When sour isn't sour enough

Last Wednesday I already wrote that I didn't like the action in NLY over the past week. Thursday NLY gapped down 20% on concerns about possible margin calls. Underneath I'll give you my story of that day which had some interesting thoughts in it.

Pre-market

Underneath you see a chart (taken from QuoteTracker) of NLY in the premarket.



Things became really ugly and when $16 broke under increasing volume I sold. Nothing special you would say, NLY went down, was in a downtrend, you had to take the stoploss. But look at the next chart.



After I sold, NLY recovered and at the opening we were back well above $17. It looked like I'd sold the bottom :o(

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This reminds me of HPT who lost a few 10K on 21 January. He posted a video on YouTube and his site showing what a desperate trader looks like. I still find it a pitty that he removed the video because it was a good lesson for all traders. I'll give you a few links to HTP's blog about his trade, but you wont find the video anymore. (link1, link2, link3 and link4)

I find this a perfect example why it is possible that someone who is experienced (yes, I find myself an experieced trader :o) ) sells the bottom. If you look at the second chart only, you laugh at someone who sold @ $16. But the first graph shows a completely different picture. And I'm sure this was the case for HTP too when he sold his bottom.

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but now back to my trade.

Thus I sold NLY @ $15.96, meaning I was down a whopping $4.41 a share. But I had sold calls for $3.50 a share, so I was down 'only' $0.91 a share. This shows the 'power' of hedging your position with ITM covered calls. Most investors would have been much more down than $0.91 a share after a 20% drop.

I didn't feel good at the opening selling more than $1 lower. You can bet the F-word crossed my lips a few times. But instead of being desperate, angry or whatever and closing down my computer and running away from reality (a thing novice trader often do in such situations) I stayed at my computer looking for a possible daytrade which would/could offset my losses.

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The state of mind I was in at that moment reminded me of an article on Traderfeed : Why Trading Might Be the Most Difficult Job in the World. One sentence I want to highlight out of this article :

How many guys do you know who can be wrong, lose money, not feel bad, and reverse their position quickly?

This was exactly the thing I did (although I felt a little bad :o) )

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To make a long story short. I shorted NLY @ 16.96 when it hit a ceiling at $17. I covered at $15.61 which wasn't a good exit. But this trade made me $1.35 a share turning my loss of $0.91 a share into a possible profit of $0.44 a share.

I have still those contracts open so I could end up with a loss after all if NLY goes up again. But for now it doesn't look to good for NLY.



Like I said I didn't liked my cover @ $15.61, let me explain how I came that far.

When NLY hit $14.5 I knew it would bounce back because it was too far from it's MA's. I expected a bounce until it's 20MA or a little higher. @ 11h01m NLY pierced through the 20MA which was only the second time that day it succeeded in that. But because of the declining volume I was still confident it was just a bounce. Besides that $15.50 seemed a resistance level to me. But when NLY gained volume again, pierced through $15.50 I had to get out. So $15.61 became my exit and I wasn't very pleased with it.

Underneath the chart of the whole day. And although I could have covered lower, just look at 12h15m and see how NLY ran up $2 in 45m. The bounce at 11h00m didn't follow through at that point, but you never know that in advance. So in the end you have to be satisfied with the decisions you made.



Conclusion

NLY is one of the most ugly charts I've been into. Such a chart has the potential to decimate an account. But because I'm very conservative about my profits, and in this case hedged my position with ITM covered calls, my loss was still acceptable.

Even when I was in a lot of sh*t, I was still focussed and made a good trade which offset my losses completely.

I now have 3 calls left which are worth an average of $1.22 a share. With my temporary profit of $0.44 a share I'm still down $0.78 a share at the moment, but this is acceptable imho (given a drop from $20 to $15).

It seems that I survived this ugly chart. The only thing which can go wrong now is that NLY raises back above $17.5, so I'll still need to keep an eye on this one.

But this whole 'thing' set me thinking ... ... but that's for a next post.




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NLY turning sour ??

In my previous post I already said NLY concerned me a bit.

Today the chart of NLY looks like a mess.



Mind the large volume of the last days. Of course this could be 'normal' selling given the run NLY had and the problems around ABK and TMA, but such action is enough for me to abandon the 'maximum profit' path and be a little more conservative. (Just like I did with my DELL puts in this post.)

In an earlier post I talked about 'advanced exit strategies' which are only possible with options and not with stocks. This is the time to try my ideas on NLY.

Underneath a diagram with the transactions I did.



NLY would be my first covered call play, so I started with only single contracts. I bought 200 NLY for $20.38 and sold 1 APR and 1 JUL call 20.

