Updated Option Article Through Bear Market

http://faculty.london.edu/mchernov/Papers/BCJ2.pdf

Note especially table 1 on page 9.

It turns out that returns on index put options are also quite negative if we include the bear market from 2000 to 2003

Options Are Overpriced

I just skimmed a good study on options: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=424384


A Portfolio Perspective on Option Pricing Anomalies
JOOST DRIESSEN University of Amsterdam Business SchoolPASCAL J. MAENHOUT INSEAD - Finance
October 2004AFA 2004 San Diego Meetings; EFA 2003 Annual Conference Paper No. 916

Abstract: We empirically study the economic benefits of giving investors access to index options in the context of the standard asset allocation problem. We analyze both expected-utility and non-expected-utility investors in order to understand who optimally buys and sells in option markets. We solve the portfolio problem with a flexible empirical methodology that does not rely on specific assumptions about the process of the underlying equity index. Using data on S&P 500 index options (1987-2001) we consider returns on OTM put options and ATM straddles. CRRA investors find it always optimal to short put options and straddles, regardless of their risk aversion. The option positions are economically and statistically significant and robust to corrections for transaction costs, margin requirements, and Peso problems. Surprisingly, loss-averse and disappointment-averse investors also optimally hold short positions in puts and straddles. Because derivatives are in zero net supply, this suggests that generating empirically relevant option prices in an equilibrium model is a challenging task, even with investor heterogeneity and even with commonly-studied behavioral preferences. Only when loss aversion is combined with highly distorted probability assessments, can we obtain positive portfolio weights for puts and straddles.

A Study on XLE

My first study compares 20 day changes in the market (SPY) and oil (using the oil ETF XLE) with subsequent changes in the market 5/17/04 to 3/16/07 (713 days). My results:

All periods 20 day average SPY price change : 0.86%

Subsequent SPY 20 day return
XLE outperforms SPY over 20 days by 5%: 0.22%
SPY outperforms XLE " " " 5%: 2.49%
Both are up " " " > 5%: 1.05%
Both are down " " " > 5%: 2.51% (small sample of four)
Both are down > 3%: 2.28%
SPY up > 3% and XLE up 4% more than SPY: -0.4%

These findings confirm and extend Steenbarger's results to a 20 day period. (see his column http://traderfeed.blogspot.com/2007/01/xle-when-energy-sector-spyders-are.html)

Trades and Rationales

The market was up handesomely today, and I swept out the system trade stocks a half day early to get the jump on any other system traders.

Sold

CHB $10.68 The one week hold was almost over and the stock was up large today.
GERN $7.41 This my baby was up 5 days in a row, and yet was still below its 200 dma.
RSC $17.37 A good rebound for this illiquid stock, also due out tomorrow morning.

Bought

CKFR 500 @ $34.13 One week rebound play for this Buyback Newsletter stock
EML 500 @ $26.725 Ibid, only this most actives plunger dropped 5% more immediately after
purchase, so its already underwater.

Mark Hulbert

Mark Hulbert recently pointed out that newsletter sentiment is not bullish, despite the market recovery, and that this bodes well for prices. He is a wise and hard working analyst, and I subscribe to his "Hulbert's Digest" and read his columns in MarketWatch.

Here is a link to his latest article:

http://www.marketwatch.com/News/Story/Story.aspx?guid={C85B5CD0-BD39-4789-A646-76F967A05BFB}&siteid=mktw&dist=nbc

Just Dodged A Bullet

Adolor reported today that results of their latest study on Alvimopan show that it increases the chance of cardiovascular events. They also said that they, and partner Glaxo-Smithkline, are halting all clinical trials on the drug. Predictably the stock price of ADLR cratered, dropping
57% to $3.75. I think it will drop more, I am damn glad to have gotten out of the stock just last week, for it has been a favorite of mine - the market for opoids that do not affect the gastro-intestinal system is just huge.

What this shows is how risky one trick biotech stocks are, and how well deserved any success is that comes their way. In the meantime, Progenics (PGNX) is the other pure play biotech company with a product designed to meet the same needs as Alvimopan.

Trading Summary And Analysis

I've just completed my analysis for Feb 22 to an intraday time today, April 3:

Benchmarks: SPY -1.43% QLD -6.31% Russell 1000 Value -.83%

My stocks showed a profit of $1270.5 net of commissions: $1030.5 (24 trades).
Since my starting amount was $112 437 (includes the add on) this is 0.9%

I used six basic strategies, grouped post hoc with average results as follows:

a) Buyback and value: -3.7% seven trades
b) Buyback and > 3% one day drop and > 200 day avg: 2.2% three trades
c) other <5%> 200 day avg: -28.4% one trade
d) Subjective story: 11.8% averaged over five trades!
e) Sentimentrader timing trade: 1.4% over three trades
f) 5/1 plus value plus 5/1 industry: 4.5% one trade

These were most of my trades, a few are omitted because I'm not sure why I made them.

These are my conclusions:

Foremost seems to be the large loss I had buying TSTC, a high flying small cap stock that had a large one day drop due to disappointing earnings. It just kept going down. I'll make sure the stock has a low PE if the news is bad earnings, and stay away from blogging chartists' recommendations.

The other bad area was the poor performance of my Buyback passive portfolio. I'm not sure what to do about this, perhaps it is just the large variance, but perhaps the buyback stocks don't do well unless they are moving a lot already, up or down. My adjustment will be to hold fewer stocks but to put more money in them, and to trade situations more.

On the positive side was the standout performance of my subjective selections. LEND and ADLR deserve remembering, and it shows how being interested in stocks and their stories can pay off big time.

Also worth noting is CTB, a value down 5 year/ up one year stock. It is doing well so far.

Also doing well was the strategy of buying stocks that are down large but are in one of my lists (like Fry or 5/1), and the strategy of buying indiscriminately when Sentimentrader gives unequivocal signals.

I must fine tune the Hulbert signals for gold - finding a reliable vehicle - and the short selling strategy I've devised from his newsletter data.