Divide by Nought

2. Daily Market Wide Watching

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To be serious about anything you really need to spend time on it, and in the case of the markets with it.  I’m not a day trader, but I do pay attention to the markets daily.  Because to trade well and be profitable, to be serious about it, it’s helpful to get a feel for the markets, and that takes spending time with it.

Further, I tend to make most of my trades leading up to and trailing off from an expiration date.  Which means during that period I’m paying even more attention.  I want to get a feeling for where the markets might be heading, how quickly (or not) they’re going there, and when a good time will be to get into some new trades.

The reason for this is simple, pricing.  In options trading cents can mean hundreds or even thousands of dollars, so getting the best fills that you can is important.  Doing that well means knowing what the markets are likely to do within the day that you intend to make the trade.  And a large part of that is simply having a good feel for the market.  To do this well, its important to be looking at and using the right tools.

I like the following:

  1. Volatility Skew
    The closest thing there is to an indicator that can tell the future is the volatility skew, or positive and negative skew.  It is a measure of how out of the money puts are trading in relation to an equally out of the money calls.  This can be used as an indicator of market makers’ expectations of the direction of the underlying.

    Positive Skew: Out of the money calls trading with higher implied volatility than the related out of the money put; that is both x points out of the money. This suggests that the underlying is expected to move up. This is often seen in commodities, where it is less likely to have a surplus, and more likely to have a shortage, driving the price up.

    Negative Skew: …is the opposite, and creates an expectation that an underlying is more likely to have downward movements.

  2. Delta Skew
    Again looking to implications of the future one can look at the delta and volatility skews in an option chain.  If the markets didn’t have an expectation of direction, then at-the-money options would be equally priced at 50 cents.  But they’re not.  Delta is also a calculation of the probability of expiring at least 1 cent in-the-money.  Meaning a higher Delta implies a higher probably that the option will be worth something at expiration.  Or, taken a different way, a lower delta for an at-the-money call implies that the expectation is for the market to head down.
  3. Put/Call Ratio
    Also worth looking at as a future indicator is the put/call ratio.  This is exactly what it sounds like: take a ratio of open interests for puts vs. that of the calls for a given underlying.  A vlaue of 1.0 indicates a perfect balance.  Anything above 1 the bears are, at the moment, winning and the markets will likely fall.  the greater the number the more likely the markets are to fall.  The opposite is true for values under 1.0.  It’s also worth noting that there is a negative bias.  That is, 1.1 to 1.2 are closer to the balance point than is 1.0.  This is due to the tendency for people to bu protective puts, no matter what the market conditions.
  4. Price & Volume
    You’ve heard it before, “price is king”, and it is…kinda.  If nothing else it is representative of what the market mentality is right at the moment, with volume acting as the strength of that mentality.
  5. Breadth & Depth
    The market Breadth is the number of advancing underlying within a composite compared to those that are declining.  The Depth is the volume of the advancers vs. the volume of the decliners.  Again, these essentially shows the strength of movement in the markets at a specific point.

EVERYTHING BELOW NEEDS TO BE UPDATED — 2008/04/09

The point then is to take these indicators and find a way to reference them quickly, so it can be done throughout the day to get the feel for the market, without having to stay glued to the screen. I don’t have a good quick way to look at volatility and delta skews.  The platform I’m using will graph it, but I don’t like the result; it’s not all the easy to read.

Any given day I’ll have a few different pieces of information; they are:

  1. A histogram of intra-day price moment for 36 indexes and ETFs that represent the broad markets and specific sectors. This gives a good view of what is going on in the markets at a glance. Because it’s a percent change histogram I can see how far each has moved relative to each other, where the high and low points have been. This is pretty close to the same information that you could get with 36 intra-day charts but it’s much faster to read and takes up a lot less space.
    2008-02-16-watch.gif
  2. For those 36 indexes and ETFs I also look at the numerical breakdown of:
    1. Advancing vs. Declining issues. Even with a histogram, this is faster to see how many are up or down.
    2. The volume for all Advancing, Declining and all issues.
    3. The put/call ratio for all Advancing and Declining issues. Using this, to a certain degree the aforementioned volume, are really good at showing where the market is likely to go within (at most) the day. Usually within the hour.
    4. The total capitalization for all Advancing and Declining issues. I don’t really pay that much attention to this, but I suppose it could be used similarly to the volume or put/call ratio.
  3. For the NYSE, NASDAQ, and AMEX I chart the Advancing (UVol), Declining (DVol), and Total (TVol) volume. I’d like to also chart the Ratio of UVol and DVol but the platform that I’m using doesn’t currently support that.
  4. For the NYSE, NASDAQ, and AMEX (and a couple broad market ETFs) I have the net change of the UVol, DVol, Advancers, and Decliners.
2008-02-16-uvol-dvol.gif
NYSE, NASDAQ, & AMEX UVol, Dvol, & TVol

Written by me

Thursday, March 13, 2008 at 3:17 am

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