Market Condition: Uptrend continues ↑
This edition looks at TSCO, CLR
General Market Outlook: The market is in a continued uptrend. The markets got a boost from the Federal Reserve delivering the message that rates will not be increased until 2014. Markets celebrated as did gold and silver. Last week the NASDAQ rose 1.1%, the S&P 500 inched up 0.1 %, and the DOW slipped 0.5 %. Earnings season continues, as European news leans on the markets.
General Market Outlook: Last week the market continued to move higher despite continued negative news out of Europe. The S&P 500 rose 0.9%, the Nasdaq rose 1.4% the Dow rose 0.5%. There appears to be a change in tone, the last two weeks the market has been to be able to shrug off bad news and move higher. It appears that signs of institutional selling have abated and there appears to be more institutional appetite for stocks. Still one should remain vigilant since last Friday we saw a 0.5% loss on the S&P 500 which came in on higher volume than the day before, thus adding another distribution day. Despite Friday’s negative close, once again we saw the market was able to come off the lows and move higher coming into the close.
So late Friday night we learned what the market knew and what we did not. United States Debt was downgraded to AA+ by S&P. However, although we did not know this we knew from reading what the market was telling us – cash is a position. When the market starts to falter as it started to correct two weeks ago we were raising cash. Don’t wait for the announcement – go into cash. Gold and silver were acting as safe havens, but silver also started to be sold perhaps on just massive market liquidation. (more…)
Have you been watching gold continue higher, and asked yourself when do I get into a long position? Have you been asking that since Gold was around 1000? I know a lot of people who have. This is a mental debate whenever anything increases in value in this type of manner. The debate is as follows: “I know gold has gone up a lot, but I know the second that I get into it, it will surely go down”. This happens around every 100 points. So, with gold just passing the 1600 mark, it seems timely to address an investment strategy that gets you in, while still applying sound risk management. (more…)
It may be a popular show hosted by Howie Mandel, but in this context we are talking about the ongoing debate about the debt ceiling and what effects it may have on the economy. There is a lot of talk right now about the debt ceiling. As the markets continue to show uncertainty in each move up and down, the market actually showed characteristics of a Howie Mandel-esque market. First, a press release comes out saying there is a deal. Then, a few minutes later, there is another announcement saying there is no deal. It was a nice move for a day trader (assuming they were on the right side of it). (more…)
Don’t let the politicians and the media fool you, and always hedge your portfolio. (more…)
Gamma is one of the least understood but most powerful of the options Greeks. Gamma is the variable that tracks the rate of change of Delta. If we compared Delta to the horsepower of a car than Gamma is the acceleration or rate of change of the car. How quickly can each car make use of its available horsepower? That’s Gamma.
Unfortunately, many options investors fail to recognize the effect that Gamma can exert upon the value of an option. In reality, knowing how the Delta changes can make a significant difference in the profitability of an option play.
Here’s an example:
Suppose that XYZ is currently trading for $23.00 per share. Suppose further that a glance at the options Greeks showed that the current Delta for the $20 strike price option was .96. This means that for every dollar per share the stock price rises, the $20 strike price option will increase $0.96 per share. That’s the current situation, but a quick check of the Gamma value for the $20 strike Calls is 0.04. This means that if the stock were to increase a dollar per share, the Delta would increase by 0.04, resulting in a Delta of 1.00. Once the stock price reaches the level of $24 per share, the $20 strike price options will increase dollar for dollar in value with any further increase in the value of the stock.
Now, suppose that you were faced with two different option plays. Each of the two plays have the same Delta, and each option costs the same to purchase. But suppose one of the options carried a Gamma of 0.01, and the other carried a Gamma of 0.05. All other things being equal, the option contract with the higher Gamma would generally result in a greater profit for a given period of time, when compared to the option with a lower Gamma. A higher Gamma often equates to greater acceleration in profitability with a given increase in the value of the stock.
As expiration week approaches, I think of questions that come in from our clients as well as newer traders in the business. Expiration week is an exciting time for a lot of people in the business. This is the time that every option is a weekly and theta is paramount.
Many traders find the temptation to sell out-of-the-money (OTM) options in expiration week. The temptation can come in the form of credit spreads, covered calls, or naked options (among other things). This can be a very successful strategy if you know what you’re doing. However, if you are a unaware of the risks of gamma….BEWARE!
Question: “I can sell the OTM option and get a 2% rate of return for only 3 days…the probability of it not touching is 85%…how can I go wrong?”
Answer: Gamma
If you sell an option far OTM for a small credit, it is likely that you will be right. However, when you are wrong (notice I said when and not if), it can wipe out months if not years of profits in a single day.
Let’s say you sell an option for .35. If you are right 10 months in a row, you are ahead 3.50. In one month, you can lose 10.00 if you are not careful. I’ve seen it happen more than once.
Gamma impacts option prices more and more as expiration gets closer and closer. Indeed, the closer to expiration, gamma influences an option so much that an option can appear to be worthless and minutes later an option can take on the full charecteristics of the underlying component.
Over the years many traders have devised ways to manage the risks of gamma in the days approaching expiration. The first step of managing gamma risk is to be aware of gamma. Once you have a comprehensive understanding of how gamma affects an options price, you can begin to use strategy to manage these risks.
If you have any questions about gamma or would like some ideas to hedge gamma risks in your strategies, feel free to get in touch.
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