Utilizing "Allocated" Capital

Trading fade trades againt the trend and against the momentum speculators involves "tiering" into positions. This type of trading often involves commitment of excess capital to support the trade and give you the "staying power" to stay the trade until profitable. There are numerous ways to "utilize" this reserve capital, which is allocated to the larger trade, to collect additional gains.

Utilizing the capital which is allocated to the larger trade requires this capital to be "liquid" at all times. This means, if required, you can pull this capital out of any existing positions with little, or no loss, to support the fade trade when, and if, it is required.

For illustration purposes, let us say we have an incline fade trade against GOOG. The option trade profile has a capital allocation requirement of 50,000.00. The first entry in the fade matrix is a $5,000.00 entry. The entry price of GOOG, in this example, was 200.00, the next entry is to purchase a similiar lot size at 210.00.

In this example, we need a 10.00 move in GOOG before we utilize any further capital whichis already allocated to the trade. This is leaving $45,000.00 of capital idle awaiting utilization.

Since this is an incline fade we are either a. shorting shares, or b. going long puts on GOOG. We need a general increase in the overall market of 5% before even entering tier 2 of the trade matrix. At this point, we have the opportunity to utilize a portion of this un-utilized (allocated) capital to set up a trade against the original fade. This is a hedge of sorts.

A hedge is typically designed to decrease leverage, or exposure, to the markets should we suffer a dramatic move against our overall portfolio delta. In this scenario, the counter-fade trade is hedging the original position, but both positions have an end goal of exiting profitable in each respective issue.

To find this "free profit" opportunity, we can set up several different types of trades. A momentum trade, a primary fade, a secondary fade, or an arbitraged pair trade. In this example, and for ease of illustration, let us suppose we identified a decline fade on CAT.

CAT and GOOG have no direct correlation, yet they typically move, or trend, with the overall market. They are not directly inverse to one another, so for our purposes, this will qualify. We have now identified a downward extension on CAT and set up a decline fade matrix to go long calls and tier into the position on CAT.

It is very common for issues within the same market to become inversly extended, such as CAT and GOOG in our example. Let us take a look at the methodology here.

If the broad market continues to trend upward, capital will be utilized on the GOOG trade, if the market declines, capital will be utilized on the CAT trade. In very rare cases, will both issues need addidional capital simultaneously (but when they do, it is a great opportunity!). A downward move will have CAT compounding its position and eventually trigger out GOOG for profit. An upward move will have GOOG utilizing capital and triggering CAT to exit for profit.

In either case, the initial fade play remains in tact once the other issue is triggered out for profit. At this point, you can set up another hedge for fading your fade play! As the market fluctuates (typically referred to as "whip-sawing") you positions are triggered out for profit, not stopped out for loss. You are increasing your staying power within the trade initially by averaging into the position, and further increasing the staying power by hedging the position.

If the market is going to move against your initial fade trade and "utilize" more of your allocated capital, well, at least it has to pay you to do so!