Sunday, July 31, 2011

Late night bull session

I was talking with a young relative late into the evening. Some of my big picture long term ramblings:
* U.S. Bond market headed for a bubble
* Gold market is not yet in a bubble
* Stocks will likely benefit from inflation
* Real estate will eventually benefit from inflation

First the bonds. I often write that calling tops tends to be a low percentage play. It is so here. So many keep calling for a crash in bonds, a spike in yields, it is unlikely to happen soon. This past week, even the possibility of a debt ceiling impasse did not nudge yields significantly higher. On Friday, yields actually spiked lower as bonds roared ahead. The Fed keeps propping up U. S. bonds and has a lot of bullets left. They have fired off QE1, QE2 and could do that at least four more times before the jig is up, and it might be more than four. If I had to guess, the spike up in yields is six years out, but that is just a guess. Still, I would not buy and forget long term bonds at what I see as record low Fed manipulated yields.

Next gold, not yet to the bubble stage. Yes, eleven straight up years is a concern, record highs are a concern. Still, sentiment is not frothy enough to be calling long term top. I believe most of the demand is from Asia, and their economies continue to grow. Demand for gold will grow with those economies. If and when gold goes parabolic again, it will be trickier. Sentiment remains one of the best indicators for turning points. Gold will eventually be turned back by high interest rates, but someone else pointed out that there is often a two or three year lag before the start of rates rising and gold turning back.

Third, stocks can do well in an inflationary environment. Higher interest rates will be a head wind, and make for a bumpy ride, but both the top line of revenue and bottom line of profits will increase as prices increase. Over a long time frame that will increase the stock price and dividends will increase.

Fourth, real estate will eventually be a buy, but a spike in mortgage rates can cause a crash in prices. If and when 30 year mortgages go back to 8% or 10%, real estate values could tumble an additional 33%. There are some cash buyers, but the vast middle of the market still gets and needs a mortgage. Another potential wildcard is the reduction of the mortgage interest deduction. This is being openly talked about and could be a knife to the belly of a weak market. Longer term, real estate will benefit from inflation, but if the first prediction about bonds comes true, it will not be a smooth ride.

As always, these are my thoughts, don't take what I write as advice, as it is not meant to be. I am another small fish in a big ocean.

/edit to change:
* U.S. Bond market is in a bubble
* U.S. Bond market headed for a bubble

Saturday, July 30, 2011

Nusbaum: 200 DMA & bear market?

Roger Nusbaum writes about the 200 day simple moving average and the possibility of a new bear market (link).

As far as a "new" bear market, I believe the 200 DMA will tell us the answer, what is more important than guessing correctly is (also repeated for emphasis) having some sort of objective strategy for defensive action ...

If market timing were so fool-proof as one indicator, we'd all be rich. (Or more likely the indicator would stop working.) Nusbaum is an advocate of gradual moves, as am I. When average folks make rash, all-in or all-out decisions, they tend to be bad decisions, often near the worst possible time.

As for trading the news, I am reluctant to take on much more risk, even if I may anticipate certain markets to react a certain way. I am a bit stunned that TLT had a monster up day given the news background.

I tend to believe that U. S. Treasury bonds are near an all time bubble top. The Fed manipulation, investor sentiment, the all time low low short term yields are all elements. However, as always trying to time a top tends to be a low percentage play, and markets can remain irrational far longer than a bear can remain solvent.

As for gold, even with record highs, I am not seeing the sentiment signs of a bubble. Skeptics remain skeptical. Small timers occasionally buy here and there, but are not lining up to buy with their credit cards. Folks rarely mention gold in casual conversation, and if mentioned, their eyes still tend to glaze over, instead of their ears perking up. Now, we may not get a bubble top. Bull markets don't always end with a moon shot.

Thursday, July 28, 2011

Everything I know...

I talked to a young man today, and gave him a one hour version of everything I know and have learned during my 24 years of option trading. Here are some of the topics covered:

* The importance of finding your own style. What works for me, may not work for someone else. For novices, keeping a trade journal (that's what this blog is) can be a good way to find what works.

* What I do: I mostly sell puts on ETFs (SPY, TLT, GLD) and to a lesser extent (IWM, EEM, TBT). I tend to be delta positive, theta positive and aim for about 90% probability of winning. If the market is unchanged every day that is a good result because I am theta positive, meaning I benefit from time decay. Overall, this translates into about 80% winners because of stops and the occasional shots at the long or short side.

