Those of you who subscribe to my Twitter feed got a message yesterday that I re-entered my favorite (recent favorite, anyway) DXD Call trade. It's not a trade for the faint of heart, but it paid off over a triple last month and I think we're going to see at least a double this month. I bought the October 25 DXD Calls for $1.45 each. I also put in an order for a bunch of the September (yeah, the ones that expire in 48 hours) 26 DXD Calls at a dime apiece when the market was rallying, but I didn't get filled.
In a nutshell, the trade works out when the market drops, specifically when the Dow drops. It has been a reliable trade all year when the Dow has approached the 10,600 level. That's not to say it has always worked for me (I've had options expire before the drop occurred more than once), but I bought myself an extra four weeks this time, so I'm pretty sure I'll be making a tidy profit.
For those inclined to join me, take a look at this chart. It shows the stochastic upper end is at 10,657 and the lower end is at 9,872. Relative strength looks to be topping out around 63%. When the market dropped to 9,936 last month, DXD went over $29. A similar move this month would make those calls you paid $1.45 for worth $4 each in intrinsic value alone.
On top of the bearish technicals, we have the other X factors in the market: a confirmed Hindenburg Omen set to wreak havoc in September (if it's for real - a BIG if), October traditionally being the worst month of the year for stocks, the uncertainty of the coming election, gold surging, and an overall bearish sentiment to the market. Not to mention the variety of economic reports due over the course of the month, all expected to be more negative than positive.
I'm not trying to sell you on the trade. I'm just letting you know what I'm doing. Best of luck to those brave souls who choose to join me. If you think the trade won't work this time, I'd love to hear why.
What's your view on purchasing in the money vs. out of the money for this position?
I've actually learned the hard way that you always buy these in the money. The out the money calls carry an exorbitant time value that dries up once they're in the money. For example, I was able to buy October 25's for $1.45, which was essentially 65 cents time value for 31 days, when an out the money September 26 with only 48 hours till expiration was carrying a 45-cent time value. Gotta buy in the money options when you're trading DXD, and the deeper in the money, the better you do premium-wise.
There is one important factor that could totally pop equities - investors leaving the bond market. Will it happen, yes; will it happen soon, ?.
I like your trade though!
Make that money!
QE2 ends tues will see what the curve does
trading seems like such fun instant gratification... pretty much the opposite of PE... alas, in a different life
Eddie, love the idea. However the young investor has a valid point. Although the bond market won't turn overnight. This flee into equities will be over time and it will be after the stock market has already had a significant move and investors want to get into the market again.
My concern with this trade is the fact that everyone has spoken about how bad the markets SHOULD be this month. I'm a contrarian and I when I see how bearish people have been on this market, it gives me some hope. In regards to the election, I believe that's partially what is moving this market north. It's pricing in the stampede the Dem's will face in November and lose the House. Gridlock is usually good for the markets. However we have had a decent move in a short amount of time, so if we continue to rally further, I may have to look into this trade. Best of luck!
Why not simply buy puts on DIA (the unleveraged DJIA ETF)? Volume is pretty decent and you won't get too pinched on the bid/ask.
Leverage. DXD multiplies the drops by 3x, and the options multiply that by 100x. All for a limited and pre-defined downside.
I thought DXD was 2x. Isn't the BGZ 3x?
He already answered that
Sorry. Typo. The DXD is 2x leveraged to the short side. Nice catch, moneyrunner.
BGZ is 3x vs the Russell 1000
I like the trade, I wish I'd put it on in August (I think a lot of us saw the drop coming).
A couple longer term trades I'm wondering about:
Jan 11 BGZ options. I think we'll be sliding downward for the next 6 months and this seems like a good spot. The $17 calls are going for 1.36.
Shorting Long-Term Debt. It's going to happen someday, probably not anytime soon, but rates will go up. A prime candidate for getting smashed by this would be ultra-long debt. Are there any ETFs on the horizon for this asset class? I'm in no place to be shorting Ultra bonds but an ETF option would be more doable.
Sorry if this all sounds naive, I'm still very green at macro calls and options trades.
Threads like this reinforce how little I know outside my specialisation.
what is the time frame you are looking at, held to maturity?
also, how does the JPY move impact you trade? Assuming that JPY will con't sell off, lead to high dollar and short term rally
For time frame, you'd ideally sell half the position at a double or better as soon as that happens, holding the remainder until expiration provided that it's deep in the money. October is a good month to be short the market in general, so you never know what might happen.
