Changing a Profit Curve

I'm making some good paper profits on my GOX spread. I sold the Dec 140 Puts at an opportune time (see prior post).
As the price showed me a profit, instead of recognizing the profit by selling, I started to build a spread; which is a hedged position. Today I increased the short side of the hedge by buying more puts (see ticket to the left). After several years of spread building, I can usually visualize the profit curve that it generates, pretty well. But it always worthwhile to graph it, to quantify the exact tradeoffs.

Below is the profit curve before and after today's trade (click on images for full screen view):

Before the trade I clearly favored a bullish GOX index and after the trade I now favor a bearish one. The reasoning is that the GOX index has climbed from 126 to 141 in quick order, and I anticipate some "back and filling' in the price. At that time I will do some more selling of the Dec 140 put.

The macro factors to keep in mind are that Bernanke will probably have to cut interest rates to save the financial markets. That will put the Fed back on track to do what they do well; that is to destroy the dollar. That makes the case for long-term bullish positions in gold. However these are the December options, so I don't see the need to project that far.


Using an Up Day to Get Short

Today's 200 point up-move (DJIA) is providing a good opportunity to establish some short positions. I believe further deteriation of the financials and mortgage mess, will seize the consumer spending habits. Therefore, I'm shorting the financial ETF, XLF and the retailer JC Penny.

Looking at the JCP one-year chart, all you have to do is imagine that the chart is inverted. If the stock had sold off, then rallied back, there would be many a technician ready to believe the stock has consolidated and is ready for new highs. I'm in the opposite camp looking at a rise and sell-off, now expecting new lows.


Knife handled and all fingers are accounted for

The prior day post detailed my entry into the falling Natural Gas market with an option purchase on UNG. Not only did I not get bloodied from reaching for the falling knife, I immediately started a hedged position today on the strength of a nearly 4% bullish move. The ticket to the left shows that I sold 5 calls at a 39 strike price, five points higher than the calls were bought yesterday (34 strike price).

The table and graph show my hedged position with profit and loss results in a range of +/- 15% from today's closing price on UNG (36.36). The story is not yet written as I will likely make more trades, changing the profit curve over the next few trading days. The intrinsic value of my position shows a loss of $695, and the market pricing of the paired options shows me a paper loss of $80.



Trying to Catch a Falling Knife

It's a cliche on Wall Street. "Don't try and catch a falling knife." I couldn't resist; even knowing Natural Gas supplies are running ahead of short term demand. I bought calls on UNG on August 27. I will build a spread by selling higher strike price calls. It is customary to buy and sell both sides together as a hedge, but the speculator in me likes the asynchronous action.

A good trade on the GOX (gold index)

I thought the GOX had become very oversold at 126.42 on August 16, so I swallowed hard and sold puts (OptionsXpress ticket copy below). This was a very good trade as the GOX recovered 10 points very quickly giving me a $4,000 paper profit. Instead of recognizing the gain, I built a vertical spread by buying the December 160 puts on August 22 (ticket on the right).

This provides a favorable profit profile as the GOX moves +/-15% from here @ 136.62.


BTU - One Week Update - Commodities Secular Bull

One data point does not make a trend, but it is worth noting that BTU increased 2.7% this last week while the broader averages (DOW) increased 2.3%.

This makes the last post of noting the rhyme between an old tech bellweather to a new energy bellweather more relevant. Peabody Energy a bellweather? The U.S. is to coal what Saudia Arabia is to oil.

It is easy to reflect back to the two decade run of the techs and think how easy it was to enjoy the ride. In fact from the early 80's it took a couple of years to recognize the new bull market 1982-1984; then it was interrupted in dramatic fashion in 1987; met with a recession in 1991-1992; and saw two financial crisis in 1994 and 1997. The lesson learned was to buy the dips; the ride was going to be a long one.

In 1998 Jim Rogers started a commodity index and made the bold prediction that the following two decades were going to be the era of commodities.

The graph below compares the 1982 Dow Bull with the 1998 Commodity Bull (with the time axis showing the current Commodity Bull).



Randomly found Rhyme


Quite by accident, I found this rhyme by casually looking at the pricing action of the fallen energy stocks, then looking at some of the casualties of the tech correction in 1997-1998.

I found this rhyme between Applied Materials (AMAT) from 1997 and Peabody Energy (BTU) in 2006.

This rhyme is only 70 weeks old, so I don't have the confidence of the several hundred week rhymes of the indices in other posts; but it bears watching and could foreshadow a strong rebound in BTU in the next ten weeks going into Halloween.


NASDAQ continues strong rhyme with 1930's DOW


The Golden-125 (explained in the previous post) continues to marry the post-NASDAQ bubble of today to the post-depression DOW of the 1930s.

The Golden-125 is a derivative that measures momentum strength in the market prices.

The dramatic sell-off is followed by a robust rebound, only to turn into a head fake before prices return near the lows. 2010 and 2011 NASDAQ projections are noted on graph.

Golden - 125 explained

In earlier posts I demonstrated the strong rhymes generated by the G-125 score.

Here is the secret recipe to generating the G-125 score.

Eight moving averages are used; 8-week, 13-week, 21-week, 34-week, 55-week, 89-week, 144-week, and 233-week. Each moving average is .618 in length to the longer one. This is accomplished using the Fibonacci sequence, which adds the prior two numbers in the sequence to generate the next number. This is known as the golden ratio, thus the name Golden-125.

The shortest moving average (8-week) is compared to the seven longer averages and one point is earned for every time the shorter moving average exceeds the longer average. The second shortest moving average (13-week) is compared to the six longer averages, earning two points. This progression continues using a Fibonacci sequence of increasing points (1,2,3,5,8,21).

A table demonstrating the points earned follows:

8-wk compared to 7 longer averages (7 x 1) = 7 pts
13-wk compared to 6 longer averages (6 x 2) = 12 pts
21-wk compared to 5 longer averages (5 x 3) = 15 pts
34-wk compared to 4 longer averages (4 x 5) = 20 pts
55-wk compared to 3 longer averages (3 x 8) = 24 pts
89-wk compared to 2 longer averages (2 x 13) = 26 pts
144-wk compared to 1 longer average (1 x 21) = 21 pts

The longer averages are weighted heavier as it is more significant when longer moving averages change positions, rather than the more easily moved shorter moving averages.

This is easily accomplished in an Excel spreadsheet that has the weekly closing prices of the Dow and NASDAQ.