Archive for November, 2010
Options vs. Common Stock
November 17, 2010 at 11:13 am
Traders face many hard decisions every day…buy or sell, add or lighten, stand aside or get involved. Among them is the choice between trading options or common stock.
There are no doubt benefits and shortcomings of both choices, as everything literally is a trade-off.
Common is usually much more liquid, it can be traded in the after hours or premarket, and it’s by definition 100% exposure to the company. However, it is more capital-intensive since it’s not a leveraged position, which means less room for other positions in an account. Common alone is also going to carry with it greater dollar risk, as a major headline can bring tremendous gap potential.
Options are leveraged, they offer lots of versatility and possibilities (speculation, hedging, income, etc.), and they are less capital-intensive. However, liquidity is often inferior compared to common, they can’t be traded as many hours of the day as stock, and they offer only fractional exposure to the underlying stock.
The Case for Options
Options can be an excellent vehicle for trading, provided the situation is well-suited to them. The biggest 3 considerations for options are (1) the time expectation for the trade, (2) the liquidity of the options being traded, and (3) the risk involved in the trade. Let’s break those down.
Timeframe
First things first… The time you expect to be in the play is important because options will carry a bid/ask spread often times up to maybe .10-15 cents. For a stock that’s not a huge deal, but for an option which might only be trading at say $2 or lower, that’s a big percentage if you pay the spread both ways (market order getting in & out). So if you’re looking at being in a trade for at least a couple of days, that’s usually much better for an options trade than if you’re just looking to scalp it over the next half hour.
Liquidity
Second, there are quite a few stocks which have high trading volume, but for whatever reason their options are just not heavily traded. For any trade I take, whether a stock or an option, I want to feel confident there will be buyers when I go to sell, and sellers when I go to buy. Sufficient liquidity is a requirement for any trade, whether in options or common. So taking a look at the open interest, the volume, and the bid/ask spread is important in gauging the liquidity of the options. When in doubt, take a look at the highly liquid options like QQQQ, SPY, or mega-cap stocks like MSFT or INTC. That will help you get a feel for how tight the market is in the options you’re considering. You don’t ever want to be the ‘big player’ in any contract.
Risk
Third, limited risk is an advantage which options carry, such as buying put options vs. being short stock. Risk is defined with the puts, and theoretically unlimited with the short stock. Options are a great choice in particular when the stock has the potential to gap big, whether due to news coming out or simply based upon recent price history of the stock. Always consider the risk involved when weighing options vs. common, as that’s an important element of the decision-making process.
Finally, here are a few occasions to consider options rather than the common shares:
1. In front of big news (earnings, conference calls, or anything else scheduled).
2. When limited on capital (the leverage of options helps offset a limited amount of funds).
3. When the stock moves are too shaky to sit through (when a really wide stop is necessary).
4. Trade timeframe is between a couple days and a few weeks.
** If you’ve got something else to add, please share it in the comments.
Trade Like a Bandit!
Jeff White
Producer of The Bandit Broadcast
Are you following me on Twitter yet?
Trading Up from Mediocre to Great
November 8, 2010 at 12:28 pm
Can you imagine working hard for insignificant results? Or setting your standards so low that you need not put forth effort in order to attain your goals? Never, right?
A competitive drive pushes many traders from the inside, causing them to take on risks others wouldn’t accept. They shun the security of a regular job, opting instead to speculate in an arena filled with financial danger but unlimited upside potential. Long hours are often recorded in an attempt to gain an edge. Tedious tasks like sifting through hundreds of charts nightly, religiously reviewing results, or poring over statistics of trades past are done with the sole purpose of improvement by traders who are hungry for success.
In other words, they want it.
Those kinds of things are what it takes to get better in trading, and many are willing to pay the price. Yet far too often – unfortunately – some traders settle for less.
I’ve encountered many of them. They say things like “I’m not really trading right now because I’m waiting for XYZ to bounce back and let me out of a pretty big paper loss I’m facing.”
What’s interesting is that the ‘paper loss’ they’re referring to is quite real. Even more noteworthy is what they fail to see, which is that other trades could put them back on the right track and actually get them turning a profit again – if they’d free up their account to allow themselves to actually take those trades. Sadly, they’re just unwilling to turn loose of a mistake, so they cling to hope and wait for a miracle.
Are you one of them?
Trading Up
Often times on the road, I’m looking for an opening in the left lane to get around that slow lady ahead of me who is too busy talking on the phone to go (at least) the speed limit. In the mall, I’m amazed at how many people walk aimlessly, without a clue, as if there’s no purpose or destination to move towards. Yes, I am a bit impatient, but the point I’m making here is that it’s a habit I’m in of continually looking for ways to improve my situation.
That’s particularly true in my trading. I don’t mind putting on risk, and I realize plenty of trades will fail. What’s most important to me is to monitor how those trades move and how the stocks are behaving.
