Friday, August 29, 2008

A Very Attractive Strategy on Oil

Oil prices are expected to move quite a bit in the next few days. Straddles and strangles could be considered. These strategies allow the investor to benefit if the oil moves both up or down. This page shows some possibilities for both USO and UNG (prices will be updated a few times during the day today):

Clearly the USO positions are very attractive. The first two positions require a move of around 9% to be profitable. With oil expected to either move to 130 or drop to 110 that will be achieved and surpassed. Given that we still have more than 2 weeks to expiration, there will be also residual value on the side of the straddle that goes wrong.

Looks very good, please do your due diligence.

UPDATE 3:50PM: Best strangle was:

93 puts: $4.20 x 12 = $5,046
94 calls: @$4.15, *12 = $4,986

Total invested = $10,032


UPDATE Tuesday September 2nd, prices, 10AM:

93 puts: $7.70 x 12 = $9,240
94 calls: @$1.60, *12 = $1,920

Total amount = $11,160

Return on Investment: 11.1%

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Tuesday, August 26, 2008

Correlation of the Most Traded Stocks in the US

Following up on yesterday's correlation study, here is a table of correlations of the most traded stocks in the US. This list contains all stocks whose 90 day Simple Moving Average of Volume multiplied by the closing price is greater than $1B.

Please click on image to enlarge.

NOte that GS (Goldman Sachs) is not correlated to anything else in any major way.

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Monday, August 25, 2008

Stock Correlation Study: Oil, Gold, Currencies are Highly Correlated

This article shows a study of correlation on a number of stocks and ETFs. The correlation uses closing prices data since August 1 2008.

Correlation is very useful for hedging and diversification. An investor who wants diversification should always look at the correlation factor between stocks and should not buy highly correlated ones. Similarly, an investor who is looking at hedging long position should be looking at negatively correlated stocks.

The data is also useful for investors in registered accounts who cannot short stocks or buy puts. An investor who wishes to shirt oil for example, can simply buy UAUA as the two stocks have been highly negatively correlated.

Clearly, there is a large relationship between currencies and oil and gold. Clearly also there are very high negative correlations between the general markets and oil and gold.

Please note that correlation does not necessarily mean a causality relationship, but it does indicate that the prices march together.

The following table shows the high positive and negative correlations of over 0.85 (or -0.85):

(Please click on image to enlarge.)

The following table shows the positive and negative very high correlations of over 0.90 (or -0.90):

The following table shows the positive and negative extremely high correlations of over 0.95 (or -0.95):

The following table shows the list of positive correlations (<0.90) for each of the symbols:

Similarly, this table shows the list of negative correlations (<-0.90):

(Please click on image to enlarge)

Some of the data may surprise investors. Clearly there are clusters of highly correlated stocks. Please see the maps below, which show a graphical representation of the very highly correlated stocks (<0.95), green edges are positive correlations, red are negative:

And this is a graphical representation of the very highly correlated stocks (>0.90):

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Monday, August 18, 2008

Max Pain Report For August 2008

This is a report of what happened at the end of options expiration.

The week started with DIA and SPY significantly off their Max Pain values, 3.3% and 2.1% respectively (please see the max pain live page). At the end of the week, these figures were down to -0.4% and 0.9%. This was quite remarkable. However, what also occurred is both stock prices and max pain values fluctuated. DIA went from $117.80 to $115.40 on Wednesday to $116.43 o Friday. DIA's max pain went from 114 to 115 on Tuesday, jumping 2 points to 117 on Friday. While the stock prices moved closer to MP, MP also moved closer to the prices on the expiration day.

The situation with SPY was similar. Stock price went from 130.71 to 130.57 to 130.17. Its max pain was steady at 128 all week, moving one point to 129 on Friday.

These changes throughout the week can be seen in the chart below, which shows the average difference between the stock price and the max pain value for DIA, SPY, XLF, and QQQ.

The following chart shows the final differences in $ (stock price - max pain value):

Clearly, max pain theory was correct this moth for DIA, SPY, XLB, and XLF. Clearly it did not work so well for XLE, GG and USO (energy ETF, gold miner and oil respectively, commodities which have suffered very significant declines in the last couple of weeks).

As for Max Pain theory, "one month a proof does not make". There seems to be indeed a magnet for prices somewhere. What can be said at this point is that Prices and max pain values do appear converge to each other.

In term of money and profits made. This was the situation for DIA at the end of the day on Friday:

This is what option writers made for several average premiums charged.

This is what the in the money options holders kept, and made, at the end of the day:

This was the situation for SPY at the end of the day on Friday:

This is what the SPY option writers made for several average premiums charged.

This is what the SPY in the money options holders kept, and made, at the end of the day:

These figures do not include the trades made on Friday itself, options buyers who cashed into their profits or any writers who simply locked into their profits by covering or buying back their options. The total number of options closed (which means open interest dropped) on Friday, as well as the $ traded is shown below:



It can clearly be seen that the $ traded on Friday were primary for calls: 68% for DIA and 76% for SPY. This makes sense as call holders do not want to exercise their rights (and buy a very large number of shares), but rather they just wish to cash into their profits by selling the calls.

The total $ value for SPY was $26M, again shared between buyers and writers. Since this constitutes a small fraction of the open interest $ we will add the amount traded for the calls to their profits. Remember this is just an estimate.

Therefore, at a $2 average premium, the DIA options writers made approximately $49M. The options buyers made approximately $27M . The SPY options writers faired even better making approximately $480M, while the options buyers made approximately $142M.

