The Gold Spread Moves Sharply Against Us

The spread that occupied most of our attention this week was $GLD-$GDX, and we didn’t even trade it this week.  We have been short $GLD-$GDX since late April and the spread recently moved sharply against us.  The spread is currently trading at its highest level since late 2008.  Of course it’s always a good idea to re-evaluate a position that has made such a large move.  We’ve decided to leave it on for now because we don’t believe there has been any fundamental change in market conditions to justify the current level.  We feel the move is attributable to the recent sell off in silver (and other commodities).  We think this sell-off spooked some holders of $GDX even though gold itself has held up rather well compared to other commodities.  Also, our position is relatively small compared to the size of our portfolio.  We try not to have many positions that are so big that we can’t take a little pain once in awhile.

Written by Norm Winer. Follow me on Twitter and StockTwits.

Your Gift to Them

Wouldn't be awesome to read Russell Sage’s story via his own blog posts as he created calls and puts instruments during the second half of the nineteen century? Or J.P. Morgan’s decision to help the market during time of crisis? Or Jeff Bezos’ detailed account of his decision to leave D.E. Shaw (my ex-employer) to start Amazon.com?

So much uplifting financial experience throughout history has been lost forever. Capturing the insights in real time that led to these financial tipping points changes all that.

It will get very interesting when the new generations of financiers blog the thought processes they use to iterate towards achieving their dream. It will get even better if they start at an early stage with no clue about where the journey leads them.

I remember the day in 1995, when Benoit Lavigne, Co-founder of Innovative Fibers, came to New York to ask me for financial help with his business. I had been preparing for this moment since the day I met him. I saw so much potential in him; I wanted to invest in him.

Sitting on the couch in my apartment, Benoit was trembling as he explained to me the precarious situation his business was in. His sales were growing at 100 percent per annum but he did not have any more money to pay his employees. His inability to raise capital would shut down his business. He got denied financing by a few financial institutions in Canada.

It was just a regular New York day, but at that moment I said to him - YOU ARE DONE!

I wish I could have captured all the subtleties of the raw emotions filling the room at that moment and share them with all of you.

Written by Michael Bigger, author of How Traders Achieve Creative Flow.

What Else Can We Trade Against This?

Sometimes you have a particular spread trade in mind and you can’t do it for a variety of reasons: you already have too much exposure to one of the stocks in the pair, or you can’t get a borrow on the short side, or one of the stocks in the pair isn’t liquid enough, etc…  When this happens it is time to look for a substitute.  Earlier this week we were looking to buy $USO (United States Oil Fund) and sell $XOP (SPDR S&P Oil & Gas Exploration & Production ETF).  In one of our accounts we couldn’t get a borrow on $XOP so we substituted $XLE (Energy Select Sector SPDR).  We like $XOP better because $XLE is heavily weighted toward the major integrated oil companies while $XOP offers a broader based portfolio.  But $XLE is good enough.  As a matter of fact when we originally decided to trade the “Oil vs. Oil Companies” spread last year we did our first trade with $XLE, but later decided that $XOP was the better ETF for our purposes.  So if for some reason you can’t trade one side of a pair, look for a substitute.  You may even find a more suitable security.

As for the results of the trade, unfortunately it moved sharply against us with the big sell off in oil.  But we’re confident it will rebound.  Perhaps that will be next week’s topic.

Written by Norm Winer. Follow me on Twitter and StockTwits.

Trading Spreads This Earning Season

No single spread trade we made this week stood out from the others so we thought we’d mention a few spreads that made large moves.

Earnings season often provides a catalyst for entering into a trade.  On Tuesday II-VI Inc. ($IIVI) was up over 20% after easily beating expectations.  We decided to wait until the stock stabilized before shorting it as part of a pair trade.  On Friday we sold IIVI and bought Roper Industries ($ROP).  By then the spread was trading lower than Tuesday’s levels, but still considerably higher than its one year average.

We typically leave positions on through earnings, and sometimes this works against us.  We were long Mercury Computer Systems ($MRCY), short Stratasys ($SSYS) coming into the week.  $MRCY reported disappointing results and closed Friday 8.5% below last Friday’s close.  $SSYS reports next week.  Another potential catalyst.

$GLD-$GDX has been interesting lately, to put it mildly.  We sold the spread on Monday, and averaged down on Wednesday.  The spread closed Friday at close to its highs for the week despite $GLD being up almost 4% for the week, which would have typically translated to an even bigger move in $GDX.

Written by Norm Winer. Follow me on Twitter and StockTwits.

Is Day Trading a Losing Proposition?

In the past, I found day trading to be a losing proposition.  I lost money day trading when I wanted to day trade.  I find it to be the most difficult aspect of trading I have ever experimented with.

I usually make money on a trade held for a short period when I am buried with work and have only a few seconds to make a decision.  In those cases, I don’t over-think things.  I just make the obvious decision and usually it is the right one.

Leigh Drogen explained to me that by not having the goal of day trading, I choose the best opportunities when they present themselves.  I pick only the low hanging fruit.  Focusing on day trading forces me to do go for some fruit higher up on the tree, and that is where I would lose money.

Recently, we decided to give day trading as a business a second chance. We decided to think creatively and develop our own methods using experimentation rather than use traditional technical and supply/demand indicators. So far the results have been quite amazing despite not using moving averages, Bollinger Bands, level 2 profiles, and other tools. It is still early in the game but we are very encouraged by the results.  

