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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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Single stock futures (SSFs) are futures contracts on individual stocksPROPULSION PLAYS-SWING PLAYS USING STOCKS, SINGLE STOCK FUTURES, AND STOCK OPTIONS SETTING UP FOR THE BIGGER MOVES IN INDIVIDUAL STOCKS To me, some of the greatest risk-takers on Wall Street are long-term investors. They will stubbornly hold onto a stock they bought three years ago because they have a long-term view;* It doesn't matter that the company is beating off creditors with a lead pipe, ft doesn't matter that the stock is down over 80 percent from the entry price. It doesn't even matter if the CFO was recently seen sharing an 8 X 8 cell with Manna Stewart. What matters is that* come hell or high water, they have blind faith that by stepping back and taking the long-term view, all will be well in the end. All's well that ends well, right? Of course. Unfortunately, this ain't Shakespeare's play: this is Wall Street. This came to light in glaring, full color for me in early 2000, First, there was the Super Bowl I don't even remember who played in that game, but I do remember the 18 commercials that played advertising various dot-com companies that were blowing their whole annual marketing wad on this one 30-second spot. I also remember that this was the time the first ever day trading expo took place in southern California, Finally, I remember my refrigerator breaking down, It wasn't the actual breaking down that was significant* but the man I called out of rhe Yellow Pages who came to fix it for me was. The job took him exactly 84 minutes. The first 12 minutes were spent fixing the refrigerator. The rest of the time he spent preaching to me about his favorites stocks in the NASDAQ and why Cisco was worth $500 a share. I tried to stop him halfway through his lecture to let him know thai a fleck of saliva was hanging off his chin, but he wouldn't let up. As he preached the gospel of the Internet, [ realized that there was so much excitement in this current market that it really didn'1 matter how far down it went when the crash finally camepeople were now believers, and they would hold on until they got their margin call. By the time he left, I started looking at my charts for any breaks of the low of the high day. There weren't any that day, but a month later there were plenty. I do focus some of my efforts on Finding newer companies that have the potential to make a big splash with a new product, such as a RIMM (Research in Motion Ltd) or a TASR (Taser International Inc). There are many long-term trend-following opportunities m the markets, on both the long and the short side. However, finding the next Microsoft is not my trading niche. If I do find it, great, but in the meantime, I'm going to keep looking for setups. Therefore, most of my long-term efforts in the stock market are involved in swing trading, and one of my favorite setups is what I call propulsion plays. This is a systematic approach to getting positioned in stocks over a few days to a few weeks. Seventy percent of the time individual stocks spend their days backing and filling in a tight range, building up steam for their next major move. This approach looks for stocks that are done with their resting period and are getting ready to spurt higher (or lower) once again. The idea is to already be in the stock when it makes a push higher (for longs) or lower (for shorts), instead of trying to chase it intraday. The reason I like to do this is that there are many times in the market when very few intraday trading opportunities in the stock indexes set up. Some of the sectors are up, some are down, resulting in a very choppy and quiet overall market. However, during these times, there are always going to be individual stocks that are making a move. By being positioned in these stocks over the course of a few days to a few weeks, I don't feel forced to get into intraday trades in the stock index futures when nothing is really setting up. This is because I already have positions on that are set up to take advantage of their next mini-move For this setup, I'm focusing mostly on individual stocks. However, on individual stocks that also trade single stock futures (SSFs) and stock options, 1 will consider plays in those instruments as well. Because SSFs are so new and because most people play options incorrectly, I'm going to spend a little time reviewing how they work and how I use them. Let's review, THE TRADER'S GUIDE TO SINGLE STOCK FUTURES Single stock futures (SSFs) are futures contracts on individual stocks. There are currently around 130 well-known stocks such as IBM, QC0MT EBAY, GOOG, RIMM, and MSFT that have futures on them. This is a recent development since it was only in late 2000 that Congress passed legislation lifting the ban on these products, which were already trading in Europe and other countries. There are also futures contracts available on many exchange traded funds (ETFs). To get a complete listing of all these futures contracts, a trader can visit www.onechicago.com. One Chicago is an electronic exchange that is a joint venture of the Chicago Board Options Exchange (CBOE), Chicago Mercantile Exchange Inc. (CME), and the Chicago Board of Trade (CBOT). Now, how do they work and how does a'trader use them? Many brokers have been slow to adapt to these new trading instruments, but they are