Be Careful Trading VXX and UVXY

From Our August 2015 E-mail Archives: One of our traders had a question about trading volatility. Our Senior Risk Manager, Corey, replied with a detailed explanation of why Maverick Trading trades VXX and UVXY differently than other assets in the market.*


-----Original Message-----

From: Roman F.
Subject: Trade Alerts

Hello,

Thank you for the ideas and updates, I check them every time.

I have one question about today's ideas: VXX. I constantly trade it and would like to confirm something. It looks like it's overbought and reached the resistance levels, but it opened above 17.00 today and still trending above this level. Why did Maverick Trading go long puts for 16.00 (delta 0.31, theta 0.02)? I have entered this position today with long puts at 18.00 (delta 0.51, theta 0.02).

If you have a chance, could you explain it for me?

Thank you in advance,

Roman


-----Reply Message-----

Hi Roman,

Thanks for the question. We trade VXX [iPath S&P 500 VIX Short-Term Futures ETN (Exchange Traded Note)] a little differently than we would most other assets in the market. The reason is that this is a flawed asset that is nearly always on its way to zero.

I have included a chart to the right (click the chart to make it larger) that shows VXX since its first trading day. It appears that the shares first started trading in 2009 for around $6,500 per share.

Did they bring this to market at such an expensive share price? The answer is of course, "No." This simply shows what one share was worth in 2009 compared to what it would be worth today. In other words, for every $6,500 invested in VXX in 2009, it is worth around $17.50 today (a loss of 99% of your investment).

The creators of the VXX reverse split this ETN whenever the share price drops. So, if you bought 100 shares at $100/share, then you have invested $10,000. If the shares fall to $10.00/share, then your $10,000 is only worth $1,000 today. If they come in and reverse split the stock, it won't help or hurt your situation. If they take that now $10.00/share price and boost it back up to $100.00/share ($10 x 10 = $100), then they will divide your share count by 10 at the same time. So, you now will only own 10 shares of the $100/share stock. If the stock falls again and again and again and they keep reverse splitting the stock, then you eventually have fractional shares (and essentially nothing).

The VXX and UVXY [ProShares Trust Ultra VIX Short-Term Futures ETF (Exchange Traded Fund)] work differently than most ETFs. This is due to their not really being able to "own" anything. A stock ETF is backed by shares of the companies that it tracks. Gold ETF is backed by Gold. VXX and UVXY track volatility, which is only a market gauge. In addition, VXX and UVXY have to use the futures to track volatility. Since volatility trades in "contango" (i.e., long-term volatility is a lot more expensive than short-term volatility), this is not a good thing.

To track volatility, both VXX and UVXY have to constantly buy expensive and sell cheap futures contracts. This creates a negative yield in VXX and UVXY that, over time, has them always going to zero (although they counteract this by constantly reverse splitting the shares). You can make money bullishly on VXX or UVXY only when there is a gigantic increase in volatility and even then you might not be able to outpace the decay.

In summary, we would be very careful and suggest avoiding VXX and UVXY as bullish candidates for the reasons above. However, trading them to the downside can be very advantageous.

I hope this helps.

Corey

* NOTE: Some original wording has been modified for legibility.

End of Day Post

The markets closed higher for a second day in a row, putting an end to the current surge of selling. GDP for the second quarter was revised slightly higher than expected, and the weekly jobless claims report decreased from last week. Both of these reports are indicating that the U.S. economy is still showing signs of strength and could have contributed to today's rally.

Today's close did confirm a new pivot low in the markets. This doesn't mean it will hold or we will necessarily continue higher, but a bounce here can trigger new opportunities in both directions.

The VIX is still in dangerous territory, so we should continue to stay cautious. Technically, the last two days should be viewed as an oversold bounce and/or the start of a bear rally pattern. Overall, our longer-term outlook should stay to the bear side. We are anxious to see how Friday plays out and what pattern the market gives us going into the weekend.

Continue to wait for confirmation before entering new trades. We just established a pivot low in the markets, so there is no reason to try and guess how far this bounce will take us.

