Final update on FAS FAZ short

It’s been quite a while since I last updated this blog. I’ve been busy programming BlackBerry applications for a personal project. I think the FAS and FAZ short strategy I explained a few months ago is due for a final update.

As expected, with lower volatility, the profit potential of this strategy decreased to almost nothing. for the past 6 months, the strategy performed a meagre 4.8% annualized. It’s time to put this one to sleep.

I intend to update this blog more often for the time to come. If you’re interested in specific subjects, let me know and I will look into writing an article about it.

Interesting new pattern found in prime numbers

Image by cinderellasg via Flickr

A team of Spanish mathematicians, Bartolo Luque and Lucas Lacasa, found a new pattern in prime numbers that may have great repercussions in many fields such as cryptography and finance and fraud detection. The researchers found that the first digit distribution of prime numbers conforms to the Generalized Benford Law.

On a cryptography level, this may allow us to find big prime numbers faster or even help factoring prime number products; the basis of today’s cryptography.

Looking at the financial implications, the fraud detection properties can also apply to stock market analysis. As the team pointed out, naturally generated data will follow Benford’s law but randomly generated data or guessed data will not.

Update: Shorting both FAS and FAZ

It’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:

Performance graph at expiration:

Volatility graph when bought: