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!