Price Action: What it Means to ME

The ideologues of success faithfully believe that enlightened self-interest is the greatest virtue. I think Elvis Costello asked the right question, however, during the tenure of Maggie Thatcher: “What’s so funny about peace, love and understanding?” A quick run down of my thought and actions qua libertarians might be: naive and romantically inclined. Perhaps so.

But I’ve learned a thing or two from the Rand school about the stock market– namely, price action can only be interpreted relative to my positions, once I have opened them. For while a person can’t know the truth about the future movement of price, one can detect when the possibilities of exit with profit begin to diminish. Two weeks ago, I had the best moment to exit at the top. But one doesn’t know at the time. The next time I had a very good chance occurred a week or so later, and the window closed faster. When the window for exit begins to close, the opportunity to close a position start to recede into the past. When the opportunity sinks to a few hours or even minutes, I have come to the conclusion that a whole lot of people are trying to get out while they can. The more they/we try to leave, the narrower the opportunity until it dissolves.

Opportunities depend on one’s time frame. Long-term players have longer to exit. Short term traders better be fast and decisive by the minute. When short-term traders don’t exit at their moment, they either become longer-term holders or they close at a loss.


S and P 500 daily, 6-month chart

Above, we can see that the S and P 500 closed at or just above a long term channel line that has served as support and resistance over the past four months. I would consider this objective and unrelated to my subjective experience.


One never knows, of course. The market could rocket tomorrow.  And for me, another opportunity may or may not present itself. But what is crucial for the subject is that over time the opportunities have either begun to increase or dissipate. The degree to which one acts upon this subjective sense of the market can fairly be called enlightened self-interest. It is also a good means to judge partially the market. When one’s window is closing or opening, there is a near 100% chance that others with similar positions are also noticing the moment. Peace, love and understanding don’t help a bit. Save these key virtues for when the position is closed. When positions are closed, objective judgment can return.

We're not enemies but allies who face each other.

We’re not enemies but allies who face each other. Credit: Antrhopoliteia


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The SDS Play


SDS (2x leveraged S and P 500 short) weekly and monthly charts

I’m long SDS, and I like it. I sell calls against the position to reduce the cost basis. The tactical idea is pretty simple.  One day, the S and P 500 will begin to sell off systematically or wildly. Who knows? When that trade begins, I’ll be in it all-ready. There will be no psychological resistance to going short.  Of course, the SDS stock can be called away, and I can open another position. The upside is really tremendous, and I can congratulate myself for being right and ready days or months or even years in advance.

young republicans support labor 1956

Working the workers well in advance of the 1980s’ payoff

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Listening to the News

Friday was fascinating, pure advertising.

SPY daily, credit Effective Volume

Another day on Wall Street when the S and P 500 reaches new highs. This message is broadcast to millions in their cars, driving their lonely roads to work and and back. The underlying message is “come buy US equities there is room for more growth.” There remain many late-comers to this market, and this is more than a dog-whistle at this point. Meanwhile, it seems to me that the big players are going to load up on banks (higher interest rates) and emerging markets (cheaper relative to the US market). New-high rallies provide good opportunities to unload stock (see the chart above) with the intention of buying the dip again later.


Sometimes the joke isn’t very funny

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When your screen is green


When your screen is green,

There’s no time for dreaming.

There is work to do.

It might be red, so blue, tomorrow.

Take profits in short term trades.

Manage all the spreads.

Above all, Sell Something!

Like, calls against the booming stock.

On red days, you can take a little extra.

On green days you may sell them again.


A rough day in Taiwan

Screens are red on bullish days in Taiwan.

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Cut Cost, Reduce Risk, and Increase Reward

A principle benefit of calendar spreads is that they are simpler. One short, near-term option to every long, longer-term option. If one opens the trade above the money in the calls and has a mildly bullish outlook on the underlying, one holds a number of possibilities for profit.


A risk graph of a number of calendar spreads in Apple options, MAR14 expiry.

The first possibility is that the price rises, toward the center of the graph. So long as the move is not too fast, a 10% profit can usually be had in the weeklies. In the two months prior to earnings when the volatility of the underlying’s options are steadily increasing, there is less risk that the graph will collapse. (Currently, Apple’s implied volatility percentile is 5%; there is not very far for the price of options to fall.)

If the price of Apple should fall and its option prices rise, then the graph will expand normally– providing one with a greater probability of profit. When this occurs, one is usually given an extra opportunity to reduce the cost basis of the longer-term option by closing the front-term option and opening another short option closer to the money to create a diagonal spread. Perhaps the spread will not make money should the price fall, but the chance of generating a scratch or small loser becomes much higher.

The key idea is that if handled correctly, calendar spreads lose a lot less than they make. What’s more, from time to time, a spread can be closed at the center of the graph near expiration. When this happens, the risk to reward is fantastic.


