Welcome to Wall Street, Main Street and Me


Saturday, December 15, 2012

LIARS! Slowly but surely, the truth will emerge....

I've been taking a bit of a sabbatical, of late, trading less because I have needed the dough in my trading fund to live on, due to a major real estate setback, (the damned house sold for much, much less than it was worth). (Which is how "Main Street" got changed to "Mean Street.")

However, that has been no reason not to continue my studies, and I'm still involved in reading/learning about commodity options.  But I'm not ready yet to discuss them intelligently, much less trade them!  All of my years of equity option training will be useful in commodity options, so it's just another step up the ladder of derivative trading.

Meanwhile I have been reviewing all the various philosophies of trading I have studied, and while I don't regret one bit of my past learning, I think I am settling on Tom Sosnoff's and Tasty Trade as the most realistic and honest trading principles.  I still endorse Options Animal as the best foundation for beginners, but then I think Tasty Trade is the next step.   And for very good reasons.  I see their "truth" subtly reflected in various books and on website articles, but it's never put out there as cleanly and clearly as Tasty Trade does.

So what am I talking about?  It's a bit shocking if you tear off all the "wrappings" and look at what is really going on.   Options trading is a huge business -- bringing income to brokerages, teaching programs, trade advice services, monthly newsletters, clubs, ad nauseum.   Most of us who begin trading fall prey to many of these entities.

As an example, my brokerage, Think or Swim, has fabulous option chains that show percentages in and out of the money, theoretical pricing, and real time prices on both equities, futures and forex. It's a terrific full service brokerage, designed by Sosnoff  and Tom Price before they sold  it off.  It took me four brokerages before I found Think or Swim.  At first it looked too complicated, but what it is is exceptional, unlike any other broker platform because it's been designed by guys who breathe option trading.

So you can imagine my confusion when reading one of Carley Garner books (on commodities), telling me that I must  BUY trade services to get real time prices on commodity options. She said that you needed to subscribe to different ones for different commodities, at prices like $75 per month.  NOT true. TOS has the information for free on their platform.

This is just bad information.  She's also  said in almost every beginning chapter that the retail trader  needs a commodities broker  (which she happens to be) because the floor trading of commodities cannot be navigated easily, and certainly not electronically, without a commodities broker.   That's just not true, and it  is reprehensible to cajole new traders with such misinformation.  Some of that information WAS true decades ago, but when I checked the copyright, it was 2010.  Feh.   Think or Swim can access any of the normal commodity markets electronically with no problem, and no assistance needed.  It really pisses me off that these lies are propagated by supposedly reputable individuals.  And this is just the tip of the iceberg.

It's one thing to say that "This is my trading style, and how I like to do it."  It's something else to say "this is how it's done and how you must do it."

So what else do "they" lie about?   Well, given my opinions, here's a little list of things I've been told and which I now reject out of hand as untruths:



1. NEVER SELL A NAKED OPTION!

The lie:  You should never sell a naked option!  It's unlimited risk, thus suicide to even think about it.

The truth:  Selling naked puts is a well-known, often used strategy for buying stocks at favorable prices.
Selling naked straddles and naked strangles has been documented as a more profitable and successful
trade than selling risk defined iron condors.  (statistics available in Market Measures archives on Tasty Trade website).  Hop over to YouTube and watch a couple of videos of "Karen, the Super Trader" if you have any doubts.

The caution:  Nobody should be selling (or buying, for that matter) any options for any reason until they know what the obligations are, and how to exit the trade in a safe and timely fashion.



2. YOU MAKE MORE MONEY BUYING CALLS/PUTS THAN DOING RISK-LIMITED SPREADS!

The lie:  Doing spreads instead of buying Calls and Puts is a waste of time, because the premium is so low.
And when you BUY a call or a put, there is unlimited profit if the equity moves in your favor.  Besides it's
easier, and is what everyone else does.

The truth:  Buying Calls and Puts is a beginner's trade.  Everyone else who are amateurs are doing it, that much is true. But the odds are against long trades.  The odds favor short (selling) trades.  The percentages of options traders who are unschooled and/or ignorant overwhelmingly buy long options, and lose their money to Sellers.  Most professional traders are Sellers.  A retail trader can emulate the professionals and make a lot more money.

