck me as interesting.  From March to May, the price appreciation of DNKN stock was approximately 10%, where as after an initial drop off in the price in Coffee, we see a tight price fluctuation and a breakdown that occurred throughout most of June.  Over a time period that is two times longer, from October 2012 to present, we see close to a 20% move in the DNKN price and a tight price fluctuation that has yet to truly blow out in Coffee.  The question is whether or not Coffee has anymore room to move lower, and if it does, how low will it go and will a further price decline result in DNKN’s stock price moving higher?  We can get a completely different picture of this correlation through a paired chart over the same time period:

DNKN, KC 5yr Price Comparison  (1232013)

Looking at the Pair Ratio indicator (teal), we can see that over the price depreciation in Coffee, the ratio became tighter and tighter.  On the slight Coffee rally, the ratio backed off and the price of DNKN stock, as you saw from the previous chart, pulled back with the ratio.  We’re currently at a Pair Ratio level that has been accurate on calling DNKN stock tops in the past, but with earnings approaching next week and a similar pattern we’ve seen in before, the probability of a DNKN stock spike before the stock pulls back is more likely on a bullish earnings report.  The most recent price activity from yesterday’s close on a 15 minute, 20 day time frame can be seen below:

DNKN, KCH3 Side-By-Side  (1232013)

Through my trusted resources regarding the most recent prices of a DNKN coffee (also known as close friends who can’t go a day without having three cups), a 12-ounce “Cup of Joe” will run you about $1.95.  DNKN has research from the National Coffee Drinking Trends Study (2004) that shows statistics of approximately 2.7M cups of coffee being sold a day by the company.  What does simple math tell us about this?  That DNKN makes sales revenue every day, ceteris paribus of all costs, of about $5.27M.  If you REALLY want to extrapolate the data and figure that DNKN franchises are open 350 days a year, we see a yearly sales revenue of $1.8B.  DNKN had revenues in fiscal year 2011 of approximately $628M, and so far through three quarters of fiscal year 2012, the company has put up $496M in revenues; through another extrapolation, the company should be on par for matching revenues from last year with the possibility of a slight beat being great.  So, where does the company really take the cake on becoming a growth play for this upcoming quarter?

Two words:  franchise expansion.  DNKN CEO Nigel Travis announced not only a new push to expand on the West Coast of the United States, the most recent expansion announcement from the company, but also overseas to expand in the Chinese and Indian market.  Both expansions are set for 2013, but the company’s expansion growth so far is close to 4.00% in the United States for this past year.  With their push to move the brand internationally, the company is making huge strides and is cutting their cost through franchising the operations…  And how do the franchises and the company as a whole control their commodity costs, their biggest burden as connected as they are to the Coffee commodity?  They outsource the production of coffee beans to the National DCP:  the franchise pays the supply chain manager for services, DNKN pays the supply chain manager a set fee, and the game of fiddling with commodity prices is handled by the middleman entity.

In the anticipation of this earnings report, someone has become incredibly bullish on the stock within the February options chain.  On the day before the contract rollover last week, we saw typical, very illiquid activity in the February 2013 37.50 Calls and I thought nothing of the premium fluctuation back to my entry price as DNKN underlying stock had rallied on the decrease in price of Coffee.  I added another four contracts, as the tape in DNKN was fairly bullish and had busted a couple of technical levels I was paying attention to.  The following day on the official options expiration day, an influx of orders rolled through the 37.50 Calls and by the close on Friday, 9850 contracts had been traded on an open interest of 43:

DNKN Option Chain  (1172013)  DNKN Option Chain  (1182013)

Gangbusters – I closed out a third of my position and was willing to see what we got going into the week ahead.  When this activity continued through Tuesday and Wednesday, however, I realized that there was someone out there that has the same thoughts about earnings that I do, as this particular strike price became the most heavily traded of the entire chain (including other months that could have been traded):

DNKN Option Chain  (1222013)  DNKN Option Chain  (1232013)

After closing out another third of my position on Tuesday, I continue to hold my final third and will continue to do so through the earnings report next week.  Due to the elevated premium of the 37.50 Calls, I would be incredibly cautious about buying into this strike right now; a way to take advantage of this, however, would be to create a Vertical Spread on the February 2013 37.50 and 40.00 Calls if you share the same bias I do regarding the company’s earnings.  Bring on the 31st!

