Managed Risk Investing

IWM

2010-08-09T13:30:00.000-07:00

Taken some time off from posting this summer. I currently have a call diagonal and a call calendar on the IWM. I like using options on the major ETFs because of their liquidity and tight bid/ask spreads. Currently this position is designed for a gradual move into 68 by the end of Aug expiration next week. I will be watching the 64 level to hold as support in the current trend.

MLM - closed

2010-03-25T19:48:00.000-07:00

Well that was a quick trade ... stopped out as the market reversed mid-day today. I'll look for another bullish entry after the pullback is complete. Remember, one of the keys to profitable trading is keeping losses small and letting winners run ... this is just a numbers game.

MLM

2010-03-22T14:19:00.000-07:00

This month I am going to move from trading diagonals and calendars to using verticals. All of of these strategies are vega positive but the vertical has the least exposure to dropping volatility which is the currently the market we are experiencing. (Take a look at the VIX since early Feb)

A vertical spread trade is constructed using two strike prices in the same month. In the example below I noticed MLM pushing new highs on above average volume with resistance sitting at 95. I've constructed an April 90/95 vertical call spread. I'll stop out at 86.86 which is a 78% fib retracement for a $85 loss in an attempt to capture $160 which makes this a 1:2 risk/reward trade. With strong buy volume coming into the stock and OBV on the rise there appears to be a bullish tendency in play at the moment. I will give this position between 5-10 days to reach either my stop or target amount before closing.

US Steel (X)

2010-02-19T12:57:00.000-08:00

I ran my scan 6 days ago and noticed the market was showing signs of a healthy rebound. Just prior to this period I noticed an early mover on the DJIA ... CAT. I started a call diagonal and ended up closing it the following week for a nice gain.

This week I opended a similar position on US Steel as it pushed above the 20DMA. I used an OTM Mar55 SC with an ATM April60 LC to create a bullish spread trade. My intent was to capture both time decay and directional movement with limited risk. There are several adjustments to this position if the price breaks down but I haven't had to use them yet.

I like this spread because I have defined risk ($322) with a good return target (50%-75%) and plenty of time for adjustments.

Trade setups

2009-12-21T15:13:00.000-08:00

Today I saw several good swing trade setups that are showing low risk entries. All of the following can be managed for an adjustment or close below Friday's low. Remember, these are not reccomendations ... be sure to do your own research before entering.

AMZN, BEN, BUCY, BXP, EMN, FCX, FFIV, GS, JOYG, MOS

AMZN update

2009-12-21T14:01:00.001-08:00

I made several adjustments this month to capture the fall after placing the original trade. I rolled down from a Dec 140 SC to a Dec 135 to capture more premium along with some other adjustments. Currently, I have a positive delta position based on the positive move in pricing today. Having the price close above the falling 5DMA is a bullish signal. I'll be using the low of Friday as my adjustment/close point in this trade.

AMZN

2009-12-12T08:54:00.000-08:00

AMZN has been in a pullback from it's recent earnings excitement. The stock made a nice base into the 78.6% Fib retracement area and then bounced nicely on Thursday. I started a Bull Call diagonal using a Jan 135/Dec 140. The time decay is about $14 per day on the Dec short call which is currently out of the money. Dec options expire next week. I plan to hold this position for a few weeks unless the price moves over 140 next week then I will need to make an adjustment.

ZION - again

2009-09-15T11:30:00.000-07:00

Yesterday I entered ZION again based on several technical setups on the 60min chart. The price has been falling for the last few weeks and remained below the 50ma until yesterday afternoon. The price also pulled back to the 38.2% Fib retracement and has been bottoming for the last few days. With the MACD below 0 and rising this looks like a good opportunity to enter.

I like to buy value at a discount to recent pricing. Entering ZION at 15.97 vs. the recent high of 18.75 allowed me to buy at a 14.6% discount. However, yesterday I had no idea if the market would continue to take the price down and since I dislike undefined risk I bought the stock with an Oct 16 long put. This made my max risk $137 if the stock closes below 16 in October.

