A Capital Idea

It has come to my notice that the best stocks for writing puts on are ones that go up.It seems that this little fact has been overlooked by me over the last 6 years or so. It might seem blindingly obvious but in fact it wasnt.

I have been looking at the optionable stocks on the FTSE and flicking over the graphs. It seems to make sense to choose stocks that have good profits and a decent business model. But how can you tell this from looking at the graph ?

If you look at a 10 year graph of a stock, it will most definitely show fluctuations,but is the trend upwards? I have recently been hammered on all my march expiry puts because the companies I have chosen do not show this trend. Whether you can correlate the two is another matter but why choose anything else that doesnt show this trend ?

You would have thought that a share like Shell, trading at a P/E of around 7, would be a good long-term stock. Well, its not really the case. Sure, it makes money but not the sort of money the market likes. It is virtually totally dependant on the price of oil. At least, thats what the market thinks. So, whilst it may appear a screaming buy (it did on my value calculations) I will lose on it this quarter.

One company I am very fond of is Capita. It has just announced its results and they came in just under analysts forecasts. They were unjustly punished for this so I sold some june puts to take advantage of this downturn. This company has a very sound business model i.e. long term residual contracts and increasing revenues and the share price of the graph is good i.e. it goes up at around a 45 degree angle.

Certainly, it has a bit of debt but it leverages it very well. So I am prepared to put my money where my mouth is and back it.

Let us see if June is kinder to me than March

Have I got any energy left?

Well, after the excitement of last weeks price drop to 385p it has now recovered to 410p.

I am disappointed as I was so close to my exit point of 22p. The closest it came was 18p. With hindsight, I should have sold off a few more at this price and waited for another downturn to sell the rest.

This would have increased my breakeven point but at least I would be sitting on about 60% of my original funds as opposed to 30% now.

I have used this technique of buying/selling in stages before and it works well and is one way of coping with randomness of share movements.

Of course, the share price could fall further from now but time is running out. Can I recover in time ?

When volatility doesn't matter

When you first learn about options, you soon start to realise that there are a hell of a lot of things to learn. In fact, its a bit of a bottomless pit. You could spend years and years getting into the arcane calculations and eventually be as good as a quant.

But you have to ask yourself, am I am mathematician or a trader. Sure you have to be a bit of both, but it would be far more profitable to be a good trader than a good mathematician.

For example, a mathematician looking at an stock put option might say. Hmm, is the implied volatility higher than the historical? Yes, so in theory a good reason for selling it. Ok, now lets look at the greeks (the values that determine the properties of the option). Hmm interesting, the delta is bigger than it should be.

In fact, he will examine all types of things surrounding the option and come to the conclusion that historically, now would be a good time to sell it and take in some premium. So he does

But from the trader's perspective, it might be completely different. He looks at the put and says hmm, thats high. Why is that ? Does a bit of research into the company and sees that its results are due out soon. Does some more digging and sees the fact that the company has increased its debt in the last 6 months and that it was done on a floating not fixed rate. As interest rates have moved up twice in the last 6 months AND it was a substantial amount of debt that was taken on, this HAS to impact profits. So he says I will buy the put option even though it's not good value.

Day of reckoning
The results come out and wham! the share price drops 10%. The trader HAVING LOOKED AT THE COMPANY made the money. The mathematician HAVING LOOKED AT THE OPTION lost.

Was this a random occurence? Would the share price have dropped anyway? Who knows? But one thing is for sure. I would rather be a trader than a mathematician.

The company is the dog and the share/option price is the tail. Make sure you know the dog before he bites you in the ass!

Its almost Christmas

Can you ever be wise in the presence of random movements ? Poker is considered a game of randomness but good players manage to overcome the bad hands and win.

This is, of course, down to psychology and depending how you play your hands. How much you raise, varying your game are all part of it.

Can you bluff a share into dropping ? Hmm doubtful, but today just fear was in my favour and the share dropped 20p to 390p.

This set my option put value at 14-20 (14 to sell 20 to buy), so I might have been able to sell the lot at 16 as the share price fluctuated and break even on the second half of contracts. However this would still leave me with a 6p loss on the first half I sold. I need to sell the rest at 22p to break even (less costs)

However, there are a couple of ways I might be able to get out of this. If the share price drops further but the and the 390 put bid hits 22p I just sell the puts. However if doesn't get to 22p I might be able to sell the 400 put for 32p. Here's why. As an option increases in value the percentage difference in the spread will decrease.

So if the share price drops to around 370 I might see 21-24p for the 390 put and 32-35p for the 400 put. If I sold the 400 put for 32p, I get back the 22p but lose the 10p difference between the 390 and 400 put. If I just closed out my position I would get 21p back i.e. 1p short of my breakeven

What will tomorrow bring ? Watch this space

Win some, Lose some

Was in constant contact with the broker today. I went out for lunch and forgot the mobile phone :-(

When I came home, I saw I had 7902 missed calls, 1 from the broker and 7901 from the answer phone.

The price had been moving down towards 410, then bang hit 406. The broker managed to sell half my contracts at 10p. I know, I know this is a loss but it is still better than the position I was in last month when they were virtually worthless.

