Wednesday, October 15, 2008

Volatile Markets: ETF transaction delays and Options B/A Spreads

I wanted to make a few observations regarding the trading environment regarding ETF's and options.  None of this is advice, but merely my sharing with you my process experience, which is the point of this blog.

First on the ETF's.  While ETF's are a very convenient way to trade, you should be aware of three things particularly as they relate to the inverse ETF's (1x and 2x long/short. 

  • Thing 1:  The openings of ETF's in volatile markets can be difficult.  You may notice very wide bid and ask spreads.
  • Thing 2:  It may take as long as 25 minutes to get a fill on the open for either a buy or a sell order which means that you can get significant profit slippage or loss augmentation.  That happened to me twice within this past trading week.  In selling DUG last week, my sell went in at $80.  My fill came in at $74 and more than 20 minutes later.  Yesterday, I lost some points on getting my DIG purchase sold. 
  • Thing 3:  Options on these ETF's may also carry wide bid/ask spreads.

Based on my observation, FAILING TO HOLD OVERNIGHT can put you out of
significant dollars if the market gaps in the predicted direction. My own strategy to deal with these swings overnight, is to carry a hedge (partial or full)--pairing DUG/DIG--unloading the profitable one when the directional has been met and a reversal is underway.   The hedge obviously is underwater, but it is increasing in value if I'm getting slippage on my sell order for the profitable position that I want to close because the direction is changing.  Naturally, the one that is kept is underwater on a absolute basis (but on a relative basis it was neutral if you had a 1:1 hedge).  So long as the direction that you are holding continues to be in harmony with the index, every dollar of loss that you recoup increases your account position. 

This may sound both complicated and even stupid, but FOR ME it equates to peace of mind and not panicking out of a position on volatile openings.  If you have qualified money that you are trading with, you also have to be attentive to the cash settlement times--so you may not be able to sell an unprofitable position prior to settlment if you do not have adequate cash in your account. 

With regard to option bid/ask spread on MANY stocks during last week's dislocation.  I had several put positions.  Admittedly, these put positions were NOT in very liquid options--and I knew that risk.  I had one put position on NPO that had a $5 b/a spread.  Yep.  And my HE puts didn't even have a bid!  Of course, I could fish around in the upper third of the range and get a hit.  But, I was VERY surprised, and I wanted to share that experience with you. Others noted some 'no bids' as well.  So keep this in mind if you are new to options.


nice said...

People/ Funds still being forced to sell these commodity/energy stocks

Was reading the other day where lots of execs in energy companies had bought their own shares on margin and were getting margin calls recently...

Remember the good ole days when the XLE used to lead the markets and carry SPY higher?

$75 has been my target on oil all along - near a 50% decline...

The usually play now is that 'they' start sending out all kinds of bearish stories about oil going to $40 etc and entice Fast Money to short into the bottom.

OPEC probably doesn't care as long as the USD keeps floating - but at some point they will have to act.

INTC bucking the morning trend...


nice said...

It's almost like they 'game' the market down now when ever Ben B speaks...

Oh well, shorted some gold stocks while he was speaking - LOL - but that play is getting a bit old...


Leisa said...

The energy trade has been pummeled. So may piled into energy/gold thinking that both the end of the world and the USD were upon us.

I always thought that on a relative basis the US would fare better due to our FED than other currencies I didn't see oil going up. Plus, I saw deflation, not inflation.

But, I could have easily been wrong.

nice said...

As of 3:00 pm

We've retraced 50% of the DOW's rise off the low last Fri a.m.

The NASDAQ has retraced 61.8% of it's lows

We've paused here - still amazing how many seller's there are in the market - in the past we used to bounce up fast on these typical retracements.


nice said...

It's clear 'they' are playing the market down now - with all the Fed speakers dishing out bad news and the market accelerating down as they speak... I mean they have to justify the 1/2 point interest rate cuts...

And it would be easier on the market if the banks rather than forcing margin calls on these large funds - would simply freeze them and then do the selling in drips...

The dollar amount of Hedge Funds that were linked to LEH is very large - and to liquidate those troubled funds all at once does not help out average joe's 410K

... As far as earnings - not that bad - but guidance??? - there is none! ... so sell good news, sell bad news. I guess..


S&P retraced to 61.8% of the total runnup from Friday's low

Bulls better hope it holds and bounces ...


I need to remind myself more that:

In good times buying weakness (pullback) and buying strength BOTH work - and using margin is ok...


In bear markets/corrections the opposite works...

ie: selling strengh and shorting weakness

Finally I get the impression that many traders have been conditioned from the past 5 years are still buying the dip... but are being overwhelmed by longer-term holders and liquiditors - esp. in resource stocks.

Now it must be heartening to the Central Banks to see the large scale liquidation of commodities occuring... they will have acheived their primary aim - bring down prices.

And see what happened in Brazil today?

Good thing that DIG was unloaded - indeed!


sysin3 said...

The -really- liquid ETFs are not so much of a problem (QQQQ, SPY, DIA, probably XLF these days)

They even trade pretty smoothly pre-market.

Being a (very) simple guy, and noticing that most stocks trade with the market .... I just trade the market ;-)

Primarily QQQQ, mostly because it trades on the fully-computerized Nasdaq and, in the old days, the amex market (e.g. DIA and SPY) was so laggy, prone to bad fills, and possibly corrupt. Probably still true today.

On most options, the same difficulties will arise. I always prefer very thick and liquid markets for options. They usually open fairly promptly.

Leisa said...

Sysin--DIG/DUG are trading more than 20M shares a day--perhaps the 2x's have a little more trouble--but the seem so easy to some folks, and I wanted to communicate problems I've noticed with both. Thanks for the comment.

sysin3 said...

QQQQ -- 311 million shr today. Normally around 100+ m.

THAT's liquid.

AAPL -- 58 m today. And that's an abnormally high volume day. Volume is a little skewed in the past 3 weeks or so. Previously, it would go around 20 m shr / day.

Liquid = smooth.

Smooth = better trading, much better options.

sysin3 said...

one more thing about options ....

DIG options are really really thin .. a few hundred open interest at various Oct strikes.

(these are not hard and fast numbers, and I'm still adjusting / learning) ... but if less than several thousand open interest at near money strikes, or if bid / ask spread is more than, say, 20 cents ... fuggetaboutit.

I once had a long put (WMG I think) which I could not sell for a nice profit, because it was very thin and the market maker wouldn't even honor a good bid. He kept moving away. Finally dumped it to him when the thing cratered.

Just some things to think about. Goodness knows, I don't know the answers, but I have been screwed many times for not considering some of these things.