Archive for August, 2009
The Week That Is To Be: 8/17-21/2009
August 14th, 2009 | 
Author: ECONOMIC REPORTS
MONDAY 8/17
Empire Manufacturing, Net Long-Term TIC Flows
TUESDAY 8/18
Building Permits, Core PPI, Housing Starts, PPI
WEDNESDAY 8/19
Crude Inventories
THURSDAY 8/20
Initial Claims, Leading Indicators, Philadelphia Fed
FRIDAY 8/21
Existing Home Sales
EARNINGS OF NOTE
MONDAY 8/17
LOW, TSL
TUESDAY 8/18
CAH, HPQ, HD, LZB, SKS, SOLF, TGT
WEDNESDAY 8/19
CYBX, DE, GYMB, HOTT, JDSU, NTAP, PERY, PVH
THURSDAY 8/20
FLWS, ARO, BKS, BRCD, FL, GME, GPS, HNZ, HIBB, HRL, JMBA, PSUN, ROST, CRM, SHLD, STP, BKE, PLCE, TTC
FRIDAY 8/21
ANN, SJM
Posted in 
Commentary: How Does The Market Maker Take The Other Side Of My Trade?
Both the conversion and reversal are tools that the market maker uses to spread off risk. It is a three legged position very similar to a collar. Let’s say that the market maker receives an order to buy 10 call contracts long ATM one year out for a $30 stock. How is he going to hedge that. Well first, he will take that other side of the 10 call order and short 10 calls ATM. However, what is the risk in that position?? If the stock goes up, the market maker will be losing so he must hedge that position by buying 1000 shares of the stock at $30. However, there is still risk in the position for the MM. The risk is the stock goes down. So, the MM must buy an ATM long put.
What the MM has done is construct a riskless postion to hedge the 10 contract long call order. The MM is guaranteed to receive a profit of $30,000 on the postion because of the hedge. So one must figure out the present value of 30K today. If you used 3%, the present value would be $30,000/ 1.03 = $29,126. If the market maker pays $29,126 and get back 30k in one year then the ROI is 3%. This must happen in order to make this a risk free investment for the MM. We already figured that the MM will pay 30k for 1000 shares of the stock and let’s assume he paid another 3k for the 30 long put, his total cost is 33k. We have already figured that the MM should pay $29,126 for the trade in order to make it a risk free trade, so by paying 33k, he would be overpaying by $3874. So how does he make up for this shortfall? He charges the retail trader approximately $3.87 for the long call (10 contracts x 3.87 = $3874). The MM also makes his profit on the bid/ask spread.
So what we have is the MM spreading off the risk by using a conversion and adding in his profit margin with the bid/ask spread.
A reversal is the exact same thing except it is the mirror image of the conversion. Instead of the MM spreading off the risk of a long call, if he receives a long put order he would hedge with a short put, short stock and long call.
The Week That Was: 8/3-7/2009
The DOW continued its trek up, closing higher week over week by 198 points. The ascent has flattened and we could be forming a rounded top. Fridays’ action pulled back into the sideways trend that has been evident for the past four trading days. Volume has been unremarkable. Support resides at 9088, 9007, 8878, 8221 and 8087. Look for upside targets at 9654 and 9794.
My upside projection from last weeks’ blog for the SPX was 1007 and we settled at 1010 at the bell on Friday. There was a confluence of indicators with a fibonacci level and a swing high from 11/4/2008 that is forming resistance. We are currently overbought and looking for a pullback soon. I don’t believe it will be severe, but more of a general “shake out” before resuming higher. Support is at 992, 969, 956, 944, 930 and 869. The next upside target is 1044.
The COMPQ is currently in a Bull Flag and looks as though it wants to roll over. If the index breaks below the low of this past Thursday, and it does it on volume, we may begin a more significant pullback. RSI, Stochastics and MACD are all looking toppy. Stay nimble and follow the market.
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Risk Graphs: Short Call Butterfly
The short call butterfly is a limited risk, limited reward strategy that is best implemented when volatility is relatively low in anticipation of increased volatility after entry. The short calls reduces the cost of the trade but also decreases the reward. The long calls are placed ATM and the short calls are equidistant from the long call strike with one short call above and the other below the long call strike.
The Week That Is To Be: 8/10-14/2009
ECONOMIC REPORTS
MONDAY 8/10
None
TUESDAY 8/11
Productivity –Prel, Unit Labor Costs, Wholesale Inventories
WEDNESDAY 8/12
Trade Balance, Crude Inventories, Treasury Budget, FOMC Rate Decision
THURSDAY 8/13
Export Prices- Ex Ag, Export Prices Ex-Oil, Initial Claims, Retail Sales, Retail sales Ex-Auto, Business Inventories
FRIDAY 8/14
Core CPI, CPI, Capacity Utilization, Industrial Production, Michigan Sentiment – Prel
EARNINGS OF NOTE
MONDAY 8/10
CPST, CEA, CLNE, DISH, SATS, FLR, MDR, NLS, PCLN
TUESDAY 8/11
BOBE, CREE, DNDN, FOSL, MBT
WEDNESDAY 8/12
BHP, JASO, LDK, LIZ, M, NTES
THURSDAY 8/13
BBI, BGG, DV, GNC, KSS, JWN, URBN, WMT
FRIDAY 8/14
ANF, JCP
Commentary: The Tortoise and the Hare
The other day a car raced past me jutting in and out of traffic, tailgating and quickly changing lanes without signaling. The driver was obviously stressed to the max, trying to get somewhere fast.
The interesting thing about this is that about 1 mile down the road at a stop light, I looked over to discover the same driver sitting right beside me. He was pounding on his steering wheel and the only thing he had accomplished was putting other people and himself in danger through his wreckless driving and taking a hunk out of his own emotional state.
Do you trade like the stressed out driver jutting in and out of trades with unnecessary and wreckless adjustments trying to get ahead only to realize that your efforts were not fruitful. So, the question is, are your frantic adjustments worth it? Are you getting ahead? The answer is, rarely do quick impulsive moves result in putting you ahead in the trading business. Most of the time those types of decisions are not well thought out and result in losses.
The epilogue to this story is that such activity will also translate to a very stressful experience that will only contribute to more of the same behavior in the future. So slow down and don’t put yourself and others in harms way. You will find yourself getting to your destination in one piece and with money in your pocket. Best, Robin
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