The JPY move is interesting, but I don't think it has the legs to keep American equities higher. I think yesterday's surge in the USD/JPY will be the most significant move there and anything else won't be nearly as dramatic. I could be way off base, but I don't think the JPY manipulation will effect the DXD trade going forward.
That said, a sovereign debt crisis in Europe would definitely be an exit signal for me, and you have to be ready for that to happen any day now. I'm not saying something is immediately imminent, but some kind of European default is inevitable at some point, so it's best to be ready for it.
why would the sovereign debt crisis in Europe be an exit for you... i am assuming that will lead to a broad crash across all sectors and region? Isn't that good for this trade?
My concern would be a flight to American quality. Yes, a European sovereign debt crisis could trigger the opposite and cause a broad-based collapse both here and abroad. But I probably wouldn't risk it.
Considering how correlated asset classes have become these days, I think a European debt crisis would only benefit US govies. The turmoil during the Spring had a negative effect on the US stock market, so I'd be willing to wager DXD would go through the roof on a full-blown default.
Eddie,
I love reading your trade ideas, Patrick was looking for post ideas at one point - I love this type of content!
Additionally, because I'm not too familiar with option strategies, your posts often leave me wanting to learn more. I think it says a lot about your posts that they trigger me to do additional research and learn about the basic strategies.
After doing some research from a previous DXD post I bought DXD in my 401K (which doesn't allow any option trading). I viewed it as a nice hedge to a largely vanilla portfolio. It worked well for me until I sold about 2-3 weeks ago.
My current concern with DXD - while I believe we are heading towards some tough times, I believe that information is already out there and therefore should be priced into the market. Also, with earning season upon us, there will likely be some positive earnings that may cause the market to rally slightly. With that said, I will definitely be monitoring this and at some point will likely get into DXD calls.
accountingbyday,
I feel like I have to mention that leveraged index ETFs like the DXD are really not appropriate for retirement accounts. I'm sure you probably know this and just did it on a lark, and I'm really happy it worked out for you, but they're really meant more for trading day-to-day than any kind of long term hold.
Now that that's out of the way, I agree that a lot of negative sentiment is already priced into the market - but so is a great deal of positive sentiment. The market is pretty news driven right now, and you just have to ask yourself where the greater potential lies. Is it more likely that something surprisingly good could happen that would drive the market to 11,500, or is is more likely that something surprisingly bad could happen to drive the market to 9,000?
Glad you enjoy the posts. Patrick and I have spoken more than once about me making trade recommendations more often. The problem I have with it is that I only trade when I'm fairly convinced it's a sure thing anymore. In other words, I don't need to trade to eat, and that complacency robs me of my edge. Rather than tell you guys what you should be trading, I'm more comfortable just telling you what I'm trading and you can do with that what you will.
Edmundo,
I totally agree with your stance on leveraged ETFs in retirements account. But I've been pretty doom and gloom the last few months, so I wanted to temporarily hedge my investment risk (I'm basically in mutual funds and cash right now) so I held DXD for about 2-3 weeks. It worked out alright for me and when I "felt" (admittedly not scientific) like the doom was subsiding a few weeks ago I sold my DXD.
I'm by no means suggesting you start posting trades that you wouldn't invest in yourself and I obviously am not trying to turn you into an active trader when you;ve already broken through those chains. These are just posts I tend to enjoy and I wanted to let you know that. Maybe an idea would be a mini series on trading tutorials?
In general I have a negative outlook on the economy, but aparently the dow isn't being brought down by bad news these days. I also think there is decent chance of positive earnings announcements that will lead the dow up. So, while I would not bet for the dow to rise, I also won't bet against it until after earnings season.
TBT- Doulble short 20+ Lehman Treasury
calls are down to 80 cents. now the 24 ones are about 1.20 if I'm reading this correctly. Would you still go with the 25's or would you buy the ones that are in the money?
I'd go for the 24s now. Better acceleration when the trade turns around. If the market's up again today, I'd even start looking at the 23s.
DXD 24s still looking attractive today. Anyone get into DXD 24 calls today against today's rally (at around the +70 points)?
Can't see what tangible effect the "possibility" of a QE2 would have on the real economy besides inflating commodity prices, deflating the US dollar, while the effects on incomes and employee hiring has still yet to be seen.
FYI
Just doubled my position in the DXD 25 Calls @ .25 each, lowering my average cost to .875.
In for a penny, in for a pound.
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