starting to catch on. Because these are futures con tracts t traders need to have a futures account in order to trade them. On top of that* they also need to be trading with a broker that is set up to trade them, as not every broker is equipped to handle these trading instruments. Once that is completed, these are traded just like a normal futures contract and they are available through eCBOT and Globex, just like the mini-stock index futures. Whereas mini-stock index futures contracts like the YM and ES trade quarterly, the SSFs trade monthly. Traders who aren't familiar with the letter codes for the various months should write this down and tape it to their wall as a reference guide. These are applicable to all futures contracts: F=January G-February H=March J=April K=May M=June N=July Q=August U=September V-October X=November Z=December To get a quote on an EBAY (eBay Inc) single stock futures contract in TradeStation, a trader would type in EBAY (underlying stock symbol) IC (One Chicago) V (Month Code) 05 (Year). So the final quote for the EBAY October 2005 SSFs would look like this: EBAY1CV05. There are a few nice features regarding SSFs that I find attractive. First, the $25,000 day trading rule does not apply. Active traders who have a $50,000 account and who tie up $26,000 of that in options trades will suddenly find themselves out of luck. They will not be able to execute any new stock or options trades because the broker won't count the option value toward the traders' equity. This situation would draw their countable account balance below $25,000, and traders would be locked out of initiating any new trades. An annoying feature to be sure. SSFs provide the leverage of just in the money options without the restrictions constraining pattern day traders and their account size. Here are a few additional key points: On stock accounts, a trader can get a 2:1 overnight margin, and the interest charged is the same amount a person would pay for a mediocre deal on a credit card. For SSFs, the equivalent of a 5:1 margin is available, and there are no interest fees. 5:1 leverage equates to having to put up 20 percent of the purchase price of the under lying stock. A trader who buys $10,000 worth of IBM (100 shares at $100) by 302PART TWO Specific Intraday and Swing Trading Setups using one IBM SSF contract would have to put up only $2,000. A trader who buys 10 contracts IBM 1C at $95 ($95,000 worth of IBM) would put up $19,000, and so on. When shorting stocks, a trader has to wait for an uptick in order to get filled. There isn't any uptick rule for short selling an SSF contract This is becoming less important as more and more actual stocks are becoming shortable on down ticks. One SSF contract equals 100 shares of Mock. A one-point move equals $ 100 per contract. These are monthly contracts that expire the third Friday of each month, just like options. If traders own a February contract on the day it is expiring, they will need to sell the February contract and buy the March contract. This is also known as rolling over into the next month. If traders hold onto the contract through expira tion, they will have the stock delivered into their account. Don't worry about for getting, because brokers don't want to deal with this, and they will call and pester you to close out your position days before expiration. The biggest question I get about SSFs has to do with their volume. For many of these contracts, there is not a lot of volume traded at this time, and this is an obvious concern for traders. However, it is important to note that the real volume of an SSF contract is in the underlying stock itself. The LMMs (lead market markers) and MMs (market markers) for SSF products make their living buying and selling SSF contracts and immediately hedging or arbi-traging that position with the underlying cash stock. Because of this, they will fill any order that is in line with the underlying volume of the stock. Since most of these stocks trade millions of shares, getting a fill is not an issue. There have been days when I've been the only one trading the SSF, and yet 1 have no problem getting in and out of the position. On those days, which rarely happen anymore because volume is steadily growing, it's fun knowing I'm the only person in the entire world who made money on that trade. The other question I get from traders involves the spreads. If there aren't any orders coming in, then the LMMs and MMs keep the spreads wide. This is so that they don't end up trading against each other However, once a real order comes in, they will close the bid and ask to be in line with the underlying stock and snap it up. Because of this, 1 never use market orders when getting into an SSF trade. I just look to see where the underlying stock is trading and place a limit order based on the underlying price of the stock. The other thing to remember about SSFs is that their charts are pretty much worthless at this time. The volume is sporadic, so the charts aren't very clean. The best way is to chart the underlying cash stock and then base all decisions to get in and out of the SSFs on the underlying stock. What I will do is set up the chart of an underlying cash stock and then put the quotes for both the cash stock and the SSF contract below it so I can see where the current bid ask is located. However, because most of my trades in the SSFs are swing trades, I don't even watch the charts intraday. I just set up my limit orders the