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Case Study: Trading A Balance-Breakout Failure In NYMEX WTI Crude

What Happened: On April 20, 2021, market participants attempted to move NYMEX West Texas Intermediate (WTI) Crude Oil futures up and out from balance, an area of recent price acceptance.

Further, participants failed to find acceptance beyond the balance area, given WTI’s move back into the prior range. As a result, odds favored (1) sideways or (2) lower trade, as low as the balance area low (BAL) near $62.50, or so.

Adding, the breakdown happened in conjunction with fears that India, a large importer of oil, would impose restrictions as coronavirus infections and deaths soared in the country. Given this news, there was an increased potential to trade below the $62.50 BAL, into prior poor structures and low volume areas (LVNodes) that ought to offer little-to-no support.

In response, the following sequence analysis unpacks how Physik Invest traded options tied to the NYMEX West Texas Intermediate (WTI) Crude Oil futures (Future: /CL).

Note: Click here to view all transactions.

Sequence 1: On April 20, 2021, Physik Invest applied the balance-break and gap scenarios, monitoring for acceptance (i.e., more than 1-hour of trade) outside the balance area. 

Typical Balance-Break and/or Gap Scenarios: Monitor for acceptance (i.e., more than 1-hour of trade) outside of the balance area.

Gaps ought to fill quickly. Should they not, that’s a signal of strength; do not fade. Leaving value behind on a gap-fill or failing to fill a gap (i.e., remaining outside of the prior session’s range) is a go-with indicator.

Auctioning and spending at least 1-hour of trade back in the prior range suggests a lack of conviction; in such a case, do not follow the direction of the most recent initiative activity.

After a confirmed balance-breakout failure, given a bullish outlook on oil, Physik Invest opportunistically bought the following structure for a $1,410 debit. At this point, if all legs were to remain out of the money (i.e., expire worthless) by May 17, 2021, the maximum loss would have been $1,410.

  • 65.50+2/70.50C-4/75.50+2 /CL long call ratio spread

On April 27, 2021, for a $1,000 debit, the following position was added after participants found acceptance in the aforementioned LVNode.

  • 65.50+2/70.50C-4/75.50+2 /CL long call ratio spread

By 4/29/2021, all positions were closed for a $4,800 credit, a 99.17% return on the initial debit outlay.

The above call-side structures were initiated against the $68.00 rally-high. However, after 3-days of high-paced price discovery, Physik Invest removed all call-side structures on the first sign of responsive selling at $65.40, a minor 127.20% Fibonacci price extension.

Entry Checklist Recap:

  • Setup: Buy failed balance-area breakout liquidation for a move to new highs
  • Target: $68.00
  • Time Frame: 1 month
  • Risk: 2% of account
  • Strategy: Call debit (ratio) spread structured around target

Summary: After a failed balance-breakout setup presented itself, Physik Invest opportunistically bought call-side structures targeting a test of the prior rally-high, risking a standard risk unit in debit, over a time frame of less than one month.

In total, the sequence of trades net a $2,291.76 profit after commissions and fees.

The above strategies were employed in accordance with Physik Invest’s core edge: the trade of ratioed, multi-leg strategies that combine short and long positions to reduce risk and increase returns.

Reflection: The entry and exit were, unusually, well-timed. Though the spread did price higher, closer to expiration, it lost nearly half its value on the responsive selling that surfaced at $65.40, a minor 127.20% Fibonacci price extension.

The correct move would have (1) to narrow the width of the spreads at entry, and (2) cut the position in half at $65.40, the minor 127.20% Fibonacci price extension. Thereafter, spreads could have been added on the liquidation from $65.40.

In all, the target, time frame, and strategy were incorrect.

Expectations should have been tempered; given the time frame, odds of further discovery, up to the $70.50 short strike, were poor.

A better spread to open in size?

  • 64C+1, 66C-2, 68C+1 long call ratio spread
  • 64C+1, 68C-2 long call ratio spread
  • 65C+1, 70C-2 long call ratio spread

Additionally, to lower cost, puts could have been sold at and below the $57.00 support.

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Results

Case Study: Trading A Balance-Breakout Failure In The Nasdaq 100

What Happened: On April 29, 2021, market participants attempted to move the Nasdaq 100 stock index from balance, an area of recent price acceptance, above a developing ledge, or flattened area on the composite volume profile.

