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Tuesday, 25 December 2018

TRADE OF THE WEEK #2 - HSI-H4O (PUT WARRANT)

Note : The 'Trade of the Week' series showcases an interesting recent trade to highlight winning strategies in a basic, short form format. Not all trades deserve a long form writing treatment; some readers may also prefer a quick read. 

There will be no external links in these posts; we also hope you can read candlestick charts to get a better sense of our market timing. 


The Hang Seng Index (HSI) is a perfect proxy for all that is happening in the world's markets right now.

Like Japan's Nikkei, most of the time it takes its cue from movements in the US markets (S&P 500 and the Dow Jones). There are tangible reasons for this - many HK-listed companies have direct business interests relating to the US, like Apple's parts suppliers. It is also proxy to the ongoing trade war, given that the largest HK-listed companies tend to have sprawling businesses in mainland China; Tencent and the biog property developers, for instance.

We are not experts on Hong Kong or China's markets. But we do study the index movements closely. We especially like the correlation between how US markets perform and how the HSI would be impacted as a result.

We are of course aware of all the headlines generated out of the US, and the current fears in the market. We read the same papers and check the same Twitter accounts as you do.

To overly simplify our approach - and without giving our secret sauce away - this is what we tend to check before deciding whether to trade (Editor's Note : the timezone is Malaysia, +8 GMT) :

1) Last night's US markets performance (any decline of above 1.5% will trigger alarms for us).

2) The top headlines over the past 24 hours globally - we get everything we need from Twitter.

3) US markets futures after closing - the crucial hours between (1) and Hong Kong's market open.

4) 'Pre-market' prices for HSI warrants, both calls and puts - the crucial 30 minutes when Bursa Malaysia opens (9AM) prior to Hong Kong's market open (9:30 AM).

Because of the direction of the global markets right now - you know which way that is - we are more interested in trading put warrants. The reasons:

1) Liquidity and volatility is assured (unlike Malaysian stocks/warrants during this current market phase)

2) Real momentum exists (unlike Malaysian stocks/warrants, whose upward trajectory tends to be interrupted in a bad market).

3) Nothing else is gaining (when everything is declining, only put warrants look attractive. Hence, other people would be inclined to trade them too, resulting in situation (1)).

In December 2018, the put warrant that we usually trade, HSI-H4O, tends to be heavily and actively traded. It is incredibly sensitive to movements in the underlying - the actual Hang Seng Index - while liquidity is virtually assured. It is a good product; we take our hat off to Macquarie Capital Securities for producing such a reliable, tradeable warrant.

You may be wondering: why choose this warrant? To us, it's simply because it has good liquidity and constantly reflects actual movements in the underlying index. Many call and put warrants out there tend to have one or the other but not both. Through painstaking research and observation, we chose this particular put warrant.

And one last thing : we trade put warrants on an intraday basis. Hence, we don't have to look at the technical characteristics of the instrument (things like exercise price, theoretical breakeven point, implied volatility etc). Our time frame for trading this is very, very short.

One last, last thing : trading HSI put and call warrants is very risky. You need to be certain you know what you're doing, otherwise your P&L may be down to sheer luck. The approach that we're describing here is just one way of trading them safely and profitably. Your risk appetite may differ to ours, but we hope this trade can generate some ideas for you and lead you in your own research.

Here we will describe two separate trades for the same put warrant, HSI-H4O.


The Hang Seng Index, daily price movement in December.

TRADE #1 : 20 DECEMBER, 2018


5-minute candlestick chart, 9:00AM to 11:25AM.

We wanted to be in a trade on this date because the night before, the Dow closed at a new low for the year. At 9AM, HSI-H4O opened at 36 sen to reflect this, an increase of 9% from the previous day's close.

While wary of the potential fallback, we were keen to take a position. Hence by 9:21AM we bought in at 35.5 sen and 36 sen for a total exposure of 60,000 shares.

But in the next hour we were swept into a wave of unwanted downside volatility. The actual index rallied for a short period, driving down put warrants to an intraday low. Our put warrant position was suddenly staring at a 7.5% paper loss.

