The USO does provide a vehicle for the average investor who does not trade futures to speculate or hedge themselves with or against the changes in price in crude oil.

One of my biggest sources of contention with the fund has to do with its monthly rolls, which are posted on their website for everyone to see.  A “roll” is similar to what we do with options trades we choose to extend to a later month.  The USO only holds futures contracts in the front month, so each month, they sell their front-month contracts and buy the next month.  There are two issues here, the first being the fact these dates are known and the market makers can take advantage of this immense order flow, which they know will always be the same: sell the front month, buy the next month.  This could be a detriment to the holders of the USO in that they may not be getting the most advantageous pricing.

Now in the USO’s defense, I am sure they have top-tier traders working those rolls and doing everything they can to make the best of it.

Even more important than the roll dates being a foregone conclusion is the ‘negative roll yield’ that USO will experience each month in a contango situation.  A contango is when the future price for future delivery of a commodity (in this case, oil) is higher than the spot price or nearer delivery contract.    A contango is normal for oil because it is a non-perishable commodity has a cost to carry (storage, interest, etc).

Normally, each month, the USO sells its thousands of contracts (22,000+ currently) for a certain price in the front month then has to go out and purchase more contracts at a slightly higher price the next month, meaning they are able to buy fewer contracts, thus having a negative effect on yield.

Think about it like this (I’m over simplifying here):

You have 10 contracts of crude in May that you can sell for $80.00 – you net $800.00

You MUST buy $800 of the next month’s contracts, which are trading at $85.00, which means you can only buy nine contracts (balance goes into cash, which is invested in short-term treasuries)

Now let’s assume that crude rallies $10.00 to $95.  You would make or $90 (9 contracts x10) , where the month before you would have made $100.00 on the same price advance.

So what happens in Backwardation?

Today, gas/oil futures in Europe flipped into backwardation mode – the opposite of contango – where the forward price of a commodity is LESS than the spot price.  In this case, you are able to potentially buy MORE contracts during each roll, thus potentially increasing yield.

I pulled the futures strip for West Texas Intermediate Crude futures and it looks like the curve has flattened a bit, but is not in backwardation yet, in any month.  The good news is that this flattening helps USO, but certainly does not eliminate risk or costs associated with trading in this product.  Be sure you check on the futures prices of WTI as well as the roll dates of the USO before investing.



The bigger issue was the statement by Eric Krasnoff, Chairman and CEO

“Our prior EPS guidance for fiscal year 2010 forecast an earlier and stronger recovery for the Industrial markets and a benefit from foreign currency translation of $0.17. Applying an estimated benefit from foreign currency translation of $0.09 based on current exchange rates, we have retained the low end of our guidance at $1.95 and reduced the high end to $2.05 (excluding Discrete Items). Including the Discrete Items in the first half, EPS are expected to be in the $2.11 to $2.21 range.”

This updated guidance was a disappointment to analysts and investors and sent the stock lower this morning, which is what I had anticipated in my Practical Options Trader analysis on Wednesday.

So, given the move this morning,  the collar strategy was successful and now is where a trader must choose how to finesse the trade and make the decision whether to close it or keep it on.

The good news is that the spread can be closed this morning for about $0.80, which would result in a profit of $1.40 in the collar trade I referenced.  That is with the stock down to $39.00, $2.00 from the $41.00 price level on Wednesday.  So if you feel the stock will recover from here, you could close the collar, which would reduce your loss to $0.60 versus $2.00 if you only owned the stock.  This leaves you with only long stock.

If you are concerned that the stock can drop further, you can choose to leave the trade on. These options don’t expire until April and theoretically could continue to profit, but keep in mind that the put strike is fairly far away.

Implied volatility has been reduced this morning and if the stock were to drop again, volatility could jump back up.  One caution here are the  bid-ask spreads in the options, which are unusually wide.  Use limit orders when executing options trades in this issue and don’t be afraid to get aggressive with your limit amounts.

The bottom line is that the collar served its purpose and even though we didn’t recoup all of the losses in the stock, we did reduce our losses by 70% in this case.  Not to mention if the stock had a catastrophic loss, we would have been protected.



Pall reports earnings tomorrow and I wanted to offer investors a look into PLL’s history as well as a way to protect into the number tomorrow.

The nine analysts that cover PLL are expecting earnings to come in between $0.46 and $0.49, with the consensus coming in at $0.47.  PLL recently raised its quarterly dividend 10.3% to 16 cents per share.  The stock falls right between the buy and hold ratings, with most issuing a neutral rating of sorts and one-third of the analysts rating the shares a strong buy.

In the past, the actual earnings date has been quiet; it has been the day after the fact when during which PLL tends to move.  The past four earnings events have seen movements as follows: +8.6%, +1.9%, +7.8%, -17%. PLL has a tendency to move higher, but this is only about 65% of the time.  Its bullish moves outweigh its bearish tendencies over earnings.

Since 2007, PLL has only missed analyst’s projections in two quarters, occurring in the second quarters of 2008 and 2009.  Second-quarter earnings are due tomorrow.

At 23 times trailing earnings, the stock may seem a bit rich here and it has had a tremendous run since its recent low of $33.50 back around February 11th. The stock has stalled here in the past week and a half and even with the lack of movement, average implied volatility remains elevated at 35.5%, with the 30-day historical coming in around 28%.

All of the moving averages are at $35.00 or below… that may be where support is, if PLL drops.

Based on what the stock has done in recent weeks and the history of its Q2 earnings report, I would approach with caution, although we are seeing strength in the macro recovery, which should feed PLL’s earnings as well, as production/usage may be rising.

It really boils down to p/e, which I think is a bit rich, therefore, I am looking at an aggressive covered call, Selling the April 40 call for $2.20 and buying the April 35 put for 20 cents.  This will be a net credit of $2.00 and will reduce cost basis in the stock by that amount.  Because the call has 90 cents of parity (intrinsic value), I am actually only capturing $1.10 in time value if PLL rallies from here.

In other words, if PLL rallies from this point, I may be required to sell my stock at $40.00, but since I received $2.00 to do this trade, it’s the equivalent of selling PLL at $42.00, which is still $1.10 higher than where we are right now.

If the stock drops, I will buy back my call and sell my put, hopefully for a profit and retain my stock position.

Please be sure you understand the risks associated with any trades that I discuss and ensure that the trade suits your thesis.

Today’s picture is a bit different, but not much.   The VIX is currently at 17.90% and has been creeping higher; even with the flat open, this could be a sign of what’s to come.  In my short article on Friday, I noted the S&P’s current and forward valuation, which looks much better than it did about month ago, given the most recent earnings reports.

As for the VIX level, it actually is most likely where it needs to be, maybe even a bit rich (on average) if you look at how the S&P 500 has been moving.   The 30-day volatility of the S&P over the past three months or so has been hovering around the 15% mark. Back in mid-January, it was moving at a little over 10%, which created a wider gap between the two, which possibly was one of the reasons for the sharp increase when things got a bit squirrely in the S&P.

I always tend to get a bit nervous when the markets are doing nothing, even though sometimes that lack of trend can continue for some time.

Implied volatility typically is higher than observed volatility, but not always; we should expect to see a slight premium.  The question from today until the next earnings season is what would be the catalyst for the markets to see a marked increase in volatility, especially now that most public sentiment has begun to shift to positive?   The space in between earnings reports is punctuated with economic data as well as corporate and geo-political news, but as long as there are no major surprises in that data, I see no reason why this market cannot remain stable until next earnings season.  That is not to say we won’t see a 2% intraday pullback here and there, especially if the technical traders begin to see a short-term overbought situation developing, like the one we may have on our hands right now



The SPX is currently trading at 1133 and the SPDR S&P 500 (SPY), which is an ETF representing  1/10th of the SPX, is trading at $113.   According to Bloomberg, the current average trailing price-to-earnings (P/E) ratio is about 18 for the S&P, a relatively high number.  After the most recent quarter of earnings, the forward P/E, looking one year out, is about 14, which is much more in line with the historical P/E ratios of the S&P.

For most investors, earnings are the be all, end all when it comes to the decision to buy, sell, or hold a company.  The trailing P/E ratio of the S&P historically is in a range between the 14-17 level — lower if we are going into a recessionary period and higher when we are emerging from one.  Remember that the markets are forward looking, so if the market perceives danger ahead of time, prices may drop, which would lower the trailing P/E.  If the market perceives recovery and stock prices rise, on the other hand, the trailing P/E may appear high in anticipation of a higher earnings number.

The latter scenario is the case in the current market environment.  The key is how aggressive analysts and companies are forecasting earnings, combined with the prices investors are paying for stocks today.  Then obviously there is the economy as a whole, which hopefully is figured into the base cases of most analysts. At the current levels, based on forward valuations and the many opinions of analysts and professionals, it appears as though there still is some value in the S&P moving into the latter half of the year.  With that said, one must take into account recent movements when deciding when to enter.

After six straight days of rallying and some uncertainty still lingering in Europe, covered calls may offer investors a bullish, but partially hedged strategy for entry.  The SPY does offer strikes at every dollar, which broadens the choices available to traders.   Watch the volume, or lack thereof,  up at these levels as of late, as this could be a sign of a weakening short-term trend.

According to OptionsHouse, analysts are expecting earnings to come in anywhere between $0.37 and $0.41 per share, with the consensus estimate at $0.38.

Over the past two weeks or so, SPLS has recently had quite a rally from the $23.00 area to its current level of $25.64. The average daily trading range of SPLS is about $0.50 ($0.46 currently) and the recent tear in the stock has put it above its 20-day, 50-day, and 200-day moving averages, which in my opinion will add support down around the $24.60 mark, where the 20- and 50-day simple moving averages converge.

The recent momentum appears to be slowing if you look at the MACD and 14-day moving average of the volume.

Historically, Staples’ movements around its earnings report have been fairly muted, with the stock averaging less than 2%. There were a couple of exceptions to this; in December of 2008, SPLS saw a 13% selloff ahead of the report , followed by a three-day, 18+% rally in the stock. The other major exception came in November of 2007, where the stock had an effective move of about 12%.

In broader news that might impact SPLS, personal spending was up 0.5%, slightly more than expected, while personal income was actually lower than expected and came in at 0.1% versus expectations of 0.5%.
The nation has also experienced some extreme weather this winter; you might say businesses were “frozen” across the eastern seaboard and elsewhere. Staples has a high concentration of stores in that area, many of which may be impacted by this weather.

Heading into the report, we saw some options action last week where a trader took a very market neutral to moderately bearish position in SPLS by trading the April 24-26 one by two (buying one 24 call to sell two 26 calls for a $0.40 debit). This position offers the trader a negative Vega stance and makes the most profit with SPLS at $26.00 on April expiration. This does give the trader big risk to the upside, so they are obviously not betting on the stock rallying from here.

Both implied volatility and observed volatility have been on the decline in the past couple weeks, but implied volatility still remains elevated at 25.11%, while the stock has been moving at about a 16% vol over the past 10 days.

In my opinion, the weather and consumer spending factors will weigh on SPLS and I would be looking more bearish, but with less risk to the upside in case of a surprise. The March 26/27 call spread can be sold for a 34-cent credit, which takes a bearish stance, with only 66 cents of risk to the upside per spread. If the stock sells off tomorrow, I would look to close the spread out for a profit. The advantage of this spread compared to the one by two is the lack of severe exponential upside risk. Even though the max profit is only $0.34, it is still a 52% rate of potential return on your risk.

The call spread also offers a breakeven up to $26.34, which gives the stock a little breathing room to the upside, but not much. Before applying any options strategy, be sure that you understand your risk and the trade completely. Also, by using a free virtual trading account with OptionsHouse, you can build a profit/loss diagram to help visualize the risk/reward profile of this strategy.

In the video linked above, I mention the stock’s average true range and Bollinger Bands, which essentially is a visualization of observed volatility. ADSK was making an abnormal move, outside of its “normal” behavior, and many traders use this as an opportunity (in both directions, but typically to sell into).  ADSK has a history of volatile earnings and we expected to see a 10%-15% move this quarter, based on five of its last six reports (the lone exception was August, which was only a 5% move).  Volatility was especially likely this time around given the fact that the company did not offer any mid-quarter guidance, thereby increasing the “unknown” factor.

Coming into this number, the consensus estimate was 23 cents per share and was within the guidance range they gave with its November earnings release.  The actual 30-cent per-share number (excluding items) obviously looked stellar by comparison.

Their analyst day won’t be until early April and they usually give guidance during the meeting , this can also be another volatile event on the horizon for ADSK.

I mentioned as well that analysts have also been watching the monthly AIA Architecture Billings Index, a leading indicator of U.S. nonresidential construction spending, the results of which can affect  ADSK.  This index came out yesterday and the numbers were not great, dropping in January to the lowest level since August 2009.   According to Reuters, the index has remained below 50 since January 2008.  Its lowest recent reading was in January 2009, when it reached a revised 33.9-level.  A reading below 50 indicates contraction in demand for design services.

On the analyst front, Morgan Stanley maintains its “underweight” rating on the stock,  but upgraded its estimates to a $24 price target. They see fiscal 2010 EPS of 60 cents and fiscal 2011 EPS of 78 cents.

So with the still-shaky fundamentals surrounding the stock and its negative trailing p/e ratio, one must express care, caution, and tact when choosing to invest in/trade this stock.

My main fear was not that the stock can’t move higher from here over time, but more so that buying this stock, which is making an abnormal uni-directional move, will most likely revert to the mean.  In other words, it will fill in some of its gap up (which it did, dropping by $1 yesterday and even more this morning).

Today, with the unexpected jump in unemployment, the market is moving lower.  We do have more testimony from Federal Reserve Chairman Bernanke, followed by consumer sentiment and GDP data tomorrow, any and all of which may also impact the broad market (and ADSK).

Regardless, buying any stock when it’s making an abnormal bullish move may add risk to the trade, similar to buying volatility right ahead of an earnings report.  Volatility in the at-the-money straddle was sucked out of ADSK after the report, even with the big move.  The straddle was 8.4% of strike on Tuesday and yesterday sank to just 5%.

For me personally, selling the March 27 put may have been the best medicine for a bullish trade on ADSK. Hopefully, I was able to help you take some profits if you were long yesterday or – if you were not in it yet, given you some reasons to wait.

Sales at the home-improvement retailing giant, meanwhile, were just slightly higher in the last quarter versus the same quarter last year. This increase was minor, roughly $200 million, which was not enough to bring the year to a positive. For the fiscal year ended January 29, 2010, total sales declined 2.1 % to $47.2 billion. So in total, for the fiscal year 2009, net earnings declined 18.8% to $1.78 billion and diluted earnings per share also declined 18.8% to $1.21.

So why did Lowe’s bid higher at the open? This is part of the “art” of investing, but before I get into that, I do want to make a case for Lowe’s and why it should continue to do well. Unless you have been stuck under a rock for the past three years, you probably know there are a ton of existing foreclosures on the market now and more coming on the market every day, as these homes are bought by investors and by regular folks trying to get a good deal.  And after buying a foreclosed property, generally the first thing people do is fix it up to make it livable and/or customize it to make it feel more like home. Whether they do it by themselves or with a local contractor, chances are that most of the materials needed can be found at one of Lowe’s 1,700 stores in North America — or at a Home Depot (NYSE: HD) location, which are typically right around the corner from their main competitor .

Most large homebuilders source much of their materials directly from the manufacturers, so a new home construction boom probably wouldn’t help LOW as much (not to mention many of the new home buyers probably won’t be spending as much at Lowe’s as someone who just got a fixer-upper).  Regardless, based on the roughly 3.29 million homes for sale at the end of December, coupled with a consumer that is beginning to get confidence back and maybe splurge on some new home adornments in the coming months (spring is a great time for that), LOW has a not-so dim future.

As for the reasoning behind an early-day rally on what seemed like a not-so-great report? Well, remember stocks trade off future expectations and many were still expecting weakness from Lowe’s. The results actually bode well for investors who want to purchase a stock with good growth potential that is priced relatively cheaply.  Again, use caution in the short term as LOW is approaching some technical resistance. Finally, don’t forget that if you are an options trader, a buy-write may help mitigate, but not eliminate, your risk.

For more on LOW:

Options action out of the gate in Schlumberger, Lowe’s

Lowe’s Drops Back into the Red in Early Regular Session

Freeport (FCX) Call Action Continues, Lowe’s (LOW) Sees OOTM Call Trading

The mechanics and technology of the markets have changed quite a bit in recent years, not to mention options volume has been growing exponentially as of late. All contributing to a change in the behavioral characteristics of options expiration and like most recent changes, in my opinion, benefiting the “home gamer.”

When you think about it though, expiration is a time to asses and adjust your risk, possibly selling or buying options and stock to mitigate your risk. It creates a sense of urgency for some traders, forcing them, in a way to become a bit more active, thus increasing volumes and also adding massive amounts of liquidity.

In fact, if you look at the past four expiration Fridays from January back to October, the average high-low variance for those days was 1.05% – not terribly volatile. To put this in perspective, using some quick and dirty math, a VIX at 25% basically means that the market expects SPX will move about 1.56% per day 68% of the time (remember that the VIX measures implied volatility, which is often higher than observed). If expiration is supposed to be such a volatile event, one would expect that intraday movement would be at the tail ends of the bell curve, in other words, greater than the 1.56% the VIX is “predicting.”

Even if we forget the VIX and just focus on the average observed 30-day volatility in the S&P 500 over the last four months, it falls right around 17%, which means that a one daily standard deviation move (68% of the time) is about 1.1%, again proving that expiration has not really been all that volatile.

So, instead of fearing the specter of expiration volatility, maybe we should embrace the added liquidity of the event and possibly use the other market participants as a means to get more efficient pricing and maybe even more aggressive fills in our options positions due to the fact that most are scrambling to exit as well.

The sign of recovery in the housing market, in my opinion, is more of a psychological boost than an actionable trading item. I bring up housing, because more than a year ago I wrote about the importance of a stable housing market and positive equity relates to consumers spending on non-staple goods and services like gambling and vacations. I think the stabilization of the housing market has helped the consumer rationalize a decision like a vegas trip.

LVS is actually more a story about Macau, however, which the company’s market share is roughly 23%. Macau has also seen its VIP table, mass table and slot wins all increase in the past quarter, according to Barclays. Macau is currently 75% of revenue, with Vegas coming in at 20%. Vegas visitor numbers were up in December and the cannibalization fears of CityCenter have been minimal. In addition, we should see room rates and occupancy stable, not strong, but this should be offset by the strength in gaming revenue. Traders will also be looking for more specifics on the Singapore opening.

As for the trade, I think LVS has had quite a run during the past week or so from the recent low of $14.88, which gives me pause in my bullish sentiment. The 20- and the 50-day simple moving averages are right around $16.45, about $1 below where we are currently trading. I think the report will be good, but I would not be a stock buyer here, nor would I look at a call.

I think an out of the money bull put spread or even a naked short put would be more appropriate, as it lowers my risk and breakevens compared to the stock. Believe it or not, the 30-day historical volatility of 67% is actually higher than the implied volatiltiy of about 65%. I was looking at the skew for any abnormalities that may lead me to believe the market is taking a bias, it looks at first glance like the options traders have been a bit heavy in the put buying and call selling, maybe more so than usual (the skew is a normal occurrence with downside puts having higher IV than upside calls generally).

Even with the current situation, I still maintain my moderately bullish stance. I would continue to examine something like selling the March 16-14 put spread for 42 cents. This spread reduces my total risk to $1.58 and allows me the potential to make 27% on that risk. The breakeven for this trade would be 15.58 and offers some downside cushion for the stock.

Be sure you understand all these principals before applying any of these techniques with real money.

As Google Inc. (NASDAQ: GOOG) approaches $540, the 520- and 510-strike puts begin to have less and less of a delta and remember that the gamma will increase the closer we are to expiration, causing even greater changes in delta and in options pricing.

Delta doesn’t only tell us how much an option’s price will change relative to the stock; it is also the percentage chance that option will expire in-the-money.

So a delta of 0.10 (10%) also means the option has roughly a 10% chance of expiring in-the-money (or, in other words, being worth anything!).

Don’t forget that delta will either be 1 or 0 – 100 or zero – upon expiry and if you are short at 520/510 bull put spread (the one we have recommended in our premium Option Trading Alert Service) and if GOOG stock moves above $540, the statistical chances of the stock dropping 20+ points becomes less and less the closer you get to expiration Friday.  This should lead to these puts being worthless at expiration, allowing you to retain the credit you collected when initiating the trade.

There is still a tremendous amount of doubt when it comes to the strength of this market and it has really been apparent when you survey the market action, especially late in the day.  We have seen the market falter into the close on otherwise bullish days; this is NOT a sign of bullish strength and confidence.

GOOG has also had a tough time moving out of the $540 handle; it has been bumping its head on that level since the 29th of January.  With that said, if you are still short this spread or another out-of-the-money bull put spread, you may begin to realize some profit in your trade this week as time decay, gamma, and delta begin to work for you.

It is important to watch this spread’s value and maybe even put a limit bid to buy back the spread for a profit if you can, if you are feeling a bit nervous about the strength of the market or GOOG in particular.  It does not hurt to sell into a little strength. And while you most likely won’t be able to book your max profit (that only occurs if both options are zero), you may be able to sleep a bit better and find your next trade that may have a bit more edge.

I find that it is much easier to sell into strength than into a stock that is on the way down.   With that said, we are still short this spread in our Options Trading Alerts, but you must always evaluate your own risk and market opinions.

Where is the market headed and why are the financials rallying when the FED is talking about tightening?

–The short term market fluctuations are a manifestation of participant’s emotions, in other words, in between news and earnings events, many traders base their trade opinions on technical, statistical and media analysis (what are others doing/thinking).

Agriculture

–Global food consumption shifts in Asian Countries and increased global demand over all, from grains to meats,

–Look at stocks like ADM, CAG, DE, CAT, MOS

–Cattle futures at six-month high – Have to feed cattle, grains cost more, meat demand, it’s a cycle -  cool climate a factor as grains prices have risen, will need fertilizers to maintain high yields on crops.

– Late-day selling the norm, traders are looking for reasons to SELL not to BUY

–I am focusing on the last 30 minutes of the day, for confirmations of moves.

Natural Gas

–Our sidewinder caught a large roll of calls in Williams Companies, Inc. (NYSE: WMB), a natural gas company. It primarily finds, produces, gathers, processes and transports natural gas. It has operations in the US and Canada.

–They sold 52,800 Feb 10 calls  (which have an OI of 58000)  to buy 58,800 May  16 calls, so essentially extending their long position into May,  These calls both have large deltas, they are much like stock, the equivalent of 5.8 million shares

–I would take it as a bullish bet on Nat gas, but obviously the person or firm may have an existing hedge already on.

–We also have a delay in the energy data release this week because of snow.

–Natural gas is actually in a short term bearish channel pattern with support around $5.00….

–The longer-term picture does look slightly better. in 2007 and 2008 Nat Gas caught a bid from February to May….that could be the bet or it could be company specific, but this trade is really high risk for betting on an acquisition or other factors.

Marriott (NYSE: MAR) Earnings

–MAR is trading roughly at $26.50 – it has been pummeled over the past two weeks off from $29.69, while Wyndham Worldwide Corp. (NYSE: WYN) has been on a tear.  I think some of those good numbers from WYN will rub off on MAR.  WYN tripled their dividend.

–I would sell the March 24/20 put spread for $0.40,  as the 200-day simple moving average (SMA) is $24.77.  Strong support between 24-25 has a history of making about a 4% average move, which is about a 1.06 down from here.

Hotel Industry Data :

– From two weeks ago- 19 of the top 25 urban markets had year-over-year increases in occupancy and over the last 28 days, 18 of the top 25 urban markets had year-over-year increases in occupancy.

–MAR Analysts set price targets after the last earnings release that are in $24-$31 range.

–The upper upscale segment (which includes Marriott, Hilton, Sheraton, and Westin) did see a moderate drop in RevPAR  (revenue per available room).



Moving forward into 2010, with global economies hopefully continuing to stabilize, DIS hopes to bring a little more joy to its shareholders. In the works is a theme park in Shanghai, which could be a huge bet and potential payoff for DIS, as long as China remains strong (the growth picture certainly doesn’t look as strong there as once thought, as the government tightens to curtail any bubbles). The largest city in China, Shanghai has a population of more than 20 million people and growing.  It is often viewed as the center of finance and trading in China. Disney has already expanded its empire into Asia, as it already operates a park in Hong Kong.

New ABC series including Modern Family, The Middle, Flash Forward, and Cougar Town have been well-received this season and Disney’s movie divisions also have some cool looking movies in the works such as Alice in Wonderland, The Price of Persia: The Sands of Time, The Sorcerer’s Apprentice, and Toy Story 3.

As for the shares, they have been a bit choppy of late and is off three-plus dollars since hitting a new 52 week high on 12/31/2009l; that’s a drop of almost 10%.

Analysts, meanwhile, are mixed on DIS, with nine recommending it as a “strong buy,” four as a “moderate buy,” 12 as a “hold,” one “sell,” and three “strong sell.” Based on the analysts covering DIS, the consensus earnings estimate is $0.39 per share, and the high and low estimates are $0.51 and $0.34, respectively.  Personally, I think the company’s results will come in near the high end.

Technically speaking, last week the stock finally broke out of the bearish channel it was but it still remains below its 20- and 50-day simple moving averages, which are situated around $30.25 and $31.05, respectively.  The shares also appear to be drawn to support around the $29.00 level.

I do not believe DIS is overbought or oversold in the near term. The downward momentum we have seen in the past couple of days seems to be normalizing, which is a good thing if you are bullish.

I also do not believe the observed volatility is abnormal. DIS has been returning to a more ‘typical’ behavioral pattern since the elevated volatility state it has experienced over the past year and a half.

The observed 30 day historical volatility of DIS is about 21% and the mean of the implied volatility for front-month options is about 33%. This elevation is typical ahead of a report and one that should be an important one for DIS.

The 200-day moving average is way down around $27.30.  In a recovery off the bottom in what is supposed to be a “bullish” market, I prefer to see stocks continue to stay above that average.

Disney, in normal situations and in a quasi-normal macro market environments (unlike the one we saw at the end of 2008 and early 2009), tends to be a relatively quiet stock around earnings.  Typically, the stock moves less than 3%, with a couple 4.5% moves here and there. That would equal a move of less than $1.20 and chances are that it will move less.

I also like the recent correction we have had in the broad market and while I feel we could go a little lower, I am comfortable with beginning to sell some at-the-money puts to begin my systematic acquisition of stock. So with that said, I am going to take a slightly aggressive position with DIS and sell the Feb 29/26 put spread for 40 cents. This spread reduces my risk down to $2.60 and gives me the potential to make 15% on my risk. If the stock drops sharply, I will consider risking a $1.00 in the trade, but only if the stock begins to break below 28.

Much of the Disney conglomerate does have a high sensitivity to economic slowdown, although some of its media properties may offer a bit of a buffer, namely movies and TV.  Buying DIS, however, is essentially placing a bet on recovery.

For more on DIS:

Sector Update: Consumer

MidnightTrader’s Analyst Notebook: DIS

Volatility Explodes in the Market, Walt Disney (DIS) Sees Call Buying

We lost more jobs than was expected, and gave back another 65,000 jobs in December with the most recent revision. Maybe some market participants were focusing on the 3% selloff we expereinced yesterday and were thinking a bounce was in order and since at first glance the jobs number didn’t seem all that bad, maybe it seemed like the right thing to do.  That sentiment may have been their reasoning for leaning bullish right after the number was announced this morning, but I don’t buy it.  Don’t forget that this is an estimation folks; we need to look a bit deeper into this survey.

The bigger headline though, was that the overall unemployment rate dropped unexpectedly, again, this could be the ‘bullish nugget’ that traders are focusing on.  Regardless, the major index futures changed direction in a big way when this data was released this morning, from being way down, rallying to flat.  The market is still having a tough time as we have begun the session.

Here were the BLS results:

• January Nonfarm Payrolls -20K vs +15K consensus, December revised to -150K from -85K
• January Unemployment Rate 9.7% vs 10.0% consensus, December 10.0%
• January Average Hourly Earnings Y/Y +2.5% vs +2.2% consensus
• January Average Hourly Earnings M/M +0.3% vs +0.2% consensus

So we lost 20,000 more jobs, when many analysts were expecting us to gain over 10,000-20,000, we also lost an additional 65,000 job in December. Take a look at the chart below (courtesy of Forex Factory) showing the trend for the past two years.  It  has been moderating as of late, but is certainly NOT strong — we are still losing jobs!   But miraculously, the unemployment rate is less? I have some issues with the validity of that number.

Let’s take a look at some other figures.

The table below comes to us from the Bureau of Labor Statistics and shows the specifics on the actual data collected in the month of January 2010, as well the months of December, November and January of 2009 for comparison.  I wanted to draw your attention to several data points, the first being the participation rate. This is basically the ratio of people working versus the number of people who are “in the labor force.”

The labor force does NOT include include students, retirees, stay-at-home parents, people who are incarcerated or in similar institutions, people who work “under the table” or who do not report their income, as well as discouraged workers (basically anyone who is not looking or having luck finding a job or is disabled) who cannot find work.

These figures also do not include military jobs, and remember all the numbers are estimates (hence the revisions).  The full table is available here.

It is the participation rate that skews the real unemployment rate; take a look.

While the historically low participation rate has helped make our current picture look a bit better, a rising participation rate would actually cause the unemployment number to rise.  In all fairness, there was not a large month-to-month change (decrease) in the “participation rate,” which would lower the unemployment rate.

The “civilian noninstitutional population” consists of persons 16 years of age and older residing in the 50 States and the District of Columbia who are not inmates of institutions (for example, penal and mental facilities and homes for the aged) and who are not on active duty in the Armed Forces.  – according to the B.L.S.

If you take the “employed” number and divide that by the “civilian noninstitutional population,” you get an employment rate of 58.4%, which would equal a rate of 41.6% of the eligible populous that is NOT working…This is not cause for a panic, but more to keep us aware of the whole picture – the fine print, and not just the headlines.

Things that make you go hmmmm…

Maybe I am just skeptical by nature, but I think I have proved my point that we are NOT out of the woods just yet with respect to employment.  I think we are now seeing the markets examine this data a little deeper as the major indices continue to slip on a day were we may have seen a bit of a bullish reversion to the mean.

The implication of this was that those institutions calling themselves “banks” would fall under “Banking Regulatory Guidelines” and would not be able to trade the financial markets, essentially re-instating the Glass-Stegall Act.   Also known as the Banking Act of 1933, Glass-Stegall in part separated commercial banks who took deposits from investment banks who took bigger risks.  It also created the FDIC. In reality, it was supposed to prevent banks that took depositors’ money from making risky investments following the great crash of 1929.

This legislation remained in place until 1999, when certain provisions were repealed through the Financial Services Modernization Act, including the prohibitions that prevented a bank holding company from owning other financial companies, including investment banks.   I guess it’s time we got less modern?

I am going to oversimplify some points here for the sake of brevity and simplicity, so if you are an economist or bank analyst, please understand 

I don’t think the government understands enough about derivatives, trading, or the banks’ specific complex internal structure to enact such a drastic change that would have such a polarizing effect.  Potentially, some banks could lose tons of money while investors and others benefit.  I also do not think the government will gain international support to pass as robust and restrictive plan as they may have thought.

We still don’t have any specifics on a plan and don’t think we will for some time.

The government should maybe look to the exchanges and the Options Clearing Corporation (who guarantees all options transactions), both of which have been very good at managing risk and setting margin requirements.

As a market maker, I was subject to those rules every day and was still able to make a good living.  For every trade made, there is a counter-party involved.  In other words for every share that is bought, one has to be sold, etc.  So in essence, in every trade, by itself, there is a winner and a loser, period.  But as we all know, professional traders typically hedge their positions. In other words, if I buy 100 shares of Goldman Sachs (NYSE: GS), I may sell 20 shares of the S&P 500 Index short as a hedge or buy an out-of-the-money put in GS, to either reduce my losses if the trade goes against me or buy some insurance (the put) to prevent catastrophe and put an absolute limit on my downside.

Another way to modulate the risk is to enforce position limits and certain margin/capital requirements on certain trades.  For example, if I only have $10,000 dollars in my account, I am only able to risk $500 in any given sector. Basically, this can prevent someone without the money or knowledge from making a trade they can’t cover if it went against them.

Professional trading firms do this frequently, as do to the exchanges for their members; traders must have enough capital or cover their position if things were to go against them, and this risk is determined by several factors, one of which is historical volatility of the underlying stock or instrument. (Mr. Volcker touched on this as well)

Unfortunately, the mortgage-backed securities models that some firms were using were obviously not conservative enough, not to mention most over leveraged their investments (borrowed too large of a portion of their investment/risk dollars).

In specific, maybe the government should look at the possible risk of a particular security or derivative and compare that to their existing risk/assets.  From there they could derive a “risk measurement” and have some rules in place that compel the bank to either reduce their exposure by exiting the position or buy a put-like instrument that helps cut risk to a certain level that is congruent with their capital at hand.