– ZMoose

“Did You Know?” Dunkin’ Brands Fast Facts ; “Arabica Premium” Bloomberg Article ; Dunkin’ Donuts Announces Plans to Enter SoCal

** All other information regarding the company was found from the most recent 10K and 10Q reports **

Tagged , , , , , ,

UPDATE: As History Would Have It: An $AAPL Earnings Play

As many of you read my post two days ago outlining how to play Apple earnings, I want to check in and see how the position is performing. Despite the position being relatively expensive, Apple did not disappointing and is currently down 10 percent after hours, trading at $460.

If you recall, I created a strangle on Apple using the current January weeklys. I paid a net cost of $23.40 to establish the position using long position in a $490 put and $510 call. Since the position was relatively expensive to create, I had break even points at $463.60 and $536.40.  Obviously, the more important break even point in this situation is the $436.60.

Looking back, the position was probably too expensive and had already priced in the volatility. However, As of a few minutes ago, The position is in the money. I am looking for this position to continue deeper into the money for the following reason.

Apple has broken below its 3 year upward trend line, which in my opinion is the start of a significant down trend. Even after the dip below this trend line, technical indicators are not indicating that the stock is, by any means , oversold.

trend

Tagged , , , , , ,

Breaking Down $AAPL Earnings

OB-TW733_apple0_E_20120724165406

After much anticipation, Apple released its first quarter earnings for FY 2013. As many of you know, this was a crucial earnings report following a 20% sell off over the last three months.

Apple announced that it had quarterly revenue and net profit of $54.5 billion and $13.1 billion, respectively or $13.81 per diluted share. These results can be compared to quarterly revenue and net profit of $46.3 billion and $13.1 billion a year ago, or $13.87 per diluted share. This is a 15.05 percent increase in revenue from a year ago, but a zero percent change in net profit. Furthermore, profit margin fell from 44.7 percent to 38.6 percent, yielding a 6.1 percent drop.

Despite narrowing margins, Apple sold a record 47.8 million iPhones. This can be compared to just 37 million iPhones sold in the year ago quarter. This is a almost a 30 percent increase in iPhone sales compared to the year ago quarter. Similarly, iPad sales increased from 15.4 million units to 22.9 million units, yielding a 49 percent increase. Sales of both mac and iPod fell modestly.

The tighter margins can be attributed to an increase in operating expenses compared to the year ago quarter. Specifically, spending in research and development increased 33 percent to $1.01 billion.

Sales in Europe, China and Japan increased 11, 67, and 25 percent respectively.  Currently, these three countries are supplying apple with 61 percent of its revenue.

Apple indicated that they expected revenue for the second quarter of FY2013 to be between $41 billion and $43 billion, with a gross margin between 37.5 percent and 38.5 percent. Furthermore, they expect gross expenses to be between $3.8 billion and $3.9 billion.

As we now await Q2 earnings for FY 2013, I expect international sales to increase and become an even bigger part of Apple’s revenue. The U.S. may not be saturated with regard to the entire mobile phone and tablet market, but it is saturated in the sense that people middle to upper class individuals who can afford Apple products can already afford them. On the contrary, international markets are largely untapped and whether it be through a cheaper iPhone or already existing products, I am expecting them to continue to tap these markets.

Tagged , , , , , , , , ,

The Business Behind the Bowl

 

With Super Bowl XLVII just two weeks away I figured it would be appropriate to take a look at the business side of the much-hyped game. The average ticket price this year is nearly $3,100. That means ticket revenues alone will be about $227 million. In 2012 it was estimated that Super Bowl fans would spend approximately $11 billion on Super Bowl related costs. To put it in perspective, that is more than Fortune 500 company, Stanley Black and Decker’s (SWK) revenue in 2011. However, one of the most unique aspects of this business is the highly anticipated commercials. This year companies have gone to great measures to promote their commercials even further. Anheuser-Busch went as far as airing a preview to their ad for their new product, Black Crown. The frenzy surrounding these commercials has grown year after year and the ads are now one of the biggest attractions for many of the viewers. The 2012 AFC Championship game had 48.7 million viewers. This was a record high number, however it was still trumped by the 111 million viewers attracted by the Super Bowl last year. That leads us to the question, why does the Super Bowl attract so many more people? Both games are played at a very high level and have background stories that make for great football games. The difference can be attributed to the unique experience that surrounds the game itself. It’s the one time each year when it is okay to have a party filled with beer, wings and pizza on a Sunday night. On top of all that, the Super Bowl is commercial free! Sort of.  During any other TV program the commercials are ignored, even hated. In a survey by BIGinsightTM 73% of people surveyed said they viewed the Super Bowl commercials as entertainment. Many people are more excited to see what Pepsico’s new commercial will be than they are to see the two Harbaugh brothers go head to head.

