Monday, 16 January 2017

The Real Time "Coiled Spring" Experiment: Nike, Discovery, Abbott, Lennar, and Viacom

All of this thinking over the weekend on pennants, triangles, and strangles got me thinking.

I have long been of the belief that consolidations inside pennants / triangles lead to resolution, either up or down once price reaches the apex of the pattern. The longer the pattern of consolidation, the more meaningful the resolution.

The issue I have always had in my own speculation is leaning to one side in terms of positioning myself in advance of any resolution, and this is a dangerous endeavour because I truly believe that flexibility is the epitome of a successful speculative trading operation, not stubbornness. Anticipatory trading is bad enough: anticipatory stubbornness is a sure path to losing money!

(On the flipside, stubbornness is most likely the epitome of a successful investing operation, as evidenced by great investors who have succeeded because they have had better and deeper anchors than their participant counterparts in evaluating and sticking with great businesses over time)

Well, it's time to put my theory to test, partly by way of a real money experiment, and partly by way of a hypothetical paper trade experiment.

I spent this past weekend scouring the S&P 500 and the DJIA for monthly or weekly consolidation triangle / pennant patterns and have found the following 6 charts out (of 500+, believe it or not).

First up, Nike (already mentioned last week):
















Next, Discovery Class K:
















Next, Abbott Labs:
















Next, Lennar:
















Next, Viacom:
















And finally, Sealed Air:


















There is a noticeable commonality amongst all six setups, and this appears to be characterized by a long term consolidation inside a pennant / triangle over the last two years in each case. I have indicated total distance inside the consolidation, and the option strikes to be considered on eventual breakout/resolution.

I have added a link to a new model to the blog which assumes that I invest equally in six strangles positioned slightly above and slightly below the apex of each consolidation pattern, and this is where I ran into my first problem, in that the spreads on the Sealed Air options are too wide, so I dropped Sealed Air from consideration due to illiquidity in the spreads.

I used the closing prices of the strangles as quoted at optionsexpress for each of the five remaining setups being considered as of Friday January 13th, 2017, assuming I purchased the strangles at the market.

In my new model spreadsheet, I have added objective targets based on breakout / resolution resulting in a move up or down equal to the triangle / pennant width, and my assumption in updating the model once a week is that I will have GTC orders in the market at all times equal to a theoretical profit of 1/2 x the resolution distance to be conservative.  Once a pattern resolves, the 1/2 x resolution P/L GTC order will theoretically close out one half of the strangle, while the other half is left to expire at a loss.

By conducting this experiment, I hope to see how resolution unfolds in real time on a forward looking basis.

As disclosed on Friday, I am currently long two June Nike spreads ($57.50/$62.50 and $47.50/$42.50) and I have decided that being the long the spreads is incorrect as it locks me in and there is diminished flexibility inherent in being short the out of the money spread strikes. Therefore, I have an order in the market GTC to buy back the short legs of the spreads which I will execute at some time tomorrow, leaving me long one Nike $57.50C  / $47.50P strangle.

I also have a GTC order to buy an ABT May $44 C / $38P strangle outright for a debit of $1.80 based on my evaluation of potential resolution of ABT's current consolidation.

Once I have executed my closing NKE short legs and ABT long strangle, I will immediately place GTC orders in the market for each leg of the strangle I own based on my evaluation of potential resolution in the market.

Finally, I have compared the overall P/L of the "Coiled Spring" Experiment to equal dollar exposure to SPY as of the close on Friday January 13th, 2017.

This should be an interesting experiment overall.


5 comments:

  1. Interesting post, thank you. Will you do a follow up?
    I got BMY at $50, so that was a good "coiled spring".

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    1. Hey congrats! I didn't look at BMY at the time I put this post together but I'll do a follow up post shortly. Suffice it to say, I've updated the real time googlesheets portfolio and the coiled spring experiment is up 25% ytd vs. SPY up 7%...

      I'm pretty shocked that this worked actually.

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    2. Wow that's excellent!
      I think sometimes it's good to take profit and then do nothing for a while...patiently wait for another opportunity.

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  2. Interesting post and really interested in the results and follow up article. Good luck in your trades!

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    Replies
    1. Just posted the follow up Duncan, happy reading

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