Mid-Week Outlook

• Bullish: 14%
• Sideways: 48%
• Bearish: 38%

Have a great night,

The Maverick Trading Team

SLB: Highlighted Trade From One Of Our Traders

Another great trade made in Schlumberger (SLB), a basic materials company specific to oil and gas equipment and services. This trade is a nice example of using increasing volume to extend a possible target ‐ in this case, to the downside.

There are many different trading strategies available to take advantage of this type of setup in the options world. In this case, our trader wanted to take advantage of favorable volume. The trader decided to use a diagonal put spread, with the ability to adjust and take advantage of further gains.

Typically, for the strategy chosen, the risk is the premium paid and our traders aim for a 50%+ return. At Maverick Trading, we pride ourselves on our community of traders. Every week in our live Trading Room, our traders share their favorite new trade setups (like the one above from last week) with all of their fellow Maverick traders.

NOTE: Chart(s) courtesy of FINVIZ.com.

End Of Day Post

The markets appeared to be making an oversold bounce today; however, another round of selling sent them even lower into the close. The INDU made a 600 point swing today – up over 400 points earlier in the day and then closed down 205 points to end the day.

Today's action is the continuation of the same move that started last Friday, as the markets continue to search for support. The market action today is a testament to why we need to see the formation of a pivot point before taking action in directional trading. This amount of volatility can be dangerous and unpredictable and guessing here will just cost you money...no reason to try and catch a falling knife.

We have seen some overseas weakness, specifically out of China. However, there really isn't much in the headlines to warrant this type of market reaction. That being said, there is an enormous amount of fear driving this current move and we should continue to expect high volatility.

If you are going to take new trades here, then ensure that they can survive this volatility. Consider lower position sizes and increasing trading ranges for better probability. Options could be a little more expensive here and have wider than average bid/ask spreads. Make sure to take this into consideration when entering or adjusting positions.

Have a great night,

The Maverick Trading Team

Managing Collar Trades Before/At Expiration

From Our May 2015 E-mail Archives: One of our traders had a question about Collar trades before/at expiration, so he asked our Head Trader, Robb, for some guidance.*

-----Original Message-----

From: Evan S.
Subject: Collar Trade Management

Robb,

I just watched the "Retirement Planning – Session #3" class that you did on April 28, 2015. I had a quick question on trade management for the Collar trades; specifically, what needs to be done before/at expiration? The risk graph looks like a vertical spread, but as I'm thinking through it, the trade management will not be the same. In thinking through it, I believe that you should do the following if:

1. Above Max Gain - Do nothing, short call will be exercised and you receive full premium, long put expires worthless and you will sell the stock


2. Below Max Loss - Receive the full premium on the short call and it expires, long put will be exercised and stock will be sold


3. Between Max Gain And Loss - Do nothing, receive full premium on short call and it expires, long put expires worthless and you keep the stock

Is this correct? Basically, you never have to do anything...it is just a matter of "Do you sell the stock or not?", right?

Thanks,

Evan S.


-----Reply Message-----

Hi Evan,

You have the right outcomes if you just let everything get exercised. However, there are actually some things that you can do to hold onto your underlying ETF/position. Here are the choices that you have on each:

1. Above The Call That You Sold
1. Do Nothing – You were correct about the outcome
2. Buy Back The Call That You Sold – You may end up taking a loss on closing this short Call (if you are paying more to close the Call than you originally collected). However, you should have a nice profit overall. This is due to the stock having increased much more than the loss in the short Call position. By buying back the Call, you have removed the cap on the upside and are now back to a simple long stock position (with a profit). You would either let the long Put just expire worthless or close it out if there is any value left.
3. Roll Up To A Higher Strike – Let’s say that you own an ETF and sell the $35 Call for $1.00 when the ETF is at $34. The ETF moves higher (unexpectedly, since you placed a Collar) towards $35.75 and looks to be breaking out. You could buy back the $35 Call for probably close to where you sold it and you could sell the $36 Call for $0.75 (or whatever the market price was). You have now given your underlying an extra $1 of profit. You would either let the long Put just expire worthless or close it out if there is any value left.


