Market / Position Update

Even though short term indicators are signaling an over bought condition, this market is acting very strong.  After a strong week, we are still barely retracting from the highs.  I would expect with this kind of market action that we could finally see a break to the upside where it will test the resistance around 10700 for the DOW (and may actually try to test 11,000 or so).   

I noticed a nice pattern on Goldman Sachs (flag pattern) earlier in the week.  Planned to buy some options but got too busy and forgot to buy.  GS broke out of the flag formation today to the upside.  I just saw it and jumped in with Aug 155 Calls at around 1.31 each.  The Flag pattern is one of the most powerful move patterns.  Its called the Flag pattern because the stock price moves up very rapidly (like a flag pole), followed by a short consolidation that may look like a flag.  A variation on the pattern is called a Pennant - where you have a formation that looks like a Pennant (triangle).  The Pennant can be even a more powerful pattern.  Now the stock has broken out of the pennant formation to the upside and will bear close watching.  If the pattern fails, one is advised to get out immediately.  But a successful breakout can net the investor with some nice profits.  One of the things I like about the Flag/Pennant formation is the the move is approximately known.  The stock will tend to move the same percentage amount as of the previous move.  So if in the first move, if the stock rapidly moved from 20 dollars to 30 dollars then formed a flag / pennant pattern, that is a 50% move.  The next move is also likely to be about a 50% move (from the bottom of the flag).  So if the flag takes the stock to about 26 dollars, the potential move target is around 39 dollars.  This helps me set an exit point that I can put a sell order for ahead of time.  I have made more money using this pattern than any other pattern in the books.  In times of bubbles (and yes, I love bubbles since the most money can be made in the shortest amount of time in those days) flag/pennant patterns are very common.  If you go back and look around the end of 1999 and early 2000, you will see these patterns everywhere.  Using this pattern, I think we are looking for about a 9% move in GS stock.  (Assuming a low of 130 and the top around 147 (average for the flag formation)).  So around a $14 move in the stock starting around 147.  We have already made about a $5 move from there.  I would start thinking about taking profits around 160.  (Although the stock has the potential to move to 172 or so as well).

Also, I am using front month options to play this position.  If I am wrong and the pattern fails, I am risking about 1.31 per stock that I would lose. But I am looking at a potential gain of around 350-400%  if the pattern is successful.  A pretty good risk in my mind.  The options are now at 1.30 bid and 1.46 ask.  So I am getting close to break even.  You must, however, realize the inherent risk in playing front month options.  Time decay really starts affecting the value of the option with a couple of weeks to go.  80% or more of all front month options expire worthless according to industry data. 

Good luck and happy trading.