Now comes the hard part of trading ... when to exit. Do I take the current profit? Do I hold for more profit? As I discussed earlier I would like to have trades show a Risk/Reward of 1:2 however, I am usually fine taking profits at a 1:1 ratio. This ratio would have me considering an exit when the entire position reaches $137 in profit. With today's massive push forward there still appears to be room to move back up to 18.75 in the next couple of days so I will wait to see if I can reach the 1:1 ratio.

ZION pushed above 18 into the close and I'm nearing my target R/R ratio so I decided to close the position for a 7% gain on the day. Now I am on the hunt for the next low-risk setup. With the market so strong right now I may waiting awhile.

Closing trades

2009-08-27T13:28:00.000-07:00

This week I closed both of my trades ... RIMM began to break down on Monday so I closed that position for a 3% profit. RIG followed suite on Tuesday so I closed that position for a 4% profit.

I have learned over the years that if a position doesn't feel right then take the profits and wait for a new low risk entry. I am feeling the market is topping out and may pullback into Sept / Oct time frame. If that occurs, I want to be quick to capture profits and have cash in reserve to capture pullbacks.

After closing both of these trades I began building a bearish position on the market using SPY 104 puts. I closed them on this morning's 62% Fib support bounce for about 8% profit.

Beta Weighted Portfolio

2009-08-21T07:39:00.000-07:00

This week I put on two bullish positions. An OTM Call Calendar on RIMM and an ATM Call Diagonal on RIG. Both entries were made when my bullish entry signals triggered on the daily chart timeframe. I am slightly delta positive to reflect the continued bullish nature of the market and have positive theta so I can benefit from option time decay.

I continually ask myself "what-if" questions to make sure I am prepared for price movement in the 3 market directions ... up, down, or sideways. When I entered these two positions this week I started with a Call Calendar which gives me a lot of room for price to move sideways with very little risk. I set my exit point on this position just below the recent low so I was risking about $25 to make $100. I like these kind of trades because I can't watch the markets all day long for intraday swing trades.

Later in the week I added the RIG Call diagonal to give the portfolio a slightly delta positive posture. I also set the exit point on this position below the recent lows formed late last week.

Here is a picture of my overall portfolio beta weighted to the SPX. It looks a double calendar with a bit of a bullish bias.

So here come the "what ifs" .... what if the market falls and my positions fall with it? Answer: I have stops in place on both positions below recent lows. What if the market bounces around for the next 4 weeks? Answer: I have positive time decay and I let my short positions decay. What if the market races up? Answer: My bullish Call Diagonal on RIG will give my portfolio room for a bullish move however, if there is too much upward movement then I will need to watch the RIMM Call Calendar as it will begin to drag on the profits coming from the RIG position.

SPY - Closed Vertical

2009-08-17T07:37:00.000-07:00

Last week I closed the SPY put vertical after the price closed back above the 5DMA which reversed my Bearish bias. My loss was small because my risk was small. I will look for a new bearish entry which may occur today if the market can hold today's gap down below the rising 20DMA.

SPY - Reversal

2009-08-11T14:17:00.000-07:00

The market closed today under the rising 5DMA for the first time since July 13th when the current bullish trend began. With Stochastic sitting in the overbought area and falling I have a slightly bearish bias. Since we are now trading above the 200DMA there is an longer term bullish bias so I will be using Fib retracements to identify potential support areas.
Support can occur at the rising 20DMA (97.88) and the 38.2 Fib (96.37) However, since a new downtrend has not been established I will respect the current short-term bullish bias in the market. This caution calls for using a Put Vertical using Sept 100 LP and Sept 98 SP. If the market only takes a quick breather and continues upward then my risk will be small. If it free falls for the next week then I can ride the position until a reversal signal occurs. I plan to close this trade for a small loss if the price breaks above the recent highs of 102. According to the risk analysis below I will be risking about $25 to make $100. This is a Risk/Reward of 1:4. The amount of capital you commit to this strategy should be based on you risk management rules for your individual portfolio size.