2. Between Max Gain and Loss
   1. You are correct in your analysis and there really aren’t other choices.
   
   
3. Below The Put That You Bought
1. Do Nothing – You were correct on your analysis
2. Sell The Put For A Profit And Hold The ETF – Obviously, this is the correct choice if the stock/ETF has reached a bottom and bounces higher from there. You will simply sell the Put for a nice gain, which offsets the loss on the ETF. I just did this in my retirement account two weeks ago on a long Direxion Daily Russia Bull 3X ETF (RUSL) position when it hit $36. I bought Protective Puts and closed out the Puts when the ETF pulled back to $31. I still hold the position.

Hope this helps,

Robb

* NOTE: Some original wording has been modified for legibility.

End Of Day Post

The market's broke down today as support finally gave way. All three indices broke major support levels, giving up more than 2% on the session. Yesterday’s FOMC statement didn’t give too much clarity on whether or not a rate hike will happen in early September. Today’s move was more of a technical one, rather than a reaction to a news event or economic catalyst.

Today’s action included large volume, big range and a huge spike in volatility. The cause for this move isn’t as important as its effect. The amount of selling through these levels indicates a huge swing to bearish sentiment. With all of today’s action, along with the VIX spiking above 19, we should expect more weakness moving into next week. Don’t be surprised if we get an oversold bounce tomorrow, but unless we retrace back above support levels, it’s nothing more than just that.

August expiration is tomorrow, so make sure to address your portfolios. You may want to double check those bears. Usually, we would suggest taking your time in building positions going into next month; however, today has opened up some bearish opportunities. Make your trades as they confirm, but stay mindful of your overall account exposure.

Mid-Week Outlook

• Bullish: 8%
• Sideways: 32%
• Bearish: 60%

Have a great night,

The Maverick Trading Team

AET: Highlighted Trade From One Of Our Traders

Here is a great trade made in Aetna (AET), a healthcare benefits company. This trade is a good example of implementing a gap strategy, along with using it as a possible target.

There are many different trading strategies available to take advantage of this type of setup in the options world. In this case, our trader wanted to take advantage of a recent gap. The trader decided to use a vertical spread, using the gaps range to select strike prices for the combo.

Typically, for the strategy chosen, the risk is the premium paid and our traders aim for a 50%+ return. At Maverick Trading, we pride ourselves on our community of traders. Every week in our live Trading Room, our traders share their favorite new trade setups (like the one above from last week) with all of their fellow Maverick traders.

NOTE: Chart(s) courtesy of FINVIZ.com.

End Of Day Post

The markets took a step back, but not by much, as the S&P and Nasdaq are starting to show some signs of consolidation. Last Wednesday, the markets started breaking down pretty hard, but then ended up recovering their losses into the close. Since then, we haven’t seen as much volatility along with some slightly bullish movement.

The S&P and Nasdaq are moving higher from previous support levels set back in early June, looking more like consolidation than a bear rally. The INDU, however, looks to be in a classic bear rally pattern.

We haven’t seen much change in relative strength or weakness over the last few weeks, so the overall market sentiment is still difficult to read. We should expect some more sideways action, unless we get an unexpected catalyst, which could drive the markets in either direction from their current levels. Best to lean a little bearish here, just to be sure, but don’t open up too much to one side or the other just yet.

Have a great night,

The Maverick Trading Team

Best Order Entry for Spread Trade

From Our April 2015 E-mail Archives: One of our traders had a simple question on the best way to do an order entry for a spread trade. Our Head Trader, Robb, replied to the question and showed that the answer is anything but simple.*

-----Original Message-----

From: Shanti M.
Subject: Order Entry on a Bear Call Spread

Hi Robb,

What is the best way to do an order entry on a Bear Call Spread (buying and selling calls) when you want it to trigger on a breakout to the downside? This is for my virtual trade account. I have not figured out how to enter here apart from a market order, which can be dangerous. Thanks!

P.S. See you at the Maverick Trading New York Summit!!

Thank you again,

Shanti


-----Reply Message-----

Hi Shanti,

Your question is a very good question and I wish that I had a very simple answer for you. The biggest problem that you have already identified is that a market order is very dangerous to use – especially on an option combo where there is a wide bid/ask spread. So, here are some things you can do to try to control your entry:

1. Use a Contingency Order and Only Trade Highly-Liquid Options: This is actually a great choice since it takes away a lot of the risk of those market orders.
   
