What Bogleheads may be missing

There is a lengthy thread on one of the Vanguard forums asking what may be missing from Jack Bogle's investment approach. For those that are not familiar, the philosophy in a nutshell, is to pick an age appropriate asset allocation, and then to use passive index funds, and rebalance as assets move up and down in value. Age as a percentage in bonds, the rest in U.S. and world stocks is a common asset allocation. For example a 30 year old might choose to have 30% in bonds (split between BND and TIP), maybe 45% in U.S. stocks (VTI), and 25% in world stocks (VEU). Add in a healthy cash reserve for emergencies.

Let me say, that I am a fan of the Vanguard approach of passive indexing. Experience shows that over the long haul, indexers will beat 80% of active investors. Future results are likely to be similar because of human nature. Indexing and disciplined rebalancing forces a person to buy assets when they are cheap, when they go on sale, when no one wants them. Human nature is to chase performance, so tends to buy what is hot.

The Bogleheads aren't "missing" anything. However, they do use certain postulates that may be faulty. The first and foremost is the long term stability of the U.S. government. While many may cry that this is doom and gloom talk, let's look back 100 years. Go back to 1911, and buy the bonds of all sovereign nations issuing government bonds. How many paid interest continually and could be rolled over until today? Maybe 5 countries out of 50 issuers? How many at some point in the cycle went to zero, or near zero? Almost all of them. Certainly Germany, Japan, Russia, China among major powers all had bonds and domestic stocks go near zero during that century when major historic events such as losing a major war, or revolution occurred. The UK, Canada, Australia, Switzerland and the U.S. were among the very small long term stable group. Off hand, I can't name any more than that five.

The open question is will the U.S. be in that small and lucky group in the next century. Most Americans and most all Bogleheads of course assume yes, mostly because they have never seen their government fall, but the odds are far from 100%. That is the biggest thing the Bogleheads may be missing. Events such as major wars, major famine or plague, revolution or coup, do happen. Those kinds of catalysts can mean a repudiation of the U.S. debt, and a currency that goes to zero. When that happens, U.S. equities, and even U.S. traded ETFs that hold world stocks may not have any value because there is no exchange to trade at for U.S. citizens or trade at bizarre discounts. In war time, or times of revolution, assets get frozen, assets get seized.

I don't want to bring this up in their forum, because they won't get it and will mostly just get mad. Arguing is one of the least productive activities, and rule #1 is that no one wins an argument on the Internet.

Overall, I find the majority of Americans to be a myopic bunch and most will assume that because their government has never fallen, that it can't--that is faulty thinking. The odds will depend on how far out the timeline is extended. The U.S. experience of stable governments, peaceful transitions of power, is more the exception than the rule. Governments fall, countries erase their debts, equities and currencies go to zero. Whether they will happen in the U.S. is an open question, not a postulate that can be depended on to be 100% true.

This is one reason I would tend to favor an asset allocation like the Permanent Portfolio (25% each in cash, bonds, stocks, gold), which includes 25% in physical gold. In an all out war, or revolution scenario, sometimes leaving the country is the best option. Physical gold might be one of the few assets that can be gotten out, or get a person or family out to start life over.

I feel no need to debate the point, or convince anyone. Folks can read up on their own world history and figure out their own odds of the U.S. government making it another 100 years or how ever far they want to extend the timeline. Every decade a few governments fall. Every century, the vast majority do, or at least restructure their debt and currency so that bondholders and paper money holders get the shaft.

Cover short puts (IWM, SPY)

Buy back IWM Aug 75 puts with IWM@72.0
Buy back SPY Aug 117 puts SPY@120.1

Stock market turns lower after a pop up at the open. I am reducing risk, and taking some huge losses on those positions. As I type, markets careen lower for a minute or two and now are stabilizing at lower levels. On the edit for typos, stocks are moving up off the lows. Seems like too many brave heroes are stepping into the breach, and that usually means lower.

As for yesterday's plan, it reminds me of boxer Mike Tyson saying “everyone has a plan, until they get hit in the face.” Ouch. -1600% on the IWM and -900% on the SPY puts, on the dollar value of the options. Writing naked puts can be a risky strategy, and when markets go straight down fast and volatility explodes higher, losses like that happen. Hopefully, I don't have many more of those as open positions, but I do still have some exposure. Taking those two losses doesn't mean the losing is done.

Thankfully, I had less than average exposure at the time of this tumble and didn't buy heavily into the debt ceiling rally, and didn't keep selling puts when SPY touched the 125 support level. So while the losses are terrible, traders that came in long two weeks ago and kept doubling down took a lot bigger hit, with aggressive put sellers likely getting margin calls. Of course, a few were short and made a ton, so overall the glass is three-quarters empty, but it could have been a cup of poison too.

Long GLD, SPY, TLT

Worst day ever

I believe that today was my worst day ever since I starting blogging in February 2006 as the stock market melts down and the Dow is down over 500 points. I am tempted to say "the pain, the pain," as a parody on the old Fantasy Island TV series where Tattoo opens the show with "the plane, the plane," when the guests are arriving.

It is kind of bizarro Fantasy Island, more like nightmare island. What I kept telling myself today was "stop digging." Most of my recent moves have just made the hole I am now in, deeper. I had some "brilliant" ideas for trades today, but resisted.

My current plan is to wait it out. Roll out to further months any short puts that are going to be expiring in the money. My short IWM Aug 75 puts are already deep in the money, and another day like today, and the SPY Aug 117 puts and even the Aug 112 puts are threatened.

SPY broke support at 125 and now projects to 113. This target is by taking the width of the range and subtracting that from the breakdown point (137-125 = 12 points wide, 125-12 = 113 SPY target).

With all that, and despite today's losses, I still have a good bit of dry powder, but am reluctant to take on any more risk. Fast markets are not my friend.

Buy BRKB (buy calls)

Buy BRKB via buying Aug 77.5 calls with
BRKB@74.0

A departure for me, buying calls. Berkshire Hathaway earnings come out after the close on Friday, and stock is near support. I am buying the 13% chance 77.5 calls because if earnings are bad, the higher priced, higher probability 75 strike calls are likely to go out worthless.

Long BRKB, GLD, IWM, SPY, TLT

Buy SPY (sell backratio)

Buy SPY via selling a backratio with
SPY@124.7 -0.80 for the day

Sell twice as many lower strike puts, for every put bought
Sell 2x SPY Oct 104 puts
Buy 1x SPY Oct 109 puts

This adds a bit of SPY delta, while also getting some downside buffering. The short backratio is an odd duck in that it is delta positive (a bullish bet) but has a max profit if SPY closes at 104 at October expiration. I like this trade when volatility is high.

Long IWM, GLD, TLT, SPY

Buy GLD, TLT (sell puts)

Buy GLD via selling Sep 143 puts with GLD@160.7
Buy TLT via selling Sep 92 puts with TLT@100.9

These moves can be characterized as a rebalancing, to add more delta in bonds and gold. My delta for stocks is increasing as the market declines. The closest short puts in danger are IWM Aug 75 puts, with IWM now at 77.7. My current thinking is to roll those puts down and out if they come into the money.

Long GLD, IWM, SPY, TLT

Hulbert: VIX as a timing tool

Mark Hulbert has a Marketwatch article (link) about using VIX to time the stock market.

>>
Consider a hypothetical portfolio that switched in and out of the Wilshire 5000 index according to whether the VIX was above or below 20 — investing in the market on a given day if the VIX closed the previous session below that level, and otherwise staying in cash. This portfolio would have produced an 8.9% annualized return since 1990, when the CBOE’s data for the VIX commence, in contrast to 8.5% for buying and holding. (I chose 20 as the threshold level for illustration purposes only; it is not far from VIX’s median level over the last two decades.)
>>

As always, backtesting and curve fitting is easier when a person knows what has already happened. Sidestepping much of the 2008 decline is where this timing tool likely makes the bulk of its advantage. Still, it is another possible tool to use, like the 200 day simple moving average, one that has proven to be useful.

An interesting strategy going forward would be to do the opposite, buy on the sell signals given by VIX 20 or the 200 DMA crossovers. Why would anyone do that? Because when an indicator becomes too popular, gets a lot of press, it often starts to fail. I'm not saying I'm going to do that, but it is worth a thought. From the late night bull session a few nights ago, my young relative mentioned he watched the financial news much of the day. I told him that its best use might to use it as a contrary indicator when certain commentators "guaranteed" certain outcomes, to go opposite.

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

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.

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.

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.

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.

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.

Long GLD, IWM, SPY, TLT

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.

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.

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.

Long GLD, IWM, SPY, TLT

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.

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.

Long GLD, IWM, SPY, TLT

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.

Long GLD, IWM, SPY, TLT

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.

