Although this market definitely favors bullish strategies, there will come a time when more neutral strategies will be par for the course. Strategies such as a ratio spread where we sell two out of the money puts and we buy an at the money put or a closer out of the money put. This startegy works great in normal volatility environments and offers tons of availability as one can make money if the price of the stock goes up or goes down.
A variation of this startegy (for those who do not want to roll those puts if needs be) would be a covered call along with the purchase of an out of the money put. Take Sigma Labs, Inc. (SGLB) fore example currently trading around the $7.50 mark. Shares spiked higher today and implied volatility in the near-month cycle (March) exploded above 600% at one time. Even in the back month (April) where 300%+ levels were available, one could have bought 100 shares at close to the $7.50 level, sold the at the money call ($7.50) for $2.80 per contract while simultaneously sell the $5 put for roughly $1. This setup is very close to being delta neutral and it offers significant risk-protection to the downside. Furthermore the net credit comes in at $1.80 per contract on the options which is attractive for a low-priced stock.
Sigma Labs Spikes(SGLB)
Posted in Sigma Labs
Warren Buffet stated that the two most important rules of investing are
- Not to lose money &
- Never to forget rule No 1.
We believe that it is essential to adopt the same mindset in our trading exploits. One must hate losing in this game. Paul Tudor Jones (one of the best short-term traders in the world) has stated that his focus is predominantely on never letting the “market” get into his pockets.
So how do we set up a “no lose”mentality for our short-term trading exploits? Our short-term strategy at present in this market is to trade low-prices socks which are trading with high levels of implied volatility. We then either sell puts or covered calls in these underlyings. Ratio spreads are also an excellent option if one wants to use more capital (hence, less time) in each position but that strategy is for another post. The next obvious quetion is why do we cap our potential gains with these types of strategies. For two reasons.
- Selling covered calls or naked puts enables us reduce our risk
- Secondly and probably more importantly, it gives us the opportunity to defend if the respective position were to go against us
Take Auris Medical Holding Ltd. (EARS) for example. As we can see in the chart below, shares have once more spiked to the upside on strong volume in March. This volume spike has spiked implied volatility to much higher levels than we usually see in this stock. This means “Fear” is elevated in this company at present which means a big move is expected shortly. However, given the price of the company ($4.40) and the liquidity of the options as well as the high level of implied volatility, we believe we are in a very good position here to defend if needs be. If the volume trend is correct though, we should have have to defend here as the chart has a bullish bias. Next week will tell us a lot about the future directions of this stock.
Volatility in EARS spikes
Tellurian (TELL) has broken out of a multi-month trading range. This company´s aim is to build a huge LNG export facility in Louisiana to ship the commodity to the world. As an investment, the firm has major funding risks. This is a sizable project which is expected to generate significant cash/flow if indeed the project can get completed. Furthermore shareholders will also be hoping that it does not come in way over budget.
We understand why value investors may not be attracted to this company because of its lack of any real earnings plus the fact that significant capital will need to be raised to pay for the project. This obviously raises risk a lot especially if the price of natural gas for example were to drop sharply in the coming quarters ( We remain bullish though on Nat.Gas).
However, from a market´s standpoint at present, the fundamentals are bullish. How do we know this? Because the price is going up. As technicians, that is really all we have to know. If prices are rising, the fundamentals are bullish, if it is the opposite, they are bearish.
The beauty of sharp moves in price is that this causes implied volatility to spike which in turn increases the prices of the stock´s options. We expect the breakout to hold which means price has now no business dropping under $1.80 per share approx once more.
Breakout in TELL
Posted in Tellurian
Proverb 13:11 – “Riches gotten quickly will dwindle, but those who acquire them gradually become wealthy”
We want to make the portfolio as simple as possible. We actually started a few weeks back and have recommended stocks but we want to get even smaller. If you have the patience to to make consisten gains while controlling risk, here is the model we follow
- Invest in beaten down stocks with really attractive valuations. If we can pick up companies trading under book-value, all the better
- The cheaper these companies, the better. $3 or less per stock for example is favourable as the amount of capital to write covered calls is less.
- The state of the balance sheet is crucial. The number 1 focus from our perspective is to make sure the company in question will not go bankrupt. The more cash, assets, etc and the less debt the firm has, the less downside risk in the investment.
- We write covered calls on the stock every month to bring in income for as long as we can. If the stock is called away from us, well and good. We constantly look for opportunities to keep our funnel full.
