Wednesday, July 18, 2007

Earnings strategy

For this quarter, I plan on evaluating a few strategies on investing. I definitely want to research this quite a bit more before I bet real money on it. Earnings is a notoriously volatile time for stocks. A company can have profits increase by 50% and still have a stock price drop of 15% because revenues were 1% lower than expected. It really makes little sense.

Anyway, the companies I watch tend to react violently one way or the other. It's fairly rare that the stock doesn't move considerably up or down. We'll start out by looking at Google (GOOG), because it's closing price on Tuesday of $555.00 is ideally suited to such an analysis, being halfway between two strike prices.

So, GOOG earnings is July 19. I wouldn't want to buy options for July, as those expire on the 21st. Chances are that I'd lose everything. Instead, I'll look at August contracts.


As you can see, puts are relatively cheaper, meaning people expect Google to rise. I tend to agree with this prediction, but that's not the exercise at hand. I'm trying to figure out what exactly will happen if I purchase both calls and puts right before earnings. I will definitely lose a day of time value, which is a fairly significant portion of the month of time remaining.

If the stock price rises, the calls will gain value and the puts will lose value. The delta (change in option premium for every dollar change in underlying stock price) gets higher as options get more valuable, though. This ends up keeping the premium at least as high as the stock price - strike price (for calls). What this means is that as the stock moves in one direction, the profitable contract should theoretically start to gain value faster than the losing contract loses value. Also, if there is a significant move one way or the other, the volatility will increase, further improving the profitable contract's price while padding the fall of the losing contract.

Now, if the stock doesn't move much, then the time value lost will outweigh any of the above considerations. I estimate this to be well under a 5% loss for the day, though. I also need to look at the effect of trailing stop orders and regular stop orders. For GOOG, I'm currently thinking something along the lines of a trailing stop on the call that would trigger a trailing stop on the put. I'm hoping this would make the call's spike right after earnings result in maximum profits and then trigger an order to take advantage of any overcorrection or profit taking.

Over the next week or two, I'll do some virtual trading and see how things work in practice with various stocks/options. I'll keep you posted.

Thursday, July 12, 2007

Limit Orders

Similar to my previous post on the financial-benefits-to-homeownership, I am now making a list of the benefits of limit orders:
  • The market sometimes behaves irrationally - a large institution buying or selling stock can significantly affect the price in the short term. You can place buy limit orders to take advantage of spikes downward in the market and sell limit orders to take advantage of upward spikes in the market. For regular purchasing or selling, this also makes sure you don't get taken for a ride between the time you get a stock quote and the time you press the 'Place Order' button.
  • Options are priced based on the underlying stock value, but they tend to move in $0.10 increments. A buy limit order of $3.50/share will theoretically be executed as soon as that jump takes place, meaning the stock has to move back a smaller amount before it rises to $3.60 (again, theoretically. Also, this doesn't equate to profitability, as there is the ask/bid price spread). A sell limit order has the opposite property, but is still a good thing due to the previous point.
  • Limit vs Trailing Stop: a trailing stop order can result in higher profits if the stop price rises above the limit price. However, the actual execution of the order is a market order, which means it could execute at any price. For instance, I tried a trailing stop on some Google options. The stop value got up to $9.50, but when it finally executed, I only got $9.33. A limit order may miss more profits than a trailing stop order, but the profits are more predictable.
  • Limit orders may not execute, which can be both bad and good. First, you may not have your order execute and your money will sit idle (or you will still own a stock you may not want). But, this makes them ideally suited to conditional orders like one-cancels-all. For example, let's say I have $10,000 to invest. I can place a one-cancels-all order on three different stocks - 20 shares of GOOG @ $500, 133 shares of GRMN @ 75, or 100 shares of IBM @ $100. Given today's closing prices of $544.47, $79.69, and $109.10, none of these are likely to execute - I chose the prices for easy calculations in my head. But, if any of these stocks suddenly (even if only briefly!) becomes an amazing deal, I'd be able to take advantage.
Fewer points here compared to the homeownership post, but they're longer. I have a couple options/earnings strategies I want to flesh out, too, so be looking for that. Hopefully I get around to it soon.

Saturday, July 7, 2007

High school and facebook

I was bored the other day, as usual, and decided to check facebook for updates, again as usual. I saw a friend's friend and remembered she was someone I used to like in high school. This got me to look at all the SME 2001 graduates.

It was interesting to see the variety of life paths even just six years after graduation. Some people were wearing suits, traveling for their job. Some were still partying nightly. A surprising number were still best friends with their high school friends. I did't recognize quite a few names. A few were married; a few had kids. The married part may have influenced the name recognition, though.

I recently watched Grosse Pointe Blank again, and my uncle was just in town for his 30-year high school reunion. This may have something to do with me thinking of seeing all these people again in a few years at my 10-year reunion. It will be interesting, for sure. I also knew a lot of people older and younger than I. I guess I won't really be able to see them at any reunion.

Strangely enough, I've always lacked school spirit or any real connection with classmates of any particular year. I don't know exactly what makes me feel some sudden connection on facebook with my fellow 2001 graduates. A friend recently talked to me about how older people have a more developed empathy center of the brain. I commented on how this made sense given my recent observations: I got a bit emotional during Freedom Writers, among other movies, whereas I used to feel next to nothing when family members and/or neighbors died. I guess the same thing applies to school pride.

Well, here's to 2001 Shawnee Mission East.