The Perfect System, Part IV

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How to view the entire chart:


1. Try clicking on the name of the most recent article in the column on the right. This will remove the "Archives" list.
2. Try right click on the chart itself and open it on a separate window.


I am sorry that I cannot always make the chart small enough to fit neatly on the left column. I want you to be able to see the details I want to point out.


I Hope this helps,


Juan

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Are you tired of "stock picking" just to be stopped out of your trade within days?
Are you tired of placing Bull Call Spreads with 3 months to expiration, in the believe that your stock will do well through Christmas only to have to close the position when the October earnings turn out to be dismal?
What if your trade is doing well and all of a sudden your company preannounces?
What if you pick a stock that is sure to rally in the next few days, based on your technical analysis buy signals, only to see the stock go sideways as your options lose premium day after day?

Trust me, I have done it all. I have been studying and putting into practice a great deal of Elliott wave analysis, since 1995. I can categorically tell you that all my knowledge in the matter has only served me to increase my chances of success, but never to assure me a regular gain in my trading.

In the last 3 years I have invested considerable amount of time (almost full time) and money to find a system that would allow me to generate a steady income and thus give me the freedom to travel and spend my days in leasure by putting my capital to work effectively, without babysitting my trades on a daily basis. If this sounds like an infomercial for a get rich scheme, it is not. I am not planning to make one penny out of this effort, I am merely sharing what I know. I started this blog only slightly over a year now, and you could go back and see some of my explorations. I recommend that you DO visit old articles and view my video clips:

http://www.pathometrix.com/Movies.html

Here are some of my earliest documments on advanced trading strategies:
http://www.pathometrix.com/Archives/JISarPapers.zip

I started this blog to share in the hope that others will teach me things too. I am still hopeful that others will open up and share what they have learned.

I believe that the PCCRC is the perfect trade in part because it demands no secret knowledge of Technical Analysis. No advanced knowledge of were is a stock going to go while the options are cheap. In fact I choose stocks that have already shown momentum, and/or a piece of news that have caused them to move strongly. In the 1990's, I used to avoid internet stocks because they would jump 20% in one day, making the call options extremely expensive. I would say to myself: I lost my chance, and focus on which stock would make the next big move. With the PCCRC, it is precisely the big movers that are the best candidates for this strategy. I will demonstrate this to you.

Only recently I have come to see that right after earnings, volatility declines rapidly only to begin to rise again shortly thereafter. If the stock goes sideways after earnings, I make good money because of the Theta decay of the options I sell right after earnings. While IV declines at first, eventually, the long-term options acquire value because I.V. climbs, while the quick decline in options of the front month options, which I sell, are already eroded by declines in Vega. Finally, if the stock rallies, it is Delta that gives me the greatest profits.

Only a decline in the stock price along with a decline in volatility can cause my gains to fail to materialize. Even in such cases, a stock usually recovers from any loses, eventually meeting the strike price of my shorts. Only experience can teach you how to produce the best results. I can tell you, however, that you can still be REACTIVE, rather than PROACTIVE in the adjustments to the trade. In other words, your modifications will have as a goal the taking of profits and never the attempt at improving your chances of a reward. If you DO NOT have the time or inclination of babysit the trade, you simply set a profit target and exit the trade when the target (usually a 30%) is reached.

Let's show an example already. On September 29th, RIMM exceeded 10% price gains intraday after reporting estelar earnings:

http://finance.yahoo.com/q/h?s=RIMM&t=2006-09-29T10:08:53-04:00

The gain in stock price, as I told you, is associated with a declined in I.V. due to earnings:


Be sure that the options of the stock in question declines below 40% (this is an arbitrary number, but it is what has worked for me). At this point you may say that you are paying too much for the options, given the sudden interest in the stock. However, here you are selling both short-term puts and calls, while buying long-term puts and calls. It is important that the IV is similar for both long-term options, or that at least the IV of the long-term options is smaller. Here is the PCCRC. As you can see, I enter the trade as a Calendar Straddle. First, I buy a straddle using long-term options, then I sell a short-term straddle using 1/2 the number of contracts as the long term straddle.

The number of options make little difference. The capital is fairly well protected because most trades make money, and the ones that lose money, they usually don't lose much. I confidently enter 10 of these trades at a time. I use very close to all of my trading capital in this system. I consider the trade safe, so I trade around $25,000 per position currently. BUT PLEASE, don't trade money or copy my examples. Limit yourself to the learning, until you feel competent enough trade large sums. It has taken me over a year, but I have made 30% on my capital. Enough to make me a living.




One week before expiration of the shorts is the first decision point. I may decide that the trade is not worth my time and close it, or perhaps the stock is moving sideways, very near the strike price and both shorts have lost by Theta decay, making may trade profitable, so I go all the way to expiration and then close the longs and the shorts that are ATM. Some stocks may be reporting earnings on the week of expiration, which requires a special treatment. BUT for the most part, I just rollover to the next month, or even take some profits by increasing the number of shorts in the call or put side, depending on what seems to be advantageous


Ultimately, the goal is to maintain the format of a straddle for the life of the trade, and thus take profits as the stock does what it must do. The results will speak for themselves.

You never need to adjust to make the trade more profitable. Only adjust to take profits. You never need to think too much about your next move, just let the moves happen. Identifying candidates such as RIMM should be easy. If your broker does not get you the Percent gainers, take a look at Optionetic's Market Snapshort and select the right column of the page for the pop up menu and select % gainers. Here focus only on stocks with 10% gain or more. I choose to trade stocks trading at >$30/share, simply because that way I can trade less contracts, thus reducing my commissions.

http://marketdata.optionetics.com/custom/optionetics-com/html-marketsnapshot.asp?exchange=0&screen=2