The caution:  Emulating professional traders means HONING your skills, so that you know what they know, and maybe a little bit more.  (which by the way is possible!  You'd be amazed what some of them
don't know).

3.  YOU MUST KNOW THE FUNDAMENTALS AND TECHNICALS (HOW TO READ CHARTS) OF A STOCK BEFORE YOU TRADE AN OPTION ON IT

The lie:  You must know fundamentals (company information)  and technicals (charts) before you can trade options on an equity.  All the education that you pay for is going to teach you that you MUST know the company fundamentals, the charts' indicators, and the sentiment of the equity.  This can accrue to a LOT of expensive schooling by folks who make their money teaching.

The truth:  There are lots of traders who never look at fundamentals, and seldom even glance at the indicators on a price chart.  (They may use charts for a  visual of the price trends, but do not study crossovers, MACD or RSI).   Instead they are what is known as "Tape Readers" and do an entire 'take' on an underlying by watching prices, opens, closes, volatility, liquidity and their own experience of the equity's movement.  Trading is a probability game, and historical and technical information does not necessarily inform a trader of the future.  Take a look at Netflix and Rimm if there's any question that you can't count on
yesterday's information to predict today.

The caution:   I do believe that the more tools you have in your bag when trading, the easier and quicker you will become profitable at trading options.  But the point here is to try dissuade you from thinking that there is only ONE holy grail of trading, or that it must be done a certain way, taught by a certain teacher, and that there is no margin for creativity and luck.

4.  OPTIONS ARE EASY MONEY.  TAKE $5,000 AND TURN IT INTO $1 MILLION IN NO TIME!

The lie:  If you receive newsletters, email promotions, or any kind of options' marketing materials
(and most of us do),  you will be promised the moon, and the stars, and a private guru---all for the price of whatever they're selling.  Some of the promotions are SO well done, that it is easy to believe that they know what they are talking about.   Trust me!~  It's all a lie, or half truths at best.

The truth:   It takes money to make money.  If you have a $5,000 trading fund, I can almost guarantee that
you will not make more than 10% profits while you're learning (if indeed, you do that well).  I've been studying for four plus years, and still have a long way to go.  My losses in that time would make your head
swim, to say nothing of the thousands I paid for education.   So don't get hooked into "Blue Sky" promises and schemes.  DON'T let some "service" do your trading for you.  You can be sure that if you don't know and understand what you're doing, you're bound to eventually lose.

The caution:   Sometimes we just have to drink the Kool Aid and make our own mistakes, but I hope that
you can find your own path, without being too much in awe of others, their promises and their hype.  I heard the other day about one service who bragged that in 100 trades they hadn't lost one.  Well, it turned out that they just kept rolling their losers forward, forever and ever, increasing the risk, increasing the costs, so they would not have to admit to a losing trade.  AND guess what?  They also didn't tell you that the stats were all based on a paper-trading account.  Not real money.

I wish you wealth, and I wish you well.  But don't be lazy about exploring what's out there for free.  There are websites that offer endless education for free, including brokerage platforms, YouTube videos, Yahoo Financial, FinViz, and countless others. Even the well known teachers who are trying to grab your money offer free webinars on a regular basis, and have education videos on their websites for free.  Don't be shy.  Look around, check out everything.  Just google, and you can study for weeks without it costing you a dime.

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Monday, November 26, 2012

Mini-Options Anyone?


Wow, this is exciting.  On some equities, we'll be able to trade options on 10 shares of a stock/ETF
instead of 100.   This will mean less margin, less fees and likely less premium, but for the small,
beginning trader, this is WONDERFUL.   Unrolling on March 18, 2013 according to  Futures Mag.