* What I term shots are lower percentage trades. I tend to favor vertical spreads or calendar spreads to lower the costs and increase the probabilities, and decrease the time decay.

* More: for technical analysis I tend to keep things simple. I mostly use a 1-year candlestick chart, with a 50 day simple moving average and a 200 day SMA, and in the lower box a momentum indicator such as RSI. I tend to look for support levels and look to sell puts at a strike price below support.

* I am a relatively slow moving trader, so I tend to avoid fast markets and the most popular stocks.

Some more links
Option greeks (link1)

More on verticals vs. calendars (link2) (scroll down to the April 09, 2011 entry labeled: Options 201: calendars vs. verticals .

ThinkorSwim (my broker, do your own search) they host a weekly market wrap up every Friday afternoon 4:30 eastern time, and it is open to anyone who registers to listen.

Wednesday, July 27, 2011

Ferri: Invest like a Marine

Rick Ferri has an interesting perspective with his article (link).

I had several other sobering conversations with squadron buddies about how they were investing their retirement money. All in all, it’s a mess. That sixth sense they had for staying alive while flying didn’t transcend well into the investment arena. I cringed with every story they told. These guys lost money day trading, in stock options, commodities, hedge funds — you name it. One couple was even swindled by Bernard Madoff himself.

Often times accomplished men think that investing will be easy for them because they are top notch in another field. The above is another anecdote in the quilt of evidence. Ferri is an advocate of the Vanguard/Bogle philosophy.

As for the markets, I am mildly surprised with the recent market action. My most recent option sales are deep in the red. For now, I am going to sit, watch, and wait.

Saturday, July 23, 2011

Vanguard on tax efficient placement

The Vanguard folks have a good article about placement of various assets for tax efficiency (link). It tends to be of more interest to slow and steady long term investors vs. rapid-fire traders or all-or-nothing plungers.

Where might precious metals fit in? For ETFs like GLD and SLV, they are tax inefficient and would preferably go in tax deferred or tax exempt accounts. For physical metal, I would tend to say in taxable accounts even though the tax rate for those honestly reporting is often at the 28% collectibles rate. The additional paper work to hold physical metals in retirement accounts is a negative. Even though I am an options trader, I often prefer simple, and less paperwork, less tracking is a good thing.

Friday, July 22, 2011

Buy GLD, SPY, TLT (sell puts)

Buy TLT via selling Sep 87 puts, TLT @95.9
Buy GLD via selling Sep 139 puts, @156.0.
Buy SPY via selling Sep 113 puts, @134.6

I open some September positions which feels wrong because of recent run ups in GLD and SPY and the looming issues regarding the budget for TLT. I hold my nose and take some small low risk, low reward positions.


Monday, July 18, 2011

Italian bond, Japan & the U. S.

In the news is the 10-year Italian government bond yield touching 6.0%. Here is a link to a site with a chart (link).

From 1993 until 2011 Italy's Government Bond Yield for 10 Year Notes averaged 5.94 percent reaching an historical high of 13.75 percent in March of 1995 and a record low of 3.22 percent in September of 2005.

I believe that the recent massive interventions in the market have kept certain yields artificially low. In the U. S. it was QE1 and QE2, in Japan it has been going on for over 20 years.

For the Japanese perspective here is that link2.

Here is the same site's entry for the U. S. (link3).
The United States' Government Bond Yield for 10 Year Notes declined 9 basis points during the last 12 months. From 1971 until 2011 The United States' Government Bond Yield for 10 Year Notes averaged 7.17 percent reaching an historical high of 15.84 percent in September of 1981 and a record low of 2.05 percent in December of 2008.

A big question for American investors is whether the U. S. bond market will go more the way of Italy or Japan. Again, the Japanese central bank has been doing similar policies for far longer than the U. S. Fed, and their government debt situation and demographic rooted problems even more intractable.

If the U.S. ten year moves in a short time period to an historically average 7.0 yield from the current under 3% yield, it will be a bloodbath for current bond holders, and likely almost as bad in the U. S. stock investors. Some may see this as alarmist, but Italian bonds went from 4.0% to their historical average of 6.0% in less than a year. So I wouldn't even classify that kind of move as a Black Swan event, it would be normal and expected market action during a bear market for bonds. What we have now in the U.S., historically low yields, that some believe is in large part due to massive government distortion of markets, is more of an exceptional kind of event.

