Covered Calls
Unfortunately, all good things must come to an end. My autotrader is still doing great, but it appears that it’s pushing up on the limits of how much capital it can trade before I move the market too much and slippage starts hurting it. Without any changes, the return on capital will start to slowly dwindle as the capital goes up, but the return levels off. So I need to find some new investment ideas.
I remember the first time I read about covered calls, aka a buy-write, I thought it was the stupidest strategy. Capped upside and unlimited downside don’t seem like a good combination. Then I learned a little more about position sizing and how to set a constant risk amount so that you don’t just view risk as how much capital you put up to establish the position. That made the unlimited downside part a little more manageable.
Recently I’ve been reading more about real estate (related to the fact that I need new investment ideas) and getting a much better grip on controlling cash flow. With a far better grip of expectancy analysis over when I first learned about covered calls, they’re actually starting to seem interesting to me when viewed as cash flow. After rereading chapter 2 in the McMillan options book as a refresher, I think I may start to dabble in this a little. I don’t know if I’ll actually follow through on this, but it may add some different types of stocks that I look at in the future.
Stock Term – Breakout
Breakouts are simply price moves above or below a level of support or resistance. I’ll usually call a breakout that falls through resistance a “breakdown” for clarity. I’ll also tend to call things “breakouts” only if they’re supplemented with significantly higher than average volume. These are the things that kick off new trends, so needless to say they’re important to watch for.
Stock Term – VIX
According to Wikipedia:
VIX is the ticker symbol for the Chicago Board Options Exchange Volatility Index, a popular measure of the implied volatility of S&P 500 index options. A high value corresponds to a more volatile market and therefore more costly options, which can be used to defray risk from volatility.
The VIX can be used for a lot of things, but I usually use it as a complementary indicator to volume. A declining VIX often means a consolidation period, and an increasing VIX often means an accumulation or distribution period. You can find the chart for it here, but it’s available on pretty much every stock site.
Consolidation Confirmation
Just checked my blog traffic for the first time in many months and noticed how closely the traffic keeps up with the volatility in the market. Ramps up at the end of the summer, peaks in October and November, and declines through December and January. I don’t need the VIX to tell me how volatile the market is, I should just check my web stats a little more often. Yet another reason to add to my post extolling the virtues of starting a blog…
Improving Your Decisions
What if I told you I had a trick that could help you make better decisions, not just with stocks, but with everything in life? Okay, maybe it’s a pretty obvious thing, but it’s surprising how few people actually do it. Are you ready for the big secret? Here it is… think things through before you make your decisions. "That’s stupid," you say, "everyone thinks about things before they make their decision." True, you may think about things, but do you really quantify your reasoning behind each choice?
How do you "really quantify your reasoning" though? The easiest way is to write a blog! I’ve said before that I would post on my blog even if nobody read it, and I actually mean it. It doesn’t matter how well you write or what you end up saying. The important thing is that you have to think about what to write. Just trying to jot down a few sentences about a stock you like can be a very enlightening experience. There have been numerous times that I liked a stock, sat down to write about it, and then realized that I really didn’t like it so much when I had to rationalize it in a public forum.
It also works for things beyond just stocks. Thinking about leaving your wife for the stripper down the street? Go write that blog post first and see if you can come up with a solid appraisal of the situation. If you end up with a well thought out 10,000 word post that backs your decision to leave, at least you know you’re making a conscious decision to do it. Chances are though, once you sit down and are forced to formalize your arguments you’ll realize it’s a stupid thing and you would probably be embarrassed to have any of your reasons read by everyone you know.
I also have a selfish reason for this tip. I have a lot of friends who are very smart and know a lot about stocks, and I want to be able to see what they’re thinking too. But even if you don’t want to make a public blog, a private journal can also do the trick. You’ll be amazed at how much your opinion can change the first few times you try it. And this doesn’t even go into the benefits of having a historical record of your thoughts, but that’s what I’ll be talking about next time. So set forth, start your blog, and make sure you give me the address.
Downside Of Short ETFs
Yesterday I mentioned one way to size short ETF positions to hedge a portfolio. So if you can do just as well without putting up as much cash, why would anyone not go for these things all the time? Well, there’s a lot that goes on behind the scenes with these guys. Short ETFs just attempt to match the daily move of the underlying index by fudging their positions on a daily basis. Since it’s an ETF that’s very actively managed, there are a lot of fees that go along with it.
Also, since it’s just matching the daily movements of the index, over the long run that doesn’t quite work out due to compounding. Say you started both funds at $100, one which is a double short of the other. If the index goes up 1%, the double short goes down 2%. After the first day, the index would be $101 and the ETF would be $98. If the same thing happened a second day, the index would be $102.01 and the ETF would be $96.04. Now let’s say the index goes back to $100 on a 1.97% drop; the ETF would go up 3.94% and end up at $99.82. That’s minor right now, but over the long run it will end up not tracking the index as tightly as you may be hoping for.
While not a disaster, it helps to understand why the S&P500 may go down 30% but SDS only goes up 50%. Ideally, if you truly want two times the short exposure to an index, you would play the index futures or options so that you can manage your long term exposure a little more finely, but of course those have a whole other can of worms that go along with them. Your 401k probably doesn’t have that option though, so knock yourself out with the short ETFs and watch your portfolio at least stay afloat while everyone else is eating it.