How is margin trading pretty safe if the margin trading side of things can buy more value than they're borrowing?
This is my first go at understanding margin trading vs lending. I'm trying to understand all the risks associated with it. I understand if the exchange goes down things can be jacked up, but for the purpose of this discussion lets ignore that scenario. I've searched on YouTube and found some videos, but haven't found anything yet that cleared it up for me. I see a LOT of people say that how Poloniex does it (with the collateral liquidation) makes it almost risk-free unless there's something massive that happens with the price in a very short period. Poloniex's web site gives the following example:
Current Margin: The percentage of your Total Borrowed Value that your Net Value currently is (in other words, Net Value over Total Borrowed Value). Current Margin is a critical value, because if it dips below your Maintenance Margin, your account will undergo a forced liquidation. For example, suppose you have 1.5 BTC in your margin account, and your Maintenance Margin is 20%. Borrowing 3 BTC, you open a long position in the XMR market. Now, in order to avoid a forced liquidation, the Net Value of your margin account must remain above 20% of the 3 BTC you just borrowed, or 0.6 BTC. If the price of XMR starts declining, the amount of BTC you can get by selling the XMR you just purchased diminishes, and you start to incur a loss. This is reflected in your P/L and Net Value. If the amount of this loss, together with the lending fees you owe, reaches 0.9 BTC, the net value of your margin account will be 0.6 BTC (1.5 BTC minus 0.9 BTC in unrealized losses) and a forced liquidation will trigger.
Is this saying that the borrower must maintain a value of at least 3.6 BTC in their margin account? If so, it makes sense why this seems risk-free aside from an issue with the exchange going offline or very steep fluctuation in price...
The dollar standard and how the Fed itself created the perfect setup for a stock market crash
Disclaimer: This is neither financial nor trading advice and everyone should trade based on their own risk tolerance. Please leverage yourself accordingly. When you're done, ask yourself: "Am I jacked to the tits?". If the answer is "yes", you're good to go. We're probably experiencing the wildest markets in our lifetime. After doing some research and listening to opinions by several people, I wanted to share my own view on what happened in the market and what could happen in the future. There's no guarantee that the future plays out as I describe it or otherwise I'd become very rich. If you just want tickers and strikes...I don't know if this is going to help you. But anyways, scroll way down to the end. My current position is TLT 171c 8/21, opened on Friday 7/31 when TLT was at 170.50. This is a post trying to describe what it means that we've entered the "dollar standard" decades ago after leaving the gold standard. Furthermore I'll try to explain how the "dollar standard" is the biggest reason behind the 2008 and 2020 financial crisis, stock market crashes and how the Coronavirus pandemic was probably the best catalyst for the global dollar system to blow up.
Tackling the Dollar problem
Throughout the month of July we've seen the "death of the Dollar". At least that's what WSB thinks. It's easy to think that especially since it gets reiterated in most media outlets. I will take the contrarian view. This is a short-term "downturn" in the Dollar and very soon the Dollar will rise a lot against the Euro - supported by the Federal Reserve itself.US dollar Index (DXY)If you zoom out to the 3Y chart you'll see what everyone is being hysterical about. The dollar is dying! It was that low in 2018! This is the end! The Fed has done too much money printing! Zimbabwe and Weimar are coming to the US. There is more to it though. The DXY is dominated by two currency rates and the most important one by far is EURUSD.EURUSD makes up 57.6% of the DXY And we've seen EURUSD rise from 1.14 to 1.18 since July 21st, 2020. Why that date? On that date the European Commission (basically the "government" of the EU) announced that there was an agreement for the historical rescue package for the EU. That showed the markets that the EU seems to be strong and resilient, it seemed to be united (we're not really united, trust me as an European) and therefore there are more chances in the EU, the Euro and more chances taking risks in the EU.Meanwhile the US continued to struggle with the Coronavirus and some states like California went back to restricting public life. The US economy looked weaker and therefore the Euro rose a lot against the USD. From a technical point of view the DXY failed to break the 97.5 resistance in June three times - DXY bulls became exhausted and sellers gained control resulting in a pretty big selloff in the DXY.
Why the DXY is pretty useless
Considering that EURUSD is the dominant force in the DXY I have to say it's pretty useless as a measurement of the US dollar. Why? Well, the economy is a global economy. Global trade is not dominated by trade between the EU and the USA. There are a lot of big exporting nations besides Germany, many of them in Asia. We know about China, Japan, South Korea etc. Depending on the business sector there are a lot of big exporters in so-called "emerging markets". For example, Brazil and India are two of the biggest exporters of beef. Now, what does that mean? It means that we need to look at the US dollar from a broader perspective. Thankfully, the Fed itself provides a more accurate Dollar index. It's called the "Trade Weighted U.S. Dollar Index: Broad, Goods and Services". When you look at that index you will see that it didn't really collapse like the DXY. In fact, it still is as high as it was on March 10, 2020! You know, only two weeks before the stock market bottomed out. How can that be explained?
Global trade, emerging markets and global dollar shortage
Emerging markets are found in countries which have been shifting away from their traditional way of living towards being an industrial nation. Of course, Americans and most of the Europeans don't know how life was 300 years ago.China already completed that transition. Countries like Brazil and India are on its way. The MSCI Emerging Market Index lists 26 countries. Even South Korea is included. However there is a big problem for Emerging Markets: the Coronavirus and US Imports.The good thing about import and export data is that you can't fake it. Those numbers speak the truth. You can see that imports into the US haven't recovered to pre-Corona levels yet. It will be interesting to see the July data coming out on August 5th.Also you can look at exports from Emerging Market economies. Let's take South Korean exports YoY. You can see that South Korean exports are still heavily depressed compared to a year ago. Global trade hasn't really recovered.For July the data still has to be updated that's why you see a "0.0%" change right now.Less US imports mean less US dollars going into foreign countries including Emerging Markets.Those currency pairs are pretty unimpressed by the rising Euro. Let's look at a few examples. Use the 1Y chart to see what I mean. Indian Rupee to USDBrazilian Real to USDSouth Korean Won to USD What do you see if you look at the 1Y chart of those currency pairs? There's no recovery to pre-COVID levels. And this is pretty bad for the global financial system. Why? According to the Bank of International Settlements there is $12.6 trillion of dollar-denominated debt outside of the United States. Now the Coronavirus comes into play where economies around the world are struggling to go back to their previous levels while the currencies of Emerging Markets continue to be WEAK against the US dollar. This is very bad. We've already seen the IMF receiving requests for emergency loans from 80 countries on March 23th. What are we going to see? We know Argentina has defaulted on their debt more than once and make jokes about it. But what happens if we see 5 Argentinas? 10? 20? Even 80? Add to that that global travel is still depressed, especially for US citizens going anywhere. US citizens traveling to other countries is also a situation in which the precious US dollars would enter Emerging Market economies. But it's not happening right now and it won't happen unless we actually get a miracle treatment or the virus simply disappears. This is where the treasury market comes into play. But before that, let's quickly look at what QE (rising Fed balance sheet) does to the USD. Take a look at the Trade-Weighted US dollar Index. Look at it at max timeframe - you'll see what happened in 2008. The dollar went up (shocker).Now let's look at the Fed balance sheet at max timeframe. You will see: as soon as the Fed starts the QE engine, the USD goes UP, not down! September 2008 (Fed first buys MBS), March 2009, March 2020. Is it just a coincidence? No, as I'll explain below. They're correlated and probably even in causation.Oh and in all of those scenarios the stock market crashed...compared to February 2020, the Fed balance sheet grew by ONE TRILLION until March 25th, but the stock market had just finished crashing...can you please prove to me that QE makes stock prices go up? I think I've just proven the opposite correlation.
Bonds, bills, Gold and "inflation"
People laugh at bond bulls or at people buying bonds due to the dropping yields. "Haha you're stupid you're buying an asset which matures in 10 years and yields 5.3% STONKS go up way more!".Let me stop you right there. Why do you buy stocks? Will you hold those stocks until you die so that you regain your initial investment through dividends? No. You buy them because you expect them to go up based on fundamental analysis, news like earnings or other things. Then you sell them when you see your price target reached. The assets appreciated.Why do you buy options? You don't want to hold them until expiration unless they're -90% (what happens most of the time in WSB). You wait until the underlying asset does what you expect it does and then you sell the options to collect the premium. Again, the assets appreciated. It's the exact same thing with treasury securities. The people who've been buying bonds for the past years or even decades didn't want to wait until they mature. Those people want to sell the bonds as they appreciate. Bond prices have an inverse relationship with their yields which is logical when you think about it. Someone who desperately wants and needs the bonds for various reasons will accept to pay a higher price (supply and demand, ya know) and therefore accept a lower yield. By the way, both JP Morgan and Goldmans Sachs posted an unexpected profit this quarter, why? They made a killing trading bonds. US treasury securities are the most liquid asset in the world and they're also the safest asset you can hold. After all, if the US default on their debt you know that the world is doomed. So if US treasuries become worthless anything else has already become worthless. Now why is there so much demand for the safest and most liquid asset in the world? That demand isn't new but it's caused by the situation the global economy is in. Trade and travel are down and probably won't recover anytime soon, emerging markets are struggling both with the virus and their dollar-denominated debt and central banks around the world struggle to find solutions for the problems in the financial markets. How do we now that the markets aren't trusting central banks? Well, bonds tell us that and actually Gold tells us the same! TLT chartGold spot price chart TLT is an ETF which reflects the price of US treasuries with 20 or more years left until maturity. Basically the inverse of the 30 year treasury yield. As you can see from the 5Y chart bonds haven't been doing much from 2016 to mid-2019. Then the repo crisis of September 2019took place and TLT actually rallied in August 2019 before the repo crisis finally occurred!So the bond market signaled that something is wrong in the financial markets and that "something" manifested itself in the repo crisis. After the repo market crisis ended (the Fed didn't really do much to help it, before you ask), bonds again were quiet for three months and started rallying in January (!) while most of the world was sitting on their asses and downplaying the Coronavirus threat. But wait, how does Gold come into play? The Gold chart basically follows the same pattern as the TLT chart. Doing basically nothing from 2016 to mid-2019. From June until August Gold rose a staggering 200 dollars and then again stayed flat until December 2019. After that, Gold had another rally until March when it finally collapsed. Many people think rising Gold prices are a sign of inflation. But where is the inflation? We saw PCE price indices on Friday July 31st and they're at roughly 1%. We've seen CPIs from European countries and the EU itself. France and the EU (July 31st) as a whole had a very slight uptick in CPI while Germany (July 30th), Italy (July 31st) and Spain (July 30th) saw deflationary prints.There is no inflation, nowhere in the world. I'm sorry to burst that bubble. Yet, Gold prices still go up even when the Dollar rallies through the DXY (sadly I have to measure it that way now since the trade-weighted index isn't updated daily) and we know that there is no inflation from a monetary perspective. In fact, Fed chairman JPow, apparently the final boss for all bears, said on Wednesday July 29th that the Coronavirus pandemic is a deflationarydisinflationary event. Someone correct me there, thank you. But deflationary forces are still in place even if JPow wouldn't admit it. To conclude this rather long section: Both bonds and Gold are indicators for an upcoming financial crisis. Bond prices should fall and yields should go up to signal an economic recovery. But the opposite is happening. in that regard heavily rising Gold prices are a very bad signal for the future. Both bonds and Gold are screaming: "The central banks haven't solved the problems". By the way, Gold is also a very liquid asset if you want quick cash, that's why we saw it sell off in March because people needed dollars thanks to repo problems and margin calls.When the deflationary shock happens and another liquidity event occurs there will be another big price drop in precious metals and that's the dip which you could use to load up on metals by the way.
Dismantling the money printer
But the Fed! The M2 money stock is SHOOTING THROUGH THE ROOF! The printers are real!By the way, velocity of M2 was updated on July 30th and saw another sharp decline. If you take a closer look at the M2 stock you see three parts absolutely skyrocketing: savings, demand deposits and institutional money funds. Inflationary? No. So, the printers aren't real. I'm sorry.Quantitative easing (QE) is the biggest part of the Fed's operations to help the economy get back on its feet. What is QE?Upon doing QE the Fed "purchases" treasury and mortgage-backed securities from the commercial banks. The Fed forces the commercial banks to hand over those securities and in return the commercial banks reserve additional bank reserves at an account in the Federal Reserve. This may sound very confusing to everyone so let's make it simple by an analogy.I want to borrow a camera from you, I need it for my road trip. You agree but only if I give you some kind of security - for example 100 bucks as collateral.You keep the 100 bucks safe in your house and wait for me to return safely. You just wait and wait. You can't do anything else in this situation. Maybe my road trip takes a year. Maybe I come back earlier. But as long as I have your camera, the 100 bucks need to stay with you. In this analogy, I am the Fed. You = commercial banks. Camera = treasuries/MBS. 100 bucks = additional bank reserves held at the Fed.
Revisiting 2008 briefly: the true money printers
The true money printers are the commercial banks, not the central banks. The commercial banks give out loans and demand interest payments. Through those interest payments they create money out of thin air! At the end they'll have more money than before giving out the loan. That additional money can be used to give out more loans, buy more treasury/MBS Securities or gain more money through investing and trading. Before the global financial crisis commercial banks were really loose with their policy. You know, the whole "Big Short" story, housing bubble, NINJA loans and so on. The reckless handling of money by the commercial banks led to actual money printing and inflation, until the music suddenly stopped. Bear Stearns went tits up. Lehman went tits up. The banks learned from those years and completely changed, forever. They became very strict with their lending resulting in the Fed and the ECB not being able to raise their rates. By keeping the Fed funds rate low the Federal Reserve wants to encourage commercial banks to give out loans to stimulate the economy. But commercial banks are not playing along. They even accept negative rates in Europe rather than taking risks in the actual economy. The GFC of 2008 completely changed the financial landscape and the central banks have struggled to understand that. The system wasn't working anymore because the main players (the commercial banks) stopped playing with each other. That's also the reason why we see repeated problems in the repo market.