NEW YORK, November 26, 2012 - The International Securities Exchange (ISE) today became the first exchange to confirm a launch date of March 18, 2013 to commence trading in Mini Options. Since receiving Securities and Exchange Commission (SEC) approval for this innovative new product offering, ISE has been coordinating with its member firms to determine an appropriate date for launch readiness. Mini Options will represent a deliverable of 10 shares of an underlying security, whereas standard contracts represent a deliverable of 100 shares. ISE will initially list Mini Options on the following securities: APPL, AMZN, GLD, GOOG, and SPY.
"We are very pleased to announce a launch date of March 18, 2013, to begin trading Mini Options," said Gary Katz, President and CEO of ISE. "This exciting new product will make trading options on popular, high-priced names like Google and Apple more affordable and more flexible for the retail segment of the market. We look forward to coordinating with our member firms to achieve a smooth rollout of Mini Options in March and to broadening the reach and appeal of the options product to retail investors with this new offering."
Mini Options will have the same expiration dates as their standard counterparts, including Weeklies and Quarterlies. Strike prices will also align to those of the standard contracts, as will the quoted bids and offers. The fees associated with Mini Options will be filed with the SEC and announced at a later date.

Sunday, November 11, 2012

Options on Futures

My last post had to do with Karen, the Super Trader, and it seems to be no accident that Sosnoff introduced me to naked OTM short strangles, and then Karen comes along and validates the strategy with her incredible story. (if you haven't watched her videos, you really should.)

If you don't know what a short strangle is, watch out. You'll hear alllll kinds of scary warnings (like NEVER do a naked option, EVER, EVER). You need to open your mind to learning it ALL and THEN make up your own mind. Just remember we are talking about very, very far out of the money options.

One of my Trading Divas last year was a professional futures trader, and she came to our group to learn options. I just assumed (silly me) that she was going to trade equities, like the rest of us. But no, she planned on trading options ON FUTURES. My eyes crossed and then she went north for the summer, but "futures" stuck in my head. Something I knew nothing about. But didn't I have enough on my plate??

So this just set me up for the next step. Fascinating.

Well, it seems that every day brings new information, new depths to options trading. I no sooner learn one system of trading than a whole new view pops up. I met a local trader here in Naples who only trades Oil Futures, naked strangles...and trading with options. He was kind enough to give me some basic information and turned me onto a book called "The Complete Guide to Option Selling" (second edition) by James Cordier & Michael Gross.

That was a revelation.  I got a "crash course" on Futures.  Stay tuned.  I expect to fill these pages with new education.  I find it so invigorating to know this education just goes on and on and on.

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Friday, October 12, 2012

Karen the Super Trader

I'm very excited to see Karen speak again next Tuesday night (before the Prez Debate) on the TastyTrade.com network.

Here's a video of her visit to Tasty Trade. Inspiring!!!!

Sunday, August 19, 2012

Implied Volatility and Probability

Okay, I'm just beginning to wrap my head around the Tom Sosnoff/Tom Preston view of trading. And it makes a lot of sense to me.

You have to accept (first of all)that the market is fairly priced and efficient, and dispense with the idea that some ogre market maker is out to screw you. (providing, of course, that you are trading liquid stocks that have buyers/sellers in abundance). You MUST have high frequency trading in order for the suppositions to work.

WHAT HAPPENS TO PROBABILITY WHEN IMPLIED VOLATILITY CHANGES?



So, let's say that you decide to SELL a strangle on AAPL when it's selling for $598.75. Let's say that this is an earnings play, (meaning that we KNOW IV will contract after earnings).

Looking at the chart, and the Standard deviation channels, I can see that ONE STANDARD DEVIATION upward from the price is $658.94, and downward from the price is $538.77.

(if you must know, a standard deviation equals the price x the implied volatility x the square root of the days until expiration divided by the days of a year. Fortunately the Think or Swim software calculates this for us!).

Looking at the option chain, using strike prices that are one standard deviation away from the money, the "Prob OTM" (Probability of being out of the money at expiration) is 68.2%.

Looking at the slide above, take a look what happens when the Implied Volatility drops down to a "normal" level of implied volatility of 25%. THE PROBABILITY GOES UP!!

I don't have the kind of money to SELL Strangles, but this is a good argument for NOT buying LONG Strangles. Unless you know enough to sell them very quickly before the implied volatility contracts right after earnings.

But this is a great lesson in understanding WHY you should know and understand both volatility and probability when trading options.



So, based on the slides above, it makes more sense to be a Seller than a Buyer of options, and if you MUST be a Buyer, do it in times of Low Volatility when your probabilities increase!

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Wednesday, August 15, 2012

Tasty Trade is tasty indeed!