Actual Hang Seng Index price movement, 30-minute chart. The downwards movement means profits for us.


In moments like this, we don't panic (although the inclination is there).  We took emotion out of the equation and made a logic-driven decision: if prices do not recover by 11AM, we will exit this position. The movement in the put warrant already threatens to invalidate our expectation for going into HSI-H4O in the first place - we had expected it to hit a peak of 38 - 38.5 sen.

By 10AM, it was clear that the upsurge was shortlived; the put warrants went back to 35.5 sen. Seeing this, we were willing to stay a bit longer in the trade.

Then the moment came : at 11AM the Hang Seng dropped 1% (see the big red candlestick right above). On this day, the correlation exists: the Dow Jones fell 1.5% the night before, after all.

HSI-H4O also rocketed upwards to 37.5 sen; a 5.6% gain in 10 minutes.We decided to exit at this price.

The reasons for exiting are simple: we were indeed fortunate to have derived profits at all. The downward volatility showed that we didn't enter at an optimal price point, thus undercutting our potential profits. And because of that volatility, we didn't have the luxury of waiting until the put warrant hits 40 sen (our best case scenario). Short term upward bursts are the perfect selling opportunity; indeed, it is when everyone else is buying.

HSI-H4O closed at 38 sen that day. We were happy to exit from this trade, lasting all of 2 hours and 20 minutes. Thematically, we would be looking at the put warrant with a fresh perspective the next time we decide to jump in.

As we explain here:



TRADE #2 : 21 DECEMBER, 2018

5-minute chart, 9:00AM to 4PM. Notice the huge range and volatility!

US markets went through another bad day, losing around 2% in value overnight. This spelled trouble for Asian markets.

As expected, HSI-H4O opened higher at 40.5 sen, or a 6.5% gain from the previous day's close. It actually went further to 42.5 sen by 9:10AM.

But this time we weren't too eager to go in. For obvious reasons - if you're into technical analysis - 40 sen and above is not a good price point to enter; there may be selling pressure to drive it below this resistance point. It would be ideal for us to get a position in below that, so we nibbled a bit.

When the put warrant headed downwards, it presented a buying opportunity. We bought small positions at 38 sen and above based on simple parameters; either it goes back to 40.5 sen or it doesn't. For reference, we would be happy to cut our losses at 36 sen, coincidentally our entry point from yesterday's trade.

Based on experience, we were acutely aware of two things:

1) If the warrant quickly went back from an intraday low to a position of strength (in this instance, from 38 sen to 40.5 sen), there is a real possibility of further strengthening. This is the characteristic of the underlying index, of course, not just the put warrant itself. Fear is a key driver for the market during times like these, so this kind of volatility is to be expected.

2) But if the move happens, and happens quickly, it is time to sell. It is the only moment to know for certain that we are selling when everyone is buying - it is a limited window of opportunity.

So HSI-H4O subsequently went back up to 40.5 sen. We managed to buy some more at 40 and 41 sen, expecting the put warrant to at least reach the prior intraday high of 42.5 sen (this principle is based on our description of (1)).

Being aware of (2), we decided to count our blessings and run. We sold at 42 sen for a profitable trade lasting just over an hour.

Remember that volatility is not the same as momentum. We have learned from bitter experience that holding on for longer translates to much more risk assumed (Editor's Note : on this note, we also believe that you should NEVER hold on to any overnight position in HSI warrants, no matter how strong the momentum is. What happens the next day will be a 50:50 option between profits and destruction; there's just too much risk involved).

It was the right decision to exit. For the rest of the day (after we sold at 10:08AM) the put warrant practically collapsed. It fell to a low of 33.5 sen by 4PM. Had we stayed, we would've risked a 14% loss.

At the end of the day, in each of these trades we took the safest route possible. There is no point waiting for bigger gains if you're risking even bigger losses.

We didn't say it was easy, but if you have the opportunity to make RM1,000 in an hour from trading, would you take it?




OUTCOME

Gross profit : RM2,880 from two trades
Average Return on Investment (ROI) : Above 4.5%
Duration : Intraday







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