Wednesday, February 17, 2016

Traders Expo Speech, OptionsHedger, Potential Opportunity For Gold Bulls

Dear readers and friends,

This coming Monday, Feb 22, at 3:15 PM I will be speaking at the Traders Expo New York.
Below are links for the Traders Expo.

I’d like to thank Options City for coordinating the opportunity to give this talk.

I would also like to announce the launch of our new website, OptionsHedger.com. Scheduled to be up next week, OptionsHedger will feature consultancy and commentary across multiple options markets. All commentary on the site will come from people who professionally trade the markets they comment on.

The vision for the site is to become the place individual traders and small-mid sized businesses come to get their options questions answered. Understanding options is becoming more important with the recent onset of global volatility. We are creating the site to become the resource that sophisticated traders and businesses come to when they are considering putting on options trades. In world markets that feature progressively less real liquidity, slippage in options trades, or undisciplined execution of a concept can become costly. OptionsHedger will be the one stop shop for those who want to avoid those costs.
Please visit us next week at OptionsHedger.com

Topic for the discussion Monday Feb 22, New York Marriott Marquis Times Square

The goal of this talk is to discuss how directional traders can use options to create trades with better risk profiles than simply buying or selling futures, ETFs or Stocks.

Why this topic?

Recently a number of traders I consider to be market savvy have asked me whether options make sense for them to trade when they are bullish or bearish in a given market. That is an impossible question to answer without knowing more details about how the options in that market are priced. That being said, there are ways that directional players can learn to find opportunities within these markets using options. A friend of mine who has market experience but limited options experience recently asked me about whether he should be using options to carry out his directional bias on the S&P. After about 45 minutes of asking questions about where things were priced, I still had no simple answer for him. I spent about an hour talking about all the risks that he probably hadn’t considered. Don't worry, I promise this talk won't be that long.

“Why Directional Traders Need to Understand Options” continues my conversation with Brian to explore the ways that options can be used to generate better returns. I will spend a portion of the talk going through historical examples in gold, where opportunity was clear for those who were paying attention. This will not be a long complex rant on options pricing. The goal of the talk is to help traders and hedgers consider ways to more intelligently approach the options markets they are trading in.


Gold Update:


Gold has been extremely exciting since I last wrote. A near 70 dollar rally on Feb 11 was the crescendo of a near 200+ dollar rally low to high.
In my last post,(Feb 6) I showed the below 3 year gold chart and said the following::


I think the chart above tells gold’s story. The upper line of the down-channel, which has held as solid resistance for nearly 3 years comes in near the October high around 1190-1210 depending on how you draw the line. This however, is not the 1200 of old. Consolidation around this area would be to my eyes bullish and would expect a retest of the 1325-1350 area should it break above. The length and strength of the down-channel we have seen for the last 3 years in gold must be respected. The extremes have brought buying in on the lows and selling at the nearby tops. I am not one to question history, so I will be watching these levels and the ensuing price action very closely. If gold is able to regain this area for a period of time, buyers may be emboldened if the resistance appears to weaken around 1190-1210.

This same chart 12 days later looks like this.



You can see that gold pierced through that upward resistance. It has quickly sold off and sits hovering right above the line. In keeping with last weeks theme, I think the concept that consolidation around this area could be quite bullish. The push through 1200 led to an onslaught of buying. Once that resistance gave way, new highs were established over 60 dollars higher. It is back here again, but those who hate 1200 in gold because of the monotony of last time should not lose sight of opportunity if we sit here for a bit. The longer gold is capable of hanging around up here even if it is doing nothing, the more bullish it becomes. Spending time above this clearly defined trend line would signal that the conviction of sellers had weakened. The longer term and bigger a price a channel is, the more likely you are to see a strong move when it breaks away from it. We shall see if this was a blip and a fail, but this type of situation might create opportunity for options traders with a directional opinion on gold.

Gold Options are historically expensive right now. Volatility, while off the highs, is at the far upper end of its multi-year range. While that does not mean they are overvalued, they are not at the point that a directional trader considering using options should look to be getting involved. But the opportunity might arise.

