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Contr ary O pi ni on &O pt i o ns S tr ate gi e sFo r a V o lat i le M arke tPrice Headley, CFA, CMT
President & CEO
May 26, 2004
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Contrarian Philosophy The majority of investors are usually wrong, being too
Reactive in taking positions
Contrarians profit from the UNEXPECTED what isexpected is already priced into the market
Spotting these reversals is the key most people see
Contrary Opinion as too subjective. My aim is toquantify investor emotion so that we can assess it in an
analytical, non-emotional method.
This allows for a Proactive approach to take advantageof other investors emotional over-reactions.
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Contrary Opinion Indicators
Contrarian Investing Capitalize on theEmotional Reactions of Other Investors
Techniques: CBOE Equity Put/Call Ratio
CBOE Volatility Index (VIX)
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Options Indicators are especially useful to
measure Fear & Greed why? Because
option traders use Leverage, and they feelthe swings of the market more quickly and
more dramatically
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What is the VIX? A: The CBOE Volatility Index (VIX) plots an
average implied volatility in put and calloptions. The irony is that at extremes, thesemarket expectations often signal a reversal.__________________________________
Puts increase in value when a stock declines Calls decrease in value when a stock declines
Calls increase in value when a stock rises Puts decrease in value when a stock rises
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Using the VIX
Extremes in the VIX reading indicate a likely
beginning or end of a trend
Readings above 40 indicate much fear
Usually comes at a market bottom a buy signal
Readings below 20 indicate much confidence
Usually comes at a market top a sell signal
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History of the VIX
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VIX dropped to 20 at the market top
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VIX spikes to 40 and 50 at lows
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When VIX signal fails after 4 weeks, GET OUT!!!
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VIX now staying under 20
Is that Bullish or Bearish?
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VIX Relative Extremes with Bollinger Bands
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VIX Relative Extremes with Bollinger Bands
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CBOE Put/Call Ratio
A measure of how many puts are tradedrelative to the number of calls traded on any
given day
High put volume, relative to call volume,
indicates bearish sentiment High call volume, relative to put volume,indicates bullish sentiment
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Extremes in the Put/call ratio
Put/call ratios under 40 indicate TOO much
bullishness and optimism a sell signal
A market top
Put/Call ratios over 80 indicate TOO much
bearishness and pessimism a buy signalA market bottom
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CBOE Equity Put/Call Ratio Daily
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New - CBOE Equity Put/Call
Ratio Daily
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OPTIONS TERMS
Call - right to buy stock at a specific price
good through a specific date
Put - right to sell stock at a specific price
good through a specific dateStrike Price -price you can own stock
Expiration - date the option ceases to existVolatility - % movement in the stock
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OPTIONS TERMS
In-The-Money (ITM) - Option Has
Intrinsic Value
At-The-Money (ATM) - Strike = Stock
Out-of-The-Money (OTM) - Option isAll Time Value
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Buying a Call
When buying acall, you believethe price of thestock will increase
in value. Here wehave bought theright to BUY 100shares of XYZ at
$60 per share, andwe have that rightuntil December
Option: XYZ December 60 CallPrice: $2.00
Quoted price $2.00x 100 shares x 100
Total purchase = $200
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BUY CALL
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Buying a Put
When buying a put,you believe theprice of the stockwill decrease in
value. Here wehave bought theright to SELL 100shares of XYZ at$60 per share, andhave that right untilDecember.
Option: XYZ December 60Put
Price: $2.00
Quoted price $2.00
x 100 shares x 100
Total purchase = $200
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BUY PUT
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BUY PUT
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TIME DECAY
EXPIRATIONMONTHS UNTIL EXPIRATION
TIME PREMIUM
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In The Moneys as a Stock Substitute
Buy In the Money Options to ReduceTime Value => Focus on Intrinsic
Sell 100 XYZ shares @ 56.60 = $5660
Buy 1 June 60 PUT @ 4.70 = $ 470XYZ goes to 50 before mid-June:
Short Shares gain $660, or 11.7%
ITMs gain $530, or 112%
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B LEAPS S ll Sh t T C ll
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Buy LEAPS, Sell Short-Term Calls You can reduce your cost in the
LEAPS by selling short-term calls Buy 1 Jan. 2006 45 call @ 20 = - $2000
Sell 1 3-month 60 call @ 4 = + $400
Do this 5 times and you have no costeffectively in your LEAPS position
Benefit: Time decay on the short-term
out-of-the-money much greater
Risk: Sharp rally may require buying inthe short-term call due to gamma risk
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The Credit Spread Strategy Profit from Time Decay
IF Bullish: Instead of buying calls,be a net seller of puts
100 QQQ shares @ 36
Sell 10 June 35 puts @ 1.25 = +1250Buy 10 May 34 puts @ 0.85 = - 850
Net Credit Collected = + 400Options expire if QQQ closes over 35 on
third Friday in June, you keep the $400
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Using Puts for Portfolio Protection
When Should You Buy Puts for Protection?Technical Indicator says SELL
Options are Cheap Low Volatility Levels
Concerned about Giving Back Big Gains
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How Big Should Your Deductible Be?
