Friday, July 11, 2014

Friday's Prospects: Round 2

The four symbols that survived my first round of analysis had all given bear signals. That means I can trade them only if they have sufficient liquidity to support construction of a bear position.

The symbols are ADXS, PIKE, BAS and BGG, all from the small-cap prospects list. See "Friday's Prospects" for a description of the first round of analysis.

There are two ways to build a position that will profit from a price decline.

The classic method is to sell the stock short. This involves borrowing the shares and selling them to another, then buying the shares back later and returning them to their owner.

The whole borrowing thing is done through a broker and is wholly behind the scenes. From the trader's viewpoint, it's simply a matter of selecting "short sale" as the type of trade.

Of course, the borrowing of shares is real, however hidden the process might be. Shares have to be available for borrowing if the process is to to work. Highly liquid stocks can always be borrowed for a short sale; illiquid shares -- not so much, and mostly not at all.

The other method is to construct a short position out of stock options, by buying puts, selling calls or setting up an options spread of some sort.

Options are always far less liquid than shares. Low liquidity means wider bid/ask spreads, and that in turn makes it more difficult to have an order filled at a decent price.

The degree of illiquidity an options trader is willing to accept is purely a matter of taste. I look to open interest in determining how liquid a symbol's options are.

Open interest measures how many contracts are left open or undelivered on a day. It shows the current level of potential trading, as opposed to volume, which shows historical trading. Open interest is forward looking; volume looks back.

My rule of thumb is to require open interest of 100 contracts or more, and also a bid/ask spread of below 10%, at the strike prices I'm likely to use in constructing the trade.

None of the four first-round survivors are liquid enough to trade under my guidelines.

Therefore, I won't be posting further analysis today nor trading off of the prospects lists.

Enjoy the weekend!

-- Tim Bovee, Portland, Oregon, July 11 2014

My shorter-term trading rules can be read here. My longer-term trading rules can be read here. And the classic Turtle Trading rules on which my rules are based can be read here.

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decisions for his or her own account, and take responsibility for the consequences.

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