How QE actually decreases liquidity before it's effective
The funny thing about QE is that it achieves the complete opposite of what it's supposed to achieve before actually leading to an economic recovery. What does that mean? Let's go back to my analogy with the camera. Before I take away your camera, you can do several things with it. If you need cash, you can sell it or go to a pawn shop. You can even lend your camera to someone for a daily fee and collect money through that.But then I come along and just take away your camera for a road trip for 100 bucks in collateral. What can you do with those 100 bucks? Basically nothing. You can't buy something else with those. You can't lend the money to someone else. It's basically dead capital. You can just look at it and wait until I come back. And this is what is happening with QE. Commercial banks buy treasuries and MBS due to many reasons, of course they're legally obliged to hold some treasuries, but they also need them to make business.When a commercial bank has a treasury security, they can do the following things with it:- Sell it to get cash- Give out loans against the treasury security- Lend the security to a short seller who wants to short bonds Now the commercial banks received a cash reserve account at the Fed in exchange for their treasury security. What can they do with that?- Give out loans against the reserve account That's it. The bank had to give away a very liquid and flexible asset and received an illiquid asset for it. Well done, Fed. The goal of the Fed is to encourage lending and borrowing through suppressing yields via QE. But it's not happening and we can see that in the H.8 data (assets and liabilities of the commercial banks).There is no recovery to be seen in the credit sector while the commercial banks continue to collect treasury securities and MBS. On one hand, they need to sell a portion of them to the Fed on the other hand they profit off those securities by trading them - remember JPM's earnings. So we see that while the Fed is actually decreasing liquidity in the markets by collecting all the treasuries it has collected in the past, interest rates are still too high. People are scared, and commercial banks don't want to give out loans. This means that as the economic recovery is stalling (another whopping 1.4M jobless claims on Thursday July 30th) the Fed needs to suppress interest rates even more. That means: more QE. that means: the liquidity dries up even more, thanks to the Fed. We heard JPow saying on Wednesday that the Fed will keep their minimum of 120 billion QE per month, but, and this is important, they can increase that amount anytime they see an emergency.And that's exactly what he will do. He will ramp up the QE machine again, removing more bond supply from the market and therefore decreasing the liquidity in financial markets even more. That's his Hail Mary play to force Americans back to taking on debt again.All of that while the government is taking on record debt due to "stimulus" (which is apparently only going to Apple, Amazon and Robinhood). Who pays for the government debt? The taxpayers. The wealthy people. The people who create jobs and opportunities. But in the future they have to pay more taxes to pay down the government debt (or at least pay for the interest). This means that they can't create opportunities right now due to the government going insane with their debt - and of course, there's still the Coronavirus.
"Without the Fed, yields would skyrocket"
This is wrong. The Fed has been keeping their basic level QE of 120 billion per month for months now. But ignoring the fake breakout in the beginning of June (thanks to reopening hopes), yields have been on a steady decline. Let's take a look at the Fed's balance sheet. The Fed has thankfully stayed away from purchasing more treasury bills (short term treasury securities). Bills are important for the repo market as collateral. They're the best collateral you can have and the Fed has already done enough damage by buying those treasury bills in March, destroying even more liquidity than usual. More interesting is the point "notes and bonds, nominal". The Fed added 13.691 billion worth of US treasury notes and bonds to their balance sheet. Luckily for us, the US Department of Treasury releases the results of treasury auctions when they occur. On July 28th there was an auction for the 7 year treasury note. You can find the results under "Note -> Term: 7-year -> Auction Date 07/28/2020 -> Competitive Results PDF". Or here's a link. What do we see? Indirect bidders, which are foreigners by the way, took 28 billion out of the total 44 billion. That's roughly 64% of the entire auction. Primary dealers are the ones which sell the securities to the commercial banks. Direct bidders are domestic buyers of treasuries. The conclusion is: There's insane demand for US treasury notes and bonds by foreigners. Those US treasuries are basically equivalent to US dollars. Now dollar bears should ask themselves this question: If the dollar is close to a collapse and the world wants to get rid fo the US dollar, why do foreigners (i.e. foreign central banks) continue to take 60-70% of every bond auction? They do it because they desperately need dollars and hope to drive prices up, supported by the Federal Reserve itself, in an attempt to have the dollar reserves when the next liquidity event occurs. So foreigners are buying way more treasuries than the Fed does. Final conclusion: the bond market has adjusted to the Fed being a player long time ago. It isn't the first time the Fed has messed around in the bond market.
How market participants are positioned
We know that commercial banks made good money trading bonds and stocks in the past quarter. Besides big tech the stock market is being stagnant, plain and simple. All the stimulus, stimulus#2, vaccinetalksgoingwell.exe, public appearances by Trump, Powell and their friends, the "money printing" (which isn't money printing) by the Fed couldn't push SPY back to ATH which is 339.08 btw. Who can we look at? Several people but let's take Bill Ackman. The one who made a killing with Credit Default Swaps in March and then went LONG (he said it live on TV). Well, there's an update about him:Bill Ackman saying he's effectively 100% longHe says that around the 2 minute mark. Of course, we shouldn't just believe what he says. After all he is a hedge fund manager and wants to make money. But we have to assume that he's long at a significant percentage - it doesn't even make sense to get rid of positions like Hilton when they haven't even recovered yet. Then again, there are sources to get a peek into the positions of hedge funds, let's take Hedgopia.We see: Hedge funds are starting to go long on the 10 year bond. They are very short the 30 year bond. They are very long the Euro, very short on VIX futures and short on the Dollar.
This is the perfect setup for a market meltdown. If hedge funds are really positioned like Ackman and Hedgopia describes, the situation could unwind after a liquidity event:The Fed increases QE to bring down the 30 year yield because the economy isn't recovering yet. We've already seen the correlation of QE and USD and QE and bond prices.That causes a giant short squeeze of hedge funds who are very short the 30 year bond. They need to cover their short positions. But Ackman said they're basically 100% long the stock market and nothing else. So what do they do? They need to sell stocks. Quickly. And what happens when there is a rapid sell-off in stocks? People start to hedge via put options. The VIX rises. But wait, hedge funds are short VIX futures, long Euro and short DXY. To cover their short positions on VIX futures, they need to go long there. VIX continues to go up and the prices of options go suborbital (as far as I can see).Also they need to get rid of Euro futures and cover their short DXY positions. That causes the USD to go up even more. And the Fed will sit there and do their things again: more QE, infinity QE^2, dollar swap lines, repo operations, TARP and whatever. The Fed will be helpless against the forces of the market and have to watch the stock market burn down and they won't even realize that they created the circumstances for it to happen - by their programs to "help the economy" and their talking on TV. Do you remember JPow on 60minutes talking about how they flooded the world with dollars and print it digitally? He wanted us poor people to believe that the Fed is causing hyperinflation and we should take on debt and invest into the stock market. After all, the Fed has it covered. But the Fed hasn't got it covered. And Powell knows it. That's why he's being a bear in the FOMC statements. He knows what's going on. But he can't do anything about it except what's apparently proven to be correct - QE, QE and more QE.
A final note about "stock market is not the economy"
It's true. The stock market doesn't reflect the current state of the economy. The current economy is in complete shambles. But a wise man told me that the stock market is the reflection of the first and second derivatives of the economy. That means: velocity and acceleration of the economy. In retrospect this makes sense. The economy was basically halted all around the world in March. Of course it's easy to have an insane acceleration of the economy when the economy is at 0 and the stock market reflected that. The peak of that accelerating economy ("max velocity" if you want to look at it like that) was in the beginning of June. All countries were reopening, vaccine hopes, JPow injecting confidence into the markets. Since then, SPY is stagnant, IWM/RUT, which is probably the most accurate reflection of the actual economy, has slightly gone down and people have bid up tech stocks in absolute panic mode. Even JPow admitted it. The economic recovery has slowed down and if we look at economic data, the recovery has already stopped completely. The economy is rolling over as we can see in the continued high initial unemployment claims. Another fact to factor into the stock market.
TLDR and positions or ban?
TLDR: global economy bad and dollar shortage. economy not recovering, JPow back to doing QE Infinity. QE Infinity will cause the final squeeze in both the bond and stock market and will force the unwinding of the whole system. Positions: idk. I'll throw in TLT 190c 12/18, SPY 220p 12/18, UUP 26c 12/18.That UUP call had 12.5k volume on Friday 7/31 btw.
Edit about positions and hedge funds
My current positions. You can laugh at my ZEN calls I completely failed with those.I personally will be entering one of the positions mentioned in the end - or similar ones. My personal opinion is that the SPY puts are the weakest try because you have to pay a lot of premium. Also I forgot talking about why hedge funds are shorting the 30 year bond. Someone asked me in the comments and here's my reply: "If you look at treasury yields and stock prices they're pretty much positively correlated. Yields go up, then stocks go up. Yields go down (like in March), then stocks go down. What hedge funds are doing is extremely risky but then again, "hedge funds" is just a name and the hedgies are known for doing extremely risky stuff. They're shorting the 30 year bond because they needs 30y yields to go UP to validate their long positions in the equity market. 30y yields going up means that people are welcoming risk again, taking on debt, spending in the economy. Milton Friedman labeled this the "interest rate fallacy". People usually think that low interest rates mean "easy money" but it's the opposite. Low interest rates mean that money is really tight and hard to get. Rising interest rates on the other hand signal an economic recovery, an increase in economic activity. So hedge funds try to fight the Fed - the Fed is buying the 30 year bonds! - to try to validate their stock market positions. They also short VIX futures to do the same thing. Equity bulls don't want to see VIX higher than 15. They're also short the dollar because it would also validate their position: if the economic recovery happens and the global US dollar cycle gets restored then it will be easy to get dollars and the USD will continue to go down. Then again, they're also fighting against the Fed in this situation because QE and the USD are correlated in my opinion. Another Redditor told me that people who shorted Japanese government bonds completely blew up because the Japanese central bank bought the bonds and the "widow maker trade" was born:https://www.investopedia.com/terms/w/widow-maker.asp"
Since I've mentioned him a lot in the comments, I recommend you check out Steven van Metre's YouTube channel. Especially the bottom passages of my post are based on the knowledge I received from watching his videos. Even if didn't agree with him on the fundamental issues (there are some things like Gold which I view differently than him) I took it as an inspiration to dig deeper. I think he's a great person and even if you're bullish on stocks you can learn something from Steven!
Hi guys, I have been using reddit for years in my personal life (not trading!) and wanted to give something back in an area where i am an expert. I worked at an investment bank for seven years and joined them as a graduate FX trader so have lots of professional experience, by which i mean I was trained and paid by a big institution to trade on their behalf. This is very different to being a full-time home trader, although that is not to discredit those guys, who can accumulate a good amount of experience/wisdom through self learning. When I get time I'm going to write a mid-length posts on each topic for you guys along the lines of how i was trained. I guess there would be 15-20 topics in total so about 50-60 posts. Feel free to comment or ask questions. The first topic is Risk Management and we'll cover it in three parts Part I
Why it matters
Using stops sensibly
Picking a clear level
Why it matters
The first rule of making money through trading is to ensure you do not lose money. Look at any serious hedge fund’s website and they’ll talk about their first priority being “preservation of investor capital.” You have to keep it before you grow it. Strangely, if you look at retail trading websites, for every one article on risk management there are probably fifty on trade selection. This is completely the wrong way around. The great news is that this stuff is pretty simple and process-driven. Anyone can learn and follow best practices. Seriously, avoiding mistakes is one of the most important things: there's not some holy grail system for finding winning trades, rather a routine and fairly boring set of processes that ensure that you are profitable, despite having plenty of losing trades alongside the winners.