Remember, we can’t ensure the banks will be on the right side of all the trades or investments they make, but what we can do is help ensure that one bank is NOT holding all the losing trades and is thus forced into failure. Sometimes, collapse is inevitable, by the way, and I think Mr. Volcker is correct in that we have to let them fail, let the markets be free and operate without the hand of some politician meddling with the natural order of things.

Some rules or guidelines are okay, but stifling already deeply integrated banks, which are trying to recover along with all of us, is not good for our economy.  The markets are like water, they will always find the path of least resistance.

Jobs, or the lack thereof, have become the President’s priority (we hope so) but more importantly, for your money, the employment picture has become more of a market focus as well.  Now that we have realized an exponential price gain in the S&P over the past nine months and returned to a more “growth oriented” profit picture, the market realizes that in order for continued growth, American citizens need to be able to spend.

The jobs picture will have to improve if the U.S. equity markets are to continue to grow. With that, UPS (who ships a large amount of the goods our companies produce and consumers buy) will be extra-sensitive to these numbers.  This is especially true in the next year, as traders will be looking for not only a reduction in the nation’s unemployment, but real top-line growth within companies that hire our neighbors and enable us to consume their goods and use their services.  If companies are cutting costs by slashing their workforce, that most likely will NOT translate into strength for the consumer and certainly not in wages earned or spending activity.

As for UPS, I believe they have a challenge ahead of them. UPS has MISSED estimates the last four quarters and with 15 analysts covering UPS, the consensus earnings per share estimate is $0.73, and the high and low estimates are $0.75 and $0.63, respectively. UPS is currently trading at roughly 24x trailing earnings. What is even more interesting about UPS and the market’s reaction to its shortfalls is that it actually has more of a history of rallying slightly on the release as opposed to the expected selloff. UPS is not a big mover in either direction over earnings, with an average move of less than 3.5%.

Taking a look at the volatility picture, UPS has seen both its 30-day observed volatility and its implied volatility on the rise.  As of Friday, 30-day observed volatility was roughly 24.75%, with implied volatility on the front-month options coming in slightly higher at about 27%.

Given the data that is on tap for the week, I would be careful not to take on a uni-directional trade, because the near future is just so unclear. Not to mention, the new market mantra (at least for the next couple of weeks) is to “sell the rallies,” as the market has been unable to hold its bids.

Technically speaking, UPS has had a wild ride along with the rest of the marketplace the past couple weeks.  We saw a rally in UPS shares to $63.38 and then a subsequent selloff to its current level of $57.59.  There seems to be some stickiness around the $57-$58 area and the next stop for support comes at about $53.00. Volatility has swelled quite a bit, indicated by the gap in the stock’s Bollinger bands.  Currently, momentum seems to be to the downside.

UPS is also below its 20- and 50-day moving averages, which takes a bit of credence away from the support immediately below it. The 200-day moving average comes at about $55.00.

The trade of choice, I believe at this point will be a moderately short volatility trade with some flexibility in movement. I have been on a ratio spread kick and I think the March 57.50/55 put 1-by-2 put spread seems to fit my thesis.  It’s a moderately bearish trade that would be the most profitable if UPS expires at 55 by expiration.

But if UPS decides to stay put and rally, we get to keep the 34-cent credit that we collect at the onset. Breakeven for this trade is at $52.16, all the way down below the 200-day simple moving average, which gives me some comfort. That’s not to say that a sharp selloff is not possible. If UPS drops on earnings and I can sell this spread back to the market for even or better and the market begins to look nasty, I would probably exit. But this trade does offer us a nice range on a stock that will most likely mimic the already skittish nature of the broad market.

By opening a free virtual trading account with OptionsHouse, you can build a profit/loss diagram (such as the one below) to help visualize this trade.

The trade was an out-of-the-money ratio put spread, which involved the purchase of one 28-strike put and the sale of two 27-strike puts for a credit of $0.27 (that was the fill I received) .  The trade has a relatively high probability of success with a breakeven down at $25.73. As long as the stock stays above that level, the trade will be profitable.  If MSFT were to continue to rally, the 27-cent premium would be held as profit as both puts would expire worthless.

MSFT announced a record second quarter, with revenue of $19.02 billion, a 14% increase from the same period in the prior year.  This is huge for MSFT from a growth perspective. Operating income came in at $8.51 billion, net income at $6.66 billion, and earnings per share at $0.74, which represented increases of 43%, 60%, and 57%, respectively, compared to the same period one year ago.  Those numbers included the recognition of $1.71 billion in deferred revenue.  If you back that out, earnings per share come in at $0.60 per share. Windows 7 certainly helped the cause.  Out of the 29 analysts covering MSFT, earnings were 25.42% greater than the consensus estimate of $0.59.

The bottom line is that even with the fantastic report, MSFT shares are off 2.5%, or $0.73, to $28.43.  Typical for the current market climate.  More important was the move after the report, which is what I expected – muted – although I thought it would at least hold its ground and move slightly higher.

I put a support level on the stock and for me, personally, I would be okay maintaining this position, simply because it actually will get more profitable if MSFT SLOWLY goes down to $27.00 (slowly being the operative word here).  The position will also benefit from the passage of time, being that the theta is positive.

So why did I title this article ‘taking profits in MSFT’ if I am okay with holding onto it?  Well, remember I am not here to manage your accounts.  That would be impossible and certainly absurd, because I have no idea what YOUR sentiment, risk tolerance, or personality is.  The point is this; whenever you read an article from me or from one of my colleagues (or from any investment professional), be sure their thesis not only falls in line with yours, but that you have a goal or target in mind when placing the trade as well as an acceptable stop for the trade as well.  Lastly, be sure you are confident in the behavioral characteristics of that strategy in the open marketplace, as some options strategies can have certain”gotchas” with respect to Theta and Vega especially.

As for the MSFT spread, one could close the trade for a small profit today, which would be only about 1% of the margin required to put it on. But if your sentiment has changed for MSFT, don’t ever be afraid to take risk off the table, especially if you can do it for a profit   Should you want to build your own profit/loss chart for a visual representation of this trade, consider signing up for a free virtual trading account at OptionsHouse.

Have a fantastic weekend and stay tuned Monday and all through next week as we offer more strategies to trade this market and earnings, while minimizing risk.

Expectations are high for MSFT, especially given the release of Windows 7 and what looks like strong holiday sales and high consumer demand for that product.   There has also been an increase in Bing usage. MSFT is heading into this report under expectations that it will announce quarterly results that exceed Wall Street’s consensus expectations.

Both IBM (NYSE: IBM) and Intel (NASDAQ: INTC) have had strong quarters, but MSFT does find itself in a unique situation. One of the wild cards in this situation is Apple (NASDAQ: AAPL), which today is expected to release its new tablet computer. The “iPad” may not only take more market share away from the PC market, but potentially the XBOX 360, both of which may hurt Microsoft.  The AAPL tablet will have accelerometers similar to the iPhone and iPod, which may add a new competitor in the gaming space offering a unique tactile and visual experience.

Regardless of those issues, tomorrow’s earning report should be a positive one for the stock, although the market’s expectations are high as of late.  Using both Google (NASDAQ: GOOG) and AAPL as examples, both reported strong quarters and the response to both of these names, among others, was relatively poor.

This may be partially attributed to market participants rotating out of the high-beta tech trades and into lower-beta, more stable stocks. MSFT does has an advantage in that it is NOT typically a volatile stock and has behaved like more like a mature conglomerate as opposed to a tech stock.   As you will note below, MSFT has been moving on less than 17% 30-day volatility for the past several months. There is quite a differential between the implied volatility and the historic, with IV at a 62% premium to 30-day historical vol. This would incline me to be a seller of volatility as I believe that MSFT will have a relatively muted earnings report. MSFT is typically NOT a big mover over earnings as well, with the average move being less than 4% the day of its earnings report.  It does, however, tend to move a bit more (>5%) the day after.

There are 29 analysts covering MSFT.  The consensus estimate is $0.59, and the high and low estimates are $0.66 and $0.45, respectively.  Revenue estimates are sitting around $17.8 billion.   These estimates would be  a considerable increase from a year ago, when the company brought in earnings per share of $0.47.

Of the analysts that cover MSFT, 59% of them list MSFT as a “strong buy.”   Microsoft’s outlook appears stronger than it has in some time and consumer spending on technology and electronics is returning but is still far from 2007 levels.

If I were to have a bias with MSFT, it would be to the upside.  MSFT is up 98% from its 52-week low back in March, 2009, but is off 16% from its week-ago high.  The 29 mark  seems to be a moderate support point in recent trading and is a level at which I would feel comfortable owning MSFT.  The broad market is a bit shaky here and we do have a busy week ahead as well as the President’s State of the Union address tonight.   I do NOT, however, see MSFT below $26 in the next month or so.

With all that said, I thought I would mix it up a bit and use an uncommon options strategy to trade MSFT.   I am examining a 28/27 March Put Ratio Spread for a 0.25 credit.  This meets my short Vega desire, takes a moderately bullish stance on MSFT, and utilizes my absolute support level of $26.00 in MSFT.  If MSFT drops to $27.00 or more importantly finishes there on March expiration, I stand to make my max profit of about $125 per spread.  Synthetically, this is like selling the March 26 put for $0.25, but allows an extra profit between 26 and 28.  Happy trading…

For more on MSFT:

Cramer and Microsoft (MSFT) Option Plays

Long-term call selling in Microsoft (MSFT)

From time to time, I certainly break the rules … I have never been a big risk taker and part of the reasoning behind that is that I recognize my faults and realize I am human and I have certainly allowed greed to sometimes control me.  In hindsight, I needed to be able to control myself, when my back is against the wall.  I needed to be able to just stop the bleeding, take the loss, and move on.

With large positions and big risk, you may have so much on the line, you bet big with the intentions of the big win.  And when it goes against you, the loss may be too big to stomach, forcing you to hold on.  So it gets worse and worse until you have to exit to salvage what is left of your account, or you leave the position untouched until it expires worthless.  Either way, you are left with a fraction of your starting account value but with shattered confidence.  You are also likely reluctant to continue following your investment plan, for fear of a recurrence.

Having a manageable position also comes in handy when you need to hold on to a position that may be oversold and likely to recover.

Very seldom does one walk into a trade thinking how much he will lose. Why would investors do that? Seems like they would be setting themselves up for failure right from the start. But on the contrary, it may be the thing that saves your life (or at least your dollars and sense).  I have been pondering these thoughts over the weekend and they were fueled by an investment property that I am buying. In my due diligence prior to entering a bid for the home, I put the investment through a stress test of sorts.

I looked at worse-case scenarios like major plumbing or electrical damage, structural damage, the life expectancy and age of the systems in the building, the condo board’s management style and history, budget, taxes, the possibility of going months without rent, etc.  All these possible occurrences and data were entered into my own little regression model of sorts and from that I came up with an acceptable price to bid for the home given my findings.

This sounds rather complicated and in reality, placing an options trade is much, much more simple and there are many more realistic opportunities. The regression model that you use for gauging an options trade could be something like the Profit/Loss and Probability calculators at OptionsHouse, or other tools or group of tools that allows you to model possible situations and outcomes.

Once you have narrowed down your strategy, you must decide on how much risk you want to take. This would depend on other positions in your account, macro market sentiment, earnings, etc. Adjusting your contract size or modifying the width of your spread are both simple risk adjustment measures.

Options and investment properties?

Trading options, in many ways, is similar to me only being committed to the property I am buying for only a year’s time and having the option to renew if I wish. For that exposure, I risk much less than the full price of the home. If things are going my way and I believe that they will continue, I may take another option on the home or just buy it outright, but having reduced risk is the name of the game.

We should trade the market the same way, but often traders do not. Options are frequently misused and losing positions that should be cut are held, typically because of the fear of being wrong and giving up some potential profit. Another problem I see frequently is the abuse of leverage, where a trader buys as many option contracts as they would shares of stock, hoping to amplify return…

The problem is that many times, leverage works both ways; you can lose money just as fast as you can gain it…

Just pulling the plug on a profitable investment and locking in profit before it deteriorates should happen more often, but here is another situation many traders find themselves in today, as markets have recovered. They stay in and watch a once-profitable trade turn negative. Apple (NASDAQ: AAPL) comes to mind here.

Maybe it is the desire to earn back losses from a prior year, or maybe you think you are “on a roll.” The market does not know who you are, it doesn’t care whether you make or lose money, and it certainly does not owe you anything.  Take your bits and pieces while you can and keep your risk minimal. If something seems too good to be true or you think the market needs a break, chances are that many people are thinking the same thing.  Perception often becomes reality in the marketplace as all market participants are human like you and I.

I am sorry for the rant, but the recent turmoil last week and a sense of concern for our viewers got me on my soapbox. I am sure these concepts are not foreign to many of you, but sometimes it just helps to hear them.

We really do care how you perform and I know I speak for the team when I say we want you to succeed and profit from the marketplace.

In October, I felt a bit more bullish on AAPL just ahead of earnings and went with a bullish synthetic, selling a put and buying a call for a small debit. This synthetic was a ton of fun and proved to be not only very successful, but was also appropriate given the bullish stance I was taking on AAPL in front of the report.

With earnings approaching Monday, I have mixed emotions about AAPL in the near term. I still remain bullish on the stock and believe it looks attractive from a price-to-earnings perspective. Most of the iSlate potential is already built into the stock, in my opinion, although if there is an unknown feature or distribution channel that was NOT expected, we could see an excessive upside move. More news on the rumored tablet is expected (but not confirmed) on Jan 27th.

The way I rationalize my thesis on product rumors is by searching through all of the most popular financial and technology-based blogs and articles and discovering what the masses believe that the iSlate (or whatever they choose the name to be) will be when it comes to market. I also pay close attention to the expectations the masses are placing on a certain product and evaluate the stock’s movement throughout the course of this news stream.

People can get quite creative and some seem to have a very good idea about what a product will look and function like and some may have sources on the inside from which they gather their data.

I have noticed that many of these “rumors” about Apple products, specifically, have been quite accurate. I also believe the market prices in the bulk of the technological expectations for a product like the iSlate or whatever name it eventually takes.  When the product is finally released, the market compares its data and features to what was expected and the stock will then deviate accordingly.

Again, this is an art and a bit of a gamble. There are obviously many unknowns, but I believe overall the Street still likes AAPL and the company will continue to innovate and excite us, not only on a product and services level, but culturally as well, which should translate into higher prices being paid for their stock.

In technical terms, after stocks took a  nosedive yesterday following a special press conference from President Obama, AAPL’s support comes first at around $208 and then again around the $203 level, which is the site of the 50-day simple moving average (SMA). Apple created a nice channel between mid-October and the end of December, which gave the stock some levels we can use to find support and resistance.

The breakdown of the S&P Wednesday and Thursday does concern me, despite the fact that I have been calling for an 8% correction in the broad market.  Mr. Obama may have actually helped my prediction come to fruition, even while questioned certain elements of his speech. Anyway, back to Apple …

The selloff can actually work to our advantage if we have a bullish bias as puts get more expensive and calls cheaper when stocks drop. With that said, I am looking at another bull synthetic in AAPL. I’ll collect a credit this time with my put strike below $200, to allow for some movement in AAPL.

With AAPL around $208.00, the February 195 put can be sold for $4.15 and the 230 call can be bought for $2.48, netting us $1.67 or a little less than 1% on our total risk in the trade. Obviously, the credit is not the expected return in the trade.  What I would prefer would be an extreme sharp rally in the stock, which would enable me to close this risk reversal for more than the credit I collected.  In other words, selling it for any credit would be a win – even buying it back for up to $1.67 would still be profitable.

The bottom line is that I still want to be bullish, but in case things don’t work out and AAPL just stays here, I can make some coin as well. By doing this trade, I am also okay with owning AAPL for $193.33 – a level that is below the current support I pointed out earlier.

Alternatively, if you are slightly more bullish and want much less risk and feel that AAPL my settle in around $220 into February expiration or after its earnings report, you could examine buying an OTM call butterfly using the February 210, 220, and 230 calls for a cost of about $1.40, which is the max risk in the trade.  It’s a cheaper alternative to just buying the 210 or 220 call and will not have as large a vega exposure, nor will it suffer as much damage from time passing by.

Just a couple of strategies ahead of Apple’s Monday report. Remember to always hedge your bets

We also saw Morgan Stanley’s (NYSE: MS) earnings drop,  which reflected a decrease in trading revenue, while Wells Fargo (NYSE: WFC) turned profitable as well as Bank of New York Mellon (NYSE: BK), which itself reported a huge jump in profit from $66 million to $595 million for the quarter.

Certainly a mixed bag, but overall, positive in my opinion. Goldman Sachs (NYSE: GS), meanwhile, does NOT owe TARP any money and has been the best of breed and remained the strongest of the large wire houses throughout all of this.

Aside from what GS has done fundamentally, we must examine its recent price action.  GS rose as high as $178.75 in the past week or so, but has since come back to its current level of  $165.50, which is below both the 20- and 50-day moving averages, which may now pose some resistance, but not much being that we are up against an earnings report and the stock could be thrust sharply in either direction.  The 200-day simple moving average (SMA)  comes in right around $159.00 per share, which is also an area where I find technical support going back several months in time.  I also like the fact that $160 is a big round number  — humans tend to gravitate to round numbers and thus stocks also tend to do the same .

Analysts expect Goldman  to report earnings of $5.19 per share, which assuming stagnant growth, that’s about $20.00 per year and at a 10 multiple, that puts GS at $200.00 conservatively.  Of course, this is only an assumption.   Anything can happen, but I still remain cautiously optimistic on the economy as a whole.

Goldman Sachs also made the single biggest warrant repurchase of the banks thus far when back in July, they paid $1.1 billion to the government to repurchase their  TARP warrants.  Goldman does not owe anything in TARP, nor do they have any outstanding warrants, which is an added plus.

Historically, over earnings, GS is not a big mover.  Although there have been a few times GS has moved greater than 10%, this is the exception, rather than the rule.  I suspect a 5-6% move would be more realistic.  This earnings report will be one to watch and should also reveal Goldman’s strength or weakness in its trading activities.  I would guess that they won’t reap the great rewards they did earlier in the year with the volatility in the markets, and this will certainly dig into their overall profit picture as it did for Morgan Stanley.  Compensation is also a factor, with both firms increasing comp to record proportions.  It look likes $22.3 billion for GS for 2009.

Regardless, I think traders still like this stock, as do I and analysts also remain overall bullish.  I also feel good about the stock’s modest reaction to the selloff today.   As stated earlier, I feel strong support right around the $160.00 level, not to mention, I feel this is a reasonable valuation for Goldman, therefore, I am examining selling the February 160/150 put spread for 2.30.  This puts breakeven down at $157.70, or $2.30 below my support point.  It also gives the stock about a 5% cushion to fall from its current level.  As long as GS stays above $160 by February expiration, the trade stands to make 62% on its total risk of $3.70.

This may be an alternative to buying the stock outright ahead of the report.

For more on GS:

Call selling in Goldman Sachs (GS) ahead of earnings

Put Buyers Active as Goldman Sachs (NYSE: GS) Pulls Back

The 20-day SMA is currently at $66.45 while the 50-day, which currently sits at about $63.20, typically provides a bit more support when compared to the 20-day trendline.  Regardless, the trader yesterday probably got it right if he traded into a buy-write or covered call strategy.  I say that because with the broad market dropping and RIMM off about $0.75, those short calls may be providing some cushion; the trader can also buy back those calls if you feel the stock will rally back up.

Both the buy-write and the out-of-the-money short put, I feel, are appropriate strategies for a stock like RIMM, which I have made several bull cases for in the past.  I did, however take profits ahead of earnings, which is part of my strategy to mitigate risk exposure, as earnings can really be a wild card (take a look at Intel (NASDAQ: INTC) today) I did, however, re-iterate my bull case for RIMM going into the new year.

So what about RIMM now? Typically, I tend to buy on weakness and sell or protect that position if the underlying stock experiences an extended rally or abnormal move to the upside, especially if the broad market is shaky.  (RIMM tends to have a low correlation to the S&P).

Technically speaking, I feel RIMM has been in a downtrend since its last earnings report, but seems to have broken that with the move up on the 13th.  However, I do want to see RIMM close above its 20-day SMA and continue to move above it for a more confirmed uptrend.

Traders could begin to examine selling out-of-the-money put spreads in February with RIMM lower, using the 60 put (which is below the 50-day SMA) as the short strike and buying something below to minimize margin and risk.  This is more aggressive than waiting for the confirmation of the crossover over the 20 SMA, but the $6.00 plus of cushion that the put spread allows for in RIMM, gives the trade a much higher statistical probability.

Fundamentally, RIMM, in my opinion, is still attractive.  According to RIMM’s recent third-quarter report, Revenue was 3.92 billion, which was up 11% from the prior quarter and up 41% from the same quarter the year before.

RIMM added 4.4 BlackBerry subscriber accounts in that quarter, which brought its total subscriber base to 36 million.

Jim Balsillie, Co-CEO, noted that RIMM had exceeded its own expectations with record shipments of more than 10 million BlackBerry devices, as well as its revenue, earnings, and subscriber base for the third quarter.

RIMM also is pushing into China, which is a place where one of its competitors, Apple (NASDAQ: AAPL) has been struggling.

RIMM also released the Tour for Sprint and Verizon.  This is a speedy world phone that certainly is a big step up in features, power, and browsing from the Curve and Pearl, which were the only RIM phones available on Sprint prior to the Tour’s release.

Finaly, available in the U.S. and Canada is the Bold 9700, available through AT&T and T-Mobile and four different carriers in Canada.  The Storm2 9550, which is RIM’s premium touchscreen phone, is currently only offered on Verizon.

Hopefully with Google (NASDAQ: GOOG) setting a precedent with the Nexxus One, we will see a move towards having unlocked phones being offered by RIM and others that may cost a bit more upfront, but cheaper plans and no contracts from the service providers will help offset that cost and free us from those sometimes awful cell phone contracts, especially when one is stuck with a carrier they are not happy with.

I recently bought the Tour and love it, but I have to admit that I am a BlackBerry guy, and there will always be a place in the world for the iPhone.  I think that both can share the limelight together and offer unique products that cater to a diverse and often demanding consumer base.

Smartphones will become more of the norm and even though prices will most likely continue to decline,  affordability and the need to be “plugged in” at all times will drive demand and units sold.

The bigger story is the Smartphone universe as a whole, which is still majorly untapped.

Regardless of whether you agree with this thesis, approach any trade with a plan and preferably the odds on your side.

For more on RIMM:

Betting on a comeback in Research in Motion (NASDAQ: RIMM)?

RIMM, AAPL, and GOOG in the Smartphone universe

As soon as I was writing this, it seemed GOOG caught a bit of a bid and is now only down $8, which would equate to a loss of $2.5 billion in market cap.  The shares outstanding  differ greatly for the two, with GOOG at about 317 million and BIDU at 34.7 million.

So actually, GOOG is losing more market cap because of its larger float than BIDU is gaining in this instance.

BIDU could be potentially gaining the 80 million people per week that currently use GOOG’s search.

According to Bloomberg, Google’s China revenue is small relative to its nearly $22 billion in search revenue in 2008.  GOOG achieved revenue of two billion yuan ($293 million) in the third quarter of 2009, an increase of 28% over the prior year.   In that same quarter, Google had a 31.3% market share in China, versus Baidu’s 63.9%. All the other search engines control less than 1% of the collective market share.

China is the world’s largest internet user with more than 338 million active users (as of June 2009).  This compares to the 231 million-plus users here in the U.S. as of the end of 2008, according to the CIA.

All this stems from a direct and “highly sophisticated” attack on GOOG and at least 20 other companies’ systems, which came from China.  GOOG currently censors its content for distribution in China, but was looking to move forward without censorship, something that no other search company has done.  According to a blog by GOOG’s chief legal officer, David Dummond “GOOG has decided we are no longer willing to continue censoring our results”.

There are many sides to this story that could have political ramifications much larger than what is on the surface for both the people of China and Google, as well as the companies involved with GOOG and the ones that may want to do business with China in the future.

I continue to hold my ground  for the trade that I mentioned last week after the weakness in GOOG following the release of the Nexus One.  The trade is still $60.00 out-of-the-money and I believe that this pullback in GOOG may deepen slightly, but with the elevated volatility in GOOG today, the out-of-the-money put spread will increase in value, hurting our P&L. I will continue to evaluate GOOG as this story unfolds.  If GOOG does indeed close GOOG.cn, the shares could drop further, possibly another$10 to $20.

I personally don’t think we have seen the last of GOOG in China.

For more on Google and Baidu:

Google’s (GOOG) Nexus-One Phone Was Baked In

Sector Update: Technology Shares Mixed in Pre-Market Session – Google May Pull Out of China

BIDU: Trades for Option Bulls and Bears

Earnings and the subsequent movements in a stock are the public’s reactions to the news releases and may or may not change the future outlook of that company’s stock price. Current P/E ratios often trade at a premium to their typical ratio in a recovery cycle, because the markets are always looking forward, typically somewhere 3 to 9 months ahead, depending on the overall economic and geo-political situation.

When options traders are placing trades, we not only look to the future expectations of stocks, but also examine how a stock tends to behave in certain situations. I wanted to offer a look-back into some of the average earnings behaviors of companies that are reporting earnings this week, so you can get a realistic handle on the possible movement of these companies as they report.

The percentages that are displayed below are the average effective moves these stocks have seen the day of earnings, looking back over the past 11 or so earnings reports. Direction is not important here. Remember that some issues are volatile going into their reports, while others do nothing, so do your homework before making trades based on this data. This type of data can be especially useful if you are a spread trader or if you are wondering how much protection you may need going into an earnings report.

Monday :
Alcoa (NYSE: AA) – 3% ( Alcoa also tends to continue to move in the days following the report)

Tuesday:
K.B. Homes (NYSE: KBH) – 4.8%
SuperValu (NYSE: SVU) – 7.25%

Thursday:
Intel (NASDAQ: INTC) – 1.75% (Intel tends to make its moves the following day, with those movements coming in at a little over 5%)

Friday:
J.P. Morgan (NYSE: JPM) – 4.75%

Fundamentally, one would initially think that the trade would be to go long AA stock, because it seems that metals, both common and precious, have been in demand with global economic growth on the rise. I certainly question the rate at which the market has been pricing in this growth, but I’ll save that for another article. As for AA, it has had quite a run in the past couple weeks. On Dec. 9, AA was trading at $12.77. The stock is now at $16.80, a $4.03, or 32%, run in that time. Remember, when you buy stock you have unlimited upside, but also full one-to-one exposure if the stock drops, you will lose $1 for every dollar AA falls.

At first glance, analysts have mixed opinions on AA. Although most are leaning to hold, there are about 40% who believe it is a buy. These folks have not done a good job collectively, based on their recommendation history and the stocks movement in the past year, so I will put less credence in that moderate buy reading. The stock has a monthly ATR of about $5.70, so it is within that range with its recent move up, however the breakout has been quite sharp.

Technically, AA has some support around the $15-level, which was its previous resistance point and then were it broke from. The 50-day SMA falls at $14.08, which is also a level I will watch in the short term for support since it is below the strike price. Both fall on big round numbers, which tend to be sticking points for stocks (more so than points in between) this is a human trait that translates into stock behavior. Looking back on the previous 12 earnings reports, AA has had an unusual history, most of the time it is fairly flat, but it does have the potential to move big. Back on April 7 last year, AA moved up 44% and on Oct. 8 it moved down 27%, but typically the average is about 2%-3%, which would be about a $0.50 move in the stock. So that still makes me feel comfortable with the $15/$14 levels, which are $1.80 and $2.80 below the stock respectively.

So how about volatility? Both historical and implied volatility (February) are settling in right at about 47%. There is really no major discrepancy between the two. Historically, Alcoa’s 30-day HV has been moving lower overall but sticky between 40%-48%, that tells me that there is no large impetus for a bet on volatility in either direction.

So now on to the trade, I like the 15 and 14 points in the stock for reasons stated above, if I were to sell a 15/14 bull put spread there is a 25% chance statistically that AA finishes lower than 15 and a 12.86% chance it goes below 14, which would be my maximum loss point.

I can sell this spread for $0.17, which doesn’t seem like much, but I only would have $0.83 at risk at all times. Not too shabby considering AA has the potential to move big. In this trade all AA has to do is stay above $15 by February expiration and I will make 20.5% on my risk.

This allows AA to actually oscillate without giving me too much heartache and also gives me a statistical edge. Instead of having large exposure to the stock, I am taking a moderately bullish position. It certainly is not a guarantee of success and I do give up the opportunity to make any more than 20.5% in 40 days, but I have probability on my side and I will reduce my risk into the earnings report. Not to mention, 20.5% is not a bad return in 40 days or less.

Also, if AA is right at or slightly below 15 on February expiration, I can exercise my 15 put and sell covered calls against my stock.

I hope this got your mind going, if you do decide to employ a strategy like this, please be sure you understand all the risks before entry.

Always hedge your bets.

GOOG, like Apple (NASDAQ: AAPL), is known for keeping things under wraps (although Apple might be slightly better at this). Even with Google’s tight lips and with little-known facts about the new Nexus One, the stock managed to rally almost $100.00, or 18%, since the first week of November, 2009 in anticipation of this phone.

While everyone wants to just love GOOG (me included), one also has to be aware of the underlying forces that are driving this stock and know when to jump off the wagon or at least take some risk off the table. I am not going to classify the GOOG Nexus news as a “buy on rumor, sell on news” type of event, but I would adjust my risk at this point.

While I still want to be long GOOG, I would be taking profits in my current aggressive long positions (such as stock, long calls, etc.) and moving into a less-aggressive February bull put spread. Currently, one standard deviation for GOOG out to February 20th is about $56.00, and remember that GOOG can move more than 6% on average surrounding an earnings report. Let us also not forget about non-farm payroll numbers on Friday, which could be a broad-market mover.

One specific possibility might be the 520/510 February put spread for a credit of about 40 cents. Although small in profit potential, this might be a trade I would examine. Yes, this has a very high risk/reward ratio, but also a very high probability of success that caps your risk at $9.60, which is a far cry from the $60.00+ movement we could see in GOOG over the next three weeks.

Remember that the bull put spread has limited upside potential (about 4.2% in this case), but also realize that 4% translates to a $24.00 move in GOOG stock and the bull put spread would still be profitable if GOOG were to drop $98.00 from this level.

GOOG implied volatility remains elevated going into this week’s CES show, at which the Nexus One will be the topic of much conversation and scrutiny, I am sure. GOOG reports earnings on January 21st, which is where I believe most of this volatility support is coming from. This will likely be a volatile report for the stock price of GOOG given the recent run-up in its shares.

Much of the Nexus story has already been baked into the current stock price, and investors will next want to see how the Nexus performs and sells in the real world. As for AAPL, I believe much of the tablet hype is as baked in as well, although AAPL is good at surprises. I would be slightly more aggressive in AAPL to the upside, but not much …

Coincidentally, Mr. Castro sold 17,000 shares of his WMT shares on Dec. 29 at an average price of $54.06 a share and another 42,071 shares back on Dec. 14 at the average price of $53.92.

While it is certainly more comforting to have the executives buying shares if you plan to invest in a company, remember there are many reasons why a director may sell or buy shares, which may be more personal than corporate. Stock repurchase plans initiated by a company itself are generally a positive sign, but certainly not a guarantee of success.

With WMT, its stock price has been fairly flat on the year. While this may not be exciting, the price movements in WMT over the last year were much more tolerable than the rest of the equity markets, not to mention could make WMT the perfect covered call candidate.

As discussed before, the covered call is almost identical in risk and usage as the short put, however, timing the entry and exit of each strategy are slightly different. Typically, traders who sell covered calls against long stock do so at different times. In WMT for example, a trader who bought on Dec. 18 at $52.50 might be looking to sell their covered call (possibly the February 55 call for 90 cents) on a day like today when the stock is rallying. The covered call trader would like to acquire their stock as a cheaper price, possibly on a day when the stock is down, which was the case on Dec. 18 and then let the stock rally until selling the short call in the front month against the long stock position (remember you sell one call for every 100 shares owned). The short call is typically sold at or out of the money, which means the call strike is at or above the stock price.

This technique allows the trader to not only lower his cost basis in the stock, but also increase the premium collected in the call that is sold being that call prices rise when stocks rise. Once the trade has been made, the ultimate goal is to have the stock finish right at the short call strike.