 

With over 110 million viewers likely for this upcoming Super Bowl, companies including Pepsico (PEP), Coca-Cola (KO), and Anheuser-Busch (BUD) have paid, on average, $4 million for a 30 second spot. But, is it really worth $4 million dollars? Over the past three years Pepsico, Coca-Cola, and Anheuser-Busch have seen their stock prices increase by 33%, 52%, and 90% respectively. While Coca-Cola and Anheuser-Busch have vastly exceeded the return of the S&P 500 during this time, 38%, Pepsico has not. These are three of the most noted companies in any Super Bowl advertisement discussion. However, no clear conclusion could be drawn regarding a correlation between their Super Bowl commercials and financial performance. Before writing this investment off, it is important to consider the size of the investment. $4 million dollars is just .08% of Anheuser-Busch’s sales and marketing expense for 2011. At such a minimal cost, it is difficult to claim that the commercials are a poor investment. With more than 2/3 of the US population watching, it is the ultimate stage for any company. Companies such as GoDaddy have built their entire brand image around their Super Bowl commercial. This opportunity can’t be found anywhere else. The survey by BIGinsightTM showed that 8.4% of people watching the Super Bowl claimed that the advertisements influence them to buy the product from the company. So, while these companies have not seen a directly correlated increase in their stock prices over the past several years, the have been able to take advantage of prime time exposure to develop their brands and position themselves well within their respective industries.

Tagged , , , , , , , , , , , ,

My Favorite Exit & Entry Technical Indicators

chart

Relative Strength Index

Definition

The relative strength index is a technical indicator that looks at the speed and significance of historical price movements of a market or stock over a defined time frame. In it’s simplest definition, the relative strength compares the number of higher closes to the number of lower closes. A stock or market with more or stronger higher closes will demonstrate a higher relative strength index. On the contrary, a stock or market with fewer or weaker higher closes will demonstrate a lower relative strength index. The relative strength index is displayed as a ratio from 0 to 100.

Interpretation

The relative strength index can be used as an overbought/oversold measure. As I mentioned before, we know that if a stock has a higher relative strength index it will have more or stronger higher closes. In other words, a market or stock with a high relative strength index will exhibit rapid upward price movement.  Typically, stocks that are bought rapidly will become overbought. Overbought stocks or markets can be identified as ones which have a relative strength index of 80 or above. Wilder, who is the creator of the relative strength index, said that if a stock or market is oversold, it is bound to reverse at some point. Similarly, we know that if a stock has a lower relative strength index it will have fewer or weaker higher closes which will exhibit rapid downward price movement. Stocks or markets that are sold rapidly will become oversold. Oversold stocks or markets can be identified as ones which have a relative strength index of  20 or lower.Again, stocks or markets that become oversold will have to reverse at some point.

The Fast Stochastic

Definition

The stochastic oscillator is a technical indicator that uses key support and resistance levels to examine the momentum of a stock or market. The stochastic oscillator compares a stocks or markets current price to its price range over a period of time. When a stock or market’s current price moves towards the price ranges upper boundary, the stochastic oscillator will be higher. When a stock or market’s current price moves towards the price ranges lower boundary, the stochastic oscillator will be lower. The stochastic oscillator is displayed as a ratio between zero and one-hundred.

Interpretation

Similar to the relative strength index, the fast stochastic can be used as an oversold/overbought indicator. It is not unreasonable to see a stock or market trade within a certain range over a defined period of time. If a stock or market is trading with within a certain range, you can assume that as the price reaches the upper boundary, the stock or market becomes overbought putting downward pressure on the price. On the other hand,  as the price moves towards the lower boundary, the stock or market becomes oversold which puts upward pressure on the price of the stock. Generally, a stock or market is considered overbought if the fast stochastic is above 80 and oversold if they fast stochastic is below 20.

Using These Indicators

After conducting other supporting types of analysis, I use these indicators to determine an entry or exit point with regard to a particular stock or market. Generally, I look for both of these indicators to unanimously point to oversold or overbought. In my experience I find that if these indicators both point to overbought or oversold they are extremely accurate and can indicate the start of a upward or downward trend. These indicators, when used together, can prevent you from entering a stock in a downtrend or exit a stock in the middle of an uptrend. Even though they are both accurate on their own, they are much strong when combined.