Capital and position sizing
The first thing you have to know is how much capital you are working with. Let’s say you have $100,000 deposited. This is your maximum trading capital. Your trading capital is not the leveraged amount. It is the amount of money you have deposited and can withdraw or lose. Position sizing is what ensures that a losing streak does not take you out of the market. A rule of thumb is that one should risk no more than 2% of one’s account balance on an individual trade and no more than 8% of one’s account balance on a specific theme. We’ll look at why that’s a rule of thumb later. For now let’s just accept those numbers and look at examples. So we have $100,000 in our account. And we wish to buy EURUSD. We should therefore not be risking more than 2% which $2,000. We look at a technical chart and decide to leave a stop below the monthly low, which is 55 pips below market. We’ll come back to this in a bit. So what should our position size be? We go to the calculator page, select Position Size and enter our details. There are many such calculators online - just google "Pip calculator". https://preview.redd.it/y38zb666e5h51.jpg?width=1200&format=pjpg&auto=webp&s=26e4fe569dc5c1f43ce4c746230c49b138691d14 So the appropriate size is a buy position of 363,636 EURUSD. If it reaches our stop level we know we’ll lose precisely $2,000 or 2% of our capital. You should be using this calculator (or something similar) on every single trade so that you know your risk. Now imagine that we have similar bets on EURJPY and EURGBP, which have also broken above moving averages. Clearly this EUR-momentum is a theme. If it works all three bets are likely to pay off. But if it goes wrong we are likely to lose on all three at once. We are going to look at this concept of correlation in more detail later. The total amount of risk in our portfolio - if all of the trades on this EUR-momentum theme were to hit their stops - should not exceed $8,000 or 8% of total capital. This allows us to go big on themes we like without going bust when the theme does not work. As we’ll see later, many traders only win on 40-60% of trades. So you have to accept losing trades will be common and ensure you size trades so they cannot ruin you. Similarly, like poker players, we should risk more on trades we feel confident about and less on trades that seem less compelling. However, this should always be subject to overall position sizing constraints. For example before you put on each trade you might rate the strength of your conviction in the trade and allocate a position size accordingly: https://preview.redd.it/q2ea6rgae5h51.png?width=1200&format=png&auto=webp&s=4332cb8d0bbbc3d8db972c1f28e8189105393e5b To keep yourself disciplined you should try to ensure that no more than one in twenty trades are graded exceptional and allocated 5% of account balance risk. It really should be a rare moment when all the stars align for you. Notice that the nice thing about dealing in percentages is that it scales. Say you start out with $100,000 but end the year up 50% at $150,000. Now a 1% bet will risk $1,500 rather than $1,000. That makes sense as your capital has grown. It is extremely common for retail accounts to blow-up by making only 4-5 losing trades because they are leveraged at 50:1 and have taken on far too large a position, relative to their account balance. Consider that GBPUSD tends to move 1% each day. If you have an account balance of $10k then it would be crazy to take a position of $500k (50:1 leveraged). A 1% move on $500k is $5k. Two perfectly regular down days in a row — or a single day’s move of 2% — and you will receive a margin call from the broker, have the account closed out, and have lost all your money. Do not let this happen to you. Use position sizing discipline to protect yourself.
If you’re wondering - why “about 2%” per trade? - that’s a fair question. Why not 0.5% or 10% or any other number? The Kelly Criterion is a formula that was adapted for use in casinos. If you know the odds of winning and the expected pay-off, it tells you how much you should bet in each round. This is harder than it sounds. Let’s say you could bet on a weighted coin flip, where it lands on heads 60% of the time and tails 40% of the time. The payout is $2 per $1 bet. Well, absolutely you should bet. The odds are in your favour. But if you have, say, $100 it is less obvious how much you should bet to avoid ruin. Say you bet $50, the odds that it could land on tails twice in a row are 16%. You could easily be out after the first two flips. Equally, betting $1 is not going to maximise your advantage. The odds are 60/40 in your favour so only betting $1 is likely too conservative. The Kelly Criterion is a formula that produces the long-run optimal bet size, given the odds. Applying the formula to forex trading looks like this: Position size % = Winning trade % - ( (1- Winning trade %) / Risk-reward ratio If you have recorded hundreds of trades in your journal - see next chapter - you can calculate what this outputs for you specifically. If you don't have hundreds of trades then let’s assume some realistic defaults of Winning trade % being 30% and Risk-reward ratio being 3. The 3 implies your TP is 3x the distance of your stop from entry e.g. 300 pips take profit and 100 pips stop loss. So that’s 0.3 - (1 - 0.3) / 3 = 6.6%. Hold on a second. 6.6% of your account probably feels like a LOT to risk per trade.This is the main observation people have on Kelly: whilst it may optimise the long-run results it doesn’t take into account the pain of drawdowns. It is better thought of as the rational maximum limit. You needn’t go right up to the limit! With a 30% winning trade ratio, the odds of you losing on four trades in a row is nearly one in four. That would result in a drawdown of nearly a quarter of your starting account balance. Could you really stomach that and put on the fifth trade, cool as ice? Most of us could not. Accordingly people tend to reduce the bet size. For example, let’s say you know you would feel emotionally affected by losing 25% of your account. Well, the simplest way is to divide the Kelly output by four. You have effectively hidden 75% of your account balance from Kelly and it is now optimised to avoid a total wipeout of just the 25% it can see. This gives 6.6% / 4 = 1.65%. Of course different trading approaches and different risk appetites will provide different optimal bet sizes but as a rule of thumb something between 1-2% is appropriate for the style and risk appetite of most retail traders. Incidentally be very wary of systems or traders who claim high winning trade % like 80%. Invariably these don’t pass a basic sense-check:
How many live trades have you done? Often they’ll have done only a handful of real trades and the rest are simulated backtests, which are overfitted. The model will soon die.
What is your risk-reward ratio on each trade? If you have a take profit $3 away and a stop loss $100 away, of course most trades will be winners. You will not be making money, however! In general most traders should trade smaller position sizes and less frequently than they do. If you are going to bias one way or the other, far better to start off too small.
How to use stop losses sensibly
Stop losses have a bad reputation amongst the retail community but are absolutely essential to risk management. No serious discretionary trader can operate without them. A stop loss is a resting order, left with the broker, to automatically close your position if it reaches a certain price. For a recap on the various order types visit this chapter. The valid concern with stop losses is that disreputable brokers look for a concentration of stops and then, when the market is close, whipsaw the price through the stop levels so that the clients ‘stop out’ and sell to the broker at a low rate before the market naturally comes back higher. This is referred to as ‘stop hunting’. This would be extremely immoral behaviour and the way to guard against it is to use a highly reputable top-tier broker in a well regulated region such as the UK. Why are stop losses so important? Well, there is no other way to manage risk with certainty. You should always have a pre-determined stop loss before you put on a trade. Not having one is a recipe for disaster: you will find yourself emotionally attached to the trade as it goes against you and it will be extremely hard to cut the loss. This is a well known behavioural bias that we’ll explore in a later chapter. Learning to take a loss and move on rationally is a key lesson for new traders. A common mistake is to think of the market as a personal nemesis. The market, of course, is totally impersonal; it doesn’t care whether you make money or not. Bruce Kovner, founder of the hedge fund Caxton Associates There is an old saying amongst bank traders which is “losers average losers”. It is tempting, having bought EURUSD and seeing it go lower, to buy more. Your average price will improve if you keep buying as it goes lower. If it was cheap before it must be a bargain now, right? Wrong. Where does that end? Always have a pre-determined cut-off point which limits your risk. A level where you know the reason for the trade was proved ‘wrong’ ... and stick to it strictly. If you trade using discretion, use stops.
Picking a clear level
Where you leave your stop loss is key. Typically traders will leave them at big technical levels such as recent highs or lows. For example if EURUSD is trading at 1.1250 and the recent month’s low is 1.1205 then leaving it just below at 1.1200 seems sensible. If you were going long, just below the double bottom support zone seems like a sensible area to leave a stop You want to give it a bit of breathing room as we know support zones often get challenged before the price rallies. This is because lots of traders identify the same zones. You won’t be the only one selling around 1.1200. The “weak hands” who leave their sell stop order at exactly the level are likely to get taken out as the market tests the support. Those who leave it ten or fifteen pips below the level have more breathing room and will survive a quick test of the level before a resumed run-up. Your timeframe and trading style clearly play a part. Here’s a candlestick chart (one candle is one day) for GBPUSD. https://preview.redd.it/moyngdy4f5h51.png?width=1200&format=png&auto=webp&s=91af88da00dd3a09e202880d8029b0ddf04fb802 If you are putting on a trend-following trade you expect to hold for weeks then you need to have a stop loss that can withstand the daily noise. Look at the downtrend on the chart. There were plenty of days in which the price rallied 60 pips or more during the wider downtrend. So having a really tight stop of, say, 25 pips that gets chopped up in noisy short-term moves is not going to work for this kind of trade. You need to use a wider stop and take a smaller position size, determined by the stop level. There are several tools you can use to help you estimate what is a safe distance and we’ll look at those in the next section. There are of course exceptions. For example, if you are doing range-break style trading you might have a really tight stop, set just below the previous range high. https://preview.redd.it/ygy0tko7f5h51.png?width=1200&format=png&auto=webp&s=34af49da61c911befdc0db26af66f6c313556c81 Clearly then where you set stops will depend on your trading style as well as your holding horizons and the volatility of each instrument. Here are some guidelines that can help:
Use technical analysis to pick important levels (support, resistance, previous high/lows, moving averages etc.) as these provide clear exit and entry points on a trade.
Ensure that the stop gives your trade enough room to breathe and reflects your timeframe and typical volatility of each pair. See next section.
Always pick your stop level first. Then use a calculator to determine the appropriate lot size for the position, based on the % of your account balance you wish to risk on the trade.
So far we have talked about price-based stops. There is another sort which is more of a fundamental stop, used alongside - not instead of - price stops. If either breaks you’re out. For example if you stop understanding why a product is going up or down and your fundamental thesis has been confirmed wrong, get out. For example, if you are long because you think the central bank is turning hawkish and AUDUSD is going to play catch up with rates … then you hear dovish noises from the central bank and the bond yields retrace lower and back in line with the currency - close your AUDUSD position. You already know your thesis was wrong. No need to give away more money to the market.
Coming up in part II
EDIT: part II here Letting stops breathe When to change a stop Entering and exiting winning positions Risk:reward ratios Risk-adjusted returns
Coming up in part III
Squeezes and other risks Market positioning Bet correlation Crap trades, timeouts and monthly limits *** Disclaimer:This content is not investment advice and you should not place any reliance on it. The views expressed are the author's own and should not be attributed to any other person, including their employer.
The TSLA 2K Play - A Trade Retrospective on Taking a $.21 Credit to Make $8.34 More
There are different ways to play TSLA to $2000 this past week. Here’s my thought process on how I approached trading the move up, without paying a debit (but uses margin).
On Monday, August 17, besides TOS being absolutely atrocious, TSLA was lurching higher, and at around 11am PST or so, when it broke out to new highs, my thought was that there’s probably going to be a short squeeze again that takes us to $2000, the target that basically everyone was looking at. So, I looked to put on a play that captured something to that $2000 price level by Friday, Aug 21 expiration. I began by looking at the 1980/2000 long call vertical. At the time, that spread cost $2.28 debit. So if I were to just put on that vertical, I would be paying $2.28 to make potentially $17.72. But I don’t really like paying large debits (large is anything above $.25 per spread), especially for these types of short-term directional bets. So I looked for other ways to reduce the debit. Alongside the purchase of the long call vertical, I also sold the 1650/1625 put vertical, for $2.05 credit. The reason for placing the short strike of the put vertical at 1650 is that it was under Monday’s low, and the reason for the long strike at 1625 was that it made the put vertical wide enough to collect a decent credit. Now, the total debit on the trade became $2.28 (debit of 1980/2000 call vertical) - $2.05 (credit from 1650/1625 put vertical), or $.23. $.23 was pretty cheap, and honestly I could’ve stopped there. But as I was thinking about the trade, I realized I didn’t really like how the short put verticals actually added more downside risk to the trade. So I was thinking that as early as I could, I would buy back that short put vertical once it drained in value, as TSLA continued running up with the momentum it had. And given the huge upside momentum that day, I thought that TSLA would probably gap and continue higher the following day, or at the very least just move sideways, which would drain the value of the short put vertical and allow me to buy it back for a low debit. However, if I bought back the put vertical before it fully drained to 0, then my overall debit on the trade wouldn’t just cost $.23 anymore - it would cost more. So in the spirit of keeping the debit as low as possible, I needed to actually collect more credit from somewhere else, if I really didn’t want to pay for this trade. So, I decided that I was going to sell a call vertical above the 1980/2000 long call vertical. And a safe enough distance above the long call vertical, would be up at 2200, which gives me 200 points of runway above 2000. So I sold to open the 2200/2250 call vertical, for $1.27 credit. I felt safe about selling the 2200/2250 call vertical, because for it to really be at risk, TSLA would first need to move above 2000, the psychological level, and by the time it starts to get near 2200, the 1980/2000 call vertical will be 20 points deep ITM, so I have 20 points of coverage. Of course there’s still 30 points of risk (given that the 2200/2250 short call vertical is 50 points wide), but time is on my side. Assuming that TSLA even gets near 2200 on the last day, given how little time left there is, that short call vertical would probably be trading for maybe $10 or so, and the 1980/2000 long call vertical in front of that short call vertical, would be deep ITM and worth $20, so I can just close the entire spread at a profit anyway. So after selling that 2200/2250 call vertical, the trade went from $.23 debit to $1.04 credit (because $.23 - $1.27 = -$1.04, or $1.04 credit). Now I’m getting paid to play the breakout to TSLA 2K.
On Tuesday, TSLA gapped up higher, and right off the bat, the short put verticals basically drained from $2.05 to $.83. I closed that out to remove any downside risk, so that if TSLA decides to reverse and tank, or hang out sideways and never make it to 2000, no harm no foul, I have the upside play on for a credit. Recall that $.23 (the debit of the initial entry) - $1.27 (the credit collected from the sale of the 2200/2250 call vertical) + $.83 (the debit of buying back the short put vertical) is -$0.21, which is a $.21 credit, after adjustments. And now, I just have to manage TSLA to the upside. The result of this adjustment left me with a 4 legged spread where I’m long the 1980/2000 call vertical and short the 2200/2250 call vertical (this 4-legged spread is also called a condor, specifically a Call condor). Throughout Tuesday and all of Wednesday, TSLA just moved sideways, and I was fine with that. Others who purchased naked long calls far OOM were worried about the premium drain, but I was fine knowing that I got paid to play the move to 2K, whether it happened or not. It completely did not matter if TSLA moved sideways or tanked, because it wouldn’t negatively impact the equity curve. Another reason why I actually liked TSLA hanging sideways is that it gives TSLA less of a chance to surge higher and run over that 2200/2250 short call vertical with the time left before expiry.
Thursday was where the magic happened (for pretty much everyone). As we know at around 7:45 am PST, TSLA rallied from around $1900 to almost $2000, and the Call condor really started to expand in value. When TSLA was at $1990, the call condor spread expanded to $8.34. Recall that the cost on this trade (after the closing the short put vertical) put my cost at a $.21 credit. Now, I can sell this condor out and pocket another $8.34. That’s pretty sweet. Getting paid $.21 to make another $8.34. (At this moment, I noted what the legs were trading for. The long vertical of the condor was trading for $9.27, and the short vertical was actually trading for $.93. Recall that when I entered the short vertical on Monday, I actually collected a $1.27 credit on it. Now, even after the 150 point move up in TSLA, even after volatility expansion, that short vertical was still worth $.34 LESS - that’s the power of theta decay). So at that point, I pretty much just closed out the entire position. I was pretty happy with essentially getting paid $.21 to make another $8.34 (in hindsight, I could’ve milked another $11.66 per spread, but that’s besides the point).
What if TSLA decided to tank upon entry, jeopardizing the short put vertical? Upside conviction was strong, but I would have to buy it back and find a way to reduce the new debit on the overall trade.
What if TSLA decided to make a run up to $2000+ very early on in the week (ie. on Tuesday it runs up to $2100)? Then the 2200/2250 short call vertical would’ve expanded too much and offset the gains of the deep ITM 1980/2000 long call vertical. I would have to cough up the debit and buy additional call verticals to cover the upside. Perhaps a 20 or 30 point wide call vertical around the 2100 strike to cover the remaining upside risk, which would cost around $10-$15 debit. Then work to reduce that debit over the week.
But what if TSLA decided to tank below 2100 after adjustment above? Or lower to below 1980? Or even further down? Sell more 2200/2250 call verticals. Then sell out the long call vertical for whatever remaining debit. Then sell out the 1980/2000 call vertical for whatever value it has left.
So many adjustments. KISS. You will just get whipsawed and use up a ton of margin. It's just what I have to do. I have to be mechanical about the greeks and not play the hope card. This trading style is not for everyone and is not the holy grail.
Plain english warning about CFD trading, just something I wish someone had told me
tl;dr - trading CFD's is the equivalent of drag racing your drunk mate down the freeway into oncoming traffic. No self respecting adult would bother with them, CFD's are for cocaine-snorting thrill-seeking morons (like me apparently) who have no respect for risk management. Don't gamble with your savings. What are CFDs CFD's are 'Contracts for Difference'. Very simply, if you have a trading account with the right permissions you can trade in CFD's. Why are they dangerous Because say you trade $250, on a normal trade (ie stocks etc) if the price falls by 10% you lose $25, which sucks but isn't world ending. CFD's are NOT like that - they are 'leveraged' which just means that if you put up $50 your exposure is many many many many times larger than that EXAMPLE You buy 50 contracts on a stock that is trading at $100 a share.The stock then drops $10 in value.Your exposure is (50 * 100) = $5,000 BUT because your 'margin' is only 5% of that, the initial amount you put up is a mere $250. So to illustrate: Stock Trading Initial Investment - $250 Value drop - 10% Loss - $25 CFD Trading Initial investment - $250 Value drop - 10% Loss - $5,000 Closing remarks These things are illegal in the US for a good reason. CFD's are for suckers, don't listen to anything that you hear to the contrary. EU regulators say that 76% of CFD accounts lose money. Let me say that again, 76% of these things lose $&*#ing money. If the odds at the casino were 1:4 there is no fkn way anybody would go. When you trade CFD's you are essentially just gambling but with WAY WAY worse odds.Cited: https://www.iexpats.com/76-of-cfd-traders-lose-money-on-their-deals/ You can't make long investments with CFD's, they aren't a long-term strategy and they are not part of ANY investment strategy with a reasonable risk profile. Please don't make the mistake I did and get sucked into trading them, it's stressful as hell and it is pure bravado driven bullshit. Stay safe out there folks, times are nuts Edit 1: Formatting got stuffed up
So everyone is wondering about the new WMT+ model, revenue, and profit potential. I did some research and want to share it with you retards in hopes we can all make some tendies. Here goes nothing. Jeffries analyst Christopher Mandeville said - "1Q21 was downright impressive as WMT's superior omnichannel approach to catering to the consumer on their terms shone brightly, with outsize comps helping to offset ... COVID costs," he said in a May 19 research note. "Given consistent market share gains, further evidence of a sustainable productivity loop, a strong financial positioning, and future e-commerce profitability enhancements to pair with already advanced omnichannel capabilities, we continue to view WMT as a core long-term holding." Also, I don't know if you've heard about WMTs Data Café, but it's kinda insane. They pull data from 200 sources like meteorology, Nielson, Telecom, Econ data ect, and almost 200 billions rows of customer transactional data every few weeks, 2.5 petabytes an hour. They analyze all of this to make product placemt/pricing decisions across all 8k stores. This allows on the spot shifts, instead of monthly/weekly sales reviews. So allow E-commerce WMT+ access to this data, and you've got amazon level targeted ads and products. "Walmart plans to save $60 million/year on shopping bags alone." -random quote about WMT+ That being said, have you ever met anyone or heard any one say they were "really frustrated with Prime?" I think WMT+ could help offset e-commerce costs to the consumer but wonder if those consumers would drop their Prime membership for the $20 savings, much less carry both. Scott Galloway, Professor at NYU Stern, had the following to say about the new strategy: "The most accretive action taken by any $10 billion or larger business is to move from a transactional model to recurring revenue. This exploits one of the fundamental flaws of our species, the inability to register time. Time flies — it goes faster than our estimated consumption of a product during a given time period. Only 18% of gym members go to the gym consistently. In addition, the markets are a reflection of ourselves, and humans hate uncertainty. Waking up next to a stranger is exciting in the short run but exhausting in the long (see above: recurring revenue). Walmart interacts with American families transactionally, while Amazon lives in 82% of their homes. That could begin to shift with Walmart+." As someone who long has advocated for subscription and auto-replenishment services that allow retailers to effectively compete with Amazon's Subscribe & Save, I totally agree with this but the keyword in Galloway's analysis is "could." Saying it and doing it are different things. So since 2016, Walmart’s online sales are up 78%. Walmart’s online sales are also now growing twice as fast as Amazon’s. Walmart is already the world’s third-largest online store. Another benefit to the costs associated with going online is warehouse space, which walmart has a lot of. They are using their stores as warehousing space for online sales, which is brilliant. Their distribution network is already set up, they already have storage, and delivery speed can be ramped up at lower extra costs because of this. That means Walmart will soon have the biggest and most effective “shipping network” in America. By the end of the year, Walmart plans to deliver stuff from 1,600 stores. For comparison, Amazon has only 110 warehouses across the US. And they can get this done, like I said, at little to no additional cost. 8/10 americans also live within 5-10 miles of a Walmart physical store, reducing shipping costs, which are the most cost intensive part of the e-commerce space. That means they are already beating amazon on profit margins for their service. This turns into possible billions in savings. I also like to look at the P/E for AMZN(2963.55) and WMT(131.77) which is 143 and 25 respectively. With so much room to grow, and WMT trading at .04% of this price of AMZN, I think it's a no brainier that there is almost unlimited potential upside to this stock. Now getting the customers to use the service will be the hardest part, potentially garnering new/existing customers and stealing some from Amazon. But I think having physical locations as well as online services gives people the day to day access they need for "right now products" and the easy of comfort of the "need it soon/laterecurring deliveries products." This is a major advantage over AMZN, because customers can choose to drive to a store, or have something shipped depending on their needs and wants. Last thing to mention, COVID economic security is built in to this new program. No matter how long it lasts, americans will always feel more safe getting things delivered, and same day grocery is going to slay down the competition like nobody knows. Could be a potentially huge upside to this stock. TLDR; Buy WMT hold long term. Not sure about short term, but I think profit potential could be huge. Already winning against AMZN with profit margins(it seems) I know I'll be signing up for the service, to get all my groceries delivered the same/next day. Anyways, positions for the autists in the crowd. WMT: 135c 7/31, 145c 8/21 160c 3/19/21 Now go get those tendies. Edit: added some words for clarity. And a position I'm considering because of you clowns. Thx Edit: copy pasted quote and took some extra text with it. Oops. Thanks for the call out @notholdingbackcc. Walmart returns are not up 30% on amazon.
Long Thesis - Progyny - 100% upside - High-growth, profitable company is the only differentiated provider in a large, growing, and underserved market. PGNY’s high-touch, seamless offering helps them stand out against large insurance carriers.
Link to my research report on PGNY Summary High-growth, profitable company is the only differentiated provider in a large, growing, and underserved market. PGNY’s high-touch, seamless offering helps them stand out against large insurance carriers. Covid-19 has shown the importance of benefits for employees and will continue to be the key differentiator for those thinking of changing jobs. According to RMANJ (Reproductive Medicine Associates of New Jersey), 68% of people would switch jobs for fertility benefits. For employers, Progyny reduces costs by including the latest cutting-edge technology in one packaged price, thereby lowering the risk of multiples and increasing the likelihood of pregnancy, keeping employees happy with an integrated, data-driven, concierge service partnering with a selective group of fertility doctors. Upside potential is 2x current price in the next 18 months. Overview Progyny Inc. (Nasdaq: PGNY), “PGNY” or the “Company”, based in New York, NY, is the leading independent fertility and family building benefits manager. Progyny serves as a value-add benefits manager sold to employers who want to improve their benefits coverage and retain and attract the best employees. Progyny offers a comprehensive solution and is truly disrupting the fertility industry. There is no standard fertility cycle, but the below is a good approximation of possible workflows: https://preview.redd.it/7aip8pna9zi51.png?width=941&format=png&auto=webp&s=7ef868a67eae10534bac254ab58fb3d4295aef37
Patient is referred to fertility center for evaluation for Assisted Reproductive Technology (“ART”) procedures, including in-vitro fertilization (“IVF “) and intrauterine insemination (“IUI”). Both can be aided by pharmaceuticals that stimulate egg production in the female patient. IVF involves the fertilization of the egg and sperm in the lab, while IUI is direct injection of the sperm sample into the uterus. Often, IUI is done first as it is less expensive. As success rates of IVF have increased, IUI utilization will likely fall.
Sperm washing is the separation of the sperm from the semen sample for embryo creation, and it enhances the freezing capacity of the sperm. Typically, a wash solution is added to the sample and then a centrifuge is used to undergo separation. This is done in both IUI and IVF.
Some OB/GYN platforms are pursuing vertical integration and offering fertility services directly. The OB would need to be credentialed at the lab / procedure center.
Specialty pharmacy arranges delivery of temperature sensitive Rx. Drug regimens include ovarian stimulation to increase the number of eggs or hormone manipulation to better time fertility cycles, among others.
Oocyte retrieval / aspiration is done under deep-sedation anesthesia in a procedure room, typically in the attached IVF lab. Transfer cycle implantation is done using ultrasound guidance without anesthesia. (Anecdotally, we have been told that only REIs can perform an egg retrieval. We have not been able to validate this).
Many clinics house frozen embryos on-site, while some clinics contract with 3rd parties to manage the process. During an IVF cycle, embryos are created from all available eggs. Single-embryo transfer (“SET”) is becoming the norm, which means that multiple embryos are then cryopreserved to use in the future. A fertility preservation cycle ends here with a female storing eggs for long-term usage (e.g. a woman in her young 20s deciding to freeze her eggs for starting a family later).
Common nomenclature refers to an IVF cycle or an IVF cycle with Intracytoplasmic sperm injection (“ICSI”). From a technical perspective, ICSI and IVF are different forms of embryo fertilization within an ART cycle.
ART clinics are frequently offering ancillary services such as embryo / egg adoption or surrogacy services. More frequently, there are independent companies that help with the adoption process and finding surrogates.
ART procedures are broken into two different types of cycles: a banking cycle is the process by which eggs are gathered, embryos are created and then transferred to cryopreservation. A transfer cycle is typically the transfer of a thawed embryo to the female for potential pregnancy. If a pregnancy does not occur, another transfer cycle ensues. Many REIs are moving towards a banking cycle, freezing all embryos, then transfer cycles until embryos are exhausted or a birth occurs. If a birth occurs with the first embryo, patients can keep their embryos for future pregnancy attempts, donate the embryos to a donation center, or request the destruction of the embryos.
The Company started as Auxogen Biosciences, an egg-freezing provider before changing business models to focus on providing a full-range of fertility benefits. In 2016, they launched with their first 5 employer clients and 110,000 members. As of June 30, 2020, the Company provided benefits to 134 employers and ~2.2 million members, year over year growth of 63%. 134 employers is less than 2% of the total addressable market of “approximately 8,000 self-insured employers in the United States (excluding quasi-governmental entities, such as universities and school systems, and labor unions) who have a minimum of 1,000 employees and represent approximately 69 million potential covered lives in total. Our current member base of 2.1 million represents only 3% of our total market opportunity.” The utilization rate for all Progyny members was less than 1% in 2019, offering significant leverageable upside as the topic of fertility becomes less taboo.
