Anatomy of a Trade

Why I bought calls on a 2X ETF of the S&P 500 in the last hour of trading yesterday.

Investors see little benefit from volatility, while traders thrive on volatility. For the buy and hold investor (in, say, Joe's Beanery) who bought stock in Joe's because he liked the food and the place was always busy, then volatility brings bad things: his stops (if he followed all the investor gurus' advice and set stops) get triggered and blow off his position, and he's left with the discomfitting dilemma of either buying back in after the stock has popped back up or wait for another dip.

If the investor is really long-term, then when Joe's gets dumped along with all other equities, then he sees the dip as a buying opportunity. This works in a Bull market but not in a Bear market. The long-term investor is basically counting on a permanent Bull market. That works until it doesn't.

The boring melt-up that delights buy-and-hold investors bores traders to deathbecause it's hard to make a killing in a low-volatility melt-up or meltdown. So this week's trading is Heaven-sent for traders. Even a two-bit player like myself has been able to make a few bucks on the long and short side.

I am both an investor and a trader. As an investor, I'm buying small U.S. oil companies with leases in the U.S. I don't really care if they go up or down, it's a long-term play on $300/barrel oil. If they get trashed, fine, I'll add to my positions. (I suggested this idea in my Weekly Musings--not as investment advice but as an investment idea.)

Speaking of which, please note this is NOT investment advice--it is only the freely offered weird and colorful ramblings of an amateur observer. Please read the HUGE GIANT BIG FAT DISCLAIMER below for the very good reason that trying to duplicate the trading strategy presented here could wipe you out.

Nuff said, right? DO NOT make investment decisions based on the colorful ramblings of an amateur.

Yes, I am about to describe an extremely high-risk trade which nonetheless strikes me as a very low-risk trade. Only an idiot trade options on a leveraged ETF--unless said idiot is relatively confident in trading options, i.e. only trades what he can afford to lose and/or as a hedge against another position on the other side of the trade.

Basically, I made a bet that the market is poised to make a nice little rebound right here. If I am wrong, then I will be spectacularly wrong, and if I'm right, then it may well be a profitable little gamble. I am posting it tonight, before the market opens, so I can't second-guess my positions.

I sent a Tweet about mid-day which asked if Da Boyz (Wall Street) would suck up these huge imbalances in their trading positions (long and short) come Friday options expiration. In general, they don't like sucking up huge losses, and for that reason alone I expect a rally (bogus, engineered, real, take your pick) tomorrow that lasts into Friday so Da Boyz can exit their options positions without sucking too much wind.

The market has fallen to major support. The Dow Jones Industrials have slumped to the 11,600 area, a level of support/resistance going back to the 2000 dot-com peak and the 2007-2008 head and shoulders. A bounce would be technically typical here.

Then there's the Bollinger bands--price has punched right through the lower band, an extreme that is typically resolved by a short-term bounce.

Lastly, there's the pervasive expectation of complete disaster regarding the Fukushima nuclear reactors. If you read/watch the mainstream media and the blogosphere, then you might conclude that it's only a matter of seeing just how awful and horrendous the criticality will be.

In other words, the market has discounted the possibility of any good news on the reactor front. I have a bit more faith in the resilience and work ethic of the Japanese, however, and therefore I anticipate some good news shortly: one of the reactors will cool off, some measure will finally provide some positive results, etc.

At that point, the market could explode in a relief rally, and I will be poised to gain from that reversal of guaranteed disaster to glimmers of hope because I bought calls when the market was plumbing the depths of dispair.

I have no idea what will happen on March 17, and neither does anyone else. But I do know one thing, which is violent swings of hope and despair and high volatility are a trader's best friends--if the trader is on the right side of each swing.

In other words, I may have my head handed to me on a platter. I am well aware of this possibility and sized the bet accordingly.

I have been setting up a new PC and a bunch of other tech stuff, so please bear with delayed email responses. Your understanding is greatly appreciated.


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