Today I rolled the JUL call 20 over to a 17.5 strike. My maximum profit if called went down from $150 to $50 (excluding 1 or 2 dividends of around $0.35) but I lowered my breakeven price from $18.58 to $17.03

On the APR call I took an other approach. I sold a second APR call at a lower strike for $3.30 and left the call 20 open. By this I lowered my breakeven to $16.63 but I have to keep an eye on the open call.

I plan to buy back the call if NLY break it's downtrend (anything more than $0.80 will leave me with a small, but probably, sure loss on this call). If NLY sinks even more, I don't need to buy it back at all.



For me this is an ideal practise in option trading :o))) Keep in mind that someone who only bought NLY would be left with a loss at the moment and would be very big in the red when NLY really dives. With this strategy I'm safe until $17 which is the first support. At $16 - $15.5, where the second support is, I'm at a loss but it's still 'recoverable' while a drop from $20 to $16 is something of an other order.

So I'm curieus how this will turn out :o)

A word on NLY

In a previous post I highlighted NLY in an option strategy.

I just want to come back to NLY again. On the day I made that post NLY made some strange action.



It fell to $18.40 ($18.20 was a bad tick) in a few minutes but recovered to a certain extend. Yet the next days we went into a downtrend.

Although that sell-off scared me to a certain extend, the thing I really don't like is the high volume in MAR and APR $12.5, $15 and $17.5 puts on friday, monday and even today. On the other hand the open interest is still the same according Yahoo (don't know if this figure is updated regularly)



The rumor is that NLY is also exposed to some bad loans. Although until now we haven't seen any evidence of that, so it still remains a rumor.

But because of risk control, I'm thinking of exiting the trade. I just wonder if I wait till the bounce or if I take the loss now and move on.

Lowering your stop with options

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first attempt at a more comprehensive post :o)
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Underneath I'll give one example why I like options.

I sold DELL MAA08 20 puts @ $0.60 because I thought (and still think) DELL will trade above or near $20 at the end of the month.

But my timing was not that good and the markets didn't help me either. So DELL went down below $19.40, my initial breakeven point. Now I had 3 choices :

1) exiting the trade with a sure loss. But why would I want to leave the trade ?? If I thought DELL was a buy at $20, it sure is @ 19.40, nothing changed in 3 days.

2) taking everything below $19.40 as a paper loss (and possible real loss) but keeping the possibility of the maximum profit if DELL traded above $20.

So far the common solutions. But I had a third option which is only possible with options and not with stocks.

3) roll over to $19 puts, lowering my breakeven point $19 but limiting my maximum 'profit' to breakeven.

Many will say this is silly. I can't gain anymore with this trade. BUT imo I reduced my possible loss with 2% and increased the chance of a breakeven significantly. I think/find that preserving capital is more important than a possible gain.

note : Also mind that DELL went down $0.60 but the puts 'only' went up $0.40. This is because Delta is <1 for close ATM options. It only goes to 1 for deep ITM options. I think this is something we can take advantage of to a certain extend. But more on that in a later post.

Underneath the P/L graph and a graph with my trades :





chart with courtesy of StockCharts.com

Advanced option exits ?

In a previous post I already said options seems worth a closer look. Therefor I bought "The Bible of Options Strategies" by Guy Cohen to get some advanced ideas. But I must say I'm a little disappointed in the book. It does list all options strategies nicely in an order way, but such info is already available on the net. For example on theoptionguide.com.

I won't go further into detail on the book, nor will I make a book review yet because I find I'm too unexperienced in this to give any opinion. But in this post I want to make clear what I was looking for. For example :

a risk analysis of a 'advanced' exit strategy.

Let's first look at my intentions and the underlying.

I think/thought NLY is a good buy for the next 6 to 12 months. Maybe it has not much room ahead, but it's downside should be limited too (don't mention the action of today :o) ). It pays a 6.5% dividend.

My intention is/was to write covered calls in NLY. In this way collecting both the premium and the dividend. I'm not looking for stockprice appreciating but I do want to have some downside protection.

Underneath the chart of NLY which does indeed look a little stretched.



SETUP

Buy NLY @ $20.30
Sold JUL08 20 call at $1.80
premium = $1.50 (7,4%)
breakeven = $18.50
B&H would be better @$21.80
MAA div $0.35 (1,7%)
JUN div $0.35 (1,7%)

max profit with 1 divi $1.85 (9,1%)
max profit with 2 divi $2.50 (12,3%)

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So far the numbers. As long as NLY stays above $20, no problems for me. But once NLY drops below $18.50 my loss starts to count. So what should I do from $18.50 and down ??? If I look at Cohens book and see what exit strategy he has for a covered call I read and I quote :

"If the stock falls below your stop, then either sell the stock (if you're approved for naked call writing) or reverse the entire positing (the call will be cheap to buy back."

