The Amateur Trader

This morning (after the opening bell) we purchased June $26.25 put options on NVidia Corp (NVDA) for $1.10. Thursday of last week Nvidia released positive Q1 earnings, but received negative prospects of future growth by analysts. 3 red arrows, mediocre fundamentals and more than double sell-off volume indicates institutional selling. The question is how many institutions are bearish on this stock.

The VIX hit a 3-month high this morning, which is a mixed signal here. The news is also mixed. If there is no significant downward movement this week, we may sell.

Our DLQRE options were sold near the end of the day today at $1.20. We made 4% on this 4-day trade. We wanted to get out of this trade as soon as possible (without incurring a loss) since we had lost so much of our leverage when it was originally purchased. The $1.20 limit order was set earlier in the week.

The main points learned from this trade are:

• Never submit a market order prior to the opening bell if there is a significant chance of abnormal trading on the security.
• When trying a new strategy (try to) paper trade it first. On the Dell option we ignored 2 of the fundamental indicators (macd and stochastics). Given the number of opportunities that come about, there is no need to compromise these indicators for the trade that motivated opening this option play.

Today we traded like an amateur. Last night we placed a market order for the June 2006 $25 put option on Dell Inc. (DELL), and it was purchased just after the opening bell this morning at the peak-high price of $1.15. DELL opened at $24.64. That means the instrinsic value of the option at that time was $25-$24.64=$0.36, which we paid $1.15 for. Not a good deal at all. Moreover, on a day of heavy trading the stock closed up at $25.20, meaning we are now out of the money. So why did we purchase this option? Good question. The short answer is that we acted emotionally, and didn’t stick to the system. Longer answer:

1. After the closing bell yesterday, Dell announced that it will fall short of hitting its first quarter profit target.
2. The stock is already down-trending, according to the 30-day moving average.
3. The stock is in a down-trending industry group (Technology/Computer Hardware).
4. Weak to average fundamentals.

What did we learn from this? Kind of early to say – let’s see what happens in the next few days or weeks. Fortunately we didn’t invest as much into this speculative buy.

Other notes for future reference:

1. Dell stock fell 5.8% to $24.90 on Monday during after-hours trading after the announcement. So a fair amount of trading already occurred after the announcement and before our option purchase.
2. Today’s volume on DELL is 84M, average is 25M.
3. Today’s volume on DLQRE is 13,333, open interest is 23,898.

There is one thing that we learned from this so far: Be cautious when placing overnight market orders for securities that may be in high demand. The price you buy it at may be temporarily inflated by the demand. In this case the $1.15 price is the current all-time high for this option.

Been lagging in updates due to a small vacation. Last Thursday May 4 we purchased Adobe Systems Inc (ADBE) June 2006 $37.50 put options at $3.10 a day after the company announced lower expectations in Q2 results. At the time ADBE had heavy volume on 3 red arrows:

Today in mid-day we sold the options at $3.65 for a 17.7% gain in 2½ days. However it seems we sold too early. ADBE had a strong support at $34 for the past few days; see first image below for a 5-day view. Since we were already up with a healthy profit, and didn’t want to risk a pull-back, we sold. Part of the speculation was that the news wasn’t very strong — it wasn’t like the actual earnings were posted as it was for the Motorola option play. Part of what gave the impression of the strong support was the scale of the 5-day image — when the chart includes the large jump that produced the sell signals, it also scales the graph so that other fluctuations seem small. This is a pattern to learn from.

All MOT options were automatically sold this morning at the market value of $3.50, a 40% gain from the purchase price of $2.50 7 business days ago.

Below is a 6-month graph of MOT with the resistance line drawn in black. This is drawn from connecting the lowest closing prices, and extrapolating forward. It may very well go lower in the immediate future, but this option play should not assume it, as this rate of return is good enough.

We will be looking for more option plays like this. The key features here that motivated this play are the following, based on the day with the right-most 3 red arrows:

• Broke down through 30-day moving average
• MACD turned negative
• Stochastics crossed down through 75% mark
• Heavy volume (at least 150% of average)

In addition to these technicals, there should be 1 other outside influence adding force to the play, without anything else significant that would push it in the other direction. In this case the outside force was the down-trending industry group.

