Using Probabilities In Your Trading

As I have discussed previously on this blog, probabilities and volatility are very important factors when trading options. When you combine the 2, you set yourself up to win. You must look for stocks or etfs with volatility over 50. This covers the volatility part and ensures that you will collect enough option premium. Secondly, you cover the probability part by trading a lot. This is an area where investors struggle. This is because they dont trade enough. You have to trade alot and in different stocks to make the probabilities work out.. Lets go through an example or two..

Ok, first up is Twitter.

rrrr

As you can see ( the orange line). Volatility was up near 100% and is now dropping. This is a prime canditate for our strategy. Depending on your directional biase, you can sell a call, a put, a credit spread, a , strangle, an iron condor, etc. The good thing about the stock is that its volatility is on the upper side of its range. If the volatility keeps dropping, traders who sell premium in here will be rewarded.

Facebook is another stock that has good volatility at the moment..

fbbbb

As you can see, volatility spiked in the last 2 weeks. Its on the way down again but this is again a prime canditate as it has rich volatility..

Finally, Tesla is another prime canditate for trading..

tsla

Again, a burst in volatility has occured. This should revert to the mean so selling volatility in there should be profitable. You need to trade small and trade alot of different stocks. By doing this, you are mitigating risk and putting the odds firmly in your favour. Look for volatility spikes, get in there and sell premium and take profits when you have 20-50% max profit… Rinse, wash, repeat…

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Stock Market Bubble Phase Back On?

Well it look like the FED has rescued the market as the markets over the last few sessions has rallied hard and is now above support at the 1840 level on the S&P500. If the bubble phase is still on the cards, we may still be looking at a 20-30% gain from here. Because I know this rally is only temporary and once and for all, the market forces will overpower the interventions from the FED, I will stay frosty.

If you want a piece of the action here are a few stocks you can use to go long. Nevertheless if we don’t get a stock market bubble and you get these stocks put to you.., then I believe you can trade them as long term holds..

First up in Coca Cola (KO). Look at its chart over the last 30 years and also their dividend information and you will come to see that price always recovers in this stock. Another market leader that dominates its sector is McDonald’s (MCD). Again people are always going to need food and fast food at that. As the world population grows, this company will open more restaurants and as a result more profits will be made. Its a proven recipe. All they do now is buy prime real estate to leverage the company even more..

Third up is IBM. Again this is a market leader and even if we get a market crash, this stock has shown that it consistently rises over time..

I for one believe that there is far more opportunity in the precious metals and commodity sectors. The problem with human behaviour is that we rush in to buy when we see a sector going up such as the S&P right now. Nevertheless this market is near its all time highs and I for one have learned the lesson not to buy stock at all time highs. Silver and Sugar for example are stocks well below their lows. Even though these commodities may be dropping at the moment, I see them with far more possibilities than US stocks..

We must learn to invest when there is pessimism and sell when there is optimism. If you do in life what the majority are not doing, then you are probably right on with your strategy..

If we get this bubble phase, it will be short lived. Don’t get caught because as I have said before, markets come down completely differently to how they go up..

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Stock Market Very Volatile – GDXJ

Stock Market Very Volatile today with violent moves in each direction. At first we were down over 10 points on the s&p only to finish the day 12 points up!!. Today you had a viscous 28 point swing but these types of days bring great opportunities for traders such as the following…

1. Twitter was up huge today – over 11% due to news about them buying another company. Anybody short puts – I was short the May16-34Put could name their price when buying back the put as the buying really got into a frenzy in twitter going into the close. Volatility was up again giving volatility traders opportunities to sell more premium.

twtr

I am also short the 53 Call May 16. I didnt liquidate this today – I only liquidated my profitable put. I have to watch this position closely as if twitter moves like it did today, its price will be all over my call strike and I will have to either roll or liquidate for a loss. Nevertheless, we are still nearly 20% away from my strike so I have some breathing room yet. This is the advantage of trading volatility stocks – you can get further out and your probability of success is much higher as a result..

Gold stocks took a hammering today. GDXJ was down over 4% at one point. SSRI was down over 6%. While some people are saying the gold will go to $1000 an ounce and it may do, I am a cash flow trader and I dont think of what-if scenarios. I took this opportunity to buy into the heavy weakness today. What I mean buying into the weakness was to sell naked puts. I did so on GDXJ and SSRI. When you consider that the all time lows on the GDXJ are $28.82 which occured last December, I see little risk. I sold the MAY16 – 32PUT FOR $0.8. Now if the likes of goldman sachs is right and gold goes to $1000, obviously GDXJ will go lower than the current all time lows.

