While the Diary of a Mad Hedge Fund Trader focuses on investment over a one week to a six-month time frame, Mad Day Trader, provided by Bill Davis, will exploit money-making opportunities over a brief ten minute to three-day window. It is ideally suited for day traders, but can also be used by long-term investors to improve market timing for entry and exit points. Read more
Global Market Comments
September 21, 2020
Fiat Lux
Featured Trade:
(HOW NOT TO MAKE A FOOL OF YOURSELF TRADING OPTIONS)
I very rarely publish the works of other financial writers, as I usually have a hundred research ideas of my own in the works and lack the time to get them out.
However, I will make an exception for last week’s Barron’s piece on options trading written by Steven M. Sears.
I have spent the past 13 years teaching investors how to trade options. This is more important than ever, now that the hedging of options accounts for more than 50% of all stock market daily volume.
Those who get it make millions and this year, in particular, seems to have produced a bumper crop of new fortunes.
It’s really not all that hard as I know many who are complete dummies on all other matters but earn a decent living trading options. All they need is to follow a few valuable rules that have stood the test of time.
I could add to this list as I possess additional skills and experience that other options traders and Barron’s writers lack, but the ten tips below are a great start.
Needless to say, following the Mad Hedge Fund Trader is crucial in best obtaining the correct timing in implementing these rules.
1) Have an investment thesis. Know why you are doing what you are about to do. Focus on events like earnings reports or product launches and try to figure out how the underlying stock might react.
2) Use your opinion on the stock to decide whether you will buy or sell a call or put option. Don’t delude yourself into thinking you have an educated view of options contracts until you have traded for a few years and understand how the stock and options markets work with each other.
3) Focus on options that expire in three months or less. The sweet spot for many investors is about 30 to 45 days, which is enough time to benefit from time decay (more on that later) and for your stock thesis to work itself out without paying top dollar.
4) Before you buy or sell options, divide the contract’s implied volatility by 16. This will tell you what the options market thinks the stock will do each day through expiration. If the call has an 80% volatility, the call is priced as if the stock will move 5% each day until expiration. If you think the stock will move more, buy the contract, If, you think it will move less, sell the contract. The Rule of 16 is a powerful tool.
5) Good trading is about understanding events and how they are packed into your expiration. Understand everything that could happen to move the stock during your chosen expiration cycle, such as earnings reports, and anything that could move the entire market, like Federal Reserve meetings, elections, and economic reports.
6) Options contracts lose a little value each day. Time decay, or “theta,” is a powerful force that can be monetized by options sales. It’s also the reason that many investors try to trade options that expire in under a month. No one wants to pay a time premium, which you can think of as the inventory carrying cost for owning options.
7) If you are thematically confident on a stock but unsure of the timeline, many institutions buy options that expire in a year or more to rent exposure to the stock. If the stock goes up, the call goes up. If the trade fails, options always cost less than the associated stock, which means that options, when well used, help investors limit risk.
8) Don’t be a pig. If you make 50% or more on your initial trades, take profits. If you make 100% or more, definitely take profits. If you are so convinced that the market is wrong and you are right, take out your initial invested capital so you are playing with house money.
9) Be afraid of excess leverage. Options contracts represent 100 shares of stock. Don’t trade 10 contracts if you cannot afford to cover 1,000 shares of stock. All tyros should trade one or two contracts at a time until they develop some mastery of basic trading rules. Never trade “naked” contracts that aren’t covered by cash or stock.
10) Simplicity is everything. Avoid strategies with many moving parts. Many seasoned options traders focus on hitting singles and doubles, creating significant income for themselves. Master buying a call and put and selling a call and put, and then consider spread strategies.
When in doubt, remember: Bad investors think of ways to make money. Good investors think of ways to not lose money.
It’s Just a Matter of Learning a Few Tricks
“The U.S. hasn’t had economic leadership this weak in key positions since World War II, and there is now next to no scope for international cooperation. The world economy hasn’t been this brittle during my 40-year career,” said Dr. Larry Summers, former director of the national economic council.