While these figures are approximations, it clearly pays to write options as opposed to buying them.

If you wish to track the max pain values for September, please visit the max pain page.

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Thursday, August 14, 2008

Unusual Activity in Financial Puts Bought for September

Yesterday there was strange activity in the out buying of Bank of America. A large number of fairly out of the money puts were bough for both August and September. For example, while the stock closed the day at $28.86, there were 60,000 August 25 puts traded. Those puts closed at roughly $0.13. In terms of $ spent, this amounts to approximately $780,000.00.

Where there is a buyer there is a seller, so could it be that the seller was a market maker trying to pocket the premiums as most options expire worthless. But to sell 60,000 puts still requires a major buyer, or buyers, in order to avoid causing a drastic drop in the value of the premiums. Maybe someone knows bad news are coming in the next couple of days, may be not. Because of the very short time to expiration (this Friday) the premiums are quite low. It is difficult to know what was going on.

This study instead focuses on the September puts in most of the financial institutions, as well as MCO and the popular XLF ETF. It looks at the total number of puts bought, at the out-of-the-money puts, and at the deep out-of-the-money puts traded today.

Total number of puts bought, as well as a rough estimate of the $ spent (based on the closing price):

The total number of puts traded is 288,928, for a $ figure of $59M. BAC puts are approximately $9M, comparable with MER and GS and XLF. This is also illustrated by the chart below:

Now let's look only at the number of puts that were out-of-the-money:

The total number of OTM puts is 208,639, for an estimated $ figure of $22M. BAC's share is now $5M, much higher than all the other institutions (except XLF itself).

Finally, let's look at the deep out of-the-money puts, defined as being more than 20% below the closing price.

This is where things get really interesting. BAC's share is now $1.4M out of the total $2M traded. The next one is MER with $147k. The following chart illustrates well the difference between BAC puts and the rest of the institutions:

You can see below the actual traded numbers for each strike price in AIG, AXP, and BAC.

Please click on the image to expand.

You can see over 19,000 September 22.50 puts and over 4,000 September 20 puts traded - today alone.

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Wednesday, August 13, 2008

Max Pain Update

Yesterday there was a remarkable reversion closer to the max pain values. The current stock prices for DIA, SPY and QQQ were around 2-5% off their max pain values, now they are within 1%, and XLF is at 0.86%.

The max main values and the current differences with current prices are updated live (20-minute delayed) at

This page also shows you how the theoretical max pain values have been shifting every day.

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Sunday, August 10, 2008

Max Pain Theory and Options Expiration This Week

Max Pain options theory tells us that the majority of options will expire worthless. The assumption is that most of the call or put options associated with an index or equity will expire worthless. To achieve this the underlying stock has to end the week somewhere above most of the open put options, but below most of the open call options.

Options expirations this month is this Friday August 15. With the big up move on Friday by the stock markets we will have a golden chance to see this theory proven right - or not - as current prices are significantly higher than what the max pain numbers.

Here are some max pain numbers, as well as the current price, and the price differential:

DIA: 114 (current: 116.95, +2.6%)
SPY: 128 (current: 129.37, +1.1%)
XLF: 21 (current: 21.94, +4.4%)
QQQQ: 45 (current: 47.32, +5.1%)

These are the numbers for QQQQ:

A more interesting example is DIA. The following table shows the number of options in-the-money and out-of-the-money, as well as the total $ profits that holders of in the money options could make.

This table shows the revenue that will be made by the options holders once they sell their ITM (in the money) options, not deducting the premiums paid). With Max Pain, there is a difference of $11M in profits. This means that holders of in the money options make less money, and the writers of the options make the most money. Notice also the number of OTM (out of the money) options at expiration. If Max theory is correct, the writers of the options will stand to keep 257,615 contracts, versus 234,388 if the current price stands. That is a a difference of 23,227 contracts. The table below shows the profits made by the options writers at several average premiums charged for these contracts.

Finally, the table below shows the actual profits made by the ITM holders at expiration versus the premium paid.

Note that at an average premium paid of $3.50 no ITM holder actually makes any money as the profits from their sales does not cover the cost of the options. At $5 premium the difference does not make sense as Max Pain theory benefits the buyers (fewer buyers, fewer losses!).

The figures in the two previous tables also clearly show that it its much more advantageous to write options as opposed to buying them. At, for example, $3 premium, the writers stand to make profits of $70M to $77M, while the buyers only make $7M to $11M.

If Max Pain is correct and if these numbers remain the same this week, the markets should correct. It will be very interesting to watch.

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Monday, August 4, 2008

Correlation Between Oil and Natural Gas

Natural gas prices collapsed yesterday, dropping approximately 40% from their peaks. An easy way to invest in this commodity is through UNG in the US and through the HNU and HND ETFs in Canada. The Horizon's ETFs work very well in terms of not losing their value over time, as per extensive studies I have done, and are shielded from the drop in the USD, while UNG has the advantage of having options (calls/puts).

The following table shows the correlation among oil (through USO), UNG, HND, and HNU.

As expected, the correlation between HND and HNU is very high, and the correlation between UNG and HNU is even higher at 0.99, in spite of HNU being a 2X ETF. Of interest is the correlation between USO and UNG, roughly 0.89 since Jan 15 2008. This information is useful if you wish to diversify or hedge your holdings. In 2008 there is too much correlation between natural gas and oil.

The following table shows the correlation each quarter this year (Q3 being very incomplete).

Q1 2008: 0.90
Q2 2008: 0.95
Q3 2008: 0.93

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