Okay, Think or Swim is really serving me well. It has more bells and whistles than a steamship, the more I learn about it (and how to use it), the more I appreciate the deft sophistication of this platform. And after reading a bit of its history, I am really excited to know that I currently have access to its founder, one of the giants in option history.


Tom Sosnoff, CEO, tastytrade, host of Get Tasted
Photo: Saverio Truglia Photograph


"Tom Sosnoff, CEO of tastytrade and host of “Get Tasted,” is a recognized online brokerage innovator and sought-after financial educator. Tom founded thinkorswim in 1999, before the options market was electronic. Leveraging over 25 years of experience as a market maker for the Chicago Board of Options Exchange (CBOE) and one of the original OEX traders in the S&P 100 Index pit, Tom pursued a vision to educate retail investors in options trading and to build a superior software platform at a brokerage firm that specialized in options. His efforts ultimately changed the way these instruments traded by pioneering single click trading functionality for complex spreads.

Under Tom’s leadership, thinkorswim evolved into the leader in daily retail options trading, and a pioneer in investor education services for options, futures and FX trading. Tom led the company’s corporate strategy and was dedicated to systems development and trading innovations. He continues to advance understanding of the active trading marketplace by personally teaching and executing complex, non-directional option strategies for investors and traders at all levels."


Tom's co-host and sidekick is Tony Battista.



Tony (known also as "Bat") started his 22-year career in options and futures trading in 1983, as an independent Market Maker at the Chicago Board Options Exchange (CBOE), as well as a local independent trader at the Chicago Board of Trade (CBOT), where he traded the 30-year bond future. While primarily an independent trader in the S&P 100 Index (OEX, XEO) pit, he also spent three years in the AOL equity pit. He served on the CBOE arbitration committee for over 10 years, ruling on disputes between traders and trading firms, prior to joining thinkorswim.Presently he is Co-Host with Tom Sosnoff "Get Tasted" on the tastytrade network the #1 ranked financial program on the internet.


WHAT IS TASTY TRADE?


The tastytrade Network was founded in May 2011, as an Internet-based channel for original financial news, investment strategies, and entertainment for the masses, with programming geared to various investment levels, from beginner to professional. Members get access to exclusive programming, trade ideas, plus significant discounts to investing products and services.

tastytrade currently produces seven hours of original, live programming every weekday, with “Get Tasted,” “The Liz & Jenny Show,” “Ask Slim,” “Last Call,” and “Sneek & the Geek.” tastytrade is available at www.tastytrade.com, on iTunes, Apple TV, Apple Radio, and on Roku. Programming is archived, cataloged and accessible 24/7 at tastytrade.com.

WHAT DOES IT COST?

Normally it runs about $95 per month, BUT if you go to their tastytrade.com website and open a Think Or Swim (TD Ameritrade) brokerage account (via tastytrade) you will get a 2 year FREE membership to tastytrade, PLUS a new account which is funded with $2000 is eligible for 300 FREE TRADES. THAT is a bargain~!

WHY IS IT BEING GIVEN AWAY?

Believe it or not, just as Tom was inspired to change option trading to an online, click and trade innovation, he is now equally inspired to teach the normal joe and jane HOW to trade his way, making option trading a mechanical "odds-driven" probability profession where, with enough training, one can make more wins than losses and actually earn money trading options. He believes in selling premium, and is not a buyer of options in the typical way of only buying calls or puts. He teaches spread trading and Think or Swim supports his views in its design.

You could do a lot worse than listen to this man and his team, his lessons, his philosophy, and his wisdom. Plus tastytrade is FUN. There is a lot of good ol' boy banter, humor, games and interviews thrown in with the heavy duty tasks of learning to trade options.

MARKET MEASURES

One of my favorite sections of the shows is called "Market Measures" where Tom and Tony actually demonstrate and teach a facet of options trading.

These are the slides from one of the recent shows, telling how you can compute the probability of a trade making at least a one cent profit. (i.e., not losing). It would take a much longer blog entry to elaborate on this particular show, but as a teaser, I thought I'd post a few of the slides. POP stands for Probability of Profit.