The short put is just a single trade, which does not require the purchase or sale of stock. In WMT, if a trader were to employ a short put, typically the best entry would be on a day when the stock is selling off. Remember that the put is the polar opposite of the call and put prices increase as stocks fall. Because the short put is a single leg trade, it might be a bit easier to time, but again this depends on the trader. The different with the short put is that it obligates you to buy 100 shares at the strike price you sold minus the credit you received. With WMT, today would most likely not be the best entry point for a short put, but again it depends on your view on the future of the stock. If you believe that WMT will rise from this level and at least stay above $52.50 for the next month and a half, the February 52.50 put can be sold for 77 cents. This essentially means that you are OK with possibly owning WMT at $52.50 – 77 cents, or $51.73 per share. WMT has not traded at $51.73, since Nov. 9, 2008. WMT does have a 31-cent quarterly dividend, which you do not receive if you are short the put. But both the put prices and call prices are adjusted to account for this dividend. In other words, calls are cheaper and puts more expensive by the amount of the dividend if there is one or more within their expiration.

Regardless of what strategy you choose, both the covered call and short put offer potential strategies that investors can employ on a moderately bullish WMT.

Anyway, this article isn’t to bash a creative, but undesirable product. I would like to offer some picks for 2010.  

Housing prices will moderately recover and stabilize, but they have a long road ahead and once the FED begins to tighten and rates begin to rise once again from the 50+ year lows, rest assured, the average price of housing will come under pressure.  So where do we go from here?  I believe that the XHB and HGX will be sideways, if not falter early in the year, but may begin to move slightly higher towards the latter half of the year as both indexes are comprised of not only home builders, which will most likely struggle for several months, if not more. But they also comprise of companies like BBBY, MHK, WY, which should strengthen first and mitigate the pain the housing sector may still have to endure over the next couple of months, even with the consumer beginning to come out of the woodwork and spend again.  Needless to say, if I were to invest in these names, it would be using very aggressive covered calls (greater delta, higher premium); buying stock and selling the closest call to the purchase price to collect the yield and help offset retracements. 

My preferred stocks this year will be Home Depot and Lowes and WY, as a proxy for lumber prices. 

These three choices in the housing sector should benefit, not from a rise in home values, but the steady demand for fixer-uppers.  Yesterday, Fannie offered us a look into the serious delinquency rates that it is still experiencing in its conventional single-family-home mortgage portfolio, posting a 4.98% rise in October from 4.72% the previous month. This same period last year, the rate was at 1.89%.

This pipeline of delinquencies, will feed foreclosures and will lure investors and regular folks alike to gobble up the cheap inventory of existing homes and drive demand for the aforementioned companies goods and services.  On those names, I would be selling front month puts, just slightly out of the money on days when the market dips, with the intention of possibly being forced to buy the stock at a discount. If I am not assigned, I will continue month after month.  Be sure and assess your own risk before placing any trade.

As for the Smartphones, I maintain my bullish stance on GOOG, RIMM and AAPL into 2010. My reasoning and rationale for the trades has not changed, although I would be exploring out of the money bull put spreads on all of them, as they all tend to have ample premium to collect.

Always hedge your bets and have a safe, happy and healthy New Year.

Back in March, when things were at their worst, savvy traders could place out of the money call spreads or just buy tons of cheap out-of-the-money (OTM) calls and get the big payoff on the rebound. This sort of strategy made sense because of the market certainly seemed oversold.

Now, it’s not that we are completely overbought. The market may be just slightly overvalued, at least for the next couple of months until financial and economic data firms a bit. So, if anything, I would be examining credit vertical spreads that are OTM (selling put spreads below and selling call spreads above). The beauty of these strategies is they allow the stock to actually move around. As long as the stock stays above the short put (or below the short call, if you are selling a call spread) you will gain your max profit. You can also use a put spread to get long stock, while having some downside insurance in case things really get nasty.

Stay tuned to ONN.tv and watch me on Fast Money on CNBC for updates to strategies and my pics on what stocks you should be watching.

Let us not forget, that it is quite common for implied volatility to come in sharply after an earnings report.  So holding a long straddle through a flat earnings report where the stock doesn’t move can be quite disastrous, as your long straddle premium may quickly evaporate with the massive volatility crush that comes with the passing of earnings. 

This is a dilemma for any average retail trader.  Do I get long a straddle and hope for a big move and maybe I am able to scalp my stock out to overcome my theta and any reduction in implied volatility, or do I sell the straddle and pray that the stock stays within a range until expiration.  Here lies the dichotomy of the straddle: One camp might be a seller of that straddle, thinking there is no way the stock moves greater than what the straddle is selling for and volatility is certain to come in, and then you have a another camp that believes the opposite; that either volatility will expand or that they will be able to positively scalp their gamma or maybe that the eventual parity of either the call or put will lead them to victory in the trade.

Short-gamma players certainly have their work cut out for them, or maybe it’s better to say that they don’t want to have their work cut out for them.  As I have become a general premium seller in my life as an off-floor retail type trader, I tend to favor being short credit spreads, which would thus lead me to the land of being short gamma.  But also remember that the gamma of a say a credit vertical spread varies greatly from and has less risk than a short straddle.  Selling an at-the -money straddle is the most efficient way to get short gamma and sell premium as at-the-money (ATM) options have the most time value (vega sensitivity) in real dollar terms and the most gamma.  It is also a high risk proposition when un-hedged - this is why most professionals would look to buy or sell stock against that trade to even out their deltas at least most of the time.

 Think about your goal as a straddle seller. It is preferable to have the stock expire right at the strike you sold. Approaching expiration, if the stock is below your strike your short put would eventually force you to buy shares at a higher price, which means you need to sell stock to offset the risk of being long stock at a higher price. In essence, the farther your stock moves below strike, the longer your position delta gets -you have to sell stock when spot is low.  What about when the stock rallies above your straddle strike?  Then your short call starts to kick in, you get short more and more deltas the higher the stock goes which means you would have to buy stock to hedge.

 Ut oh…Sell low and buy high?  Something doesn’t sound right!  But this is a struggle that dynamic hedgers have to face every day.  Unlike the long straddle which is costing you theta as each day passes, the short straddle is paying you theta every day, assuming nothing else changes (like volatility or the stock price). Remember, there is no such thing as a free lunch and because you chose to collecting theta (cash) every day, you can’t have your stock move and if it does, you may be forced to negatively scalp your position, which means that you may lose money every time you have to buy or sell, but not always. 

Some of you might be asking yourselves, why do I have to hedge, or who cares if I am a little short or a little long going into the close? Again, this all comes back to risk tolerance. Imagine that you sell 10 RIMM January 65 straddles for $5.50 and the stock  closes up around $69. This leaves you short about 550 deltas going into the close. You decide not to hedge (buy shares at $69.00 and the next morning, the stock gaps up to $73.00

With the gap up to $73.00, now the position is now short 830 deltas.  Not only are you now shorter, but you could have bought 550 shares at $69.00 and made $4 per share or $2200 dollars to offset your losses, which now, without the hedge would be totaling over $3200.00.

This is where negative scalping can bite you, because now assume that you bought 550 shares at 69.00, but the stock turned around and dropped to $66.00.  

Take a look at your deltas now!  Your long 305 deltas, which means to neutralize you would have to sell down here at $66 and take a $3 loss on 305 shares, now what do you do.  Because you have long deltas, you want the stock to rise, if it drops more you will be hurting even more and if you hedge and it rallies then you may feel equally as bad, what a spot to be in.  As bad as this may seem, hedging is an art in itself.  Over hedging and under hedging can equally be a problem. At the end of the day, having a strong knowledge of the stock that you are trading and its patterns of volatility, stock movement and news can help you not only select the appropriate strategy, but also adjust and hedge that position as you move forward in time.

After many requests, I decided to offer some basic insight as to what it means to gamma scalp, both positively and negatively.   Professional options traders tend to approach the markets and options prices specifically in a different way.  As a former market maker, my day-to-day consisted of trying to buy options for less than their theoretical value at that moment and sell them for more than that value thousands of times daily.  Whether it was a call or a put, it generally did not matter. I was more concerned with the movement or volatility of the underlying spot price in whatever security I was trading and, thus equally concerned with the volatility of the options that I was buying or selling were implying (this was determined by the price that the trades occurred at).

More often than not, I tended to end my trading day delta-neutral or not have a “directional bet” going into the next morning.  We options traders tend to have an “if, then” type of attitude as opposed to a regular stock trader’s, which tends to be more rigid in their predictions and theses.  I certainly prefer the former versus the latter, because I still have yet to meet the one who knows exactly where a stock is going, not to mention, I always like contingency plan as well as having the choice of getting or giving odds depending upon the situation.  So let’s get back to the “if, then”-thing.  Most stock traders have two choices when it comes to investing: long or short. They will either begin to lose or gain money immediately once they have entered the trade. If the stock rallies, they must sell to capture that profit, and if it falls, a long stock holder needs to sell at a loss or get the bible out and hope it doesn’t fall too far.

Options traders can use certain strategies to take a neutral position in a stock and either use gamma or their dollar breakevens to become profitable.  There are, of course, ways that options traders can simulate the exact risk profile of a stock…but who would want to do that?

The gamma function can be quite intimidating to understand completely as it is an extension of the factorial function to numbers and has several definitions.  We don’t need to know all of the intricacies of gamma to be able to trade with it and know how your options position will be affected.   

What you do need to know is that gamma tells us roughly how much our delta will change for every dollar-move in the underlying spot price.  Gamma is greatest in the at the money options, both calls and puts.  When you buy an option (call or put), you are long gamma, when you sell an option you are short gamma. 

Being long gamma enables you to scalp stock (which is your hedge) for a profit, while maintaining delta neutrality in your overall position.  Typically you are paying theta to have long gamma, but there are some exceptions to this.

Let me explain…

Ahead of RIMM’s earnings, the December 65-straddle was trading for roughly $6 with five days until earnings and subsequent expiration the next business day.  This means that the options markets were essentially betting on roughly an 8% move over earnings (I backed out the small amount of parity that was in the call options as the stock was slightly above $65.20 at the time).

So, what if you bought that 65-straddle for $6? How can you make money? There are several ways that this trade can be profitable.  The first, and probably the easiest way, would be for the stock to move away from the strike more than the amount you paid for the total straddle, so $71 or $59 would be your breakevens.  The next effect would be an unexpected jump in volatility, which would need to be greater than the amount of theta that you are paying each day.  You see, nothing in life is free, and options are no exception. The third way you might be able to get profitable would be to scalp your gamma.  RIMM must not only move around for you to do this, but you must also time your entries and exits and be extremely proactive in monitoring and trading the position.  The beauty of being long a straddle and having long gamma is that even if RIMM gaps up or down unpredictably, you may still stand to benefit.

Take a look at the profit-loss chart of a January 70 straddle in RIMM with 25 days to expiration (DTE).  Cost is about $5.50 (earnings just passed). Also take a look at your delta and gamma.  In this chart, you see you have about 113 gamma and you are long 145 deltas, or the equivalent of 145 shares of stock.  That means that for every dollar that RIMM moves, your deltas will increase or decrease by about 113.  You are paying approximately $112 per day to be in this long straddle position (10 contracts) that is certainly something you cannot ignore.

So what if RIMM jumps to $73.00 today? What is your position now?

 As you can see the deltas are 452.38, which means if you wanted to neutralize this position, you might go and sell 450 shares of stock. As you can see, we are now flat delta, which means we have no directional bias at this moment.

Now if the stock drops back down to say $68 dollars tomorrow, we will most likely be short about 420 deltas. Remember that our gamma tells us how much the delta will change.   Guess what we can do now?  We buy back the 450 shares of stock that we sold and pocket $4 X 450 (shares) = $1,800 over two days.  Did we pay for the $220 in theta?  Yes!  And chances are that if the stock made that big of a move, we might see a slight jump in implied volatility that would cause our spread to increase in value and maybe we could sell it back to the market for what we paid for it two days ago and keep the $1,580 in profits we made, minus any commissions of course.

Hopefully, this gets your mind going about Gamma. There will be more to come and I am hearing rumblings that we will be doing an advanced session on gamma in our free webinar series.  Also stay tuned for Wednesday’s negative gamma scalping article and what it means to be short gamma.

Hopefully if you’re reading this, you also have paid a visit to some of the other costless tools and educational resource on ONN.tv.

Thank you for reading

Jared

RIMM reported net income of $628.4 million, which equates to roughly $1.10 per share, compared to 69 cents per share last year.  Revenue climbed 41% over the quarter.

Feeding those great numbers was the number of new subscribers added in the quarter. RIMM exceeded that expectation as well, adding approximately 4.4 million (net) new BlackBerry subscriber accounts this quarter. They shipped a total of 10.1 million smartphone units at an average sales price of $317.00.  Roughly 80% of these sales were non-enterprise customers.

As I talked about in my earlier notes and recommendations, RIMM has strong international exposure and an extremely dependable platform, which is paramount when trying to break into new territory and knock out competitors.  The company’s international exposure paid off as 37% of the company’s revenue was derived from international markets.

So what about the trade?  Why did I take off my long positions in RIMM just ahead of the report?  Some would think it makes no sense to like a company as much as I do fundamentally and yet remove my bullish bets. 

What has made me successful as a trader has been my high probability, low risk, statistical approach to trading, which has been formed over many years as a trader, market maker and derivatives analyst/specialist.  I view the markets in a different way than most.  I focus on taking frequent small bits from the market in a very precise manner, and having minimal exposure to delta (movement) for the most part.  From time to time, I will alter my exposure to different Greeks as I see fit.

 I also set a daily, weekly, monthly and annual goal for myself and every trade I make, I have that goal in mind.   If I am close to my goal, I will take less risk.  If you couple that goal with the fact that I have a very specific time horizon and trade rules, I sometimes will be removing risk, even when most people think that risk should remain on the table. 

This means that I will often sell into strength as well as systematically buy in weak times.  I generally never get the entire move of a stocks run or drop, but I also tend to be right in my trades much more often and get to sleep soundly at night.

I have been recommending RIMM for some time.  Back in August, I recommend it when the stock was trading around $72. Then, it ran to $88, Ahead of September earnings, I went on CNBC and urged investors to collar any long term holdings and sell short term holdings, which most should have been very profitable.   The stock subsequently tanked - hard.  Good thing we took chips off the table when we did.

I recommended RIMM again in November, both here and on CNBC with the stock anywhere between $58 and $60.  I made a long term case for RIMM, which proved itself, at least partially, last night.  But even with the strong long term bull case, on CNBC Wednesday, I recommended that long term traders do a December credit collar on RIMM, when it was trading around at $65. This would have forced them to sell the stock around $67.50, but protected downside below $62, and I also recommended that short term traders take profits.  I did this because no matter what any analyst, trader, broker or any market participant says, they have no idea what the stock will do when earnings are released, at least in the short term, because you are not only talking about the company’s results, but the consequent psychological response of millions of investors .     

I had a bird in hand and I took it, and  I will continue to do so.   I think that if I had  left all long positions out there in the wind, I would be doing a disservice to my viewers/readers.  This time may have netted a couple more dollars, but if RIMM had moved like it did last quarter, it would have wiped out all profits and then some, putting your back against the wall and probably shuddering your confidence quite a bit, which is never a good thing as a trader.  I will always stick to my guns and I will always admit when I was wrong.  Am I upset that I didn’t squeeze an extra $3 out of the trade? Not at all.

We will trade it again…

Remember to always remain hedged and live to trade another day. Have a wonderful weekend.

Photo by markjhandel

Boeing’s (BA) 787 “Dreamliner” has certainly been a long time coming.  It was seven years ago that Boeing said that it would develop the 787, which was originally designated 7E7, while in the earlier, more radical designs.  Yesterday that vision finally became a reality, even with the flight being cut from five to three hours due to inclement weather.  The original maiden flight was actually set for September, 2007 and it has been a costly, winding road for the composite jet that sourced parts from several suppliers from around the world.

The 787 design allows for much lighter-weight construction.   Materials used in construction, which make up the total weight of the 787, are  50% composite, 20% aluminum, 15% titanium, 10% steel, 5% other.   The 787 will be 80% composite by volume. Each Dreamliner contains approximately 35 tons of carbon fiber reinforced plastic, using 23 tons of carbon fiber.   The interior passenger compartment will boast a more comfortable climate, pressurized at the equivalent of 6,000 feet above sea level versus 8,000 used on most jets.  Humidity and air quality will also be greatly improved and offer travelers better comfort over long hauls.

The windows will even be larger, letting passengers get a better view of what is going on  outside.  An even larger draw for airlines will be the 20% reduction in fuel consumption for long-haul routes when compared to today’s similarly-sized airplanes.  There will be three main variants of the 787 to begin with, they are the 787-3, 787-8, and 787-9, with a average price of about $175 million per plane.

Now that BA has begun in-flight testing, they still now test the 787 to ensure its air-worthiness and gain FAA flight approval before planes are delivered.  The delivery pipeline is a large part of Boeing’s future earnings ability and in turn, their stock price.   One must also account for cancellations.  Obviously, the quicker BA can produce and deliver the 787, the quicker they can realize profits on the 840 aircraft currently backordered.

Because of the possible unexpected turbulence in the research, production, and delivery cycles,  the options markets may offer a more efficient and lower risk way to  play BA.  Needless to say,  I would still approach BA with caution, because they are still in the testing phase and there are still problems that can arise and potential re-design costs that BA could incur.  If you couple that with the fact that BA depends upon vendors around the world to source different parts for the plane, the supply chain must keep moving without any kinks, which might cause further delays.

Without going into all the specifics, a bullish trader might begin to employ at-the-money bull put spreads.  For instance, the January 55/45 Put Spread can be sold for $1.65 today, which gives you a break even down at 53.35 and limits your maximum risk in case something catastrophic happens with testing and/or production, which could send the stock sharply lower as analysts are factoring in BA reaping the rewards of this huge delivery backlog spread out over a given period of time.

From the pictures floating around on the net, the phone looks somewhat like the HTC Hero and exactly like the HTC Passion/Dragon, whose pictures are floating around on the net.  The new Google phone lacks any analog buttons on the front plate and appears to be completely touch scree.  This may be disappointing for us tactile feedback folks and business power-users, but I don’t think that is GOOG’s target market for this phone.

Sizing, according to several blogs, is very close to the iPhone, but with a scroll wheel.   This phone and its rollout could be a game changer for the cell phone industry and appears to be a shot directly at Apple (AAPL).

The phone is set to initially be released without subsidies from carriers and will untethered to any carrier, which may have hurt AAPL, who has been married to AT&T (T) since the iPhone’s inception .  It will be an unlocked GSM device for use on any GSM network, which is more akin to the way Europe does mobile communication.

There may be a bit of a backlash from other cellphone makers who offer phones with the Android OS, but this will certainly depend on the price point of the Nexus.  As for the phone carriers themselves, they just want to accumulate paying customers. I have a feeling that the customer service agents at AT&T, Verizon, Sprint, and T-mobile are going to start getting really friendly, as the way of the contract-by-subsidy may be slowly going away…

Let us not forget that this will most likely be a premium-priced phone and for most Americans, and the initial cost of the phone is a huge barrier to purchase.   The smartphone market is potentially huge and penetration is still relatively small and growing – see my smartphone universe article for more details).

As the “economic recovery” marches on, maybe more and more folks will be able to afford a smartphone.  Nokia had a hard time selling untethered phones here in the US, but maybe they were just a bit ahead of their time.  Now, more than ever, more and more Americans want not only a phone, but a mobile computing/multimedia/gaming device in their pockets.  There are several phone makers jockeying for position in this high-growth area.

My opinion is that if this rumor is indeed true and Google rolls out the Nexus One, it will most likely be a positive for GOOG.  The biggest risk they have is offering a sub-par product that tarnishes their name.  The probability of that, in my opinion, is very low.  HTC will also help ensure that the product is quality and scalable.

I would be a buyer of GOOG here, as I have been for a long time. Options traders can examine slightly out-of-the-money call spreads in June to allow for delays.

Common terms for these American-style warrants included long-date expiration dates, no voting rights, and pricing based off of the 20-day trailing average stock price before the Treasury Capital Purchase Program (CPP) application. There were other provisions in the agreements for piggyback rights, as well as dividend adjustments above a certain level and an anti-dilution provisions date.

Pluris found that many of the banks repurchasing their warrants typically were doing so at an extreme discount to fair value, based on several pricing models. These average discounts to fair value were fairly substantial earlier this year, starting at 68% on April 1, 2009 and coming down to 65% as of July 1, 2009.
This trend of a reduction in discount can most likely be attributed to several factors, one of which would be the Treasury possibly getting better with its modeling, but more likely due to the decrease in “optionality” as a percentage of price that occurs as options become more in-the-money.

When you think about it, which options have the highest percentage of volatility sensitivity relative to their price and thus would be the most sensitive to changes in implied volatility calculations as a percentage of the price of the security? Out-of-the-money options are completely comprised of time value and would have the highest sensitivity to changes in implied volatility as a percentage of price when compared to in the money strikes. This is followed by at-the-money options, then in-the-money options, which have the least amount of optionality as a percentage of price due to the higher intrinsic value.

So this year, as stock prices have risen 20%, or 30%, or 75% + in some cases, those out-of-the-money warrants are now in-the-money and thus will have less of the “time premium fudge factor” built into them.
Pluris also noted that as total bank assets increased, the discount the warrants were bought at decreased substantially. Banks with less than $100 million in total assets experienced an average discount of 72% whereas banks with total assets in excess of $10 billion experienced an average discount of only 51%.

Yesterday, the US Treasury auctioned off approximately 88,401,697 warrants to purchase the common stock of JPMorgan Chase & Co. (JPM) through a modified Dutch auction. The bidding began at 8:00 AM Eastern and went through 6:30 PM last night. The opening bid was $8.00 and bidders could bid anywhere above that in 25-cent increments. The JPMorgan warrant matures 10/28/2018 – that’s 3,234 days from today – with a strike price of $42.40. JPM closed at $41.27 on Thursday. This morning it was announced that the warrants were auctioned off at a price of $10.75.

Call me crazy, but the Jan 2012 40 calls are $8.00 mid-market and the 45 calls are $6.00. If we were to create a 42.50 strike, I’d call it $7.00 without even looking at a model. These JPM warrants go out another 6.8 years longer.

So what is fair value? How did the market arrive at a price of $10.75? The dividends are tricky, as is the volatility input, but if I drop my implied vol down to a 20 (I’d buy it all day long there), plug in 3.5% for a long rate and 3% for a short rate (because I would have to short stock to hedge these), and leave quarterly dividends at $0.05, the call should be worth at least $11.00.

So what happened? Did the government get a raw deal? Will this be cannon fodder for the talk shows this weekend? Not necessarily. The answer lies in the dividends, which is the biggest unknown in making this price. The rest of the variables have at least some hedge.

So the market told us with this price of $10.75 that it expects JPM to begin raising its dividend again soon. But if you don’t agree with the market that JPM will raise dividends, and you think the stock will still rally, you can go out and buy these warrants yourselves now. They are publicly traded on the NYSE.

At first glance, this seems like quite a bullish maneuver.  This may be a signal that that United (and perhaps other U.S. carriers as well), are finding a bottom in the global economic slump. United has the oldest fleet among all U.S. carriers and this may be not only an effort to refresh some of its fleet, but also to become more competitive with long-range/overseas flights.

Let us not forget that North America as a whole has the oldest aircraft when compared to the rest of the world and renewing this fleet will be a goal once demand increases (this may reinforce the argument to buy the makers of the planes) .

The new aircraft that United are ordering will be much more efficient than a comparable aircraft being used today.  Boeing estimates the 787 will consume 20% less fuel per passenger and with ever-rising energy costs, those numbers could add up, but the question is whether demand and cost savings will outweigh the costs of the planes themselves and how the investing public will digest these charges.

On December 4, 2009, the Airports Council International (ACI) said, in reference to October traffic, that  stabilization continued and freight traffic growth was seen for the first time since July 2008 during teh month.

ACI’s monthly Freight Flash reported a 1.4% increase in international freight, a 2.2% increase for domestic freight and a 1.3% increase for total freight traffic in October 2009 compared to the previous year. Angela Gittens, Director General of ACI World, noted, “The black ink in all three freight categories for the first time since July 2008 is the best traffic news of the month. This is welcome positive progress coming on the heels of a steady narrowing of the negative gap with 2008 traffic results. This pattern mirrors the ‘down-flat-up’ curve we have seen in passenger traffic over the past few months.”

On a year-over-year basis, airports saw an increase of 1.8% in total global traffic.  Breaking this down, domestc traffic grew by 3.5% and international traffic was relatively flat, down 0.2%.   Positive results in October were bolstered by improved results in Europe and North America – mature markets hard hit by economic recession.

Latin American and Caribbean airports registered strong domestic growth  as well, climbing 26%. Continuing growth in Asia Pacific and Middle Eastern markets also contributed to the improving overall results, although these faltered slightly when compared to September. African traffic also came in slightly below the monthly growth levels seen in September.

As an options trader, I have to take a step back and dissect the situation and weigh out the pros and cons of this news.  In terms of cost, it’s a big one for UAUA and frankly, air travel still is not where it was pre-2008 and certainly not where it was pre-2001.  So how can I get all the upside in the stock, while having less money tied up?

One strategy that comes to mind, with UAUA right below $10.00, would be a risk reversal in June, specifically selling the June 2010 9 put for $2.00 and buying the June 2010 11 call for $3.05, for a net cost of $1.05.

I chose this trade because of the limited cost, unlimited profit potential  and because I bought and sold an option with such a long expiration, I am mitigating my vega risk (changes in implied volatility).  As stated, this trade has unlimited profit potential and has a max risk of $10.05, just slightly more than the stock itself, but it will cost me much less, allowing me to possibly hedge my investment with a bullish spread in oil or something along those lines.  Also, my breakeven in the stock is 10.05; if UAUA is at $10.05 or above by June 2010, I will be profitable.

You may also want to take a look at Boeing and Airbus parent European Aeronautic Space & Defense Co. (EADS.Y).  They may be the bigger beneficiaries of this transaction, but remember, without air traffic increasing and airlines making money, they will fail to perform as well.

While the long-term gold bugs may be using this pullback as a buying opportunity, we may see the SPDR Gold Trust ETF (GLD) and the price of the yellow metal come down even further.

GLD has just broken below the ascending channel it has been in,  not to mention that the GLD has been pressing its upper Bollinger band for almost a month now, which itself has been wider than normal.  When I see the bands open up way beyond their normal width compounded with the stock (spot) price tracking along one outer edge or another, my mind immediately thinks of the analogy of a runner who just ran top speed in a 26-mile marathon and each day faces another 1/4 mile that runner has to go before stopping to rest.

While this may be possible, the longer the run without a rest, the higher the possibility of collapse.  Also remember that a wide Bollinger band means observed volatility is higher.  We have therefore seen a rise in the implied volatility, which would prompt any red-blooded options trader to have a bias to selling implied volatility by way of selling an out-of-the-money vertical spread or buying an in-the-money vertical.  The call implied volatilities have been higher than the puts because of the huge bullish options appetite in GLD.

Based on what I see in the charts, GLD has blown through its 20-day simple moving average and broken that ascending channel I mentioned earlier.  Currently, the GLD is bouncing off its lower regression channel level of about $110, which offers some relief for the bulls as long as we hold this lower level.

Gold, unlike a basic equity, has forces that are pushing and pulling on it, which may be larger than the technicals and thus make technical analysis less accurate. With its strong negative correlation to the dollar, any hawkish word from chairman Bernanke hinting could cause a sharp bearish move in GLD, which may not be visible in the charts.  Most likely, that same spike in the dollar (at least in the near term), could cause a bearish ripple in the broad equity markets.

For the options traders, using this dip to sell put spreads that are another one standard deviation out-of-the-money in January might be a way to take a moderately bullish position while limiting risk.  Implied volatility is spiking above 29% and the puts are once again more expensive in GLD when it comes to volatility.

Inflation will be a factor and the FED will have to perform its version of Swan Lake to remove liquidity, get banks to actually lend to more borrowers (other than the Treasury), keep consumers spending and confident, and keep our homes from dropping in value any further.  Dr. Bernanke will be speaking today at 12:45 Eastern Time.

I still remain bullish long term in GLD.

ONB may have bought its warrants from the Treasury at a huge discount to their “fair value,” and while the $1.2 million goes back into the Treasury’s pockets (our pockets), the other $2.8 million to $3.8 million does not. Let us not forget that these banks owe us to some extent, don’t they?

To that end, one would think that the Treasury would do everything they can to obtain a fair price for these assets. Selling the warrants does not cost the underlying company any money, in other words, if the Treasury sells ONB warrants to PEAK6, ONB is not affected by the transaction, similar to if I went and bought call options on the Indiana-based bank.

Part of the problem was there really was not a marketplace for these warrants; it was the treasury and the bank itself finding a fair price. The equity and options markets are more efficient mainly because of the millions of traders, customers, investors, funds that are bidding and offering to find the best fair value at that moment.

Warrants are essentially call options; they have an expiration date, strike price and account for dividends and volatility. Pricing out a warrant should be fairly easy for any professional options trader with access to an option price modeler. I have to admit, that there are some difficulties with finding an appropriate volatility input as well as accounting for dividends as they will reduce the price of the warrants (just like calls).

Now that the Treasury has opened up the bidding by way of an auction, taxpayers should get a better deal and maybe a fair price. The first warrants to hit the auction block yesterday were from Capital One Financial (COF). The auction ran from 8 a.m. EST to 6:30 p.m. EST yesterday, with minimum bid at $7.50 per warrant. In the end, the Treasury sold its COF warrants for approximately $146.5 million. That was still a bit cheap in my opinion, but probably better than if no auction had occurred in the first place. The COF warrants expire on Nov. 14, 2018, and have a strike price of $42.13.

The Treasury stated, “These proceeds provide an additional return to the American taxpayer from Treasury’s investment in Capital One beyond the dividend payments it received on the related preferred stock.”

We will also see Treasury sell warrants from J.P. Morgan Chase (JPM) and TCF Financial Corp. (TCB), whose warrants were also obtained through the Troubled Asset Relief Program, aka TARP. According to the treasury, there are 693 banks in the capital purchase program. Expect more auctions on the horizon. We will keep you posted as we learn more about timing and pricing of the auctions.

Intuitively, when you think about it, making a bet on the “price range” of a stock should be easier than making a bet on its specific direction. This is not without a caveat, as it’s not just the range of the stock, but how quickly it gets from point to point. At the end of the day, it can also be as simple for a trader as guessing the range by expiration; this can be done with long or short straddles or strangles.

Yesterday in Bank of America (BAC), we saw heavy options selling in the May months. May 20 calls were for sale (26,000 of them traded) and the May 15 straddle was also on the chopping block. The May 20 call trade makes some sense as financials are beginning to weaken after the strong rally we have seen over the past couple of months.

JP Morgan Chase (JPM) released a note indicating that major banks are scaling their lending activities to boost capital to cover credit losses. (Well duh, they can borrow from the FED for 0.25% and lend it right back to them at a guaranteed 3-3.25%, not too shabby). So things at the major banks might be fairly quiet (at least on the lending front) for some time.

But back to the 15 straddle that was sold; why someone would trade this straddle? In BAC, there was quite a bit of horizontal skew, or the difference in implied volatility going out in time. Think of it as an “options contango.”

December at-the-money implied volatility was around 37, while May volatility was above 47; that is a 27% difference in volatility, essentially meaning that fear was in the back months. In other words, the market is more afraid of BAC in April and May than before the new year. January and May are both the expiration months that include earnings and this could certainly be a reason for the elevated volatility. Regardless, traders still believe that it is too expensive.

The May 15 straddle traded for $4.12 or so, which means your breakeven in that trade is $4.12 in either direction, so if BAC stays between 20.02 and 11.78, the trade will be profitable. Considering the stock has been in that range since June, which it about six months, and has been moving at less than 40% volatility for the past 60 days, it would make sense that it may continue for the next six months … or does it?

The short straddle is certainly a risk proposition, with unlimited loss potential to the upside and in this case only $11.78 of risk to the downside. I am sure these traders weighed their risk carefully before executing, as should you.

While the traffic seems to be higher, spending (at least estimates of) is down from $373 per person to $343 per person.  (I have no idea how  accurate this data is as it is a selective, verbal and written survey offered to a relatively small number of consumers).

About the Survey

The survey, conducted Nov. 26-28, 2009 by BIGresearch for NRF, polled 4,985 consumers and has a margin of error of plus or minus 1.4%. BIGresearch is a consumer market intelligence firm that provides unique consumer insights that are gathered online utilizing very large sample sizes.

Remember this is just a small first glance, which may or may not be the case for the industry as whole.  One might also expect large deviations from these predictions for some of the smaller boutique retailers.

Let us also not forget that many of these retailers, both online but more so in the brick-and-mortar space, are much leaner and meaner than they were a year ago. Most of the positive earnings we saw over the past two quarters have been due to major cost cutting, which have improved margins and profitability.  If we see topline growth in these retailers, the net picture should look even rosier, with the cost cutting we have seen over the past year.

Here are the full numbers from the national Retail Survey Federation’s findings.

Whether you agree or disagree with the findings, one of my favorite retail ET’s is the Merrill Lynch Retail HOLDRs product (RTH).  The product will give you exposure to 18 companies and its largest holdings are Wal-Mart Stores (WMT), Amazon.com (AMZN), Home Depot (HD), and Target (TGT).