This evening we submitted a market order to sell all of our options of MOTQE that were purchased on April 21. It will be fulfilled tomorrow morning. We are changing our intial strategy – the level of resistance identified at $20.50 was too optimistic, especially when seen in greater detail on the 6-month graph below. Drawing a line from the 2 lowest closing prices last February and March brings us to where we currently are now. Given the risk to begin with of simple put option strategies such as this, we are comfortable with our gains and are choosing to risk selling too soon rather than too late.

Our general investing strategy is medium term – 1 week to 3 months. We aren’t day-trading, nor looking for long-term investments. Operationally, we strive to spend 15-30 minutes per evening prior to days when the market is open reviewing existing investments and searching for new ones.

Factors considered when searching for an investment:

• Technical indicators:
  • 30-day moving average
  • 8-17-9 MACD
  • 14-5 stochastic oscillator
  • Volume
  • General price pattern movement as identified in the technical analysis literature
• Insider trading (what company insiders are doing as reported to the SEC)
• Movement of industry group
• Fundamental analysis (company financial statements)
• News

Fortunately much of this can now be automated, summarized, and most importantly, searched for. We pay around $50/month for an online service to supply this data. Most of the above information for any given stock are typically available for free from sites like finance.yahoo.com. Rather than advertise here any particular paid service, if you want to know who we use, feel free to email and ask.

On Friday we bought a $25 May 2006 put option on Motorola (MOT) for $2.50/option. Their Q1 earnings report earlier in the week gave a very strong sell signal according to 4 technical indicators: price broke downward through 30-day average, macd turned negative, stochastics broke downward through the 75% mark, under very heavy volume (53M shares vs. a 52-week average of 20M). Though their company fundamentals aren’t too bad, their stock group Technology/Communications Equipment is on the down-turn, so this looked like a good opportunity for a 1-month put option play.

We’ll discuss exactly what a put option is on a non-trading day, but for now these are the steps that were taken for choosing the best option. We went to http://finance.yahoo.com/q/op?s=MOT&m=2006-05 and copied and pasted the put option table that expires in May of 2006 into a spreadsheet. We then created an ROI (Return On Investment) table for the range of target prices from 20-25. This range was chosen because the stock has been fluctuating in the 20-25 price range for the past 9 months. Balancing safety with profitability, it seemed the $25 strike price was most attractive. If MOT closes at $22.50 on May 19, we break even (minus brokerage fees.) If it closes at $22, we make 20%. If it closes at $21.50, we make 40%, etc.

Our exit strategy is to sell all the options prior to the option expiration date of May 19 if the stock price hits or drops below $20.55. This price was chosen from observing price resistance at around $20.50 for the past 6 months. Our online broker conveniently allows an options trade to be triggered by behavior of the underlying stock. A trade trigger was set to sell all options if MOT hits or drops below $20.55.

Options trading can be very risky. For example if MOT closes at $24 on May 19 and we have not yet sold our options, we lose 60% of our investment. If it closes at $25 or higher we lose 100%. Today we are up 16%. Not bad for 1 trade in 1 day. But these tempting returns attract many investors into trades that will take the shirt off their back.

Today we bought some shares of SunOpta Inc. (STKL) for $9.20/share. This was identified as an uptrending stock in a rising industry group with solid fundamentals, was just oversold according to the stochastics and macd, and rising on heavy volume. Click the below image to see the stock and these indicators. On a non-trading day we will discuss these indicators in greater detail. We will keep an eye on this stock daily and follow the technical indicators for sell signals.

Robert Kiyosaki says in one of his books that information is like wine – sometimes it takes time to age. I’ve done some heavy stock and options trading a few years ago after paying a good 4 figures for a class and inhaling a few books on the subject. I’m ready to take that bottle out of the cellar now and uncork it. Let’s see if we have something comparable to that unforgettable bottle of Côtes Du Rhône I had at a friend’s bachelor party dinner some years ago – or vinegar.