Market Timing – The Thursday/Monday Syndrome Revisted

“That was some tsunami of selling today” quipped one of my friends. I guess I have some ‘splaining to do.

For those that missed the previous article (click here for the full post), the “Thursday/Monday Syndrome” takes hold with massive selling on Thursday, choppy trading on Friday, and then another massive sell off the following Monday.

Instead, the NYSE and S&P500 rose 2.5% and 2.3% respectively, while the NASDAQ put together a 1.3% gain. And these indexes closed near session highs, which is another sign of strength.

What gives?

A deeper look makes me think it was a lack of sellers, rather than a tsunami of buyers, that pushed the markets higher today.

The 2.5% gain in the NYSE was accompanied by a 26% drop in trading volume (lightest since 9/20). The NASDAQ was actually up 0.5%, but that is hardly a sign of strength. And either way, both indexes were under their average volume, which is not a sign of strength. Couple this with the fact that new 52-week lows outpaced new highs, and today’s rally is suspect.

I recorded the bid prices for the first in the money call on DRN, EDC, FAS, TMF, and compared them with the bid prices for the first in the money calls from last Monday. The bids for today (on a percentage basis) were higher than last week! EDC calls were paying out a 20% premium! This doesn’t seem like the stuff that rallies are made of…

Catastrophic Success
John Mauldin | September 24, 2011

Stocks Extend Rebound In Mixed Volume
Vincent Mao | September 26, 2011

P.S. Free Access to IBD from Sept 26 to Oct 9th!


September Technical Analysis – EDC

As mentioned here, I decided to put my September technical analysis of ETF’s on hold for a week. You never know what you’re going to get from a day of Fed meetings, let alone 2!

Let’s revisit my August technical analysis for EDC:

Short term resistance is now at 25, with EDC currently trading around 20 (which is awful close to the near term low). Don’t hold your breath…there isn’t too much (technically speaking) to hang your hat on at this point. We’ll see what happens this month, and hopefully September will have a little more info to go on. On the plus side, EDC is still within it’s maximum 20-day price decline (%), so no need to adjust my position size based on volatility. However, I am tightening up my max loss rules portfolio-wise (I’m now using a max loss of $3,000 per trade, rather than 10,500). With it’s current price at 20, this means that I need to reduce my EDC position by 200 shares.

As of last weekend, EDC was still in a long-term downtrend, but looked like it had found short-term support around ~20.00.

Here is the DRN chart as it stands today.
EDC price action indicates near term, mid-term, and long term weakness

The next price support is around $5.00 (!), which was set back in early 2010. We’ll have to wait and see what Monday/Tuesday have in store for us. Hopefully, we won’t see a reverse split anytime soon.

September Technical Analysis – DRN

As mentioned here, I decided to put my September technical analysis of DRN on hold for a week. You never know what you’re going to get from a day of Fed meetings, let alone 2!

First, let’s revisit my August technical analysis for DRN:

DRN sits $30/share below its price at July’s option expiration date (almost 40%). The August downtrend is pretty steep, so I would expect some moderation over the next few weeks as DRN tests the near term high around $55/share and a near term low around $36.

Now, take a look at the chart I planned to use last weekend.
DRN price action indicates near term support

From a simple moving average perspective, DRN was back above the 20 day, but still below the 50 and 200 day. DRN didn’t test the August low. Instead, the ETF continued to test the $55/share mark.

Since initiating my August covered calls expired, DRN has experienced 4 bullish and 3 bearish technical events according to my brokerages technical analysis software. And the Commodity Channel Index says DRN just oversold (versus greatly oversold).

I assumed DRN would break through the $55 or the $36 floor “soon”. The catalyst for either move being Fed action/inaction.

Here is the DRN chart as it stands today.
DRN ETF price action indicates near term, mid-term, and long term weakness

We didn’t pierced the $36 floor last week. Unfortunately, I don’t see much support above the $30 level. We’ll have to wait and see what Monday/Tuesday have in store for us.

Market Timing – The Thursday/Monday Syndrome

Before getting to my monthly posts on ETF technical analysis, I saw something over the weekend that gave me pause; something called “The Thursday/Monday Syndrome”.

From John Mauldin’s weekly newsletter:

“The classic Thursday/Monday syndrome starts with the kind of action we saw yesterday [Thursday]. The markets open under pressure and selling accelerates in swelling volume. By early afternoon, there is a virtual stampede of selling. Then, later in the session, stocks stabilize a bit based on some reassurance. The action on Friday is uneven, often ending choppily steady or somewhat weaker. Then on Monday, the trapdoor opens with liquidation and margin calls bringing tsunamis of selling.”

The paragraph went on to say that the carnage could carry over into the following Tuesday before any kind of relief is seen.

I have not idea if this is going to happen tomorrow. But if it does, I could see a trading opportunity for covered calls. Bid/Ask spreads can provide many opportunities, especially when liquidity is an issue.

So I will have my eyes on the markets Monday and possibly Tuesday to see if there are any bargains in October covered calls. Otherwise, September may be the first month this year when I don’t see any income from covered calls.