This diverse product blend, in my opinion, offers a balanced portfolio in some of the best companies in that sector, not to mention that I believe most shoppers this year will be focused on the discounters as opposed to the boutique and high-end firms.

Always remember to pay close attention to the history of RTH’s movement, as it is up 5% during the past month and has risen more than 25% in 2009.  With that said, I think we will see some upside growth, albeit moderate, in the RTH.  I would look at trading at-the-money buy-writes or short puts, closely dated.

Here are the holdings and weightings for the RTH:

For beginner investors, being short or long gamma may not have much significance in the beginning of their trading life.  Most retail traders are more concerned with the ultimate outlook they have for the underlying instrument they are trading.

In other words, most retail traders tend to use different options strategies based upon their risk/reward characteristics and bullish or bearishness.  This moderate amount of ignorance is okay, as long as it is successful and repeatable.  But as one progresses farther and farther into the options universe, understanding the second derivative, gamma, becomes more and more important as you monitor your trading.  Understanding gamma completely is not necessary to trade options, but it should be learned.

Gamma, which measures the rate of change of the delta, can play a large part of the change in behavior of your option trade or spread.  Gamma, like delta, can and will change as the option moves closer to expiration and as the underlying stock and volatility change.  Gamma specifically measures the rate of change in an option for every one-point move in the underlying stock.

When you purchase an option, whether it be a call or a put, you are getting long gamma, which means that delta is changing in the direction you would want it to. In other words, when you purchase a call with a delta of .60 and a gamma of .05 and the stock moves up a dollar, your new delta might be something like .65, which essentially you are getting ‘more bullish’ as the stock rises, which is a good thing.  If that same stock were to drop 1 dollar, the new delta might be something like .55, making your option position less bullish and thus having less relation to the stock’s movement.

In the professional market-making word, one of our objectives was to remain relatively delta neutral, which meant we had to buy or sell stock (or something else) against our trades to mitigate our exposure to the underlying stock’s movement.  So if we bought a call with a .50 delta, we might sell 50 shares of stock to delta neutralize our position.  IF that stock went even higher, I was forced to sell even more stock, because remember my call delta was increasing.  Then if the stock came back down (like they often do) I could buy back those shares I sold as a hedge to make a profit.  Hopefully I made more money ‘scalping my stock’ then I was paying in theta or time decay each day.

By the way, when you buy ANY option, you are typically paying theta, which means it cost you money each day to be in that position, but like I said earlier, you are long gamma and you want the stock to move up and down so you can scalp your hedges or so your call or put option will be worth more money because the stock moved favorably.  When I was young, most of my money was made on collecting edge (the difference between an option’s theoretical value and what you were able to buy or sell it for) as well as making bets on volatility.  I also considered myself a darn good scalper of stock. Very seldom did I want to take a large directional (delta) position in a stock, because stock movement was much harder to predict.

So back to gamma. When a trader is long gamma, he or she has the ability to scalp stock (for a profit) against his position to help offset what that options’ position is costing him.  Being long gamma is warranted in some situations, typically if a stock is expected to be very volatile.

Short gamma, on the other hand, means you want that stock to stay perfectly still if at all possible and also most short gamma positions want to see a decrease in implied volatility once the position is put on.  This is logical, because if buying options makes you long gamma, selling options makes you short gamma.  A position that is short gamma can really behave oddly if you are not used to it.

Short gamma means your position deltas are moving opposite to what the underlying stock is doing, so if you are short a call and the stock begins to move higher (not a good thing), you get shorter and shorter, which would mean you would have to buy stock to remain delta neutral. Then if the stock drops you get positive delta, which means you  may have to sell stock to neutralize.  Some of you are scratching your heads, thinking that situation makes NO sense; buy high, sell low, how do I make money?  Well, remember when you are short options you are COLLECTING theta; time is benefitting your position.  This is true for both calls and puts.  Hopefully when you are SHORT Gamma, those losses from your negative scalping will be less than the theta you are collecting

So as you begin to understand more and more about position behavior, think about what gamma situation you would like to find yourself in.  There is no right answer, because there is a time to buy and a time to sell options.  But I encourage you next time you make a trade, whether it be a single option or a spread, take a look at your Gamma and watch how it behaves as you progress towards expiration.  Also remember that gamma is greatest in the at-the-money options, which means you will see your biggest change in delta the closer the option is to the stock price.  Gamma is also greatest in those options right before expiration, because remember that an option will either have a delta of 1 or 0 at after expiring and the gamma will help dictate how fast it will change.

Hope your tryptophan high has allowed you soak up this data like a good gravy on stuffing; have a great weekend!

But with all that, my grandparents recently bought a new home and are quite happy to have paid 70% less than the previous owner who bought it 16 months before they did.

The point here is that value, in many ways, is subjective. Obviously there is going to be factual data that will influence the worth of something or one’s decision to buy or sell, but like homes, stock prices are determined by emotion and belief, much of it based on some sort of forward-looking thesis, (i.e.  back in the late-90s, everyone knew – or believed strongly – that the Internet was going to change the way we do business and be the next revolution in our social fabric.  The masses then bought, with almost no research whatsoever, any stock that ended in “.com”).

It could have been fuzzybunnyslippers.com that wasn’t making a dime and the stock may have gained 200-500% in a matter of weeks or months, with no fundamental data or earnings even to support such a valuation - just hope.

Part of what has happened in the real-estate market can be attributed partially to the “future value” fear that many Americans had.  Obviously this fear was not unfounded, but I am positive that it accelerated an already deteriorating situation.

Most of what a “market guru” does is realize when a situation may be a bit overdone (expensive or cheap), then takes advantage of that situation using calculated risk.  I have always realized my greatest returns when the market was in a buy frenzy or a sell frenzy and I took a contrary position.

Using this technique does require a bit of skill and also an understanding and examination of the behavior of the masses and how they have tended to act in the past.  I am not saying that the past tells us exactly what will happen, but it offers us a glimpse into the behavioral characteristics of market participants, allowing one to make an educated judgment or bet on the next move within a specific time frame.

As a long-time bull, I tend to take long positions. This would also be the norm for the majority of market participants. Currently, I believe the American economy is on the mend, and if you ask me where the S&P 500 Index (SPX) would be in a year, I would say there is an 85% chance it will be higher than its current level of 1108, 70% it would be higher than 1160, 50% higher than 1200, etc.

Options traders must not only decide if they are bullish or bearish, but also ask the question, “How bullish or bearish?”  Based on the answer, traders should then use the appropriate strategy that coincides with this sentiment. If you asked me where the the SPX would be by December 31, 2009, my outlook might look like a 20% chance it will be at its current level, 5% chance higher than 1160, and so on.  For me to just go out and buy SPX futures or SPY shares might not be the best use of my money based upon my hypothesis.

Let’s go back to real estate. Let’s assume that you currently wanted to invest in the Florida real estate (which is still on shaky ground) because you believed values were on the rise.

1.  Would you go out and just start buying up tracks of housing? Paying full price?

2.  Would you buy (call) options and pay the home seller a nominal amount to purchase their house slightly higher than it is now for the right to buy it at that price for the 18 months (If the price rises above your call option price, you get to keep that profit, while only risking the premium you paid for the call option)?

3.  What if there were housing futures you could buy options on that allowed you to make 30% annually as long as the housing market prices stays stable (Maybe a housing ETF such as the UMM or HGX)?

Around 80% of you probably gravitated toward the third section, while 18% could have selected the second question, and 2% would just go buy houses.

What I find interesting is that 85% investors use Section #1 to invest in the stock market.

Think about this concept and run it by your family at the Thanksgiving table. Give them the quiz and see how they respond.  Chances are that if they understand the second and third concepts, they will chose those selections.  The folks who fail to understand the concept will gravitate toward the first section, which is the one with the highest amount of risk and exposure, and it is this option that causes people to panic more so than the others, because of the risk of losing considerably more money.

Options can be powerful risk-reduction tools, so learn them!

Happy Thanksgiving! I’m off to bake some sweet potato pie!

In a weak dollar environment, U.S. goods (exports) become comparatively cheaper for foreigners to buy, so U.S. companies that are large enough and have the ability to sell these goods to buyers around the world stand to benefit.  In turn, U.S. companies end up selling more goods overseas and thus improving their earnings picture and rewarding their common stock.  This process can be complicated by several factors such as where the company has factories, its labor force, etc. 

The weak dollar will also obviously cause foreign goods to become more expensive here in the U.S.- this would put a damper on imports.  Being that the U.S. is the “world’s consumer”, discouraging its purchase of goods from other countries may not be in their best interest either (as long as the US continues to consume).

This is a delicate balance, that, frankly, I try to not spend too much time on, because finding the right answer, in my opinion, is impossible because most solutions have their shortcomings. Also, as the world evolves and political processes, beliefs, energy solutions (that’s the big one) and global economies shift, this will be an everlasting argument that always be sure to spark debate. 

When it comes to the dollar, most Americans I believe, should favor strength for obvious reasons. 

Low borrowing rates mean low savings rates for Americans, with a weak dollar. Americans, in turn, will be saving less because they are spending more on food and goods as well as earning less both in interest as well as the actual value of their savings.  This will force many to take more risk in investments, which could have catastrophic monetary and psychological consequences if those investments don’t pay off or lose value.  Think about the ramifications of another huge wave of Americans defaulting on their mortgage and debt obligations.  Our savings rate, even though it has risen as of late, is still dangerously low.

The government also has quite a bit of debt to service; a weak dollar wouldn’t benefit the boys in Washington either.

But, I digress…

We have to play the hands we are dealt and exploit the situation before us and the fact of the matter is that between materials, industrials and energy you have almost 30% of the S&P 500. These sectors will benefit the most from a rise in commodities stemming from a weaker dollar.  Gold and oil have historically been a hedge for a weak dollar and/or inflation because of their global usage and dollar denominated value.  The FED has indicated that it will be some time before rates begin to rise again and if the world continues to claw out of the “global recession,” demand for both these commodities will continue to rise.  I would remain long both, but reduce most exposure to out-of-the-money put spreads as there may be pullbacks along the way.

DELL is the world’s third-largest PC maker and these earnings are a contrast from the strong results recently previewed from its larger rival, Hewlett-Packard (HPQ).

DELL reported a net profit of $337 million, or 17 cents a share, for its fiscal third quarter ended October 30, down from $727 million, or 37 cents a share, in the year-ago period. Regardless of what the numbers were, the stock is down sharply and, at least for now, is bucking its recent trend as well as defying analysts’ expectations.

This past Tuesday, I was scanning the IGP to find something interesting to bring to all of you.  I found the Jan 14/12.50 put spread, an interesting play ahead of this earnings report. As noted in our trade idea, no analyst had DELL rated as a “sell,” not to mention the stock was up more than 14% in about a two-week period.

Sometimes you have to look at the situation at that moment in time and be careful to not just act based on what is on the surface. Analysts, do just that — they analyze data, many times using models that create projections and estimates, based on various inputs and research that they do. But just like you and me, they are forming an opinion.

Granted, it is hopefully an educated and researched one, but still an opinion nonetheless. If you have been following DELL or have a strong fundamental or technical view on DELL that contrasts what the analysts are projecting, don’t be afraid to apply your theory. Depending upon how much conviction you have in your theory, chose the appropriate options strategy that meets your risk appetite.

Remember the Hindenburg … this may be a grim reminder, but think about the countless hours it took the teams of engineers and designers to manufacture the largest flying machine ever built. All that time and effort failed to catch the flaws in the skin and coating, which were the main factors in the horrible incident, but I digress.

Just because an “analyst” says so, does not mean it will happen.  In the short-term, analyst upgrades and downgrades may have an effect on prices, but earnings and perception of a company’s business are typically the last word when it comes to a stock’s direction.

As for the spread trade we recommended on Tuesday to purchase at 23 cents, it hit a 40-cent bid this morning as the stock dropped, a 74% profit in three days. Don’t forget there is a beginning and an end as well as a winner and a loser in every trade; this one proved to be a winner.

Many of us want to be connected to our email, messages, internet, radio, camera, gaming, and even TV on our mobile device.  As we become more and more of a wireless culture and depend more on having these tools at our fingertips, we need to have inexpensive, seamless access to these resources and this is why demand for smartphones is expected to rise.

The three companies that I favor in this space are Research in Motion, Limited (RIMM), Apple (AAPL), and Google (GOOG).  Each company is unique in what function it serves in the space and in this article you will find some of my talking points on each of them and the sector.

There are many other players in this space, all with unique products and services, so I urge you to explore them as well.  Competition will always be there and market share may be lost, but it is the size of the marketplace (which has only been penetrated mildly) that offers the most potential, in my opinion.

Let’s first examine the 90/10 Rule when it comes to typical usage.

• Calls and email/messaging 90%
• All other apps 10%
• RIMM is great at the 90% part and its torch mobile acquisition earlier this year should help with their web browser experience, which is lacking
• AAPL excels at the 10% part
• GOOG fills in the blanks on both with its applications (mostly through apps and email)

RIMM, AAPL & GOOG

1. RIMM: pure wireless play, should earn $5.00 (analysts expectations) by February 2011 and at a 15 multiple, plus $5.00 in cash, you have an $80.00 stock

2. AAPL: more blended company that should capture a fair amount of the wireless smartphone business.  AAPL is currently a one-trick pony when it comes to wireless, but its other products will help to support the company if the wireless smartphone theory doesn’t come to fruition.

3. GOOG: no hardware as of yet, but a great ancillary beneficiary to the entire move toward smartphones.  And like AAPL, Google has its hands in many different pots and unique revenue streams, which it still needs to expand on.

Here are the general points

• 165 million smartphones are projected to be sold in 2009; this is projected to increase to 430 million-plus in 2012
• AAPL and RIMM already have proven legacy technology and reliability with their products and operating systems
• RIMM and AAPL have the capability to cannibalize and integrate other smartphone companies’ ideas (of course, this could work the other way as well)
• RIMM is slower to bring new products to market, but products are stable, dependable, geared towards business users
• AAPL’s i Phone is geared towards techies, the young, and artistic types.  Currently, there is limited carrier distribution, but exclusivity is expiring overseas in 2009 and here in 2010*
• GOOG should reap benefits, not only from android phone sales, but with the integration of its services, derive revenue from ad sales and subscriptions.
• The android open source operating system will most likely be the largest of all phone systems, according to many analysts.
• Phone companies typically pay the high”average sales price” (ASP) for a phone,  which is much higher than what the consumer pays. This is subsidized by the carriers themselves, as trends are showing ASPs  decreasing over the next couple years.
• The volume of phones sold will increase as global market penetration moves from about 15% currently to 28% in 2012*
• The iPhone not catching on well in China, so RIMM may emerge as a better contender there, however, there is a mass of competition there which makes entry difficult.

*estimates

Out of the three, RIMM is the most pure wireless play and has seen its stock battered and bruised, which is completely contrary to what GOOG and AAPL’s stocks have done.

As a contrarian, I may look to RIMM as my stock of choice for a pure play, using out-of-the-money short puts to acquire the stock at a discount.

Analyst Jonathan Chaplin said that S will benefit from sharp cost cuts, stronger sales of prepaid service and better retention of “postpaid” customers who sign up for annual contracts. The company has been losing as many as 1 million postpaid customers each quarter throughout the past few years, a number that CS expects to shrink. In related news, S said it paid down the $1 billion it owed on a $4.5 billion revolving loan and that it no longer has an outstanding balance (according to a Marketwatch.com report).

S is currently followed by more than 18 analysts, four of whom rate the stock as a strong buy, 12 as a hold, one as a moderate sell and one as a strong sell (this data as of end-of-day Friday).

The stock has been in a technical bearish trend both in the near term and during the past couple years, although it did recover somewhat earlier in the year. There has been a 20% nominal gap between the implied and historical volatility of S, with the implied volatility averaging about 78% and the stocks observed volatility coming in around 56%. Maybe those downside puts were a sale after all. S has been more volatile over the past week and with the 10.5% move today, observed volatility is on the rise again and the two lines are now intersecting.

But this article is not about volatility or charts necessarily; it’s about anecdotal observations combined with fundamental evidence of a company doing well and it not being realized yet in the stock price. While it can be dangerous to just take a couple opinions and make your decision to buy or sell a stock, I could not help but share this story as a S customer.

S is currently losing money – granted, its much less than last year – but this is certainly something we must take into consideration, as it can be extremely difficult for the average investor to create a pro-forma forward looking earnings expectation along with a P/E multiple that the market will find acceptable.

Having been a customer, and an extremely passionate one, since early 2008, I have noticed S making strides to retain customers and launch new and exciting products in the marketplace, including the Palm Pre, Blackberry Tour and HTC hero among others. I went to 19 different Best Buy stores and Sprint stores in five different cities and parts of the U.S. and observed the way the sprint customer service agents represented Sprint and its services and listened closely to customer feedback as well. I pay attention to casual conversations over the past year from dozens of different people from different social and economic backgrounds when they are talking wireless, I read through hundreds of blogs and tweets about S and its competitors.

I also noted the ratio of people in my social circle who use S currently versus other wireless carriers. While I did not write down every single thing that people said about S, I was able to weigh its advantages and disadvantages in the marketplace and form an overall opinion about the company and maybe help my decision making, or at least give me some confidence. If everything I heard about the company was negative, I would be less likely to buck the bearish trend and place a bullish strategy on the stock.
The fact is that S is far from perfect; they have been bleeding customers for some time now, but the company is doing everything they can to stop this bleeding and begin to grow again. While I think the upside is in the stock is limited in the near term there may be a place for S in the long term, with their competitive rates, improving customer service and retention along with solid coverage and speed of its 4G networks.
Maybe I might sell the 3-strike puts in December for 10 cents.

The anecdotal evidence I observed has partially manifested itself and may continue to do so, but I want to encourage all of you to be sure that you know the companies you are investing in and understand the business they are in if you are investing in them. Go to their websites, walk into their stores, use their products and read the research reports. Also, go with your gut. Many experts might disagree, but intuition and contrarian or forward thinking is a large part of investing.

As for the wireless space, I would be focusing more on the phone makers than the wireless providers for the global trade; more on that to come.

Before I place any trade, whether it be options or stock, I asses the fundamental climate of the marketplace and the individual stock itself.  DIS, for example, has been cutting costs and changing the way it makes and markets moves in our current economic climate.   In many ways, buying DIS is placing a bet on economic recovery in an ancillary way, which I am bullish on the economy as a whole, save some exceptions.  DIS’s parks and resorts are a moderate chunk of its revenue and as attendance rises in the parks and folks spend more money at those parks and resorts, the company stands to benefit.   The economic ramifications also will manifest themselves in Disney’s studios , consumer products and lastly in its media division comprised of Disney-ABC, ESPN and its internet group. ABC ad rates are 20% higher than last year by the way. Theme parks didn’t fare so well; their profit fell 17%.

But there has been positive data (green shoots) beginning to emerge from several areas, including retail, media and even in tourism.

The markets are extremely efficient, certainly far from 100% efficiency, but generally efficient enough that information is digested and interpreted the best way it can, finding a valuation and multiple for the stock itself.  Most of the opinions that we form about stocks are shaped by the analysts and by the media.  Having a more bullish or more bearish opinion about a stock is not a bad thing, just make sure that your rationale for doing so is justified.  

With DIS, I looked at the past six months of performance in the stock versus its competitors. I also took a look at the company’s past activity in terms of percent gains over certain period of economic ebbs and flows and how it responds to certain data, if at all.

Once I have my basic fundamental opinion, it’s time to start taking a long hard look at some technical and statistical data.   At the end of the day, price is paramount.  One could have a strong stock that is growing with cash on hand trading at a lower multiple than its peers for one reason or another.  Sometimes, it may take a while before the most <em>appropriate value</em> is found for a company.

DIS is not typically a big mover over earnings reports,  as it moves around 5% on average.  The third quarter is also not one that I think would carry the same weight as a fourth-quarter report, which really takes into the holiday season, where DIS might be expected to perform a bit better.

 Disney shares are about double their March lows and they were up close to 4.5% to $30.40, surpassing the $30-mark for the first time since October 2008.

For this strategy, I have a moderate bullish view on DIS and wouldn’t have minded owning the shares down around $27 (28-strike minus premium).   Even after the volatility crush we are seeing this morning, the at-the-money calls are still yielding $1.10, or 3.6%, over a 35-day period.  If I had to get long the stock, I would immediately sell the at-the-money call and further reduce my $27 price point down below $26, which would put me at September levels.  Furthermore, DIS’s Monthly ATR is normally around $4. A move like that would have an extremely low probability (20%) by January, which will be about the time, where I could sell another call if I was not assigned on the first.

The point here is that with a little fundamental data and some contingency plans, you can generally find a way to trade anything – even Mickey Mouse!

Have a great weekend!!

This theoretical value is ever-changing and there is no “right price” for an option ever that still contains time value, because one never knows what will happen.  In other words, NO ONE knows exactly what the time value of an option should be.

To simplify, time value is determined by the amount of implied volatility assigned to that option, in addition to days until expiration, dividends, and interest rates.  Another word for time value is “risk premium.”  Options are not only used to speculate on a stock’s move, but also to provide protection either to the upside or the downside.

This protection factor is the reason why out-of-the-money puts tend to be more expensive than their same-delta call cousins, which are also out-of-the-money.  This is not a hard-and-fast rule, but tends to be the norm, rather than the exception.

Think about your friends who invest and trade stocks.  Chances are that a greater percentage of them tend to be long side traders, or they typically prefer to be long stock versus short stock.   This is a normal psychological tendency as well, both from a logical perspective (one would typically want to buy good American companies as we are taught this from our early market education)  and from a risk perspective (if you pay $30.00 for a stock, you know no matter what happens, you can only lose that $30, whereas when you short stock at $30.00, your loss potential is theoretically unlimited.  This can be hard for most human minds to quantify and thus most shy away from this practice.).

The bottom line is that because most of us tend to take long positions, the put provides the only downside protection for us and thus costs more typically, because the fear of a stock going to zero is often a more widespread fear compared to the fear of a stock doubling in value.  Remember, like stocks, supply and demand drive options prices.

This is why puts tend to cost more than calls of the same delta, when they are out-of-the-money.  Now on to the original question posed.

Why is implied volatility for the Financial Select Sector SPDR (XLF) (vol mean 34.63%)  about 67% greater than the implied volatility for the S&P 500 Index (SPX) (vol mean 20.69%)? As all of the stocks in the XLF are part of the S&P, one might think they should be much closer.

This gets back to some simple logic and some other not-so-simple algorithms.  The SPX is comprised of 500 unique stocks in several different sectors.  The chances of all these stocks moving in perfect unison in one direction or the other is much less than a small group of, say, 30 stocks.  Thus the larger sample size of companies offer a quasi-hedge to one another and thus lower implied volatility or risk premium, because essentially there is less risk of a catastrophe affecting such a large collection of issues.

In the XLF,  you have a concentrated index of companies in the same sector (a sector that has recently been more volatile than in the past).  This increases your exposure and reduces your hedge, and the chance of a catastrophe affecting that index increases due to the lack of a hedge.  So aside from the fact that financials have been a mess for the past two years, a smaller, focused index will tend to have a higher implied volatility than a larger, more diversified one.

In just about all cases, implied volatility tends to be higher than the actual observed volatility, which is why most professional options traders tend to be better sellers of options, while having limited delta exposure,  I know I am.

Cheers!

The Dow Jones Industrial Average has broken through its 2009 high and continues to plow higher.  I feel the Dow – and the related Diamonds Trust ETF (DIA) -  are flawed and do not really  represent the broad market in the most accurate or efficient way most of the time as they  are a group of only 30 stocks, which are weighed by stock price, not market cap.

But I’ll go along with the masses in this case and break out the bubbly for the new 52-week high in the DOW today.   If you’re stuck on the DOW, maybe try following the S&P 500 Index (SPX), as it tends to be a bit more accurate in its depiction of true overall market strength or weakness.  Both the SPY and DIA are extremely liquid products and great to trade both stock and options on regardless of your opinion on the indexes composition.

My good pal and fellow trader Kevin Cook called it in his article (link to Kevin) last week after the Fed meeting citing five reasons why the market should be moving higher here.  While I have an immense amount of respect for and partially agree with Kevin, I am also a statistical nut and my derivatives-driven nature forces me to want to increase my hedge the more something keeps going in one direction.

It really boils down to your time horizon and exposure.  In reality, most of investing really comes down to these two things, but for some reason, they are often not given the time and dedication that they deserve. Understandably, because everyone has unique time constraints and risk tolerances. Not to mention it’s much easier for the analyst or TV personality to appear correct if they just say I like the ABC stock here, even if it takes a year for the stock to rise 10% after being down 8% for 10 months. 

As for me, I tend to be a shorter-term trader, focusing my view about 1-7 days ahead.  Obviously, I have longer-term outlooks as well, but for my media appearances and for these articles, my outlook is generally very short term.   I have the belief that finding short-term trends and patterns is just as easy as making longer term directional calls. The intermediate-time frames, I have found to be the most difficult to predict  (just my opinion here).

With that said, I concur with Kevin, that the Fed’s lax wording and indication that rates will remain low and liquidity high, should bolster commodities/stocks.  (Energy stocks currently comprise 12% of the S&P).

With the broad markets near their highs for the year, I would be adjusting my long stock and long call positions to less expensive, less risky long vertical call spreads out in February-May of 2010 as well as selling puts here in November and December.   The Nov 106/107 puts in the SPDR S&P 500 ETF (SPY) are yielding an annualized 10-15%, respectively.

For every share you own you are long one delta, which means for every $1 the stock or index moves up or down you make or lose $1.  You also are exposed to risk at whatever price you own the stock at and all the way down if the stock were to fall to zero.

When the markets begin to look a bit toppy (even if there is still room for upside), you can always reduce your risk by reducing or selling your stock and purchasing a call spread, which might have a delta of +/-0.20,  which means you will make or lose $0.20 for every $1 the underlying stock or index moves.

The point here is that even if you feel we could squeeze a little more to the upside, I would recommend limiting  exposure to the downside, using spreads such as bull call spreads or collars or short puts even (short puts are like covered calls in that you are still exposed to the downside) may help reduce your risk if we see a 2-3% correction.  Not to mention it will preserve the 40+% appreciation the market has seen in the past six months.  I’m still bullish, just reducing my delta exposure here for the rest of the year.

Here are some points to coincide with my point of view on gold the commodity and the related ETF, the SPDR Gold Trust (GLD).

• A weaker dollar has been key in gold’s rally, as the yellow metal is being recognized as a quality global currency.
• The GLD is up 38 points (54%) in the past year; this may seem extraordinary, but it also dropped 30-plus% from its peak in early ‘08.
• Fed’s policy and strategy will be tough to call, but rates are indicated to remain low for an “extended period of time,” which will in turn help to keep a strong dollar at bay.
• More central banks may look to shift into gold and out of the dollar – India made the first high-profile move.
• Barrick Gold (ABX) is removing their short gold hedges … more than one million ounces in October, with more planned.
• Gold does not have the industrial usage of silver or copper, but is more of a safe haven.
• GLD holds actual gold bullion:
  • Started five years ago
  • Expenses are 0.4% per year
  • That equates to a GLD trading at roughly $22.00 discount to gold itself after the 10 times multiplier
• Gold is minimally correlated to markets (or negative at times). This also is a benefit if you feel markets may be a bit overheated.
• On a fundamental basis, gold should remain in demand through the holiday season, as usage rises globally during the holiday season (side note: India sees increased demand in October as well).
• Traders are still concerned about inflation and government spending.
• Currently, GLD is slightly overbought in the short term; it is outside of its upper Daily Bollinger Band.

I still like owning GLD here and I would enter by selling the November 105 puts. If you must be long, you might consider buying the March 105/111 call spread for $2.55. This strategy will return 135% if gold gets above 1,100 by March expiration.

The VIX has undergone some changes in its lifetime, from first measuring at-the-money implied volatility in S&P 100 Index (OEX) to now using a complex formula to predict the next 30 days of volatility of the S&P 500 Index (SPX).

I will be the first to tell you that I am certainly not a math professor, nor did I create the VIX product, but I have been using it for many years now and am impressed with the options product that was created around the VIX. The mathematical laws that govern the world of options tend to be the same no matter what the product is.

There are many nuances to trading options on the VIX versus trading plain vanilla calls and puts on most standard equity or index issues. While the VIX is a fantastic product, it requires a bit of homework to trade. I believe it was created to serve the professional as opposed to the average retail investor, but that is not to say it cannot be traded by any home gamer out there with the appropriate amount of due diligence.

Here are some of the unique characteristics of the VIX options:

The vertical skew, or change in implied volatility as you move up and down the strike prices in the same month, is extremely positive, to the point where upside call strikes have a volatility variance of more than 110% from the 30-strike call up to the 60 call in December for example.

The downside, or out-of-the-money puts, are skewed down, which is not typical. In fact, the VIX skew profile looks more like a stock that is being taken over (no one is worried about the stock dropping). The at-the-money puts have 80% higher implied volatility than the calls today, which looks much like an impossible-to-borrow stock (when a stock cannot be shorted, puts become a proxy for short stock positions, which in turn raise the price of those options).

The implied volatility of the VIX options themselves is all over the place and very high. The average at-the-money implied volatility right now in the front-month options is about 90% (average). This implied volatility can change very rapidly as well.

You essentially have a product that is measuring 30-day future volatility (or variance) on a cash-settled index, using an amalgam of the first two months of options prices that are trading. The behavior of the VIX typically has an inverse relationship to the underlying index’s directional movement (when the SPX is up, the VIX is generally moving lower), then you have the implied volatility on the VIX options moving inversely to the direction of the VIX, which can then impact the pricing of the options you bought or sold in an adverse way.

In other words, if you buy calls on the VIX, and the VIX rises, chances are that the implied volatility of those calls will drop, negatively affecting your position. Conversely, if you bought puts and the index drops, then volatility will generally rise, but those put are already priced 60-80% higher than the calls, so is it really a great deal?

Money can be made in this product and I certainly support and respect my friends who trade and make markets in this issue, but please do your homework before firing off a trade in the VIX because you heard it on TV.  If you do decide to trade the VIX, be sure to use limit orders as the bid-ask spreads tend to be wide as well.

There are simpler ways for the average retail investor to buy volatility. Also remember that the VIX is a fantastic indicator of general short-term market volatility, but there will be exceptions as you look through individual stock issues and indexes. As for right now, I would be a moderate seller of volatility. The average volatility of the SPX for the past 20 years, should fall somewhere around 19-20%…

Option Chain for VIX - November 2009, courtesy of OptionsHouse.com

]]> http://www.onn.tv/practical-options-trader/buy-calls-on-the-vix/feed/ 0 http://www.onn.tv/practical-options-trader/cit-group-inc-cit-put-options-active-152/ http://www.onn.tv/practical-options-trader/cit-group-inc-cit-put-options-active-152/#comments Mon, 02 Nov 2009 15:28:37 +0000 Jared Levy http://www.onn.tv/?p=421727 For some time now, CIT Group Inc. (CIT) has struggled to avoid entering into Chapter 11 bankruptcy.  On Sunday, that battle ended as the century-year-old bank holding company moved forward with a prepackaged reorganization plan.  Expectations are for the company to emerge from bankruptcy by the end of the year … I think I heard the same thing about GM…

The majority of CIT debt holders support the re-org, which may position the company with a leaner debt load and streamlined capital structure.  While the bond holders may support this decision, the shareholders, who are lowest on the “bankrupt payoff” totem pole, will most likely be completely wiped out.  In other words, as the stock is delisted and eventually ceases trading altogether, their equity will be gone.  Certainly not a positive outcome for the equity holders.  But what of the traders and investors who own puts in CIT?  While their investments may have paid off, now is not the time to be greedy.

The stock traded as high as $6.62 in the past year and options do continue to still trade.  Today is the last day the stock will trade as CIT on the NYSE.

At the end of the trading day, CIT stock will be de-listed from the NYSE and move to its new home,  trading on the pink sheets, an electronic over-the-counter marketplace (pinksheets.com).

I contacted the NYSE and PinkSheets and they informed me that they do not yet have a symbol, but one will be created later today.

Today, options are trading normally. Tomorrow, however, while this stock continues to trade, you will be able to sell your puts in a closing-only transaction. The puts will most likely have a wide bid-ask spread in relation to their price, because of the lack of liquidity as well as the inability to short pink sheet shares as the market makers will need to hedge those trades.

The other scenario is if the courts decide to completely remove the shares from trading all together.  This  scenario may be the ultimate fate of CIT’s existing shareholders.  For an example, we can use the January 5 LEAPS, which are now regular options.

Let’s assume you paid $1.00 for those options late last year.  In this situation, the puts should settle into parity or their intrinsic value upon a complete delisting of the stock altogether.  So if you own the January 5 call, it will be worth its strike price, or $500.00 per contract (because the stock is 0).  This ultimate fate may be months down the road and while you may get a couple extra pennies or nickels if you hold your put options until that point, it may behoove you to sell them now using a limit order.  As you can see by the OptionsHouse options chain, the January options are trading for parity, which means all time value has been removed.