This may seem an odd topic for a trading blog on a day when the Dow is making a big move down, but it is what is on my mind. For now I am planning to sit tight and see were the dust settles before making any moves. Fast markets are not my friend. Often the best move for me is to do nothing. Fast market days tend to be better for day traders vs. me, the relatively slow moving position trader.

Friday, July 15, 2011

4-1 for July

It is a muddled picture for this option cycle because some positions were initiated as part of a spread. Anyway, six options expire worthless, one of them a long option. So the overall picture, counting spread trades as a single entity, might be characterized as four winners, one loser.

GLD turned into a frustrating trade. I bought a Jun/Jul 160 call calendar way back when. After the Jun 160 call expired worthless, I sold the Jul 161 call, turning it into a vertical. GLD did rally but not enough for this to turn profitable.

Going forward, I am short August puts on GLD, IWM, SPY, TLT, and also am short a SPY Sep 105/110 put backratio spread. Historically, August sometimes is a volatile month, so positions remain small.

Tuesday, July 12, 2011

Buy SPY (sell puts)

Buy SPY via selling Aug 112 puts, SPY @132.00. I add another layer of short puts, further out. I am already short Aug 117 puts.


Nusbaum: Safety First and baby ducks

Roger Nusbaum quoting James Stack (link) in his blog entry "Cash is Not Trash."
Stack calls his method Safety First. If this is new to you, the big idea is that over the long term you can outperform the market by avoiding the full consequence of large market declines. In the past I've referred to John Serrapere's strategy of 75/50 which is trying to capture 75% of the upside with only half of the downside

This kind of stuff is more for long term investors interested in doing some kind of active protection management. It isn't for everyone. Cash is a good cushion to have, even when many money market funds are paying zero. As for specifics, Nusbaum uses the popular and simple 200 day moving average as a timing mechanism to slightly reduce equity exposure.

I want to mention the "baby duck" syndrome for traders as well. A baby duck will attach itself to the first thing it sees regularly as the mother duck. Similarly, many traders get imprinted by the first markets they experience. I started trading in the summer of 1987, a few months before the 1987 crash. That searing experience has stayed with me, so I remain ever vigilant and cautious, and tend to keep a decent amount of cash or equivalents as a cushion.

Going further with the baby duck theme, a person's first experiences with money and spending also can imprint upon them. Suzy Orman talks about this and how it can effect a person's lifelong attitudes towards money. Think back to your first memories of money, finding a coin in the dirt (Suzy's experience), or spending to buy candy or being given an allowance. The energy from those early experiences and what was said to us, often shape the long term attitudes towards money. Whether it is scarce or not, whether it is meant to be spent freely, or hoarded, or treated with respect.

Friday, July 08, 2011

Buy IWM (sell puts)

Buy IWM via selling Aug 75 puts, IWM @84.8. I open an August position in short IWM puts, adding modestly to stock market delta long. I've been looking for a one or two day smash down in the stock market. August often is a more volatile month, but I have some margin for error by selling puts so far out of the money.


Wednesday, July 06, 2011

Buy GLD, SPY, TLT (sell puts)

Buy GLD via selling Aug 137 puts, GLD @149.1
Buy SPY via selling Aug 117 puts, SPY @134.0
Buy TLT via selling Aug 88 puts, TLT @94.2

I open some August positions though I remain skittish about all markets.


Tuesday, July 05, 2011

Another "permanent portfolio"

Carlton Chin has another version of a so-called permanent portfolio (link). The concept was popularized decades ago by Harry Browne. The original was 25% cash, 25% bonds, 25% stocks, 25% gold, rebalancing maybe once a year as asset prices move up and down.

Chin adds some in vogue wrinkles such as REITs and international exposure, and substitutes a broader commodity fund for gold.

I am a fan of the concept of permanent portfolios. I see a lot of plungers betting heavily on the latest hot market, and eventually get left without a chair when the music stops. They tend to have the belief that they will get out before that happens. Rarely does that happen. Those that can some what consistently call tops in major markets tend to be very wealthy, and only maybe 5% to 10% get their calls correct. Mostly top callers are too early, with 10 tops called for every top that occurs.