Traders Edge Blog

Then and Now…

Good friend of mine recently turned me on to a blog run by an author/blogger/music company vet who prolifically cranks out some good stuff near daily. He weaves a good story laced with perspective, insight, history, opinion, humor, anecdotes, etc. One of my favs from amongst his offerings is his “Then and Now” postings, in which he provides a good take on the changing nature of all things in his business.

Well, our playground is the market, which is synonymous with change each day. As such, I thought I’d throw together a short list of examples of how trading and the markets have changed…both for giggles sake and to get you thinking about where things might head next in this dysfunctionally crazy business in which we participate.

Options

Then – Few knew anything about them and most who did purchased them as a hedge against their equity holdings.

Now – Those of you following Preston or Karson sell contracts to make income…now weekly income… Gone is the day you had to purchase equity shares and tie up huge sums of money and margin to participate in a stock’s movement…no reason to do so with options.

Then – Lots of peeps purchased LEAPS of a year to two years on individual stocks, hoping they would go somewhere significant given enough time.

Now – Weekly options were introduced with little fanfare several years back on a small handful of stocks, ETFs and Indices. Now the list of underlying assets with weeklies attached has grown significantly (160 stocks with weeklies presently) and promises to expand much further still. Moreover, volumes are ever increasing and actually surpassing the daily trade activity associated with many monthly options. Here at TE, one of the major approaches to trading is that of writing contracts using the weeklies to bag income.

Then – Set in stone – options were always tied to 100 shares of the underlying stock.

Now – Minis have just become available in the last couple weeks that are tied to just 10 shares of stock. At this rate, we’ll soon be ordering McOptions from the value menu at McDs.

DJIA

Then – The venerable benchmark index of the masses (let’s face it – those who trade with any regularity are looking at the S&P, COMPX, Russell, Euro, Dollar, Gold and others such indices to trade off of) tagged the 10K mark for the first time ever in March 1999.

Now – After plunging to a low of 6,469 in 2009 during the midst of the financial meltdown that precipitated the Great Recession, the INDU pulled a V-shaped turn that few trusted and everybody thought would eventually be retested. The bull-run embarked on at that time has now lasted four years…and in the last week culminated with an all-time closing level high for the index just above 14,660.

Futures

Then – Futures were the playground of the institutions exclusively…fund managers used them to hedge, as a trade mechanism for portfolios balancing (especially those with funds tied to key benchmarks, such as the S&P 500) and to engage in short-term directional bets.

Early on in the days of day-trading, traders would watch them closely as a “tell” on when major money-flow surges where occurring, along with major swings in the tick and other such indicators, in an attempt to time entries and exits on individual stock trades…especially those scalping.

Now – Lots of peeps shun stocks and instead trade futures on everything from the major equity indices across the globe to currencies, crude oil, gold, soybeans, treasuries and anything else you can place a financial bet on.

Scalping

Speaking of scalping…

Then – Inside-term bandied about by unscrupulous brokers in regards to their treatment of unsuspecting clients. Churning, front running and other forms of outright fraud were the norm in many firms and taking scalps to secure fat commissions was a routine practice.

Now – Scalping has always been a big part of day-trading…either by choice or because of undisciplined trade management. It’s one thing when you’re trading many time over for pennies and dimes (tough way to make a living, but it can be done)…quite another indeed when you’re trading approach boils down to cutting your winners short and always letting your losers run (guaranteed quick trip out of the business)…

Trading

Then – Your broker called you incessantly with hot tips when you didn’t want to hear from him and couldn’t be reached when those hot tips turned south and you were desperate to know what to do…

Now – You cuss at your computer screen and “those” peeps out there who always seem to be lurking and whom inevitably know what you’re doing, and in turn do everything in their power to head hunt you and rob you of your bank… Tell me you haven’t at times felt someone was out there targeting you while you were trading…raining down on your every trade!

Then – Back in the 80s, the challenge was convincing peeps to pull their money out of the banks and CDs to invest in a stock market that most knew little about and feared. It was a big step for an individual to buy into mutual funds, let alone purchasing individual stocks.

Now – No one would trust putting money in a bank (ask the peeps in Cypress how they’re feeling about their deposits and the banking system…while you’re at it, might wanna ask their thoughts on the Germans and entire EU…or whether they still think membership in the EU has its privileges), one of the most popular ads on TV is centered around a baby talking up investing using a certain online brokerage firm, and you’ve got cab drivers from here to Dubai trading Forex pairs between fares.