This just in: Here are the trading symbols for CIT Group, effective tomorrow, November 3, 2009:

• CIT Group, Inc. (The) – CIT – NYSE – New Symbol – CITGQ – piggyback qualified for Pink Quote (Common stock)
• CIT Group, Inc. (The) Pfd A – CIT$A – NYSE – New Symbol – CITBQ – piggyback qualified for Pink Quote (Preferred)
• CIT Group, Inc. (The) Perp Pfd C – CIT$C – NYSE – New Symbol – CITDQ – piggyback qualified for Pink Quote (Another Preferred)
• CIT Group, Inc. (The) Units – CIT$Z– NYSE – New Symbol – CITEQ – piggyback qualified for Pink Quote (A type of bond)

While production is great, being able to sell all that production at a high price would be even better. Analysts as well as I believe that natural gas should be moving higher, but the question is when and how far. As U.S. and global economies continue to recover and demand rises, natural gas usage should follow suit. It is also a clean energy alternative.

The weekly chart below of shows natural gas futures have gained 216%% since the September low and the 200-day (40-week) moving average is perched at 3.887. I believe there is some small technical resistance slightly above this level, close to the $5.50 area.

As for CHK, for this trade, the focus is the earnings report due out Monday after the market close. Analysts are expecting $0.65 versus $0.85 the previous year. CHK has a habit of making its moves the day before and the day after, which is key when monitoring and exiting this strategy.

CHK does NOT tend to be a big relative mover over earnings with the average coming in around 5.5%, although the May report caused the stock to rally 15%, then drop 11%, then rally again. Today, the stock is down $1.05 to $24.98, and the chart looks a bit oversold here. This will cause me to be less aggressive with my long put and open the long side up a bit.

On 10/27/09, we saw the January 2011 30.00 calls trade over 35,548 times against open interest of 4,056; this volume came through with the stock at $26.34. I thought this was curious activity, looks like predominant selling based on what implied volatility has done. The 30 mark is the 52-week high in CHK by the way…

For this trade, I am looking at buying the November 24 put for $0.85 and selling the 26 call for $0.70, which will cost $0.15. This gives you limited downside ($0.88, from current price of $24.88) and allows about $1.12 of upside in the stock.

If you want to just lock in the stock’s current price, you can sell the 25 call for $1.25, which would net you a $0.45 cent credit, but completely limit your upside in the stock. This would be the strategy if you thought the risk was greater that the stock would drop. I personally would be looking at the 26 call . Remember, be sure you own the stock below the call that you sell to prevent your stock being called away at a loss.

Photo By http2007/Thierry

After last night’s close, Wynn Resorts (WYNN) reported third-quarter earnings per share (excluding one-time items) of $0.33, easily beating estimates by 18 cents; revenue was fairly flat compared to the same period one year ago. The Vegas-based Wynn Encore proved to be a bit a boost to the report, (or perhaps “bit of a skew” might be more appropriate). Even though WYNN was generating more hotel revenue with the 2000+ new rooms at Encore, WYNN saw drops in its average daily rate, occupancy levels, and revenue per available room. Occupancy was down to 83.9% from 96.1% during the same period one year ago.

WYNN’s total cash on hand at the end of September was $1.3 billion. Debt stood at $4.2 billion, with $2.7 billion coming from Wynn Las Vegas and $1.5 billion from Wynn Macau. Las Vegas was flat, while Macau was growing, according to CEO Steve Wynn. Mr. Wynn was extremely cautious in his future outlook for growth and noted the struggles that Vegas was facing – especially with mid-week occupancy – with the weak economy dramatically reducing the number of conventions, meetings, etc., which contribute quite a bit to the bottom line of many of the large casinos.

Anecdotally, on my last trip to Vegas, it was not hard to notice the lack of patrons in the casinos, bars, clubs, and shows. Aggressive sales on goods, drinks, food, and rooms were prevalent and the trip cost me about 30% less than the average I spend when I am there.

As for the trade that I discussed, the stock did exactly what we wanted it to do. The stock now sits at $56.50, almost $10.00 away from where our maximum loss would be (at $65) in the Iron Butterfly. If volatility continues to dissipate and the stock stays below $60, we will be in good shape.

You can most likely sell the Butterfly today at $4.30 if you want to make a quick 8% on the trade.

Looking to tomorrow, Las Vegas Sands (LVS) reports earnings. Most likely, the picture will look much like WYNN, I suspect.  Yesterday, we saw heavy action in the LVS November 15.00 calls, as more than 7,789 traded versus open interest of 2,139.

I would have to lean more toward the sell side here, but suspect any selling may not be quite as aggressive as the movement we saw today in WYNN.  WYNN, I believe, eliminated most of the “surprise” factor from the sector and hopefully the shock that WYNN caused will mitigate the effect of LVS earnings.

I am looking at the 12.50/10 Bull Put Vertical Spread in November , selling it at $0.45, with a max risk of $2.05. Statistically, based on the past 30 days of historical volatility, there is a 30% chance the stock will get below my breakeven point. If it does, I would be okay with owning LVS down at $12.05, and then beginning an aggressive covered-call regimen.

Be sure you understand this strategy,  do your homework, and understand your risk before applying any options strategy.

Wynn reports earnings tomorrow (this was just confirmed) and the stock has been moving lower in the past month or so after hitting an annual high of $74.90. This stock has come a long way over the past year; I remember recommending a 15/12 bull put spread back in February on CNBC . And 266% later, here we are at almost $65.00, about $10.00 off its 52-week high.

Wynn has also experienced a wave of good news over the past couple weeks, including credit ratings boosts from Moody’s (to Ba3) and Fitch after Wynn raised $1.87 billion for Wynn Macau, Limited.

There has been a change in the tone of Vegas and Macau, as Vegas casino operators have dramatically slowed their growth and Macau, which saw gambling revenues peak in August, is also considering raising the legal gambling age as well as putting limitations on the location and amount of gambling tables. Slower expansion by competitors in Vegas and restrictions in Macau (China also lowering other restrictions) may benefit the operators with properties already in place.

But this strategy is not a necessarily a fundamental one. The markets are currently taking a dive from the highs today, led by the financial sector. Wynn tends to be a big mover and I thought about an interesting limited risk, limited reward trade on Wynn.

WYNN tends to move more than 14% on average following earnings releases and the last couple earnings reports have been catalysts for even larger moves. My thought process was to keep it simple here, getting minimal risk for decent reward.

I don’t think that WYNN will be at $65 by expiration in November. I am examining the 60-65-70 Iron Butterfly, selling the wings. It’s a five-point fly, so the max it can be worth is $5.00. I essentially will buy the 65 straddle and then sell one 60 put and one 70 call for a net cost of $3.95 (you may be able to get it a little cheaper). My breakevens are $68.95 to the upside and $61.05 to the downside, if WYNN goes outside of those areas, I will be profitable. If WYNN ends up below 60 or above 70 on November expiration, I will make $1.05 (or 27%) in less than 25 days.

Let’s see what happens tomorrow. Happy trading.

Apple sold 3.05 million Mac computers last quarter, which was a 17% unit increase over the year-ago quarter. The Company also sold 10.2 million iPods during the quarter, which meant 8% fewer units sold from the year-ago quarter.

In the iPhone department, Apple sold 7.4 million in the quarter, 7% more than in the same quarter last year. This news has sent the stock from the $190 level on Monday to its current level of $206 today. Yesterday, we heard news of a patent infringement lawsuit from Nokia (NOK) against AAPL and others, but this had minimal effect on the stock, which continues higher today. As I stated on Monday, I liked Apple, but wanted to get a little edge in the trade and reduce my risk versus just going all in and buying the stock.

Remember, when you buy stock, you are buying one delta for every share. Essentially, it’s the most bullish you can be. Since options typically control 100 shares of stock, let’s assume that if we bought 100 shares, we are all in -100 shares, 100 deltas, and risk is whatever we paid.

If we buy 100 shares of AAPL at $190, at all times we have that much money at risk. Ahead of an uncertain earnings report, this could be exposure that you don’t want. On Monday, the second strategy I offered readers, was buying the 175/195 Risk Reversal for $1.60. In detail, this means I would buy the November 195 call and simultaneously sell the 175 put. Synthetically, this position has much of the same characteristics as long stock, but with less risk and less capital outlay; let me explain.

Remember earlier, when I talked about how 100 shares of AAPL purchased at $190.00 have a 100 delta? This meant you are all in and you are making (and losing) a dollar for every dollar the stock moves up and down. The breakeven on that trade is what you paid for the stock, or $190 in this case.

If we look at the risk reversal, you are short the 175 put, which obligates you to buy the stock if its trading at or below 175 on November expiration. Then we purchased a 195 call, which was out-of-the-money at the time. The entire trade cost us $1.60 at the onset, although that is not the most you can lose.

Let’s say that both options had roughly a 30 delta. We sold the put (all puts have negative deltas, as they move opposite to the stock) so with that part of the trade we were long 30 delta. Then the purchase of the call added another 30 deltas to our net position. Now we are long 60 deltas or about 60% in, if you will. This doesn’t mean that if AAPL drops to 100, we will only be exposed to 60% of our risk. Below 175 and above 195, our position becomes like stock. Our breakeven in this trade is 196.60 (our call strike plus what we paid) our position will just expire worthless if AAPL stays above $175. I like this part of the trade, because it lowered our downside breakeven to $176.60, which gave us a nice cushion going into earnings.

The beauty of this trade is that it has unlimited upside potential and is now marked at $11.80, which represents a 738% return in five days on less than a 10% move in the stock. Leverage can certainly be a good thing if you know how to manage it.

Remember the VIX is a measurement of volatility looking forward 30 days. This can be deceptive to some traders who use the VIX as a fear gauge. Being that the VIX is only looking 30 days ahead, one’s sight becomes hazy moving out in time. In essence, we have to look a bit deeper and see where implied volatility stands in the back months.

With that said, the VIX hit a new 52 week low today, down to 20.10%. As the old adage goes, when the VIX is low, “it’s time to go,” or exit your long positions. But then again, looking back 52 weeks, the VIX may seem low, but looking back three or so years, we are still relatively high, as the VIX was trading at nearly 10% back in early 2006.

It was a different time back then, as irrational exuberance was beginning to take control of the marketplace; can we compare that to now?

I must say that in our current climate, even with all the “good news” and “better earnings” we have been seeing, we are not out of the woods yet. The VIX is said to measure fear, but I like to say the VIX is really measuring uncertainly and expected movement in the S&P 500 Index (SPX).

At 20%, given our present situation, I would say it may be a trend that we have been seeing in the CBOE SPX Volatility Index (VIX); we have broken through the 22% support level that held for some time. I do not see the VIX falling much below 19% in the next six months and I would be cautious with my long positions here.

Also, don’t forget that the latter part of the week may cause the VIX to look artificially low as market makers begin to “take out weekend decay” they will typically do this with volatility.

Many analysts believe Apple will earn roughly $1.42 per share on $9.2 billion in revenue for the quarter; this would be a 12.6% increase in earnings per share (EPS) over the same period last year.  The whisper number is higher, at $1.60 per share; that is what we will likely need to see the company beat to see a further rally in the stock after the report.

Analysts remain bullish and have kept their targets high for the maker of the iPhone, with the average price target coming in at about $212.00.  As an options trader, we can take a multitude of approaches depending on our opinion of the stock’s movement and mass sentiment of Apple’s stock going into earnings.

When it comes to trading options, there are two basic camps into which traders tend to fall, with some exceptions.  For some, buying options, or “buying premium” is the only choice, while others tend to be net sellers of premium.  I am not talking about professional traders making vega bets, but more so referring to a trader’s personality type and risk tolerance.

This could also be due to his or her profession, options education, or a gambling tendency (or lack therof).  This trait really tends to manifest itself ahead of an earnings report.   Let me just say for the record that I tend to fall more in the “selling premium” category, but both styles have their merits and disadvantages.

Aside from the directional opinion we have derived either from technical or fundamental analysis, an options trader should also examine what the stock has done historically following earnings reports and whether the current report holds less or more significance or could be more or less volatile depending on the facts surrounding it as well as the broad market’s condition and signals.

Apple makes up 15% of the Nasdaq-100 and 5% of the S&P; this could cause reverberations in those indices if the stock makes a large move in either direction.

As for Apple, I like the company fundamentally; technically,   there is support at $174.00 and down around $150.00, but frankly, the stock has been on quite a tear here in the past couple weeks and has not really had a chance to stabilize around a price or range to give me a stronger reading on technical support.

For the buyers of premium, the November 190 straddle is going to cost you $16.50, which is 8.6% of the stock price and will have breakevens at $206.50 and $175.50 by November expiration.  The normal effective move of AAPL over earnings is about 6% on average,  with most moves falling very close to that number.  Some traders may choose to buy this straddle if they feel that AAPL will exceed this range.

For me, I would look at two different strategies, depending on whether I wanted some long exposure or I was neutral and thought the stock would stay within a tight range.  Apple’s implied volatility has risen quite a bit above its 30-day trailing historical, which could be a cue to sell some options here.

If I thought that Apple would stay in a range, I might examine selling the November 160/155 – 210/220 Iron Condor for $1.30 per condor, which gives me $3.70 of total risk exposure (per spread) and will net me 35% on expiration if AAPL expires between $160 and $210. With AAPL at $190, I have spaced my downside put spread 30 points away vs. the call spread at 20 points away, because I feel the risk is to the downside.

If you were all bulled up on AAPL but didn’t want to spend too much money, but were okay owning the stock  down around $178, you could examine a risk reversal in November, selling the November 175 put for $3.60 and buying the November 195 Call for $5.20, which is a net debit of $1.60.

At expiration, the upside breakeven for this trade is $196.50 and will help to neutralize the volatility crush we will most likely see after the report.  We have also seen activity along these lines in our Sidewinder reports, not to mention many traders selling upside calls…

You can also look at a collar if you already own the stock!

Don’t forget to hedge… happy Trading!

While Google maintains an extremely strong almost monopolistic hold on all things search, it is also spreading its albatross-like wings to encompass other segments of the internet — voice, mapping, wireless phone, video, and operating system business, among many others.

Google does this by precision acquisitions (they have got the cash to do more) and efficient integration into the “Google suite of products and tools,” which all seem to complement each other perfectly.   This quarter should prove to be a strong one as well, with advertising dollars hopefully back on the rise.

Google Analytics are a benchmark by which companies measure their traffic, and the Google bots that crawl and index search results seem to be a mystery that every SEO specialist wants to crack.  Everyone wants to be “top of the list” when it comes to Google search.

Google further secures its stability, growth, and sexiness by continuing to hedge its bets and create/integrate new and exciting apps that weave their way into our lives both on a personal and corporate level.

Speaking of “creating,” sometimes the easiest way to create is to just acquire technology and mold it into the best shape for your business. The latest chatter surrounding Google is a possible acquisition of Akamai Technologies Inc. (AKAM), which provides streaming video and other applications.

This acquisition would provide GOOG with a free look into measuring viewing frequency and repetitiveness of these  videos and apps and may be frowned upon by existing users of AKAM.  Regardless, the chatter is alive and well and we were seeing large buying of out-of-the-money calls yesterday in AKAM at the October 21 strike; this was also noted in The Wall Street Journal.

As for the stock price itself, Google has more than doubled its market cap since its March lows of $247.30.  It is still a favorite among its analysts, getting a “Buy” rating from 98% of the group.   The median target price, based on analysts’ expectations, is about $550.00 per share, with some targeting $620.00 in the stock.  As for me, I recommended it two weeks ago on CNBC and here on ONN.tv.

I promised I would follow up my trade of the 450/460 bull call spread that was purchased for $8.60 back on 10/1/09 (some folks may have gotten in a bit cheaper).  Below you can see a table outlining the movement of GOOG following its 12 past earnings reports.  This grid shows two days prior and two days following earnings with the effective move on the right-hand side.   The average effective move over earnings is about 6.5% or so.

Based on the OptionsHouse Probability Calculator, the options are implying a 75% volatility (roughly a $25 move) in GOOG in a day’s time.

OptionsHouse Probability Calculator

The great part about this is that given past statistics and what the options markets are telling us – barring a major disaster or something completely extraordinary – I would maintain my 450/460 call spread up until expiration, as there is less than a 5% chance that the stock will drop below $460.00 by Friday.

Remember if you bought the spread for $8.60, that is your maximum risk in the trade. As long as GOOG closes above 460 at 4:00PM Friday, you would realize a 16% return in about two weeks.

Happy trading, and always remember to hedge your bets!

Earnings are the keystone for fundamental investors. For most companies, the lack of earnings growth spells doom for a stock. But there are exceptions with certain types of companies. For example, pharmaceutical and biotech companies may lose money for some time waiting for that new drug, device, or process to be approved, and newer growth companies with unknown technology may also see their stock prices rise amidst the lack of earnings growth or even positive earnings at all (at least for a little while). Remember anycompany .com in the 1990s?

Obviously, stocks can also rise and fall in contrast to their earnings reports. But generally speaking, if the earnings trend is stable and growing, the underlying stock’s price should follow suit over the long term. There are also other factors that may influence short-term stock prices, such as industry or broad market downturns; this is where technical analysis and statistics may help a trader get a grip on price movements over the short term.

Other influences may be positive or catastrophic geo-political news or economic data, which may either spook or accelerate momentum in a stock’s price.

This is where the “magic” comes in. How can you find the right time to buy or sell? Are current stock valuations being influenced too much by forces that may be unrelated? If the broad market drops, how much will your stock drop along with it? Is the broad market currently undervalued or overvalued based upon trailing p/e or forward p/e and what are investors paying more attention to at this point in time? Balancing all this data can certainly be a bit tricky.

Below is a snapshot of S&P 500 Index (SPX) earnings going into this reporting season. Based upon the data below, the S&P is currently trading at 20.31x price/earnings on average and at about 18x its earnings estimates for the upcoming quarter.

Normal range for P/E in the S&P is about 15-18, so obviously one would be more aggressive on the multiple if they thought the S&P was in a growth period, which is obviously the situation we find ourselves in today. The multiple going into this season’s earnings looks a bit rich here (noted in green), however, this number will fall if companies not only fall in line with estimates, but beat them.

Only seven of the roughly 500 companies currently contained in the SPX have reported, so it would be quite unrealistic to paint a clear picture and either justify or deny the premium at which the SPX is currently trading. I will say that so far that growth is not looking so strong, but again, one cannot make that judgment following the release of just seven companies.

This week will be a big start to the season as we see earnings in Johnson & Johnson (JNJ)JNJ, Intel (INTC), Abbott Laboratories (ABT), JP Morgan Chase (JPM), Charles Schwab (SCHW), Citigroup (C), Google (GOOG), IBM (IBM), Bank of America (BAC), General Electric (GE) and Halliburton (HAL), among others. Rest assured that the broader earnings picture will be coming into focus in the next couple of weeks.

I will be sure to keep you abreast of how the options traders are placing their bets. As for now, the CBOE SPX Volatility Index (VIX) has been getting pummeled as the markets continue to move onward and upward. How soon we forget how bad things were (and still are) not too long ago.

There are times to be a contrarian, and now, in my opinion, is one of those times. I still maintain my overall bullish sentiment for the year on the S&P, but my pessimism is also on the rise. Because of the overall market “high” that most investors seem to be on, upside calls are bid and the downside puts are not bid enough, which provides a unique opportunity for long stock holders to buckle up for safety ahead of the blizzard of earnings set to release in the next two weeks.

For now, buying collars (for a credit preferably) would be the trade of choice as everyone seems to believe that the path of least resistance is higher. (For information on the collar strategy, tune in to our Options Physics series).

I would actually be fairly aggressive in my call sale choices at this juncture. In other words, sell the first strike out-of-the-money, just be sure the call you sell is above your cost basis. In Wednesday’s edition of the Practical Options Trader, I will be discussing the GOOG bull call spread I recommended on CNBC and when to take profits on that trade. Trading is all about consistency and longevity, and preservation of capital should be an integral part of every trade that one contemplates.

This article is not about my opinion on the issue, rather a simple explanation of how rising rates may affect options pricing – both calls and puts – and what you need to know as a retail trader. If you’re not a math whiz, no need to worry, I’ll keep this simple. Those of you who are familiar with put/call parity may also be familiar with basis or carrying cost.

Before I get into how interest rates affect calls and puts, we need to find out why it is even important at all.

When trading options, basis is used to calculate the value differential between a call option and a put option.

The first approach is to look at the forward value of a stock, by looking at the appropriate risk-free interest rate for the time to expiry and subtract from that the dividends that would be paid up until that date. Typically treasuries are used to find this rate.

Let’s suppose that IBM (IBM)stock is currently trading for $100.00 and we are examining the Jan 2011 100-strike Call and 100-strike Put. I am going to give you two ways to look at the relationship between the stock and both the call and put. First, we have to be sure we are using the correct rate (this can vary from person to person).

Assume for this example that January 2011 options expire exactly 469 days from today. The current yield on the 12-month treasury is 0.35% (wow). Now divide 469 (days until expiration) by 365 (days in a year) = 1.28 (our interest multiplier). When finding our forward price, we are going to multiply the stock price of IBM by the interest we would have received if we had invested that money in a risk-free asset. So that is (100(stock price) *.0035 (annual rate))*1.28(interest multiplier) = $0.45.

This interest will raise the forward price of IBM to $100.45. We are not done yet; now we have to subtract any dividends as that would lower the forward price of the stock.

IBM has several dividends scheduled between now and January 2011 expiration: 11/09: $0.55, 2/10: $0.55, 5/10: $0.59, 8/10: $0.59, 11/10: $0.59. That is a grand total of $2.87.

If I subtract the total dividends ($2.87) from $100.45, I get $97.58, which would be my expected forward price for IBM on Jan 2011 expiration.

My forward price can also tells me that the IBM 100 puts (currently at-the-money) should be trading $2.42 over my 100 calls, because now the 100 puts have $2.42 more value based on the forward pricing calculations. This above method is a bit more quick-and-dirty as opposed to using the following compounding interest formula to find the forward:

Where:

• F is the forward price to be paid at time T
• e^x is the exponential function (used for calculating compounding interests)
• r is the risk-free interest rate
• q is the cost-of-carry
  
• S₀ is the spot price of the asset (i.e. what it would sell for at time 0)
• D_i is a dividend that is guaranteed to be paid at time t_i where 0 <t_i < T.

What if we want to find basis?

You can do this for any strike.

Multiply the strike price times the interest until expiration (using appropriate risk-free rate) then subtract the dividends; this is your basis. You can use the basis to find where the put should be trading at in relation to the call and vice-versa.

If the call price is known, you subtract basis from the amount the call is trading over parity to find the put’s value. If the put price is known, you will add basis. (If the call has parity value or intrinsic, the same-strike put will not, and vice-versa).

This put/call parity relationship will hold as long as there is not an unusual situation in the stock, such as the stock being hard to borrow, where the puts may be elevated to account for the lack of interest collected on short stock (it may even be negative).

But what if interest rates may be on the rise? How do you know which rate to use? I find it fascinating to play around with put/call parity and try to back out the interest calculations that the market makers are using.

More importantly, this introduces Rho, which is a lesser-known and used Greek. Rho is an estimate of how much the theoretical value of an option changes when interest rates move 1.00%. The rho for a call and put at the same strike price and the same expiration month are not equal.

For the call owners out there, an interest-rate hike will make your calls more expensive, which obviously is a good thing for you as an owner. Put owners will experience the opposite effect; they may see values drop as interest rates rise. The bottom line is that an option does have sensitivity to interest rates and here are some bullets to help you along:

• All futures options have a negative rho, by the way.
• Deep out-of-the-money options have lower Rho, while at-the-money, and in-the-money options have a relatively higher Rho.
• More expensive stocks will have high relative Rho than cheaper stocks.

There are actually options strategies which only have Rho risk. To explore some of these concepts further, check out our free Options Physics series!

Have a great weekend!

Universal Display is not currently making money, which in and of itself is certainly a high risk, but I believe in the technology, being the geek that I am. There is also added risk to this trade because the stock trades very low volume, which typically spells caution for me and can make it tough for an investor to buy or sell shares at a single price, I highly recommend using limit orders. Short interest in PANL is also relatively high at 16% of float.

When I am looking for potential opportunities, I try to find a company with a product or service that will not only be in demand, but would make common sense to the masses. With that said, if material costs are lower as compared to a comparable-sized LCD panel, while the efficiency and quality, response rate, and versatility are greater, that would create a favorable situation for PANL to find themselves in.

OLED technology is unique in that it truly has limitless possibilities in terms of its application. Many of these possible applications were not an option for LCD displays, not to mention that Universal Displays OLED’s are extremely efficient, it has 100% internal quantum efficiency (100% conversion from energy to light). In the energy conscious world we live in, that advantage can only help promote and market OLED technology.

PANL is the inventor and patent holder of PHOLED (phosphorescent) OLEDs (amongst many others), which means PANL will be paid on virtually every OLED that is sold in various forms. They have formed partnerships with PPG to provide the materials used in the manufacture of its products along with key partners and customers around the world for research and distribution of its products. Universal also is working with the Department of Energy to develop PHOLED lighting panels to be used in commercial use along with Armstrong World Industries.

With all that aside, if you have risk capital and you have done the rest of your homework, I believe that PANL may offer long-term possibilities and could be a potential takeover/merger candidate in the future, this is only my opinion.

Here are some Bullets:

TYPES of OLEDs

• PHOLEDS – phosphorescent OLED
• TOLEDS – top contact, cathode OLED
• FOLEDS – flexible OLEDs
• WOLEDS – white OLED

PANL Technology Licensing

• Original inventor and key technology patent holder
• Over 960 issued and pending patents worldwide
• Fundamental PHOLED patents now issued in the U.S., Europe, Japan, Korea, China, India and Taiwan
• OLED revenues are projected to grow to $5.5 billion in 2015 from $615 million in 2008* (*according to display search)
• Used in military applications, commercial lighting, TV, mobile phones, electronics devices, advertising, automotive applications
• Flat Panel display market is 100 billion in 2009, est.
• OLEDs can be made flexible and applied to unique and varied substrates
• Partners and customers include Samsung, LG, Pioneer, Epson, Konica, DuPont, US Navy, Army

ADVANTAGES

• 100% energy to light conversion – extremely energy efficient
• Flexible & transparent
• Cool to touch
• Fast response rate
• Extremely bright and sharp colors – true black color
• Company holds patents on technology, which has innumerable applications and possibilities
• Business model structured for high profit margin

DISADVANTAGES

• Will not see profit unless demand and production increase
• PANL is at the mercy of the OLED marketplace
• Global Economy not in the best position for more expensive technologies
• Cost of OLEDs still relatively high* (*this will change if and when production and demand increases)

I do believe, however, that thinkers like Nouriel do the general investment public justice, by keeping them aware of impending issues and getting folks down off of the heroin-market high that occurs from time to time.

I try to never take an extreme, one-sided position on anything market-related, because at the end of the day, just about everyone is right sometimes, right? I have also found that being an radical thinker/investor is a surefire way to lose your shirt (and on occasion, is a surefire way to be labeled a genius as well).

Nouriel brought up some good points following the G7 meeting in Istanbul. He noted “anemic” growth/recovery versus the swift strong recovery forecasted by many. I do not, however, agree with the individuals that have used the words "sage" and "Cassandra" to describe Mr. Roubini. (I too, along with many of my colleagues saw this coming – didn’t take a Harvard degree to forecast a correction in a market that was experiencing unsubstantiated growth rates of 20-40% per year, when the average for the past 75 years was about 6% ).

I believe that Roubini is really just pointing out the obvious. I am certainly no economist, but if you look around, you’ll notice that stores are not as full, people are still concerned about job security, an abnormally low interest-rate environment and tax credits are potentially supporting home values and stimulating turnover in an artificial manner, many small business are still on the brink of failure, the nation’s savings accounts are drained (even though we are saving more to help buffer potential disaster) … I could go on and on.

Then there is the U.S. government, which is spending at an enormous rate (I know the money is cheap, but it will still need to be repaid), which puts inflationary pressure on every dollar that every American earns, which is both damaging to the consumers’ real spending power and psyche.

All of this is also reflected in the bulk of the earnings reports from companies within the S&P. There are exceptions, of course, but my issue here has more to do with the valuations that investors have given to many of these stocks. I believe we will recover, but the recovery will most likely be moderate, with certain sectors obviously growing faster than others.

I still believe that housing will stabilize and I have already made my bets and been paid on them with regard to equities. For most of us, the bet is not on if, when, how, or how fast we will recover. The bet is on which sectors and individual companies will investors flock into and out of and when and how we can profit from it.

I suppose economists add needed value to the soup of commentary and data we sift through on a daily basis, but it is rare that economists (and analysts for that matter) make good traders (there are certainly exceptions to this).

For the average retail investor, I think they should focus on finding the "tone" of the current and future news and try to correlate this with current market trends. Using statistics and options (and spreads) to increase your odds will help to maintain an edge in this marketplace.

It is not just the tech sector that has experienced a huge recovery in the past six months; many sectors have experienced 50-100% price appreciation since the March lows.

Currently, I am a bit concerned at the forward multiples being assigned to the S&P and my answer to this would be to take a much lower delta exposure to the long side than I have taken up until this point.

I would begin winding down my more aggressive positions and examining put spreads that are at least 1.5 standard deviations away from the current spot price of what you are trading, while selling these spreads 30-50 days out.

If you are investing in individual equities, remember that generally speaking, it may be better to move into either lower-beta stocks or Index ETFs, such as the SPDR S&P 500 Index (SPY) or PowerShares QQQ Trust (QQQQ) to further mitigate your risk as they tend to be less volatile and don’t carry the severe earnings exposure that individual stocks do.

The broad market selloff yesterday dragged most stocks down with it, not to mention driving increased volatility higher across the board in most issues. This may provide us with some opportunity in MOS in terms of selling volatility. The unexpected jump in unemployment this morning is sending markets lower and adding even more volatility premium to options.

If you couple this with an impending earnings report on MOS, implied vol will certainly feel some upward pressure, which again may offer us the additional edge we need.

Back on September 18th, competitor Potash (POT), said it expects fiscal full-year earnings of $3.25 to $3.75 a share, down from a previous forecast of $4 to $5 a share. Analysts were forecasting roughly $4.16 a share for the year.

"The change primarily reflects lower-than-forecasted potash sales volumes due to continued slow demand and limited restocking by fertilizer distributors around the world," Potash said in a statement.

This news sent POT and its competitors tumbling, including MOS. MOS has dropped $10.00 from its September 18 level and currently sits at $45.70

Leading into earnings, I would love to say I know exactly what direction MOS is headed, but obviously that is impossible. One could rationalize the recent selloff as a correction and as long as MOS doesn’t disappoint in a big way, the stock will remain fairly stable (as stable as earnings can be).

The big question is … how disastrous can the earnings report be?

As an options trader, I can look back at past earnings as one method to get a gauge of how the stock tends to react. Before I even look at implied vols and price levels of the stock , I want to get a snapshot of its behavior over earnings periods.

MOS has been an interesting animal over the past couple of years with regard to its effective earnings movements. If you don’t count 10/1/08 and 4/4/08, MOS tends to move roughly 5.3% over its earnings periods (two days before and two days after). On 10/1, MOS moved 41.21% and on 4/4 it moved 10.44%. If we average those two numbers out, it is roughly 26%. If I skew up the smaller average by the two extraordinary moves, I’m looking at about 15.5%.

Based upon the fact that MOS has been moving lower for two weeks and now a "not good" earnings report is somewhat expected based upon POT’s earnings warning, I would be more inclined to take a more neutral Iron Condor type strategy with a very slight bullish bias, due to the broad-market retracement.

If I really wanted to get specific here and give myself more of an edge, I may go back and look at why the October earnings number for last year caused such a huge rift in the stock. Was it a seasonal thing? A one-off event? Be sure you do your homework!

So for this trade, I thought I would have a little fun and demonstrate the iron condor in action. By no means is this a buy, sell or hold recommendation as I don’t like the strike selection in the issue. Because of the recent price action in MOS and the recent sharp downturn in the stock, I have chosen in this case to sell my put spread closer to the stock than my call spread.

I will be selling the November 40/35 put spread for $0.80 as well as selling the November 55/60 call spread for $0.55. This gives the stock some upside if they rally from here. Remember that at expiration, I can only lose on one side and being that both sides (spreads) are $5 dollars wide and I collected a total of $1.35 for the condor, my total risk is only $3.65.

Remember that this trade is a winner as long as MOS stays between 40 and 55 by November expiration. My breakevens are $56.35 and $38.65. If you thought that MOS was going to move beyond these levels on the earnings announcement, then just go out and buy the October straddle for $4.45. The options markets are not pricing in more than an 8% move for this report

On my way to grab a cup of decaf yesterday, I ran into one of my mentors, Joe Troccolo. He was teaching an intermediate options class here at PEAK6. After exchanging pleasantries, Joe asked me what I thought was hot these days (besides First Solar (FSLR), which I was buying at $80…) I told him I was looking at selling put spreads in Research in Motion (RIMM). This is obviously a bullish move and Joe knows they were probably out-of-the-money, because I didn’t want to take an extremely bullish bet in RIMM, I just thought it could stay above 63 or so by October expiration.