Don’t Believe Me?

The SPY one year daily chart highlights this entry/exit technique in greater detail. The blue arrows all point to areas in which the relative strength index and fast stochastic are below twenty, or oversold. Using what I described above, we would expect that touching these levels would be followed by a moderate to significant upward price movement. As the chart illustrates, this held true.

You will also notice that if the indicators do not agree, they are not as powerful and often have price movements inconsistent with what I described above.

SPY

Tagged , , , , , ,

As History Would Have It: An $AAPL Earnings Play

OB-TW733_apple0_E_20120724165406

What:

To profit from Apple’s earnings report this Wednesday, we are going to create a strangle using out-of-the-money options.

Why:

Date Estimate Actual Close Pre Earnings Close Post Earnings Percent Change
10/25/12 $8.75 $8.67 $609.54 $604.00 -0.91%
7/24/12 $10.36 $9.32 $600.92 $574.97 -4.32%
4/24/12 $10.06 $12.30 $560.28 $610.00 8.87%
1/24/12 $10.08 $13.87 $420.41 $446.66 6.24%
10/18/11 $7.28 $7.05 $422.24 $398.62 -5.59%

Simply put, I am making this trade based on history. Nothing more, nothing less.

Historically, Apple stock exhibits volatile and large price movements following it’s earnings releases. In fact, four out of the last five earnings reports have resulted in price movements of at least four percent. With that being said, it is not unreasonable to anticipate a significant price movement following Apple’s earnings report this Wednesday. In order to take advantage of this, we can employ a basic strangle using out-of-the-money options that will allow us to profit from a significant price movement, regardless of direction. A strangle also limits the loss of the position to the net cost.

How:

Price Call Strike Price Put
25.9 $485.00 $11.00
23 $490.00 $13.05
20.3 $495.00 $15.30
17.8 $500.00 $17.75
15.45 $505.00 $20.40
13.35 $510.00 $23.20
11.45 $515.00 $26.15
9.65 $520.00 $29.40

To successfully create a strangle, we need to take long positions in an out-of-the-money call and an out-of-the-money put. It is recommended that the strike prices of these out-of-the-money options be equidistant from the current price of the underlying instrument, which in this case is Apple common stock. The further out of the money the options are the cheaper it will be to establish the strangle and the smaller our max loss per contract will be. However, the further out of the money the options are, they less likely the strangle will expire in the money.

Currently, the price of the underlying Apple common stock is exactly $500.00 (Cool, I know). Using the January weeklys, which will expire this coming Friday (January 25th, 2012), I am going to take a long position in a call with a strike price of $510.00 and a put with a strike price of $490.00. These options are priced at a per contract cost of $13.35 and $13.05, respectively. Since we are taking a long position in both the out-of-the-money call and the out-of-the-money put, our net per contract cost is equal $26.40. Options contracts are usually denominated in terms of 100 shares meaning the absolute net per contract cost of this strangle is $2640.

Profit/Loss & Break-even:

Break Even

When using a strangle, there are two break even points. Ignoring the cost of commissions, there is a break even point below the strike price of the out-of-the-money put (B1) and above the out-of-the-money call(B2). B2 can be calculated by subtracting the per contract cost from the strike price of the out-of-the-money put. B1 can be calculated by adding the per contract cost to the strike price of the out-of-the-money call. In this particular example we can calculate B1 by subtracting $26.40 from $490, giving us a break even point of $463.60. Similarly, we can calculate B2 by adding $26.40 to $510, giving us a break even point of $536.40.

Profit Loss

Scenario 1: Max Loss

As I mentioned before, my max loss per contract is limited to the absolute cost of the contract. In this particular setup, my max loss is $2640.00. I will experience this max loss if the price of the underlying at expiration is between the strike price of the put and the call. Specifically, I will experience this max loss if the price of the underlying at expiration is between $490.00 and $510.00. In my opinion, this is not likely but could happen if Apple reports earnings consistent with estimates, no misses or beats.