Catastrophic Success
John Mauldin | September 24, 2011

September Option Investing – Commentary

Normally, this is the time of month that you’d expect some technical analysis posts and option trades for September. But these are not “normal” times. The coming week brings us the September FOMC meeting.

You may be asking yourself why I’m touching on this subject. Here are some facts from the August FOMC meeting in Jackson Hole:

  • Additional rounds of unconventional easing were discussed
  • The Dow rallied 430 points after the August FOMC press statement
  • The September meeting was extended to two-days (verses the normal 1 day meeting)

And here are some facts from the last time an “unexpected” 2-day meeting was held by the FOMC:

  • The last two day meeting was December 2008
  • The two-day meeting was used to unveil QE1
  • After the QE1 announcement, the Dow soared 360 points

In his book “Methods of a Wall Street Master”, Victor Sperandeo discusses the US “Fed” and the fact that investors and traders MUST respect its ability to move markets. In other words, the Fed has to ability to stop trends dead in their tracks, so technical analysis of individual investment vehicles is pretty useless. And we all know that fundamental values of leveraged ETF’s are suspect at best. Even if those values were useable, they aren’t a good indicated or short-term price performance.

And apparently, I’m not the only one that is concerned. Zero Hedge posted several commentaries on the short covering that occurred last week, and at one time stated that “Hedge funds do not want to be short ahead of next week’s FOMC meeting”.

So we should all go long, because the markets are headed through the roof…right? Anyone? Anyone? Not so fast. Is some sort of QE3 is already priced into the market? This would mean that something on the order of QE3^2 would be needed to really ignite a rally.

More bad news: Late last week, we learned that the European banking crisis is worse than we feared. How do we know this? Because the Fed announced it was teaming up with the central banks of Great Britain, Japan, and Switzerland to provide US dollars to European banks that lost the ability to access capital markets. Is this the QE3 that is already priced? Or is this just a teaser?

As Barry Ritholtz pointed out:

“The rescue plan could be looked at as awful news — more economies and banks in such dire straights as to need yet another central bank bailout, moral hazard notwithstanding.”


“Consider the TARP rescue, how Bernanke and Paulson had to scare the congressmen to death to get them to take action. Now consider that in light of what must be going on behind the scenes to get this announcement of 5 Central Banks coordinated intervention.”

John Mauldin had this to say:

The only reason for this move must certainly be that they are acting to prevent what they fear will be another Lehman-type crisis. Otherwise it makes no sense. They can give us any pretty words they want, but this was not something calculated to make the US voter happy. To do this, you have to be convinced that “something evil this way comes.” And to recognize the costs of not doing anything, and try to head them off.

The Bottom Line
No amount of money management can counteract this level of uncertainty. Time to sit on my hands (and money) and watch what happens. The good news? With all the uncertainty comes volatility. And with volatility comes high option premiums. So even if I wait a week or so to judge the fallout, I still have a good chance of meeting this months cashflow target.

Financial crisis: central banks do not take this kind of action unless something is up
Alistair Osborne, Business Editor

QOTD: What Coordinated Central Bank Action Means…
Barry Ritholtz | The Big Picture

Anatomy Of A Squeeze
Tyler Durden | Zero Hedge

Forget Operation Twist: Rosenberg Says Bernanke Will Shock Everyone With What Is About To Come
Tyler Durden | Zero Hedge

Twist and Shout?
By John Mauldin | Sept. 17, 2011

Gluskin Sheff

Cashflow Report – Paper Income during August 2011

Welcome to my cashflow report for August 2011!

Every month, I create a “cashflow report” to review the paper income I’ve created from trading covered calls. Every investor and trader should review their trades on a regular basis, and I use my reviews to do the following:

  1. To help me track my progress towards financial independence
  2. To maintain my focus on increasing paper income and meeting my goals each month
  3. To provide an example of creating an income from investing/trading
  4. To get your perspective


August 2011

I feel like I wrote the last cashflow report ages ago. The October 2010 DRN uptrend was still intact, with a price that was range bound between the mid-60’s and mid-80’s. EDC was in a short-term downtrend, but remained range-bound between the mid-30’s and mid-40’s. TMF gaped up at the end of the month and pierced the $40 level. And FAS was headed south.

So many events roiled the markets in August that it is hard to know where to begin. You can take your pick between the S&P downgrade, US debt ceiling debate, Europe’s banking crisis, and the sputtering US economy.

But as an option trader, these events are actually GOOD things. More uncertainty creates more volatility, which in turn creates higher premiums.

What I learned in August

The major “duh” last month came in the form of higher premiums.  I traded more often (mentioned here and here), so my commissions and fees were higher.

As for “ah-ha’s”, anytime I have a loss, I know there is an opportunity to learn. And since I had some large losses in August, I know there are some large lessons to be learned.

First and foremost, August served as another example for the importance of having trading money management rules. Had I been “all in” on DRN, EDC, or FAS, my losses would have been staggering. Not that my position sizes in DRN or EDC were ideal, but I am glad that I limited my position in FAS (instead of buying as much as I could in order to chase option premiums). I get to live to trade another day!