Mad Hedge Technology Letter
September 21, 2020
Fiat Lux
Featured Trade:
(WHAT’S NEXT FOR THE TECH MARKET)
($COMPQ)
The tech market appears to be stalling out confronting uncertainty on a host of fronts, but investors betting on one theme—the unfolding economic recovery—appear positive.
What is certainly uncertain is that elections, brazen geopolitics, healthcare bills, inflation, forbearance, natural disasters are piling up like a dirty laundry basket of heightened risk.
Cyclical outperformance has been the catchphrase since the start of September, and the establishment on Wall Street has been barking for a rotation in market leadership from mega-cap tech.
As much as I love the business models of Apple, Google, Amazon, Microsoft, and Netflix, they have come too far — too fast.
We are currently smack dab in an economic phase where growth stocks won’t perform like they did when the broader economy was humming along just before March and the shelter-at-home trade has faded away from its initial boost.
There are knock-on effects and big tech doesn’t just live in a silo which is why investors are searching for reasons to take tech higher.
That being said, big tech did harvest the lions’ share of the gains from March until the end of August and in relative terms, they have emerged the ultimate winners during this health crisis.
Many upper-middle-class families are beginning to feel the economic pinch as well, as the damage is starting to be felt further up the economic food chain.
But these families will still need their tech software and services when they do a cost-benefit analysis and items such as car loans, entertainment, and food delivery will be more likely on the cutting block.
The overextended S&P 500 technology sector has lost 8% in September, while value-oriented materials and industrials have added 6% and 2%, respectively. The overall S&P 500 has declined 4%.
The valuation of the market is arguing for a rotation, not a continued leg up.
In the short term, tech stocks could lose out to U.S. small-caps and specifically small companies with high returns on equity, or ROE.
Low-ROE and nonearning stocks have dominated the Russell 2000’s rebound since late March, as investors focused on revenue growth above all else. That has benefited a lot of software, biotech, and other stocks, but forced investors to pay a high premium.
When the economy is in free fall, many companies have negative sales growth, and the market will favor those who aren’t overvalued.
By my estimation, tech is overvalued in the short-term but still a great long term bet.
Now that the fiscal morphine shot is wearing off, tech appears to be resting while it consolidates while waiting for an “event” to give it more juice.
Some fiscal tools just don’t work now like share buybacks. Management would be tone-deaf to the economic carnage going on in the U.S. — not to mention that tech stocks just visited all-time highs.
The Federal Reserve now sees 4% gross domestic product growth in the U.S. next year, followed by 3% in 2022.
This small-cap rotation will come and go, and once tech gets a little cheaper, the dip will be bought.
As the retracement goes from 20 days to one month, some positive news comes in the form of Walmart and Oracle acquiring parts of TikTok even in a highly diluted form.
Fortunately, the tech portfolio has been in 100% cash as I sensed the consolidation in time.
We will search for better entry points and will need to be patient.
“Strip malls are history.” – Said CEO and Founder of Amazon Jeff Bezos
When John identifies a strategic exit point, he will send you an alert with specific trade information as to what security to sell, when to sell it, and at what price. Most often, it will be to TAKE PROFITS, but, on rare occasions, it will be to exercise a STOP LOSS at a predetermined price to adhere to strict risk management discipline. Read more
When John identifies a strategic exit point, he will send you an alert with specific trade information as to what security to sell, when to sell it, and at what price. Most often, it will be to TAKE PROFITS, but, on rare occasions, it will be to exercise a STOP LOSS at a predetermined price to adhere to strict risk management discipline. Read more
While the Diary of a Mad Hedge Fund Trader focuses on investment over a one week to a six-month time frame, Mad Day Trader, provided by Bill Davis, will exploit money-making opportunities over a brief ten minute to three-day window. It is ideally suited for day traders, but can also be used by long-term investors to improve market timing for entry and exit points. Read more