This is a perfect example of how a trader with a directional opinion can monitor options prices and find real opportunity with some basic homework. Let's say looking at this chart that you are bullish gold. You believe that gold will chop around this area for a while and then rally to new heights. Whether or not gold is to rally, someone who is bullish could reasonably look for an extend move higher because it would appear that it has broken out of its downchannel. This might be a reason to own options.

But the problem is if gold sits, and you buy options, especially at prices well above the 3 year historical average, you will painfully lose your premium. Time becomes your enemy. However, if you are of the mind that consolidation here is bullish, then you should be monitoring the options market carefully and waiting to look for entry points where the risk reward gets good.

Understanding the risks of owning options can be complex but in a scenario like this it can be simple. If gold consolidates into a tighter range, options almost inevitably get sold. As the movement becomes and less more and more options selling ensues as the cost of owning in a dead market is too high based on the movement. This creates the opportunity to put on an options trade based on the concept of a breakout out of consolidation.

The key is not to be in a rush. You do not have to do any trade. But if gold consolidates, and you view that as bullish, you will be able to buy options at lower and lower prices, giving you a lower cost basis on your investment/trade. In its simplest form, I am advocating that anyone who is bullish gold, unless they see it spiking back up, start monitoring the implied volatility in the options. If you view consolidation as bullish, and watch closely, you can find opportune times to get options at prices that give you a better risk adjusted return than you can get by trading futures alone.

I hope to see you all on Monday Feb 22nd.

Ben


Saturday, February 6, 2016

Gold takes out 200 Day Moving Average. Front month Gold Options continue to provide good risk return for directional traders. 2/6/16

On January 20th I wrote the following:

The last week or so has shown that a down stock market does not necessarily mean higher gold. Today the February gold futures contract made a high of $1109.9. That is lower than the 1113.1 high that gold made on January 7th. Stocks made a new low today with the S&P making a low of 1804; on January 7th the low in the S&P was around 1930. So 125 handles lower in the S&P later, gold did not make a higher high.

In the ~ 3 weeks since then gold has rallied 65 dollars to Friday’s high of 1175. During that three week period, The S&P rallied a similar ~60+ handles and is currently trading near 1870.

Gold and the Stock market rallied together. I track price post to post because it can help show how perceptions on the day to day can be misleading. The idea of stocks and gold working inversely makes intuitive sense, but it works inconsistently over unpredictable time frames. We should remain careful not to let biases that a rising or falling stock market is what is driving gold’s price.

Admittedly, my comment from last week warned to be careful about getting long gold. I was taking a very neutral stance because it wasn’t clear what the Yen would be up to next. The yen, unlike stocks, seemed to show a much more real correlation to gold. You can read my last post here which goes into more detail on the yen and gold. Safe Haven Status Wearing Off? 1/20/16

Had you told me what the Bank of Japan would do since I wrote that post, I would probably expect gold to be trading somewhere around 1000. The BOJ announced NEGATIVE INTEREST RATES. Being forced to pay to hold bonds is a TAX on the currency. Logically, this should lead to a sell-off in the yen… The BOJ must have thought that. Take a look at the 20 day, 15 minute chart of the Yen.


Notice that big move down. That was what happened after the Bank of Japan announced negative interest rates. The yen is now trading HIGHER than where it was trading before the country effectively put a tax on holding the currency. So logically, if you had known the BOJ would ease, you would sell the Yen and gold because the two have tended to correlate. You would’ve lost. Both are higher.

It is times like this that I work to adjust my trading strategies to be as nimble as possible, because, simple logic simply doesn’t prevail in these markets. Moves like this on news like that tells me that there are forces involved in markets that will move things in ways that are not intuitively logical to most of us. The global stage has materially changed over the course of the last few years. The lowering interest rates method of easing gets tough when interest rates are 0%. Our intuitive logic is accustomed to thinking about lowering rates from 4 to 3.5% as an incentive for businesses to borrow. But when we are going from 0 to negative, the implications are a lot different. I don’t profess to understand all of those implications, and I don’t want to make my opinion on them the basis of my trading.