Missing the rally boat

For the most part, I missed this week's rally in SPY. I did not pull the trigger, often thinking that there would be some give back to this rally. Another factor, is that August sometimes spawns big moves. I don't have any open August positions. I may take on some smallish positions, but for the most part, am content to sit this one out.

QE2 is supposed to end today, and the bond ETF TLT has been falling the last few days. It is difficult for me to gauge the action, because the market is distorted by the intervention and traders jockeying for position knowing that the buy program is ending.

Barrons "worlds most crowded trade"

... Investors began to unwind what might be the world's most crowded trade—short the U.S. dollar and buy commodities

The above quote is from a Steven Sears Barrons article "Reversing the QE2 Trade" (link). If the link is expired try searching on the article title, June 25, 2011.

The rapid two day smash in GLD might be part of that unwinding. Sears focuses more on oil and currencies in his article than metals.

It is sometimes difficult to tell where the crowd really is, and the second and third level observations. Treasuries as tracked by TLT certainly have the look of a crowd. Then again it might be more of a tug-o-war with shorts establishing positions while QE2 is winding down.

SPY Backratio

I sell some SPY Backratios, Sep 105/110 puts, SPY @126.80, selling two 105s for every 110 that I buy. Overall, it is net delta positive, meaning a bullish bet, with some twists such as a max profit with SPY @105 at Sep expiration, another breakeven point at below 100. I get a small credit, and it is theta positive, meaning it benefits from time decay.

Here is a YouTube link to the Beach Boys singing their song "Wipeout" (link). It is symbolic for my GLD calendar call spread.

Long GLD, IWM, SPY

4-1-1 for June

Four winners, one loser, one break even for the June option cycle. The winners include: tWo short SPY puts, short EEM and GLD puts, all expiring worthless, so I pocket 100% of the modest option premium.

The strangle on TBT/TLT that broke even, counting two winning short TLT puts expiring, against one covered TBT put at a loss. One loser was the lifted long leg of the SPY Jul 115/120 vertical put spread. The timing on that exit was terrible as the sold put more than doubled after lifting that leg.

Also in GLD, the Jun leg of the GLD calendar 160 call spread expired. I sold a GLD Jul 161 call to turn it into a 1-point-wide vertical call spread. That caps the profit at 1 point, which is decent given a cost basis of the position of 1/3 of that.

It felt like a very frustrating month, despite a modest profit, because many times it seemed like I entered or exited trades at near the worst levels.

Long GLD, IWM, SPY

Buy SPY (sell puts)

Buy SPY via selling Jul 110 puts, SPY @127.8. I am already short SPY Jul 115 puts. Looks like my short Jun puts are coming in okay, so I replace some of that delta with this layer of way out puts.

Long EEM, GLD, IWM, SPY, TLT
with EEM and TLT expiring today

Buy IWM (sell puts)

Buy IWM via selling Jul 69 puts, IWM @78.6. Another low risk, low reward, high probability put sale. IWM at support.

Long EEM, GLD, IWM, SPY, TLT

Hall of mirrors

As summer nears, carnivals travel the country. One of the attractions is a "fun house," often with a hall of mirrors that distorts images and causes confusion. Right now, QE2 (quantitative easing) is causing distortions in the market.

As is often the case, the straight line analysis is only sometimes useful, as players try to guess what others are doing. With the purchase of $700 billion in Treasury bonds and notes winding down, many believe that interest rates are going to rise. However, if enough players are positioning that way, the second order impact may be something different.

Some believe that QE2 has been what has been propping up the stock and commodity markets, and when it ends, those markets will turn lower. It may play out that way, but again, in the Hall of Mirrors, not all is as it seems.

I have a few modest positions and a lot of dry powder. I don't particularly care for the distortions of the Hall of Mirrors, the in-person carnival kind, or the financial market Fed QE2 kind.

Sell GLD (sell calls)

Sell GLD via selling Jul 161 calls, GLD @149.8. This adds a layer of complication to a Jun/Jul 160 call calendar spread. I am long Jul 160 calls, short Jun 160s and short Jul 161s, and short Jul 138 puts and Jun 134 puts. Net long GLD, but this move reduces my exposure.

Long EEM, GLD, SPY, TLT

Buy GLD (sell puts)

I open a July position on short GLD puts. I am also long Jun/Jul 160 calendar spread calls and short Jun 134 puts.

Long EEM, GLD, SPY, TLT *
* I mistakenly left GDX and IWM on some previous lists. Those positions expired with May expiration.

Cold streak

Song for the day is "Cold Day in July" performed by Carrie Underwood (YouTube link). Yeah, I know it is still June.

Anyway, I've been laying low, because it feels like I am out of step with most of the markets. Combine that with some recently closed trades where the timing seemed atrocious, and I have been reluctant to initiate new positions.

All traders go through cold streaks and I seem to be in one now. I am working through it by trading less, reducing risk, and paying less attention to the markets.

Sell TBT (buy back short puts)

Sell TBT via covering short Jun 33 puts, TBT @32.8. The short strangle blew up as TLT went on a strong trending bull rally (TBT is the inverse of TLT). I take a 180% loss on the value of the sold options. I remain short two TLT puts on the other side of the strangle and that would offset this loss, if they both expire worthless.

Long EEM, GDX, GLD, IWM, SPY, TLT

Buy SPY (sell put)

Buy SPY via selling Jul 120 puts, SPY @134.3. I leg out of the long end of my SPY Jul vertical put spread, selling the Jul 120 puts. I remain short Jul 115 puts. I take a large loss on this leg of the vertical, but it has served its purpose as a hedge for many other short put positions.

Long EEM, GDX, GLD, IWM, SPY
TBT/TLT = short strangle on TLT

Las Vegas is built on the rule...

Listening to sports talk radio this morning and I hear this "Las Vegas is built on the rule, not the aberration." Readers know I like the odds in my favor. Other traders may do fine with a relative low percentage of winners, and big winners. A common trading methodology is to aim for 1/3 winners, but make them big, and 2/3 losers keeping them small. My loss averse personality can't stick to and follow that kind of plan. As I often write, it is vital to find a trading style that fits your particular personality. For novice traders that's where journaling (like this blog) can be a powerful tool.

I lot of traders and investors think they are the aberration. Whether it means putting all their eggs into one basket, one asset class, or buying low percentage option plays, they are convinced that they will be that aberration that beats the odds. Yes, a few do beat the odds, but most do not, and that's how Vegas builds and supports those billion dollar casinos.

There is little point in arguing or trying to talk sense into someone that is sure they are the aberration. It is sometimes like trying to convert someone to another religion. That ain't going to happen with logic and sense. It will take more than that. If a person has the track record to back their belief, it is one thing. For others, it might be a lesson they have to learn on their own. Some never learn the lesson, and continually lose money in the latest and greatest aberration.

Bob Dylan's 70th bday

One of my hobbies is songwriting. Bob Dylan is perhaps the most influential songwriter of the century. Here are a couple of lists of his top songs (link1 and link2). Many of Dylan's songs became top hits when performed by other artists.

As for the markets, they continue to frustrate. In hindsight, I would have been better off holding all three positions where I recently cut the losses. This happens and is an average event, though hopefully not that frequent an event. I tend to have a low tolerance for losses, so I remind myself to limit exposure after taking some big losses. I'll be back, but it is often best to take it slow after taking some big hits.

9-3 for May w/ some big losers

Nine winners, three losers for the May option cycle. Unfortunately, the three losers included two big hits in GDX and TBT and a monster loss in SLV. Winners include a GLD call calendar, and short puts on GDX, TLT, three SPY puts, EEM and IWM.

Overall it nets to a sizeable but manageable loss. This is my worst month of 2011 and the first month in the red. I went into survival mode after taking the big hit on SLV and closed out some other trades that I might have held on, had I not been knocked silly by the 880% loss in SLV (that's on the value of the sold put).

Going forward, I have a GLD call calendar, GLD short puts, SPY short puts hedged with a vertical put spread, TLT/TBT which translates to a short strangle, short puts on EEM.

Sell TBT (buy back short puts)

Sell TBT via covering short May 34 puts, TBT @33.4. The bleeding continues, as this is my third big loss for this cycle. This one is 200% on value of the option. I remain short TBT Jun 33 puts and they are deep in the red. The other half of the trade, short TLT puts are green, but have not made up for the losses. This is the risk of selling strangles, that a large directional move breaks the trading range.

