trader’s journal

Position: WFC July 2008 $32.50 Put
Size: 8 percent*
Opened: 11/23/2007
Closed: 01/22/2008
Profit (Loss): 56%

trade thesis

When I was a broke ass graduate student, I had the pleasure of living in an apartment in Texas with several thousand unclean and unwanted roommates. With the lights on, I might see one or two of my uninvited little guests. When the lights went dark, the rest of them came out to play.

By November of 2007, the meltdown in the housing market was in full swing. While the usual cadre of idiot talking cement-heads was busy calling the bottom on CNBC**, I was trying to guess the first money center bank to blow up. While the train wrecks known as Countrywide (CFC) and Indymac (IMB) were not complete at the time, both had derailed and the end result was easily predictable.

Based on my experience in the Lone Star State, I figured there were several others scurrying around the banking sector. So I decided to short Wells Fargo (WFC) using puts. The key to my decision was WFC’s large book of home loans in California, where declining home prices had given CFC and IMB fits. I was wrong about the bank being the next to blow up, but I still made a profit.

mistakes, flashes of brilliance, and lessons learned

This trade turned out quite well, despite my lack of a brilliant exit strategy. When the trade showed a decent open profit, I bailed.

Luck is important - even though my thesis did not play out, I was able to get out of the trade with a decent profit. Additionally, expiration makes options tricky. There have been several red flags in WFC’s conference calls***, but the share price has not imploded as of this post. Had I held through expiration, the put would have finished in the money and the intrinsic value would have been slightly less than what I paid for it.

notes

* Of total account equity.
** This channel is guaranteed to cause brain rot. Turn it off.
*** E.g. redefining non-performing as 120 days past due instead of the traditional 90.

Position: UNP May 2008 $120.00 Put
Size: 15 percent*
Opened: 11/20/2007
Closed: 01/04/2008
Profit (Loss): 17%

trade thesis

The United States appeared to be headed for a recession, if not already in one, and container volumes at the ports of Long Beach and Los Angeles were declining year over year. Also, Union Pacific (UNP) appeared to be a poorly run railroad when compared to its peers, based on fundamental analysis.

mistakes, flashes of brilliance, and lessons learned

This was a successful trade and my first profitable one at Optionsxpress. A key mistake was committing far too much of my account equity to the position. However, in this particular trade it worked out because I was nervous and took a profit when it was available, in contrast to a similar trade in CSX.

In this particular case, UNP proceeded to rise from when I took the profit through expiration. Had the opposite ocurred and UNP dropped substantially, I would have missed out on a potentially substantial profit by closing the position too early because I was worried about the large size.

notes

* of total account equity.

Position: XOM April 2008 $100.00 Call
Size: 4 percent*
Opened: 10/31/2007
Closed: 04/20/2008
Profit (Loss): (100%)

trade thesis

Federal Reserve Chairman Ben Bernanke was dropping interest rates like they were hot. Every time he opened his burrito hole, the dollar tanked and the price of oil jumped. Expecting more rate cuts from Easy Ben, while his counterpart in Europe kept interest rates steady, I speculated the bull market in oil would continue and took a bullish position in Exxonmobil (XOM).

mistakes, flashes of brilliance, and lessons learned

While my thesis turned out to be correct both in direction and time frame, the price of XOM did not follow the price of oil and the call expired worthless. In retorospect, the correct trade would have been to take a position in oil, either through futures, an ETF, or options on either of the former. Better money management would have mitigated the loss - I should have closed out while the call still had some value, instead of stubbornly believing I was correct and XOM would cross the strike price.

request for input from the peanut gallery

I still don’t understand why XOM did not follow the price of oil - can anyone enlighten me as to why this went horribly wrong? Taking a 100 percent loss on the trade stung, does anyone have money management tips to share?

notes

* of total account equity.

Position: CSX May 2008 $40.00 Put
Size: 6 percent*
Opened: 10/16/2007
Closed: 03/17/2008
Profit (Loss): (76%)

trade thesis

Despite jawboning by prominent economists, I suspected the United States was in a recession and certainly headed towards one. Because freight companies are often impacted first by a downturn, I figured shorting them would pay off. Additionally, based on my fundamental analysis of freight railroads, CSX Transportation (CSX) performed poorly on several key measures compared with its competitors.

mistakes, flashes of brilliance, and lessons learned

This was my first trade at Optionsxpress and also my first money losing option trade. Key issues resulting in the loss were my lack of understanding of technical analysis, volatility, and money management, along with a limited knowledge of the effect of time decay.

Even though economic reports during the holding period were generally negative, the CSX share price never dropped below the strike price of the option. However, there were a few opportunities to take a modest profit, notably November 21st through the 26th, and later on January 8th.

Instead of closing out the position when it was profitable at those points, I chose to hold with the expectation the option would soon be in the money. Instead, CSX rallied off the lows. I closed the position two months prior to expiration, while the option still had some time value, for a loss of 76 percent.

While the initial trade thesis turned out to be incorrect, knowledge of technical analysis would have helped me choose better entry and exit points, increasing the probability of profit. An understanding of how volatility affects options pricing would have also provided insight to entry and exit points, again increasing the my chances of profiting. Better money management would have resulted in a smaller loss.

request for input from the peanut gallery

What would you have done differently? Was the initial trade thesis correct? If so, how could this be traded in the future?

notes

* of total account equity.