Friday, August 21, 2009


.X is the ticker suffix on yahoo for derivatives. UVACN is the March 2010 call for NVDA with a strike price of $14. Going to play a blog game on paper. Recall that I consider 50% cash to be sufficiently diversified. This is probably only true if you want to trade options. The biggest advantage of cash diversification is that you don't have to watch it at all. It's safe and keeps you from experiencing catastrophic losses, which is the point of diversification.

If you're not into options, just take this opportunity to watch me try to make the best of what's ahead. This will be the first trade that I'll make to build up a small pile of case studies in various types of trading regimes.

I've been waiting on NVDA to perform a gap fill for some time. The reason is that I'm long NVDA. In other words, I beleive that inevitably the value will hit $14, and when it does, there will be a gap fill. Leeroy has continued to relinquish market fears about larger economic recession. The right numbers with the right amount of sunshine keep trickling in.

Ideally I would wait for support, but we're reaching a critical level of contention. The gap is at $14 and 20day EMA support is over $13. Without some type of market pullback, we're going to hit the gap, and that's a sensitive trading region -- too sensitive to wait for the support.

Ideally you always buy options when the stock is trading down because the option orders are very finicky and whenever you trade them with the grain they tend to run away. Trade them against the grain and they will sell you all you want. To make a bar room analogy out of it, you're headed towards one side of the room when most people are moving away in search of greener tables.

However, it's still possible to trade a larve volume of options very quickly. Buy all at once, so that your crashing through existing orders before they can move, and buy into the market depth. I have seen numerous occasions where 2k or 3k contracts for large cap stocks are just twiddling around $0.05 across the spread. That's equivalent to 200k or 300k shares under contract.

In this theoretical trade, because I want to go ahead and open a position before the gap starts to fill, I will hypothetically trade 1k contracts at $2.15, which is a little over the current ask price. This would cost about $215k In reality I would try to work with 25% of my capital, which is 50% of the money I'm willing to commit. This is to hold a little bit of cash in case we do get a pullback. So I'm assuming a working capital of $860k. These numbers are just to keep the calculations simple.

Now, here's what I see in my crystal trading ball at this point:
  • Over the EMA20 - check
  • Over the MDA50 - check
  • Below a gap - check
  • Stock is long - check
  • Market has no imminent contention points to resolve - check
  • No pending (known) Leeroy events - check
  • Stock is far away from plausible valuation limits - check
  • No immediate additional product competition - check
  • Potential to enter additional markets - check
Each one of these factors tells me some very important things. There are support points below, so even if there is a decent sized disruption, the stock will likely recover. In fact, with 25% cash in waiting, I'm willing to sit through a 50MDA check. Without large, unresolved questions whose answers will have material impact on the fundamentals, I'm essentially saying that the existing pattern, not fundamentals will drive this trade to profitability.

Here goes 1k UVACN.X @ $2.15

After following up with another 25% of my paper capital, I will continue to monitor and look for the right time to sell, at which time I will be accepting the bid price on these options. Right now that's at $2.00, so just by making the trade, I've lost a little bit of ground. This what options are. You have to be able to trade with a very high degree of certainty. The moment you commit to a trade, you've already stepped backwards across the spread. After that, the time value will continue to decay until the expiration date. You don't break even on options hardly ever. Even if your predictions about the stock market are mostly right, you can still lose money. At around the one-year interval, I'm not too concerned about the time premium I'll be losing, but if things drag out, it's usually best to pull your cash out once your predictions are getting stale.

Oh, and if I were actually doing this, I would be using an IB account. Whatever you do, get real time quotes and market depth when you start getting this serious about trading. Delayed quotes will destroy you on options. Interactive Brokers has a decent UI, very serious minded trading fees, and access to lots of markets.

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