OK, this is an options trading blog, but I’ve been obsessed lately with these 3x levered ETFs and how much they move intraday.  Just last night I was up until 3:30am researching price patterns and paper-trading it in my mind with various intraday indicators that I like, mainly the CCI.  Particularly, the most volatile is the FAZ, a 3x levered ETF which shorts bank stocks.  This thing moves 20-30% intraday quite frequently!  With that kind of volatility this is day trader candy!  I also noticed something interesting: it gaps up or down overnight about 10% each day!  So at the end of the day if you can guess which way it’s going to gap open the next morning you get a nice 10+% move by putting on a trade at 3:55pm EST and taking it off shortly after the market opens.

Since this is an options blog, I have to consider some sort of options play on FAZ.  Looking at the chains the options are pretty pricy since they are so volatile.  I’d hate to short anything in here since it moves so wildly and I don’t like shorting options on levered ETFs because of their bias towards intraday price correlations: over longer trends they do not correlate to the movements of their underlying stocks very well, only on a shorter term basis.  I think one interesting idea is to consider trading these during expiration week, where you’re paying for less theta and just speculating up or down on their short-term price movements, or maybe short some options a few days before expiration that are still a fair amount out of the money so they expire worthless.  Still, this one is a scary beast to play with.

In the meantime, I’ll be looking more into this constant overnight-gapping phenomena and see if I can get good at picking which direction it’s going to gap.  I picked DOWN last night and I was right, it gapped down on the open about 11% from yesterday’s close after the first minute of trading from $56 to $50.

Monday, 12/15

Goldman Sachs (GS) comes out with earnings tomorrow morning and I thought it might be a good opportunity to sell volatility ahead of earnings.  With the historical volatility currently at 122 and the IV at about 100, this high volatility allows us to collect more premium than in a more normal, low volatility environment.  Also, being that this is options expiration week, the front month options don’t have much time value.  I figured I wanted to sell out of the money puts and calls (strangles) and hope that the price of GS after reporting earning remains within the range of my strikes and that they will expire worthless in the next 4 days.

At the time of purchase GS was trading at $65, a nice mid-strike price to work with.  I sold 50 of the 85/45 strangles, giving me a wide $20 range (30% of the current price) for an income premium of $3,600.  I also got a little riskier yet smaller by selling 10 of the 75/55 strangles for an additional $2,640 of collected premium. That position gives me a $10 range on both ends (15% of the current price).  So basically, I’m betting GS won’t move more than 15% by Friday.

If stock price starts to reach the edge of the inside strangle (75/55) I will look to get out at my break-even points ($77.64 and $52.36) on this position but keeping my premium on the wider strangle.  The break-evens on that strangle are $88.60 and $41.40.

I’m liking the options action during expiration week, esepcially the selling of options.  Since there is not much time value left the premiums are not as juicy, but the probabilities of success (expiring worthless) are higher so these trades are more conservative in that regard.

Tuesday 12/16

GS closed the day yesterday up to $66-ish and this morning it’s up to $71 after the earnings announcement this morning.  Of course, the puts are worth much less now, down about 70%-90%, yielding a nice gain so far. And the 85-strike calls I sold also came down in value due to a decrease in volatility, even though they are closer in-the-money now.  The 75-strike calls I sold however are up, but not by much, only from 1.15 to 1.40.  The decrease in volatility has helped to minimize their upside gain.  It’s Tuesday and I’m thinking of just holding everything to expiration (this Friday) so they expire worthless.  The only one that worries me is the 75-strike calls that I sold, though the stock would have to go up another $5 to start to reach my break-even point and I’m somewhat reassured in that these contracts expire in less than 4 days.

Tuesday, 12/23, after expiration

Well, I wish I had covered those $75 calls before expiration, GS went all the way over $80 by the end of the week and never came down.  So those calls expired $5 ITM (in the money) and by Monday the calls were exercised and I found myself short 1,000 shares of GS!  Luckliy though GS came down near $75 again today and I covered my short position for a small $300 loss.  Not bad considering on Friday I was sitting on a $5,000 loss!  So overall, I squeaked by with about a $5,000 one-week gain.  I just felt GS was overpriced at $80 and I’m glad I held on enough at least to cover my short instead of covering on Friday and taking the $5,000 loss.

I think the takeaway for me was that when you’re selling volatility before an event, after the event happens and the volatility comes back down you need to take off the nearest-risk position (in this case, being short the $75 strike) and watch the rest of the positions closely until expiration.  I would have been happier taking the loss on covering the $75 strike and sleeping more easily for the rest of the week.  And I feel lucky GS eventually came back down to $75 after my calls were exercised.  Because this was an event-driven play, once the event plays out you should take off some or all risk since it the position was based on a short-term thesis.

Even though the stock rose 8% shortly after I sold the calls, the fact that the calls only rose 21% is a testament of the power of volatility in pricing options.

I’ve been pretty inactive with the market lately. I put on some long-term call spreads back in December and the January sell off really killed them. They are spread out to April so I still have time but they’ve got a long hill to climb and I may get out of them soon while they’re still worth something.

The market in general is pretty tough for my “take profits when you’re +100%, cut losses when you’re -50%” criteria as volatility is very high, making options pricy, and the market is not trading in any real long-term trend as it is trading in a large range with massive intraday swings, so it’s hard to make directional picks unless you can pick a top or bottom and are actively trading these things, looking for smaller but more nimble gains.

My day job has kept me pretty busy and I don’t have time to day-trade the market now so I’m on the sidelines so far. I’m looking at perhaps just selling some covered calls for some small income plays to sell volatility, or look at buying stock in some beaten down names and just keeping them protected with collars. I’ll let you know what I decide.

On Wednseday morning Lehman Bros (LEH) released quarterly earnings. There was a lot of negative sentiment against LEH going into earnings and I considered getting buying some puts on Lehman but I didn’t do it soon enough and I don’t like buying options the day before the announcement due to the risk of getting caught in a volatility crush.

Shortly after the earnings announcement in the morning, the stock was down $2.08, almost a 3% move down. However, the December front-month ATM and OTM puts, which should have gone up, actually went down in price. The reason is that once the earnings came out uncertainty went down, which decreased volatility. Volatility affects options closer to expiration . This teaches 2 things when trying to time the market with options:

1. When volatility is high (like the market is now) beware of volatility crushes like these
2. You’re more likely to be a victim of volatility crushes when playing with options close to expiration

I had been the victim of a crush in the past and didn’t know what it was and didn’t understand why when the underlying stock of my calls went up why my call options went down in volume. That’s because as a beginner I often traded front-month option near earnings. Sometimes it worked as an earnings surprise was announced, surpassing all of the volatility premium I had paid for. However, on other times what the company announced was what everybody expected, or worse, and I got caught in a crush.