Fertility has historically been a process fraught one-sided knowledge, even more so than the typical physician procedure. Despite the increased availability of information on the internet, women who undergo fertility treatments have often described the experience as “byzantine” and “chaotic”. Outdated treatment models without the latest technology (or the latest tech offered as expensive a la carte options) continue to be the norm at traditional insurance providers as well as clinics that do not accept insurance. Progyny’s differentiated approach, including a high-touch concierge level of service for patients and data-driven decision making at the clinical level, has led to an NPS of 72 for fertility benefits and 80 for the integrated, optional pharmacy benefit. Typically, fertility benefits offered by large insurance carriers are add-ons to existing coverage subject to a lifetime maximum while simultaneously requiring physicians to try IUI 3 – 6 times before authorizing IVF. The success rate of IUI, also known as artificial insemination, is typically less than 10%, even when performed with medication. As mentioned in Progyny’s IPO “A patient with mandated fertility step therapy protocol may be required to undergo three to six cycles of IUI, which has an average success rate range of 5% to 15%, takes place over three to six months and can cost up to $4,000 per cycle (or an aggregate of approximately $12,000 to $24,000), according to FertilityIQ. Multiple rounds of mandated IUI is likely to exhaust the patient's lifetime dollar maximum fertility benefits and waste valuable time before more effective IVF treatment can be begun.” Success Rates for IVF IVF success rates vary greatly by age but were 49% on average for women younger than 35. The graph below shows success rates by all clinics by age group for those that did at least 10 cycles in the specific age group. As an example, for those in the ages 35 – 37, out of 456 available clinics, 425 performed at least 10 cycles with a median success rate of 39.7%. https://preview.redd.it/d2l5dtw89zi51.png?width=4990&format=png&auto=webp&s=5ff2ab9948b94419558a27ac861d4e498dce6713 Progyny’s Smart Cycle is the proprietary method the company has chosen as a “currency” for fertility benefits. As opposed to a traditional fee-for-service model with step-up methods, employers may choose to provide between 2 and unlimited Smart Cycles to employees. This enables employees to choose the provider’s best method. Included in the Smart Cycle, and another indicator of the Company’s forward-thinking methodology, are treatment options that deliver better outcomes (PGS, ICSI, multiple embryo freezing with future implantations). https://preview.redd.it/np577a389zi51.png?width=734&format=png&auto=webp&s=c061a2b24c8515890ba204479b4677893dabf755 As detailed in the chart above, a patient could undergo an IVF cycle that freezes all embryos (3/4 of a Smart Cycle), then transfer 5 frozen embryos (1/4 cycle each; each transfer would occur at peak ovulation, which would take at least 5 months) and use only 2 Smart Cycles. Alternatively, if the patient froze all embryos and got pregnant on the first embryo transfer, they would only use one cycle. Before advances in vitrification (freezing), patients could not be sure that an embryo created in the lab and frozen for later use would be viable, so using only one embryo at a time seemed wasteful. Now, as freezing technology has advanced, undergoing one pharmaceutical regime, one oocyte collection procedure, creating as many embryos as possible, and then transferring one embryo back into the uterus while freezing the rest provides the highest ROI. If the first transferred embryo fails to implant or otherwise does not lead to a baby, the patient can simply thaw the next embryo and try implantation again next month. Included in each Smart Cycle is pre-implantation genetic sequencing (“PGS”) on all available embryos and intracytoplasmic sperm injection (“ICSI”). PGS uses next-generation sequencing technology to determine the viability and sex of the embryo while ICSI is a process whereby a sperm is directly inserted into the egg to start fertilization, rather than allowing the sperm to penetrate the egg naturally. ICSI has a slightly higher rate of successful fertilization (as opposed to simply leaving the egg and sperm in the petri dish). Because Progyny’s experience is denominated in cycles of care, not simply dollars, patients and doctors can focus on what procedures offer the best return. 30% of the Company’s existing network of doctors do not accept insurance of any kind, other than Progyny, which speaks to the value that is provided to doctors and employers. For patients not looking to get pregnant, Progyny offers egg freezing as well. Progyny started as an egg-freezing manager, which allows a woman to preserve her fertility and manage her biological clock. As mentioned previously, pregnancy outcomes vary significantly and align closely with the age of the egg. Egg freezing is designed to allow a woman to save her younger eggs until she is ready to start a family. From an employer’s perspective, keeping younger women in the work force for longer is a cost savings. Vitrification technology has improved significantly since “Freeze your eggs, Free Your Career” was the headline on Bloomberg Businesweek in 2014, but we still don’t yet know the pregnancy rates for women who froze their eggs 5 years ago, but early results are promising and on par with IVF rates for women of similar ages now. From a female perspective, the egg freezing process is not an easy one. The patient is still required to inject themselves with stimulation drugs and the egg retrieval process is the same as in the IVF process (under sedation). The same number of days out of work are required. Using the SmartCycle benefit above as an example, the egg freezing process would require ½ of a Smart Cycle. The annual payment required to the clinic is typically included in the benefits package but may require out-of-pocket expenses covered by the employee. Contrary to popular belief, IVF pregnancies do not have a higher rate of multiples (twins, triplets, etc.), rather in order to reduce out of pocket costs, REIs have transferred multiple embryos to the patient, in the hopes of achieving a pregnancy. If you have struggled for years to get pregnant, and the doctor is suggesting that transferring 3 embryos at once is your best chance at success, you are unlikely to complain, nor are you likely to selectively eliminate an implanted embryo because you now have twins. There are several factors that are making it more likely / acceptable to transfer one embryo at a time, enabling Progyny’s success. https://preview.redd.it/48vk9gc69zi51.png?width=953&format=png&auto=webp&s=2c75a2771a1dd9a079074331b317451f076725ca From the Company: “According to a study published in the American Journal of Obstetrics & Gynecology that analyzed the total costs of care over 400,000 deliveries between 2005 and 2010, as adjusted for inflation, the maternity and perinatal healthcare costs attributable to a set of twins are approximately $150,000 on average, more than four times the comparable costs attributable to singleton births of approximately $35,000, and often exceed this average. In the case of triplets, the costs escalate significantly and average $560,000, sometimes extending upwards of $1.0 million.” “Progyny's selective network of high-quality fertility specialists consistently demonstrate a strong adherence to best practices with a substantially higher single embryo transfer rate. As a result, our members experience significantly fewer pregnancies with multiples (e.g., twins or triplets). Multiples are associated with a higher probability of adverse medical conditions for the mother and babies, and as a byproduct, significantly escalate the costs for employers. Our IVF multiples rate is 3.6% compared to the national average of 16.1%. A lower multiples rate is the primary means to achieving lower high-risk maternity and NICU expenses for our clients.” An educated and supported patient leads to better outcomes. Each patient gets a patient care advocate who interacts with a patient, on average, 15x during their usage of fertility benefits - before treatment, during treatment and post-pregnancy. The Company provides phone-based clinical education and support seven days a week and the Company’s proprietary “UnPack It” call allows patients to speak to a licensed pharmacy clinician who describes the medications included in the package (which contains an average of 20 items per cycle), provides instruction on proper medication administration, and ensures that cycles start on time. The Company’s single medication authorization and delivery led to no missed or delayed cycles in 2018. Previous conference calls have made note of the fact that the Company would like to purchase their own specialty pharmacy and own every aspect of that interaction, which should provide a lift to gross margins. This would allow PGNY to manage both the medication and the treatment, leading to decreased cost of fertility drugs. Under larger carrier programs, carriers manage access to treatment, but PBM manages access to medications, which can lead to a delay in cycle commencement. Progyny Rx can only be added to the Progyny fertility benefits solution (not offered without subscription to base fertility benefits) and offers patients a potentially lower cost fertility drug benefit, while streamlining what is often a frustrating part of the consumer experience. The Progyny Rx solution reduces dispensing and delivery times and eliminates the possibility that a cycle does not start on time due to a specialty pharmacy not delivering medication. Progyny bills employers for fertility medication as it is dispensed in accordance with the individual Smart Cycle contract. Progyny Rx was introduced in 2018 and represented only 5% of total revenue in 2018. By June 30, 2020, Progyny Rx represented 28% of total revenue and increased 15% y/y. The growth rate should slow and move more in line with the fertility benefits solution as the existing customer base adds it to their package. Progyny Rx can save employers 5% on spend for typical carrier fertility benefits or 21% of the drug spend. Prior authorization is not required, and the pre-screened network of specialty pharmacies can deliver within 48 hours. Additionally, PGNY has 1-year contracts, as opposed to 3 – 5 years like standard PBMs, but with guaranteed minimums, allowing them to purchase at discounts and pass part of the savings on to employers – another reason the attachment rate is so high. Large, Underpenetrated Addressable Market Total cycle counts are increasing (below, in 000s), including both freezing cycles and intended-pregnancy cycles. Acceleration in cycle volume is likely driven by a declining birth rate as women wait later in life to start a family, resulting in reduced fertility, as well as the number of non-traditional (LGBT and single parents). Conservatively, we believe cycles can double in the next 8 years, a 7% CAGR. https://preview.redd.it/y6y7jb559zi51.png?width=943&format=png&auto=webp&s=6cc5cdde7c6583d8e943d2675ad3b6ae85f818de Progyny believes its addressable market is the $6.7B spent on infertility treatments in 2017, but these numbers could easily understate the available market and potential patients as over 50% of people in the US who are diagnosed as infertile do not seek treatment. Additionally, according to the Company, 35% of its covered universe did not previously have fertility benefits in place previously, meaning there is a growing population of people who are now considering their fertility options. According to Willis Towers, Watson, ~ 55% of employers offered fertility benefits in 2018. A quick review of CDC stats and FertilityIQ shows a significant disparity in outcomes and emotions for those who are seeking treatment. While technology in the embryo lab is improving rapidly and success rates between clinics should be converging, there continue to be significant outliers. Clinics that follow what are now generally accepted procedures (follicle stimulating hormones, a 5-day incubation period and PGS to determine embryo viability) have seen success rates of at least 40%. There continue to be several providers that offer a mini-IVF cycle or natural IVF cycle. Designed to appeal to cost conscious cash payors, the on average $5,000 costs, is simply IVF without prescription drugs or any add-ons such as PGS. However, the success rates are on par with IUI and there is an abundance of patients over 40 using the service, where the success rates are already low. Additionally, success stories at these clinics frequently align with what is perceived as the worst parts of the process: One clinic offering a natural cycle IVF has a rating at FertilityIQ of ~8.0 with 60% of people strongly recommending it. This clinic performed 2,000 cycles in 2018 (the most recently available data from the CDC), making it one of the top 10 most active fertility center in the US. Their success rate for women under 35 was 23%, as opposed to the national average of 50% for all clinics. For women over 43, the average success rate for the most active 40 clinics in this demographic was 5.0% this clinics success rate was 0.4%. The lower success rate is likely due to the lack of pre-cycle drugs and PGS, but the success rate and the average rating is hard to understand. Part of this could be to the customer service provided by the clinic, or the perceived benefit of having to go into the office less often for check-ups when not doing a medication driven cycle. . Reviews from other clinics with high average customer ratings, but low success rates include: - “start of a journey that consisted of multiple IUI’s with numerous medications, but they were not successful.” - After an IVF retrieval, the couple had two viable embryos, both were transferred the next month” - “The couple started with a series of IUI treatments, three in total that were not successful.” - “After a fresh transfer of two embryos, again another unsuccessful cycle”. - “He suggested transferring 2 due to higher implantation rates, but there is increased rate of twins “ Valuation https://preview.redd.it/tqcykjm39zi51.png?width=6358&format=png&auto=webp&s=b63fd53c054ac5cbacaf9ccc734c7e73f0ea3c32 Progyny’s comps have typically been other high-growth companies that went public in the last two years: 1Life Healthcare (ONEM), Accolade (ACCD), Health Catalyst (HCAT), Health Equity (HQY), Livongo (LVGO), Phreesia (PHR), as well as Teladoc (TDOC). Despite revenue growth that outpaces these companies, PGNY’s revenue multiple of 4.4x 2021E revenue is a 40% discount to the peer group median. PNGY’s lower gross margin is likely limiting the multiple. However, Progyny is the one of the few profitable companies in this group and the only one with realistic EBTIDA margins. SG&A leverage is the most likely driver of increased EBITDA and can be achieved by utilizing data to improve clinical outcomes in the future, but primarily by increased productive of the sales reps, including larger employer wins and larger employee utilization. Perhaps the best direct comp is Bright Horizons (BFAM). BFAM offers childcare as a healthcare benefit where employees can use pre-tax dollars to pay for childcare. BFAM offers both onsite childcare centers built to the employer’s specification (owned by the employer and operated by BFAM), as well as shared-site locations that are open to the public and back-up sitter services. Currently, PGNY is trading at 4.4x 2021E Revenue, in-line with BFAM’s 4.3x multiple. I would argue that PGNY should trade significantly higher given the asset-lite business model and higher ROIC. Recent Results Post Covid-19, fertility treatments came back faster than anticipated, combined with disciplined operations, PGNY drove revenue and EBITDA above 2Q2020 consensus estimates. Utilization is still below historical levels, but management’s visibility led to excellent FY21 revenue estimates (consensus is around $555M, a y/y increase of 62%. 2Q2020 revenue increased 15% to $64.6M, and EBITDA increased 18% to $6.5M, primarily driven by SBC as the 15% revenue was not enough to leverage the additional G&A people hired in the last 18 months. The end of the quarter as fertility docs opened their offices back up for remote visits saw better operating margin. Despite the shutdown in fertility clinics during COVID-19, Progyny was able to successfully add several clients. “The significant majority of the clinics in our network chose to adhere to ASRMs guidelines, and our volume of fertility treatments and dispensing of the related medications declined significantly over the latter part of the quarter. . . Through the end of March and into the first half of April, we saw significant reductions in the utilization of the benefit by our members down to as low as 15%, when compared to the early part of Q1 were 15% of what we consider to be normal levels. In April, the New York Department of Health declared that fertility is an essential health service and stated that clinics have the authority to treat their patients and perform procedures during the pandemic. Then on April 24, ASRM updated its guidelines which were reaffirmed on May 11, advising that practices could reopen for all procedures so long as it could be done in a measured way that is safe for patients and staff.” Revenue increased by $33.8 million, 72% in 1Q2020. This increase is primarily due to a $19.0 million, or 47% increase, in revenue from fertility benefits. Additionally, the Company experienced a $14.8 million or 216% increase in revenue from specialty pharmacy. Revenue growth was due to the increase in the number of clients and covered lives. Progyny Rx revenue growth outpaced the fertility benefits revenue since Progyny Rx went live with only a select number of clients on January 1, 2018 and has continued to add both new and existing fertility benefit solution clients since its initial launch. Competition The only true competition is the large insurance companies, but, as mentioned previously, they are not delivering care the same way. WINFertility is the largest manager of fertility insurance benefits on behalf of Anthem, Aetna and Cigna and are not directly involved in the delivery of care. Carrot is a Silicon Valley startup that recently raised $24M in a Series B with several brand name customers (StitchFix, Slack) where they focus on negotiating discounts at fertility clinics for their customers, who then use after-tax dollars from their employers. Risks to Thesis Though there is risk a large carrier may switch to a model similar to Progyny’s, I believe it is unlikely given the established relationships with REIs at the clinic level, the difficulty of managing a more selective network of providers, and the lack of interest shown previously in eliminating the IUI. It is more likely a carrier would acquire Progyny first.