   For example, assume that you are attempting to enter a Facebook (Ticker: FB) 80/82 Bear Call Spread if/when the stock breaks below 81. In this case, it would actually be OK to use a contingency order to sell (enter) the Bear Call Spread at market since the bid/ask spread on the combo will be something like 1.00x1.02. As you can see, there will only be very reasonable 0.02 of “slippage” (i.e., $2.00 per contract).
   
   
2. Use a Limit (LMT) Order Attached to Your Contingency Order: Let’s say that you are trying to enter the same FB 80/82 Bear Call Spread if/when the stock breaks below 81. This time, though, the options aren’t as liquid as you would like and there is a 0.25 bid/ask spread (something like 0.90x1.15 when the order triggers).
   
   If you use a Market order and the “stock breaks below 81” contingency triggers, then you will be filled at 0.90, which is too low. If you used a LMT order of 1.00, then the lowest that you would sell (enter) the Bear Call Spread for is 1.00. Using this LMT order will ensure that you get at least the acceptable minimum credit that you are looking for. The downside to the LMT order is that you can end up not being filled and you end up with no position at all, especially if the stock keeps breaking down.
   
   
3. Use a Stop Limit Order Directly on the Combo: This one takes the most amount of work, but will also likely be the most effective. With the other examples, you are using either a market or limit sell to open order contingent on the stock breaking below 81. So, all that is happening is that you have an order to sell to open the 80/82 spread that won’t go out to the market until the contingency is hit (stock below 81).
   
   For this third method, you won’t have any contingency on the stock itself and will be completely based on the price of the combo (i.e., the FB 80/82 vertical spread). However, you will have to use your knowledge of the option Greeks to estimate what the price of the spread is likely to be when FB stock breaks below 81.
   
   Let’s say that you are looking at this position when the stock is at 81.50 and want to enter the 80/82 Bear Call Spread if/when the stock breaks below 81. The current market price of the 80/82 combo is 1.25x1.45 at the combo and has a net Delta of 0.60. So, with a 0.50 move down in the underlying stock, we would assume that there would be a 0.30 (0.60 Delta X 0.50) change in the combo price (i.e., 0.95x1.15). So, we would basically put in an order directly on the combo itself at this level.
   
   We would use a stop limit order with the stop being the trigger and the limit being the lowest price that we would pay. Thus, we could put in a Stop Limit order at 1.05 Stop (you will need to specify the trigger as midpoint, trade, etc. I use midpoint of the bid/ask) and 1.00 LMT. When the midpoint of the spread reaches 1.05, then the order will go out to be filled at no lower than 1.00. This is similar to bullet #2 above, but will get you more fills on average since you are really pinpointing the price.

As you can see, you opened up quite a can of worms. I wish there was a simple way to structure everything to be automated.

Can we make it easier for ourselves in trading the FB combo above? With mobile trading being so effective and easy now, I typically tell people to set an alert at 81.05 (text message, email, etc.). When you get the alert, you usually will have time to jump on your smartphone, log in and place the order based on the current market prices.

Of course, there are some people’s lifestyles that just don’t have the freedom to step aside from what they are doing for 1-2 minutes, but I have found that most people usually can do this pretty easily. If you have a lifestyle or something that day where it needs to be automated, then just decide which of the above three (3) methods for entry you like best, then just set it up and let it happen.

Hopefully this helps,

Robb


* NOTE: Some original wording has been modified for legibility.

End Of Day Post

The markets hesitated after an exhausting first part of the week. We have seen our fair share of volatility, but we still haven't seen much directional follow through. This week, the overall tone is still bearish; however, yesterday's hammer candle put a strong stop to the current bear move. This is not to say that we won't see more selling, but a close above the 200 MA on the S&P is a strong sign of support.

The VIX also pulled back below both its 50 MA and 200 MA, but is still hovering around 13.50 (well above its all-time lows). For now, it looks like the markets have avoided a pretty large sell-off, although the week isn't over quite yet. After yesterday and today's action, we didn't get to see many opportunities to the downside, but tomorrow could give us another chance.

Stay patient in the morning tomorrow (Friday). We know that the markets can retrace directions quickly. If we open higher tomorrow, then we could see some selling come in later in the day. Wait for confirmation and pick your spots when they confirm.

