For me, I am about to dump my portfolio aside, make it a low yield cash cow, and instead move on to other Alpha generating strategies.
The traditional fundamentals and portfolio management is just plain slow and boring, and hmm… its time i bring up my VB6 / Java and the days of day trading algos… all into Automated Day trading.
As of today, Citigroup shares stood at $4.77 after hours.
The idea is to use Options derivatives to trade its shares and hopefully earning a small risk free profit, though there are still risks involved.
This is what I think is called “Calender Bull Spread”.
Heres the example that I have actually traded (Taken from Yahoo Finance):
Option pricing for C Mar 2011:
4.00 0.85 Up 0.07 0.85 0.86 9,098 289,566
4.50 0.49 Up 0.06 0.48 0.50 4,525 216,261
5.00 0.25 Up 0.03 0.24 0.25 26,869 327,288
Option pricing for C Jan 2011:
4.00 0.80 Up 0.10 0.78 0.79 25,408 946,186
4.50 0.38 Up 0.06 0.37 0.38 39,751 585,347
5.00 0.14 Up 0.02 0.13 0.14 104,742 2,410,326
The idea:
To buy In-The-Money Calls at March, and sell Out-of-the-Money Calls in January.
Based on the volume, we see the Jan 2011 $5 Call is very much traded up, causing the value to go up.
And to play safe, a $4 ITM Call is bought, because I guess it is unlikely the shares of Citi will drop below $4 by Mar 2011, with the Fed already clear their stake of Shares to the open market. (I am bullish on this, hence the name Calender Bull Spread)
So let’s do the Maths (Excl. Commissions):
Buy Jan 2011 $4 Call @ 0.86 x 20 calls = $1720
Sell Mar 2011 $5 Call @ 0.14 x 20 calls = – $280
$1720 – $280 = $1440
1) The ideal situation is Citigroup shares went above $5 by Jan 2011.
You’ve spent $1440 on a $4 Call that you can exercise anytime, or simply 72 cents a share. Now Citigroup is trading @ 4.77, and you’ve got an option to buy at $4 with 0.72 cents a share.
How nice ?
Next the real thing is if it goes through $5, and got exercised:
$5- $4 = $1 * 2000 would give you $2000. This is the profit “spread” you will have if its exercise.
Now take $2000 + $280 – $1720 = $560. This is the profit less the expenses.
2) What if it doesn’t go to $5 … by Jan ?
No worries, you have 2 more months. and you’ve just pocket $280 worth of options. Try selling this again in Feb and Mar. Remember the $4 Long Call Options still has value, in case something happens, you still can sell it off.
If you sold $280 x 3 for Jan, Feb, and Mar, and then selling off the Long call then you would have earned :
$840 / $1720 = 48% “interest” ROI
Based on the $1720 you’ve spent.
So why does this happen you may ask ?
The reason why this opportunity exists, all because the calls were slightly overpriced resulting this Relative value arb.
- The $5 Jan 2011 calls were to optimistic. The value went up, and so you Short the overpriced.
- Decided to buy a $4 Call because it simply cost 0.85 cents, just 8 cents higher than 4.77, and so you Long the “fairly priced”.
You may buy a $4 Call at May or August, but it may be slightly higher, probably $0.95, but its “Delta” is not gonna be priced higher (a 20 cents move in stock means a 20 cents move in Options value for March, as opposed to 20 cents move in stock with a 22 cents move in the Options value in August)
And if all doesn’t work well. Simply write/sell a $4.00 Call at March. You won’t lose much.
Disclaimer: I own shares of Citigroup, that is why I bother to look at the Options book =)
Well, I was delighted and to execute my first arbitrage trade, not sure if I am considered a Junior “Quant”.
The objective is to earn risk free through trades, scanning the market for floating risk free arb. Now I wish I could develop a machine solely for scanning floating prices like these.
This trade involves simultaneously Long the shares and short the In-the-money call option. In Hedge Fund terms, this is called a Relative Value Arbitrage. (Disclaimer: This is after all not a true risk free trade, because it involved using funds from my acct)
Analysis:
On 21 September 2010 10:30am, HPQ shot up from $39.5 to $40. As I am writing this post at 10:48am, HPQ is trading at $40.02.
The trade:
Ignoring the fundamentals of Hewlett-Packard Company (Public, NYSE:HPQ), we are also interested in its derivatives options market. It opened at $39.5, went up to $40 within 1 hour. The Options, HPQ Oct10 39 Call was price around $1.6+. Then it went to $1.7 when it hit a high of $40.05.
As a Call option Buyer
As a buyer, I would buy a HPQ Oct10 39 Call at $1.7. I would then be able to purchase 100 shares of HPQ at $39, but I have the option to exercise this option. If I do, I will be able to buy this at 100 shares at $39. I may then keep this shares, or sell on the open market at $40 (current price). Looking at maths, its stupid to spend $1.70 to a stock at $39, when you should be spending $1 to buy it at $39, since the stock is trading at $40.
As a Call option Seller
As an options seller selling an options to someone else, the other party buying my option will be able to buy the stocks @ my strike price. I am obligated to sell him at $39 per share. This could happen any time from now till expiration around mid October. In order for this Covered call to work, I need to buy 100 shares of HPQ at $40.05, and simultaneously sell/write the contract at $1.7 per contract for 100 shares. If I didn’t purchase 100 shares of HPQ while I wrote the options, I will be known as ‘Naked Call’.
So as a buyer, for $1.70, you have the option of buying 100 shares HPQ at $39. As a seller, I am forced to sell him my HPQ shares should he exercise his option, but I have already pocketed $173, so I am not concerned if he wants to exercise or not. Note that the current price is at $40.
For this arb covered call strategy to work, I bought on the open market 100 shares of HPQ at $40.05. I then sold the options of HPQ Oct10 39 Call at $1.73.