Joe, being the options brain that he is, couldn’t resist the temptation to say, “Jared, why don’t you just buy the call spread.” I couldn’t help but smile. I tried to defend myself and tell Joe that I taught this method years ago and I agreed. Then he replied, “Why didn’t you do it this time?” Okay, Joe, you got me; I then had to quickly run to a meeting and didn’t have time to finish my conversation.

Being the obsessive person that I am, I laid in bed last night thinking about Joe’s reasoning for call spreads vs. put spreads. I mean, he is my former boss, a quant and a mathematical genius, and there has to be some highly advanced mathematical reasoning I must have overlooked as to why one would do the call spread instead of the put spread.

I went back and forth in my mind looking at both the practical and mathematical differences (or lack thereof) and couldn’t come up with any reason. This was going to be bad … I had all night to think of a theory and couldn’t produce one.

So in the morning, I and gave up and gave Joe a call, I asked him what is the exact mathematical reason he prefers buying call spreads to selling put spreads, and he shocked me…THERE ISNT ONE!! Joe just said it made more psychological sense to pay for something upfront then make the profit on what you paid versus getting a credit upfront, then potentially losing more than the credit you collected. It was purely a mental thing! I was blown away…but then I remembered, even the most sophisticated and advanced traders have their "happy place," and buying call spreads was Joe’s.

I did also bring up the bid-ask spreads, which tend to be larger in deep-in-the-money calls vs. lower priced out-of-the-money puts, which can be a factor as the retail trader tends to buy at the ask and sell at the bid.

Anyway, the point of all this is that puts and calls are essentially the same in many ways. There are also relationships that exist between the two. When you sell a 60/65 put spread, you essentially do the same thing as if you bought the 60/65 call spread in the same month. An in-the-money call spread’s behavior is similar to out-of-the-money put spreads in terms of Theta, Vega, etc.

In both strategies, your goal is to have the stock finish above the short strike on expiration. Both positions benefit from the passage of time and both strategies will benefit if volatility decreases. Hopefully this intrigues you and doesn’t scare you By the way, if you bought the 60/65 call spread and also bought the 60/65 put spread, you’re long the 60/65 box. Let’s break it down.

Let’s assume the 60/65 put spread is trading for 1.00 mid-market; the call spread will most likely be trading somewhere around 4.00 mid-market if you are close to expiration with low interest rates and as long as the stock is not hard to borrow and there is no dividend between now and expiration.

As you can see, they both offer equal risk/reward; it is really a matter of credit/debit and margin differences. If you bought the call spread and bought the put spread, you synthetically bought stock at 60 and sold stock at 65.

There is a little relationship called put/call parity that exists between the 2. Puts will typically cost less than calls by the basis amount or interest minus dividends. If the dividend is greater than the amount of interest, then the opposite will be true.

I am not going to make this a lesson on put-call parity or where boxes should be trading at. By the way, if you can buy a box for less than the difference in strikes, i.e. if you can buy a box for $4.80, you have a virtually ris- free trade other than interest rate exposure, as it will be worth$ 5.00 on expiration. Basically, buying a box is like issuing a loan or it can also be like borrowing money if you are short the box.

The bottom line is that you should trade what is comfortable. Buying call spreads takes on the same risk as selling the put spreads with the same strikes and expiration. Be sure that you practice both.

Hopefully this article helps you with the bull call spread trade in Google (GOOG) that I just discussed on CNBC.

As I mentioned in this article last week, I like RIMM as a company and I believe they have a place in the smartphone world. I also believe the selloff may be a bit overdone. I talked about how sensitive RIMM is to movements in the S&P as well the fact that it has a BETA of almost 2, which means it can essentially move twice as fast as the S&P (or more specifically the NASDAQ, which it is a part of).

As an options trader, I look for opportunities, or more specifically, anomalies I can take advantage of. RIMM is outside of its 1st lower Daily Bollinger band level of 69.58, which to me may indicate an oversold condition (remember with the recent moves, the Bollinger has opened up as well). Also, the 200-day moving average is at 62.59.

On CNBC, Matt Nesto asked me if it would make sense to "trade" RIMM and he questioned whether this is the type of stock that, if it sells off, you can buy cheaper and ride it back up. I don’t know how convinced I am that RIMM will see a strong rally, but I do think there is a good possibility that the stock can stay above 60 until October expiration. I also wouldn’t mind owning RIMM down at this level. I will say I still have doubts about the strength and continued momentum of the broad market.

If we look into its most recent earnings report, Research in Motion reported revenues of $3.42 billion, up 37 percent from a year earlier. RIM shipped 8.3 million BlackBerry devices in the quarter, and a net 3.8 million BlackBerry subscriber accounts were activated, for a total of 32 million worldwide. Net profit fell to $475.6 million, or $0.83 per share, from $495.5 million ($0.86 per share) the prior year. The result includes a charge of $112.8 million for settling its litigation with Visto.

RIMM forecast third-quarter sales of USD $3.60-3.85 billion, with a gross margin of around 43%. Net subscriber additions should reach $4.0-4.3 billion in the three months to November, while earnings per share are estimated at $1.00-$1.08.

This forecast is a large part of what sent the stocks tumbling. The bottom line is that they are still growing and I believe RIMM’s future not only depends on RIMM itself, but the broad equity markets and a sweeping economic recovery that fuels corporate usage.

So now that I have rationalized my reasoning for going long RIMM, the strategy I think I would chose here would be a bull put vertical spread, which offers limited risk and allows the stock some flexibility in its movement.

As I said before, I don’t think RIMM will skyrocket, but I think it can stay above its 200-day moving average at about $63.00. But because I think RIMM is temporarily oversold, I want to get a bit more aggressive, therefore I am looking at selling the October 65/60 put spread for $1.35. (where it is trading at 8:39 a.m. CT). This puts my breakeven on the trade at $63.65 and as long as the stock stays above $65.00 by October expiration, I can make 37% on my total risk of $3.65 in the trade.

This trade or rationale is NOT for everyone, but in a volatile stock like RIMM, the vertical put spread not only offers flexibility, but softens the volatile movements that RIMM tends to experience.

Their earnings come tomorrow after the close and many analysts are expecting a “good” quarter, with revenue coming in line and unit sales strong. I wanted to offer some suggestions on how to play and/or protect yourself ahead of this number and what the ramifications of different trades might be.

RIMM has maintained strong market share in the smartphone space with its widely-used corporate enterprise service. The BlackBerry is to email, communication, and organization what the iPhone is to music, apps, and photos. On the flip side, there is also chatter of a secondary offering in RIMM, which generally is bearish for a stock.

Here are some notable points for RIMM:

• Apple (AAPL) and RIMM are the major players in the smartphone space; RIMM currently has a market share of 55%-plus.
• RIMM may give up gross margins if they want to compete with the rest of the space (non-smart/premium phones).
• Credit Suisse previews second-quarter earnings, due Thursday after the close: expects revenues/EPS of $3.6 billion/$0.99, in-line with the mid-point of guidance ($3.6 billion /$0.99) and consensus. Estimates are based on units/ASPs of 8.4 million units (+8% quarter-over-quarter)/$345 versus consensus of 8.5 million/$344.
• Despite competitive launches (iPhone 3GS, Pre) during the quarter, I believe (along with credit Suisse) that RIMM’s volumes have held up, driven by the Tour at Verizon/Sprint, as well as the reinstatement of the "BOGO" offer at Verizon.
• Analysts are looking for strong unit sales/ASP estimates of 9.0 million (+7% quarter-over-quarter) driven by new product launches (Storm 2, Onyx), continued momentum of recently launched products (Tour, 8520, 8900), and timing of competitive launches (CLIQ, Pixi).
• I believe earnings will be strong, but fall in line with upper estimates ($3.45-3.7 billion in revenue and $0.94-1.03 in EPS)
• There is future growth potential, not only as corporations begin to retool and re-staff, but if RIMM can continue to innovate and not lose a grip on its roots as a dependable, corporate-friendly device with tactile feedback.
• The sector is obviously hot as the PALM secondary, which would be dilutional, is being extremely well received by the markets.
• Watch out for broad-market influence, as RIMM has a high beta and the S&P is on shaky ground from a technical perspective.
• There is a HUGE discrepancy in the historical volatility of the stock and what the options markets are pricing in; 30-day historical volatility is about 25% and the implied volatility of the options is currently greater than 55%.

When greed is in control, people search for reasons/excuses to get in/stay long. When fundamentals are in flux, technicals can offer solstice even for the staunchest fundamentalist.

Technically and statistically, I would be collaring my long stock or selling a put that was at least 8-10% out-of-the-money.

• The stock will most likely hold its ground, with a modest retracement of 5-8%, but after last quarter, which was not horrific, the stock moved lower for the two days before and the two days after earnings for a collective drop of 16+% and continued to move lower all the way down to $63.
• If I were long stock, I would be doing everything to protect. If we are going to see any upside in the SHORT TERM, I’m thinking it will be minimal, maybe to $90-96, as options traders are betting on a slight pullback, with decreasing volatility in the near-term options, but maintaining a long volatility and delta position in the out-month calls. A strategy to examine here might be to sell the October 95 Call for $4.00 and buy the October 80 Put for $2.35, yielding a $1.65 credit to you. This credit will increase if the stock drops; it also will offer a hedge and absolute protection below $80.00 in RIMM. You can always cover the position if the stock rallies or remove it for a profit if the stock drops.
• Traders who do not own the stock might examine selling the October 80 put, as I see technical support in the stock at $78. This offers long investors a way to acquire the stock at a discounted price if the stock drops. If not, this offers a 3% yield in 24 days.

Just some of my personal thoughts ahead of RIMM earnings.

Today the market is pulling back a bit (which is normal). It is on these days when traders can re-evaluate their covered-call positions. Remember, a covered call involves owning shares of a stock or ETF and selling one call option for every 100 share that you own. I typically sell calls at a strike price I would not mind selling the stock at, and I sell a call with less 35 days until expiration, so I can collect the most amount of theta as options typically decay the fastest in the last 30 days of their life.

Obviously, the market has been rallying for something now and there is a possibility that many traders have seen their stocks exceed the strike price of the call that they sold. Even though a trader may be okay with delivering those shares at the original strike price they sold, traders can also use mornings like this to "massage" their position.

If the market has a sharp pullback in the morning, it may offer an opportunity for the trader to "buy back" their covered call at a discounted price, if the trader believes that the stock will continue to move higher.

Here is an example. Let’s say back on September 3, you bought IBM (IBM) at $115.00 per share and sold the October 120 call for $2.00. Not a bad call to sell and you collected some decent premium. On Friday, the call was trading for $4.90, with the stock at about $122.00, which means you are making $7.00 on your stock, but losing $2.90 on your option. You could have closed the position on Friday for a profit of $4.10 (minus commissions) on this trade.

If you thought the stock was going to move higher, however, you can use pullbacks like today to buy back your covered call for a little less (this morning it was trading at $4.20), then wait for the stock to rally back up and maybe choose the October 125 call, which you may be able to sell for $2.20-$2.50 if the stock rallies back over $122. A move like this offers you a bit more upside potential in your stock position.

Again, realize that by doing this, you have to time the trade out a bit more. By selling the 125 call, you will have less of a hedge against your IBM stock, as it has a smaller delta than the 120 call.

• Remember that in-the-money calls will not be exercised, unless they are completely devoid of time value or if there is a dividend that is greater than the amount of time value of the option.
• Basically, it is unlikely that an at-the-money or slightly-in-the money call will be exercised before expiration day.

Hopefully this opens up your mind about the covered call trade. Remember to always keep your options open. Looks like this market may end up higher today…

Yesterday morning, I overheard him talking about OLEDs (organic light-emitting diodes) and then he asked me if I knew who was the world’s largest producer of this technology … I thought it would make a great article.

I believe the obvious core of investing, especially if you are thinking like a Warren Buffett or Peter Lynch, is looking for profitable companies that have a product or line of products/services that will be in demand for a long period of time. Maybe their product or its true potential is not yet recognized by the masses as something great or scalable.

Whatever you choose to buy or sell, I believe you should invest in what YOU KNOW. If you’re comfortable with the underlying fundamentals of a company and understand the way its products and services not only come to the marketplace, but also how demand for those products or services may shake out, you put yourself at a distinct advantage and have an air of confidence when monitoring your trade. You must also be aware of who and what the competition is and what effects they may or may not have on the companies you invest in.

Your confidence and experience levels, along with how the stock has actually been performing, will help you select the best strategy to play.

So back to the OLED. I have to tell you I am a complete geek at heart and have an extreme fascination and appreciation for technology. When Andy started talking OLEDs, it really got me thinking about all the application possibilities and growth potential with this technology.

OLEDs create bright, long-lasting, extremely efficient illumination in a wide assortment of colors. OLEDS differ from LEDs, in that instead of emitting points of light from a single source like a light bulb, OLEDs create uniform light that can be spread across ultrathin sheets of material that can either be flat or flexible.

OLEDs have several advantages over LCDs in that OLEDs can be printed onto any substrate; once this process is improved upon, OLEDs would have a significantly lower cost. OLEDs may eventually be printed on fabric, films, and other flexible and unique substrates that will open the doors to some very cool applications, marketing, etc. Think about Times-Square-type advertising everywhere!

OLEDs also offer a greater range of colors, gamut, brightness, response time, contrast, and viewing angle than LCDs, and unlike LCDs (which must use a backlight), OLEDs can show true black.

Obviously, there are disadvantages, the first being cost, which is extremely high now vs. LCD. There are also lifespan drawbacks, but this is being addressed. Regardless, I agree with Andy that this technology will be huge and its possibilities endless.

Advertising, interior lighting, decorative lighting, cell phones, displays in your home (think Back to the Future II), ceiling tiles that double as light fixtures, and an architectural movement to implement OLED displays into your home and office. TVs that you can roll-up and travel with (great for convention displays). Automotive heads-up displays built into the lower part of your windshield, etc. (I have a big imagination).

So how does an investor partake in this potential? Well that is a tough one. I personally would focus on the companies that are not only manufacturing OLEDs, but maybe also have a history of bringing innovation to the markets.

• Microsoft (MSFT) just launched a 3.3" OLED media player called the Zune HD. (It looks cool, but I think Apple (AAPL) is the king in this field).
• Toshiba will be producing a ton of OLED panels for cell phones and hopefully economizing the process
• General Electric (GE) projects its first commercialized OLED products will be introduced in late 2010 or 2011.
  • GE is developing a roll-to-roll manufacturing process, similar to the way photo film and food packaging are created.
• Eastman Kodak (EK) was awarded a $1.7 Million U.S. Department of Energy Contract to Develop OLED Lighting; the technology was discovered by one of their scientists.
• Universal Display (PANL), which trades on the NASDAQ, has received more than $10 million in government grants over the last five years for OLED development for several applications. Additionally, on August 19th, the company was awarded a $1.65 million, two-year contract from the U.S. Department of Energy (DOE) to demonstrate a thin, highly-efficient, white OLED lighting concept for under-cabinet applications.
  • PANL is a world leader in the development of innovative OLED technology for use in flat-panel displays, lighting, and organic electronics for over 15 years.

DisplaySearch projects that OLED display revenues will grow to nearly $18 billion in 2015. While passive-matrix OLEDs are expected to maintain a share of the market, most of this revenue growth is expected to come from active-matrix OLED products including a variety of small-area displays for mobile phones and other consumer electronics applications and the introduction of notebook PCs and OLED TVs during the period.

There are certainly some ideas to explore in a very cool, very interesting technology that may have a very bright future

• Stock market index futures
• Stock market index options
• Stock options

I get tons of questions on this topic and what exactly happens before, during, and after the expiration process and how it affects the markets and adds volatility. I remember my first expiration as a rookie market maker in the mid ’90s on the floor of the PHLX. The floor was packed – probably about 40% more traders than on a typical day – the energy was frenetic … and for good reason!

Front-month options were expiring and most of the traders were trying not only to reduce their risk, but also frantically absorbing orders that were flying in from customers and other traders around the world, who were closing and/or rolling positions out to the next month or perhaps just letting their options expire.

At that moment, I didn’t realize the enormity of what was going on or how this simple monthly occurrence could potentially have such a major impact on a trader. The risks of expiration vary from trader to trader; retail and professional traders both may have issues to deal with on expiration day.

For the average retail investor, this may be the end of a "hope and pray" trade that never worked out as they find their option moving closer to worthlessness. Another may be elated that the covered call they wrote on a stock they owned is finishing just out-of-the-money, allowing them to keep the premium they sold it for and hold on to the stock as well.

For the market maker on the floor, expiration usually means something different. For most of us market makers, we are there providing liquidity, buying and selling options that OTHERS want to trade. Because we are there to take the other side of everyone else’s trades, we may sometimes be forced into positions we may not want and we also have to be aware of what those positions might morph into when we come in Monday following expiration .

For the sake of brevity, I am not going to go into all the possible scenarios, but let’s just examine one situation that a trader may find him or herself in. Let’s assume I am a market maker in Google (GOOG) and I am short 10,000 at-the-money ($400) straddles on expiration Friday in GOOG. Even if I have been profitable in the overall trade, I still have some issues on Friday. At 3:00 pm, Google is trading right around $399.95 and remember that at 4:00 p.m. eastern, either my call or my put will have a 100 delta and one will have 0.

Another way to think about it is that depending on where Google stock closes, I will be assigned on either my call or put and come in Monday with either 1,000,000 shares long or short. Right now, if Google stays put, my put will be in-the-money if I have no other position in my account.

Come Monday, I will have no options position and be long 1,000,000 shares of stock. The question really is, which is it going to be? What if I come in Monday long and the stock is gapping down on economic data? Or what if GOOG closes at $400.25, then I come in short stock on Monday and the shares rally on a brokerage upgrade?

The bottom line is that I don’t know the future of GOOG and probably don’t want that exposure at all, so I am going to be selling or buying stock accordingly to level out my position; here is where part of the volatility comes from.

So again, if the stock looks like it is going to stay below $400.00, I may be selling some shares to neutralize my delta. But then if it rallies, I may have to buy some shares to neutralize my delta. This is called negative gamma scalping and it can further contribute to a stock “pinning” at a strike price.

Gamma – which measures the amount by which delta affects an option’s price – is greatest in an at-the-money option on expiration day, because that option’s delta will either be 1 or 0 by 4 pm. All this buying and selling can create added volatility in both the stock and options.

Some traders will look to trade with each other to get out of their positions. For instance, I may trade with someone else in the pit who has the opposite position as I do (they would be long the straddle). Traders are also rolling their positions out and up (or down) or possibly repositioning a trade they may want to stay on. With the advent of advanced computers and more efficient markets, expiration Friday has become less of an event. Although it is still paramount that you understand how expiration will affect your positions.

The BLS actually releases CPIs for two population groups: (1) the CPI for Urban Wage Earners and Clerical Workers (CPI-W), which covers households of wage earners and clerical workers that comprise approximately 32 percent of the total population and (2) the CPI for All Urban Consumers (CPI-U) and the Chained CPI for All Urban Consumers (C-CPIU),which cover approximately 87 percent of the total population and include (in addition to wage earners and clerical worker households), groups such as professional, managerial, and technical workers, the self-employed, short-term workers, the unemployed, and retirees and others not in the labor force. CPI-U is the number that most of the media publicizes.

Prices for the goods and services used to calculate the CPI are collected from 87 urban areas throughout the country and from about 23,000 unique retail and service establishments. Data on rents are collected from about 50,000 landlords or tenants. The weighting for an item within the CPI numbers is derived from reported expenditures on that item as estimated by the Consumer Expenditure Survey.

The CPI data can be used:

• As an economic indicator. Typically, the CPI is regarded as the most widely used measure of inflation.

• As an indicator of the effectiveness of government policy. In addition, business executives, labor leaders, and other private citizens use the index as a guide for making economic decisions.
• As a deflator of other economic series. The CPI and its components are used to adjust other economic series for price change and to translate these series into inflation-free dollars.
• As a means for adjusting income payments.

The markets interpret this data in many different ways depending on the current economic cycle and what the majority of market participants feel is the biggest risk. For instance, if inflation is a concern and the economy has been expanding, market participants would most likely want to see more moderate increases or no change in CPI. On the flip side, if we are looking for signals of a bottom during a contraction period, seeing increased spending, coupled with consumer price increases, may offer a positive indication of growth and confidence.

The CPI data used in conjunction with other data as well as an awareness of the economic cycle and current market sentiment will help you determine the effects and interpretation of the monthly CPI data being released.

Below I have copied the full data from the BLS on the most recent CPI-U data. You can see energy being the driver of most of the positive change in the total CPI number. If you look at core CPI (sans food and energy) you will note the 0.1% change for August. Funny, but it’s food and energy that are always the most volatile, but I would have to believe that we all have to eat and most of us tend to use energy in some way…

On a seasonally adjusted basis, the Consumer Price Index for all Urban Consumers (CPI-U) rose 0.4% in August, the Bureau of Labor Statistics reported today. The index has decreased 1.5% over the last 12 months on a seasonally adjusted basis.

The 0.4 percent seasonally adjusted increase in the CPI-U was driven by a 9.1% rise in the gasoline index. This increase accounted for almost the entire advance in the energy index and over 80% of the overall increase. Despite the August increase, the gasoline index has fallen 30% over the last 12 months.

Percent changes in CPI for All Urban Consumers (CPI-U): U.S. city average

Seasonally adjusted changes from preceding month.

I don’t think the launch of the Palm (PALM) Pre in June really helped the company. And since neither Palm nor Sprint will say how many of the devices have been sold, it is even more difficult to gauge the effect.

After a positive initial launch, analysts said recently that they think sales have slowed and dropped below the operator’s expectations. From personal experience as well as from reading hundreds of reviews online, it would seem that Pre technology falls short of expectations and the reception of the Pre has been lukewarm — nothing on the scale of what was expected and certainly minimal compared to the launch of the first iPhone from Apple (AAPL).

Sprint did launch a new $69.99 unlimited "mobile-to-mobile" wireless calling plan, which could shake things up a bit in the space. The "Any Mobile, Anytime" plan will include voice, data, text, e-mail, GPS navigation, and distribution of videos and images from one mobile phone to another. But "cheap" plans don’t always mean success.

AT&T (T) and Verizon (VZ) have a comfortable lead in that sector and seem to have better service coverage. Although anecdotally, I have found that most folks complain about their service at one time or another, no matter who the carrier is.

To top it all off, Deutsche Telekom approached adviser Deutsche Bank AG to examine a possible takeover of Sprint; this data was published in the London-based Telegraph last night. Sprint stock is currently 10% higher, trading up 42 cents to $4.19 on this news.

I must confess that I have not dug in too deeply on this news, but I thought it would be a great time to talk about how options traders may place a “takeover bet” on a stock like Sprint. It is also a good time to talk a bit about what happens in the options markets once a merger or takeover is announced.

Generally speaking, once a possible takeover is announced or there is a substantial rumor of one, you will begin to see this priced into the options market, usually in the form of a vertical skew increase. Vertical skew is the difference in implied volatility in different options in the same month. Skew can come in several different shapes. With a takeover candidate, you will see upside skew (out-of-the-money calls and in-the-money puts) increase for obvious reasons.

In many cases, before an actual deal as been struck, you can use the prices being bid for upside calls to get a gauge as to what price investors see the deal being struck. For example, if you look at November 6 calls in Sprint, they are currently bid at 10 cents. The 7 calls are bid at five cents, so this would tell me it’s unlikely a purchase price from Sprint would be far above the $7.00 mark, at least not before November expiration. Of course, this does not mean it can’t happen.

Also, don’t forget that Sprint is a cheap stock to begin with; a $7.00 purchase price would still be a 66% premium to the current market price, and probably more than Deutsche Telekom would want to pay .

So, what happens after a bid price is accepted? Once a company has agreed to be purchased and agreed to a price, you will typically see a drop in the amount of time value for the options of the company being acquired. This is typical if the offer is an unchallenged all-cash deal, meaning it’s highly likely that the deal will be done for that price without any other suitors bidding for the company.

If the buyout is a cash-and-stock or all-stock transaction, the acquiree’s volatility may begin to closely resemble the volatility of the acquirer, because of the exchange in stock. So not only will you see the aquiree’s stock price move in lock-step with the acquirer, but the options may also act accordingly.

Once the deal has been settled and the company being acquired ceases to exist, ALL options will move to their parity value and will be exercised into stock or must be closed prior to that date.

The bottom line is that if you are unsure of the specifics of a takeover/merger involving a company you own in your portfolio, be sure you do your homework or contact a professional that has details on the deal itself.

Especially in trading, risk/reward becomes quite difficult at times. How much do we risk and what is the potential payoff? Here is where stock traders, I think, face the most difficulty. I mean, what is the reward? How do you define it when the theoretical upside is unlimited? Some may use a technical level of some sort, using a popular technique or indicator. Some may just say that I think this trade has $10 of upside and therefore I am willing to risk $10 on the downside. This ambiguity is what makes trading difficult, but also it is what creates gurus. See, I really don’t believe that anyone can “call” the stock market. I also think that finding “psychological” price levels of stocks and placing your stops and/or targets around those levels is extremely difficult, at best.

With options, risk is more clearly defined and can be molded to ones tolerance and needs in the trade.

When I look at the American International Group (AIG) Oct. 40 short put trade, I certainly think, “HIGH RISK.” I wanted to offer a couple words on how I would be monitoring this trade if I had done it and where my uncle points would be.

By selling a put, basically I am saying: “I WOULD BE OK WITH OWNING AIG AT THE STRIKE I SOLD.” That is a key statement. Essentially, the retail trader needs to realize that this trade is basically an entry into a long stock position, that way the true risk can be assessed. When AIG was trading at $50.00 (I have to tell you) I was flabbergasted. I will not specify why, but I am sure you can guess.

I also know that the stock is hard to borrow and the new SEC laws prohibit naked short selling without having the stock earmarked beforehand. There is a bit of a fundamental story there with regard to their assests, but that is a highly optimistic one at best and by them selling parts of the company, one would suspect that their revenue stream may become dryer.

I know that people get greedy and want to ride a train that is moving fast, which AIG certainly has. This stock has seen meteoric growth (in stock price, not earnings) in the last three months.

So instead of just buying the stock at $50+, I thought that it would be a less riskier bet to own the stock at $34 (selling the October 40 put for $6). I didn’t mind giving up some upside potential, because my return on risk (6/34=18%) was acceptable to me and I thought that AIG was a bit over baked at $50, but maybe had some room to run. By the way, to achieve 18% as a stock investor, I would need the stock move up to $60+ per share, plus I would have $50+ at risk the whole time. AIG still has not hit $60 and to date I am a bit nervous, but certainly not in a catastrophic situation as of yet. AIG is trading at 38, still $4 higher than my cost basis, if I were to get assigned on the stock, which right now, looks that way. The management of this position can be difficult. Again, that depends on what your goal is. If I want to buy the stock, then I may ride this move out and get assigned and then sell a call against my long stock. Or, I may choose to just sell the put at a loss or a profit depending upon where the stock is. Either way, in this trade, its paramount that you figure out what your intentions are beforehand. The short put, may have downside risk like long stock, obviously you can’t lose more that your strike price minus the premium collected.

If you are in this trade, be sure that you examine all angles. The stock is off about $18 from its high, and the Oct. 40 put is currently trading at $8.10, which is a loser of $2.10 if you sold it at $6. If you are afraid that the stock can fall further, you can certainly buy back that put and reduce your risk. Don’t forget that you always have options.

Preparation includes research, which obviously will depend upon the amount of time you plan on being in the trade and how much risk you plan to expose yourself to in the trade. If we feel confident in our research/analysis, we then proceed to the next step, which is choosing the entry. Most of us are really good at clicking the buy button to get into the trade – I have found that an itchy trigger finger seems to be the norm, not the exception. It really is amazing how easy it is to click a mouse to enter into a trade; sometimes it’s almost too easy. Although, for some, the entry is the toughest. Getting over that hump and committing real dollars to an idea that they have in their mind (I find that this has been common among engineers that I have talked to over the years).

Once you are in the trade, being able to control the mental aspect of the trade, strict money management and the digestion and interpretation of any new pertinent data that is being received is another hurdle. But after all this, I have found choosing the “right” time to exit (where you are satisfied monetarily and mentally) to be the toughest of all and nearly just as important is the evaluation of what went wrong/right with all of these steps is imperative to mastering the craft. Without taking stock (no pun intended) of what just occurred, you can never expect to repeat the successes and mitigate the failures.

I brought this up, because both the SPDR Silver Shares (SLV) and the SPDR Gold Shares (GLD) continued to rise to new heights, with SLV hitting an intra-day high of $16.50, which is a new 52-week high for the ETF as well. GLD reached an intraday high of $98.64, which is very close to its 52-week high of $98.99. Rememer, these ETF’s try to mimic the prices of the underlying asset, with GLD being 1/10 the price of gold and SLV 1-to-1 with silver.

In terms of the underlying futures, the December gold contract (current most active) was last up $11.20, or 1.1%, to $1,008 per ounce. Gold futures last topped $1,000 back on Feb. 20. The record for gold futures is $1,033.90 per ounce, which was attained on March 17, 2008.

The London Gold Market Fixing, a global benchmark, stood at $1,004.50 on Tuesday morning.

December silver futures rose 52 cents, or 3.1%, to $16.81 per ounce.

All this bullish excitement actually ignites the contrarian in me and I feel I would be doing dissatisfaction to my viewers and readers if I didn’t talk about exiting these positions.

I began examining long positions in both of these issues using both the ETF as a long investment vehicle as well as selling out of the money puts in both of them as well. I talked about these both on ONN.tv and on CNBC’s Fast Money. When I am monitoring a trade, it is paramount that I have everything in perspective. I never want to lose sight of my long-term goal, which is to grow my capital at an acceptable rate, while minimizing my risk with the use of options, spreads, money management, hedging, etc.

If we use GLD as an example and assume that you bought it at $93.00 and let’s say it’s trading around $98 within one and half weeks, that’s a $5.00 profit, or 5.4% RETURN, in a very short time. If you annualize that number, even without using compound annual growth rate (CAGR), it’s almost a 200% return on an annual basis.

When you are in the heat of the moment, sometimes we lose sight of the broader picture. Don’t be greedy and remember it is much easier to sell into strength than weakness.

Before I go into my quick holiday volatility thesis, I wanted to offer you some words on the difference between VIX and actual implied volatility in the S&P. The VIX was created in 1993 and originally measured at-the-money implied volatility in the S&P 100 Index (OEX).

In 2003, the VIX was updated to reflect an amalgam of S&P 500 options’ implied volatility using a very specific methodology. The new VIX is based on the S&P 500 Index, and estimates expected volatility by averaging the weighted prices of SPX puts and calls over a wide range of strike prices (only SPX options quoted with non-zero bid prices are used in the VIX calculation). Then this is used to produce a 30-day forward expected volatility for the S&P 500. The VIX blends near- and next-term (generally two front-month options expirations) as inputs in its calculation.

The bottom line is that if you look at an options chain and find the at-the-money strike line (find the line where the difference between call and put is the least, this is a quick way to find at-the-money), the number you see reflected there may not be anywhere near the VIX.

For example, right now, the SPX 1005 September call is trading at a 20 vol and the put at a 21 vol, the VIX is at 26.5, a 5.5-point, or 27%, premium to the mean of these options. Volatility for at-the-money October options is slightly higher, at about a 23 vol for both. The VIX takes skew into account, which is a variation in volatility as you move away from the at-the-money strikes; there is positive and negative skew, but I’m not going to get into that in this article.

Man can I yammer on…sorry..I really do love this stuff.

I thought it would be a good idea to have a little VIX/volatility refresher on the Friday before Labor Day. Right now, even with all the volatile days we have, they really are just small punctuations on a fairly quiet market.

The S&P has been moving on about a 16% vol and the implied vol of the options is still a bit higher at around 23% or so. This makes some sense, being that September is historically a bad month for the stock market in general with the broad-based indexes losing an average of about 0.75%. September is also a triple-witching expiration, which tends to bring added volatility.

The bottom line is that the options markets are predicting a slightly wilder ride to come for the month. If you disagree, maybe you can look at selling some premium. If you agree, then the prices are justified. And if you use the VIX as a barometer of market volatility, it’s telling us that the S&P should fluctuate about $16.60 per day about 70% of the time. As for me, I think vol comes in, but I would still be cautious to the downside We should close flat today…

Have a great weekend and holiday!

Before I go into details, I need to get a few things out of the way.

