Trade The Journey

Trade The Journey

Confused

Top of the Morning! Another week and another set of new highs for most of the indexes. The Russell Index remains in a sideways range and under its fifty-period simple moving average. My charts include simple-moving averages, volume fifty period simple moving average, and implied/historical volatility chart.

Sectors ending the week in the green:

Information Technology, Financials, Health Care, Communication Services, Utilities, Energy and Industrials.

Sectors ending the week in the red:

Consumer Discretionary, Consumer Staples, Real Estate, Materials.

I wonder if we are nearing a peak. A strengthing job market wasn’t enough to influence the Federal Reserve to change its tone. Some believe the Federal Reserve has already begun tightening through the use of the REPO market. 

The markets still seem to be vulnerable, especially to the continuing Coronavirus and its implications for economies.

In the US, 70% of its citizens have received at least one shot. The government is beginning a mandate vaccination for its workers. If you choose not to be vaccinated, you will have to be tested weekly. Companies are following suit by requiring vaccination for employees.

Most of the hospitalizations and deaths due to the Coronavirus have been among the unvaccinated. Doctors are beginning to acknowledge that booster shots may be required. News reports say that the virus mutates in the unvaccinated but is not likely to do so in the vaccinated.

The ten-year yield continues to be monitored for signs of a recovery peaking. Cryptocurrency is staging a rebound, with Bitcoin leading the charge and the alt-coins following. It still amazes me that one dogecoin is nearing the worth of a quarter.

Now the worry is that the Federal Reserve will be cracking down on Cryptocurrency. The infrastructure is near passage, and one of the ways suggested for paying the bill is increased taxing on Cryptocurrency. This past week, Etherum broke above $3,000.

Etherum is in the process of upgrading to Etherum 2.0. 

Confused

My last few posts have centered on Options Trading. Options are still new to me; however, I’ve come quite far from the previous year. I tried understanding options but initially gave up due to their complexity. I intuitively understood a call option contract that involved buying and selling shares. 

Puts gave you an option to sell and the obligation to buy if you brought or wrote a put option.  

What was even more confusing for me was the profit/loss graphs for put and call options.

I can remember reading an article about options, and for the first time, I understood how they worked. Unfortunately, understanding how put and call options work is just the first step.

The next step involves options greeks, volatility, and put/call parity. 

The greeks are risk measures that state how the options values move in response to the underlying assets. The greeks are imperfect like most indicators in the market.

Volatility is what I am focusing my efforts on understanding. Volatility is a statistical measure based on the mean. It mainly measures the movement and magnitude against the standard. Initially, I thought that volatility indicated direction, but it does not.

There are two forms of volatility in options, historical and implied. Historical volatility measures what has already happened, and implied volatility is the market’s forecast of volatility.

There are several reasons volatility may spike; it could be an announcement, pending lawsuit, or earnings, to name a few.

Higher volatility causes more options to become more expensive, while lower volatility lowers the value of an option.  

Volatility is an important measure to watch; it fluctuates and returns to its average like most cycles.

Now, I’ve hit another roadblock in the form of synthetics and put/call parities. Beyond the strategies of options combinations lies another put/call option feature: synthetics.

Synthetics involve combining puts and calls to mimic options and stocks. The parity equation states that a put, call, and stock are equal. A put is a call, and call is a put.

This post assumes you have a basic understanding of how options work.

I have trouble understanding synthetics. Below is a list of possible synthetic contracts.

Position Synthetic Position

Long Call Long Put/Long Stock

Long Put Long Call/Short Stock

Short Call Short Stock/Short Put

Short Put Long Stock/Short Call

Long Stock Long Call/Short Put

Short Stock Long Put/Short Call

Long Straddle Short Stock/Long Two Calls

Short Straddle Long Stock/Short Two Calls

Why are synthetics essential to understand?

Understanding synthetics translates into an understanding of how options work. Looking at the pairings above, I remember that a long call enables you to sell the contract for an agreed-upon price. A long put gives you an option to sell the contract for an agreed price.

Long call: Bullish position. You brought a call with a strike price of $100. If the stock rises to $110 and you purchased the option contract for $1 at $100. Above $101 ($100+$1) you are profitable.

Long Put: Bearish position. With the same strike price of $1, you a buy a put. If the price falls to $98, you make $1. By purchasing the put, the breakeven became $99 ($100 -$1).

Let’s look at a synthetic long call that involves a long put + stock. A put protects you on the downside, and a long position on the stock captures the upside movement.

Stock: $99

Put: 100 long put

Put Price: $2 ($3-$1) + $1 loss on stock

Synthetic Long Call Option Price: $3 loss

Total Loss: $3 loss

Stock: $100

Put: 100 long put

Put Price: $3

Synthetic Long call option Price: $2

Stock price: $102

Loss on Put $3

Profit on stock: $1

Total Loss: $2

Synthetic call: Loss of $2

Stock Price: $103

Long Put loss: $3

Profit on stock: $3

Total Option loss: $0

$3 profit from the Stock ($100+ $3), but the price of the put option is still the full ($3)

Synthetic call: $0 because the $3 price paid for the option has not been covered.

It’s becoming clear, ignoring the greeks, that synthetics resemble the actual option’s Profit and Loss. Maybe, I’ve been overcomplicating synthetics; I tend to overcomplicate things.

Working through this gave me a little clarity on synthetics.

This past week:

What a week, an expected expense occurred and nearly wiped out my checking account. I had to dip into my savings more than once. I hate withdrawing money from profitable accounts, but this was an emergency.

Usually, I have money in my savings account, but this time I did not. Sometimes, I have a hard time telling myself “No” when I have the extra money in my account.

What’s upsetting is that I’ve done quite well managing my cash flow during the week. The problem is that all the self-denial builds up and I end making an ill-advised purchase. Since my available cash flow varies with the week, sometimes that ill-advised purchase can set me back.

I justify that purchase with the extra money in my savings account. “I’ll be receiving money tomorrow from my account, so I can splurge today.”

Grade: D+

Reason: Unprepared for an emergency expense.

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