night before based on the cash chart and then wait until the end of the day to see if I'm filled. We'll look at a couple of sample plays on EBAY and QCOM in a moment. First I want to discuss options quickly. THE ONLY WAY TO PLAY INDIVIDUAL STOCK OPTIONS I'm writing this section based on the premise that the reader knows at Jeast a little about what options are and how they work. If not, that's okay. There are plenty of Web sites out there that explain them in detail, and I would recommend reading more about what options are and how they work if you plan on using them. I'm just going to give a quick rundown and share how I incorporate them into my trading plan. There are many complicated option strategies available, and many people spend hundreds of hours looking for the perfect strategies to generate guaranteed income. Most of these strategies work great when the markets are range-boundwhich they are most of the time. Then along comes the inevitable big rally or watershed decline and all these people get hosed. For a period of years in the mid-1990s, a lot of traders and funds made a nice living selling naked puts. These are put options whose writers do not have a short position in the stock on which he or she has written the put. The goal here is that the options expire worthless, and the put writers collect the premium. Many books started popping up on the shelves about taxi-driver millionaires who discovered this amazing get rich quick trading strategy. Then along came October 27. 1997. The markets had been drifting down through October, and many of the taxi drivers, as well as several large funds with a few hundred million in assets, were busy selling naked puts. The brokers who worked with the funds started getting nervous because the positions had gone against the funds to the point where it wouldn't take much of a further decline to start forcing margin calls. The brokers, who didn't quite understand the strategy being used by the funds, started to place discreet calls to other traders asking what would happen if the Dow dropped a couple of hundred points over the next week or so. The answer was easythese funds would be forced to dump their positions because of margin calls, and this would create tremendous downward selling pressure in the overall markets. The S&P 500 floor traders at the CME got wind of this and started prepping for the slaughter. On October 16, 1997, the Dow broke through its most recent uptrend line as seen on point 1 in Fig. 16.1, The Dow then rallied and closed at 8034.65 on October 22, just below its broken trendline, at point 2. This is a common occurrence in all marketsonce a trendline is broken, the markets will come up and test it last time before rolling over, I call it, kissing the trendline goodbye, On October 24, at point 3, the Dow closed at 7715.41, down 319.24 points, This started the round of forced margin calls after the close, which was on a Friday. The margin call selling would take place on Monday. The Dow opened Monday at 7633.14, down 82.27. Then the forced selling via the margin calls began and the S&P pit traders, who knew what was happening, simply stepped back and walked away from the bids. With no support in the markets, the Dow dropped quickly and closed at 7161.39, down 554.02 points on the day as seen at point 4. By the time the closing bell rang on Monday, everyone who was selling naked puts for a living had lost a substantial amount of money. The funds that were involved not only lost all the money under their management; they ended up owing money to the brokers. Well, more correctly, the people who had invested in the fund lost all their money, and ended up owing more than they had put into the fund. Many metaphors come to mind here, but I will pass as most of them are quite graphic in nature. Once all these people were cleaned out, the markets were set to rally. The very next day the markets pushed down to new lows, touching 6927 at point 5, shedding just over 1,000 points in three trading days, before putting in a hard bottom. The Dow then closed at 7498.32, up 336.93 points on the day, and went on to rally steadily from there. Once all of the naked put sellers were cleaned out, there was nothing to do but resume the uptrend. Okay, so how do I use options? The only way I use options is as a means for owning a stock at a cheaper price. Because of the premium and time decay, 1 am very specific about the options I buy. For example, I won't buy out of the money options, as they are all premium and a sucker's game. Therefore, I want to look at options that are trading in the money (in the money means when the option's strike price is below the current market price for call options, and when the strike price is above the current market price for put options) if not more, in order to buy an option where the premium constitutes less than 30 percent of the overall purchase price. As I'm writing this in early 2005, the premium of options is generally low, so I can usually buy options just one strike in the money to meet this criterion. In 1999 and 2000 option premiums were at extremes, and I often had to go 5-10 strikes in the money to buy options that met my criteria. 1 remember when QCOM was at $250 before its infamous run to a thousand at the end of 1999. At the money call options were $45. In order to buy calls that were only 30 percent premium, I had to go nearly 15 strikes in the money. |
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