Sunday, April 26, 2009

Update: Shorting both FAS and FAZ

fasfaz account aprilIt’s been a month since I posted my article about shorting both FAS and FAZ. I received many interesting comments and e-mails. The strategy has been working nicely but not as good as it has in the past. The short availability has been a problem in the morning: most of the time, my broker will not let me short either one of them. Waiting until noon usually shows enough shares available to short. Overall, the last 30 days produced a 3.6% gain including commissions.

Option strategies: Calendar spread

I’m back from my blog world vacation. I wasn’t drinking margaritas on the beach but mostly filing taxes for a few people and working overtime on an iPhone application for a demo in Boston last week. The markets have been quiet lately and this means it’s time for a few calendar spread option plays.

The calendar spread can be done using calls or puts, depending on the implied volatility bias and which side you anticipate the market to go. Calendar spreads are best suited when used in a stable market or during a period of consolidation. Using them on ETFs is a good way to avoid exposure to a single company. The call calendar spread is established by buying a long term call with at least 3 months to expiration and selling a short term call with less than 45 days to expiration, at the same strike price:

  • Long 1 call, at the money or slightly out of the money with more than 3 months to expiration
  • Short 1 call, at the same strike with less than 45 days to expiration

This strategy works by capturing the time decay on the short term option while protecting the position with a long term option. Also, when the short term option expires, it’s possible to sell an other short them call against the long term call to keep the position running.

Risk

The maximum risk for this strategy is the amount paid for the initial position. The maximum profit varies with the volatility. The break even prices are also determined by the volatility.

Entry rules

  • Implied volatility of the front month should be 15% higher than the IV of the bought call.
  • There is a price consolidation in the underlying stock.
  • Aim for a $2 debit per contract.

Exit rules

  • Close the position during the expiration week of the sold option or let the short expire worthless then sell long call on the next business day.
  • If you want to keep the position open, roll the short option forward during the expiration week if the long term purchased option still has over 2 months left to expiration.

Strategy graph

The performance graph for this position when bought:

call calendar spread initial

Performance graph at expiration:

call calendar spread

Volatility graph when bought:

call calendar spread volatility

Sunday, April 5, 2009

Market update: Financials over-optimism?

For the past few weeks, the financial market has been getting most of the attention between the Obama speeches. The U.S. President is working hard to “fix” the system and make the world a better place:

President Obama vowed Sunday to pursue the elimination of nuclear weapons from the planet, telling a cheering throng in Prague that the United States is ready to lead an international effort to reduce atomic arsenals and the threat they pose.

This quote from an article at L.A. Times by Christi Parsons and Tom Hamburger is very pleasing to the ear and may help bring stability and boost the market on Monday. But this series of good, great and better news interleaved with a rally in the financial sector may soon take us back to reality. Analysts are digesting the new rules like the “mark-to-market” accounting method that is supposed to save the Financials but may as well be an other evil plan ready to explode. Looking at the XLF ETF, it looks like the Financials are ripe for a pull-back in the next weeks:

The next week is going to be an interesting one: I’ll be watching FAZ closely.