06/10/2022 — Rangebound…and Down
Like Kenny Powers stumbling his way through an increasingly quixotic attempt at reliving the baseball career he once abandoned, I find myself struggling to grasp the impossible task that is finding a market feel through the cold, LED indicators muttered across my computer screens. I too am back at a game that I left in my prime at the wrong time and returned at a wronger time, a small dinosaur in a huge digital marketplace.
There might be no better feeling than winning, but losing isn’t all that much fun. And for all the clichéd phrases masquerading as wisdom, there aren’t enough lessons and no amount of character-building that losing can provide that will feel better than “money in the bank.” I think Mr. Powers would agree, and if you disagree, you can stop reading here. Trading isn’t for you, but coaching little league baseball certainly might be.
When the market moves benevolently, seemingly range-bound, the trading is good and the winning follows suit. The problem lies with the illusion that this is what is actually taking place. Far more sinister, even educated market analysis consistently fails due to the necessity of viewing the market through the lens of time. Sure, for a few days this past week and the week before, S&P futures paced back and forth between the bounds of 4080 and 4170. Yet lurking in the shadows, a few sour indicators and a potential recession convinced financial punters that the future looked a bit bleak, and the market quickly burst through its false floor, seeking a home in the low 3900s. Ranges are defined by time windows. If your time window is too big you’ll never trade at all. A two year window would place the S&P futures anywhere between 3000 and 4800. Good luck using that as a guide. Conversely, choose a span too short and you may find yourself bowled over within minutes.
If market analysis is hit or miss at best, then how does a small individual trader find a way to make their daily keep?
Lacking the backing of a multi-million dollar firm, the idea of trading a full volatility curve over several expirations appears out of the question. Online brokerage restrictions simply won’t allow the necessary leverage to hold positions through market aberrations. If you do find yourself flush with the massive cash pile needed to trade like a big boy, you are either someone who plays for the thrill of the game, or a complete idiot. For the rest of us, a bit of experience, numerical savvy, restraint, and “feel” might provide enough to squeeze out a few dollars from all the madness.
Experience and numerical savvy are rather self-explanatory. Restraint is a strange bird; too much will have you sitting on your hands too much of the time, while too little will drain your coffers faster than you can say “coffers.” That leaves feel. Feel means something different to each person. Putting aside detailed company analysis (useful for trading individual equities), insider trading, and precognitive abilities, feel might be best described as the disquieting sense that change is afoot — or that a current, comfortable range might not be a safe haven for much longer.
In the Paleolithic Era of open-outcry trading, one might catch this feeling through the width of fellow market-makers’ price quotes, the urgency in a broker’s voice, or by just sensing a mood shift in the trading pit. In the electronic, off-floor world, coy lifeless screens provide no tactile clues as to what is going on, and traders are left only with thousands of numbers skittering across their screens. Hopeless, right?
Conventional wisdom states that market movement, or lack thereof, drives volatility. That is true. But traders might also glean some insight from volatility movements that don’t appear to be a result of market movement. If implied volatility rises (rising option prices) without a leading market move, that could mean that there are people out there that actually know something you don’t. They might be paying more attention to news, have a privileged nugget of information, or even be picking up on some of those long-lost sensory cues if they are on a trading floor. In short, they may have a better feel than you and option prices could be reflecting this. But there is nothing wrong with you riding their coattails to better trading decisions. As bid and ask prices start to creep up on your screen, it could be an indicator that the market might be due for a downturn. “Could” and “might” are important words here. As mentioned earlier, market analysis comes with the caveat that it might be dead wrong.
However, this unusual event of the tail seemingly wagging the dog might provide the perfect opportunity to reposition oneself to trim a position or to take advantage of overpriced options. Once again, there exists much ambiguity as to the correct course of action when these anomalies are noticed — much of it depends on the trader’s existing position. If they are flat-to-long volatility it could signal an opportunity to sell some options at an inflated price that (hopefully) will fall back in line with current market conditions before expiration. On the other hand, if a trader finds themselves short a few units of risk, a small-but-noticeable yet inexplicable rise in volatility might warrant a taking of profit and covering of position. Either way, there are little nuances in the numbers that can help a trader find an edge, and it’s best not to ignore them.
Yesterday this author noticed these strange patterns near the end of the trading day, but failed to recognize it as an opportunity to trim position. Today he finds himself un-rangebound and down — as in down money. Losing. And if you want to know how Kenny Powers feels about losing…