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The GOOG trade Still on time
A few days ago, I proposed a trade on GOOG, based on after hours' data to be entered in my Paper Trading account. Unfortunately, the stock rallied from early on the day I entered the trade, so it never filled. I wanted to demonstrate the use of the PCCRC based on the Elliott wave analysis. It is appropriate to enter a trade like this in GOOG, because the capital at risk is low, compared to buying calls or the stock alone, yet it has unlimited profit, unlike the Bull Call Spread or the Bull Put Spread.
The stock has rallied, confirming my early interpretation using RET, and the gains on the proposed trade would have been $1850 by now, or 82% of the capital at risk ($2244). I know, it is easy to talk about what could have been, but the beauty of the PCCRC is that it is never too late, as long as the conditions are met. The proposed trade was at a strike price of $470, and GOOG is now trading at $500.
Nevertheless, I wanted to follow up by showing you the Short-term RET analysis and let you now that next time I would adjust the price as needed to enter the trade, even changing strike price if necessary, and then report if and when the trade fills, rather than stubbornly wait until the trade fills at the price calculated the day before.
No matter, there are always good candidates, including GOOG itself, if and when the IV/SV ratio declines.
16 comments:
So Juan, it looks like the PCCRC may be good on stocks whose IV is < 30%. I have done a lot of backtesting but my entire backtest is based on stocks with > 30% in the long option. Will investigate lower IV stocks.
Alex
Thanks for your efforts.
My experience with IV's below 30 has not been good. think about it, low IV may mean that the underlying does not move strongly one way or the other.
By the same token, we don't want to buy options above 40% IV, because if the IV falls back below 30, we will lose on Vega, unless Delta picks up the slack.
You can SELL above 40% IV, but only BUY below 40% IV. Stay away from options below 30% IV.
Absolutely, but then can you explain why you would want to enter a PCCRC on GOOG whose volatility is ~25%? The only good thing it had going for it at the time the trade would have been placed is a +ve skew.
Alex, I am talking in general. All the lights are never green....
As I explained in the case of GOOG, it would nto be unsual to have the stock rally 100 point in just a few days. So I expect to make money with Delta, rather than Vega.
Still, I would not be surprised if GOOG went UP in volatility well above 40%, specially as it approaches earnings.
This is different than a stock such as MRK or FDX. These have usually low IV's.
If you follow my instructions and take a look at the historical IV, you'll should see what I mean.
Use your judgement and instinct, you'll get better with experience with this trade. And feel free to share your experiences too. Two heads think better than one.
Thanks.
I'm a bit of a stickler for detail but your assumption about GOOG moving 100 points in a few days isn't exactly realistic, nor is it what the market is implying - it's implying about a 50 point move within a span of 60 days, but I get the jist of what you are saying though.
I can comment on the fact that I do prefer stocks with IV levels greater than 30% based on a lot of backtesting and two actual trades thus far, but can't comment fully on stocks with levels less than that but I suspect you'd have to be very selective if you're trading this strategy with low IV-level stocks. GOOG is a good example of such a stock.
Alex, I am glad you are presenting your point of view. I fear that sometimes I might sound dogmatic. Every trader has its own biases and they act based on their own instincts or experience.
I'd admit that the PCCRC is complex and flexible.
You'd notice with GOOG that the risk in the trade is only a small fraction of the committed cash, this is why it is so important to take a look at the risk graph.
Given the RET analysis, the PCCRC, I though, was a good choice. The results speak for themselves.
Alex, please keep on reporting, even if your observations are divergent to mine, so that others may see beyond what I report.
Hi,
Why the Theta is -ve? I thought it should be +ve so we can have 3 "horse" ?!
Happy Trading
Happy,
The Theta is negative because you have more longs than shorts. What I am looking for here is an increase in Vega and/or Delta. My Theta gains compensate for the time decay, and may make you some money if the stock moves sideways.
In other words, you are partially financing the long straddle with the short-term short options that could decay if the stock goes sideways.