What is your experience with day trading?  Are you using uncommon methods to day trade?

Written by Michael Bigger, author of How Traders Achieve Creative Flow.

The Second Roach Comes Out of the Cupboard

Today we thought we’d provide an update to our $SCSS (Select Comfort Corporation) – $TPX (Tempur Pedic) trade from April 7^th and April 8^th.  On both dates we bought 5 $SCSS and sold 1 $TPX on the back of a rally in $TPX after the firm said it expected strong first quarter results.  In the prior two reporting periods $SCSS’s results mimicked $TPX’s results and we were betting the same would happen this time.  Sure enough $SCSS significantly beat expectations when it reported earnings yesterday.  The stock is up 28% today.  We unwound the spread yesterday after the report for an approximate +13% return.

Also this week we traded in and out of 4*$GLD (SPDR Gold Trust) – 9*$GDX (Gold Miners ETF) for about a +2% return, selling the spread on April 18^th and buying it back on April 20th.  We’ve been more active in this one since the recent rebound in shares of the mining stocks.

Written by Norm Winer. Follow me on Twitter and StockTwits.

Weekly Spread Re-Cap 4-15-2011

The bulk of the spread trading we do is based almost purely on statistical methods.  If a particular stock pair is co-integrated over a certain time period, the half life is reasonably short, and the spread between the pair is more than two standard deviations from its mean value we trade it.  This week we put on long 1 DRQ (Drill Quip), short 2 SDRL (SeaDrill Limited).  Both stocks are in the Basic Materials sector.  DRQ is in the Oil & Gas Equipment & Services industry, and SDRL is in the Oil & Gas Drilling & Exploration industry.  We typically stay industry neutral but we felt that the two companies were in similar enough businesses that we could relax this requirement.  We traded this spread in March and made almost $4 per spread while holding it for about three weeks.    On Wednesday our statistical software showed that it had become cheap again, so we bought it.  We were able to unwind it by Friday for a $4 gain.  We suspect the opportunity to trade in and out of this spread twice in a period of about thirty days was driven by the recent spike in oil prices coupled with the strong co-integration this pair has demonstrated over a period of more than ten years.

Written by Norm Winer. Follow me on Twitter and StockTwits.

Your Adjacent Possible

Inspired by Steven Johnson

Two weeks ago, I had the opportunity to discuss trading with a seasoned trader at the Four Seasons hotel located in Midtown Manhattan. He and I approach trading from very different angles. He trades growth stocks with solid technical characteristics. I focus on algorithmic trading. We don’t have much in common. Period.

Not so fast. Something was very enlightening about our discussion. He told me he has a knack for discovering, before the market does, technology companies experiencing an overnight change in their business model. He described a few examples that happened in the past and some that are happening now. It all made sense to me.

I could not help but think that if I had this information, I could incorporate it into our volatility trading strategy to gain an additional edge.

The adjacent possible is the vast reservoir of untapped trading opportunities created from the mash-up of different trading ideas and insights.

Have you ever explored it?

Written by Michael Bigger, author of How Traders Achieve Creative Flow.

Weekly Spread Re-Cap 4-08-2011

On Thursday, April 7^th, after the market close, TPX (Tempur Pedic International) said it expected to report strong first quarter results, and increased its full year guidance.  In the past two reporting periods, TPX announced earnings prior to SCSS (Select Comfort Corporation).  In each case a solid earnings report by TPX was followed by a solid earnings report by SCSS.  We took last night’s announcement as a strong indicator that SCSS would also report robust results in late April.  The 5*SCSS – 1*TPX spread has been trading around $10 since last quarter’s results.  It closed at $10.76 on April 7^th, so when it dipped below $8 in afterhours trading we bought it.  We bought some more on the morning of April 8^th, also slightly below $8.  As it turned out we could have waited a little longer because the spread at one point dipped below $5 and closed Friday at about $5.60.  Nevertheless, based on Cockroach Theory, we are confident it will return to the $10 plus level.

Written by Norm Winer. Follow me on Twitter and StockTwits.

Weekly Spread Re-Cap 4-01-11

This week we thought we’d talk about a couple of losing spread trades.  You can’t expect to get every trade right, so you have to develop a process for dealing with losing trades.

Our statistical arbitrage book is relatively new so we only recently developed firm rules for what trades to put on, and even more recently for when to unwind both profitable and unprofitable trades.  We are trying to avoid the situation in which we unwind our winners too soon, and keep our losers on for too long.

At the beginning of the week we decided we had a few losing spread trades on our book for too long.  We’ll briefly discuss two of them, 5*ENB (Enbridge) - 4*BPL (Buckeye Partners), and 5*AMAT (Applied Materials) – 2*VSEA (Varian Semiconductor).  We were short the first and long the second.  We entered the AMAT-VSEA trade on February 10^th.  By March 28^th, forty six days later, the spread was trading about $8 below where we bought, but because our initial statistical analysis indicated the spread should have reverted to its mean within a shorter time period, we decided to unwind.  The situation regarding ENB-BPL was similar.  This spread was trading $22 above the price we shorted it.  But the spread had been on the books too long and was not behaving as expected, a possible indication there had been a structural change in the relationship of the pair.

It’s sometimes psychologically difficult to unwind a position at a loss, and we don’t recommend using stop losses for every trading strategy.  Yet by doing so, you often avoid bigger losses.

Written by Norm Winer. Follow me on Twitter and StockTwits.