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When contributing to investments, short term fluctuations can hurt my contributions by a few percent or more. By short term, I mean on the scale of days to several weeks.

I have found that a proper use of limit orders allows me to avoid some short term highs, but when I place the order two far below current trading price sometimes I miss opportunities.

For example, I want to purchase security AAA which today is at 10.0 and over the past week has traded 9.9 +- 0.5. So I set my limit order around 9.7 expecting a down swing. Unfortunately, over the next month the prices rise to 10.8 +- 0.5 and so I miss my contribution and have a higher cost now.

Is there a skillful way of using options or futures to smooth my contributions? For example, if I could buy an option to secure the current price while placing a limit order to capture the possible fluctuation.

  • Sometimes I get lucky, but often I lose value. Have you actually tracked this, or are you just remembering some times that you lost? Your 3rd paragraph is the far more likely outcome, statistically speaking. MOST of investing is keeping your head in the game. Have you defined short term? Minutes, hours, days? Whats the horizon for the contribution? What is the point of the investment? – quid Nov 29 '18 at 0:37
  • @quid So I'd have a hard time measuring the actual loss due to the short term fluctuations. I'm not concerned about keeping my head in the game so much as timing my contributions better because I am contributing aggressively and taking a stupid hit on a contribution that was miss timed at the top of a correction can cause a ~1% loss on total return for the year. I found VCA to be helpful in my case, but if short term hedging could "smooth" the contribution, then my goal would be to reduce that ~1% hit to around 0.5%. – aidan.plenert.macdonald Nov 29 '18 at 1:57
  • Over time, the market has historically risen; meaning on average, you win by putting your money in the market (provided you have a sufficiently long timeline for it to stay there). A year is short term. Your premise is based on a phenomenon that you don't know whether or not it's happening. If you don't know if this phenomenon is real, you don't know if it's even a risk at all, let alone whether or not you should attempt to hedge it. The 1% hit isn't real because you haven't measured it. Statistically, timing your contributions is a waste of effort and likely to cost you money. – quid Nov 29 '18 at 2:35
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You cannot buy an option (a call) that will 'secure the current price' because there is always some amount of time premium that you will have to pay.

An additional complication is that the higher the implied volatility, the higher the amount of time premium in the option. For example, compare the options with the same strike and expiration for NLY at $9.99 (IV approximately 17 ) with that of VNET at $9.89 (IV approximately 58).

At best, you can buy a high delta deep ITM call to minimize time premium and unless you deal with a broker that provides free assignment and exercise, you will incur extra commissions as well, further increasing your purchase price.

An alternative would be to sell modestly in-the-money put(s) to lock in a lower purchase price should the stock not rise above the strike price by expiration. If it does rise, your put(s) will expire worthless and all you'll have to show for it will be the premium. Cash secured short puts is a low level of option approval so that shouldn't be an obstacle.

A short put is synthetically equivalent to a covered call so if short puts spook you, buy the stock and sell a modestly OTM covered call. The same circumstances apply as with the short put. You'll lock in a lower purchase price but you won't keep the stock if it is above the strike price at expiration.

Implied volatility comes into play here as well. For a stock like NLY which has a low IV, there's minimal time premium available for an OTM call write (or its equivalent ITM put write).

Since you mentioned a time frame of 'days to several weeks', stocks with weekly options would be more suitable for this. Stocks whose options have wide bid/ask spreads would not be suitable.

  • An after thought... If you're investing in AAA frequently (say monthly) and if you're going to buy more AAA regardless of price (current or lower) and if your broker has low margin rates (under 4%) then if AAA should drop below your lower limit of $9.70, buy next month's purchase on margin. For example, $950 at 4% for one month is a bit over $3 in interest. – Bob Baerker Nov 30 '18 at 15:22
  • Do you mean, basically in the event of a major drop, just buy the next month's shares early with margin? – aidan.plenert.macdonald Dec 20 '18 at 1:19
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    In your question you indicated that you want to buy AAA at $9.70 and you implied that you're contributing in some frequency of a month or less. If the amount that AAA drops below $9.70 exceeds the margin cost for that short time period then buying on margin early gets you an even better fill. So yes, in the event of a major drop, just buy the next month's shares early with margin. – Bob Baerker Dec 20 '18 at 4:11
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To a good approximation, stock prices follow random walks, not mean-reverting "swings". This means that trends and trading ranges can be identified only in retrospect; the idea that they are predictive is a powerful illusion.

No strategy, using limit orders or otherwise, can achieve an edge on a random walk. You can change the shape of your short-term return distribution, but not the mean.

In particular, if your buy limit order executes at 9.7, that price is the market's current best estimate of value and it is as likely to go up as down from there. The fact that it was 10.0 before doesn't matter. At best, by timing your purchases, you are gambling on a coin flip at fair odds with zero expected value.

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