Sunday, July 20, 2014

Long/Short Setup on Optionable Stocks

By Jon Haghayeghi | Twitter@LoneStarQuant

We are running a scan of optionable securities with market capitalizations larger than 10 billion dollars. Two trades stand out - AMGN long and GLW short.

Amgen is currently priced at $118, with a high of $129. The stock has a strong upward trend, having more than doubled in price since 2012. This is also a low beta stock, so its performance is not closely tied to that of the broad market. 

For this trade you can sell a vertical put spread expiring in October, purchasing the 115 strike and selling the 120 strike options. A single contract with generate premium of about $250 risking $250.

GLW is a short candidate with a 42 day duration.  You can use weekly options and sell the August 29th vertical call spread. With the spot price at $21.84, you can sell the 21.50 strike and purchase the 22.50 strike call option collecting $50 and risking $50. 

My portfolio is still skewed long because of FED policy, that said, geopolitical/credit risk is increasingly concerning. Stay smart and trade safe.

Thursday, April 24, 2014

Useful Questions About The Indicator


Today we are going to answer some great questions from Mike.

Hi Jon,

I captured this screenshot from INTC and highlighted two questions:

In the upper panel would it be correct that the highlighted area is a mix of bull and bear periods but the time beyond is predominantly bullish?

You are 100% correct. The 'Historical Seasonality' indicator is telling you, based on historical data, how many patterns are currently long and how many are short. 'Sell in May' is clearly reflected in the indicator, primarily for 7-30 day patterns. That said, there are still patterns of longer duration that are bullish for 30-90 days, which explains why periods beyond May/June are predominately bullish. 

In the second panel (which appears to show the "reliability of patterns) I have two questions:  1.  would we consider the mid-March to Mid April period to be less reliable than the more green areas such as mid Feb to mid-Mar?  2.  why is there no region shown from now to next few months )highlighted blank area) as this would seem to be the most important period?

Great question. So the top indicator is historical seasonality, but the bottom indicator answers 'how seasonally is the stock behaving this year?' As you see, 'Successful Patterns' are 80% red, which is because 80% of active patterns for INTC are moving against their historical averages. The reason why we do not see any data for May/June is because it is because there are no observations yet for 2014. This indicator is useful in determining whether a stock is currently behaving seasonally.

Looking further down the INTC page, on the weekly summary:

Is this the correct understanding of the headers:

Avg Gain would be for an up weeks only? Correct with out looking at losing years.
Avg Loss would be for a down weeks only? Correct without looking at bullish years.
I am a bit confused on avg G/L compared to the Avg gain and Avg Loss. The average G/L is takes the average of all the data; this is the most useful figure. In the above example it is telling you that during the week of July 01- July 06, the average move is negative 1.5%.

As far as application is concerned, one approach I would like to consider is buying a longer term ITM option - say using your 63 or 91day period and then selling the OTM weeklies against it for weekly premium income (I think most would call this a diagonal spread).  Do you have experience with this approach?

Yes, that is a great approach to trading. I encourage traders to use vertical spreads and/or calendar spreads, but the diagonal captures the best of both worlds by using different strikes (like a vertical) and different months (like the calendar). You have a bit larger margin since the strikes are apart, but you are going to quickly benefit from time decay. Tomorrow we will model a diagonal (or double diagonal) based on an upcoming seasonal pattern.

Thanks Jon,



If you ever have any questions about Seasonalysis, feel free to send me an email at As always, stay smart and trade safe!

Tuesday, March 25, 2014

Costless Ratio Spread on Questar


As you would expect, natural gas consumption is highly seasonal. Questar is a natural gas holdings company headquartered in Utah. Every year for the past 15 years, STR has rallied for the 70 days starting 3/25. The average move over the 70 days is 10.1%.