Long EEM, GDX, GLD, IWM, SPY
TBT/TLT = short strangle on TLT

Sell SLV and GDX (buy back short puts)

I sell SLV buying back my short Jun 35 puts, SLV @32.1. I take a large dose of medicine, possibly the worst trade in the four years that I've been blogging. The 880% loss on the value of the option, wipes out months of many small profits from selling puts. This is the risk of the strategy, that something blows up and I watch it go. This biggest mistake was on the entry, where greed and the high premiums lured me in. The minor recovery rally was an opportunity to get out with a large loss instead of a monster hit I am taking now. As I type this up, it looks like I picked a bad time as SLV has recovered a bit to 32.4, but that too happens if a person cuts losses.

I also sell GDX buying back my short Jun 51 puts with GDX @54.2 for a 250% loss on the value of the option.

I had more risk on the table than I would like and needed to cut back. It is painful to take some huge losses, but better that than to “go down with the ship” and see the entire account become threatened.

Long EEM, GDX, GLD, IWM, SPY
TBT/TLT = short strangle on TLT

Gold timers and retirement savers

I haven't blogged in a couple of days. I have two separate items today. First is Hulbert on Marketwatch reporting low bullishness among gold timers (link).
>>
... the average recommended gold market exposure among a subset of the gold market timers tracked by the Hulbert Financial Digest (as measured by the Hulbert Gold Newsletter Sentiment Index, or HGNSI). Just a week ago this average stood at 73.7%, one of the highest readings for this index in several years.

Today, in contrast, it stands at just 7.0%. ...
>>
This is good news for gold bulls. With such a low level of exposure, another steep decline in gold is less likely. So despite today's give back, I remain bullish on gold and am holding my positions (May and Jun short puts and a Jun/Jul call calendar spread).

In a separate article about retirement savings, few are optimistic about having enough money to retire (link2).
>>
70% of those surveyed said they are not where they need to be in terms of saving for retirement
>>
With money market funds and CDs at record low yields, few feel comfortable about their nest eggs. When yields were 3% to 5% on the guaranteed instruments, the sentiment was better. It is a difficult environment, because many feel that bonds are headed lower, stocks are overvalued and precious metals are in a bubble. Only a few might hold all three beliefs, but many folks seem to express at least one of these concerns. There is certainly a case to be made for all three.

They are valid concerns. However with "cash" yields so low, it is a difficult course to chart. The game of chasing yields, with high yielding stocks, long term bonds, junk bonds, is loaded with risk. This blog is about my short term trades. I only write about the long term in general terms here. There are other places such as the Vanguard forums where folks can get detailed comments on questions about asset allocation (link3). Though be prepared to reveal a good deal of personal information to get meaningful comments.

Does anyone pick stocks any more?

Today is the day of the Kentucky Derby. Back in the day, horse racing was a popular middle class sport. Boxing has experienced a similar decline in popularity. So has stock picking. When I was new to the stock market in 1987, it seemed a popular past time for young educated men.

Readers of this blog can observe a change here. I rarely venture into individual stocks any more. One huge reason is that in options, the spreads on the big indexes such as SPY, GLD, tends to be penny-wide or at most a few cents wide. On a few stocks that is also true, but it is a very short list. On many popular stocks, the bid/ask spread might be ten cents. Over time that adds a lot of friction and reduces returns. Especially as I venture more into spreads where it may take four transactions to complete a trade, an extra ten cents adds up over the course of a year.

As an aside, I was having breakfast with a stock picking buddy and another stranger over heard the conversation. The woman said, "I think the stock market is fixed." That is a popular feeling out there, and in some ways accurate.

Speaking of fixed, I posted a poll on the PCGS precious metals forum, asking when silver will see $50 again (link). After 80 or so responses, about half expect $50 to come before 2011 ends. Another 35% expect it within three years. As I wrote on that thread, that is disappointing after a down 38% week. More pain in the form of lower prices may be needed to dampen the enthusiasm.

Compare this to the mood at the March 2009 bottom in the stock market. Many pundits, me included thought that 3000 Dow might be in the cards. That is the kind of mood at major bottoms, not a calm optimism about the long term up trend. That said, a good many pundits called the top at $50, so who knows. I would be more optimistic, if there were more pessimists. It is a conundrum of the markets.

Is SLV done or is it 1987?

Is the bull market over in silver? Is it now doomed to see decades of decline with only failing rallies? Or is this week in silver more like the 1987 crash in the stock market, with SLV ready to recover and eventually make new highs?

I vote for the latter, that new highs for silver are out there, though it will likely take a while. It took two years for the 1987 stock market to make up that 40% lost during the crash month. It may be similar for silver. A one week 38% smack down on rising margin requirements isn't how long term bull markets typically make their final tops. I don't see a V-shaped recovery, so it isn't time to load the boat on silver. A lot of technical damage has been done to the silver chart, so I expect a lot more backing and filling. Indeed, SLV may have to go below 30 before making a short term low.

As always, no one knows the future, I am giving an opinion, and as always, I've been wrong before (like yesterday when my trading account saw its worse day of the year).

The gold chart still looks constructive, with a decent base for GLD at 140. Textbook would be a pullback to the 50 day moving average and then new highs. It is rare to get textbook charts in real time though.

Market melt down

Ouch! This is my worst day in many moons. SLV, GLD, GDX lead the losers, but almost all my positions took on heavy water.

For now I am holding on to all my positions. I may roll out the short TBT May 34 puts, same with some of the other puts for June, if they are come into the money.

I out thought the room. I posted those warnings on Sunday about silver, and thought with that with so many warnings, there was little chance of a melt down. Sometimes the pundits get it right, and those that like to fade them get punished. Ouch.

Buy TLT (sell puts)

Buy TLT via selling Jun 89 puts, TLT @94.4. This is a rebalancing trade for the TBT/TLT strangle. The most immediate concern is that I am short TBT May 34 puts and they are close to the strike with TBT @34.9. TLT is at resistance, but this morning is breaking through. While I am underwater on my TBT positions, the profits from the TLT more than compensate, so the short strangles are net positive overall. I am already short TLT May 86 puts and Jun 85 puts.

Elsewhere, I stepped into an air pocket on SLV on Monday. The high premium lured me in and I am paying for it. I am down 120% on the value of the option in two days. Fortunately, as almost always the dollar amounts are small.

Long EEM, GDX, GLD, IWM, SLV, SPY
TBT/TLT = short strangle on TLT

Buy SLV (sell puts)

Buy SLV via selling Jun 35 puts SLV @45.4. Support at 40 and 35. As I outlined in my previous post, I don't think there will be an immediate crash in silver. Volatility is at 59% on these puts, so anyone buying these for insurance is paying a hefty premium. I am willing to sell them that insurance, or to buy SLV if it falls to support at 35.

Long EEM, GDX, GLD, IWM, SLV, SPY
TBT/TLT = short strangle on TLT

Saefong: Silver Mania

Myra Saefong has a Marketwatch article (link) entitled "Silver Mania may come to an abrupt end." A few quotes from the article:
>>
Peter Grandich, a self-proclaimed former “raging bull” on silver from under the $10 level, is saying “sell all silver holdings.” ...

[Karnani] "...silver prices can crash to $25 next year."

Jeb Handwerger, editor of GoldStockTrades.com, in recent newsletters. “I am very concerned that silver may be overheating as the herd tries to force their way into this trade.”

[Ned Schmidt] “Silver is the ‘internet stocks’ of 2011”

>>

With some long time permabulls in the group or chirping birds, it seems unlikely that silver will cooperate with a crash. To me, a more likely scenario is that silver forms a new base from $40 to $50 and spends some time in a trading range.

Let me add some more perspective. For many years, I've advocated dollar cost averaging into silver and gold for long term investors. This is no longer the case. With a possible bubble forming, DCA might be about the worst strategy to start now. It might be okay to continue, if a person has a big stack at lower prices. In a bubble, the rise is short and steep and the down trend long and relentless. DCA will put way too much money into buying during a long downtrend.

In contrast to silver, the gold chart still looks supportive. So for the investor with significant net worth and zero metals holdings, it still makes sense to buy a little and have some as insurance. To tilt heavily into the hot sector after having zero exposure is always a recipe for danger.

So what kinds of strategies make sense in a bubble? Not very many for long term stackers. Selling a bit with each price increase and reallocating into other asset classes is the rational plan. That presupposes that a person has a large allocation now and bought at much lower levels. Advanced option strategies such as vertical call spreads or put calendar spreads may work.

As always, we won't know if silver is a bubble until we see more price history. However, birds don't typically chirp such loud warnings at market tops. So if I had to vote, I would vote "no, not yet." With that, for a person with no holdings, better to steer clear, than to jump in to what is likely to be fast moving water.

Buy SPY (sell puts)

Buy SPY via selling Jun 124 puts, SPY @136.0. Support at 134, 130, 125. I add another layer of short puts. I have a Jul 115/120 put vertical as a protective hedge against layers of short puts. This translates to a bullish bets in May and Jun, with a protective hedge out to Jul.

