You’re a Bear and I’m a Bear: How to trade a Bear’s cash position

You’re a Bear and I’m a Bear: How to trade a Bear’s cash position

Readers Digest

I am a long term contrarian investor at heart, I like to dig through financials, and build nerdy spreadsheets, but more than that I want to make money regardless of whether the market goes up, down, or sideways. I want win.

This is the first in a series of posts on trading my growing cash position with derivatives

The basics I am using for trading my cash position in this series

Caveat

I am a long term contrarian investor at heart, I like to dig through financials, and build nerdy spreadsheets, but more than that I want to make money regardless of whether the market goes up, down, or sideways. I want win.

A great investor/trader can make money in equities, debt, mergers, currencies, commodities, and any number of derivatives and physical assets. A great investor will take an unreadable amalgamation of technical, fundamental, and macro trends, yell ‘expecto patronum’, and arrive at a digestible product with an actionable opinion. I read that statement somewhere, or a version of it, and it holds true. You, knowledgeable reader, know this already but it is something I must constantly check myself about. Always be learning.

Trading My Cash Position

I’ve been a bear overall since the turn of the year. I went long commodities, beaten oil and gas companies, and scaled out of baseline equities as my bear outlook turned more cynical.

I jumped out of precious metals too quickly after a nice quick run and natural gas has remained stagnant but oil and agriculture has done nicely YTD.

But this isn’t an article about my commodities positions.

Over the last several months I have found that I am sitting on more and more cash as a percent of my portfolio. With that, I have taken to more risk defined high probability short term options trades on volatility in various indices, equities, and commodities.

My trading horizon has ranged from the weeklies to around 8 weeks and has netted a nice risk defined return. My portfolio is hedged overall, in fact I am skewed bearish, and each trade represents a comparatively small portion of my cash position. If you start down this road, I advise you not to take concentrated positions, even in risk defined trades, you will lose your shirt eventually.

A few points to make in this first post:

  1. I am not really a fan of trading weeklies. Ideally, if I am writing options spreads, I want premium decay to do most of the work unless I have high conviction on direction of whatever underlying asset I happen to be trading. This requires writing spreads a bit further out on the curve. If I get a directionally beneficial move early on then I take the profit off the table and look for another position. One in the hand is better than two in the bush, as they say.
  2. Some of the index expiration and settlement dates leave you vulnerable overnight for a big move against your position. In general, if most of the profit is on the table, taking an SPX or RUT spread to expiration is not worth it to me. I would hate to wake up one Friday morning to a big gap up or down against my given position when I could have taken the profit off the table the day or week prior. If selling options is collecting pennies in front of a steam roller then what do you call not closing a profit because you want to avoid commission costs?
  3. Managing your positions is crucial. If there is enough interest in this article I will do a deep dive on my approach to managing my open positions and how I cut and run if I am completely wrong on a given play.
  4. The structure to this series of articles will transform as I see what method of organization and presentation makes the most sense.
  5. Since I am a bear for the moment, and since markets rarely crash upward, most of my writes will skew to the call side.
  6. Bid ask spreads on my writes especially need to be very tight. If the position moves against you and you need to get out, a large bid/ask spread and the low volume it implies, will cream you.

My Most Recent Trades

This week my trades have revolved around the SPX and the RUT. I am directionally bearish for the long term, for now, but the choppy market movement has allowed for non-directional plays to be made. Below you can see why I am not a huge fan of trading the weeklies from week to week.

SPX May 20 2016 Call Spread at 2090 and 2085

Here I sold the 2085 strike and bought the 2090 strike for a net gain of $60 per contract and max risk of $440 per contract. The trade had an 81% chance of expiring out the money (OTM). The SPX gapped up that day and then down the next. On the gap down I closed the position for a $22 per contract outlay for a net profit of ~$38 per contract. That is a %8.6 gain on that position. I am comfortable risking $440 with an 81% chance that I can take profits on that position in just a few days. There were 4 days to expiration when this position was opened.

The problem I run up against with weeklies is the lack of time to adjust, or if the conditions are favorable, to let a position ride and let decay eat the written spread down.

SPX May 20 2016 Put Spread at 2000 and 2005

Here, much like the above, I sold the 2005 strike and bought the 2000 strike for a net premium intake of $65 per contract and a max risk of $435. I bought this back on yesterday’s choppiness for ~$28 per contract and closed with a ~$37 net gain for ~%8.5 gain on position. Again this had a %80% chance of expiring OTM.

Going Forward

For the next few articles I will talk about the different facets of trading my building cash position via derivatives, managing risk, worst case scenarios, and different trading strategies.

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