Scenario 2: Loss

If the underlying price change of Apple is not big enough following Apple’s earnings report, I will experience a loss less then my max loss at expiration. This can happen if the price of the underlying is in one of two ranges. The first range is if the underlying price closes below the strike price of the out-of-the-money put, but above b1. Similarly, the second range is if the underlying stock price closes above the strike price of the out-of-the-money call, but below b2. The loss in these situations is equal to difference between the price of the underlying at the sale and the strike price, plus the cost of the contract.

For example, lets say the price of the underlying Apple stock is $520.00 at expiration. Since I am long the $510.00 January weekly, I will be able to buy 100 shares of Apple at $510.00 and sell them on the open market at $520. This means I will make a profit of $10.00 per share. Even though I profit on the sale of the Apple shares on the open market, I am still responsible for the cost of the contract, which is $26.40 per share. This leaves my net loss at $16.40 per share, or $1640.00. As you will notice, this is still a loss but is less then my max loss.

Scenario 3: Profit

This is the most desirable and most likely scenario in my opinion. There are two situations in which I will experience a profit. The first is if the underlying Apple Stock price at expiration is below B1, and the second is if the underlying Apple stock price at expiration is above B2. In the first situation, I will be able to sell the underlying shares higher then market price. In the second situation, I will be able to sell the shares at a higher then market price. If the underlying stock price when I exercise is less then B1, the Profit will be equal to the difference between B1 and the price of the underlying at expiration, minus the per contract cost of the strangle. If the price underlying Apple stock price when I exercise is above B2, the profit will be equal to the different in the underlying price at expiration minus B2, minus the per contract cost.

For example, lets pretend that the price of the underlying Apple stock at expiration is $545.00.Since we are long the $510.00 January weekly, we will be able to buy the underlying at $510.00 and sell at the market price of $545.00. Since we paid $26.40 for the strangle, our per share profit will be $8.60 ($860.00).

Tagged , , , , , ,

The Week Ahead: 1/21 – 1/25

Earnings Reports

Company Ticker Date Estimate
3M MMM 24-Jan $1.41
Abbot Laboratories ABT 23-Jan $0.72
Apple AAPL 23-Jan $13.45
AT&T T 24-Jan $0.47
Baxter International BAX 24-Jan $1.26
General Dynaics GD 23-Jan $1.92
Google GOOG 22-Jan $10.61
Halliburton Co. HAL 25-Jan $0.61
HoneyWell HON 25-Jan $1.10
IBM IBM 22-Jan $5.25
Johnson & johnson JNJ 22-Jan $1.17
McDonalds MCD 23-Jan $1.33
Microsoft MSFT 24-Jan $0.75
Proctor & Gamble PG 25-Jan $1.11
Travelers TRV 22-Jan $0.17
United Technologies UTX 23-Jan $1.04
Verizion VZ 22-Jan $0.52

Economic Reports

Report Date Time Estimated Level Estimated Percent Change
Existing Home Sales 22-Jan 10:00AM ET 5.1M 1.19%
Jobless Claims 24-Jan 8:30AM ET 360k 6.94%
PMI Manufacturing Index Flash 24-Jan 8:58 AM ET 54 -0.37%
EIA Petroleum Status Report 24-Jan 11:00AM ET
New Home Sales 25-Jan 10:00AM ET 388K 2.92%
Tagged , ,

Fun With Correlations

Screen Setup (1192013)

For those of you that do not know my history with regard to trading the financial markets, I’ve delved into a variety of different asset classes:  equities and equity options from November of 2008 to August of 2010, futures from August of 2010 to December of 2011, and foreign exchange from January of 2012 to March of 2012.  Following my short stint with foreign exchange, I decided to step my game up and train under the phenomenal proprietary trading firm SMB Capital this past summer; I can honestly say that without that training and my constant drive and motivation for trading success, I would not be anywhere close to where I am today.  I gained a valuable set of skills from SMB Capital  that I needed in order to truly understand how to navigate my way through the markets on my own, and over the course of my writings with The Invisible Hand, I’ll be showing all of you how I utilize these skills to trade successfully.