It is important to differentiate between being a trader and an economist sometimes. Understanding the economic environment at large is critical to protecting ourselves in these markets. But can that work against us? The question is, how reliable are our perceptions of how the global economy is functioning, and how might that impact our trading. I used the example of the Yen’s price action after introducing negative interest rates to show how logical ideas don’t always lead to profits. It is times like this that I believe it is easy for traders to make big mistakes, and overvalue perceptions about things that are completely random. I think it makes sense to keep a view of the bigger picture, but look for small, stick and move type opportunities. Such opportunities exist in volatile markets, and you don’t have to spend futile hours trying to figure out the world all at once to trade that way. I’ve tried trading with a “smarter than the market” attitude before.  It’s a waste of time and money.

The action in the Yen is also a reminder that there are people who have real money at stake here. When a central bank puts in an easing measure that leads to currency appreciation, there are a lot of people who get exposed to big time changes in risk profile (banks etc). When those kind of institutions have that kind of money on the line, big orders can come in at unexpected times moving markets. That is not in any of our control, and it is essentially unpredictable. When the market becomes unpredictable, volatility of all positions tend to increase. There can be opportunity in these spots, but you have to be careful not to casually leave on big positions that seem benign. When money is whipping around in an unpredictable manner, good positions don’t always work.

In the past week, there were some opportunities in gold trading. Front month vol briefly got below 13% (a daily breakeven of only 10 dollars) in a market that saw some aggressive late week moves. Gold also managed to eclipse the 200 Day moving average. Take a look at the below chart which includes the 200 DMA overlaid on the 3 year gold chart.



The 200 DMA is approximate in this picture, and denoted by the purple line. Gold has been in a steady downtrend, and spent the bulk of its time in the past few years below the 200 DMA. In gold’s last attempt higher, in Late September, the 200 day served as strong resistance. Now, Gold has blown through the 200 DMA by 40+ handles. The early October rally was less impressive with respect to the 200 day.

In this week’s trading, there were opportunities to buy the breakout. I tried a few times swinging and missing, but was there when it did move. The options, particularly front month options get priced too cheaply sometimes, and represent a real opportunity to people with a directional bias, or in this case, a possible breakout concept. If you notice, over the course of the past 3 years the times that gold did break through the 200 DMA it was often in a spike like fashion. I mentioned that the last break was more muted than the previous few, but even there you got a 20 dollar move on the break. In all cases, owning options has been very profitable. While you can’t always catch the breakout, the risk reward of owning options priced in the 12-15% range with 2-3 weeks expiration tends to be very favorable to the buyers.

I think the chart above tells gold’s story. The upper line of the down-channel, which has held as solid resistance for nearly 3 years comes in near the October high around 1190-1210 depending on how you draw the line. This however, is not the 1200 of old. Consolidation around this area would be to my eyes bullish and would expect a retest of the 1325-1350 area should it break above. The length and strength of the down-channel we have seen for the last 3 years in gold must be respected. The extremes have brought buying in on the lows and selling at the nearby tops. I am not one to question history, so I will be watching these levels and the ensuing price action very closely. If gold is able to regain this area for a period of time, buyers may be emboldened if the resistance appears to weaken around 1190-1210.

It is hard to call a breakout. Options won’t always be cheap. But it is worth looking at the options as a way to play these breakouts. Sometimes people sell options right as a breakout is underway. That represents real opportunity for prospective buyers. If you are bullish, view consolidation as positive for your view. Options will likely get hit under such circumstances, and give you a cheaper entry point for a look at a sustained breakout. Just like the 200 DMA break brought buyers (of call options as well as futures) so too would a break of clearly defined resistance on the longer term chart. When money flips at critical points there is significantly greater potential for a big move. The return on owning options in spots like that can make a year if it is done with a plan to hold for an extended breakout. These are the opportunities I will be looking for, and will write if I think an opportunity with a tremendous risk/reward profile arises.

If gold fails to gain traction above 1200, it will look like the downtrend remains in-tact. This could embolden sellers, much the same way a break above could embolden buyers. If gold is to sell off to the lows of this multi-year channel, the $1000-1025 area is where support would come in on the extreme. There are big implications for the coming months that should become clearer over the course of the next few weeks.  Keep a close eye on gold and these levels. If you don’t track volatility in gold, but trade it directionally, it is a worthwhile endeavor to start. It could just be another beleaguered attempt to rally by gold, but if it is not, there could be a lot of opportunity. It is worth the extra effort to keep it on your radar for now.

Wishing everyone good trading in the coming week,


Ben