Further, participants failed to find acceptance beyond the balance area, given the Nasdaq 100’s move back into the prior range. As a result, odds favored (1) sideways or (2) lower trade, as low as the balance area low (BAL) near $13,700.00.

Adding, a weak reaction by heavily-weighted index constituents to blowout earnings, as well as poor structure left behind prior price discovery, among other factors, such as the will to raise the Capital Gains Tax, suggested an increased potential to trade below the $13,700.00 BAL, into prior poor structures, or low volume areas (LVNodes), that ought to offer little-to-no support.

In response, the following sequence analysis unpacks how Physik Invest traded options tied to both the cash-settled Nasdaq 100 (INDEX: NDX) and Nasdaq 100 (CME: /NQ) future, leading up to the May 12, 2021 swing low. 

Note: Click here to view all transactions.

Sequence 1: On April 29, 2021, Physik Invest applied the balance-break and gap scenarios, monitoring for acceptance (i.e., more than 1-hour of trade) outside the balance area. 

To preface, gaps ought to fill quickly. 

Should they not, that’s a signal of weakness; leaving value behind on a gap-fill or failing to fill a gap (i.e., remaining outside of the prior session’s range) is a go-with indicator. 

Auctioning and spending at least 1-hour of trade back in the prior range suggests a lack of conviction.

After a confirmed balance-breakout failure, Physik Invest bought the following structures for a $203.00 debit. At this point, if all legs were to remain out of the money (i.e., expire worthless) by May 21, 2021, the maximum loss would have been $203.00, approximately 1/5 of a standard risk unit, or the debit risked in a typical position.

  • 13500+1/13300-2/13100+1 NDX long put ratio spread
  • 14100+3/14110-6/14140+3 NDX short call ratio spread
  • 14400-1 /NQ short call

By 5/10/2021, the aforementioned position was closed for a $1,855.00 credit, an 813.80% return on the initial debit outlay.

The above put-side structure was initiated against the $13,300 high volume area, also a prior balance area boundary. The reason being, a structurally sound market will build on past areas of high volume. Should the market trend for long periods of time, it will lack sound structure (identified as a low volume area which denotes directional conviction and ought to offer support on any test). If participants were to auction and find acceptance into areas of prior low volume, then future discovery ought to be volatile and quick as participants look to areas of high volume for favorable entry or exit.

Summary: After a failed balance-breakout setup presented itself, Physik Invest financed long put-side structures targeting a test of $13,300, with short-call exposure, risking ⅕ of a standard risk unit in debit, over a timeframe of one month.

In total, the sequence of trades net a $1,621.71 profit after commissions and fees.

The above strategies were employed in accordance with Physik Invest’s core edge: the trade of ratioed, multi-leg strategies that combine short and long positions to reduce risk and increase returns.

Yes, in hindsight, one could have opted for static short exposure (e.g., selling stock to open a position). However, the risks tied to such strategies are immense in a regime characterized by increased volatility and uncertainty.

By leveraging the dynamics of time and volatility, through complex spreads, unwanted directional risks were reduced.

Reflection: Hindsight is 20/20.

Though the entry was perfectly timed, the exit was not; 1-day prior to expiry, the 13500/13300/13100 ratio spread – which was removed for a $21.11 credit – priced at nearly $90.00. 

The correct move would have been to initiate the position with up to four 13500/13300/13100 ratio spreads. Thereafter, as prices moved lower, the position would have been pared down enough to at least cover the cost of any remaining spreads.

Those remaining spreads would have been kept on as so-called “lottery tickets.”

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Results

Case Study: Trading Tesla’s S&P 500 Inclusion

What Happened: On November 17, 2020, shares of Tesla Inc (NASDAQ: TSLA) surged on news that S&P Dow Jones Indices would include the stock in the S&P 500, the most liquid index in the world.

Since markets are most influenced by credit and positioning, news of the inclusion was impactful. Funds tied to the S&P 500 would purchase Tesla shares from a dealer by the addition date. This means that dealers would look to purchase shares of the stock heading into the event, to later supply funds at the close of Friday, December 18, the last session before the inclusion.

In the simplest of terms, the event was a positive since it meant that (1) speculative derivatives activity and associated hedging, (2) short-term traders, as well as (3) dealers and index funds would now support the stock.

The following sequence analysis unpacks how Physik Invest traded equity and derivatives tied to the carmaker’s stock leading up to the December 21, 2020 index inclusion.

Note: Click here to view all transactions.