Secondly, having the ability to trade naked options is extremely important for capital preservation and loss avoidance (mentioned here).

Quick Primer:
A “covered” call is a call option on shares of an investment instrument that you own.

  • If I own 100 shares of DRN, and sell a call, I have sold a “covered” call.

A “naked” call is a call option without any shares.

  • If I own 0 shares of DRN, and sell a call, I have sold a “naked” call.

Trading covered calls on an underlying positions is great when the markets are moving sideways. When the markets a rising, covered calls aren’t bad either. But when markets fall, watching the value of your underlying position fall isn’t pleasant. This is especially true when you know you should have sold because you use a mechanical trading system that TELLS you when you’re supposed to buy and sell. Since markets rise geometrically and fall exponentially, losing money happens much faster than gaining money.

Going back to the example above, to protect against a loss I would need sell my 100 shares of DRN as soon as I got a sell signal from my mechanical trading system, and then hold the “naked” call (or buy it back if the cost is low enough). Sitting on the money from the sale of my 100 DRN shares, the DRN call would be still be covered by the cash in my account, rather than shares of DRN. The problem is with my brokerage firm. Naked calls are not allowed in accounts with a balance lower than $100,000. Lesson learned – lower my risk percentage per trade until I have the ability to hold naked calls.

Finally, there is one more major lesson to be learned, but it won’t be fully realized until the current market correction/economic recession is complete. Let’s revisit a subject I touched on in July’s income report:

For example, I haven’t created the process or mechanisms in place to really live off investments. Profits are recycled back into the trading account for the time being. There are still some topics that need to be addressed before I can start weaning myself off of a paycheck…

In August, my covered call account suffered a ~15% draw-down. I still have enough capital to continue meeting my cashflow goals. But this statement is misleading, because I have not made withdrawals from my trading account each month. If I were truly “living” off my option trades, the losses would have been closer to 25% and generating $3,600 in September would have challenging.

The lesson to be learned here relates to minimum account size needed to supply $3,600 cashflow during a market correction. On the bright side, higher option premiums make my task a little bit easier.

Cashflow Report – Paper Income During August 2011 – Breakdown:

DRN-Direxion Daily Real Estate Bull 3X (ETF)

Premiums = $2250.00
Dividends = $0.00
Commissions/Fees = ($20.96)

EDC-Direxion Daily Emerging Markets Bull 3X (ETF)

Premiums = $1855.00
Dividends = $0.00
Commissions/Fees = ($34.22)

TMF-Direxion Daily 20+ Yr Trsy Bull 3X Shares (ETF)

Premiums = $0.00
Dividends = $0.00
Commissions/Fees = ($0.00)

FAS-Direxion Daily Financial Bull 3X Shares(ETF)

Premiums = $434.00
Dividends = $0.00
Commissions/Fees = ($31.53)

Net Cashflow – August 2011 = $4452.29


Paper Income from Covered Calls
GOAL: Create cashflow greater than or equal to $3,600 USD per month for 3 months straight by executing my covered call strategy.

Well, I did it. I reached my goal of $3,600/month for 3 months. Tack on my previous goal ($3,000/month for 3 months), and that is 6 straight months of steady cashflow. Not too shabby.

The Road Ahead

From here, there are several directions I could head (in terms of goals). As mentioned earlier, there is the need to get my account past the $100,000 mark. I have actually achieved three of my longer term goals this year (in terms of cashflow/month), so I could go for the 4th watermark at $6,000/month for 3 months. Given my money management rules, these two goals tie together nicely assuming an average option premium of 6%.

But my mission here is to gain financial independence. I proved to myself that creating consistent cashflow is possible. So achieving a higher cashflow each month is about having more money in my account. Sure, there will be additional money management challenges, but I think most will be mental.

I haven’t proved that I can withdrawal money from my trading account each month and still hit cashflow targets. So I think the cashflow level of $3,600 will remain where it is for the next three months…but what I do with the money will be different.

NEW GOAL: Create cashflow greater than $3,600 USD per month, and withdrawal $3,600 USD per month, for 3 months straight by executing my covered call strategy.

Related Posts

Top Secret Goldman Report

Zero hedge uploaded a top secret report on the state of the market from Goldman. Definitely an interesting read!

In summary, Goldman proposed key trades for Europe are:

  • Buy 5Y Protection on iTraxx Series 9 9-100% Tranche
  • Buy 6 Month EURCHF One-Touch Put Option

While on China Goldman recommends its best clients to the following:

  • Buy a Short Equity Total Return Swap on Chinese Banks
  • Buy a USD put CNY Call Option
  • Buy Short-Dated CNH Bonds (Dim Sum Bonds)
  • Buy AUDUSD Put Spreads or Receiver Swaptions on AUD Swap Rates
  • Buy Copper Put Option spread

Here It Is: Presenting Goldman’s “The World Is Ending So Let’s All Profit” Report
Zero Hedge
State of the Markets – Long and Short Risk Strategies

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