- Remember our risk on these types of trades is what we pay for our shares less the premium we receive from the options. The lower we buy our optionable stocks, the less risk is there for us to lose money over the long-term.
The great thing about this strategy is that it is scalable. Position sizing for everyone will be different but we can´t stress enough the importance of getting as small as you can. Step by step, trade by trade, we will get closer to our goals.
After many years in this business, I have come to the following conclusion.
“All truths are easy to understand once they are discovered; the point is to discover them”
Our strategy is to reduce basis which improves our probabilities. Not for the masses but for the few who want to make steady consistent gains for the rest of their lives.
We have three stocks to add to the 1% portfolio. We call the portfolio the 1% portfolio to really get across the message of keeping positions small. If for example, each position in the portfolio only uses up 1% of the portfolio balance, then this imemdiately decreases portfolio risk especially if the dportfolio is well diversified. We have researched these companies and believe all of them have very limited downside risk which is exactly what we want. Remember, the play with this strategy is to buy 100 shares and sell one out of the money call option (usually in the next month at around the 30 delta).
This immediately reduces our cost-basis which improves our probability of success. Furthermore let´s take our first stock- Leju Holdings (LEJU) for example which is currently trading at the $2.42 level. The January $2.50 calls can be sold for approximately $0.25 per contract. So basically, one can collect more than 10% of the premium and the call option is still well out of the money. Exactly what we are looking for.
Equate the above though with a $20 stock. For the life of me, it is very fifficult to find a $20 stock which pays $2+ per contract (or 10% of the price of the shares) for the sale of an out of money call. But even if we did, our risk would be up to 10 times more the risk you have in a 100-share investment in LEJU for example. This really is what it all boils down to in the markets. It is all about position sizing and being able to come back the following day with your capital intact. One´s ego many times is one´s enemy in this game.
Very limited downside in Leju Holdings
With many stocks in the energy sector, it is all about being able to service the debt-load on the balance sheet. Crescent Point Energy (CPG) is attractive in that it has solid growth prospects and has made improvements with relation to its cash-flow and debt profile. Furthermore, as we can see from the chart below, the technicals are bullish. This is one of the few companies in the E&P space which has undergone a clear breakout above the June highs in recent sessions. Furthermore, volume has been there is spades since the start of November to accompany the rally. Liquidity is not as healthy in CPG although we do have a $2.50 strike available for puts or calls and IV is not as high as other viable candidates (73%).
The one drawback with the strategy we recommend (selling covered calls and selling naked puts) on sound companies is that one can obviously miss a lot of upside. For example, Marathon Oil Corporation (MRO) has rallied from just over $4 a share to currently be trading at $7.17 in 6 weeks. If one back in October for example had sold November covered calls at say something like the $4.50 or $5 strike price, then one would have missed all that upside shares have tacked on over the past few weeks.
There are a few ways to combat this problem which is not getting enough upside on your investments. One is to buy a little more than 100 shares per contract. By buying 10 to 15% more shares, you are giving yourself the possibility to make gains on the extra 10 to 15% which you can hold for the long term. As we outlined in yesterday´s update, we believe the energy sector has excellent possibilities of going on a bull run over the next 3+ years which is why we will be adding more energy stocks in time to our portfolio.
On another note, Inseego (INSG) has been on the tear recently and has come up against significant overhead resistance. A triple top-reversal could definitely be on the cards here. Who though has the nerve to short this firm aggressively now with the clear prospect of stocks entering a runaway move (bubble) ?
Bullish or topping pattern ?
On an individual stock basis, we like Blackberry (BB). The reason being is that shares underwent a breakaway gap recently on very strong volume. These gaps usually begin at the start of a sustained move and usually take place after shares have been consolidating for quite some time. If indeed we have a breakaway gap in play here, the gap should now act as support. Therefore, the high risk/reward play here is to buy 100 shares and to sell an out of money call option immediately against your shares. The proceeds from the call brings your cost-basis right back down to somewhere close to the top of that gap – thereby improving the odds of a successful trade significantly.
Breakaway Gap In Blackberry
Most people have an issue with lying to other people but dont seem to be nowhere near as bothered when they lie to themselves. When you actually resolve to do what you commit to every day, your results start to get better. You know deep down what you need to do to be successful in your business or activity. The problem is that for whatever reason, we deceive ourselves and dont carry out what we know deep down what needs to be carried out. Therefore take this quote to heart and live it every day.
“DO WHAT YOU RESOLVE TO DO AND YOU WILL WIN”