Using Maths:
100 x $40.05 = ($4005) (The money I had to have in order to complete this trade)
1 x $1.73 = $173 (Call option Sold short)
To sell @ $39 if he exercises:
$4005 – $3900 = $105 (amount I will lose if the buyer exercise his call option)
$173 – $105 = $68 (Potential gain locked-in if he exercises)
Now this strategy is suppose to be bullish. There are 2 downsides.
1) The option buyer decides not to exercise his call option. Then HPQ shares slides down. If it slides pass $38.32($40.05 – 1.73) within the expiration date, I will have to buy back the option (which I believe I will still gain), then sell off my 100 shares of HPQ at a lost. But this lost has already been hedged slightly by my options (Call option prices drop if the underlying stock prices move down, and vice versa). From $40 to $38.3, it will take quite a bit of hit, though there is still risk.
2) HPQ shares rallied to $45. The call option’s price will increase, while my profits have been limited because I have to sell the option buyer @$39, irregardless of how much the market price is, no matter how higher the price is, I still pocketed $68.
Summary
I made $173 if the shares of HPQ doesn’t move higher or lower, and definitely profit if it moves higher.
I now run my personal fund, hoping to grow it. Last time I started trading without any directions. I was just like any other noobish trader looking at technical indicators, cutting loss at X%, stupid swing trading, gluing my eye to the tickers, demand and supply volume… those were a thing of the past.
What I have employed now are something very logical and something I had thought of when I started trading. And all thanks to my old brokerage which has very very limited tools, trading back then was like a Buffet’s buy-and-hold strategy only. With my new broker and some great tools, I started applying these strategies, similar to Hedge funds:
What could I say anymore ? Do take a look on Google if you want to find out more. But here’s the truth of how I manage. These strategies can be deployed by any retail investor like me and you. Use it well and master it, and I believe a 10-20% gains in a year should be very possible.
These strategies had been proven by the big boys, and so it should be. Besides you don’t need high tech/speed machines or algos because there aren’t high frequency stat arb or quanting involved.
I’ve recently gotten very interested in ways to stat arb, but without the use of high tech computers. Since as a normal investor, or even a trader, we don’t have access to highly sophisicated software, let alone machines.
If I had a brokerage that allows me to program my own logic, calculate prices, compare against other prices then execute buy and sell, that would have been great. But I doubt we have any brokerages like this, and especially able to link our orders directly to the exchanges, and a buggy program will go haywire sending buy orders wrongly.
When talking about quantitative analysis on finance, its amazing that they could use Maths to figure out mis-priced securities. I would had study hard on my Maths if I knew it could be applied.
Could there be a arb strategy with a higher time horizon, where the mispricing could exist in 1-3 months time >? Im in fact exploring it, but until then let this research work be untold.
So what do we have here, traders on fundamentals, technical, trend following, swing, and finally… quant. A special breed of maths, science, and engineering on Wall Street?
Well let’s just say I figure out this myself, after going through tons of head hunters, recruitment and job portals about jobs they are hiring, and second guessing how they make up for the department. In order to build a department of High frequency statistical arbitrage trading, we would probably need these people with these skill sets:
Quants:
2-3 Quantitative Analysts, with skill sets involving options pricing, markets futures calculation, and forex triangle arb and probably a commodity stat arb. They will need to work on using the right formulas with the right markets, and the expected output.
Software Engineers:
3-4 Java and C++. Java provides the web front ends while the C++ algo does the high frequency stuff because the language allows fast execution. Probably some very intelligent developers who wrote algos more than payrolls or database info systems. These guys need to work very closely with the quants, as well as the traders.
Traders:
Depends.. Traders who know the markets well, and know a specific market or securities well, with proven strategies. People with real trading experience provides the team, the algo, the markets sentiments, and analysis, and other events that may drive prices.
IT – Infrastructure:
This team includes networking and communications gurus from the IT industry. With good experience on linking up almost any devices, they also need to know how to allow high bandwidth, networking devices which allows high throughput of speed, ensure uptime.
Fund / Portolio / Risk management:
This is your typical guy(s) who does the most important job of managing the money. Without good management, no matter how good a strategy is, risks are still involve.
So this shall be what I think about creating one such fund. Call it a hedge fund with a stat arb strategy. Any banks or startups could build it, provided with the right tools and people.
Managemoneyonline.com is a website, a blog that I have created to write down my ideas and experience I have encountered. These serve as a track record for me and myself and for everyone else to learn. Trading and investments is a difficult tasks.
I lost quite a few grands, about $9,000 for my first year of noobish trading. That was after the 2008 financial crisis and it was some bull run to 2010, but I still lost. While I am trying to learn “everything”, yes you heard it, everything about trading and investments, I will jot down some of my experiences, and strategies as well.
Well the main key words for this site, manage money, already tells you that I am all about managing money. Afterall, no matter how daring and how much risk profile you want to take, Wall street, or the stocks market is just a random reactions of ups and downs. No repeated patterns no nothing, because if there is, even a 3 year old kid could understand.
With that bad experience, I’ve went deeper and deeper into this art or science. On the second year of my trading, I started building a small portfolio, instead of blindly trading. Reading up and understanding even more detailed into investment banks, financial institutions and hedge funds, I wanted to do what the big guys are doing.
While I go about managing my small little portfolio, hoping to beat the market and growing equity, by measuring my performance with the general market / hedge funds. With strategies such as statistical arbitrage, law of one price, portfolio rebalancing and management, risk management, long/short equities, high income stocks and dividends, and other strategies that I’ve tried, this is the outcome of a true results of a trader who trades his own personal account.
I hope I am able to grow my own funds through this never ending, tiring process of seeking The Truth, the Alpha.