Usually 1 strike out-of-the-money
Advantages: Keep Tax Basis, Lessen Painon Major Pullbacks,
Disadvantages: Cost, Hurts in Flat Market
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Creating a Low-Cost Collar
A Collar accomplishes the goal of PutProtection, but often at minimal to no cost,
by also selling a call against the stock
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XYZ shares at 60Buy 3-month 55 Put for - $300
Sell 3-month 65 call for + $275
Net Cost = - $25 This lowers your cost dramatically to
protect a stock, while giving up
appreciation above a certain level (like a
covered call
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How to Stay with Big Winners
Give yourself a chance to stay with a BigTrend by taking HALF of your position
profits at 100% or more
This allows you to release the fear of givingup profits, as you recoup your initial
investment and guarantee at least a
breakeven
Ride the other half position until it gives
back half its gains, or exit half again if it
later doubles once more
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Percentage Gain to Breakeven
After a Loss
Gain RequiredPercentage Loss to Breakeven
-10% 11%
-20% 25%-33% 50%
-50% 100%
-75% 300%
-90% 900%
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A Flaw in the Options Pricing Model
Q.Which is more important in the Options Model?
(Assume: XYZ shares at 119-1/2, Volatility starts
at 25.00%, Expiration in 70 days, Strike price is 120)
Scenario 1. 20% Volatility Rise (25% to 30%) instantly
A 20% Rise in Price or a 20% Rise inVolatility?
Scenario 2. 20% Stock Price Rise (119.50 to 143.38) instantly
XYZ August 120 call 5.50 => 24.63 a 348% gain
A.Trend impact is 19 X greater than Volatility here
XYZ August 120 call 5.50 => 6.48 an 18% gain
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Why Option Charts ?
Options are NOT the stock they can and
do move independently of the underlying
security
Options DO move in patterns that can be
forecasted with traditional technicalanalysis techniques
STOCKS VERSUS OPTIONS
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STOCKS VERSUS OPTIONS Most options traders look at the stock chart to
determine the trend of the underlying security,
and then decide whether they will buy an option
What if you also looked at an Option Chart?Is that any different than the stock chart?
YES! The additional factors of Time & Volatility oftenmake the options chart look quite different than thestock chart
1) If the stock stays flat, your option will expire and youlose due to Time Decay
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B
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eBay
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20 Day Acceleration Bands
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20-Day Acceleration Bands
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Option Scans Manage Info Overload
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Option Scans Manage Info Overload
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Stochastics Cross Over 80
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Stochastics Cross Over 80
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NFLX Dec 30 Call (QNQLF)
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NFLX Dec. 30 Call (QNQLF)
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QQQ Jan 36 Call Options Chart
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QQQ Jan. 36 Call Options Chart
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What is BigTrends Platinum Club?
Daily Email Updates1. Aggressive Options Trader
2. QQQ Options Timer
3. OEX Options Authority
4. S&P Emini Futures Trader
5. Aggressive Stock Trader
6. Ultimate Fund Investor
7. Sector Trend Advisor
8. Dow Covered Calls
9. Weekly NetLetter
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Auto-Trading
Several brokers offer the ability toautotrade the BigTrendsrecommendations.
Call 1-800-BIGTRENDS (1-800-244-8736) or email: [email protected] a complete list of autotrading
brokers.
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Phone: 800-244-8736 or 1-513-631-5015
Email: [email protected]: 513-631-5039
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