Mid-Week Outlook

• Bullish: 6%
• Sideways: 14%
• Bearish: 80%

Have a great night,

The Maverick Trading Team

CSX: Highlighted Trade From One Of Our Traders

Here is a great trade made in CSX Corp. (CSX), a railroad company serving both the U.S. and Canada. The trade is a nice example of choosing multiple target areas – a great strategy included in Maverick's curriculum.

There are many different trading strategies available to take advantage of this type of setup in the options world. In this case, our trader wanted to take advantage of continued weakness through a support level. He decided to use a diagonal ratio put spread to take advantage of two possible target areas.

Typically, for the strategy chosen, the risk is the premium paid and our traders aim for a 50%+ return. At Maverick Trading, we pride ourselves on our community of traders. Every week in our live Trading Room, our traders share their favorite new trade setups (like the one above from last week) with all of their fellow Maverick traders.

NOTE: Chart(s) courtesy of FINVIZ.com.

End Of Day Post

The markets made two large moves this week, although they were in opposite directions.

1. On Monday, we saw INDU gain 242 points. This move was primarily fueled by rumors of the Fed putting off a rate hike past September.
   
2. Today, INDU lost 212 points as the Peoples Bank of China devalued the yuan.

We have seen big volatility already this week, but no clear direction as Monday and Tuesday cancelled each other out.

Technically, we are sitting very close to Friday’s levels. These last two days have produced nothing in terms of directional clarity. Besides watching two big days, we don’t have much more to go on than we did on Friday.

Time will tell how much the markets are going to be affected by China’s move, or if the Fed will extend the next rate hike date. Either way, the bullish and bearish presence are about equal to this point. We will see if one will gain an edge over the other as summer comes to an end.

Have a great night,

The Maverick Trading Team

Stop Order Placement

From Our September 2014 E-mail Archives: One of our traders had some frustration with getting stopped out too soon on trades, so he asked our Head Trader, Robb, for some advice.*


-----Original Message-----

From: Chris T.
Subject: Stop Order Placement

Good evening,

Hi Robb,

I have a really quick question for you. I just started my 200 trades in the Maverick Simulator. I've done my first 15 and I'm up $500 or so, but there was one thing I'm not sure if I'm doing right. I've had instances where I thought I saw a beautiful bull pullback and got the confirmation...only to get stopped out at the top of a big red candle.

My question is, "Should I put my stop a little more than 1 ATR (Average True Range) from a) where I bought or b) where the stock closed for the day?

On the surface, I would think from where I bought it since capital preservation is as important as gains, but it doesn't leave the stock much room to move and I'm more likely to get stopped out quickly. I had one that was bearish (had just broken through all the moving averages) and sell volume was high, so I shorted it. Then, it gapped up $50 in 3 days!

Thanks again for the advice.

Regards,

Chris


-----Reply Message-----

Hi Chris,

Thanks for the email. Your question is a great one that is really at the heart of trading.

First of all, I personally hate stops since the thing that annoys me most is to be stopped out on a good trade due to short term price volatility. One of the reasons I love options is that I can basically put built-in stops (max loss), but hold through all that volatility. However, on the Maverick Trading Simulator and in some styles of trading, stops are the only choice that you have. In those cases, putting stops in the right place really is an art form.

The biggest thing to remember about stops is that they are there to protect you from the catastrophic losses (15%, 20%, 50%, etc.), but many people put their stops so tight that they are protecting a 0.5% loss. So, stop placement really needs to start with the big picture of "At what price will I be convinced that my trade is totally wrong (broken trends, support lines or moving averages)?" Then, you can move into the chart and start to put some numbers to it.

ATR is a good place to start, but 1 ATR is really tight. Statistically, 1 ATR gets stopped out about 55% of the time in the first 5 days. One of the things that we talked about at our 2014 Chicago Summit was using an options pricing calculator to help calculate stop losses. Start with what % of the time you are OK with being stopped out in the first 5 days.