Then – Most peeps got their stock quotes out of the paper, while those living on the cutting edge called their broker (who was unlikely to take the call unless they had something to pitch AND they weren’t currently ducking calls because of their latest disastrous suggestions…) to get a delayed quote. The really smart peeps spent their mornings perusing the Wall Street Journal to stay abreast of all things business and investing.

Now – You trade, manage your portfolio and do all your research on your iPhone while simultaneously carrying on 4 or 5 text conversations and playing Words w Friends…and checking to see if your latest posting is trending on Twitter…

Goldman Sachs

Then: GS was the Big Swingin D on the street, pushin everyone around…and the envy of all.

Now: GS is the only real holdover of the “bulge bracket firms” from days of past and now a Bigger Swingin D…one that everyone hates and gets pushed around by…even the little guy… Their executives routinely retire to run (ruin…always get those two messed up) our treasury or act as special advisors to world Governments… We’re certainly in good hands with such advice – just ask the Greeks how that turned out for them…

Wall Street Executive

Then – Bernie Madoff helped found and was head of NASDAQ.

Now – Bernie (often “affectionately” now referred to as another “B” word) went from being one of the largest market makers on Wall Street (in addition to his hedge fund business) to making license plates. Putting his executive experience to good use, he’s now the president (amongst other positions…doh!) of the Bubba T fan club in Cell Block C.

K, I did take a little license there….there are some good peeps on Wall Street – they’re not all Madoffs – they just all make-off with loads of greenbacks at the individual investors expense… just say’n…

Merrill Lynch and Lehman Bros

Then – Both were synonymous with Wall Street, investment banking, greed, power and all things trading and investing related.

Now – One is part of a bank and the other was bankrupted and now defunct, having been kicked out to the Street by our beloved Fed…an act many now credit as the singular event that led to the near collapse of Wall Street and the ensuing onset of a financial meltdown from which we still struggle to overcome.

Retirement Strategy

Then – When I was getting into the biz more than a couple decades past (yes, nearing fifty and old as dirt, as my sons often remind…those very same young Micks I house and feed and love unconditionally, who refer to me and all others of this age and beyond as “dults.” Hmmmm), and certainly ever since that time, every book, broker, advisor, financial billboard, magazine, radio commercial, infomercial, neighbor, bookie, barber, lawn boy and the 11-yr old baby-setter, has preached the same message to the baby boomer population — start young and get to socking away as much of each paycheck as possible into an employer-sponsored plan, as well as an IRA for you and the spouse… Good advice all, premised on the notion of creating savings for your retirement years that would gain benefit from the principle of compounding savings and interest, further enhanced by tax-deferral and reduced reportable income each year… Oh, and the jackpot of all benes – gaining access to a market sure to return a minimum of 8 percent on average, with some big-time returns handed out in the occasional year… Yes Mr. and Mrs. Boomer, there is a Santa……………….

Now – Would appear Santa took a header…and with him 100s of billions in retirement savings from the dult population that now finds themselves in dire need of the dough. A sign of the times is something I heard this past weekend while spending some time up in Cape Hatteras. While driving, I happened upon a station where the host was goin off on a rant, which caught my attention. I then listened to him go on for some time, preaching to his audience a message that was quite contra to the established financial services/retirement industry party-line. He was telling his listeners to clean out their IRAs and other retirement accounts (including qualified employer sponsored plans), pay the taxes now and buy tangible assets to avoid the government stepping in and taking it all away from you later… Sounds Orwellian, till you consider what’s occurring in Europe now…

Trust in Financial Institutions

Then

Now

Nuff said…

Microsoft vs. Apple

Then – Microsoft was the bell weather when it came to tech and the Nasdaq. They printed money at a faster clip than our government and their core product (Windows) rivaled oxygen in terms of life’s necessities.

Now – Do I really need to spell out how things have changed and whose products now are considered necessities of modern life?

German Engineering

Then – Audis were built to last…and they did so

Now – Don’t get me started………………

Sorry, unsure how that last one got in there… nothing to do with the 4500 pound paperweight (6 years old and less than 100k miles…) presently occupying my garage.

 

Louis entered the biz in the late 80s and spent over a decade
working as a trader, instilling him with unique insight into
trading and the markets. In 1998 he switched gears to
become the group editorial director for a large network of
award-winning, trading-focused newsletters. In 2002 he
became the founding editor-in-chief for two financial trade
magazines—each served approx. 40,000 independent
financial advisers nationwide. He’s appeared on business
TV, in the business press and on numerous biz-focused radio
programs in the past. He writes market commentary and
analysis most days and trades on a daily basis.