Sequence 1: On news of the inclusion, market participants initiated shares of Tesla out of balance, beyond trend resistance. Thereafter, in accordance with a typical give and go scenario, the stock faded, filling 50% of the low-volume area left after the initial move higher, before aggressive buying resurfaced to continue the new trend.

Through November 19, the following positions were added for a $61.00 debit, in total. At this point if all legs were to remain out of the money (i.e., expire worthless) by November 20, the maximum loss would be $61.00, approximately 1/10 of a standard risk unit, or the capital risked in a typical position.

  • 500+1/530-2 call ratio spread
  • 490+2/505-3 call ratio spread
  • 525+1/550-2 call ratio spread
  • 510+1/525-2 call ratio spread
  • 445-1 put
  • 460-1 put

By November 20, all aforementioned positions were closed for an $827.00 credit, a 1,255.74% return on initial investment.

All the above call-side structures were initiated against the $500 high open interest strike. Reason being, option expiries mark an end to pinning (i.e, the theory that market makers and institutions short options move stocks to the point where the greatest dollar value of contracts will expire worthless) and the reduction dealer gamma exposure.

On November 20, nearly 40% of Tesla’s gamma was to roll off. 

Pictured: November options gamma by Spot Gamma
Pictured: Speculative call-side options activity after the index inclusion announcement 

Moreover, since derivatives exposure was rolled into farther dated expiries, the stock would now be supported by dealers buying to hedge their derivatives exposure and facilitate the index inclusion.

Noting, at a simplistic level, prices often encounter resistance at prior highs due to the supply of old business. These areas take time to resolve. Breaking and establishing value (i.e., trading more than 15-minutes above this level) portends continuation.

Sequence 2: On November 20, the following structures expiring on December 4 were initiated for a $644.00 credit.

  • 450-1 put
  • 520+1/550-1 call ratio spread
  • 570+1/600-2 call ratio spread
  • 490-1/475+1 put ratio spread

Through November 24, the above structures were removed for a $876.00 credit.

Sequence 3: On November 24, the cost basis from November 19 ($61.00 debit) was reduced via an intraday long stock delta hedge that bought 10 shares at an average of $539.50.

The initial cost basis, after this particular trade, was brought down to a $0.20 debit.

Sequence 4: On November 25 the following positions were opened and closed the same day for a $179.30 credit.

  • Bought stock at $550.14 average
  • 480+1/500-2 call ratio spread

Sequence 5: On November 27, the following positions were initiated and closed by December 3 for a $117.10 debit.

  • Bought stock at $595.55 average
  • 475+1/437.5-2 put ratio spread

Sequence 6: On December 1 through December 3, the following positions were initiated, and then exited from by December 7 for a $1.77 debit.

  • Bought stock at $589.20 average
  • Bought stock at $563.77 average
  • 740+1/780C-2 call ratio spread

Sequence 7: Through December 17, the following positions were initiated and closed for a total $452.30 credit.

  • 720+1/820-2 call ratio spread
  • 740+1/830-2 call ratio spread
  • Bought stock at $632.17 average
  • 720+1/820-2 call ratio spread
  • Bought stock at $606.88 average
  • 800+1/860-2 call ratio spread
  • 500+1/480-2 put ratio spread

Sequence 8: From December 17 through December 23 the following positions were entered and exited from for a $322.00 credit.

  • 500+2/450-4 put ratio spread
  • 800+2/850-4 call ratio spread
  • 670+1/685-2 call ratio spread

Summary: In total, the above sequence of trades net a $3,098.29 credit after commissions and fees.

The strategies employed were in accordance with Physik Invest’s methodology: the trade of ratioed, multi-leg strategies that combine short and long positions to reduce risk and increase returns. 

Yes, in hindsight, one could have opted for something as simple as risk-reversals (e.g., buying calls and selling puts). However, the risks tied to such strategies are immense. By leveraging the dynamics of time and volatility, through complex spreads, risk was reduced.

Note: There were many times, during these sequences, that positions were structured in a way that would net no loss had the security moved sideways or lower into expiry.

Adding, per Fibonacci principles, one core aspect of Physik Invest’s market structure analysis, an upside target of $675.10 was established early on in the process. Tesla spent the majority of its December 18 session at this level.

Disclaimer: There is a $0.11 discrepancy between the transaction sheet and numbers provided in this case study. This is attributable to differences in rounding.