I have seen many times that when the stock moves sideways, that profits can be had with the decay of the shorts. Hopefully, you will have a delta or vega increase. But if you don't, theta will prevent large losses or even cause a profit.
If you'd like to play the calendar, you may increase the number of shorts, but I just don't like calendars myself. So be sure to do your own testing.
Hi,
Does it mean that we will have 2 horse only instead of 3? Do you mean that even we have -ve Theta, you will still enter the PCCRC if the condition is fine? (10% price increase, IV/SV <1, after earning...)
If we are able to find a PCCRC with +ve Theta (same ratio not calendar), can we consider it as "perfect" trade?
Since we have -ve Theta, if the stock move sideway, we are losing money and we hope we will have IV spike or price spike, if not, how long will you monitor this trade before you close it? What is your criteria to close it?
happy trading
Yes, happy, you do have your three horses even if the risk graph tells you otherwise. If the stock DOES remain at the same price, near the strike price of the trade, you will be collecting profits on Theta alone, as long as Vega remains the same or increases. It is at the time of rollover that you must decide whether to stay in the trade or exit.
Yes, the risk graph is misleading, but if you enter the trade as I have described, Vega will work with Theta for you. Even if all options increase in IV and Delta stays the same, Theta decay will affect the front month options, making them cheaper, thus accumulating profits.
I suggest that you do some backtesting so you find what I mean.
So it is indeed a three horse carriage. If Vega and Delta stay the same, Theta will pickup the slack.
Hi,
Does it mean that even though the initial Theta is -ve, it will increase by time and become +ve when it comes closer to the expiry of the front option even the price remains the same? If so, when is the best time to roll over? If the price stays for a week but nothing happen and the theta is still -ve, what should we do?
regards,
happy trading
Happy, if the stock goes strongly up, your gains will be due to Delta, even if IV will tend to decline.
If the stock goes strongly down, you make money with Delta (-ve), but you may lose if Vega goes down (unless you short more calls at the begining to make the trade more delta neutral).
If the stock declines with low IV, chances are the stock will rebound, so even if you stay in such a trade you may be OK.
As you approach expiration, Theta decay will erode the value of your shorts quickly. If the stock goes sideways in my portfolio of PCCRC's, I ear mark it for closure. One week before expiration, is decision point. If I believe that the stock may still jump strongly, I might rollover the short. Here, I am hoping to sell high IV and buy low IV.
If I believe that the stock may continue to go sideways, I may let it go closer to expiration. I don't particularly care to stay in a calendar situation, but if the stock has gone flat, I might make money on Theta decay alone.
I am a vertical trader, so I just exit the trade if is going sideways, unless I think that there is an advantage in trading IV (always selling high IV and buying low IV). I almost never play PCCRC's as calendars. BUT that is MY choice.
Thank you for your reply.
For PCCRC, how do we monitor the trade daily? I mean what do you monitor in terms of volalitity, price and time? e.g. once you enter this GOOG PCCRC, you will monitor the volatity spike (price goes down?), if so, you may consider to close for profit??!! Or if the price suddently shot up, you may have delta gain so you will consider to close it if you think it will not go further.(under what condition you think like that)??? If side way, then looking for skew and may roll to next month?!
Sorry I have too many question on it but I am very interested to know.
Regards,
Happy trading
Happy, this is good material for another article. I will do this shortly.
Juan,
with GOOG earnings coming today, there is a huge skew between July/August options.
Would you ever place a PCCRC in this context, to attempt to take advantage of the skew today, or would you wait to play GOOG after earnings, like tomorrow? Dan
No Dan, today its precisely when NOT to place this trade.
The Skew that you see will be gone tomorrow, but the longs will be affected too.
Unless you play it like a calendarized Iron Condor (I don't make this kind of trade, but you could test it), what you are doing is buying high volatility, expecting to sell it tomorrow (when it will be a lot less.
In other words, to benefit from this quick skew drop, you'd have to be equally short and long. I don't like that because I always assume that a big move will take place, in either direction.
Wait until tomorrow and see if the IV moderates. You can even take the GOOG PCCRC then, if the IV and IV/SV conditions are met.
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