Long EEM, GDX, GLD, IWM, SPY, TBT/TLT
TBT/TLT = short strangle on TLT

Buy GLD (Thu order filled)

Yesterday's order for a GLD call calendar spread Jun/Jul 160 calls filled with GLD around 149.0.

I buy the Jul 160 calls sell the Jun 160 calls. As review, this is a mildly bullish bet, with a max profit if GLD reaches 160 at Jun expiration. The trade has positive theta, so time decay works for me. If GLD falls, it losses, and also if GLD goes rapidly to 165, the trade also flips to a loser. Advantages over buying straight calls are lower cost, positive theta. Negatives are the two commissions and bid/ask spreads each way, less upside than buying straight calls, and trade flips to negative if GLD sky rockets.

Long EEM, GDX, GLD, IWM, SPY, TBT/TLT
TBT/TLT = short strangle on TLT

Buy EEM (sell puts)

Buy EEM via selling Jun 44 puts, EEM @49.7. I open a Jun position, 44 is support.

Separately, I place an order for a GLD call calendar spread Jun/Jul 160, at the mid price which means the market has to come back a bit for me to get filled. I was fortunate to get filled on Wednesday, exiting the other GLD calendar. The max profit is at the strike (which was 147) and the position starts to lose as price moves up above that.

Long EEM, GDX, GLD, IWM, SPY, TBT/TLT
TBT/TLT = short strangle on TLT

Sell GLD (sell call calendar spread)

Sell GLD by selling my May/Jun 147 call calendar spread, GLD @147.8 when trade filled. I net a 45% profit after spreads and commissions. As usual, while the percentage gain is impressive, the dollar amount is small. As GLD moves above the strike price, the spread starts to decrease in value. Each part, the May 147 call, the Jun 147 call and the calendar all went up.

The calendar has the advantages of positive theta (time decay works for me) and lower cost and a smoother ride vs. buying straight calls. A negative for calendars is two bid/ask spreads, two commissions each way. If there were no commissions, no bid/ask spreads, like paper traders might report, or some option training programs permit, the profit might have been more like 65% instead of 45% on the exact same trade.

I am still long GLD via being short some May and Jun puts.

Long EEM, GDX, GLD, IWM, SPY, TBT/TLT
TBT/TLT = short strangle on TLT

Silver: time and price

Silver futures /SI on ThinkorSwim neared the sun at $50 yesterday and fell back. Many are trying to predict how low it will go on this first pullback. I often write that when price is uncertain, look at time. On the /SI chart, the futures made a run towards $30 on 11/9/10 and fell back for five days.

It took two more runs at $30 to break through. The second run at 12/6 took out the level, but again fell back for a period of consolidation. The third try 12/31 went a little high, but actually resulted in a longer and deeper correction of three weeks.

With so many looking at price levels, time may be as good an indicator here. Next Monday 5/2/11 is five days, and may see a first bottoming attempt for silver.

Looks like I would have been done better waiting on my GDX and GLD puts sales from yesterday. I haven't hit too many trades solidly square lately.

Buy GDX and GLD (sell puts)

Buy GDX via selling Jun 51 puts, GDX @61.3. I open a Jun position. The low for calendar 2011 is 52, so a move to the strike would mean the entire year's gain is given up. Another low risk, low reward, bullish bet. Volatility on SPY is way down, but still about 37% on these way out puts.

/edit to add: I also buy GLD via selling Jun 134 puts, GLD @147.2. Support at the breakout level of 139 and the dip at 135. I also have a lot of thoughts about SLV, but it is moving too fast for me.

Long EEM, GDX, GLD, IWM, SPY, TBT/TLT
TBT/TLT = short strangle on TLT

Change in fashion

I find an interesting discussion on the Vanguard forum about changes in suggested asset allocation (link).

From that discussion:
>>
... evidence of faddishness and trendiness in investment advice. In 1989, we were being told that retirees should have 0-20% in stocks, 50% bonds, and 30%-50% cash. Today, Vanguard Target Retirement 2010 would put someone at retirement in 47.53% stocks, 51.94% bonds, and a whopping 0.53% short-term reserves ...
>>

This is normal human behavior. Every age will have investment cliches that may or may not be sound. Way back in the 19th century, the advice was to "never sell consuls [British bonds with no expiration date]," then World War I and II happened and the sun set on the Empire and the bonds weren't so good to have any more. Things change.

More recently there has been a lot more recommendations towards international investments, mostly stocks, but now international bonds are coming into fashion. Even more in the news is the current run for silver and gold. Will the Bogle-heads ever acknowledge metals? Probably not any time soon, however, the permanent portfolio folks have, and do, and it is similar approach though with a 25% weighting to gold (link to gyroscopic investment forum).

Wouldn't it be great to know what the gurus will be recommending in 2030? Odds are that it will be widely different from what is in fashion now, just as the allocations changed so much from 1989 to 2011.

Buy SPY (sell puts)

Buy SPY via selling Jun 119 puts, SPY @133.8. I open a June position on SPY. I am already short several layers of May puts (bullish bets) and have a Jul vertical put spread (bearish bet) as a hedge. SPY looks like it wants to spend some time basing at the recent highs. Support at 130 and 125.

GLD nearing my target of 147. I may let it drift a bit higher before exiting my calendar spread, because time decay is in my favor as I am short the May 147 calls, and long the Jun 147 calls.

Bonds have been volatile this week due to the S&P outlook. I still think a range is the most likely scenario and have positioned myself accordingly.

Long EEM, GDX, GLD, IWM, SPY, TBT/TLT
TBT/TLT = short strangle on TLT

The race against yourself

A guy on the radio talks about the race against yourself. It is a totally different context than trading, but it is a worthy topic. Another similar title that I've been thinking about is the "fear of missing out."

In trading, there is almost always someone who has a higher rate of return over any given period. With every monthly summary, I can point to trades not taken, or gotten out of too early, or slightly better timing that would have yielded huge gains. That is the nature of options when a doubling or tripling in a week, can be common.

Risk and reward often go hand in hand. The fear of missing out, is another phrase to describe greed. When a stock or ETF rockets higher, or lower for that matter, a lot of folks will want in, due to greed. When to chase the rocket, and when not to, tends to be clear in hindsight. In real time, those kinds of decisions might be determined by trading style or trading system, and/or by years of market experience.

Some traders do well following trend, others do better trading counter-trend. That's part of the race against yourself, that inner game of knowing yourself and knowing what kind of style, what kind of system might work best for you. Personality, risk tolerance, pain tolerance, available capital, are all factors into trading style. A good or poor memory, attention to detail, ability to pull the trigger, quick thinking vs. slow analytics and seeing the bigger picture are some more factors.

Especially for novice traders, a trading journal can be an extremely valuable tool. That's one reason I do this blog, it is a public trading journal with a record of my short term trades. If a novice trader writes about every trade, and then takes time to look back, they will start to see what kind of trades work for them. Over time a trader will develop a style that fits them, that works for them.

Some folks, aye, most folks would do better taking the other pill, and go with low cost indexing, the Vanguard way, and forget about trading. Just as options are not for everyone, position trading is not for everyone either. Day trading is for an even more select group, especially as the skill required and capital required grow ever greater as computerized "Watsons" dominate the day trade with an average holding time of 13 seconds and profits that might average 1/8 of a cent per share.

Long time readers know that I like to use baseball analogies, that I see my trading style like that of a singles hitter, striving for a high batting average, with few home runs. Bunt singles are a fine thing for me, but beyond boring for big home run hitters. For the race against yourself, golf might be the best sports analogy. While a person might compete against others, a golfer has to focus on that inner game, and keep a calm and clear mind to succeed at golf.

7-1 for April

Seven winners, one loser for closed trades during the April option cycle. The one loser was a bearish vertical put on SPY. By legging out of the trade, the overall loss was small. The winners include 3 other short puts on SPY, and short puts on GDX, GLD, EEM, TBT. All the short puts expire worthless, so the gain is 100% on the trade amount. The return based on margin required is in the 2% range for most of the short puts.

The good news is April is my best trading month of the year so far. That is faint praise because while I made profits every month, the pickings from Jan to Mar were meager.

Some new readers might ask why I bother selling way out of the money puts for small premiums. The answer is: the high probability of success, and continued heavy skew on puts making them trade for more than historical volatility would indicate. In plain English it is a slow nickels strategy, vs. fast dollars directional gunslinging. Some think of it as being paid to put in a bid at or below support. If there is an immediate sharp drop, the put seller is assigned and buys the underlying.