What is yield farming? Most broadly, it means getting some benefit for providing capital, usually in the form of tokens. Currently, there are three major different schemes:
Staked funds aren't utilized in any way and tokens are distributed proportionally to what's staked (may be dai, weth, ycrv, or other tokens). Token price risk: zero. Token accrues, but even if it falls to zero you lose nothing. Smart contract/protocol risk: depends on the staking contract, usually low to zero. Contracts are usually simple modification of the first contract used by yearn (taken from synthetix), making analysis easy by only looking for differences. APR: may start high, but usually collapses fast to relatively low values as funds pour in.
Providing liquidity in trading pools. Tokens are gained in return for providing liquidity for requested tokens on uniswap, balancer, curve, mooniswap. Token price risk: medium to high, depends on pool weights. See these two articles for details on how liquidity providing works: Uniswap - pool weight is always 50%/50% Balancer - arbitrary pool weights, down to 2% for one token. Can be multitoken, not just two. Smart contract security risk: medium to high. In addition to checking the (usually simple) staking contract, requires security analysis of the token contract. If it's possible to mint a very large amount of token, or someone has a hidden enormous stash, the attacker could clean the pool by dumping them at once. I'm aware of one scam called "YYFI" that did this - you can see the attacker successively getting DAI from the balancer pool. Fortunately for the victims, he wasn't very competent and did everything manually, giving time for people to withdraw. A more competent attacker would automate the pool cleaning process in a smart contract. APR: usually very high - upper three digits or four. It's rarely realized APR because it's calculated assuming that token price stays constant. If you think the token being distributed is undervalued definitely the best option to farm.
Depositing and borrowing funds for defi. Currently utilized by compound and cream (a compound clone). Users get rewarded with tokens for lending and borrowing tokens. Token price risk: zero. Security risk: the most complex to analyze option of all, although Compound itself is definitely the safest defi dapp on ethereum.
Warning: gas fees are high. $10k is probably the minimum amount that makes sense for active manual farming, which still only makes sense for a more long-term farms like COMP or CRV, at the cost of not maximizing APR. I have spent over $3k in gas during the last two months by farming very actively. Below $100k, or if you don't want to spend a lot of time on this, it's probably best to deposit your funds into one of yearn vaults that yield farms for users. https://yearn.finance/vaults A partial list of current yield farms (feel free to comment with more farms! I can edit and add them to this list):
COMP farming, the oldest one (I think?). Relatively low returns (58% on DAI), safe, no price risk. Efficient way to farm is to supply and borrow the same asset (can be done via instadapp) up to maximum leverage possible (with some margin for interest payments).
YFV finance, one of the many clones of YFI. The seed pool is safe IF you withdraw before the staking period ends (see the security part). Current APR on stablecoins: 121%
CRV farming, providing liquidity to curve pools. Mostly safe - curve smart contracts tself are safe, but keep in mind if one of tokens in the pool collapses (renBTC is probably the riskiest) other tokens are going to get drained. You can see the current APR on https://dao.curve.fi/mintegauges. As of now, the highest APR is for compound pool - 105.27%. It's varying and there's complicated game with CRV voting that impacts it.
Zombie, meme token. Current APR is abysmal (33.5%) but token may unexpectedly pump, increasing it. There's a smart contract bug that, as long as rewardDistribution and owner aren't set to zero, potentially allows rewardDistribution to lock all staked funds (not steal). Makes zero sense as of today.
Analyzing security. Yield farms come and go. The key to earning high returns is to be agile and to jump fast into new farms, which requires manual analysis of security. Of course it's possible to yolo in without any analysis, but I don't recommend it. I'm going to show an example on two recent farming contracts (of the first type - funds just sit in contracts). Original yearn staking contract. GRAP staking contract. Let's load two codes into a text diff tool, like this site. What interests us on the code level are changes relating to the withdrawal capability, which in the original code are limited to the withdraw() function. We can see that the only substantial change is the addition of the checkStart modifier which prevents both deposits and withdrawals if it's too early. As startime is set directly in source code and can't be modified anywhere, that change is safe - if it doesn't throw on deposit it's not going to throw on withdraw. The next step is switch to the 'read contract' tab on etherscan and look at two variables: owner and rewardDistribution. In Grap's case, they lead to a timelock contract that requires all changes to wait for at least 24.5 hours - which makes any fund lockup extremely unlikely. At worst, we only have to look at the rewardDistribution contract once a day to see if there's any pending change. GRAP farming is now finished with no security incidents. Second example: YFV. This one is still active. Contract link. After comparing them we can see that changes are much more extensive. The withdrawal function also has the checkStart modifier, but that part is fine (ctrl-f to check if starttime can be modified somewhere else - it can't). What's the problem is the checkNextEpoch modifier. There's a lot of things there and three external contract calls (mint calls). If anything in there throws, withdrawal would become impossible. Dangerous. However, that only happens after the staking period ends, so withdrawing before block.timestamp >= periodFinish is relatively safe. Another check is to look at the owner and rewardDistribution variables. Owner is set to zero, but where's rewardDistribution? Unfortunately, contrary to GRAP, it's private. It's possible to read it with the getStorageAt web3 api (although finding the index is more work - it's 3). However, the team has provided a link to the transaction in which they set rewardDistribution to 0 so it's fine. In conclusion, as long as you don't hold the funds after the locking period ended there's no security risk here. The current period ends on Tue Sep 1 14:02:29 2020, UTC.
Hello, I've been a long time lurker, but figured I would share what I've been up to for the last few months. I've been working on a few different strategies (mainly mean reversion/momentum) with different variables/indicators using tick data. After many many many hours of tweaking, I optimized it further by isolating certain days of week / times of day (down to 30 minute windows) that performed the best on average, and it's now only trading those 'successful' windows. I've been running the below strategy (lets call it strategy A) live for the past 1.5 months and so far results match the backtest. Strategy A works extremely well with high volatility, which is why I'm trying to milk it while I can. :) It trades in very tight time intervals (average time in market = 13 mins), but is extremely selective about when it takes a trade, so that usually means a few trades per week. This is running on NinjaTrader (I coded it in ninjascript) and is trading 1 ES futures contract at a time. I built in a saftey-net where it halts trading for the day if the unrealized P&L drops below a certain amount, but so far it hasn't hit it. I'm working on another strategy that performs much better in various market conditions and is backtesting successfully going back 3+ years, but is even more selective about when it executes trades. Because of this, the trades are even more sparse, but with an increased contract count, it performs quite well. EDIT: There's been some confusion about how much capital I'm using. My broker only requires $1k of margin for every ES contract. Since I started live trading (end of june), I've been using $1.5K USD total and I've only been trading 1 ES contract/order. I've added another chart below outlining what the results would look like if you were to trade 30 ES contracts per order instead of 1 (this would require 30K USD + more for buffer in case of drawdown, so 40-50K to be safe). The liquidity pool for ES futures is very deep, so in theory, you could run this strategy at 100+ contracts/order. Results: Daily P&L Cumulative Net Profit Strategy Stats Net Profit/month with 30 contracts/order
PRPL Nurples- Why purple valuation just might make your NIPS hard - DD inside
All- I have received hundreds of DM asking where the stock is going. I have received questions such as: where do you think it stops, is it over valued, undervalued, should my mom invest, should i Yolo, should i sell and take profits? blah, blah blah. Here is some DD- stop asking me about where this ends up because I don't know for sure but I have some Feely Good estimates. I hope this post makes your nipples hard and if it doesn't you're probably a gay bear. I am going to give you a quick run down of what my expectations are for Q2 earnings and it will include the good, the bad and the ugly. The ugly being the warrant accrual that will hurt GAAP. First of all, There is little that needs to be determined for Q2 top-line as they have already released April and May Sales. April Sales Came in around ~62M based on my math and May Sales came in at 88M and some change. Based on these numbers, we can safely assume that we will at a minimum have somewhere around 225M in revenue for the quarter by using the average of April and May to determine June. I believe 225M to be on the low side and I have continued to up my estimates as I believe E-commerce is still thriving, especially purple. Purple continues to climb the web traffic ladder and has moved up another ~500 spots to be the 13,000 most popular site in the world. For simplicity sake, I am going to use some historical numbers to estimate profits. If you'll look at previous posts that I've made then you'll see how I arrived at these numbers. There are some quick napkin calculations below. We can safely assume that the average wholesale selling price of a mattress is ~1350 dollars and we can assume that GM for wholesale is around 30%. This means the average cost of a mattress to manufacture is ~945 on average. From my previous posts, we knew that pre Covid the business was split by units, not by gross sales. On average, wholesale consumed 50% of capacity and DTC consumed 50% of capacity. In order to determine average DTC selling price then we can equation .5*1350 + .5*(DTC Price) = 1900. PRPL indicated their average selling price per mattress was ~1900.00, I found this in their s-3. ----------------------------------- .5*1350 + .5*(DTC Price) = 1900=========== DTC average price is 2450.00, 1350 is average Wholesale price. DTC Margin is ~62% Estimated Wholesale Margin ~30% Estimated ---------------------------------- Historically, advertising costs have been about 30% of revenue. I have been tracking advertisement for purple and from a TV cost standpoint, they have not increased their commercial count at all in the last three months. See link, PRPL is still only performing 125 commercials per day. This commercial rate has held steady for 6 months. https://www.ispot.tv/brands/tqU/purple-mattress I believe purple has increased their ad spend online but I believe it will be proportional to their new capacity on a unit basis. Previously purple had 6 Machines of capacity and spent 38M in advertising, I believe they will spend (7/6)*38M which is 44M or roughly 15M per month. Just because revenue is up, doesn't mean they will spend more per unit- they are capacity constrained and that is terribly inefficient. ---------------------------------- The following table shows my best guesses on their major category costs. This includes the gross Margin and the other costs subtracted from the Gross Margin.
Total Revenue net revenue effect
Gross Margin from Wholesale
Gross Margin from DTC
Research and Development
Profit Non GAAP
66.5M or 1.23 EPS
Profit GAAP Estimated
$31.5M or .59 EPS
--------------------------------------------------------------------------------------------------------------------------------------------------- If we used 66.5M, PRPL would report 1.23 EPS on an adjusted Basis. The warrant Accrual will unfavorably push the EPS down on a GAAP basis and we will likely see something around .59 EPS. If they can achieve this for the next 4 quarters then in a years time there is a huge potential for stock increases based on the following P/E's.
Non GAAP Est.
Stock price assuming 8x P/E
Stock Price assuming 12x P/E
Stock Price assuming 15x P/E
Stock Price assuming 20x P/E
People may say that this is super inaccurate..... but if you look at the following cash statement then you will realize that PRPL has been generating more than 1M per day in cash for the last two months - that is absolutely insane. purple has generated 70M in cash in 60 days. Mark my words, PRPL is going to be more profitable than TPX this quarter. TPX reported earnings of .68 EPS today on revenue of 665M. TPX is trading at 80+ per share. if purple reports a similar .68 EPS then it would be valued about 60% lower than TPX on an EPS basis. if purple posts EPS of ~1 dollar then it would be undervalued as compared to TPX by about 80%. I hope your NIPS are tender now. Hope this helps you understand why I believe PRPL to be so undervalued.
$LPTH - DD - lightpath technologies - A company which is growing and will keep on growing
Overview: LightPath Technologies is a recognized leader in optics and photonics solutions, serving blue chip customers in the industrial, defense, telecommunications, testing and measurement, and medical industries, for over 35 years. LightPath designs, manufactures, and distributes optical and infrared components including molded glass aspheric lenses and assemblies, infrared lenses and thermal imaging assemblies, and fused fiber collimators. LightPath also offers custom optical assemblies, including full engineering design support for both optics and mechanics. This allows for the highest level of optical integration, lower cost, and ensures the highest level of quality, performance and manufacturability. Presence in multiple countries:.
Customers: Look at these customer list, detailed list in the pic. They are separated by Infrared and Visible light. Same can be found HERE
INFRARED OPTICS : Infrared lenses designed for thermal imaging cameras operating in the mid-wave and long-wave infrared (MWIR, LWIR) bands, for applications such as thermography, diagnostics, security and surveillance.
ASPHERES : Precision molded glass lenses for applications in the visible and near-infrared (NIR) wavebands, such as small beam collimation, focusing and fiber coupling.