Of course this advice isn't wrong, but I would have liked to see a little more explanation and/or options.

So I made my own analysis, of which you can see a diagram underneath, for educational purposes. I will comment on each step.



1. The setup



Here you see the setup. Bought @ 20.30.
- 1) if NLY stays above $20 I got my maximum profit.
- 1) if NLY stays between $20 and $18.5 I still have a profit
- 2) under $18.50 I take a loss. Mind that would implicate a 8.8% drop in share price.

In 1) I don't have to do anything, let's see the possibilities in 2)

2. Price hits $18.50



In my opinion, we have 4 actions to choose from. Choices 2.1 and 2.2 are the ones given in the book of Cohen.

2.1. Sell the stock and buy back the call20.

The loss will be the amount paid for the call20. I'm not sure how much that will be. I tried to calculate this to a certain extend with FreeOptionCalculator.

If volatility stays the same (todays price action on NLY proves Vega can have a huge impact on option prices) the call20 would cost $1.17 at the most (no time decay). If enough time past away between the original purchase and the time NLY hits $18.5, the option price could be considerable lower. ($1.00 after one month, $0.70 after 3 months)

So it could well be that a $1.80 drop in stockprice only costs you $0.70. A nice example how options can provide a certain 'safety' margin.

Also mind that if you collected a dividend in the meantime, your loss could be actual lower (or you could set you stoploss lower). But the disadvantage is that you end the trade here. You don't own the shares anymore. In 2.3 and 2.4 you'll see that maybe we have some other options left.

2.2. Only sell the shares and leave the call naked.

The second option which Cohen gives us is to sell the shares only and don't buy back the call20. This leave you with a naked call. The graph underneath shows what can happen than.



2.2.1. As long a NLY stays under $20, we don't have a loss because our call will expire worthless.

2.2.2. But if NLY hits $20 (a 8% increase), we are in trouble with our naked call20. We could buy back that call20 but it would cost us up to $1.80 or maybe less depending the time left. Anyway we are sure of a loss.

The other option is the buy back NLY itself @ $20.00 instead of the call.

2.2.2.1. As long as NLY stays above $20, we still don't have any loss.

2.2.2.2. But if NLY goes under $20 anything under $20 is a full loss. But depending on the time left and/or the trend in NLY at that time, buying back the shares could be better than just buying back the call20.



So far the options given by Cohen in his book (although I think I gave a more in dept analysis). In all cases we've lost our shares.

In this case, to get a loss, NLY must first fall 9% to $18.50, than go up 8% to $20.00 and then fall back. All this within our time frame of 5 months (which is probably a too long timeframe because in 5 months a lot can happen. But with shorter timeframes this is less likely to happen)

But I think we have one more possibility (actual 2)

2.3. Sell call 17.5 and leave the call20 naked.

Things get more complicated than as you can see in the diagram underneath. Secondly I don't have a good idea how much the call17.5 will cost at that moment. Preferable I would say it should be more than $1 so you breakeven is at least $17.5. It also depends if you received a dividend or not at that time and if you're willing to bring that into the calculation. If the call17.5 isn't $1, you could roll over to a later expiration date than the original call20. Yet this all still leaves a lot of if's.

But assume we got at least $1 price for out call17.5.



2.3.1. if NLY drops below $17.5 we have a loss. But if you find NLY a buy at $20 a few months ago, $17.5 should be a bargain than.

2.3.2. If NLY stays between $17.5 and $20, you don't have any loss and maybe even a small gain (premium on call17.5 > $1 and/or dividends)

2.3.3. The share price raises above $20.00. Because we have still that call20 open, we need to take action to avoid possible huge losses. For that I refer to 2.2.2. where we also had a naked call20.

2.4. Sell call 17.5 and buy back call20.

To avoid having a naked call open, we could buy back our call20 as stated in 2.1. But this will mean that we have at least a loss.

Conclusion

Like you see there are more options than just closing the entire trade. I don't know if all of them are meaningful. But I like the fact that a lot of things need to happen within a certain timeframe before ending up with a loss. Also much will depend of the chosen timeframe, the time until experation when things happen and the volatility of the stock.

I'm not experienced enough yet to make a good estimation of when to do what, therefor I was searching for a more in dept analysis, but "The Bible of Options Strategies" by Guy Cohen didn't gave me such.