Yes, if a trader goes to full leverage and sells naked puts on exchange minimum margins it can become a highly leveraged, risky strategy. That is not my style, I tend to move slowly, do layers of different strikes, different months, hedge by buying an occasional option or vertical. If the market turns turbulent, I will use stop-losses. I also may occasionally take a shot on a low probability high reward trades.

Buy TLT/TBT (sell strangle)

Buy TLT via selling Jun 85 puts TLT @92.6. I am buying the bond rally. As I mentioned before May/Jun are two of the best months for bond seasonality. I am already short TLT May 86 puts. I also sell Jun TBT 33 puts with TBT @36.7 to make the position equivalent to a short strangle on TLT or a bet that bonds stay in a range.

Long EEM, GDX, GLD, IWM, SPY, TBT/TLT
TBT/TLT = short strangle on TLT

Buy SPY (sell puts)

Buy SPY via selling May 119 puts SPY @131.7. I add another layer of short puts. SPY down five days in a row, finding some support at the 50 day moving average. I also expect tax refunds to continue to flow into the market. I am already short May 107 and May 117 SPY puts, and have some more SPY positions, netting to slightly long SPY. Support at 125, 123, 120 and 118.

Long EEM, GDX, GLD, IWM, SPY, TBT/TLT
TBT/TLT = short strangle on TLT

$1 million in SLV put options?

Making the rounds is a story about a large put option purchase on SLV (link).

>>
A trader’s almost $1 million bet that an exchange-traded fund tracking silver will decline by July was today’s biggest single options trade on U.S. exchanges as futures on the metal reached a 31-year high.

The 100,000 puts, or options to sell 100 shares each of the iShares Silver Trust (SLV) at $25 by July, changed hands at the ask price of about 10 cents and exceeded the open interest of 6,054 outstanding contracts before today, indicating that a buyer of a new bearish position initiated the transaction.
>>

There is a chance that this is the whole story, but unlikely. Option traders prefer complexity, and often hedge one position against another. I'd put the odds at 95% that this is the case here, that the reported trade is part of a more complex strategy. My most likely guess would be a collar, financing the purchase of the puts by selling out of the money calls, while being long the underlying. A collar is a conservative bullish position with limited upside and crash protection, not a bearish bet.

Elsewhere in the news, PIMCO is reported to be shorting U. S. Treasuries (link2), and Goldman Sachs is reported to be telling clients to get out of oil (link3). I doubt that these stories are revealing all.

The old spy cliche comes to mind: "trust no one," especially news headlines, especially when they are about options.

Options 201: calendars vs. verticals

I am liking spreads more and more. Spreads typically involve two options. A vertical is the same type of option, same month, buying one strike and selling a different strike. A calendar involves the same type of option, different month, same strike, buying one month, selling a different month.

Lets look a bit closer at verticals, vs. calendars, vs. buying straight stock, vs. buying straight calls.

The purest play is just buying the underlying stock or ETF. Delta is 1, theta is not an issue. Downside is to zero.

Buying calls at the money, the delta is .5, theta is negative, especially for front month calls. Profit potential is high. Downside is the price of the option or 100%, but the option cost a small fraction of the underlying. If the stock stagnates, you lose money every day due to time decay.

The vertical has slower time decay than just buying the lower strike call. The trade off is less upside, max profit is the width of the vertical or the difference between the two strikes. The cost can be much lower than just buying straight calls.

The calendar has little to no time decay. Depending on the options chosen, theta may start out positive. The max profit price target is right at the strike, vs. way past the upper strike for the vertical, or buying one call option. The downside is that the max profit is lower than a same cost vertical, and if the underlying jumps quickly, the calendar becomes a loser.

So most bullish is just buying the underlying stock, but this isn't capital efficent as there isn't any leverage. Buying calls limits downside, and has rapid time decay. Buying a vertical call spread is cheaper than buying calls, and slows the decay. Buying a calendar means no time decay (though it varies based on options selected), and pushes the max profit zone to a closer price target, has less max profit than the vertical and also turns into a loser if the price jumps way past the strike quickly.

For example, I recently bought:
GLD calendar May/Jun 147 calls
Selling GLD May 147 calls
buying GLD Jun 147 calls

Another choice might have been
GLD vertical Jun 147/152 calls
buying Jun 147 calls
selling Jun 152 calls

Other bullish choices might be just to buy straight calls, or straight stock, or my other favorite, selling puts. For each choice there is a trade off, in terms of time decay, and cost vs. max profit and profit zone. The good news if that a person understands verticals and calendars, there is nothing more to learn. The more complex strategies are layers or combos of those.

/edited: correction made, calendars are actually positive theta benefitting from time decay, also added a link below to some free options videos, though registration is required. Option Industry Council webcasts on option basics and strategies
link

Buy GLD (calendar call spread)

Buy GLD May/Jun 147 calendar call spread
GLD @141.7 new all time highs today.

GLD breaks out from a base. My target is 147, which would correspond to $1500 for physical spot. Profit range on the calendar spread is 4 points around 147, or 143 to 151. So it bullish, but only mildly bullish. Time is a factor too, May expiration would be the best time to land on 147. Decay eats away if GLD stagnates here.

A calendar spread consists of buying the out month, and selling the earlier month.
Buy GLD Jun 147 calls
Sell GLD May 147 calls

Long EEM, GDX, GLD, IWM, SPY, TBT/TLT
TBT/TLT = short strangle on TLT

Hui: chasing premium

Cam Hui writes about the risk of chasing high option premiums when doing buy-writes (link). Similar caveats apply to those chasing high yielding stocks.

>>
the lure of free money brings out the worst in people. I think that one key area of that is the seeking of yield.
>>

I've been burned more than a few times chasing premiums. The most memorable was one time I escaped, and that was the weekend before Lehman. The stock was trading in the 30s, and front month LEH 10 puts still had decent premium. I figured it was "free money," I mean Lehman wasn't going to go from 30 to 10 over one weekend? Well, it went to about 3 the next week. It was a valuable lesson, and that particular one didn't even cost me anything.

Sometimes the market knows more than is being revealed. The closest thing to a free lunch might occur when Barrons or some brokerage house recommends a specific option trade at specific strikes. A bunch of newbies see that and get in, and pay up. Get on the other side and it is typically only a few bucks of extra premium, but it is often enough to buy that happy meal.

More on permanent portfolio

The concept of a permanent portfolio was popularized by Harry Browne. Here's another person's allocation for a permanent portfolio (link).

If I were asked, I would tend to favor something simpler for average folks. The simple Simon version is 25% each in stocks, bonds, gold, money markets or CDs, and rebalance using bands or once a year. If using ETFs 25% to VTI (Vanguard Total Stock Market) or perhaps split some to VXUS (Vanguard Total International), BND (total bond market), GLD (or PHYS), SHY or just money in the account. Simple is often better for long term investors.

Even simpler might be 50/50 VTI/BND for the investment account, some CDs and some physical gold. Again rebalancing one a year or with bands (a large market move in one or more sectors triggers a rebalance). Rebalancing is easiest if done with new money coming in, as that doesn't require selling and the taxable event in taxable accounts.

The one linked tends towards to lean towards what is hot right now, and anti-dollar themes. To illustrate the point about tilting towards the news and what is hot, I can use the example of gold. One of the best times to load up on gold was in 1999, when gold was $300 and most saw as "dead money" after a decade of poor performance. The U.S. had a Federal budget surplus, employment was near the theoretical "full employment." Stocks were doing so well, that many baby boomers were counting their chickens for an early retirement. Someone tilting then may have underweighted gold and overweighted tech stocks, and would have done poorly because of that tilt.

1st quarter review

For the first quarter (12/31 close to 3/31)
SPY +5.4%
TLT -2.1%
GLD +0.8%

SLV +21.8%
EEM +2.2%
IWM +7.6%

So again risk was rewarded with the more volatile IWM (Russell 2000) and SLV (silver) outperforming. Treasuries (TLT) were down, Emerging markets (EEM) trailed.

For stock traders the previous SPY top just a bit higher is a line in the sand for the bears. How many will cover if that is broken with conviction? How many are positioning short with the top only a point or so away (6 month chart). Support at 125, 123 and then 118 and that's why I am using those strikes to sell puts around and below.

For TLT support at 88/87 (two year chart). Observant readers might see that I recently sold TLT puts for the first time all year, after focusing exclusively on TBT (inverse bonds). I did so because of chart support, sentiment and seasonality.

The two year GLD chart (link3) is forming a base at the highs. The gold chart looks more exciting on the 6-month view, but the previous long base at 120 just below, the current basing behavior is not as exciting. We may get a bit of pop breaking out from this base, but there is not a lot of fuel, at least not yet.