So I bought the puts at the price of a Ford Mondeo and sold them at the price of a Ford Ka. This is still infinitely better than selling them for a second hand scooter!

Anyway, I still have the other half to sell and am hoping for a further drop in the share price tomorrow. When dealing with options, hope should never enter into the equation but we all have our failings.

Its ironic that the pleasure I got from making a loss (but a smaller loss than anticipated) is the same feeling I get from making a gain. It has to do with unexpected pleasure.

If only I could have had that two months ago then I would be sitting on a handsome profit.

Another day another drop tomorrow

Blood on the Carpet

Its been an exciting few days. There is blood on the carpet for two reasons. Firstly, because my favourite energyy company has just had its results out and whilst they weren't bad, the market didn't like them and they are now trading at 414. If the management doesn't do something, there will be blood on the carpet for some of them I feel.

This is tantalisingly close to my breakeven point as the puts are now quoted at 7-11. That means I could sell them at 7p realising a 9p loss or hold onto them in the hope that they will fall further

On friday, the broker called me saying someone was bidding 10p for them as they needed to cover a position. As I was at the hospital at the time and not really thinking straight. I was tempted to try and sell half the position but in the end I demurred hoping for some more bad news.

In these situations, it is really a toss up whether you make money or not. The share could go either way on good or bad news and it is a bit too random for me. With hindsight I should have got rid of them and just taken a 6p loss (i.e 6*10*Number of contracts = A small family car) but the share doesn't seem to have much support and I am hopeful of another few pennies more.

The problem lies in the fact I have little time left. The contract expires in less than 5 weeks time and the time value expires rapidly in the last 6 weeks of a contract's life.

So should I sell them at whatever price or should I hold on and wait. Post a comment to let me know what you think.

Oh yes, blood on the carpet reason 2. I have had an operation on a deviated septum (a nose joint) it was broken and straightened by the doctor on monday and he removed a polyp too. Definitely a lot of blood on the carpet!!

Blood Diamond and other gems

Having just watched Blood Diamond and the ruthless pursuit of money, I feel a little less desperate about making money on my trading.

Trading is fun and sometimes it isn't but at least I don't kill anyone doing it. I might feel like taking my revenge out on someone (like the cat ) when things go wrong but this doesn't actually happen. In fact, I don't even have a cat so that would make it rather difficult and the neighbours would start getting a bit suspicious if their moggies didn't turn up at dinner time!

My long put on the UK energy stock which expires in March seems to have gone against me. My broker very wisely suggested that I should sell some puts at a higher strike to cover some of the losses. For example as I am long the 390 put I could sell an equal amount of the 400 put to have a neutral position. If the share price moved back up I would only lose the difference between the two. If the share price moved down, my long puts would offset my short ones.

We agreed a level (the 400 march puts) and started working a price. I would have got 9p back for the higher strike so my loss would only have been 9-16p i.e. 7p X number of contracts. However, we tried working the price and got nowhere.

I suggested to the broker to keep working the price the next day and he sent me a mail first thing the next day to ask if I still wanted to do this. The share price was down another 8p to 421 so we could have got 10p per contract for the 400 puts, but by the time I got around to it the price had shot up 10p. An 18p swing in 30 minutes !!!

The share price is now sitting smugly at 452 and laughing at me saying "Ha ha better luck next time"

Ah well, this just goes to show you. Sometimes to get out of a bad situation you have to be quick and make a decision fast.

Still, 5 weeks still to go and anything could happen.

It shines for some, but rains for others

"Bring me sunshine". As Eric and Ernie used to sing. The sun was definitely shining on the market today as the Fed kept interest rates stable, the UK market rose 90 points

I was actually wishing that the market would fall today. This is ironic as most of my positions are long but I have a very big position with a UK Energy stock will provide handsome returns if it falls

I bought some 3 month March 390 puts of this stock in late November 2006 which expire on the 3rd Friday of March 2007. If the shares finish above 390p on this day I lose my money, but if the finish below 390 I make money.

I bought them at 16p so my breakeven point is 390-16p i.e. 374p. They have been steadily falling over the last few weeks from 500p to today’s 429p.

As I mentioned previously, options also have a time value as well as an intrinsic value. So when I bought the options in November the share price was around 480p. The options had no intrinsic value i.e. if they expired tomorrow they would not be above the 390p so they would be worthless. Thus the 16p I paid was entirely time value

As you get closer to the expiry date i.e. 16th March 2007, the time value of the option erodes. So a march 2007 option bought in November 2006 when the price was 480p was worth 16p, but now at the end of February it is only worth 5p and the price is much closer to 390p than before.

In order to make my money back, the share will have to fall to around 400p in the next few weeks as the option value will increase the closer it gets to 390p.

But I’m hoping it will fall further and I think it will
1) A major broker has just given the share a downgrade to 360p. i.e. that’s all they think its worth.
2) One of their power plants has just suffered yet another outage. This gives little confidence to the market that their business is running well

Will the share fall further. Lets wait a few more days to see
So “bring me sunshine” could be the song I am singing soon !!