My attitude is this. I believe that the gold bull market is nowhere near finished. If GDXJ goes to $25, I will not roll my position as I believe that it will easily eventually be well over $32 a share so I will let the stock be “put” to me. This is the best attitude when selling puts. You must sell them on stocks/etf’s that you really want to own. Also GDXJ is

1. An etf
2. A basket of the gold junior mining stocks put together.

This instrument can never go to zero + its volatility is around 50%. I thought the risk/reward was definitely on my side provided you stay small and dont go crazy with the amount of contracts you sell..

gdxj

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Volatility Chart – Twitter

Look at the chart below and follow the the orange IV. This is the the implied volatility of Twitter. The higher this is, the richer the option premium is. Option traders look for spikes in volatility and then they sell into that volatilty on both sides, the call side and the put side if needs be. When the volatility comes back down to normal levels again, the trader makes money as he buys back the initial sold options much cheaper..

nchart.j

Todays trading – Bought back some twitter puts. Sold a Facebook call early in the day when facebook was up over 3% and bought it back later when both volatility and the price contracted a bit.

Tesla came on my rader again also as its volatility has really spiked in the last week and you can get some cracking value in there..

nchart.jtss

The problem with a stock such as Tesla is that its a $200 stock. One needs quite a bit of buying power to sell naked options in there. A good alternative would be an iron condor or credit spreads on either side..

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Is The US Stock Market Going To Fall From Here?

The market dropped another 17 points on friday and has now broken through support around the 1840 level. If the fed cant rescue the market soon, I would think that the bubble phase could be off the table… The next FED meeting is April the 30th. This could be tricky for Yellen as if the market keeps dropping, I dont think she will be able to announce another “Taper”

On the other hand, if she and her team can rescue the market and the S&P is up around the highs again at 1900 at the end of this month, then she could definitely taper…

Either way it goes, traders much stay on their toes as a market like this could easily go either way..

Stay Frosty..

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Using Volatility To Trade Strangles

Strangles are an excellent choice for a volatilty investor. For example lets look at TWTR. This stock is currently trading at $40.05. Now we are going to go through a strangle example in TWTR

twtr

Ok as you can see, we can sell a 35 put for $2.20 and a 50 put for $0.90. The credit that you would collect for putting on this trade would be $3.10 for every contract sold. The implied volatility of twitter at the moment is up around 80%. This is why the option premium is high and you can get further out. For example, you can go out to $30 for example and still be able to collect some premium. This impossible with other stocks as the volatility is simply too low. The advantage of this trading strategy is your probability of profit is high. The stock in some cases can move up to 20% in one direction and you still make money. So for example, lets say twitter moves to $50 in the next few weeks and starts to test your call side. Your sold put at the stage would be in the money. You can take profits on this put and roll it up to a 35 put for example. Also, you can roll your 50 call by going out another month and selling a 55 or 60 call, etc. When a stock has high implied volatility, you can be aggressive in your trading, taking profits at will, whilst always rolling down or up depending on what side is being tested.

Another advantage is when volatility contracts, your options will be cheaper meaning you can take profits even if the stock doesn’t move. I have seen scenarios where a trader sold a 50 call when the stock was at 40 and bought the call back when the stock was at $45 and still made money. This was because of volatility contraction, definitely an advantage that volatility traders have. When a volatility trader sees a spike in premium, they relentlessly get in there and sell premium.

Of course the ultimate is having a fundamental analysis trader who trades stocks & elf’s with high implied volatility. Here for example in a strangle, you can be more aggressive and instead of selling a wide put, you can sell near to the money put because you are confident or don’t mind if the stock goes below your bottom strike..

Finally strangles are also good for buying power. They are like an iron condor, your buying power only gets reduced from one part of the trade. The put/call are treated as one so your buying power will decrease far less that selling 2 naked puts for example..

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Stock Market & Gold Update April 2014

I spoke about the possibility of a stock market bubble phase in my previous blog posts and I still think this bubble phase is on the cards even with the 40 point drop today. A lot of traders are saying that we have started a new bear market in stocks but I just don’t see it that way. If you look at the spy chart, stocks would have to drop below 1737 before one could say with certainty that a new bear market has started in stocks. Yellen the new FED chairperson is now in a difficult situation. As you know, ever since she came into office, she has tapered but she has tapered because the stock market has been rising. If she aborts the “taper” now, I doubt the markets would take it positively. Therefore she must get the market back up to where it was before she announces another taper. Otherwise, that game could be up.

Gold and Silver finished up and so far have not capitulated into a so called bear market bottom. Goldman Sachs a few weeks ago said that their target for Gold in the short term was $1000 an ounce. Jim Rogers says this is entirely possible also . His mantra is if Gold is to start anew fresh phase in this bull market, it must first reach serious depressed levels. Experienced investors believe that Goldman Sachs target is possible and will probably coincide with Gold’s yearly cycle low. Yearly cycle Lows are always scary events. Their function is to get investors to think that the bull market is dead. Then, weak hands money fall into strong hands and off we go for either an A wave or C wave advance which are always violent affairs after a yearly cycle low.