ZION - closing the trade

2009-08-06T16:45:00.000-07:00

On Aug 4th I noticed the price continued to stay above the rising 5DMA. At this point I decided to help accelerate the profitability target but adding an Aug 13 short put that would expire within 10 days. This helped protect some of the profits I had made on the position and significantly reduced my initial risk. There's the 2nd "secret" of every profitable investor ... knowing how to reduce the already small amount of risk capital committed to each investment. Remember, #1 was to take small risks to achieve large gains.

This new risk graph shows how I reduced a position risk of $144 to just under $20 assuming the stock price stayed above 13 by Aug expiration.

On Aug 5th the price continued to rise and I was near my profitability target of $144. I decided to close the entire position and now am on the hunt for a new opportunity. Remember, the advantage of retail investors is they don't have to trade everyday. With Zion being very overbought and still trading below the 200DMA I'll take this 10% profit and wait for an new opportunity where I am risking a little to make a lot.

ZION analysis continued ...

2009-08-06T16:08:00.000-07:00

Wanting to participate in the current bullish move but not get handed an overnight loss on a quick pullback is something every trader desires. Over the years I have tried a variety of option spread combination and have found I favor the "Married Put". This strategy allows you to participate in the current bullish trend while limiting the downside risk. Remember I spoke earlier of how profitable business persons and investors "think" differently ... they think in terms of risking X to make 1X,2X,3X ... you fill in the number.

Notice the chart below. It shows a position that has unlimited upside but limited downside. The actual #s are: Risking $144 to make ... well, unlimited upside. However, we know that stock prices don't go straight up so I was looking for at least a $144 gain giving me a Risk:Reward ratio of 1:1.

One of the important factors in managing a portfolio is having an idea when to get out of an investment. Knowing when to sell is one of the biggest challenges most retail investors face because they let greed shadow the evidence their investment is about to revert back to its intended value ... this is called "mean reversion" and is discussed in great detail under a mathematical discipline called Statistics.

Managed Risk example - ZION

2009-08-05T14:27:00.000-07:00

On July 30th I noticed that Zions Bank had cleared the 50DMA and was currently trading above the 5DMA which are both bullish signals. However, the price is still below the falling 200DMA and Stochastics had reached the overbought area which are bearish signals. Seeing that recent resistance areas were at the current level of 14, 15.5, and the falling 200DMA at 17.77 there seemed to be a strong possibility the stock could pullback before moving forward. But what if this analysis is wrong and the stock continued to move forward? I would certainly miss out on the current bullish trend.

Thoughts on Risk

2009-08-04T09:16:00.000-07:00

Whenever a successful business investor commits capital to an opportunity they have meticulously considered the risks associated with the future cash flows of the company. When we invest or trade a stock we need to follow similar "risk analysis" methodologies. Both technical and value traders will identify a price where their risk vs. reward is "positively skewed". This means that the amount of capital they are willing to risk is smaller than the reward they expect to gain. Other ways I have heard this concept presented is "buy low and sell higher" or "Risk 1 to make 3".

As a technical trader myself, I will look for a widely followed stock to first establish a directional trend and then look for periods of weakness in the current trend. These periods of weakness allow me to establish a "low risk" entry point. However, this is only the beginning. I then will measure the amount of risk I am willing to take before the market proves me wrong. Knowing the amount of risk before committing my capital allows me to understand the maximum draw-down to my overall portfolio.

Risk- The elusive concept

2009-08-04T09:11:00.000-07:00

Are you a technical or value investor? I propose it won't make a bit of difference until you "master" the concepts of Risk Management. This blog is dedicated to showing readers how to apply risk management techniques to their equity positions by using different option strategies.