Is Apple really a broken stock? Hardly

Our friend and colleague at optionMONSTER, Chris McKhann, just recently asked the rhetorical question, “Is now the right time to buy calls” in an article on optionMONSTER.com in which he highlighted the merits of Apple (AAPL). Readers of my DRJ’s Blog know I have discussed the strength of the business model metrics at Apple in the past (Jan 24).

To hear all the talking heads bemoan the state of Apple, you’d think the stock was heading to zero. But let’s try a little experiment. Suppose we blacked out the ticker symbol and looked only at the company’s metrics:

• Forward P/E minus cash of 7.
• Gross margin of 38 percent or 39 percent this year.
• Revenue growth this year of 17 percent.
• Growing revenues in China at almost 70 percent.

Wouldn’t you be buying the stock with both hands? I said back in January that I think we all would. Consider this experiment against the question asked at the beginning, “Is this the right time to buy calls?”

Take a look at these more recent findings.

AAPL April 4, 2013 (Source: tradeMONSTER.com)

Call buying is probably the most recommended option strategy. That does not make it the best, and in some respects it is one of the most risky. But there are great times to buy calls, and this is one of them.

The appeal of call buying is that it is a limited-risk strategy with the potential to produce substantial gains. The leverage is huge, which is why “instant millionaire” hawkers often promote it.

For example, in Apple you could buy an April 440 call with the stock trading right around $430, ensuring the right to buy 100 shares at $440. The premium of that call is $6.30 at the time of this writing, for a total cost of $630. (Remember that one option represents 100 shares.)

An outright purchase of those 100 shares, meanwhile, would cost $43,000. So if Apple were to rally up to last week’s high around $470, you would make $4,000 on the stock for a 9 percent return.

But the calls – if held until expiration – would make $2,370 ($47,000-$44,000-$630) for a 376 percent return.

The problem is that there is only a 36 percent probability that AAPL will be above $440 at expiration and only a 7 percent probability that it will be above $470.

Most call buyers bet too much money on low-probability bets, and this over-leverage is what eats up capital. That is one of the biggest risks of this option strategy.

That said, there are times when buying calls make a lot of sense. The markets are near landmark highs, but volumes are light and some believe that we are poised for a correction. And volatility is low, which can be seen in a general way in the VIX.

The volatility matters because it is a key component of the option’s price. The higher the expected volatility, the higher the option price, and vice versa. Often in options, that expected volatility is higher than the actual volatility turns out to be, and that is the reason many professional traders use option-selling strategies. This presents the other big risk in option buying; that you are paying more than you should, in volatility terms.

If you are bullish on the overall market, but worried about a potential pullback, then selling stocks and replacing them with long calls makes a lot of sense. You could buy SPDR S&P 500 Fund (SPY) calls to get that upside exposure, for instance.

The SPY Weekly 157 calls, with 10 days left to trade, cost $0.52 and have an implied volatility of less than 9 percent. That compares to the current 10-day historical volatility of 9.3 percent and a 30-day historical volatility of 11.3 percent.

The key is to only replace your current exposure, not to leverage up because of the lower cost of the calls. To be clear, I would not add long calls to a long-equity portfolio here; I would replace the stock with the calls. If you had 1,000 shares of the SPY, then I would suggest buying only 10 or 20 SPY calls.

This would allow you to continue to have upside exposure while significantly lowering risk. And you want to buy options when volatility is low, as it is now.

For those of you who can’t or don’t want to sell your stocks, then buying at-the-money SPY puts actually gives you the same risk profile.

That hedges risk while maintaining the upside exposure. Consider it a kind of “inexpensive” insurance that is priceless if we do get a significant drop.
Regards,

Jon “DRJ” Najarian

Jon ‘DRJ’ Najarian is co-founder of optionMONSTER® and co-lead analyst for the InsideOptions™ trade idea alert systems. He spent the first 29 years of his trading career trading in and around the pits of the Chicago exchanges.

“DRJ” is a frequent contributor to CNBC, the Wall Street Journal, as well as other prominent financial media organizations. Mr. Najarian also co-developed the patented trading algorithm the Heat Seeker®, used to detect unusual trading activity.

(Portions of this article appeared in optionMONSTER’s Options Academy newsletter of April 3.Chart courtesy of iVolatility.com.)