If this situation comes to pass, hold onto your gold. You will hear calls that Gold is going to $400 an ounce, statements which are just designed to make you cough up your shares and give it to stronger hands. Do not do it. Do not listen to your emotions. Stay logical. For all intensive purposes Gold has to rise in the long term. Too much money has been printed and if deflation takes over, more money will be printed. I believe Gold has been in a manipulated market for some time now but throughout history market forces have always overpowered government and central bank interventions. One day we also we have a bubble phase in Gold when all the people rush in at the end of its bull market. That is when the educated investor departs and looks for fresher cheaper pastures where another asset class is just beginning its own bull market.

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When Will The Inevitable Inflation Arrive?

Our monetary system is based on fiat currencies. Fiat currencies are backed by nothing meaning that central banks can print into infinity paper money. Look at what happened in Zimbabwe and Argentina and you start to get an idea what can happen when currencies go wrong.

In Europe at the moment there is deflation evident in a lot of sectors such as housing and food. Deflation worries central banks far more than inflation. In environments such as these where jobs are scarce, inflation is low and house prices are dropping, people generally start to hoard their money. They spend less as all the fear that is conveyed through the media scares them financially so instead of spending and investing, they hoard and save their money. Therefore, money is circulation is less and deflation occurs.

Now the natural order for central banks is inflation as this is a barometer of economic activity. Central banks want prices to rise moderately as they fell inflation is linked to growth. When more goods and services are bought, this increases demand which consequently increases prices.

The problem for example in Europe at the moment is that interest rates are practically zero. If the problem gets worse, the ECB ( European Central Bank) will have to start money printing and literally start injecting it into the economy to try and stimulate growth. The Germans do not want to do this for good reason. Back in the 1920′s in the Wiemar republic , Germany experienced hyperinflation due to the mass printing of their currency. All inflation does is impoverish the people. Inflation really hurts savers as your savings are actually losing money as their purchasing power is decreasing..

So to summarise, I believe that sooner or later inflation will come. The US have been printing $85 Billion a month up to a few months ago and are nor cutting back gradually but if the market falls, they will turn on the printing presses again in an instant. The way to protect yourself historically in inflationary is to hold hard assets. Hard assets are assets such as property, oil, gold, sugar, rice, farmland, etc

Hard assets will always have value. They never can become worthless but a currency can. The euro and the dollar are currencies whilst the assets named above are real money. A good measurement of real wealth is the measure assets values using other assets values. For example, how much is your house worth in ounces of gold or barrels of oil.. This is how you really measure wealth..

A lot of people make the mistake of thinking their house went up in value. For example if a house went up 20% in dollars in 5 years. Nevertheless, if inflation went up 25% in the same period (5% annually), this house actually lost value. It gained in currency buy lost value..

Start thinking in hard assets as they are far safer that currencies and always increase in value when you have currency debasement like what is happening presently..

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Trading Fundamentally v Trading Volatility

Trading Fundamentally v Trading Volatility.

I personally do both but there you have many traders who solely trade fundamentally whilst other traders who solely trade volatility. Which is better and which is the riskiest?. That’s a good question. The advantage of trading volatility is that you can collect more premium. Also you can get further out usually from where the underlying is trading. This definitely increases your probabilities as the underlying may have to move up to 20% in a 30 to 40 day time frame for you to get assigned stock ( wither long or short depending if you sold a put or a call..). This is definitely an advantage. For example if you are bullish on oil, you have a few different vehicles in which you can trade.

You have OIL, UCO AND USO. Now if we want to go long oil, we sell a put. The problem with USO and OIL is that they have no volatility. What I mean by this is that their implied volatility is under 20. When implied volatility is under 20 or even under 50, premium is going to be low. So, the problem, here is that we are not collecting enough.

For example, if we want to trade OIL today, we could sell the MAY23PUT for $0.27. OIL is currently trading at $23.78. Therefore the yield on this trade is 1.17%. This is far too low. Basically you are risking putting up $2,300 of capital for a measly $27. A volatility trader would stay well clear of a trade like this because there is no premium in it.

So how would a volatility trader trade OIL. One could trade the leveraged ETF UCO. Because this vehicle moves twice as much as the regular ETF, volatility here will be higher so there will be premium to collect. Nevertheless an experiences trader knows that trading vehicles like this really decrease your buying power. Yes, you could collect 3 to 5% premium form a vehicle like this but it kills your buying power. You simply are putting up too much to make the trade. It makes sense though, your broker is going to tie up more if your buying power because when you trade a leveraged ETF, the risk is higher on your part as well as theirs and they always want to cover themselves.

So Volatility traders just trade volatility. They don’t care where the stock is going in the long term. They just seek out premium and then sell it. They stay small and they trade a lot. Adopting this strategy definitely puts the odds in your favour because I repeat, the likelihood of an underlying moving 20% in 40 days in slim. Of course it could happen and will happen buy by trading a lot, your winners should most certainly outnumber your losers..

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