I tend to get frustrated when I hear things like “options are extremely difficult to understand” and “80% of options expire worthless…” Options certainly require some work to understand, but when was the last time that you read a company’s 10-K or 10-Q or had to learn advanced technical analysis? Tough, right? And guess what…companies’ businesses and earnings and the global economic climates are EVER CHANGING! One has to constantly keep up with the latest and greatest data in detail to be a master at fundamentals; you need to know about the newest widget and how much that widget costs to produce, market, etc.

Options basically stay the same; the principles that govern the way that they behave is constant. You show me a chart, tell me a couple facts about the underlying company and its stock’s volatility, and I can construct an options strategy in two minutes. This is not about gloating, it’s about the way we make decisions.

I still find it almost comical that we investment professionals sometimes pretend we know exactly what a stock will do…IT’S IMPOSSIBLE! Who knows how the masses will interpret and respond to data, news, earnings, etc. Every trade is a gamble when you think about it. I prefer to have odds on my side as much as possible.

With regard to options expiring worthless, don’t forget that there are out-of-the-money options (with no real value) and in-the-money options (these have intrinsic or real value).

According to Options Clearing Corporation (OCC) statistics for 2008 (for activity in customer and firm accounts), the breakdown is as follows:

• Closing Sales – 69.4%
• Exercised – 11.6%
• Unexercised at Expiration – 19%

So, in 2008, 19% of all options positions in customer and firm accounts expired unexercised; 11.6% of these positions were exercised; and 69.4% of these positions were closed out through sales.

Here are some basic guidelines when choosing a call option:

Delta: Before clicking the buy button, be sure the call you are selecting meets your trade-style objectives. Each and every trader will have a different pattern, different financial needs, and different goals and time frames for their trading. First and foremost, most traders have a hard enough time picking a stock that is going to move in the direction that they desire. In fact, it may be harder still to find an option with the best balance of leverage, probability of success, and enough time to expiry.

Luckily, there are some simple guidelines beginning traders can use to find the best potential call candidates.

If you want to trade an option that behaves the closest to the stock, look for a delta in the 0.70-to-0.90 range. This is MY method and does not mean that every option with a 0.70-to-0.90 delta will behave exactly like the stock, nor does it mean you will be successful trading this type of an option, it is purely a guideline. Trading a call with a high delta may solidify the relationship between stock and option (generally speaking, an option with a higher delta has a tendency to behave more like the stock), it will also help ensure a high intrinsic-to-time ratio and will increase the chance that the option will move when the stock moves.

Buying a lower delta is not necessarily a bad thing; just understand that the relationship between stock and option will be more dependent on other factors, meaning the stock may have to move further, faster for you to potentially profit. When placing a directional trade, in other words, if you are just buying a call because you feel the stock will increase in value, the delta that may NOT be desirable to purchase would be the 0.40 – 0.60 range, as the at-the-money options have the most amount of time value, relative to the other options.

Remember, time value is the decaying part of the option (more time value means you must lose more per day to get to zero by expiration). Having the most amount of time value means the option is also the most sensitive to volatility changes.

Let’s look at IBM (IBM), for example, which is currently trading at $116.00. The October 110 call is trading for 7.85, which means $6.00 of that option is intrinsic value and $1.85 is time value. The time value of the option is the portion that decreases as the options approach expiration.

If IBM were to rise to $120.00, that call would have to be trading for at least $10.00, because it would then have $10.00 of intrinsic value. Think about it… the right to buy (call) IBM stock at $110 is worth $10.00 if IBM is trading in the marketplace for $120.00. This would mean you would have made at least $2.15 on your $7.85 investment, or about 27%.

Let’s now assume that IBM does nothing here – it stays at $116.00 until expiration. What is your call going to be worth? The answer is $6.00. Remember, at expiration, an option will only be worth parity or intrinsic value (you would not have lost everything, contrary to popular belief).

Expiration: Having enough time for your trade to work is a risk many options traders have to contend with. One of the ways to determine how much time to buy is to look back on your past trading history. If you have a history of being in trades for an average of a month, then maybe you should buy a minimum of 60 days to expiration (DTE). If you have never traded live before, you should practice trading your methods. Take a look at your practice trades in your virtual account and use those as a guide to how long you tend to be in trades. Before you begin to trade real money, be sure you understand all risks involved. As a general rule, you should place at least 25 or more trades in your virtual account and have a written trade plan before using real money.

Here is an easy formula: Look back at your past two years of trading (or your total history if less than two years), then take all the trades you made and take the time you were in them and average them all. Then take your longest trade and average those two numbers (the average and the longest trade) – whatever number you come up with, add 30. The result is a good minimum DTE to purchase when you are making trades.

This is a formula I have developed myself. It does not guarantee you will always buy the right option, but it is a guideline to start with. I use this guideline because many traders I have taught over the years have experienced a trade where they felt they needed to hold an option longer than expected. This situation is why I choose to add 30 (or more) days to my average trade length.

Obviously, purchasing more time for what you deem to be a more long-term investment is generally not a bad thing, although I would be careful buying less time, as we all know that sometimes things don’t go exactly as planned in the market. Having more time in your trade may open some other “options” you may not have had available to you if you were out of time.

Most traders do not want to be long an option with 30 DTE or less, as time value begins to erode more exponentially the closer you get to expiry. Experienced traders who understand the more advanced behaviors of options may chose to trade front-month options…

Understand your risk before you trade ANYTHING!

The way we do business is forever changing and the ways that some companies make money are also changing. The world is obviously much more connected and dependent upon one another now more than ever and I would suspect this trend to become more prevalent. Global commerce and currency relationships play a larger role now more than ever in the profitability of many American companies.

America, unfortunately, no longer shares its far superior lead as the world’s richest and most productive country. I do not make my trades solely based upon shifts in the global economy or on currency strength or weakness. I am making this point because I believe, now more than ever, it is extremely easy to be a market participant, but even with all the data that flows to the average person’s computer, trading the current marketplace is a bit more challenging and confusing.

I believe that a good portion of this difficulty partially stems from the overload of unqualified, unchecked, perhaps erroneous information that has to be digested by the mind in a rather short period of time, which may prohibit the individual from verifying facts, sources, dates, etc.

If you compound this with the countless unique opinions that are being expressed at any given moment, it’s quite easy for investors to become confused or latch on to someone that agrees with their thesis even if it’s completely incorrect, leading them down a path of potential destruction.

On the other hand, the magnetism of the market is that anyone can be successful. That is not to say that there is not a plethora of folks that fail miserably. I am not a believer that all trading/investing is a zero-sum game, as the game is perpetual and has many variables. In the case of equities, the zero-sum argument could theoretically be upheld, but with options, because most professionals are hedging and taking risks other than direction, the zero-sum thesis becomes much harder to prove.

The bottom line is that I think stock traders are at a disadvantage. (maybe I am a bit biased as an options trader… They really only have one, maybe two choices when it comes to investing: buy a stock long or go short (which is extremely risky and not suitable for some).

Historically, a large group of stocks (in major companies) have been shown to appreciate over time. Investors like Warren Buffet just buy quality companies when they feel they are valuable and hold them indefinitely. Even though some of the holdings may never appreciate, on average, major market indices have shown positive returns if held for at least 10 years.

There are several flaws in this investment technique. The first is time – many of us do not have the patience and sometimes the luxury of "waiting it out." Some investors just throw in the towel before their stocks finally return to profitability and obviously there are some that never do. The other issue is stop losses and dealing with potentially losing 40+% of your account value. This has effects not only on an investor’s wallet, but on his mental well-being.

Again, this is why trading stocks can be difficult and frustrating for many of us. At what point do you "cut the cord" on an investment you are in? How long is too long to stay in an investment? Long spans of time tend to be hard for the average mind to comprehend.

I mean, think about how many things in your life will change in 10 years. Your career, your likes and dislikes, music, possessions, weather, location…etc. The average person stays in their home for seven years, but you should be expected to hold the same stock investment for longer? This is obviously not always a bad thing, especially when things are going well, but what happens when they are not.

And besides, if it’s that easy, then why isn’t everyone rich beyond their wildest dreams from investing? One reason may be that stocks really have an unlimited horizon and most traders fail to place time horizons on their investments, along with profit goals and stop losses. I feel personally that this is a detriment, not a benefit, to most investors.

Options, on the other hand, allow traders to really set up their time horizons, reduce risk, and make bets/investments with odds better than 50/50. There goes that casino analogy again, but you know, if I can place a bet with an 80% statistical probability of winning on a company that has great fundamentals, I would take that any day over just buying stock.

Not to mention when you buy a call or a put, the most you can lose is the premium that you pay. If you follow my methods and buy 0.70-0.90 delta call or put options, generally your cost will be about 10% of what you would pay for the stock. Even selling a put or a put spread at a level at which you would not mind owning the stock is a method you can employ to lower your risk.

What I like about options the most is that I can basically trade them on any company I want, without having to spend a day researching the company (and even then, I could still be wrong). The strategies are universal and can be used to place "bets" on direction, time, volatility, interest rates, etc. … essentially whatever I want.

I am not as much of a slave to the irrational crowd behavior that is often seen in the stock market; I create my own odds and I like that. Think inside the box, because once you learn options, you can trade just about anything that is presented to you and choose the appropriate strategy that not only matches your opinion on that stock but offers you a hedge against the sometimes irrational world we live in.

With regard to the title of this article, I thought it was appropriate to bring my three favorite words (besides “It’s Raining Men”) back for September. Many traders, including myself, have the feeling that September will bring not only volatility, but negative price action to the marketplace. In fact, the markets, on average, are down between 0.5% and 1.0% in September, according to Stock Trader’s Almanac.

Whatever your opinion, having a firm grip on these concepts is an integral part of not only setting realistic expectations for your trading and spotting anomalies, but possibly (and perhaps more importantly), finding a reasonable stop loss level in your trade.

All three of these measurements are somewhat related, but each is expressed in slightly different ways and interpreted differently. For most of us “home-gamers,” we are not going to use ultra-complex mathematical models to find precise deviations for a stock’s "normal" patterns as a means of finding some sort of volatility arbitrage and trying to capture it.

More likely, we are using these observations as a means to identify "realistic" and relatively abnormal occurrences in either an option’s pricing or a stock’s behavior.

Let’s start with volatility. First off, there are several types, so for this example I’ll just use historical (observed) and implied. Historical volatility is an annualized number expressed in percentage terms telling us how much a stock has moved in the past.

Volatility helps us gauge a stock’s behavior and gives us a benchmark, so to speak, when examining a potential trade strategy and setting profit targets and stop losses. Volatility is typically measured using close-to-close prices as the inputs for finding deviation or volatility.

Using close-to-close observations helps to "normalize" the intraday noise that tends to occur in the marketplace. Plus, it’s quite cumbersome to take every single price movement into consideration to compute volatility. Although with today’s technology, that is certainly possible and I know that certain market participants use that data.

For example, if I said a stock was moving on a 40% volatility and the stock was trading at $100.00 per share, that means it would be realistic for the stock to move either 40% higher (($40.00) or 40% lower ($40.00) about 70% of the time (this is where standard deviation comes in …).

Now, on to standard deviation. As a professional market maker, my options and decisions on trades were based upon how volatile a stock is, was, or will be in the future. By definition, standard deviation is a measure of the variability or dispersion of a statistical population, a data set, or a probability distribution. A low standard deviation indicates that the data points tend to be very close to the mean, whereas high standard deviation indicates that the data are spread out over a large range of values.

To simplify, standard deviation is the annualized expected movement (expressed in whole dollars), using the current stock’s price as the mean, while plugging in the observed volatility. So if the current stock price was $100.00 and we were using an observed volatility of 40%, one standard deviation over a year’s time would be $40.00 up or down, and this distribution would occur about 70% of the time.

What are the Chances?

• 1 St. Dev = 68.3% chance the stock will stay within plus or minus 1 standard deviation.
• 2 St. Dev = 95.4% chance the stock will stay within +- 2 standard deviations.
• 3 St. Dev = 99.7% chance that the stock will stay between +-3 standard deviations.

Obviously, it’s all about the input. If you are using 40% as your volatility measurement and you are taking your measurements right after March 2009, your observed volatility may be high and you may be expecting too much movement out of your stock. If, however the markets have been quiet for some time and you use that measurement, your calculations may be low.

This ambiguity is what makes the marketplace work and is also why there is NO perfect answer. For me, I like to use a blend of both the historical volatility as well as the implied volatility of the options to generate my forward-looking volatility calculations.

By the way, to determine the daily expected volatility of a stock, take your annual volatility number and divide by 16 (the square root, roughly, of the number of trading days in a year). That will be your daily average % volatility.

Now, on to ATR. ATR stands for average true range or average trading range. ATR measures the average dollar movement of a stock over different time periods, typically taking 14 periods into account. It also measures more than close-to-close pricing.

ATR takes the LARGEST movements into account, which enables the trader to get a closer look at the true recent behavior of the stock he or she is trading. I use ATR as a quick confirmation of a stock’s over bought or oversold condition.

I also use this as the outer edge of where I would place my stop- loss or profit target or as an entry for a reversion to the mean trade. For instance, if a stock or index has exceeded its daily ATR and I see a chart pattern that looks attractive for entry, I may enter long or short then cover once the stock has hit its "normal" 1 standard level. As most times, ATR will be greater than daily standard deviation.

Just some thoughts!

Closing with another favorite three-word phrase of mine: "Keep selling, Mortimer"

AIG is a complex situation that traders should understand before trading real money in there.

For all the folks who are curious as to what a short put means in terms of risk, reward, etc., let us first dissect the put itself.

The PUT defined – A put gives the holder (buyer) the right to sell a stock at the strike price on or before expiration. If you purchase a put, you pay a premium for this right. If the buyer of the put has the right to sell stock and pays for that right, the trader who SELLS the put (also called a short put) gets paid and is OBLIGATED to BUY that stock at the strike price on or before expiration. Basically, buying the put is like buying an insurance policy on a stock and the seller of that put IS the insurance company who has to pay up if things go bad, but gets to collect premiums.

So, if you are selling a put, you are basically saying “I am ok with possibly having to purchase 100 shares of the stock at the strike price for every put I sell” This may sound like an odd statement at first glance. Take AIG as an example. Yesterday, AIG was trading at $50.00 per share.

I suggested that traders could examine selling the 40 put for $6.00. This means a trader who employed this strategy would be okay owning AIG for $40.00 AND they get $6.00 to do so. This means that a trader who used this strategy would have a cost basis of $34.00 in the stock, or a 32% discount to where it was trading -not too shabby. Now on to the risks and rewards.

The cash-secured put has the SAME risk profile as a covered call.

Risks – If AIG drops below $40.00 you may have to buy the stock at $40.00. You still keep your $6.00 from the sale of the put, but you still have $34.00 of risk if the stock were to drop to $0. If AIG stays above $40 (the strike price of the put), you just keep your $6.00. If the stock runs to $70.00, you will only make the $6.00 for which you sold the put.

Rewards – The $6.00 premium you collected from the put sale is almost an 18% return on your money at risk in the trade ($34.00). This 18% would be achieved in 48 days (by October expiration). Selling an out-of-the-money put gives you some peace of mind if AIG starts to drop, whereas if you just bought the stock at $50.00, you may begin to experience anxiety sooner. If you get ‘put’ AIG stock at $40.00 (remember, your cost basis is $34.00) you can sell the 40 calls against your position.

Because of the inflated time premium, at-the-money calls with 30 days until expiration are trading for $11.00, or 20%+ of the stock price. This means if you sold the $40.00 call with the stock around $40.00, you may receive $8-10 for it, which would further reduce your cost in the stock down to $24-$26.

You could also just buy back the put if the stock rallies, like it is doing this morning. Right now you can buy back the Oct 40 put for $4.75. That would be $1.25 profit on a $6.00 credit, or 3.7% of your TOTAL risk in one day. All the while having less risk than a stock investor and a higher probability of a positive trade.

Have a great weekend!

• The prices of single-family homes in 20 major cities rose a seasonally adjusted 1.4% in June, the second increase in a row after falling every month for three years, according to Standard & Poor’s.
• Prices rose in 18 of the 20 cities in June. Detroit and Las Vegas were the obvious exceptions.
• Home prices are down 15.4% in the past year, an improvement from the 19% year-over-year drop in January. Prices are down 31% from the peak in mid-2006.
• For the second quarter, the national Case-Shiller index rose 2.9%, the first quarterly increase in three years. The quarterly index is down 14.9% in the past year.
• "This is an impressive turnaround," said Robert Shiller, creator of the index, in an interview on CNBC.

Housing has been a favorite sector and passion of mine for a long time. I have been recommending it as a buy for four months now, though many experts disagreed with me, initially. I remember my first mass media pitch for housing on the Fast Money Desk in NYC, earning a “balderdash” from then cast member Jeff Macke (I had to chuckle at that one).

It is typical that when things are looking extremely grim, people get caught up in the moment versus looking at where the data stands historically and what the possible outcomes are moving forward given current circumstances and the probability of various outcomes.

It sometimes pays to look at sectors that are NOT “hot” but have extremely high potential to be hot, (but may have not been recognized by the masses yet).

I remember several months ago, when I decided to start looking to go long in housing, I used a ton of anecdotal evidence from my own travels, in addition to some hard statistical evidence. I first began to examine public opinion on housing prices; I did this by searching local news stories on the internet using housing keywords to get an idea of mass sentiment. I was getting the sense that most citizens in major metro areas believed there was value to be had by purchasing real estate now.

It seemed from what I was reading in print and the people I was talking to in my own circles (both realtors and investors in different cities) were stating was that they certainly felt housing was affordable now. They were more so concerned with two other things: 1. Would they even have a job in a year from now? 2. Can they get a mortgage to buy the home they want (this was more prevalent in the condo marketplace, with most lenders looking for 20% down and Fannie Mae is much more selective about where it lends).

Obviously value is important, but from the research that I gathered, most thought that current price levels were attractive. I mean, we gave back seven years of gains in the course of about a year and a half. This perception is further backed by the fact that in most dense urban areas, prevailing average rents are able to provide positive cash flow using 20% down at the prevailing investment rate.

There is also a psychological effect. When you look at a $500,000 dream house that was completely out of reach just two years ago but is now listed for $220,000 in some areas, it does something to the human mind.

It’s like dreaming of buying a Ferrari as a youngster but knowing they were always too pricey. And then, all of a sudden, you can drive away in the same car, same quality, same year, same color, and same warranty for $50,000 instead of $100,000. Remember, the quality didn’t diminish, Ferrari wasn’t bankrupt, cars just became markedly cheaper. Retail buyers see that as opportunity and if they can rationalize that deeply discounted purchase in conjunction with confidence in their job and income, that is a recipe for recovery.

Housing affordability was recently at the highest it has ever been since we began keeping records. If you compound that with mortgage rates being a relative lows, everything was pointing towards a sharp reversion towards the mean in terms of housing prices and sales.

I used the PHLX Housing Sector (HGX) and the SPDR S&P Homebuilders Index (XHB) as my investment vehicles of choice. Individual builders and their related companies tend to mimic the behavior of both the Case-Shiller 20-city home price index as well as the existing and new home sales numbers. Not to mention, most of these stocks were quite battered and bruised. That is not to say these companies couldn’t fail or default, but I felt the indices provided enough of a hedge against defaults and bankruptcies within the companies.

I looked at the new MacroShares Major Metro Housing Up (UMM) and MacroShares Major Metro Housing Down (DMM) funds, which offer traders a way to bet on the forward value of the Case-Shiller 20 city index out to October 2014, but I felt it wasn’t the best vehicle in its current form for me as a shorter-term trader. I also felt it would be confusing for most to wrap their heads around, although the folks over at Macroshares (of which Robert Shiller is a co-founder) have created some fine products and are looking to add more products with varying time horizons, so investors can choose their "expiration date."

So here we are several months later, with the XHB trading at almost $16, up more than $5 (or 45+%) from where I began recommending it. The HGX is currently trading at $109, up more than $34 or 39% from the $70-$80 range I was recommending.

In proper Jared form, I do think investors should be hedging or unwinding some of their exposure in both of these issues. You can do this by selling covered calls or by replacing long stock for long calls with six months of time until expiration and a lower delta, using some of the proceeds from your stock to buy the calls.

I say protect your positions, not because I think housing will falter, but the true fundamental broad housing recovery still has an uphill battle to climb. But 35%-45% returns in four months are more than acceptable.

Trading is a game of money management. Never get overconfident; anything can happen in these markets…and a bird in hand is always better than two in the bush!

Binary Options are just another product to trade; they are nothing new and there are pros and cons to just about every vehicle that investors can trade. I can offer you my opinion on these options and how one might go about trading them.

First off, you must understand the product to trade it most effectively and safely.

Binary Options, also called all-or-nothing options, digital options, or Fixed Return Options (FROs) are offered and traded across many markets. Secondly, there is not much open interest and so the spreads are fairly wide. On the outside, when you examine the valuation of binary options, they really begin to look much like N(d2), the probability that the option finishes in-the-money. (*the other delta).

Using the Black-Scholes model, one can interpret the premium of the binary option in the risk-neutral world as the expected value = probability of being in-the-money * unit, discounted to the present value.

To take volatility skew into account, a more sophisticated analysis based on call spreads can be used.

A binary call option is, at long expirations, similar to a tight call spread using two vanilla options. One can model the value of a binary cash-or-nothing option.

I have to tell you that I have not had much time to study or trade them. I think the best use of them for a retail trader would be as a substitute for verticals, both credit and debit. There are obviously other ways one can put them to work, but let’s say spot is 50.00 and the 40/45 put spread is 0.50 cent bid with 30 days until expiration.

In this trade, you have $4.50 at risk for a $0.50 credit. or an 11% return on risk (ROR). Even with that ROR, you still can lose much more $$ than you brought in – nine times as much..

Now let’s assume we can sell the 45 Put Binary for $0.15. That option will only be worth 0 or 1 at expiry, so we risk $0.75 on a $0.15 credit, or 20% ROR. You still risk five times what you stand to make. But also remember that there is no middle ground… this is either going to be 1 or 0.

Your breakeven on the put spread is $44.50 and you gradually lose money as the stock drops.

Your ABSOLUTE breakeven on the binary is $45. PERIOD.

So there is much to consider. It certainly is a niche product that has its place. Be sure you use limit orders if you are trading them.

Hope my words offered a bit of insight.

I would trade binary options if they were liquid, but I have not yet placed a live order to find out

Let me paint the picture for you. At around 8:00PM, I was getting ready to take a ride on my Road King – great way to spend an evening, by the way. I planned on heading out to the WIT hotel, a new posh boutique hotel with a great roof deck. (A posh hotel is not my typical hangout; I just heard how gorgeous it was up there, so I had to check it out). Besides, everyone told me that the weather was predicted to be amazing with less than a 10% chance of rain in the Chicagoland area.

Anyway, before leaving, I took a look out of my 12th-story window to see a mass of what looked like Cumulonimbus clouds on the horizon and I thought, "Maybe I shouldn’t ride, better check the weather."

I went first to my browser and typed in my zip code – low and behold, it said partly cloudy, no rain, chance of precipitation 10%. I looked at the radar and nothing was there. Hmm… I then went to weather.com and saw slightly similar data, which was updated only four minutes before I checked the site. Again, just minor cloud cover, no talk of rain, chance of precipitation 10%. Took another glance out of my window, just to make sure that six-mile wide cloud wasn’t a hallucination; it was still there.

But, after checking the good ole dependable(?) weather websites, I felt fairly comfortable with riding, so going against my gut, I hopped on the bike and rode to the Wit. Upon arrival, my instincts and the smell in the air were screaming rain, but I proceeded to go up to the roof deck. At this point, the cloud formations from the west were becoming much more ominous, darkening even more, and rising higher. I started asking around, and everyone basically told me: "It’s not going to rain, didn’t you check the weather forecasts, they predicted no rain tonight." I asked the bartended to turn on the Weather Channel and again…no rain, no thunderstorms, just partly-to-mostly cloudy…

Then it started. First a couple of drops, then heavier and heavier. What I found amusing was the fact that the hundreds of people who were there were looking to the sky in disbelief, like it was not possible that it was raining because the meteorologists said it wouldn’t. What I found even more amusing was watching the Weather Channel as it was pouring down rain. They still showed partly cloudy, chance of rain 10%. That was the highlight of the whole thing…needless to say, I learned something from this experience and thought it would make a great article.

I cannot guess at the statistical probability of the accuracy of the average meteorological prediction, but I can tell you anecdotally that I often hear people talking about how bad the average weatherperson is at predicting the weather. I would be confident in estimating that most would place their accuracy somewhere around 40%…I found it even more amazing that many of us ignored our own eyes and instincts because of what we heard or read on a TV network, website, or newspaper, even when we BELIEVE that they are wrong more than they are right.

Even when the rain was pouring down, there was a palpable sense of complete shock, awe and disbelief that it could actually be raining right then and there. When all we had to do was look up at the black cloud looming overhead.

This happens quite frequently in the marketplace. We sometimes ignore all the warning signals that the actual market is giving us, which can obviously come in many forms. We also tend to ignore our gut and cling on to someone’s opinion that supports our thesis, even though things may be falling apart and this person may or may not have the best track record for success.

For instance, let’s say that you are long gold and it begins to drop. Everyone is selling and puts are being purchased. All economic data points to gold moving lower, but you ignore all this because you heard an analyst say that he likes gold, so you turn a blind eye to the actual occurrences in the marketplace and watch your account waste away. This happens every single day to thousands of traders and investors.

Much of this phenomenon is most likely due to the fact that most of us don’t want to be wrong. More importantly, we develop such strong beliefs and attachments to some of the stocks that we trade that we violate our risk limits and end up spiraling into a high risk, high stress trade that now must work out or we stand to lose a large portion of our accounts that may have devastating and irreparable long-term effects. All because we just didn’t want to believe or accept what was going on around us.

Last night, I was risking a wet, cold ride home and a bike washing, maybe even elevated danger as the roads would be slippery. As I was standing there in the rain, I thought of what an idiot I’d been – I was watching that cloud pass over me and now look at me, soaked. I then thought about how many times I felt uncomfortable in a trade and didn’t do anything about it, even when I saw signs that things were worsening and I continued to be stubborn. I was hoping I could share this with all of you to maybe prevent some of you from doing the same.

Technically speaking, Google is presently at the lower end of an ascending channel/triangle that has been building for weeks. I also like the recent retracement from the 464.72 mark down to our current level of 442.00, which represents a 4.7% move. I would be comfortable with a move all the way down to the 50-day simple moving average at roughly 432. Regardless, this is a short-term play.

With GOOG @ $442.80, I wanted to make some points:

• GOOG has slowed down and stabilized in its old age.
• It has not closed below 400 since May 2009.
• Beta of 1.14 (correlated to the S&P).
• If the S&P 500 Index (SPX) drops to 950 or 3.6%, that’s going to equal a move of about 4.2% for GOOG or about $18.50. If you round that up to $20.00, that still puts you at 424.00.
• Volatility is not what it used to be in GOOG; it’s been moving on about a 25% vol.
• Even using a 29% volatility calculation, there is a only a 14% chance that GOOG will finish below 400 on expiry. I chose 400 because it’s obviously a large round number at which I would be comfortable owning the stock.
• Earnings are not until 10/15/09, which is beyond this trade’s time horizon.

If you are a trader that would not mind owning GOOG at $400.00, I would examine selling the September 400 Puts for $2.25. Remember that the short put obligates you to purchase the stock if it is below the strike at expiration. If GOOG remains above $400 at September expiration, you will retain your credit.

Just a thought

Let’s assume you are bullish on a stock going into earnings, but perhaps it has been rallying for a while and has a history of making large 1.5+ standard deviation moves surrounding earnings. This spread is basically a ratio’d out-of-the-money put vertical, using three strikes. This strategy enables you to gain a bit more in terms of credit at the onset as well as better return on risk, but the risk is greater than just selling a put spread.

The other benefit is that the breakeven is lower because of the greater credit received.

Let’s examine the trade using CME Group Inc. (CME), which reports earnings in November.

First, I will examine the volatility of CME going into its earnings report, both what implied vol is doing as well as make some expected price calculations using the OptionsHouse price distribution model (probability calculator).

Remember that this is a moderately BULLISH trade, so I should have that opinion on the underlying stock.

This trade is best executed when implied vols seem relatively elevated. (You can see this in the Volatiliy Charts on OptionsHouse.com).

I use the probability calculator to find 1 standard deviation in the underlying stock using the implied volatility of the at-the-money strikes. I also check the 90-day historical volatility and average the number higher if it is greater than implied volatility readings.

Once I have determined what that strike is, I then look to sell that strike or move to the next lower strike if there is significant relative premium – that is the put strike in which I will sell two contracts. In CME’s case, the strikes are $5 wide. So let’s assume for this example I were to sell the December 200 put twice at $5.80 per contract. I would then purchase one of the next strike down, then one more of the next strike below that. So it looks like this:

• Short 2 December 200 puts at $5.80 (total 11.60)
• Long 1 December 195 put at $4.90
• Long 1 December 190 put at $4.20
• NET CREDIT of $2.50
• ROR 33%
• Max Risk $7.50
• Breakeven – $197.50

If you compare this to selling a 200/195 Put Spread:

Short 1 December 200 put at $5.80
• Long 1 December 195 put at $4.90
• NET CREDIT of $0.90
• ROR 22%
• Max Risk $4.10
• Break-Even $199.10

I try to time the trade on a day the S&P is down at least 0.5%-1%

Remember that the tiered spread will have more of a short vega profile and will have added risk, but potentially greater reward. I also encourage going in between the markets. In other words, don’t just pay the bid and sell on the ask. Be sure you paper trade and learn the spread’s behavior before applying real money.

The ultimate goal is to allow the stock some room to move, but ultimately you want the stock to expire above the strike of the puts that you are selling!

Happy Trading!

I am bringing all this behavior talk up this morning, because the futures moved lower this morning – finally – and I also know we have been looking at some volatility-based neutral strategies of late as well as some bearish spread strategies.

This game is all about longevity, taking calculated risk, and capturing a realistic consistent return. Sometimes we lose sight of the big picture when we get caught up in the moment.

As for credit spreads, they can sometimes be tricky when it comes to taking a profit ecause you have to buy them back for less. If you sell a credit spread that is $5 wide for a $2.00 credit and you are able to buy it back for $1.50, you just made $0.50 on $3.00 of risk, or about 17%. Additionally, you likely made this in less than 30 days, being that most credit spreads are employed close to expiry. If you annualize that number, you can see your return is upwards of 200% (I’m not using compounding).

My point is, take baby steps, both in your profit as well as your loss and take advantage of opportunities. IF you are in a profitable situation, be proactive in managing your trades. Make and take kibbles and bits from the market place. They are much easier to chew.

Here, things aren’t that easy. Many would agree that we are making strides in credit, housing, consumer spending, etc. But there are certainly headwinds to come. I am certainly not an economist, but I am pretty darn good at sifting through data and forming opinions, not to mention it doesn’t take a rocket scientist to just listen to what most experts are saying as well.

So here it is … I have to say that I think we will see 950 before we see 1,060.

The markets are an interpretation of investors’ emotions and beliefs about the securities they trade. Value is such a subjective thing – no company trades for what it’s really worth, as most trade on some multiple of their expected earnings. Dependant on what sector you are looking at and whether the company is a "grower" or more stable, earnings multiples will vary.

If we look at the current earnings multiple of the S&P, it is roughly 18.7 times current earnings (roughly $54 earnings per share). Normally, a 14-15 multiple would be more realistic. Bottom line is that roughly 300 of the 500 companies in the S&P experienced NEGATIVE growth in the last quarter, with the energy, materials and industrials experiencing the most negative growth.

To get to 1050 with an earnings multiple of 14, average earnings in the S&P need to be $75 per share. This is a 39% increase in earnings per share…

Bottom line: I think it is going to take a bit of time before that happens, and I don’t think a 19.50 multiple is realistic for the S&P to hold for an extended period. (1,050 divided by current earnings of $54).

"Sell near term, Mortimer."

Note: I began writing this 8/13/09 at 11:00 AM; sorry for the delay in completion.

Using the right order type can definitely make a difference in the outcome of your trade. It can mean the difference between disaster and profit, not to mention all the possible outcomes in between.

Because of all of the various trading styles, objectives, and risk tolerances out there, traders must really experiment with what order types are appropriate for their particular goals.

Those of you who know me understand my fascination with words; I’m always intrigued by how many of us hear words that seem to have one meaning, but really mean something completely different.

Stop-Loss Orders – The word stop, in essence, means “trigger” and the word loss means “at the market.” A stop loss, then, is a trigger order to exit your position at the market. Typically a trader would qualify this by identifying the order as a buy stop, which would trigger a market buy order for a short position and a sell stop, which would trigger a market sell order for a long position.

Stops can also be used to enter a position, by triggering a buy or sell for a non-existent position. In other words, if I want to buy the SPDR S&P 500 ETF (SPY) if it breaks thru $100.00, I may set a buy-stop at $100.00. So even if I do not have an existing position, this would trigger a market buy order at $100.00. If, however, SPY is running higher, I may end up paying a higher price. Sell-Stop orders can also be used for entering short positions to the downside. There are also “limit” stop orders, which trigger a limit order. Remember that if you use these types of orders, you have no guarantee of getting filled, as the stock or option may blow past your stop.

