May 25, 2011
The market is quiet. On Monday it will be closed due to the Memorial Day. Volumes are relatively low. It seems as if a lot of stock trading and/or option trading “players” are either taking time off to make it a longer weekend or they are simply sitting on the sidelines waiting for the market to decide where it wants to go. Take a look at the S&P 500 Index (SPX) chart:
I drew the two lines of major support (where the SPX should have difficulty in penetrating) that the market will have to overcome if it is going down much further. The first one is around the 1295 mark (blue line) and the next one is around the 1250 mark (red line). If you are into Daily Moving Averages (DMA), the 50 DMA (yellow line) is was penetrated as you can see on the chart. The 100 DMA (purple line) was penetrated during the day but the SPX closed above it. The 200 DMA (green line) is below the 1250 red line. All these can act as support (if they are BELOW the market) or resistance if they are ABOVE the market, such as the 50 DMA.
The VIX (SPX volatility index) is still quite low meaning options’ premiums are also low. Take a look at the VIX chart:
So what are we, as stock and option traders to do? Should we trade for the sake of trading (feeling that we must make many trades) or should we take a more defensive position or not trade at all until the market tips it’s hand as to where it is headed. That is the $64K question.
Until next time, Erik
May 1, 2011
Many people are confusing their brokerage account statements, thinking it reflects an actual gain or loss, with the “Mark To Market” rule that the brokers must use. One must be aware of it when one uses stock trading, options trading and/or any option trading strategy or stock trading strategy.
Basically the Mark To Market rule says that the broker MUST show the value of the asset or holding in one’s account at THAT POINT in time. Since shares and options prices fluctuate during the day and during the time the shares and/or options are being held in the account, then the Value and therefore the Gain/Loss $ will reflect these fluctuation as the broker BY LAW must show these, known as the “Mark To Market Rule”.
Here is a partial statement from an actual account with an actual open position as of April 29, 2011. The highlighting, arrows, circles and other shapes and the text inside them and the purple text are all my additions for ease of explanations and are not part of the actual reporting of the account:
This particular transaction is a COVERED CALL transaction, one of the most common and popular combinations of stock trading and options trading strategies. 500 shares were bought @ $25 per share and at a later date, a Sept 2011, 25 Call was sold against the shares. Sept 2011 is the expiration month for the option and 25 is the STRIKE price, at which price the option may be assigned or exercised at or before the expiration day.
The shares were bought on April 21, 2011 and the option sold on April 29, 2011. As of the close of April 29, 2011 the share price was $23.35 or a drop of $1.65 per share. The green price under the “Change” column reflects the change from the close of the previous day. $1.65 X 500 shares = $825 “loss”. Of course it is not an actual loss (the shares were not sold yet) but only a “Mark To Market loss” that the broker is required to show. Another way to calculate it would be the original value (that I calculated) of $10,665 MINUS the reported value of $9,840 = $825 “loss”.
Since the option was sold on the 29th, there is no “gain or loss” on that transaction on that day. The value in brackets in the “Value” column reflect a short position or a sale, NOT a gain or loss.
Let’s do quick math here: The shares were bought at $25 per share, the options sold for $3.67 per share, creating a NET COST per share before commissions of 25 – 3.67 = $21.33 per share which is 9% BELOW the closing price on April 29, 2011 of $23.35 per share. If on September 2011 expiration VXX will be ABOVE $25 per share then the option will be assigned and the shares will be sold @ $25 per share. Since the net cost is $21.33 then the gain will be $3.67 (the option’s premium) or 17.2%. If however upon expiration the VXX share price will be BELOW $25 per share, the option will expire worthless leaving the account with 500 shares at a net cost of $21.33 per share. Another call option can then be sold against the lower priced shares to reduce the cost even further and enhance the potential gain.
I hope that you can now see that the $825 “loss” showing in the account on April 29, 2011 is nothing more than a reporting required by the broker and not an actual loss, which will only happen IF one closed the position at that point in time.
Cheers, Erik Epp
April 24, 2011
Another week is behind us. The markets continued their march upward. Here is the summary:
As you can see above, the major indices are all up for the week and options’ month. However, the VIX, the SPX volatility index is DOWN 40% since April 15, 2011, the end of the last options’ month. This is something worth looking at since it may signal an upcoming market top and danger of a reversal. Take a look at the 5 year VIX chart:
As you can see in the chart, the VIX is at it’s lowest in over 3 years. Although it was lower than that in 2006 and part of 2007 (left 2 columns) this was BEFORE the mortgage and market fiascos. Here is what the SPX looks like for the past 5 years, which generally is going the opposite of the VIX:
The red line, which is about 1345 – 1350 is the first obstacle the SPX will have to overcome to move higher. It was almost there twice in 2011 but in both cases it turned around. IF it penetrates that line (the red one) the next one will be the blue line, around the 1440 – 1450 mark. By the way, notice that both lines represent previous tops for the SPX. Should the SPX get that far the VIX most likely will drop to the 2006-2007 lows.
For us, options’ and stock traders it is significant since low volatility (VIX) means low options’ premiums. It is cheaper to just buy the options (low premiums) but as statistics show, most straight options’ buyers lose money. For those who do spreads, covered calls and occasionally naked puts, the lower premiums on SELLING the options makes it more difficult to trade on a shorter term, balancing the net lower premiums and the risk.
Let’s see what happens next week. I am very cautious at this point and keeping a close eye on both the SPX and VIX. By the way, it may represent an opportunity for us to open a position on both, taking into account that USUALLY both move in opposite directions.
April 23, 2011
In my previous blog I commented on the VIX (S&P 500 or SPX volatility index) and its downward movement towards very low levels. Since the VIX usually moves in the opposite direction of the SPX, here is what the SPX looks like in various time frames. On the last one I marked some previous tops that the SPX will have to penetrate if it is to continue its upwards march. Keep in mind that as the SPX marches upwards the VIX marches downwards. Naturally, for stock trading, options trading and index trading this information is quite important and useful.
This one is for the past 3 months. Notice that the next hurdle for the SPX to go thru is the 1345 or so level.
This one is the SPX for the past year.
This one is for the past 5 years. Notice the various tops the SPX will have to overcome. With the VIX so low I think that caution at this point is much warranted.
April 21, 2011
The stock market keeps marching on. Below are 3 charts: the 1 year S&P 500 (SPX), CBOE SPX volatility Index (VIX) and VXX which is the VIX short term ETF.
As you can see in the above charts, normally as the SPX rises the VIX, and therefore the VXX fall.
The VIX is at it’s lowest in more than 3 years (see 5 year chart below) and the VXX, being newer, is at its lowest ever.
Note what happened when the VIX went that low: It started to rise, meaning the SPX started to fall, and eventually exploded to the upside. It will happen again. When? I cannot tell you that but I can tell you that the danger level is now quite high.
For us options’ traders drastic declining VIX (volatility) means much lower premiums on options we try to sell, such as spreads, naked puts/calls and covered calls. Of course it makes it cheaper to BUY the options. However, with buying options we may be right eventually, but if we are not exactly right on the timing, no matter how cheap the options are (were), they will go down in value and eventually expire worthless.
Happy Easter everyone.