More Layers for SPY

I add more layers to my SPY position. I buy a Jul 120/115 vertical put spread (a bearish bet), and I sell short May 117 puts (bullish bet). SPY @133.0 to 133.1 when these trades are legged into. It is net debit for the three new positions, slightly delta positive SPY, close to theta (time decay) neutral to May. Adding these layers doesn't change my net position of being long SPY, but does give me some measure of SPY downside protection out to July.

Long EEM, GDX, GLD, IWM, SPY, TBT/TLT
TBT/TLT = short strangle on TLT

Ritholz: QE3 here already?

Barry Ritholz writes about the Bank of Japan, injecting the equivalent of QE3 into the system with its post earthquake intervention (link).

I express some of my thoughts about QE2 a couple of weeks ago, on the PCGS Precious Metals forum (link2).

>>
I can't explain it [QE] in simple terms. It is not an easy topic. Intuitively, I know that printing money to buy Treasury bonds is a very dangerous game. It is a complicated game, where the players, don't have a good grasp of what kind of genie they have let loose on the land. I read a New York Times article about the team that does the actual buying and how and when they do it. Would it trouble you to know that the team consists of six 20 somethings? That the oldest person on the desk that does the daily buying of bonds and notes that will eventually total $700 billion is 29 years old? Well, it bothers me.

QE is playing with fire, and there is a chance that the house (the entire financial system) might burn to the ground. Again, one unintended brush fire from the policy is record food and commodity prices as well as recovery highs in the U. S. stock market. Food riots are starting to break out in the poorer countries. Is there cause and effect? Some would say no, but we won't know the history until it is written. If things go badly, historians may look back and blame QE and qe2 as the catalysts to massive starvation of hundreds of millions of poor people all over the world. That's the magnitude of the kind of fire they are playing with. If things go badly, QE might be viewed like the Treaty of Versailles (ending World War I) and the punitive reparations demanded which had a long term cost. When that war ended, very smart people sat down and wrote out the terms. It made logical sense to them.

Humans are capable of incredible financial folly. That you and others don't see a problem doesn't mean there isn't a problem. Quantitative easing is almost certain to have a long term cost. We don't know the price yet. Those in charge don't know the rules of the game. The rules of the game are being made up as we go. I see QE as a genie that has been let loose on the land, and the price wasn't negotiated when he was set free. The genie isn't going back into the bottle until his price is paid, and that price may be high, and there is the chance it may involve blood.
>>

Kaeppel on Bond seasonality (and gold too)

Jay Kaeppel at Optionetics writes about seasonal trends for U. S. Treasuries (link). The short and sweet version is January thru April are the worst four months, and four single months May, June, August and November are the best months to own bonds. As always seasonality is only one indicator, and one of the less dependable ones and one that gets easily jumped (eg: if traders expect a strong May, they will jump the trade and move that up to mid-April).

In a dated article from 2009, Jeff Clark addresses the question "What is the best month to buy gold?," specifically gold miners (link2).

I am tempted to play this by shorting gold using a Jun/Jul calendar put spread, or vertical put spread out to July. My history is that I tend to be early with these urges, so may just sit on the idea until I get more clarity or see some actual downside action. As always, calling top (or bottom) tends to be a low probability game.

Buy TBT (sell puts)

Buy TBT via selling May 34 puts, TBT @36.7. I open a May position on this double-inverse bond ETF. I am already short TBT Apr 34 puts, and TLT May 86 puts. This makes for a short strangle on TLT, or a bet that bonds will stay in a range.

Long EEM, GDX, GLD, IWM, SPY, TBT/TLT
TBT/TLT = short strangle on TLT

Buy GDX (sell puts)

Buy GDX and SPY (sell puts)
Buy GDX via selling May 48 puts, GDX @58.7. The short April puts are near delta zero, so I open a May position to have continued exposure. Like the GLD puts I sold, these are way out, with a high probability of success.

I also layer on more SPY longs via selling SPY Apr 123 puts SPY @131.8. I figure if all the news couldn't get SPY much below 125, it will take a wallop to get it below 123 before April expiration. I am already short SPY puts for Apr 103, Apr 113, Apr 117, May 107.

These are low risk and low reward trades. My broker ThinkorSwim lets me do the trades with exchange minimum margins of about 10% of the underlying strike. I can't remember ever running out of buying power or even getting close. So while these can be risky trades at full margin, I don't go near using full leverage. For any new readers, I survived 2008 selling puts, so do occasionally cut and run and take my lumps.

Long EEM, GDX, GLD, IWM, SPY, TBT, TLT

Wolfinger on Emotional capital

I found a blog called "Options for Rookies," written by Mark Wolfinger. In the linked entry, there is a first hand account of a relatively new trader caught up in an churn of emotion.

The blog has entries on a lot of topics that I don't have the time or inclination to explain, such as basic option strategy and trading tactics. The author was an options market maker in the 1970s, but does try to bring ideas down to a basic level.

A lot of traders focus entirely on the account balance, the profit and loss. A big factor is the emotional state, the emotional capital, the wear and tear on a person's psyche. What a trader chooses to spend time and energy on will have a huge long term impact on the bottom line. Sometimes it is better to exit a trade, even if odds favor it working out, if the emotional capital expended is too much.

There is the old investor cliche, "sell down to the sleeping point," for investors that can't sleep at night because they worry about their investments. I don't have a witty equivalent for short term traders, perhaps conserve your time and energy, spend it wisely.

Buy TLT (sell puts)

Buy TLT via selling May 86 puts, TLT @92.4. Support at 88 and 87. In my mind, this is like placing a bid at 86, and getting paid if it doesn't fill, and being okay with it if it does fill.

Long EEM, GDX, GLD, IWM, SPY, TBT, TLT
TBT/TLT = short strangle on TLT

Vanguard vs. the Matrix

Recently I've been reading the Vanguard forums (link1 and link2). The regulars there call themselves Bogleheads. A tribute to Vanguard founder Jack Bogle.

While much of the Internet is devoted to market timing and hot tips, a person will find none on that on planet Bogle-head. The language is different as is the attitude.

I was tempted to give this post the title, red pill or blue pill. The main character in the Matrix movie is given that choice. In the movie, the red pill leads to an escape from the Matrix. As a young person with their first decent job and some money to invest, you can take either pill. Let me randomly assign the red pill to Vanguard, this pill means you will likely be in the top 25% of U. S. investors in performance. However, what you give up is any excitement, action, and the possibility of a financial home run. With the prequisites of a high savings rate, frugal living, and a relative stable political environment (the U. S. still is on world maps) you will likely have a decent retirement.

Most people choose the blue pill, which means more excitement, more action, more frustration, and mostly lower performance. Yes, a tiny percentage will out do the other group. A tinier percentage will hit that home run (eg: loading the investment boat full of Apple, or Bershire, or Walmart at a good time in their curve).

I took the blue pill. Options might be described as the big blue pill with an exception for a few conservative strategies such as covered calls and collars. If you are reading this, you likely have chosen the blue pill. Well, I am can talk about the benefits of the red pill. It is what I suggest to young relatives that ask me about investments. Steady savings, no credit card debt, living under one's means, age appropriate asset allocation. Not many want to buy it, vs. if I had offered a hot penny stock tip. I certainly did not when I was 25. Still, for the average person that is interested in bottom line results, that doesn't want to spend a lot of time learning, or doesn't have the aptitude, the red pill, the Vanguard way, is the better way to go.

Buy EEM (sell puts)

Buy EEM via selling May 41 puts, IWM @47.4. EEM acting strong considering all the world news. My Aprils are near delta zero so I open a May position for continued exposure.

Long EEM, GDX, GLD, IWM, SPY, TBT

Buy GLD (sell puts)

Buy GLD via selling May 125 puts, GLD @139.7. I open a May position. I was tempted to move the strike to 127, but the 125s are a bit safer, give a bit more margin for error. The compromise is less premium.

Long EEM, GDX, GLD, IWM, SPY, TBT
(all short puts)

Buy IWM (sell puts)

Buy IWM via selling May 69 puts, IWM @81.5. Yesterday's attempt to split the bid/ask on EEM puts wasn't the best move. Bid was 32 cents and I tried for 33 and did not get filled. Today they are bid 22 cents. It happens.

Long EEM, GDX, GLD, IWM, SPY

Buy SPY (sell long puts)

Buy SPY as I leg out of my vertical put spread, selling the SPY Apr 122 puts for a 65% loss. The vertical served its purpose, hedging the other short puts. SPY @129.8

Earlier, I placed an order to sell short some EEM May Apr 40 puts, but didn't get filled.

Long EEM, GDX, GLD, SPY, TBT

Buy SPY (sell puts)

Buy SPY via selling May 107 puts, SPY @129.4. I add May 107 to my pile of SPY puts (short Apr 103, 113, 117, long Apr 123 puts).