Of course, without the Tom/Tony demonstration (you can find it on the tastytrade.com website) these slides may look a bit opaque. Even with the verbal and visual aids, I found myself a bit confused, but if you take time to break it down, it makes more sense. The simplest for me was the Vertical Spread.

CALCULATING PROBABILITY ON A CREDIT VERTICAL SPREAD

Let's say GS stock is at $103.26.

I SELL a Sep call at Strike $105 for $2.18; I BUY a Sep call at Strike $110 for $.79; Thus I receive premium of $1.39

Using the formula in the above slide, I divide my premium ($1.39) by the width of the strikes ($105 less $100 = 5) So, $1.39 divided by 5 equals .278

Multiply by 100 (.278 x 100 = 27.80)

Subtract from 100 (27.80 minus 100) = 72.2% probability.

Now just for fun, I went to the Options Chain on ThinkorSwim to look at the probability of this $105 Strike going in the money. Think Or Swim's calculation for staying OTM (thus safe as a credit spread) is 61.22%

I don't know why these are not closer, so I have zipped off an email to Tom and he will answer it. I could also CALL the show during their segment where they accept callers with questions. It a direct pipeline to professional traders. Free. It's an amazing gift.

I'll let you know what he says.

But you need to check it out for yourself -- there's all kinds of different trading programs on tastytrade, including "Cherry Beans" where they pay you $1 for every successful trade you make! (up to $30 per month). It's all fun and inspiring.

P.S. I heard back from Tom. The 61.22% number from the options chain is the probability of being at least one cent Out of the Money at that strike price.

The 72.2% number is the probability of being out of the money on the breakeven number on the spread.

So, if I understand this correctly, there's a 61.22% probability that $105 will not be in the money at expiration.

And there's a 72.2% probability that the breakeven ($106.39) will not be in the money at expiration.

##

Wednesday, July 25, 2012

Think Or Swim & Tasty Trade - the next step

Gather 'round, boys and girls, I've been on another search for option information. You know me, I can't sit still and need to know the best sources for everything.

I'm going to talk about Tasty Trade in my next post, but first I want to talk about my new option broker platform.

I've been doing business at OptionsXpress (my brokerage) for almost three years now, but another platform called Think Or Swim (part of TD Ameritrade) came to my attention. I had seen it before, at the beginning of my trading, but considered it too complicated to learn and went on to OptionsXpress, instead. I like OX very much; it's clean and easy to use, no doubt about it. But until now I didn't have needs that OX could not satisfy.

So, when the software of ThinkOrSwim.com was recommended to me, I decided to take another look.
It is still complex, but what I have discovered in this business is that it all takes work. The platform has some videos under "Help" which are not terribly useful, but there is another old website of theirs that has some really good training videos, and so I started there. Here's how to find them, a well kept secret: http://mediaserver.thinkorswim.com/support/learningCenter/tos_learningcenter.html

Mind you, some of the videos for the more complex functions like "Analyze" are not functional on this old website. For that, you have to subject yourself to the Seminars which are given daily and archived under "Support/Chat" tab on the platform itself. And this is where the training really starts, once you know the basics of how to navigate around. The coaches who do these seminars (and especially Don Kaufman) are quite brilliant and hold forth for as long as 3 hours every day, if you can find the time to watch and listen.

WHAT DOES THINK OR SWIM HAVE THAT IS SO SPECIAL?

I don't pretend to even begin to know all the wonderful software that TOS offers. The Analyze tab is a mystery, but I have seen Don Kaufman do wonderful things with it. I just haven't got it all in my head yet. So the list of special things is very long, and all of which is not known to me yet.

The thing that really caught my eye, however, was the flexibility of the option chains. There is a dropdown menu and you can pick different column-layouts for the chain, giving you access to the Greeks, to volatility, open interest, Intrinsic, Extrinsic, theoretical value and volume with just a click. In addition you can customize the columns to whatever you want as a default setting. It's terrific!

But the BEST park is two columns: "Probability OTM" or "Probability ITM" that are available which give you a likely probability (depending on your strategy) of whether you will be in or out of the money at time of expiration. This is the MOST wonderful data to have at your fingertips when you're trading. For example, in the Call chain below, if you sold the $52.50 Strike, you would see that there's about a 73% chance of staying out of the money by expiration. These are mathematical computations and not written in stone, of course, but what a help!