A back test of the aforementioned trade scenario.
Credit: Tom Nunamaker.

To achieve the ultrahigh profits from time to time, one must risk a few more scratches or losses.  One can win over 50% of the time, provided the trades are managed well (tactics include adding additional calendar or diagonal spreads in the direction of price movement). If one falls to the temptation of taking 10-20% profits each time, the back test results look more like this:


Back tests are gross (mis)characterizations.
Use Caution.

It may behoove one to take most spreads off at 10-20% and leave one or more on to see if it can ring the bell of max gain. I don’t know how to back test this scenario. But it is one to explore in practice, especially when the price action and the open interest suggest that the underlying will pin at a certain strike– not uncommon in AAPL, for instance.


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Markets and National Interests

I read the following in the Global Times this morning:

Analysts believe that the PBC engineered a decline of the yuan from late February to early March, in order to shake off speculators who bet on the currency’s appreciation to make profits. The purpose of that move, analysts said, was to leave a market with more rational traders and less risk of volatility when the band is widened.

I have lived in Taiwan on and off for 18 years; it was economically stable during that time. To this day, its currency is manipulated by governmental authorities. Without buying and selling New Taiwan Dollars to moderate the market, Taiwan’s economy would suffer regular shocks. As I as was told many times: “Every time the USA has a cough, Taiwan gets a cold.” Wild currency swings would crush the capacity of locals to produce any goods for export or local markets. Beijing’s People’s Bank of China knows this well, too.

Similarly, the USA stock market and its bond market are too precious to the collective prosperity of the United States as an economic totality for the government and its proxies, such as the Federal Reserve, to do anything less than protect them from violent swings. This does not mean that the stock market can’t correct 5-10% or even a little more. But I did take Chairman Bernanke seriously when he implicitly criticized the Congress for policies that have made the sustenance of the central status and health of the world’s greatest stock and derivatives markets more difficult.  In other words, the Bernanke put is in place and will remain so until there is “regime change.”

It has always been difficult for me to see through this; for even though I’ve known it since I began trading, many traders and investors complain ferociously about it. I’ve been influenced by their discourses as I tried to understand trading in the financial markets, and this has hurt my performance.  They love volatility and see reasons for it everywhere. Please note during which presidential cycles that markets–are allowed to– fall precipitously and substantially.

The Ukrainian challenge is real and so is the Malaysian jetliner saga to investors inasmuch as they reveal the limits of American power. The US can’t stop the Russians entirely; and they can’t locate an aircraft built by Boeing that may have been targeted by terrorists who the US has promised to stop with elaborate electronic surveillance and drone warfare.

I think both of these issues will be solved. First, a face-saving agreement may be reached that truly does have some benefits for Russia and US and the EU. I think traders are realistic enough to know that the US will surely walk back on this issue. It will become the new status quo. Americans know Russia shouldn’t intervene in the Crimea, but they also know that we’ve done the same previously, think Iraq and Libya.  Terrorists may be found behind the disappearance of the Malaysian airlines flight, but technological solutions will be proffered and people will go back to their routines without too much worry.

In the meantime, I would not be surprised to see the S and P 500 trade at 1750 during the next week or so.  But another, more seasoned self adds this: we could just as well bolt higher on Monday. Energy building up in the market place (as shown by the increasing volatility or value of options) will eventually need to exercise its force in one direction or another. The market has been trained to go up.  While the pot-odds are to the downside, to bet big against a national interest, protected by the United States government and affirmed by the world investing class, seems like near-term folly.


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Three Friday Trades


An AAPL expiration graph

I bought back the short side of a near-term 540 calendar call spread when Apple’s stock fell with the market on Friday. I sold another nearer the money and closed a couple hours later. The two short calls have nearly paid for the long call at 540.  AAPL’s consolidation at 530 has indicated to me that big players are accumulating stock. I like to be long Apple here, especially when the cost basis of the call is very low and when the volatility of AAPL will surely increase into earnings.

ImageCopper is at a relative low point and appears to be in consolidation. I bought a deep, in-the-money call (which is not a future’s contract– insofar as it doesn’t influence the price of the underlying) with September expiration. Since it is so deep in the money, its intrinsic value is very high; time decay is not as big a problem as the more at-the-money or out-of-the-money options. If copper continues to move down, I can sell options against the position and reduce the cost basis of the position. The weakness of this trade: I don’t really know what the world demand for the industrial metal will be over the next six months. But if I were in the copper business, it seems like a good time to begin accumulating.


A RSX expiration graph

The market continues to feel nervous, no doubt this is in part due to the Ukrainian, EU, Russian, and American entanglement. A straddle seemed like a good choice of a trade. If the situation is solved to the satisfaction of global markets, the Russian market will run up quickly. If not, the volatility will probably remain high and the ETF that tracks this market will trend lower. I have both near-term and mid-term straddles in this spread.

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