I did learn at lot by making this post, ... but still a long way to go I guess

Greetz
Stefan

p.s. Sorry for such a long post ... again. I think I need to be more comprehensive if I want that people really read mu posts. Will work on that.

Selecting a Buy or Sell list - Part 1 : Volume and Price

In a previous post you saw how I used a buy and sell list. I thought it would be interesting to explain how I select the stocks in such a list.

I want to start with the basics : price and volume but what seemed an easy task at first became a little more complicated once I began on this post.

Of course I could have said : Only trade stocks above $5 with sufficient volume of X shares. That's the advice you often read. But I wanted to backup this statement with real figure. Obtaining these data did take some time but making the charts, managing them in such a way the meaning became clearly visible, took much longer than I expected.

Why should we exclude low volume and low priced stocks ?

- low volume will increase the spread
- low volume will increase slippage
- low priced stocks increase commissions
- low priced stocks are much more volatile which will increase are stoploss

So can I prove all these assumption with real numbers ?

1. SPREAD

To see what the influence of price and volume was I opened several stocks with different price and volume in my tradestation and noted at what the spread it was trading. Then I sorted the stocks by volume and price and took the average of all spread (excluding extreme spikes).

In the graph underneath you'll see the curves for different volumes by different stock prices.



How to read the chart ? The average spread for a $0.5 stock trading at 50.000 daily volume is almost 8%. Or The average spread for a $2.0 stock trading at 100.000 daily volume is 1%

Of course the way I did this isn't scientific nor statistical correct. But yet it gives us good view on what to expect. I won't give this comment for further graphs, but it applies to all data shown here.

Underneath I'll give the whole table, so you can see the actual numbers of all stock a little better :



Conclusion : Yes, both low stockprices and low volume increases spread. If we assume that we need to 'pay' 2 times the spread when trading, I'll find that reading above 0.5% are almost unacceptable (meaning we start the trade with 1% loss, just because of the spread.)

This means that we should restrict ourselves to stocks above $5 and trading at least 100.000 shares or even 200.000 shares a day.

2. Volatility

To see how volume and price influence volatility, I used ATR14. At the moment QQQQ has a ATR14 of 2.5% and SPY had one of 2.1% (I use a percentage of the share price instead of the $ amount of ATR which makes it easier to compare stocks across a large range of price. This is also the reason why I don't understand that ATR is shown in a $-amount and not in a %-amount.).

2.1. by volume

Lets first see how volume influence the ATR. Underneath 2 tables where I divided the stocks into both a volume group and a ATR group.



The second table gave the following graph :



The graph doesn't show us that much. We'll see that high volume stocks tend to have a more modest ATR. More than 50% of the stocks with a volume above 500.000 trades at a 2-5% ATR. Stocks with a volume of 100.000 to 200.000 tend to trade with a little higher ATR (5-10%). We have a lot of very low volume stocks that trade with a very low ATR (ATR<1%). Finally the readings of ATR>15% are mostly from penny stocks.

but as said, ATR versus volume doesn't tell us that much.

Underneath a more simple graph of the same table.



2.2 by price

Let's see if sorted by price tells us a little more about the volatility.



I find this a very nice chart :o) It shows clearly the correlation between the price of a stock and its ATR.

The chart above shows the % of stocks trading at a certain ATR range within a certain price range. The chart underneath shows the actual number of stocks. So basically they are showning the same.

I'll comment on the first chart.

You clearly see that the majority of stocks above $20 traders in a ATR range of 2-5% (light blue line). Stocks within the $1-5% range typically trades at higher an ATR ( around 5 to 10% - pink line). Stocks in a $5 to $20 range are trading in a wider range. Most between 2 and 10% ATR. Finally penny stocks (> $1) trade mostly at a ATR from 5% and up. Keep in mind that QQQQ and SPY trade at an ATR of a little over 2%.

Log versus Linear scale

I want to touch an other item very shortly. Most say you should apply a log scale on a longer time frame chart. Reason : the percentage moves of a stocks should/would always be the same.

But my chart above proves that's not true. Lower prices stocks are more volatile that higher priced stocks. So a log scale isn't the solution.

I won't go any further into this subject now because this would lead us to far. But will probably come back to it on a later date.

3. Gainers and Losers

3.1 Gainer and losers by price

Traders often have the assumption that higher priced stocks are better to short and that lower priced stock will more like to raise. But is this true ? Is shorting a $5 stock a bad idea ?