Long EEM, GDX, GLD, SPY, TBT

4-1 for March

Four winners, one loser for the March option cycle. A relief rally saved my bacon on my three short SPY puts, the fourth winner was a TBT short put. The big loser was a closed trade on an April XME short put. Overall, a sliver of profit, as the one loser was a big one and the four winners small ones.

Again, it serves to illustrate how difficult it is to buy way out puts and hold until expiration. Even, with the news events from Libya and Japan, and wild market action, none of the SPY puts ever came into the money and went to a 100% loss if held to expiration. That said, at the worst of the selling, the SPY March 123 put went to a possible profit of 250%, if a person timed the best exit. That's the lure, the big winner, the home run.

In 2008, some of short puts did go well into the money, so the lesson isn't to sell puts willy-nilly and never to use stops. However, it is an exceptional market that goes straight down. Again, a 10% correction in SPY is common, but 10% down in a single month tends to be an exceptionally bad month.

Going forward I am net long SPY, TBT, GLD, and GDX, mostly with short puts. Turns out that my decision to skip selling short gold puts this cycle was a mistake as gold and miners held up ok.

The NCAA basketball tournament is sometimes called the big dance. For that theme I link the Lee Ann Womack song "I Hope You Dance (youtube link). Enjoy.

The woodshed

Like a lot of longs, I got spanked today. I vaguely remember a financial book from the 1980s, the go-go days of the Nikkei when it was 40,000. It was about a financial market crash precipitated by a massive Japanese earthquake. I don't remember the title.

I am hoping that today's wild witching Wednesday action was related to option expiration this Friday. A few more days like this and I will be in trouble, because of all the layers of short SPY puts I have on. If the 123 price level holds for this option cycle, I can rest a lot easier. There is a minor shelf of support at SPY 125.

I was tempted to sell some SLV puts early this morning. Good thing I did not, as it too turned tail.

Buying or selling on the news

Some investors are taking a look at Japan, or Japanese equities thinking to buy or sell based on the news. It is difficult to predict such a fluid situation. Sentiment can be useful. If it seems like a "smart idea" to buy, it may not be. If others are actually moving in, again, it is likely not such a good move. Traders might look at the recent chart of BP (link).

In the case of BP, the bad news was not a buying opportunity, at least not on the day of the news. The bottom came about a month later as events got worse and worse. This doesn't mean it will be time to buy TM or EWJ a month from now. That would be too easy a lesson, and too far a reach for a conclusion. It does mean that things might be bad, a stock might be at support, but if more bad news comes out, there can be a lot more downside. The chart can be helpful. For example, the two day move down in TM (link2) might be approximately half the move, so another 6 or 7 points lower to 75 makes it a lot more interesting.

Those few buying today or Friday, might use up their dry powder quickly and if the markets drop another 10% or 20%, won't have much more to commit. While those selling, might have huge positions they wish to get out of.

As always, for relatively slow moving position traders like me, it is almost always better to wait and watch. The heroes and the nimble can try and time the exact bottom, slow moving traders almost never do. Yes, sometimes a person will miss the move, but that is always the case.

The quick and the dead

For those with relatives or friends in the earthquake zone, my prayers and good wishes for safe outcomes.

I have more ideas for trades today, but after the recent disaster of XME, I stay away. I have plenty of positions for April. A big loss can make a trader punch drunk. The temptation is to try and make it back as soon as possible. That works for a few traders, but it can also lead to a spiraling losses. For any novice traders reading along, I would suggest the safer path, of trading smaller or taking a break after a loss that stings.

During volatile markets like we have been experiencing, it would be nice to be a more nimble, quicker thinking, quicker moving trader. After over 20 years in the markets, there is always more to learn, but a big change in overall trading style is unlikely to come to pass. As I often write, I usually do better after the dust has settled and trade off the support and resistance levels that have been established.

Sell XME (cover short puts)

I cover my short XME Apr 59 puts for a huge percentage loss, XME @67.0. My timing was close to the worst possible, resulting in a 180% loss on the notional value, holding for a week. I am taking my lumps and moving on. This was a “throw in trade” to me, hedging my other positions. Yeah, I was "thrown in" all right, thrown into the frying pan. Thankfully, the dollar amounts are small.

Long GDX, GLD, SPY, TBT

Anniversary talk

I started this blog in February 2006. So I can note five years of semi-regular posting.

There is some chatter about another anniversary, it is two years since SPY bottomed around 66. Back then, virtually no one thought the stock market would double in the next two years. I certainly did not. I quote a post below, and reading it back, the mention of Dow 3000 looks silly in hindsight, but I was not the only one. If I knew then, what today's prices would be, investing and trading would be real easy, it always is in hindsight. Trees don't grow to the sky, neither does a major economic power tend to wither and die overnight and go to zero. Here are a couple quotes from the depths of the lows:

From a March 3, 2009 post
"SPY Limbo, how low can it go?"
>>
... the market is not historically cheap yet, not based on current earnings. SPY 300!? Dow 3000? That would not be a pretty picture and would likely coincide with a major economic depression. Let's hope things don't get that bad. The chart does project that low. SPY 600 is some support, but it is not major support on the long term chart, not really.
>>

Though to my credit I did tell this story in my February 28, 2009 post
"Worst February since 1933"
>>
I like to tell the story about when my dad first started investing. The stock market was near a top in 1967, it went sideways for a while before spiraling down in 1973/74.

After losing 60% to 70% of his money, dad wanted to sell all his stocks and mutual funds near the bottom. My mom, who had been against the entire idea of investing in the first place, told my dad that he was an idiot. That after a 70% decline it wasn't time to sell, that it was time to buy. My dad ended up doubling his monthly mutual fund purchases. In hindsight, we all know things did turn out okay, and increasing the stock allocation was a smart move.
>>

As a footnote, the fall from the all time SPY high of 150 to 66 is about 56%.

The anniversary of the market lows is a reminder that reversion to the mean is a powerful theme for long term investors. In plain English it means if things are really bad, there is a tendency for things to get better, and if things are really good, they tend to fall back towards average. It tends to take a major historical event such as the loss of a major war, major famine, major plague, or revolution and fall of government, to destroy a major economy.

Frustrated Puddle duck

I am flummoxed and frustrated by the markets. Last week, I initiated four trades and all four are below the line after commissions. The image of the puddle duck comes to mind because it looks like he is floating effortless on top of the water while below his feet are churning for all they are worth. It seems a fitting metaphor for a lot of trading activity with nothing positive to show.

For now, I plan to let my positions sort themselves out and hope that support levels eventually hold, and that expiration comes without more shoes (or bombs) dropping.

Long GDX, GLD, SPY, TBT, XME

Buy XME (sell puts)

Buy XME mining ETF via selling Apr 59 puts. 65 and 60 are support, XME @73.0. I consider lifting the long put in the SPY vertical put spread to go totally long SPY with short puts. Instead of doing that I buy into a strong sector and leave the long put in place.

Long GDX, GLD, SPY, TBT, XME

Short SPY (buy vertical put spread)

I short SPY via buying a vertical put spread.
Buy Apr 122 p/ Sell Apr 117 p
SPY @ 131.0

I really stepped in it with my poorly timed put sales on Monday. Yikes! I am hedging my longs, though still net long SPY deltas. There are seven different options in the SPY web.

I thought I was back in rhythm with the markets, but got smacked down. Precious metals continue to run. I don't have a position in SLV, but I have a price target of 36 for the silver ETF.

/edit to add: As I tidy up my post, I see SPY rallying off its lows, so the put spread just entered is already taking on water. As the Shirelles' song goes, "Momma said there would be days like this" (Youtube link).

Long EEM, GDX, GLD, SPY, TBT

Buy SPY (sell puts)

I buy SPY by layering on more short puts, selling Mar 123 and Apr 113 puts with SPY @133.0. This adds to my SPY longs. I already short Apr 103 puts, and Mar 106, 116 puts.

Long EEM, GDX, GLD, SPY, TBT

"It's in the price" and calendar spreads

The stock market tends to be a discounting mechanism. Traders and investors are not only going by what is, but what they expect. Mark Hulbert wrote about the impact of a CEO's death, and more pointedly about Apple and Steve Jobs (link).

>>
the stock market does an impressive job of discounting the consequences of developments that are coming down the pike. So when a CEO’s health is as fragile as Steve Jobs’, and when that fact is as widely known as is the case among Apple’s investors, the negative impact of his passing will — at least for the most part — have long since been reflected in the price of the company’s stock.
>>

The game within the game is whether the news is fully discounted, usually it is not and there is a reaction on the news. However, as Hulbert's research points out, that reaction is often an over reaction. Readers know I sometimes like to buy stocks that are having headline making bad news (eg: Toyota when it was having all its recall problems.) I am also fond of buying on good earnings news and a decent looking chart, and buying ETFs on strength rather than weakness.