Taking a look at the option chain you can see contracts expiring in 24, 52, 115, or 206 days. I have modeled a costless ratio spread that can give you leveraged exposure.  If the trade moves against you, then you only pay commission. This trade uses July call options at the 23 and 24 strike. Take a look:

By selling 10 contracts that are twice the price of the 20 contracts you purchase, some of the time-decay associated with being long a call option can be absorbed, while still enjoying an exponential payoff and capping the max loss. The main 'caution area' is when STR is $23-$25, where you want to ensure time premium does not erode the position. Stay smart and trade safe!

Thursday, March 13, 2014

Standard Deviation and How To Use It


A number of attendees had questions about standard deviation at the Festival of Traders. As promised, I am going to give you a definition and intuitive example so you understand why it is important to rely on low standard deviation samples.

Definition: "In statistcs and probability theory, the standard deviation (SD) (represented by the Greek letter sigma, σ) shows how much variation or dispersion from the average exists. A low standard deviation indicates that the data points tend to be very close to the mean (also called expected value); a high standard deviation indicates that the data points are spread out over a large range of values." 

Example: Low Standard Deviation
You will notice that the standard deviation for the above pattern is 0.30%. If you look at each year from 2008 to 2013, the return over the 56 days follows a tight range between 0.60% and 1.60%, giving a low standard deviation.  

Here is a hypothetical example:
Notice in this chart that the average is clearly 1.5% since (1.5%+1.5%+1.5%+1.5%+1.5%+1.5%)/6 =1.5%. Then what is the standard deviation? It is 0. Why is it zero? Because every year the return is exactly 1.5%, so there is no 'dispersion' in the data.

An example with a higher standard deviation:

Based on the first two examples, it should come as no surprise that Camden has a larger standard deviation (because each sample average is different).  In this particular case, the average move of 8.8% is greater than the standard deviation of 5.6%, making this a quality candidate.

It is always important to identify instances where the standard deviation is lower than the average move. This helps you eliminate noise from your decision making. Stay smart and trade safe!

Monday, March 3, 2014

Preparing For Opportunity By Keeping Cash Reserves


By keeping an allocation of cash in your portfolio, you are always be positioned to seize short-lived opportunities. Some traders enjoy operating with 50% cash so that in extreme circumstances discretionary trades can be made.

On a day like today, with equities down a percent and a flight to safety in gold I am going to take advantage of the spike in implied volatility and start selling OTM bull-put spreads on stocks that rally in March. Take a look at a couple seasonal candidates under review:

BCPC is a nice small-cap stock with strong seasonal tendencies March through early May.

West Pharmaceutical Services is another great small-cap candidate.

Stay smart and trade safe!

Thursday, February 27, 2014

Bid/Ask Spreads Are Tightening On Option Contracts


Besides the broker's commission, the bid/ask spread is the only transaction costs incurred by the trader, and fortunately, bid/ask spreads on option contracts have tightened significantly over the past several years. This is particularly true for longer term contracts. For buy-side traders, this is wonderful because options are being priced with over-precision as a result of market maker competition (and active participation in the market). This allows an individual trader to navigate the market with greater speed and at a lower cost.

How can you take advantage of tight spreads besides getting cheaper market-order fills? Depending on your trading strategy and broker commission, you have greater flexibility to enter/exit positions, while paying less than 1% for the transaction. This facilitates opening a multileg option trade without having to worry about paying a significant amount of money to exit the trade.

Determining the 'fair market value' of an option is really difficult and the black-scholes model is not a holy-grail. As a result, when you see a contract that looks really inexpensive and the bid/ask spread is less that 5% of the value of the bid, then do not be afraid to enter the position. Mathematical models and fierce competition among market makers has empowered individual traders to purchase contracts at a low cost, so take advantage of it. Stay smart and trade safe!

Take a look at today's long trade candidate:
Today's short candidate:

Monday, February 24, 2014

Record High for the S&P500


Today the S&P500 broke to new highs - advancing nearly 1% this morning. Many momentum traders are stepping into positions as stock prices continue higher. Funds are also implementing new strategies based on recent news and data points released this morning. In this environment it is advantageous to be net-long, because there is no question that the markets can lift another 10% in a short amount of time. It is also smart to identify short candidates in the event that equities slide. It is better to buy insurance when you do not need it, especially if you can purchase it at a decent price. If implied volatility levels continue to fall, purchasing VIX call options can work as great insurance for a long portfolio. 