If there is one market I’d like to specialize in outside of college, it’s the futures market.  This particular market is dynamic, and in my opinion, is one of the most interesting and challenging markets to follow and trade.  The futures market allows you to spot trends on a macroeconomic, technical, and short-term basis that lets you to determine with accuracy where the markets are going.  My year and a quarter length trading the futures market, as some of you may know through my posts on Young Guns Trading, was grueling:  I started with $6,000.00, turned it into $11,000.00 in a few short months, and after getting some additional capital from my brother and my father, I took a $20,000.00 account and destroyed half of its wealth throughout 2011.  It was atrocious and damn well drove me to insanity.  I had no idea what I was doing wrong, and I was clueless as to how to get back in the game and be profitable; the problem, however, was not what I was doing wrong but rather what I wasn’t doing at all.  I had some pieces of a developing strategy that could have been a force to be reckoned with, but it wasn’t a complete strategy and because of that, I lost ten stacks.   In hindsight, that destructive behavior was a part of my tuition to market education and I wouldn’t change the way I lost that money for the world.  I not only learned about myself, but I also learned about the erratic nature of the markets that I traded:  stock indices, metals, and energy.  After moving back into this space at the beginning of this year and combining it with my equity trading, I’ve added the 10-Year Treasury Note futures to my arsenal of markets that I concentrate on, giving me an edge to cover the largest, most voluminous “slices of the pie.”

Enter the top right monitor seen in the picture above.  My strategy within these markets does not use simple moving averages, it doesn’t use an RSI or MACD crossover play, and it doesn’t focus on waiting for the price to bounce off a Bollinger Band in order to make a trade.  In an upcoming post for my readers at Sang Lucci, I’ll be discussing the idea behind Ten Thousand Hours and in that post, I cover a conversation I had with a Wall Street heavy hitter regarding the advantage of time and information.  Timing is everything when it comes to making a trade, and my strategy focuses on exploiting price discrepancies from futures market to futures market, comparing how they move in relation to each other using two correlation studies on my thinkorswim platform.  The strategy is designed to be simplistic, looking at only the raw data from the level two and time/sales to determine the supply and demand of buyers and sellers in the markets I watch and compare them to each other, attempting to spot inter-market abnormalities and capitalizing on them.  In short, it’s a discretionary tape reading arbitrage strategy that has been flawless since the beginning of 2013.

Let’s go over an example from the overnight session of Monday into Tuesday of this past week.  I was looking at Copper (HG), the 10-Year Treasury Notes (ZN), the S&P 500 (ES), and Gold (GC) in order to determine what kind of overnight activity we’d see after watching the S&P 500 drop back to it’s important 1465.00 technical level that it has continued to hover around for the past week.  The technical levels I was paying close attention to were for HG to hold 3.64 support, ZN to hold 132.02 support, ES to hold 1466.50 resistance, and GC to hold 1670.00 support.  My initial trade was to get long HG based on my thought that ES was going to trade higher, but after watching ES sell off into the Asia cash open, I decided to change my bias to a short market outlook.  After watching the price of GC fluctuate, I was anticipating a breakout in the price and began looking at trades to pair nicely with that breakout and what it meant to the other futures markets.  I came up with the following biases to support the information the market was giving me:

  1. GC Breakout = stay cautious on HG long (during illiquid trading, they tend to trade inversely of each other and thus the trade would be to go long GC and short HG)
  2. GC Breakout = risk off trade, short ES / long ZN

After coming up with these trade biases, I began to look for clues on the tape to help me with my decision and found them when ES  started getting sold on the bid, initially moving the prices in HG and GC lower.  This is where the first bias came to fruition, as a bidder in GC stepped up and held the price nicely around 1670.00, cluing me in that as ES and HG continued selling off that GC was most likely looking to move higher.  The paired trade came with ZN, as there is very rarely a time that ES and ZN trade in the same direction.  With the seller on the tape in ES and HG present, the buyer showing his cards and holding the bid in GC, and ZN holding steady with traders beginning to pay up, I added GC and ZN longs at 1670.90 and 132.055, respectively.  My risk:reward on both trades were approximately 1:3.5, and with the correlation in HG and ES holding up, the trade made sense.  I walked away with seven handles in GC and ten ticks in ZN, with this trade becoming the highlight trade to review this week.

Trade Recap (1142013-1152013)

Paying attention to all of these markets at once may seem like a daunting task:  it’s a 24/7 trading style, it’s very detail-oriented yet incredibly basic, and during times of heavy market activity takes an extreme amount of focus and understanding of how all of these markets connect.  In my next post this week, I’ll be bringing another example and more discussion regarding the Pair Correlation and Pair Ratio indicators thinkorswim has to offer traders looking at capitalizing on price inefficiencies across markets.  We’ll also be taking a look at the tape of one of the markets to breakdown how it moves and its idiosyncrasies when trading during “in-play” time periods.

– ZMoose

Tagged , , , , ,