For this I took a reference period of 6 months, starting 6 months ago and looked what the minimum low (or max high) in that period was. Then I looked up the max high (or min low) of the past six months and calculated how much percent the stock had risen or fallen.

the chart underneath visualizes the setup.



The result are shown in the graph underneath.



First of all you'll see that a greater % of stocks declined that rose. But that's normal given the market conditions.

We'll see that penny stocks rise and decline more easy than higher priced stocks. This is in line with the high ATR of those stocks we saw previously.

But we see no evidence that higher priced stocks should be better short. I would even say more, the lower the price, the harder it will go down once it goes down. So shorting a $5 could make sense, don't let that low price stop you.

3.2 Gainers and losers by volume

Does volume influence the fact that a stocks rises or declines more easily ?



Above the same data as in 3.1 but sorted by volume range. This gives us a interesting picture.

The higher the volume, the more likely a stock has doubled. Secondly, in general, the higher the volume the less likely a stock declines big time.

Interesting is the /2 column. Until a volume of 1M stocks tend to fall easier, yet, stocks trading at more then 1M tend to decline less easier. Strange ...

Mind that I excluded all penny stocks because they gave some strange spikes. But the overall view was still the same.

Conclusion :

It seems that lower priced stocks and low volume stocks tend to decline big time easier than higher priced and heavily traded stocks. Interesting is the peak in decline in stocks trading with a volume between 100.000 and 1 M. Maybe something to look into it.

4. COMMISSIONS

Finally a word commissions.

Not only the choice of broker will influence are commissions, but the stock price will also matter too.

- I pay on Interactive Brokers $0.005 a share as commission
- Let's say I use $10.000 per trade.
- Let's assume a daytrader make 400 trades a year (2 a day)
- Let's assume a swingtrader make 100 trades a year (2 a week)
- Let's assume a buy&hold trader makes 30 trades a year (3 a month)

In the chart underneath you'll see how much each of them would pay on commissions if they traded $1, $5, $20 or $50 stocks.



If a daytrader would trade a $1 stock with the amounts given above, he would have to pay $20.000 commissions on a yearly basis !! That's something to think about. Trading a $20 stock for that same trader would cost him 'only' $1000 which is much more affordable.

5. CONCLUSION : What to trade ?

Well as I told you ... it took me much more than I though at the beginning, just to prove that low priced and low volume stocks are to be avoided.

After this, I would certainly limit myself from buying stocks under $5. But as a short, low priced stocks could be better then higher priced ones. Especially when they don't have a lot of volume (less then 1M).

From a volume point I would like to see a daily volume of at least 500.000, but preferable more than 1 million. Except for a short, as shown in 3.2, I would expand the range to 200.000.

But my findings aren't final. I would really like to put a point under this 'search' for now. Maybe that I'll came back to it a little later. But for now it has been taken long enough :o)

Feel free to leave any remark you like.

Greetz
Stefan

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remark : I wonder how many grammatical errors there are in this text :o)
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How much can a trader make by trading ?

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Just some thoughts which crossed my mind this morning during training (cycling :o) )
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Of course this is a silly question, there is no limit to what you can earn.

Maybe I should rephrase the question :

How much should a trader make by trading ?

This is still a silly question. It depends mainly on the sort trading you do. But yet this is already a more interesting question. The question 'how much should I make by trading' also asks about how much the average trader does make. Because we should also be able to earn what the avg trader earns.

Be still the question is not perfect. what about :

How much do traders think they can make by trading ?

Almost the same question, but yet a little different. This question seeks for the goals traders set themselves. I often read that daytraders expect to make 100%+ a year. Is this rational ? Or do they set their goals to high, making them to trade with too much risk ?

I'm interested in any online source which covers both of the above questions. If you know one, please point me to them.

and now I come to THE question :

How much do I think I can make by trading ?

Well actually the answer to this question gives away, partly, my personal goal. I'm pleased when I can make 20 to 25% on a yearly basis, including expenses, AND with no monthly losses (that's an important addition the question didn't ask)

Is this rational ?

I think this should be easily achieved, yet, I also think, almost sure about it, that most traders don't hit this mark year after year. So why I'm I still confident that it is possible, even easy, to make this return.

Just take the Q's. They have had on average, over the past 5 years (excluding the last 2 months), a daily price swing (high - low) of 1.5%. With 20 days in a month this makes a 30% monthly swing (not to mention that their are more intraday price swings then only between high and low). Yet I only need 2% of this to meet my goal (25% annually) and this exclude the fact that you can go in margin.

So looking at that 30% to 2% figure, you wonder how it is possible that making 25% annually is that hard ...