We will look at one short trade and one long trade.

The short candidate we are looking at is a pure seasonal play with a duration that is optimal for a swing trader.

The long candidate is XRAY, which is 10% off its all time highs. Here are the seasonal statistics:
Both of these equities are worthy of a glance. Most of the seasonal trades opened within the last quarter have been closed profitably, allowing for a cascade into positions like XRAY. Right now, there are a lot of really interesting statistics, both long and short, so I encourage you to dig through the database and find the trade pattern that meets your specifications. Stay smart and trade safe!

Friday, February 21, 2014

With Equities at All Time Highs Lets Explore PRG


Overnight U.S. index futures rallied to all time highs with U.S. equity markets in the 6th year of a bull-run. I am going to be opening positions on PGR Friday morning using profits our position BDX opened in December.

The options chain is perfect for this particular pattern with contracts expiring in 80 days. I am going to combine a vertical spread with a call option, to create a unique payoff schedule using May contracts. Purchasing 5 OTM CALL options and selling 10 vertical spreads, I am able to still generate a net credit while purchasing contracts. See Below:

This is a position that, given the right price action, you collect time premium, long the stock, and in the event that there is an explosion then you will make a lot of money off the gamma obtained purchasing the 5 CALL options. Stay smart and trade safe!

Thursday, February 20, 2014

Calendar Spread on Perrigo


Perrigo has strong seasonal tendencies, so we are going to investigate opening a position based on the following pattern:

The objective of this trade is to structure a position that can be held for the next 70 days without purchasing call options and without using a vertical spread (bull-put spread).

Observing that contracts in May have a higher implied volatility than the rest of the summer contracts, you can sell the 160 strike PUT option expiring in May and purchase a 160 strike PUT option expiring in August, maximizing theta absorption. Opening such a position will leave you long the stock and allow you to collect premium. When opening and closing the trade you want to fill both legs simultaneously, with a close date on or before April 30, 2014.  Exiting the trade is a bit delicate. Even if the stock rallies, you need to be prepared to close the position near $160.  If you keep holding the position and the stock is at $170, you all of a sudden have lost money despite your directional prediction being correct.

Calendar spreads (and diagonal spreads) often have attractive properties. Anytime you are considering such a position, be sure to model it and check the greeks to make sure it offers the risk-to-premium you are looking for. Stay smart and trade safe!

Wednesday, February 19, 2014

What Are Option Greeks...And Why They Are Important


In any position, whether purchasing a CALL or entering a multi-leg trade, you can estimate a set of risk parameters known as ‘option greeks.’ Each option contract has its own collection of greeks which can be added arithmetically with other option greeks that cover the same underlying asset. As positions become more complex, traders pay close attention to these hedging parameters to ensure there is not excessive risk from changes in underlying asset price, implied volatility, time erosion, and interest rates.  
Suppose you buy an option contract on SPY with a delta of 70. What does that mean?  It is actually really simple.  It means that if SPY goes up $1, then the value of the contract you bought will appreciate by $70, holding everything else constant.  Conversely, if SPY drops by $1, then the position value will depreciate by $70.
When SPY moves $2, will your position appreciate by $140? No. This can be explained by the second risk parameter commonly referred to as gamma.  Gamma measures how much the delta changes with movements in underlying asset price.  If gamma is positive, then you would expect a positive $2 move in the price to benefit the position by more than $280 ($140 X 2).  Once again this was because gamma, the partial derivative of delta (second derivative with respect to price), is positive.
The third parameter is vega, which is a measurement of the option contract’s sensitivity to changes in implied volatility.  This is important to note because a change in implied volatility will directly affect an option contract price.  A positive vega means that your position will appreciate from an increase in implied volatility, and a negative vega will appreciate from a decrease in implied volatility. Buyers are long volatility (positive vega) and contract sellers are short volatility (negative vega).
The fourth risk parameter is theta, which is the measurement of the option contract’s sensitivity to daily time decay. It can either work for or against you.  Most inexperienced traders end up purchasing time premium from sellers because they are hoping to hit a home run. However, selling premium (positive theta) means that even if the stock stays flat you’ll still win as the value of the position appreciates with time.
The fifth risk parameter is rho, which is simply sensitivity to interest rate risk. Typically for retail traders, this parameter is ignored. There is more of an emphasis on other parameters that impact day-to-day prices more consistently.  Below is a chart of the major risk parameters and how they are all related.  In order to have success as an options trader, you’ll need to have an intuitive understanding of how the greeks relate to one another.