COLLIMATORS : Geltech™ aspheric glass lenses mounted in standard fiber-connector housings, for use in coupling and collimating applications in the visible and near-infrared (NIR) wavebands.
ISP OPTICS: We are your source for the most unique selection of IR lenses, windows, beamsplitters and other IR optical components in the industry at the best prices.
Recent News, catalysts, facts:
LightPath Technologies Continues to Experience High Market Demand for its Molded BD6 Family of Thermal Lenses. Received New Orders Totaling More Than $1.7 Million in Asian Market for Medical and Sensing Applications. Details are HERE
Jul 21 - CEO Details Competitive Advantage to Fuel Rapid Growth LINK HERE
Inclusion in Russel Index: The company was recently added to Russell Microcap Index on Jun 29. Details can be seen HERE
Infrared lenses market is projected to grow to $750M by 2024, with Chalcogenide growing to 65% of the market
Lightpath molded lenses are used in telecom equipment in interfaces of light in and out of fibers, detectors and lasers
5G network architecture requires closer together network access points, leading to higher demand of lenses
Far outperforming their industry: LPTH demonstrates a +10.16% growth in revenue based on a trailing 12-month window, versus the entirety of the Electronic Equipment, Instruments & Components Industry in which they compete, which was down -2.22% on average. Lightpath knows how to operate in their industry and can create profitability even post-Covid-19. Even in this profitable sector, LPTH outshines many other earners with a gross profit margin of 44.9% in the trailing 12-month window, versus the industry’s 38.1%.
Job posting: A whole lot of new job posting than usual for this company in this quarter. details HERE
All-Time high sales: With recorded revenue of 33.75 Million, LPTH’s 2019 revenue has set new records every year for the past 5 years running, and (excluding Depreciation and Amortization expenses) record income each concurrent year. The team behind LPTH knows how to drive valuation and increase their company’s profitability and understand how to scale a tech firm. https://www.marketwatch.com/investing/stock/lpth/financials
Insider trading : On Jun 22 there was a purchase of 1,750,000 shares at 2$. details HERE .
Gross margin as a percentage of revenue was 46%, up from 39%
Net income was $816,000, compared to a net loss of $352,000
12-month backlog reached another record of $20.0 million at March 31, 2019, compared to $17.1 million at March 31, 2019
Operating expenses decreased to $2.9 million for the third quarter of fiscal 2020, compared to $3.1 million in the same quarter of the prior fiscal year.
Growth: Company uses Chalcogenide and its low cost and very high demand. see this article Increased mutual fund ownership Mutual funds have been increasing their positions in LPTH, with previous quarter increases exceeding 48.13% .These funds include Vanguard, Royce, and Fidelity – all moving their positions deeper with Royce now holding 4.4% of the company’s shares. This shows high interest from proven winners who understand the market and a confidence in the long-term profitability of the firm. https://eresearch.fidelity.com/eresearch/evaluate/fundamentals/ownership.jhtml?stockspage=ownership&symbols=LPTH Analyst opinions - Refinitiv/Verus has a strong BUY opinion, ranking it with their “SmartIndex” score of 37.41% - a very bullish signal that indicates a strong reasoning to increase positions. This has been upgraded by 3 firms from a Neutral position to a bullish BUY, with FBR indicating a 1-year history of nearly constant outperformance for the relative sector. Upcoming catalyst: Strong earnings this year, with earnings upcoming September 10th. – Q2 and Q3 have both met or exceeded EPS estimates, with current estimates indicating a repeat of this for the upcoming report. Higher earnings per share is one of the key factors to look at when evaluating the feasibility of any Price Target: This company has a solid growth. Here is a article which clearly explains thermal imaging market continues to rapidly expand and company has a great future. This is a low float once it gets the eyes it can be move a lot. Risks: LPTH has little demonstrated interest in the usual PR-spam that people interested in volatile growth like to see. They focus on their work, and not so much pumping the news cycle. This is both good and bad – when positive PR releases do happen, historical charts show growth is positive and quick – yet the inverse is likely also true. This does also present the benefit of being a safe-haven versus a highly volatile, high volume play. Relatively low-float – Shares are, by nature, subject to higher volatility and offerings once the prices begin to increase. In companies that stay under the radar such as LPTH, there are opportunities for both buyers and short-sellers, and there is ample opportunity to end up a bag-holder if responsible exit plans are not in place. (This hopefully is becoming a common practice for everyone – know when to leave before you get in! Stock History: Look at the stock history it has been constantly growing from last 6 month. It was at .63 and now trading around 3$. Its not a pump dump but a company which actually has a growth and a solid investment as well.
Conservative Margin Lending - A tool to use, and a reason to invest outside of Super
Hi AusFinance, i thought i would write on a topic i'm rather passionate about, and hopefully offer some 'food for thought' and an alternative to the standard answers of 'Super is the best environment for your money'. Disclaimers:
this is not financial advice, i am merely trying to offer some food for thought
these examples are greatly simplified, they do not take into account interest rate risk, legislation risk (both on super, on changes to tax, etc..).
The case study below does not take into account the ability to margin lend inside super. the ability is there, such as Bell Potter's Equity Lever platform, but this is not available to your average retail/industry super, hence it is excluded.
Margin lending for the uninitiated: For those of you unaware, margin loans are borrowing to invest. Your shares/fund units act as security that let you borrow money to buy more shares/fund units. These are given different levels of "Loan to Value Ratio" aka LVR. a 75% LVR means you can make up a total investment with a minimum of 25% your money, and a maximum of 75% borrowed money. So with $2,500 you'd be able to borrow up to $7,500 (Making up a total portfolio of $10,000). Why borrow to invest? Simply put, Margin lending amplifies your gains and your losses. I have included a table below to demonstrate what a margin loan will do to a $25,000 investment at an 8% p.a. return at different LVRs. I am using Leveraged Equities variable 4.24% interest rate on their direct investment loan as the interest cost - the product offers access to the vast majority of funds and shares that an investor needs, it's just lacking advanced features like options trading (who cares!) https://preview.redd.it/42p6co191lb51.png?width=786&format=png&auto=webp&s=764b15d0695792766367cc05b5adae78f3af840a Here we can see the return improve from the standard 8% all the way to 11.8% if using 50% LVR. But in my opinion, 50% LVR is too risky for many investors appetite here, even if it is my ideal point. Instead, i would direct your attention to 35% LVR. Why 35% LVR? a 35% LVR comes with a number of benefits to an investor doing standard VAS/VGS/VDHG style etf investing.
Increased returns - as we can see it takes an 8% return and increases it to a 10.1% return
Returns slightly understated - The return is not factoring the effect that the interest will have on your tax return - it is tax deductible.
Low chance of a margin call.
Let's talk about #3. Margin calls are without a doubt the scariest part of margin lending, and i don't blame you for being afraid of them. Many people who leverage too aggressively and fly too close to the sun get hit with a nasty cycle where:
Their investment falls into margin call territory because it has dropped
They are forced to sell their assets at the worst points in the market to get out of the margin call
they miss out on the recovery because their excess cash was used covering margin calls on the way down.
But this is where a 35% LVR is so appealing. the calculation to figure out where your margin call will happen is: 1-(Loan/(Lending Value + Buffer)). So if we take a standard favourite of Ausfinance such as VAS, VDHG etc, we can see that they have a LVR of 75%. Industry standard buffer is 10%. so let's figure out a margin call on a $25,000 investment, with $14,000 borrowed funds (35% LVR): 1-($14,000/(($39,000*0.75)+($39,000*0.10))) = 58% it would take a 58% drop in the portfolio to bring it to a margin call. This is the portfolio dropping from $39,000 to $16,470. This requires a staggering drop before you experience a margin call, and if you are concerned reducing your LVR to only 25% will still improve your return and increase your chance of never being margin called. You have time to add to your holdings with equity only (buying a dip + decreasing your overall LVR). the important thing is you can manage your risk and it requires truly a cataclysmic level of decline before you experience a margin call ,and at that point that may not be your biggest concern. Why all the fuss? What's the point of risking being margin called? It's all in that % return. in the following example i will use ASIC's compound calculator, along with the following parameters: $25,000 initial deposit (your capital), $0 regular deposits, annual compounding, and a 30 year time horizon. The only assumption is that as the portfolio grows in capital value, the 35% LVR is maintained. Case 1 - 0 LVR (AKA [email protected]%) - after 30 years of compounding at 8% you end up on $251,566 Case 2 - 35% LVR (AKA compounding at 10.1%) - after 30 years of compounding at 10.1% you end up on $448,291 Verdict - Case 2 ends up being $196,725 better. a 78% superior return Every % matters so much in a long term strategy, it is truly impossible to overstate how important it is to long term outcomes. Case Study: Super Showdown As a final demonstration of the power of a low leverage strategy we will put two different cases head to head. Let us assume that a 30 year old intends to retire at age 65, and has the option of either having $50,000 in super, or invested at a 35% LVR. After retirement, they will either 1. Take the money tax free in pension phase or 2. pay capital gains tax by cashing out their own 'pension' each year, with their marginal tax rate being 30% (using the currently legislated but not implemented rates). Case 2 will overstate their tax slightly, as i will not scale it, i will just hit the whole thing at 30%. https://preview.redd.it/86c7xcrc7lb51.png?width=530&format=png&auto=webp&s=045a1774106ac8d8ac848decb04bec9a142bdc52 We can see that with the CGT discount, paying 15% tax is actually better than paying a 0% tax rate due to the higher return. It's an out-performance of $508,681 But okay, i hear you, CGT discount may be gotten rid of, let's recalculate it with no discount: https://preview.redd.it/yafmmg6p7lb51.png?width=530&format=png&auto=webp&s=d9ae4b0db5de48808ca202f7c6e40d599c34c065 Even without a CGT discount (and 30% flat is more tax than you'd pay on a CGT discounted method on the highest marginal rate currently) there has been an out-performance of $306,102 What do i hope you take away from this? Even if you decide that the risk of margin lending is too much for you, or that i'm absolutely insane to choose an outside of super strategy that relies on borrowing to invest, i hope that i have given you something to think about. the one thing i hope everyone takes away from this just as a general point is the sheer power of small changes in your long term return %. I really strongly believe in conservatively leveraging safe and boring investments to boost that all critical return over the long term to create outstanding long term results. minor edit: fixed up some grammar
How to not get ruined with Options - Part 3a of 4 - Simple Strategies
Post 1: Basics: CALL, PUT, exercise, ITM, ATM, OTM Post 2: Basics: Buying and Selling, the Greeks Post 3a: Simple Strategies Post 3b: Advanced Strategies Post 4a: Example of trades (short puts, covered calls, and verticals) Post 4b: Example of trades (calendars and hedges) --- Ok. So I lied. This post was getting way too long, so I had to split in two (3a and 3b) In the previous posts 1 and 2, I explained how to buy and sell options, and how their price is calculated and evolves over time depending on the share price, volatility, and days to expiration. In this post 3a (and the next 3b), I am going to explain in more detail how and when you can use multiple contracts together to create more profitable trades in various market conditions. Just a reminder of the building blocks: You expect that, by expiration, the stock price will … ... go up more than the premium you paid → Buy a call … go down more than the premium you paid → Buy a put ... not go up more than the premium you got paid → Sell a call ... not go down more than the premium you got paid → Sell a put Buying Straight Calls: But why would you buy calls to begin with? Why not just buy the underlying shares? Conversely, why would you buy puts? Why not just short the underlying shares? Let’s take long shares and long calls as an example, but this applies with puts as well. If you were to buy 100 shares of the company ABC currently trading at $20. You would have to spend $2000. Now imagine that the share price goes up to $25, you would now have $2500 worth of shares. Or a 25% profit. If you were convinced that the price would go up, you could instead buy call options ATM or OTM. For example, an ATM call with a strike of $20 might be worth $2 per share, so $200 per contract. You buy 10 contracts for $2000, so the same cost as buying 100 shares. Except that this time, if the share price hits $25 at expiration, each contract is now worth $500, and you now have $5000, for a $3000 gain, or a 150% profit. You could even have bought an OTM call with a strike of $22.50 for a lower premium and an even higher profit. But it is fairly obvious that this method of buying calls is a good way to lose money quickly. When you own shares, the price goes up and down, but as long as the company does not get bankrupt or never recovers, you will always have your shares. Sometimes you just have to be very patient for the shares to come back (buying an index ETF increases your chances there). But by buying $2000 worth of calls, if you are wrong on the direction, the amplitude, or the time, those options become worthless, and it’s a 100% loss, which rarely happens when you buy shares. Now, you could buy only one contract for $200. Except for the premium that you paid, you would have a similar profit curve as buying the shares outright. You have the advantage though that if the stock price dropped to $15, instead of losing $500 by owning the shares, you would only lose the $200 you paid for the premium. However, if you lose these $200 the first month, what about the next month? Are you going to bet $200 again, and again… You can see that buying calls outright is not scalable long term. You need a very strong conviction over a specific period of time. How to buy cheaper shares? Sell Cash Covered Put. Let’s continue on the example above with the company ABC trading at $20. You may think that it is a bit expensive, and you consider that $18 is a more acceptable price for you to own that company. You could sell a put ATM with a $20 strike, for $2. Your break-even point would be $18, i.e. you would start losing money if the share price dropped below $18. But also remember that if you did buy the shares outright, you would have lost more money in case of a price drop, because you did not get a premium to offset that loss. If the price stays above $20, your return for the month will be 11% ($200 / $1800). Note that in this example, we picked the ATM strike of $20, but you could have picked a lower strike for your short put, like an OTM strike of $17.50. Sure, the premium would be lower, maybe $1 per share, but your break-even point would drop from $18 to $16.50 (only 6% return then per month, not too shabby). The option trade will usually be written like this: SELL -1 ABC 100 17 JUL 20 17.5 PUT @ 1.00 This means we sold 1 PUT on ABC, 100 shares per contract, the expiration date is July 17, 2020, and the strike is $17.5, and we sold it for $1 per share (so $100 credit minus fees). With your $20 short put, you will get assigned the shares if the price drops below $20 and you keep it until expiration, however, you will have paid them the equivalent of $18 each (we’ll actually talk more about the assignment later). If your short put expires worthless, you keep the premium, and you may decide to redo the same trade again. The share price may have gone up so much that the new ATM strike does not make you comfortable, and that’s fine as you were not willing to spend more than $18 per share, to begin with, anyway. You will have to wait for some better conditions. This strategy is called a cash covered put. In a taxable account, depending on your broker, you can have it on margin with no cash needed (you will need to have some other positions to provide the buying power). Beware that if you don’t have the cash to cover the shares, it is adding some leverage to your overall position. Make sure you account for all your potential risks at all times. The nice thing about this position is that as long as you are not assigned, you don’t actually need to borrow some money, it won’t cost you anything. In an IRA account, you will need to have the cash available for the assignment (remember in this example, you only need $1800, plus trading fees). Let’s roll! Now one month later, the share price is between $18 and $22, there are few days of expiration left, and you don’t want to be assigned, but you want to continue the same process for next month. You could close the current position, and reopen a new short put, or you could in one single transaction buy back your current short put, and sell another put for next month. Doing one trade instead of two is usually cheaper because you reduce the slippage cost. The closing of the old position and re-opening of a new short position for the next expiration is called rolling the short option (from month to month, but you can also do this with weekly options). The croll can be done a week or even a few days before expiration. Remember to avoid expiration days, and be careful being short an option on ex-dividend dates. When you roll month to month with the same strike, for most cases, you will get some money out of it. However, the farther your strike is from the current share price, the less additional premium you will get (due to the lower extrinsic value on the new option), and it can end up being close to $0. At that point, given the risk incurred, you may prefer to close the trade altogether or just be assigned. During the roll, depending on if the share price moved a bit, you can adjust the roll up or down. For example, you buy back your short put at $18, and you sell a new short put at $17 or $19, or whatever value makes the most sense. Assignment Now, let’s say that the share price finally dropped below $20, and you decided not to roll, or it dropped so much that the roll would not make sense. You ended up getting your shares assigned at a strike price of $18 per share. Note that the assigned share may have a current price much lower than $18 though. If that’s the case, remember that you earned more money than if you bought the shares outright at $20 (at least, you got to keep the $2 premium). And if you rolled multiple times, every premium that you got is additional money in your account. Want to sell at a premium? Sell Covered Calls. You could decide to hold onto the shares that you got at a discount, or you may decide that the stock price is going to go sideways, and you are fine collecting more theta. For example, you could sell a call at a strike of $20, for example for $1 (as it is OTM now given the stock price dropped). SELL -1 ABC 100 17 JUL 20 20 CALL @ 1.00 When close to the expiration time, you can either roll your calls again, the same way that you rolled your puts, as much as you can, or just get assigned if the share price went up. As you get assigned, your shares are called away, and you receive $2000 from the 100 shares at $20 each. Except that you accumulated more money due to all the premiums you got along the way. This sequence of the short put, roll, roll, roll, assignment, the short call, roll, roll, roll, is called the wheel. It is a great strategy to use when the market is trading sideways and volatility is high (like currently). It is a low-risk trade provided that the share you pick is not a risky one (pick a market ETF to start) perfect to get create some income with options. There are two drawbacks though:
If the share dropped too much, you are stuck with it.
