Order Of Magnitude

We regularly size our forex positions based on the amount of risk we are willing to assume.  To detail a feel for the steps that are gone through for each trade, we're going to go through all the steps based on a hypothetical scenario.  Our situation is a young, go-get-er that is managing a ¥1M account.  Because this guy understands that he's young and can take on more risk (not to mention it makes our math easier), he is willing to lose 10% of his account on any one trade (which is not recommended, you should know your own risk levels).

The trader has been looking at the USD/CAD pair, over several timeframes.

USD/CAD - Jan 22, 2010

The trader feels that the recent short term rally is pushing into over-extended territory, and believes that the long term trend will once again assert itself and push the price back down to support around 1.025.  Examining moving averages, trendlines and other forecasting tools, the trader settles on a short entry price of 1.062.  If the price moves against him and pushes above 1.075 then the trader knows the gig is up, the long term trend has been broken and he should be out of the trade.  The total loss the trader is willing to take is: 1.0750 - 1.0620 = 130 pips.

The USD/CAD pair has all of it's profit and loss calculated in Canadian dollars.  So if the trader is going to risk 10% of his portfolio of ¥1M, first determine what ¥100k would be in Canadian dollars.  CAD/JPY is about 85.25, so the maximum ¥100k loss would work out to be $1,173.02 Canadian.  Now, what position size would result in 130 pips, being equal to the maximum drawdown of $1,173.02ish Canadian?

The position size would be: 1,173.02 / (1.0750 - 1.0620) =  90,232.31 CAD.  Now, all transactions on the USD/CAD pair are done in the base currency, which in this case is USD.  So converting the 90,232.31 into its US equivalent of  85,431.04.  This means that if out Japanese investor wants to cap his risk at ¥100,000, then a short position of 85,000 USD/CAD entered at 1.062 and stopped out at 1.075 would put a ceiling on the losses with the price targets from the chart.

This simple example is missing a couple of larger points, like the exchange rate between JPY and CAD messing with the total profit and loss, as well as interest charged/rewarded for the currency position.  This example also doesn't take into account any margin requirements, transaction fees, spread on the bid/ask or other risk factors.

Why would this Japanese trader enter this trade, if they were only planning on losing 10% of their account?  Looking at recent bottoms in the chart, the trader has determined that a price target of 1.03 is where they would close the short position, which would equate to 320 pips of profit and more than double the 10% of their account that was at risk.  Of course, the price can move in any direction, and every trader should do their own research.

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FINVIZ has for a long time been our go to for quick charts, scans and news.  They sweetened the deal adding Forex Majors, Gold, Silver and Oil.  Now it would appear they give you quotations for Futures 24/7.

If you like what FINVIZ provides, you may want to consider signing up for their Elite program.

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The Options Industry Council released a study that compared equity buy and hold against active and passive collar strategies.  You can grab the study here.

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Our Freeport position we wondered about, and eventually jumped into, has been profitable so far.  We've adjusted our stops to a hair below $32 so at the very least we can come out profitable.  There is a lot of volume in the $40-$45, which is where we are looking to get out.  The final rule for exit:  we'll close it after 8 more weeks.  We know that a volatile day could stop us out, and we are fully prepared for that.  It is, afterall, a long position in a bear market.

The rest of the long positions the scanner turned up ultra-short funds like SDK SRS and QID.  The Bear-o-meter, on the other hand pulls up a pile of names.  Most of these equities and funds are well below the $10 mark, which isn't that rare these days.  Finviz is saying that 116 of the equities in the S & P 500 are below this psychological line in the sand.

A lot of the names with high negative scores coming out of the scanner were of the full blooded financial variety, or some trust, loan or holding variant.   An old friend, Las Vegas Sands, made an appearance again.   Our entry never happened, and we figured that we sidestepped a landmine.  Putting on the glasses of hindsight, we can see that by not adding LVS to a long term list, and watch for more entries, we missed out on a very profitable trade.

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We feel that Interactive Brokers are hards down the best brokerage you can use as a personal investor in Canada.  Their a la carte approach to trading, news and data is appealing to those who count their dollars and cents.  Recently, however, because our entry targets have not been reached, we have been sitting on a lot of cash and not entering a lot of positions.  For those using IB in Canada, you can get your data and news covered, if you generate their cost in commissions.  Since we love our data fees, in January we came up almost $200 short, and had to pay out of pocket for data and news.  Not something that happens very often, and not something that we would like to repeat

As a result, we take a small portion of our holdings at IB, and put them to work in the currency markets.  We have never been successful at long term trading the currency markets, but short term, we can usually turn a small profit, or break even.  This is great, as a few hours of trading currency swaps can generate enough commission charges to pay our whole month of services.

Since the Fed is going to do something to the markets tomorrow, and the majority of participants are likely to get hurt, we decided to spend tonight trying to pull in a small profit on the Forex market.  The usual setup, is to drill down from long term to short term and determine price targets and ranges.  Most nights, after the preparation is done, the remainder of the evening is waiting for price to bounce off, or cross any of the targets that have been set.  Tonight was different, and instead of having to spend the evening waiting for something to happen, a lot of price targets were hit immediately.  We thought we'd share what we usually stare at while we are trading currency, here's a shot:

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The third week of the month is usually crazy, when short term pressures overwhelm logic and reason.  Our weekly scan produced an interesting gem: ProLogis.  Being as options expire this week, we found the bid/ask spread for the in-the-money $12.50 calls to be a bit out of the ordinary.  Examining the Equivolume:

It would appear that this REIT has been going for a bit of a run and big volume appears on the right kind of days.