Tuesday, February 11, 2014

A Year Ahead: 2014


Blackrock recently published its year ahead report, providing insightful analysis of macro themes. Although equities were choppy the last couple weeks, research indicates that there is still room for equities to rally to new highs this year before further correction.  

The banner below comes from BlackRock's report:

Again, from BlackRock

With the VIX at 15 and equities approaching record levels, Europium Funds has removed its short position on the VIX (opened last week at 20) and is once again systematically looking for prime long/short candidates.  

Monday, February 10, 2014

A Conservative Vertical Spread on 3M

3M is an innovative company that has evolved greatly over the past four decades. Interestingly, the stock has rallied following February 09 for twelve years in a row.  Take a look below:

Making the assumption that MMM is not going to depreciate over this same period in 2014, you want to structure a position that has a defined risk and benefits from premium erosion.  Here is an example:
Notice that the contracts expire in 67 days, which is approximately the duration of the seasonal pattern.  With the spot price at $130, you can sell the April $130 strike PUT option and purchase an April $125 PUT option and collect the difference. If you were to sell 10 of these 'bull-put spreads' then you would stand to gain $1,900 and would be risking $3,100.  In the event that the stock stays flat, you are still earning a few dollars per day in time (theta) decay. Stay smart and trade safe!

Friday, February 7, 2014

Thinking About Seasonal Patterns for Trending Stocks


It is important to consider whether a specific equity is in an uptrend or downtrend.  In the event of an uptrend, you would naturally expect the likelihood of identifying a long (seasonal) trade to be much higher since the stock has been moving in the same direction for several years in a row. When doing due diligence, check to see if a stock has been trending.  Take a look at PCLN which rallies every February:
An enormous uptrend.

When looking at time series data, it is decomposed into the following:

  1. Trend
  2. Seasonal
  3. Cyclical
  4. Irregular
Priceline has benefited greatly from trend. As a result, it is not surprising to see the above seasonal pattern with an average move of 26.8% over 77 days.  Be careful with these trade candidates, in many cases when a major trend breaks the seasonal component has a good chance of disappearing also. Stay smart and trade safe!

Wednesday, February 5, 2014

Take a Look at YUM! Brands and V.F. Corporation

Yum! Brands runs approximately 40,000 fast food restaurants in more than 125 countries around the world. Popular names like Pizza Hut, Taco Bell, and KFC are all owned by YUM, which have been expanding rapidly in Asia. The company is currently valued at 30 billion dollars, with 30x earning multiple.  The company is a) not enormously expensive and b) priced for growth.  More interesting, the stock has a perfect 16 year history of stellar performance during the 91 days starting February 5th.  The average move over this period is a whopping 14.6%.

I hope you find the statistics above to be useful.  To equate 16 bullish years to a coin toss, the probability of someone flipping heads 16 times in a row is .0015%.  This anomaly in YUM's stock price should be noted.

Another great play is VFC.  Take a look at this amazing history:

Stay smart and trade safe!