Changing the topic, on the Friday ThinkorSwim market wrap (anyone can listen, they just have to register at the website, highly recommended), a bearish calendar spread was mentioned. I never have done calendar spreads, and never quite understood the play. On Friday it was like lightbulb went off and I am coming to a much better understanding of when a person might use calendar spreads.

The basics are buying one option a few months out, and selling the same strike closer in. The buyer of the calendar spread profits if the market is near the strike price at the first expiration. A big move either way means a loss. In theory, downside and margin requirements are limited to the price of the spread. What can wreck that is if there is fast market and an early exercise on the short option.

Buy GDX and TBT (sell puts)

Buy TBT via selling Apr 34 puts, TBT @38.2. This opens an April position, adding to my short Mar 34 puts.

The three day bear raid has been beaten back. The puts I sold earlier this week are all now at a profit. As the Rolling Stones phrase it in their song "Paint it Black" (link) take that red door and paint it black (red being a loss, black being a profit).

/edit to add: Buy GDX via selling Apr 48 puts, GDX @58.7

Long EEM, GDX, GLD, SPY, TBT

Buy SPY (sell puts)

I add to my SPY longs via selling Apr 103 puts, SPY @130.7. I am already short SPY Mar 116 puts and Mar 105 puts. Basically, those buying the way out puts are betting on a stock market crash, or buying insurance against a crash. I am taking the other side.

My trades earlier today are under water as option premiums continue to climb and EEM moves lower. My timing could definitely have been better. I came into the cycle with minimal exposure and plan to continue to scale into positions.

Long EEM, GLD, SPY, TBT

Buy EEM and GLD (sell puts)

Buy GLD via selling Apr 122 puts, GLD @137.8. Another low risk, low reward, low conviction position. I let my Feb gold positions expire without opening up any new ones. Buy EEM via selling Apr 38 puts, EEM @45.1. EEM is near support, more support at 40.

Long EEM, GLD, SPY, TBT

3-1 for February

Three small winners, one big loser for the February option cycle gets me to about break even for trading results for this cycle. The loser was the bearish vertical put spread on SPY. The winners were short puts on GDX, GLD, TBT. The gold puts were underwater a month ago, so I am relieved that they came in safe. However, when a market rallies, traders often wish they were more aggressively positioned.

Going forward I am short puts on SPY, TBT.

For some traders there is angst about the stock market. Stock market bears can not even get one day or one hour of sustained down movement. During the last 30% increase, there have only been 13 down days of 1% or more. That is unprecedented, never has a rally of that magnitude been punctuated by so few down days. Again, some point to the high frequency trading phenomenon, some point to Bernanke. Whatever the case, the bulls have been making money and bears have been losing.

Calling turns

It is difficult to call market turns. As I have often written, calling top (or bottom) tends to be a low percentage play.

The stock market rolls on, frustrating the crowd of smart folks expecting a correction or worse. I have been in the bear camp since the beginning of the year. Thankfully, I didn't bet heavily on my belief, as stock market bears have lost their shirts with what seems like an unstoppable, almost irrational rally.

It is not so important to figure out why. I have mentioned that QE2 may be distorting normal flows. That much of that newly printed money is finding its way to the stock market. That and near zero short term interest rates on money market funds and equivalents, means folks don't want to sit in cash. Cash is and has been trash.

Many readers know of the 1988 book "Market Wizards" (link). I remember the chapter with the legend Paul Tudor Jones and his knack for calling market turns. What I remember goes along the lines of he often takes several small losses before getting the timing right and making a bundle. The headline is that Jones called the turn, when it was try-fail, try-fail, try-succeed.

I am not so ingrained a bear that I am willing to keep shoveling money into bearish stock market bets. The percentage play tends to be to wait until a turn is verified, then short the reaction rally. That may be what we are seeing in gold. There is resistance at the highs. Gold is now overbought. With that, it is difficult to go bearish on gold when the long term uptrend is so strong.

I was extremely tempted to add some small positions yesterday. Then I remembered what I wrote on the blog about sitting, and how much sense it makes to sit. So again, I did nothing. That's one way the blog helps me. It makes me accountable to my own thinking. Sounds simple, but when that itch to get in comes, logical thinking sometimes goes out the window.

Ritholtz: books and lists

Barry Ritholz has a list of lists, as well as a list of books (link).

I haven't gone through all of the entries on the list. However, from one of his blog entries "The Zen of Trading," (link2) here are a couple of nuggets:
>>
6. Take Responsibility: Many folks believe “the game is fixed.” To them, I say: get over it. Stop whining and take the proper responsibility for your trades, your losses and yourself. ...
>>

That's one of the reasons I tend to spend so little time on conspiracy theories (precious metals market writers seem most prone to this). It is mostly a waste of time and energy to ponder for traders. Little fish won't ever know the whole truth. Best to do what you can or to avoid certain markets. Reading and writing about manipulation are mostly a waste of valuable time.

>>
7. Constantly Improve: Investing is so competitive that you cannot afford to stand still. Investors should constantly seek to raise their skill level by learning as much as possible about the markets, the economy, trading technologies and various schools of investing thought. But whatever you read, you must do so with a keenly skeptical eye, while retaining an open mind (‘taint easy to do).
>>

The markets are a moving target. Back-tested trading systems marketed to individuals tend to sell well. Unfortunately, the markets change, so what worked in the past may not keep working. These days, the big firms are constantly having their computers fine tune their algorithms, every day, every hour. The same holds for any number of other indicators.

All the markets still seem risky to me. Option premiums remain low, so the risk-reward for selling options doesn't look so good. Buying options for a directional move requires a high degree of confidence and conviction. I don't have that sense of clarity for any market. For now, I have a few small positions and am reluctant to put on more. Sitting is boring. Reading about sitting is even more boring. Better to be bored than to seek action and likely lose money to avoid the boredom.

Buy SPY (sell puts)

Buy SPY via selling Mar 116 puts, SPY @131.9. A low conviction add, I am already short Mar 105 puts and Feb 112 puts. With premiums down, selling options becomes less attractive. GLD and GDX options for March don't seem to offer enough premium for what I perceive as growing short term downside risk.

Long GLD, GDX, SPY, TBT

Unwinding the vertical

I unwind one leg of my SPY Vertical, sell SPY Feb 118 put for a 95% loss on this leg of the trade. I am still short the Feb 112 puts and Mar 105 puts, so I am now net long SPY. This was a disaster trade as I bet that SPY would go down and it rallied strongly. I limited the damage by selling Jan SPY puts which have already expired.

Long GDX, GLD, TBT, SPY

Everything seems risky

On last Friday's ThinkorSwim weekly market wrap, one of the participants said something to the effect: I wouldn't buy anything, not stocks, not bonds, not gold.

I am almost in the same camp, I have a few small positions, but nothing looks compelling. Unfortunately, cash brings next to nothing with many money market funds at zero or close to it. For bonds, TLT is approaching 88, which I think is decent support.

If reports are to believed, gold was manipulated higher mostly by one hedge fund (WSJ link). The unwinding of the position pushed gold lower, so it seems highly likely that putting it on, pushed gold higher. Given the reports (which may or may not be 100% truthful) that hedge fund may have accounted for a decent portion of the 29% up year for gold in 2010.

As for stocks, the rally rolls on. Some are concerned about high frequency trading. Many old-school techniques may now be failing as computers parse every possible pattern, every hour, every day, looking for tiny one cent or even half cent trades. Some say all the Fed money from QE2 is flowing into the stock market.

Sometimes the best thing for a trader to do is to sit and do nothing, as boring as that is. I am tempted to turn towards ever more exotic option trades. The logical mind, says it is better to keep it simple, wait for more clarity, better opportunity. Again, what worked last year may not work this year. With VIX at 16, selling option premium seems like an ever more dangerous game of chicken.

As for seasonality, Feb is a poor month for stocks. Bonds are due for a seasonal low in May. March tends to be a poor month for gold, with June and September often providing much better buying opportunities.

Nusbaum: The 4% rule

Random Roger writes more about the 4% rule (link1). In the comments section a FPA article is cited as another source (link2).

For those unfamiliar with the term, the 4% rule that retirees can only count on withdrawals of 4% each year. I have been familiar with this for a long time. I remember a conversation many, many years ago, when money markets and one-year CDs were yielding over 5%. I mentioned that endowment funds will only spend 3% of their capital each year.

Over time, with average market conditions 3% means the endowment can maintain its level of giving in terms of steady buying power. So if inflation ticks up, the returns are likely to be higher than 3%, but the level of spending has to go up to maintain the level of giving in real terms.