Now for the 50-50.  We have an upward moving stock, that is due for a pullback, and in 5 trading days the options expire.  PLD has a 15 trading session average true range of $1.75, which is pretty large for a stock holding the Friday's end of day price of: $14.12. Yes, 12% of current trading price.

Now, if a covered call position could be entered under these conditions, you would lay out $1412 for 100 PLD shares, and then sell a single covered call at $12.50 strike for $2.50 a share, or $250 total.  If the price falls below the strike in the next 5 days, your cost basis is $10/share to offload, so we'll have a still profitable stop at $11.75 to exit the position.  If the equity remains above $12.50 until Friday, you'll get called away, along with all the fees that produces.  The only thing you get to take home is the premium.

So let's say your broker lets has a $10/transaction fee (hopefully you can do better).  Your initial outlay is $1412 (equity) + $10 (commision) - $250 (option premium) + $10 (another commision) = $1182 (total expenses).  You get called away, so you sell your stock for $1250 (minus $10 again, that broker!), and take home $1240.  That mean $68 dollars in your pocket, after fees, on an outlay of cash equal to $1182 (you'll lose way more in buying power) in 5 days, if the shares stay above $12.50. If they go under, get out, and keep whatever premium erosion you have accumulated at that point. So on the upside you can get 5.7% on your money in 5 days, and there is safety net down to $10 before you start to lose money.

If your greedy, or want to take on more risk.  The February call options have high volatility priced in.  Have a look at our premium chart:

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Yesterday, we talked about harvesting the weakness in Las Vegas Sands.  Of course, the caveat was that we would have to see what happened in the early morning market.  We've been burned so many times trading early in the morning off what looked like a continuation of a trend, just to be annihilated in the time it takes to drive across town.

Looking at the 1 minute chart for today:

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Avoiding the first half hour, you'd be crazy to short into an equity that was up nearly 30.  We stayed on the sidelines and watched as the short sellers squeezed in a vice to push the high of the day to twice the low of the day.  Being more agile, and flexible we should have switched opinions and tried scalping throughout the day using a two to one risk to reward ratio.

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The VIX is a measure of near term volatility of the S&P 500 index.  I got my hands on as much data as I could get my hands on, and manged to come up with this chart:

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Now, it must be kept in mind that the method for calculating the index was changed in 2004.  The new method expanded the basket of stocks to the entire S&P 500 instead of the S&P 100, the Black Scholes option pricing model was bounced for a proprietary formula, and more options were included instead of just those at-the-money.  If you want all the meat, there is a very detailed white paper on the CBOE website.

The thrown about name for the VIX is the 'fear index', as it measures the implied volatility across options trading on equities.  When the implied volatility is high, it means that option writers want a lot of money for their contracts, as no one is certain where the market is going.  Normally, anything below the 15 level is complaicent and anything above 30 is considered volatile.  There has been a couple of times previous to 2008 when the index poked above 45: Sept 28th in 1998, Oct 8th in 1998 and Aug 5th in 2002.

So far, 2008 has had the index close above 45 level 14 times this year.  If the VIX is a fear index, then people are scared shitless.  Heading into the end of option expiration week, the volatility index spent the entire 5 days above the 50 level, which is territory only found in 2008.  It closed above 70, at 70.33 on Friday for a new all time high.

The volatility can been seen in more than the VIX.  Average True Range for SPDRs over the last nine trading sessions is $9.15.  Considering it closed today at $98.81 the average trading range is approximately 9% of the current price, daily!

For us, that means that options are priced incredibly expensive right now.  Have a look at the put and call premiums for the front month:

Put Premium:

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Call Premium

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An at the money straddle would cost between 10.80 and 10.98 depending on if you went with the 98 or the 99 strike (using the last price of the day).  Not unfeasible considering activity as of late, but it makes it very difficult to turn a profit buying these contracts.  Recent market activity makes it dangerous to sell these contracts.

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Over at Gaming the Market, they've posted a list of some ways broker/dealers, market makers and others can illegally manipulate their clients or the market.  We aren't recommending any of these tactics, they are all illegal.  You must, however, know what you are up against.  Here's the list:

• Accommodation Trading
• Bucketing
• Channel Stuffing
• Churning
• Circular Trading
• Cross Trade
• Double Dipping
• Exercise Backdating
• Freeriding
• Front Running
• Ghosting
• Ginzy Trading
• Gun Jumping
• Hockey Stick Bidding
• Interpositioning
• Jitney
• Kiting
• Late-Day Trading
• Matching Orders
• Options Backdating
• Painting the Tape
• Pairing Off
• Parking
• Poop and Scoop
• Portfolio Pumping
• Pre-arranged Trading
• Pump and Dump
• Short and Distort
• Tailgating
• Trading Ahead
• Wash Trading

Collusion between two parties is always the hardest manipulation to catch.  That's why the retail investors are quite often the 'Pigs' that get slaughtered.

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Despite all our good intentions, our trade between the Euro and Greenback was stopped out. The price action could not penetrade 1.5920, and reversed. While the moon was high in the sky, and we were walking around dreamland, the price did manage to poke above the 1.5920 range for a few hours. Then as it tested 1.5950, the price was hammered down over hundred pips in 4 short hours. I'm sure someone has a strategy to trade this currency with its recent price movements, but we're going to be staying out of any large posistions.

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