For example, if a trader said that he wanted his stop outs to happen no more than 30% in the first 5 days, then all that he would have to do is put the stock into a statistical calculator (thinkorswim, OptionsOracle, optionsXpress, etc.) and see where the statistical probability of 30% falls in the first 5 days. Let's say there is a stock at $50 and the calculator says that in the next 5 days, there is a 30% chance that the stock will trade below $47. That would be the stop price for that trader and he would position size for that level of loss.

While there are several different ways to determine stop placement, the most important thing is for the stop to be far enough from the current price of the stock to not get triggered due to normal volatility (which is 1 ATR each day), but not be so far away that you give up needless $$$’s when you know the trade is broken. Many of our traders use things like the 50-day simple moving average (SMA), the most recent pivot point/support, or Fibonacci lines to determine stops. In the end, exactly where you put your stop isn't the most critical thing – as long as you aren't too far or too close.

For a simple example, let's say that you put a stop at 5% and I put mine at 7%. Sometimes, your stop will be correct (e.g., if the stock drops 10%, then I will lose 2% more than you). However, sometimes the stock will pull back 5.1% and rebound. In that price action, you will be stopped out at your 5% max loss and I will still be in the trade. At the end of 1000+ trades, there shouldn't be a huge difference as the extra 2% I gave up on the bad ones will likely be made back by me on the ones I am able to stay in and you aren't. What really matters is consistency over that 1000+ trades.

I know that I haven't given anything really specific, but I hope that this helps you determine the best place for your stops. I personally like the 50-day SMA as a really simple, loose stop point. However, with good charting skills, you can likely determine better stop points above that SMA.

Hope this helps,
Robb

* NOTE: Some original wording has been modified for legibility.

End Of Day Post

The markets gave up some more ground today with help from a weaker than expected jobless claims report. We have been seeing the markets hang on economic reports as of late. Today's jobless claims report wasn't way off the mark, but it did create concerns for tomorrows Nonfarm payrolls report.

We should continue to expect economic reports to be the main driver of these markets at these levels. Until we get a major break of support or resistance, we can expect the markets to become reactionary to news and economic reports. Don't be surprised if we see some large swings intra-day – don't get sucked into them and keep your eye on the major levels in the markets.

Technically, we are looking a little bearish here, but one single day can make a big difference in the overall outlook of these markets. Keep that in mind before opening yourself up in one direction. The idea is to string a few days together for a better perspective before coming to a longer-term directional decision. This can be difficult with the market's current action. Stick to your guns and stay balanced.

Mid-Week Outlook

• Bullish: 30%
• Sideways: 53%
• Bearish: 17%

Have a great night,

The Maverick Trading Team

CBP: Highlighted Trade From One Of Our Traders

Here is a great trade made in Campbell Soup Company (CPB) – in fact, you could say that it was "Mmm Mmm Good!" Our trader identified a really nice ascending triangle pattern, stayed patient, and waited until resistance was broken before entering. Confirmation is a key component in better timing a trade opportunity.

There are many different trading strategies available to take advantage of this type of setup in the options world. Following a personal Trading Plan, this trader decided to use a straight call option. With good trade management, a straight call option can continue to make significant money as long as the stock continues higher.

Typically, for the strategy chosen, the risk is the premium paid and our traders aim for a 50%+ return. At Maverick Trading, we pride ourselves on our community of traders. Every week in our live Trading Room, our traders share their favorite new trade setups (like the one above from last week) with all of their fellow Maverick traders.

NOTE: Chart(s) courtesy of FINVIZ.com.

End Of Day Post

The markets have moved lower over the last few days, but the volatility is still light. We did see a decent move off of support last week, although the bulls didn't stay around very long. These last few days have moved the markets lower, but not nearly as aggressively as we have seen in the past.

We would expect to see tighter daily ranges in both the S&P and Nasdaq, especially at their current levels; however, the INDU is developing a bearish pattern. So far, the bears seem to be the most active this week. We will see what the bulls have left once (or if) we retest support levels.

Earnings season is winding down, but it is not over yet. So, continue to double check earnings dates with new trades. Look for opportunities created by earnings results – relative strength and weakness should be a little easier to identify in the shorter term.

Continue to stay balanced and look to take advantage of some sideways action, especially if the markets keep moving between support and resistance levels.

Have a great night,

The Maverick Trading Team