Stop losses should be used to prevent catastrophe. They can be frustrating, but also can put an end to a trade that has gone terribly wrong from getting even worse. Be sure your stop prices are not only in line with what you can tolerate, but OUTSIDE the normal variations of the stock. This is where understanding volatility can really help you.

Trailing-Stop Orders – I think it would be safe to say that I would not use trailing-stop orders unless I was already in profit territory for a trade. I personally believe that a trailing stop is best used to retain profit and mechanize the trade.

Trailing stops are orders to buy or sell a security that “trail” or follow the market price of your security as it moves in a profitable direction, but locks in place if the underlying security changes direction.

Example: I bought an option for $5.00 and set a trailing stop at $4.50 (trail amount is $0.50). If the option moves higher to $6.00, our trailing stop is now at $5.50; if the option then trades down to $5.50, the trail will become active and take us out of our position.

Typically, trailing stops are placed tighter than regular stop orders as they are a ratcheting type of order that will let the stop price move higher but not lower (in the case of a long position) Placing a tight trailing stop at the onset may prematurely force you out of the trade. It really boils down to your ability to time your entries into positions, the volatility of the stock, and your own personal risk tolerance and greed.

If you are a longer-term trader, placing a trailing stop just outside of one monthly standard deviation in your underlying stock might be a technique you can explore.

Shorter-term traders (less than one week in a trade) might use a tight (0.10-0.40) trailing stop once their trades become profitable to try and capture momentum in the stock or option.

Be sure to paper trade any of these methods before attempting to apply them in the real market.

Ignorance is one thing that scares me. I certainly don’t know everything and will be the first to admit that, but when someone makes statements that are intended to be factual (not opinionated) to the masses and these statements are completely false, I have to call them out.

As an investor, you obviously depend upon news, facts, and proper knowledge of strategies as well as opinions to navigate your way through the sea of information. It is important that these different types of data are identified properly, so you can put them in the proper context.

After my class yesterday, a young man approached me and asked if options can be used as a substitution for buying stock. I replied "yes" but told him there were some parameters and guidelines that he needed to follow.

He was told by an instructor at the show that he should "never buy in-the-money options." That statement bothers me because there was no real reasoning behind it. The instructor reportedly said, "If you buy an option that is already in-the-money, you are paying for someone else to be profitable."

I do not understand this logic, nor can I really make any sense of that statement at all. Options can certainly be used as a stock substitute and depending on your time horizon, and opinion of direction and how far you think the stock will move, you will choose your option’s strike and expiration accordingly.

The simplest way to use an option in place of long stock is to look for a large-delta call option. With a delta of 0.75 to 0.90, an option should be mostly comprised of what is called parity or intrinsic value. It should have a small amount of time value. These options will tend to behave more like the stock vs. an at-the-money or out-of-the-money option.

To maximize this relationship, time value should be less than half of your intrinsic value (if you are buying fewer than six months out). For instance, if you have a stock trading at $50.00 and buy the 45 call for 6.00, you have $5.00 of intrinsic or real value and $1.00 of time. If the stock rises to $55.00, that call will have at least $10.00 of parity or intrinsic value even if ALL time value goes away. You do want to be sure you buy enough time in your option for your trade to work out. If you think you are going to be in the trade for 45 days, add 30 days to your options expiration, just in case. So you would then purchase an option with 75 or MORE days until expiration.

When using options as a stock substitute, it is generally not a bad thing to buy a little extra time in your option.

Another trick is to take the amount of the stop loss you were going to use in the stock (let’s say you are willing to risk $6.00 on a $50.00 stock purchase) and that would be the max amount you spend on your call option, as long as the call falls in that 0.70- to-0 .90 delta range…

Just some quick tips I thought I would share — there are much more to come!!

If you want to learn more about this, check out our Options Physics Basic series!

Here are the details…the company posted revenue of $8.34 billion and a net quarterly profit of $1.23 billion, or $1.35 per diluted share. These results compare to revenue of $7.46 billion and net quarterly profit of $1.07 billion, or $1.19 per diluted share, in the year-ago quarter. Gross margin was 36.3%, up from 34.8% in the year-ago quarter. International sales accounted for 44% of the quarter’s revenue.

Apple sold 2.6 million Mac computers, a 4% unit increase over the year-ago quarter. They sold 10.2 million iPods during the quarter, representing a 7% unit decline from the year-ago quarter.

Okay, so basically everyone thought AAPL’s earnings would be strong and they were making bets with the stock and with options. As mentioned in my article earlier this week, I was playing a little statistical, protective trade on AAPL ahead of earnings.

Let’s see how we fared.

When we first looked at the trade, AAPL was trading at $155.00 ($154.97) and I suggested the 145p/165c collar and paying a premium of roughly $0.10, to sell the call, buy the put. Over the past 11 earnings reports, AAPL has moved an average of 5.6% after earnings (both positive and negative). The largest move was 10.6% – the smallest was 2.6%.

AAPL performed just as I thought it would; it enjoyed a moderate rally, but stayed well within 165. Remember, just because I thought it would perform that way, you never know what will happen after an earnings release, which was my reasoning for buying the 145 put.

So yesterday, the first day after AAPL reported, the stock hit an intraday high of $158.73. When the stock was about $158.00, the collar was trading for $1.00, which would mean you would realize a $1.10 loss (you have to pay again to close this position; you are buying the call back and selling the put this time. Now I know the $1.10 loss stinks, but the good news is that with stock at $158.00, you made $3.00 on your AAPL stock, for a net gain of $1.90 ($3.00 stock gain – $1.10 collar loss).

Today, at 10:54am, AAPL is at $157.97 and the collar is priced at $1.03, so things have not changed much. You can remove the collar and take profit on your position as well or remove the collar and keep the stock, if you feel AAPL moves higher from here.

You could also obviously leave the collar on as long as you continue to hold the stock position and if you feel the shares could drop again.

This collar (a/k/a risk reversal strategy) is synthetically like being short stock. You do not want to have this position on by itself unless you are extremely bearish on the underlying.

Just a couple quick notes — I am taking a motorcycle trip up the coast of Michigan and into Canada and I will be gone all next week, but be sure that I will send my notes as much as I can! Thank you for reading!

Have a great weekend!

But after I saw my 10th colleague on the floor blow out his account, I decided to change my strategy. I believe longevity is achieved by lots of small calculated, hedged risks vs. ultra-large naked ones. With that said, Apple Inc. (AAPL) reports earnings tonight and I have to tell you I am concerned. Not that Apple can’t meet its expectations of $1.17 per share, but more so that the stock has added roughly $17.7 billion to its market cap in the past eight days and is up 15% in that same time period and about 76% on the year.

I never seem to have enough time on CNBC to let everyone know what’s in my head. I also find it amusing that just about every ‘expert’ seems to regurgitate the same numbers and facts over and over again. While I think it’s great that we keep people informed, this is sometimes the cause of irrational exuberance.

Most experts also fail to discuss price action or give specifics for where to buy or sell a stock or ETF. PRICE IS EVERYTHING!! I sometimes feel like most of the folks on the TV and in print are like a bunch of car reviewers, telling us what car they think is the most fun to drive, has the best acceleration, braking power, etc. and it is up to us, the traders, to act as the dealers of these cars, actually finding value.

Many times, there is a huge gap between perceived value and actual trading price. Remember the MARKET sets the price, not the company or analyst itself. That’s not to say we should go out and buy companies that are losing money quarter after quarter.

The Nasdaq has now risen for nine consecutive sessions, its longest run since 1998 – remember those days? It’s gained 9.3% in that time. The S&P 500 advanced more than 1% on Mon, adding to its 7% gain last week. Despite these powerful moves, stocks continue to have a strong bid to them as investors grow anxious and chase profits.

Getting back to AAPL, the stock was priced at $155.00 yesterday when I suggested the 145p/165c collar at a premium of 0.10-0.20. Over the past 11 earnings reports, AAPL has moved an average of 5.6% after earnings (both positive and negative). The largest move was 10.6% – the smallest was 2.6%.

The 15% move we have seen in the past eight days lessens the chances that this stock will make a move greater than 5% to the upside after the report hits the wires. A 5% move is about $8 to the upside. Right here, assuming you already own AAPL shares, I would sell the August 165 call for $3.00 and buy the 145 put, currently trading for about $3.10. You may have to lay out $0.10 (plus commissions) for this collar. Sell one collar for every 100 shares of AAPL.

During Monday’s session, AAPL was trading at +25 times its forward p/e, much greater than the average of its peers. What’s more, AAPL has not traded in the $165 area since August 2008.

Anyway, enough of my reasoning … in reality, I would protect myself ahead of earnings regardless of how attractive or unattractive I perceived the price to be.

A collar offers you absolute downside protection, but with limited upside. By purchasing the 145 put for $3.00, I purchase the right to sell AAPL at 145 until August. I chose this strike because AAPL was just at $134.00 before this recent run and there is some support there; the next stop down would be $134-ish. I also chose this strike for its cost.

As I said earlier, I thought a 5% move to the upside would be a reasonable limit for AAPL based on its recent price action and historical earnings behavior. The 165 call was selling for about $2.90 at the time, and the call helps finance the cost of the put. My net cost for the collar is $0.10, which means I have a downside breakeven in this collar of $144.90 (145 put minus the cost of the collar). If the stock drops to $130.00, the value of that 145 put will rise and the 165 call will fall, thus increasing the price of the collar spread and offsetting the loss I would have in the stock.

If the stock rises and stays under $165, my stock will make more than the collar is losing and if I believe the stock will stay below $165 by August expiration, I can just let the collar expire. If the stock blasts up through $165, I can choose to let the collar get exercised and I will be forced to sell my stock at $165. This wouldn’t be a bad thing if I the original purchase price was less than $165, (or – even better – less than $140). If I feel the stock will continue to rise above $165, I can buy back the collar for a loss, which should be slightly less than the gain I am seeing from my stock.

The bottom line is that you need to look at where you own the stock and at what point you want to insure your stock. Choose a call strike that you would be okay with selling the stock at. I chose $165 because the stock has not been to $165 since 8/08.

Use common sense and be sure you understand the strategy before applying it in the marketplace! Let’s see what happens tomorrow…

I also soon realized that no one person can predict the market with accuracy. Generally speaking, those who are consistently successful don’t make very specific market predictions; they may say something like, "That stock will be higher by next summer…" or something along those lines. They may use both time and a maybe a recent price anomaly coupled with some fundamental hocus pocus to make a prediction.

What I have found over time is that sometimes, even when a company is growing and meeting its earnings expectations, their stock gets pummeled when the report hits, because the stock price has been growing faster than the earnings. If you compound that with some new competition in the sector or maybe a stock falling out of favor, even a strong earner can see its price drop. It gets worse. What if the company is meeting expectations but the overall market is extremely bearish; this can repress a stock’s price.

The bottom line is that, with all the variables, even the best CFA can’t pick ‘em perfectly. In fact, I believe that most are about 50/50, but some of their picks may be get more publicity than others, or maybe eventually the stock rises or falls. I am saying this anecdotally; I do not have data to prove my theory in all fairness and I am sure there is a standard deviation of +-10% in terms of analyst correctness.

Time is the big equalizer in this equation. I could say, as an analyst, that I am bullish on ABC, which is currently trading at $50.00. Let’s assume over the next three months, the stock drops to 30, before reaching $70 seven months later. Was I right? Did the investor who went on my recommendation get stopped out and blog about how bad my data was or did he or she stick it out and call me a genius?

This is also the case for options. Markets fluctuate, obviously, so as an options trader, I want to stay impervious to the daily or weekly noise. I would rather my own P&L behave more like a 20-day moving average rather than the peaks and troughs of the underlying stock itself. This can be done with the use of spreads or even individual options to mitigate risk and exposure.

But anyway, getting back to the reason I wrote this article. I work with some of the greatest minds in the industry who do make some truly amazing stock picks from time to time, and I myself feel I have made some good picks myself, along with some bad ones … I don’t mean to gloat here, but COME ON!!! Meredith Whitney has been a bear in Goldman Sachs Group (GS) and banks for some time. It was NOT her that called the GS rally, nor made the stock rise!!! For Pete’s sake, I know that I and just about the whole Fast Money crew, Buffet, Cramer, etc. have been bullish on GS for a long time!

Here is a clip from May 6 when GS was about $119.00 per share. I recommended buying it here as well as several times before and after this aired. After watching it, please be sure and do whatever I say, maybe I’ll make the cover of Fortune…

No, but seriously, my reasoning for this was to warn investors about the dangers of blindly listening to a guru without doing your homework. And in this case, I feel there were many traders and analysts that were ahead of her, but the media focused on her testimony as the "reason" GS was rallying.

I think Ms. Whitney is obviously intelligent and I respect her, but she rose to "guru" status for a call she made on Citigroup (C) back at the end of 2007. Don’t forget that she has been bearish on the financial sector for some time. I have to agree with Cramer – Whitney’s waving the "white flag" and finally going long shouldn’t be glorified. Why didn’t the media publish "Whitney has been wrong for 5 months, but is ready to buy now!" or something along those lines? Just curious…

NO ONE CAN PREDICT THE MARKETS.

If some yahoo wants to start paying $20,000 for 1984 Chevy cavaliers, so be it. As long as he has the cash, I’ll be a seller, and he can only buy so much. Chances are when he is done buying, the price will return to a more normal level and if not, if he buys all the 1984 Chevy Cavaliers out there and they become the next vintage collector car. Well, then, you have new value.

The government tries to keep us from making big mistakes, but rather than restrict a global marketplace, how about empowering folks with education and resources. You will never stop humans from making mistakes, nor can you prevent the mania of crowds! There is no "perfect" way to moderate price in both tangibles and intangibles. Why does it cost $1,000,000 for a 700 square-foot apartment in NYC, but that same apartment in Detroit will run you about $30,000? How about we restrict how much people can pay for homes or maybe cap all homes at a flat rate? Obviously, that wouldn’t work.

What about beanie babies? Why didn’t the government step in and stop some of those "foolish" folks from paying $3,000 for a three-inch stuffed toy, which was made in China for a cost of $0.08? I’m not good with numbers, but I have a feeling that 37,500% overpayment is greater than the "premium" that oil was trading at, even at its high!

I firmly believe that liberated, liquid, and open markets will find their value with the data they have at that moment (even though most markets tend to be forward looking). I also believe the markets act like water, in that they will find the path of least resistance; if you try to restrict them, just like dammed water, when it bursts, it’s a disaster.

Let’s say a company begins to build a large oil position and they drive the price higher by purchasing contracts. At some point, either the price of oil stabilizes because the fundamentals of the underlying commodity move in line with the price, or the price corrects itself. If the price regresses, the buyer (the manipulator, the speculator) loses money. No regulatory body can prevent people from losing money in a free market…in many cases, it’s a zero-sum game that gets played over and over. Wealth is usually not created, it is transferred from one trader to another.

People with money will find ways to invest it, and if there is a roadblock, they will find a way around it, which could potentially be more dangerous than the original.

I certainly understand that no one would like to be paying $5.00 per gallon of gasoline, but this is where knowledge of the markets, fundamentals, and a good working knowledge of options can help you lower your risk and maybe take advantage of what you perceive to be a potentially inflated value. There will always be people who take advantage of the system, and I will be curious to hear what data is discovered at these "hearings."

I will be sure to keep everyone posted.

As I often say, stocks develop their own personalities, not only in how fast they move, but also how far and for how long before the inevitable regression to the mean. Imagine if you asked a runner after a 26-mile marathon to run another five miles. Chances are they will need a rest or regression before continuing on. To take it a step further, suppose you know that the upper limits of distance for a particular runner was 20 miles at a time; what are the probabilities that runner can run 25 or 30 or even 40 miles? Obviously the probability of a stock moving way beyond its "normal" volatility limits becomes lower and lower the further you go.

Now, barring any extremely disastrous news, such as a bankruptcy or loss of a primary revenue source (such as denial of a drug by the FDA), large short-term moves in a stock or more moderate sustained moves over a period of a couple days are typically followed by a regression or reversion to the mean. Now don’t just go out there and look for stocks having a huge move on the day and just buy or sell into it – you have a bit more homework to do.

This is certainly a technique that requires practice and a feel for the stock or index you are trading. It can also be incorporated with other methods. First, you must have a feel for the overall market temperature: bear, bull, sideways, high-low volatility, etc. Next, have a grasp of the company you are trading: its pertinent news, earnings dates, dividends, etc.

Once you’ve gathered the basics, I would suggest you begin to examine the trading behavior of the stock, not only its 10- and 30-day historical volatility, and intraday price and volume patterns, but the ATR (average true range) of the stock on a daily basis. If the stock has an ATR of 1.00 and has dropped an average of 1.20 over the past three days, I may use that data and look to time a bullish regression. Or perhaps the stock has an ATR of a $1.00 and the market is having a particularly bad day and that stock is down $3.00 on the day. Instead of jumping on the bandwagon and buying a put, maybe I’ll buy a high-delta call and look for a quick 2-10% pop in the options price.

There are several techniques that can be used if you feel a regression or retracement is coming. For one, being a statistics guy, I always want odds on my side, so if I feel the regression may take some time or it may be slower, I may sell an out-of-the-money put spread or call spread, depending on direction of course. I also take into account support, resistance, and moving averages, just because they are common points of data that pique the interest of the masses and many times can become self-fulfilling prophecies themselves.

Obviously, it’s not that easy and this article should only get your mind thinking about these sorts of techniques. I thought this was important to bring up, because many times the retail trader often is the last to buy when the stock has been running as well as the last one to sell when the stock has been dropping, right before it reverses.

What I have found is that people will try and correlate just about anything with something else to try and find relationships that lead, lag, hedge, or leverage the other. Caution must be used when "finding" correlations. The problem, I think, really, is with the word "correlation," to begin with, as I think most investors are looking not for correlation, but rather for causation.

Many correlations that are discussed or even used as indicators may be complete happenstance and may easily lose any evidence of the high correlation that is observed at that moment in time.

This "phenomenon" is actually talked about frequently. Investment "experts" will talk about how the correlation between certain securities has ceased to exist. The question is – did it ever exist at all? With the effects of the Internet, Twitter, online chat rooms, Facebook, CNBC, Bloomberg, FOX Business and others, data, news, and opinions can spread quite quickly, as can "perceived correlations."

The equity market is especially susceptible to bouts of crowd hysteria, where a "high-profile expert" may begin discussing a correlation and then the news spreads like wildfire, potentially exacerbating a "correlation" that maybe was never a true correlation to begin with, but because of the perceived correlation between the two, traders and investors actually increase the correlation rate.

I do feel some correlations are semi-dependable. One example of this may be that extreme movements in the dollar may cause inverse price action in oil or perhaps gold. Because oil is denominated in U.S. dollars, as the dollar weakens vs. other global currencies, it requires more U.S. dollars to buy oil, therefore the price rises, etc.

The question is, which is the independent which is the dependant. Which is the leader/follower? I would like to think that the more liquid, more fundamental, less manipulate-able issues, such as currency, tend to be independent, whereas smaller issues may tend to be dependant. However, I do not have the research to prove this correct.

What many fail to realize is that this becomes even more difficult when there may another force moving one or both of the securities you are trying to correlate.

Aside from the fact that you might think I am crazy at this point (the worst part is that this is what I dream about at night), hopefully this opened up your eyes a bit and maybe you will take pause next time you want to jump on a correlation trade.

The bottom line is that unless you have studied the correlations extensively and feel absolutely comfortable with them, don’t place all your bets on correlations or expect them to get you out of trouble.

The markets will obviously react when the Fed speaks, but this reaction can sometimes be misleading and muted. Like a highly anticipated earnings report, the point is that, as an options trader, we have tools in our arsenal for just this sort of thing. Trading around the FOMC meetings can certainly add risk to your trades. Before just taking a flier, either long or short, take a step back and assess the situation. For those of us who don’t have a direct line to the Chairman and to every single market participants around the world, for that matter, it’s really a matter of "feeling out the market" combined with statistics. The markets have rallied during each of the past four FOMC meetings, but it’s more than that, it’s about being attune to volatility and cognizant of what the markets did up until that point.

Market Moves on Recent Fed Decision Days:

• December 16, 2008: Dow Jones Industrial Average (DJIA) up 4.2%, 10-year Treasury yield down 0.17 percentage point.
• January 28, 2009: DJIA up 2.5%, 10-year Treasury yield up 0.14 percentage point.
• March 18, 2009: DJIA up 1.2%, 10-year Treasury yield down 0.47 percentage point.
• April 29, 2009: DJIA up 2.1%, 10-year Treasury yield up 0.09 percentage point.

Source: Federal Reserve, WSJ Data Group

For instance, going into this past meeting, the S&P 500 Index (SPX) was at the lower end of its recent range at about 900 (903 being support). Implied volatility was looking a bit rich compared to what the index was moving at. So here I pieced together a few facts:

1. The past four meetings have had bullish repercussions on the index.
2. The market had recently come down to support.
3. Bernanke was not supposed to say anything surprising, but it was suspected he might give some indications of future rate action by the FED or its Treasury purchase program.
4. Volatility was relatively low and no major earnings were due for a couple weeks.

With all this data, I might be willing to take a moderately bullish position in the SPX and possibly a short vega position based on my opinion of volatility. Maybe the sale of an out-of-the-money July put might be the best medicine in this case. As an options trader, I can have a multitude of ways to attack the situation that is presented in front of me. If I had a moderately bullish stance, but believed that volatility was a bit overbaked and I was okay owning the SPX (or the related ETF, the SPDR S&P 500 [SPY]), I could sell the 860 (or 86) put, which would certainly give me some downside risk, but not as much risk as buying the index or the ETF outright.

There are certainly a multitude of ways a trader can play the FOMC meetings; this is just one simple way a trader can take advantage of volatility with a bullish outlook and potentially lower his or her risk versus buying a stock, ETF, or index.

Don’t forget to paper trade and do your homework, as this strategy as well as others involve risk and should be thoroughly understood before applying real money.

I was compelled to write this after reflecting on the busy week I just had on TV and getting several dozen emails about how I should have been more vocal about fellow Fast Money expert Guy Adami’s response to my trade.

One of my goals as a trader/educator is to enlighten people to the way I view the markets and risk, but more importantly, inform them about options and how to use them to increase the probability of success in your trades and as a way to provide real protection for your stocks.

As it was my premiere on the Fast Money desk, live in NYC, I choose to keep myself more low-key, reserved, and learn the dynamics of the show and get more aggressive with time. Maybe this was a bad choice on my part …

My whole life I have dealt with traders of all sorts. Since I have been in this game since my teenage years and have traded on three exchanges, I have traded beside and now work with some of the most talented and brightest traders in the world. We all have our own strengths, weaknesses, and personalities. I know that I have my mine, that’s for sure.

One of the traits I feel makes a trader successful is the ability to listen and be as objective as possible, especially with subjects they do not know. I consider myself expert in options trading, knowledge, and theory, but I am always learning and I know there are people out there that are not only smarter than I, but with unique perspectives that could possibly increase my probability of success in my trading and methods.

There is a multitude of ways to view, correlate, and trade the markets. Fast Money is a fantastic show that is heavily focused in fundamentals, with a minor technical touch. I agree with both of these approaches in my trading. I feel that in the long run, fundamentals typically trump, but the short-term price fluctuations in a stock can be read more easily by reading the tape and using technicals. These fluctuations are the result of emotional shifts, correlations with indices and/or indexes amongst other things. The bottom line is that a stock’s price is just what people are willing to pay for it.

Predicting stock price moves with accuracy is like predicting the drunken walk of a college freshman after eight shots of tequila. But even the drunks have limits. Like people, stocks have different behavioral characteristics. I am not going to get into detail here, but to oversimplify, let’s say the drunk has to take 10 steps forward and it’s my goal to stay out of his way, where should I stand?

Normally his stumbling leads him to step either one foot to the right or one foot to the left at each pace forward. What are the chances that every step he takes, he stumbles left 10 times? He probably will have to take a step to the right to re-balance himself. To get out of the way of the drunk, I could move nine feet to the left of him at the end of his walk and there is a very good possibility I won’t be in his way.

As strange as this may seem, stocks tend to behave a lot like this. When was the last time you saw a stock go up 15 days in a row without closing down one day? It’s not that common.

The point of this whole thing is that I combine my fundamental and technical beliefs, make my decision on what I think the direction of the stock is, then use options to increase the probability of my success, using several measures.

On the show today, I suggested traders should look to sell the First Solar (FSLR) July 145 Put @ 3.40 (where it was trading at the time) if they are bullish on the stock and agree with me at that price point. I said this trade had roughly a 75% statistical probability of success in terms of price distribution until July expiration.

This means with the stock at $174.00 and using a 63% volatility factor (at-the-money implied volatility) there was a 25% chance the stock would touch $141.60 (my breakeven point) and roughly a 14% chance it would go below that.

I have a feeling that Guy Adami is not an options trader (I do have a great amount of respect for him) and I didn’t feel it was appropriate for me to embarrass anyone on the show. So I figured I would use this forum as well as a special show on put selling this week on www.ONN.tv.

Anyway, Guy said that "it’s the 25% that blows you out…." I respect the fact that he was most likely warning traders of risk, as trading anything involves risk, but he’s wrong in this case. In fact, this trade is MUCH less risky and less costly than buying the stock today at $174.00.

The short put obligates you to purchase the stock at the strike price you sell, so in this case, I would be obligated to buy FSLR at 145 (a $29.00 discount to current price) and I would get paid $3.40 to do so. Which means that my cost basis is actually 145-3.40, or $141.60.

The short put is also like me owning the stock at 145 and selling the 145 call at 3.40 ( a covered call).

The best part of this trade is that all the stock has to do is stay above 145 by July Expiration and can go all the way down 141.60 and I will break-even in the trade. (I like those odds!)

As for the "blow out," I certainly am assuming risk here were I to sell these puts, but the stock trader who buys FSLR at $174 will have a "bigger blow out" than I if the stock dropped to this level.

Happy Trading! I really do feel privileged to be a part of the Fast Money Team and promise to chime in more with specifics when I can.

I always say, give me a market situation and I will find a way to trade it, preferably with options:-)  (for you emoticon lovers out there).

The 0.5% increase in retail sales in May from April was less than the 0.7% forecast by economists, but upward revisions to March and April put total sales receipts for May close to expectations. Sales fell 1.2% in March and 0.2% in April. If you pick apart the report, the word "sales" doesn’t mean just the number of things sold – PRICE is a big part of that and prices are moving higher, obviously centered around energy. It’s always a challenge to find out what is wagging what in the marketplace.

With oil up more than 115% in the past couple months, and the average price for gas in the U.S. rising 62% to from $1.60 to over $2.60 per gallon, this will certainly put a damper on excess spending. If the average person drives 16,000 miles per year and(according to the EPA) the average car get around 20 miles per gallon, that’s about 800 gallons, per driver. So a family, where both parents work and drive would consumer an average of 1,600 gallons per year.

Between January and today, you have incurred an additional cost of $1,600 per year, or $135.00 per month.This was imposed on you in a short period of time with no notice. Considering the average family makes about $50,000 per year, that’s 3.5% of your income taken away without notice. If gas goes back to $4.00, you’re talking about another $2,400.00 in gas costs to your family; that’s not counting what it may cost to heat your home, power your lights, or fire up your grill.

Another way to think about it — energy, industrial and materials comprise 27% of the S&P. Those names will rally with oil and commodities, and that’s a good chunk of the market. Perception is everything; if people perceive a rally in oil and commodities as a sign of a good healthy economy, then there is a good chance they will flood equities with buy money. At the end of the day, if the costs of high energy and materials cut into the profit margins of the bulk of the consumer discretionary stocks, which I think they will, retail (other than Wal-Mart) will have a hard time maintaining strength.

I think at the end of the day, inflation will be the last man standing. With or without growth, it’s inevitable and both soft and hard commodities should stand to benefit. Not to mention humans will have to EAT through all of this (I usually like to have that constant). I would be cautious with the all out run into retail, if anything, limit your exposure with options in that sector.

We options traders know that there is not 100% certainty in anything other than our old friends, whose names begin with D and T. We also LOVE stacking odds in our favor using delta, gamma, vega, and hedged positions that can morph as time and spot evolves.

Right now, the broader market, as illustrated by the SPDR S&P 500 ETF is sitting atop a recent eight-point (9%) rally in fewer than 10 days. Even Monday’s 1.5% pullback still doesn’t make me feel all warm and fuzzy, nor does it motivate me to go all in on the long side.

Apple Inc. (AAPL) is putting on a show in San Francisco, which really doesn’t impress me much, especially since they have yet to announce any new earth-shattering products or pricing that could have a truly positive effect on the stock after its recent 18% run. Maybe its expensive (overpriced in my opinion) Mac Books will save the day, or maybe another refreshing of the iPhone line will have that effect, but I think for now the stock will move a bit lower. I do hope that Mr. Jobs is doing well and can rejoin the company, but I don’t even feel that news would push the stock beyond $150 in the next week. AAPL has been moving higher, pushing its upper Bollinger bands for four days now; the chances of that trend’s sustainability for more than five days are slim to nil.

The broad market looks tired here. Market participants are a finicky bunch, always looking for the next thing to get excited or exasperated about. Now it seems rates are back on the table for now. I think this is a fear that we should wait a couple months for, maybe as much as half a year.

If it were up to me and if my market fantasy played out, the S&P 500 Index (SPX) would drop to 850 in a couple days, give the shorts some vindication and a chance to cover, and then I would have an opportunity to sell the 790/780 SPX put spread for a decent premium. But based on the way we are trading and as long as we stay at or around the 200-day moving average, everyone seems peachy keen.

Personally, I am waiting patiently for July, when we will see earnings hit the tape once again! Being that we are trading at a historic multiple for the S&P, my statistical/logical side keeps kicking my emotional side in the butt.

In summary, if there is any opportunity today, it’s to take moderate bullish stances in the broad market by selling out-of-the-money puts about 1-1.5 standard deviations away from the spot price when the market is having these pullbacks.

You don’t have to trade if you don’t want to. The markets will always be here and there will always be opportunity.

Take a look at the last half of 2008 and you’ll see what I mean. Stocks in just about every sector saw major losses – even oil got clobbered! There was no "flight to safety" to be found anywhere.

As an options trader, not only can I limited the amount of dollars I have at risk at any given time, while still maintaining a leveraged position, I also have the capability to choose just how bullish or bearish I want to be. The whole point of this short article is to remind options traders of the power that they have. It can be as simple as adjusting the delta of the calls and puts you trade (the % of exposure you have to the underlying stock or index), or it can be more complicated with the use of spreads.

As the market climbs higher and higher, my personal bullish exposure typically becomes less and less. I also use proceeds from some of my more risky strategies that happened to work out to finance my less-risky bets in a market that has been climbing a wall of worry. Be aware of your risk/exposure at all times. No one ever went broke taking profits.

The good news is that with some solid basic knowledge of options, some fundamental data, and a working knowledge of charts and/or the technical indicators of your choice, that’s about 30% of the battle. For most traders, money management, controlling greed and fear, and finding the right ‘happy place’ when it comes to trading is the real challenge, which in my opinion is the majority of the battle.

So with today’s article I am going to stress what I ranted about on CNBC’s Closing Bell yesterday …. PROTECTION! Many traders and investors alike have gotten to participate in recent market gains and let me just say that I believe a year from now the market will be higher. With that said, I can almost guarantee that the market will have some setbacks along the way.

As a trader, controlling your greed can not only help preserve your regular capital, but your mental capital as well. Let’s assume you bought Williams-Sonoma (WSM) at $12.00 on May 27; one week later, the stock is trading at 14.70. So you could take some profits now, either by selling some of your shares or selling your in-the-money calls to purchase some cheaper out-of-the-money calls with the profit you have made. Or by even selling the position all together. Not only would you have a winning trade that would increase the size of your account, but you would also have a sense of accomplishment and feel more confident when entering your next trade. Not to mention, you would have the capital freed up to do so.

Now let’s look at the flip side and assume you don’t sell because you had no profit goal established when you initiated the trade. So you hold your long stock and WSM reports earnings, which turn out to be not so good. In addition, the market is a bit overbought and coincidentally sells off and WSM trades down to 11.50. Now you’re beating yourself up for not exiting, stressed because your opinion of the stock may have changed and your account is in the red, and you have 20% of your account tied up in this trade, which could have been used to buy a different company that may have better prospects.

All of a sudden, hoping, wishing, and praying becomes your strategy of choice. You may be reluctant to enter another trade for fear of repeating what you just did.

This is obviously an extreme example, but not out of the ordinary. In fact, I have seen this type of situation for years. The point is to have a trade plan, target goal, and acceptable loss level in place before making the trade. When things are good, do something to protect them – it’s NEVER better to sell when a market is tumbling and you are under duress.