Let me be clear… It’s unrealistic to think I can foresee the moves before they happen, but it’s not difficult to recognize price action that’s outside the recent norm. And that is the key.
Studying the price action closely allows you to identify when outlier moves begin to occur, and subsequently when an exit needs to be made.
Always Think In Terms of Gain
We just sold our house. The real estate market is still soft, and for about two months we had a lot of showings but no sale. The price was too high, and we had to come off the price a bit in order to sell the house. But we’re upsizing, so what we had to concede on the last house we more than made up in the new house.
Once I thought of a price reduction in those terms, it became a no-brainer. It was less personal. Understanding that giving up $1 here might mean I save $1.50 on the next home (because it’s larger and higher-priced), logic dictated that I think in terms of what I’d gain on the other side, not solely what I’d be giving up.
Why doesn’t everyone trade this way? Why not dump an average name for a better one – one that shows more promise, more potential? Why not put in the work to get to the next level and leave mediocre results in your rearview mirror?
Make it a habit to think this way, especially if you’re gunning for improvement. OR…be complacent and stagnate, because that’s the only other option.
What has helped you learn to dump losing trades in favor of new names with better potential? Share your thoughts in the comments…
Trade Like a Bandit!
Jeff White
Producer of The Bandit Broadcast
Are you following me on Twitter yet?
Uptrend Aside, Trading Scene Set to Improve
November 1, 2010 at 10:45 am
August seems so long ago, doesn’t it? Stocks had rebounded from their July lows, briefly, and had turned back down hard for a test. The test passed, as an important higher low was established.
From there, we all know the story of how the seasonally-weak September and October stood conventional wisdom on its head to post big gains. What’s not been spoken of much, however, is the way this 2-month rally has changed in recent weeks.
What began as a rip-roaring rise ripe with short-covering has evolved into a slower, more steady uptrend channel. The pace has cooled off a bit, while still continuing to make upward progress. In fact, new intraday highs were posted multiple times last week, despite the indecision we saw between the opening and closing bells each day. Today we’re seeing more of the same, as early strength has delivered new highs while modest profit-taking has caused the indexes to back down from their best levels.
To put it another way, the “dumb money” has had great success in recent weeks. Those who waited for strength to return before becoming confident enough to join in have been fortunate enough to chase extended markets and stocks and still profit. But for those of us who prefer to see some kind of rhythm associated with market moves, it’s been a one-way street without many ways to play the long side while still protecting the downside.
Astute traders have instead found it a bit more difficult to navigate the current environment, as anyone with an ounce of discipline has felt the uneasiness of adding long-sided exposure for overnights while simultaneously recognizing the limited opportunity of trading intraday. It has left many of us to do more scalping while waiting for more lively day-to-day price action and higher-quality bases to come along. Those bases often rely on some back-and-forth price action, which we simply haven’t seen of late.
Watch The Horizon
Any trader worth his salt knows that conditions will shift. Maybe not immediately, but eventually.
That doesn’t mean prediction is necessary, because it isn’t, but it does mean staying alert.
When trading well, keep doing what works but be on the lookout for signs the setup may be changing. When trading poorly, it’s imperative to employ some other methods which are more suitable to the conditions. At the same time, hope can be had that a shake-up in the price action will bring more opportunities.
Right now, the market is in an interesting spot. The rally has brought the spring highs into play as we’re essentially testing them in this area. That’s a logical resistance area that could prompt some selling, depending upon the news flow. The uptrend channels seen in the averages could easily be penetrated to the downside, heightening concerns of whether that’s the end of the run. The other side of the coin is that the trend is still up, and no evidence has surfaced to suggest it’s changing.
So as a trader, here’s how I’m dealing with all this. The trend is up, so I’m favoring the long side while keeping timeframes short in order to offset the risk of walking the highwire here. I’m also mindful of potential shifts which could emerge anytime. We’re in the midst of earnings season, and that could easily sour the mood. We have the November elections tomorrow and the political implications of that, which is a major event. And then mid-week we have the FOMC, and with all eyes on the economy, the attention of traders will definitely be on Wednesday’s announcement and policy statement.
We could ramp from here and take out the spring highs before a pullback begins. It’s possible. We could break the uptrend channels and see some selling accelerate as traders recognize the trend line break and move quickly to lock in profits. Several scenarios are possible, and it’s important to keep an open mind here for that very reason.
I will say this: I’m expecting volatility to pick up sooner than later, and that means more opportunities for trading multiple timeframes. That’s where the real money is made, as you can have capital working for multi-day moves while still maneuvering to catch intraday moves for profits. Look alive out there, this is no time to get lulled to sleep.
Trade Like a Bandit!
Jeff White
Producer of The Bandit Broadcast
Are you following me on Twitter yet?