You will have to be patient for the share to go back up, but often you can end up with many shares at a loss if the market has been tanking. As a rule of thumb, if I get assigned, I never ever sell a call below my assignment strike minus the premium. In case the market jumps back up, I can get back to my original position, with an additional premium on the way. Market and shares can drop like a stone and bounce back up very quickly (you remember this March and April?), and you really don’t want to lock a loss. Here is a very quick example of something to not do: Assigned at $18, current price is $15, sell a call at $16 for $1, share goes back up to $22. I get assigned at $16. In summary, I bought a share at $18, and sold it at $17 ($16 + $1 premium), I lost $1 between the two assignments. That’s bad.
If the share goes up too fast, you missed some opportunity for gain, potentially big gains.
You will have to find some other companies to do the wheel on. If it softens the blow a bit, your retirement account may be purely long, so you’ll not have totally missed the upside anyway. A short put is a bullish position. A short call is a bearish position. Alternating between the two gives you a strategy looking for a reversion to the mean. Both of these positions are positive theta, and negative vega (see part 2). Now that I explained the advantage of the long calls and puts, and how to use short calls and puts, we can explore a combination of both. Verticals Most option beginners are going to use long calls (or even puts). They are going to gain some money here and there, but for most parts, they will lose money. It is worse if they profited a bit at the beginning, they became confident, bet a bigger amount, and ended up losing a lot. They either buy too much (50% of my account on this call trade that can’t fail), too high of a volatility (got to buy those NKLA calls or puts), or too short / too long of an expiration (I don’t want to lose theta, or I overspent on theta). As we discussed earlier, a straight long call or put is one of the worst positions to be in. You are significantly negative theta and positive vega. But if you take a step back, you will realize that not accounting for the premium, buying a call gives you the upside of stock up to the infinity (and buying a put gives you the upside of the stock going to $0). But in reality, you rarely are betting that the stock will go to infinity (or to $0). You are often just betting that the stock will go up (or down) by X%. Although the stock could go up (or down) by more than X%, you intuitively understand that there is a smaller chance for this to happen. Options are giving you leverage already, you don’t need to target even more gain. More importantly, you probably should not pay for a profit/risk profile that you don’t think is going to happen. Enter verticals. It is a combination of long and short calls (or puts). Say, the company ABC trades at $20, you want to take a bullish position, and the ATM call is $2. You probably would be happy if the stock reaches $25, and you don’t think that it will go much higher than that. You can buy a $20 call for $2, and sell a $25 call for $0.65. You will get the upside from $20 to $25, and you let someone else take the $25 to infinity range (highly improbable). The cost is $1.35 per share ($2.00 - $0.65). BUY +1 VERTICAL ABC 100 17 JUL 20 20/25 CALL @ 1.35 This position is interesting for multiple reasons. First, you still get the most probable range for profitability ($20 to $25). Your cost is $1.35 so 33% cheaper than the long call, and your max profit is $5 - $1.35 = $3.65. So your max gain is 270% of the risked amount, and this is for only a 25% increase in the stock price. This is really good already. You reduced your dependency on theta and vega, because the short side of the vertical is reducing your long side’s. You let someone else pay for it. Another advantage is that it limits your max profit, and it is not a bad thing. Why is it a good thing? Because it is too easy to be greedy and always wanting and hoping for more profit. The share reached $25. What about $30? It reached $30, what about $35? Dang it dropped back to $20, I should have sold everything at the top, now my call expires worthless. But with a vertical, you know the max gain, and you paid a premium for an exact profit/risk profile. As soon as you enter the vertical, you could enter a close order at 90% of the max value (buy at $1.35, sell at $4.50), good till to cancel, and you hope that the trade will eventually be executed. It can only hit 100% profit at expiration, so you have to target a bit less to get out as soon as you can once you have a good enough profit. This way you lock your profit, and you have no risk anymore in case the market drops afterwards. These verticals (also called spreads) can be bullish or bearish and constructed as debit (you pay some money) or credit (you get paid some money). The debit or credit versions are equivalent, the credit version has a bit of a higher chance to get assigned sooner, but as long as you check the extrinsic value, ex-dividend date, and are not too deep ITM you will be fine. I personally prefer getting paid some money, I like having a bigger balance and never have to pay for margin. :) Here are the 4 trades for a $20 share price: CALL BUY 20 ATM / SELL 25 OTM - Bullish spread - Debit CALL BUY 25 OTM / SELL 20 ATM - Bearish spread - Credit PUT BUY 20 ATM / SELL 25 ITM - Bullish spread - Credit PUT BUY 25 ITM / SELL 20 ATM - Bearish spread - Debit Because both bullish trades are equivalent, you will notice that they both have the same profit/risk profile (despite having different debit and credit prices due to the OTM/ITM differences). Same for the bearish trades. Remember that the cost of an ITM option is greater than ATM, which in turn is greater than an OTM. And that relationship is what makes a vertical a credit or a debit. I understand that it can be a lot to take in. Let’s take a step back here. I picked a $20/$25 vertical, but with the share price at $20, I could have a similar $5 spread with $15/$20 (with the same 4 constructs). Or instead of 1 vertical $20/$25, I could have bought 5 verticals $20/$21. This is a $5 range as well, except that it has a higher probability for the share to be above $21. However, it also means that the spread will be more expensive (you’ll have to play with your broker tool to understand this better), and it also increases the trading fees and potentially overall slippage, as you have 5 times more contracts. Or you could even decide to pick OTM $25/$30, which would be even cheaper. In this case, you don’t need the share to reach $30 to get a lot of profit. The contracts will be much cheaper (for example, like $0.40 per share), and if the share price goes up to $25 quickly long before expiration, the vertical could be worth $1.00, and you would have 150% of profit without the share having to reach $30. If you decide to trade these verticals the first few times, look a lot at the numbers before you trade to make sure you are not making a mistake. With a debit vertical, the most you can lose per contract is the premium you paid. With a credit vertical, the most you can lose is the difference between your strikes, minus the premium you received. One last but important note about verticals: If your short side is too deep ITM, you may be assigned. It happens. If you bought some vertical with a high strike value, for example: SELL +20 VERTICAL SPY 100 17 JUL 20 350/351 PUT @ 0.95 Here, not accounting for trading fees and slippage, you paid $0.95 per share for 20 contracts that will be worth $1 per share if SPY is less than $350 by mid-July, which is pretty certain. That’s a 5% return in 4 weeks (in reality, the trading fees are going to reduce most of that). Your actual risk on this trade is $1900 (20 contracts * 100 shares * $0.95) plus trading fees. That’s a small trade, however the underlying instrument you are controlling is much more than that. Let’s see this in more detail: You enter the trade with a $1900 potential max loss, and you get assigned on the short put side (strike of $350) after a few weeks. Someone paid expensive puts and exercised 20 puts with a strike of $350 on their existing SPY shares (2000 of them, 20 contracts * 100 shares). You will suddenly receive 2000 shares on your account, that you paid $350 each. Thus your balance is going to show -$700,000 (you have 2000 shares to balance that). If that happens to you: DON’T PANIC. BREATHE. YOU ARE FINE. You owe $700k to your broker, but you have roughly the same amount in shares anyway. You are STILL protected by your long $351 puts. If the share price goes up by $1, you gain $2000 from the shares, but your long $351 put will lose $2000. Nothing changed. If the share price goes down by $1, you lose $2000 from the shares, but your long $350 put will gain $2000. Nothing changed. Just close your position nicely by selling your shares first, and just after selling your puts. Some brokers can do that in one single trade (put based covered stock). Don’t let the panic set in. Remember that you are hedged. Don’t forget about the slippage, don’t let the market makers take advantage of your panic. Worst case scenario, if you use a quality broker with good customer service, call them, and they will close your position for you, especially if this happens in an IRA. The reason I am insisting so much on this is because of last week’s event. Yes, the RH platform may have shown incorrect numbers for a while, but before you trade options you need to understand the various edge cases. Again if this happens to you, don’t panic, breathe, and please be safe. This concludes my post 3a. We talked about the trade-offs between buying shares, buying calls instead, selling puts to get some premium to buy some shares at a cheaper price, rolling your short puts, getting your puts assigned, selling calls to get some additional money in sideways markets, rolling your short calls, having your calls assigned too. We talked about the wheel, being this whole sequence spanning multiple months. After that, we discussed the concept of verticals, with bullish and bearish spreads that can be either built as a debit or a credit. And if there is one thing you need to learn from this, avoid buying straight calls or puts but use verticals instead, especially if the volatility is very high. And do not ever sell naked calls, again use verticals. The next post will explain more advanced and interesting option strategies. --- Post 1: Basics: CALL, PUT, exercise, ITM, ATM, OTM Post 2: Basics: Buying and Selling, the greeks Post 3a: Simple Strategies Post 3b: Advanced Strategies Post 4a: Example of trades (short puts, covered calls, and verticals) Post 4b: Example of trades (calendars and hedges)
Margin trading is incredibly risky and suitable only for the most sophisticated investors. Brokers have a duty to inform their clients of these risks prior to accepting purchases on margin. Margin of safety is an investing principle that involves only procuring a security when its market price is substantially less than its intrinsic value. Trading on leverage in a margin account contains a big dose of risk. If you haven’t properly calculated your money management strategy, you can easily wipe out your account and go bankrupt. Trading on margin is safe. As safe as trading in the stock market ever is. You have risk of course. Risk of losing all that you have borrowed plus any interest or fee incurred for using margin. Investors hedge the risk of trading in the open market in a lot ways. Options, portfolio diversification, position sizing, researching fundamentals, and The reality is that margin trading is an inherently risky strategy that can transform even the safest blue-chip stock purchase into a high-stakes gamble. It allows aggressive traders—both individuals and institutions—to buy more shares than they could otherwise afford.
What Is Margin Level? FXTM Learn Forex in 60 Seconds
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