Monday, February 3, 2014

Taking Control in the Midst of Uncertainty

Often correlated with equity prices, copper futures took a tumble alongside global index futures overnight as Asia's markets opened. China's PMI numbers were in line with analyst expectations at 50.5, but acted as a further catalyst for selling, pushing European index futures down .5%. Meanwhile, gold prices elevated this past month, which happens to be the first time since August. During uncertain times, investors take a flight to safety in gold, which also happens to be behaving seasonally. In fact, February tends to be a quite strong month, and March - April are historically weak.
Other indicators of fear such as the VIX are exceeding median levels.  Below is a histogram and density function VIX using daily prices for the past 5 years. Currently the spot VIX is at 18.60.

If you are looking for a way to play the rise in volatility, you can start shorting VXX leaps as the VIX futures curve flattens out.  If you are looking for a couple good opening trades for Monday, take a look at Allstate, which has rallied 17 years in a row over the same 91 day period.
Stay smart and trade safe.

Tuesday, January 28, 2014

Taking a Visit to No Man's Land

Last week we discussed the importance of waiting during uncertain times.  For those that waited, you are probably relieved to see equities down 5%.  So what now?

We are in 'no-man's-land'.  What does that mean? We stepped away from our highs and there is no telling where the next month will take us.  Why would you want to speculate the direction of the market when there is little conviction that equities will rally or sell-off?

The S&P500 is below the 20 and 50 day moving average.  With that in mind, I am preparing to sell volatility at the right time. I am also looking into the following trades.

Long YUM:

Short KEP:

Stay smart and trade safe!

Friday, January 24, 2014

Remaining Market Neutral

By Jon Haghayeghi
After a weak month (with index futures down .75% before the bell) it is particularly important to shift toward having a market neutral portfolio.  As a result, I am looking for trades that are 91 days out that are bearish to match the 'deltadollars' I have long.

I will be selling call options on a few candidates above to get my negative exposure.

Is this the start of a major correction or is this minor capitulation? I am not sure, which is why I am market neutral and looking for opportunities in the event of a volatility spike.  When volatility spikes then I can sell premium at an attractive rate and make higher probability trades.  It also opens the door for powerful VIX trades. Stay smart and trade safe.

Wednesday, January 22, 2014

Selling a vertical spread on VFC

One of the strongest signals from our database comes from VF Corporation.  The stock has rallied 13 years in a row for the quarter following mid-to-late January.  Take a look below:

If you were interested in structuring a position using options, take a look at the model below! 

The position benefits from time and is profitable as long as VFC does not depreciate over the 91 days.  You win even if the stock stays flat.  The max gain is $800 and the max loss is $1700 - the position should be closed on 4/22/13. Stay smart and trade safe.

Thursday, January 16, 2014

What is going on? Is this a market top?

To determine whether a market top has been reached, one would have to correctly aggregate the beliefs of all major players in the financial markets and process them through time - this is impossible to do. To complicate things, data points are sending mixed signals and asset prices are hovering near 5 year highs.

This morning, jobless claims decreased by 2,000 in the United States.  Yesterday, the IMF said that the global economy should strengthen in 2014, but growth is also "too low, too fragile and too uneven."

Should you sell your long positions? What about sitting back and observing? What is everyone else doing?  As time elapses, these are the questions you will never have a perfect answer to.

Whatever your investment strategy, do not be afraid to watch – sometimes sitting on the sidelines allows you to identify the most ripe opportunities. Here is a Seasonal trade for January 16th.  Stay smart and trade safe.

Tuesday, January 14, 2014

January 14th, 2014

After U.S. markets sold-off on Monday, global equities also retreated in anticipation of a widespread correction. With futures markets up in the pre-market and uncertainty around the world, it would not be surprising to see an increase in actual (and implied) volatility.

To protect your portfolio from a downside move (without bidding volatility), short positions can be opened. Here is an example of a trade being opened today, short Monster Worldwide (MWW). Because MWW has sold off 7 years in a row over the 49 days following January 14th, it is a great candidate for a short position in the event of a market-wide sell off.  Stay smart and trade safe.