Toro Poco—More Frequent, Less Volatile

Another factor that limits the usefulness of El Toro Grande is that opportunities to implement it are rare.We absolutely must witness the occurrence of a runaway bull market before we can use it, and these come along, what,once every 3 or 4 years or so.Recently, we’ve had the 2000–2001 natural gas market, the 1995 grain markets,the 1994 lumber and coffee markets, coffee again in 1997 and a little bit in 1999, and probably a couple of others that I’ve forgotten just now.There haven’t been very many in the past decade, in any case.

However, El Toro Grande has a little brother who shows up much more often. Mini-bull markets, or toros pocos as I call them, come along several times a year, and, usefully, in a wider variety of markets than the big bull.These opportunities can be somewhat more difficult to spot, and they’re considerably more difficult to define in a general way, but let’s give it a try.The first requirement, of course, is that a market be undergoing a bull move,a rather specific kind of bull move.

This condition varies a bit from market to market, but there is a useful rule of thumb available. Take the overall IV of a market’s options on a named date. Here, let’s say this figure is 35% on an annualized basis. If, over a month or six weeks, this market moves up half or more of that amount, in percentage terms, we have a possible candidate for a toro poco trade. Another condition we strongly want to observe is that this market’s options’ IVs have risen, right along with the price.

We are distinctly not interested, in this strategy,in a market that is gradually working higher and taking its sweet time about it. Further, this bull move should not be a direct result of U.S. weather and, if possible, of weather anywhere else, either. This precondition will be somewhat restrictive regarding markets such as soybeans, in which weather somewhere in the world is a factor in the market for the bulk of the year.Weather-driven markets are gamblers’ markets, and we avoid them when we’re trading to win.

Clearly, our parameter for minimum upward movement is an arbitrary number. No pretense about it, this degree of movement is not and cannot be the optimum amount for all markets. For markets that have high native volatility—our old friends coffee, natural gas, cocoa sometimes, lumber,maybe non-summer soybeans—the half-of-known-IV figure is just too low.These markets might move that much in a short time if someone sneezes twice on 8 consecutive days, and we’ll want to see a larger move here, perhaps 70–75% of annualized IV within the same short time frame.

Tactics and Timing for Toro Poco:Our technique, trading tactics, and entry timing in the mini-bull market differ from those we use in El Grande, because the premise of the trade is different.When we’re dealing with the big bad bull, we want the market itself to tell us when to push the button. For toro poco, all we want to do is to gain some assurance that the present market isn’t going to become a runaway.

Naturally, we never want to be in the position of trying to pick tops (or bottoms either, in other strategies), and to this end we’ll look for a development or an event that indicates the mini-bull won’t become parabolic. Again, I have no quarrel with technical methods for determining a likely entry point in this strategy, but I don’t use them. Give me an old-fashioned supply/demand development every time.

I might also draw an inference in the event of a rapid drop in the open interest in the market, which would presumably suggest that the traders on the long side are exiting their positions and pocketing their gains.We may want a different trading approach here also. Establishing debit put spreads is a sound and cautious tactic and is a favorite to succeed, given that our market view is even close to accurate.

If we use this tactic, we’ll tend to buy a put with a striking price just under the market and write a put two strikes below that, maybe three strikes if the put premiums are encouraging, that is, high. We also have the choice of taking a more aggressive stance without increasing risk too much. We can establish a ratio-spread below the market,then look to enter ratio-spreads above the market later on as the market begins to soften up.

“Huh? How can you put on a ratio-spread below the market?” A fair question. In almost all cases, we use calls in ratio-spreads because the premiums of OOM call options can and do become wildly skewed, offering us an opportunity for an excellent ROC. In this strategy, and it’s one of very few occasions, we’ll use puts in the lower half, the put half, of the trade. We may have to resort to a 1-to-4 ratio in the puts here, because, as with any option writing strategy, we insist on an initial credit. Also, when entering ratiospreads,we insist that the striking prices of the two options in the spread be as widely separated as we can manage.