I'll address more about this after we get into Tasty Trade.

WHY WOULD I EVER WANT TO CHANGE BROKERS AT THIS LATE DATE?

I can give you a couple of good reasons. The fees are negotiable, the service is quite good, and it offers a brand new approach to trading when coupled with the philosophy of Tom Sosnoff (creator and former owner of Think or Swim); and best of all, if you open a new account with TD Ameritrade (the ThinkOrSwim platform is a free download), you get a FREE subscription to the new Sosnoff website "Tasty Trade. com." which I will cover in my next post. ##

Friday, June 29, 2012

Putting on the Other Hat (Main Street)

Besides doing stock option trades, I also write. I was surprised today to discover that I was a Finalist in the Creative Non Fiction portion of the PRESS 53 2012 Contest. Nope didn't win, but I didn't even know I was in the running.

I sent off a memoir chapter called "Swan Song" which was about a summer in North Africa at the age of twelve.

Always nice to know there's an editor paying attention. :-)

Press 53 Awards

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Wednesday, June 27, 2012

Options- the Things They Don't Tell Beginners

Options are a mountain of information which needs to be learned before one can sensibly (or even insensibly) trade. The deeper I get in the game, the more I realize that I wasn't taught enough of the right things. So busy were they teaching me the difference between a call and a put, a Bid and an Ask, that the whole idea of defining risk was, at best, paid lip service. Yes, yes, you must protect your capital...but in the beginning, nobody tells you HOW to do that. They just assume you are going to lose a few, part of the learning process. How very unfair!~ A few can turn into many without the tools you need.



PROBABILITY

Since I started learning spreads and some of the more advanced strategies, I realized that a trader needs to have a good sense of the odds of her trade being successful. What is the probability that this trade will make money, and/or more importantly, NOT LOSE MONEY?

I bought Calls and Puts for a couple of years without a full understanding of these basic principles: protect your capital and compute your risk.

This might give you an idea (if you are a beginner) of the things you should know before leaving the paper trading mode, and using your real money.

The first trade you usually make is buying a Call, right? Beginners go long, and buy a Call or a Put. Toe in the water time. So what is the logic that goes on?

Okay, in this example, you look at an option chain. The stock is at $132. If you are buying a Call, then your expectation is that the stock is going to go up. You will note in the option chain below that the "At the Money" strike price has a Delta of .52 and a probability of going "In the Money" (by at least one cent) is 50.39%. These two figures are VERY close, and that is why traders often use DELTA has a "loose" probability calculator. In this ThinkorSwim chain, the probability column is built into the chain but not all brokers have this feature, so you can use DELTA instead.



So,what does that mean? It means that AT EXPIRATION, the 132 Strike option has a 50% chance of being in the money. Sort of like Vegas? Heads or tails, 50-50 chance.

So, a typical beginner's logic (without thinking about probability or risk) would be to buy the $133 or $134 Strike, because for sure the stock can go up a dollar or two, right?! And thus she'll have a winning trade!



But think about this for a minute. If the stock moves to $134, would she really have a winning trade? No! And why not? Because she paid $1.52 for the option. So before she comes into profit, the stock has to get to $135.52 ($134 plus $1.52). And if you look at the option chain above, what is the Delta and probability % for the $135 Strike? We have gone from an almost 40% probability down to a 30% probability just by knowing our break-even. How are those odds looking now? Not too great. A 70% chance of losing on this trade,right?

Well, that's easy to remedy, says the Beginner. She'll just buy a Call that is DEEP IN THE MONEY. How about the $127 Strike. It's sure to be in the money, look at that chain; it has a 79.96% probability of being in the money!

But wait. Don't forget the break-even calculation. The stock has to be at $127 PLUS THE COST OF THE OPTION which in this case is $6.19. So now your break-even stock price is $133.19 ($127 plus $6.19)-- and that moves you down, down, down the chain to the $133 strike which is only a 44% probability of success.



Are you beginning to see how such small treasures of information can inform your trading choices? NOBODY explained this to me. I bought Calls ITM, OTM and ATM and if I happened to win on them, it was entirely due to volatility and some huge movement that I wasn't even aware of. It certainly wasn't because of my choice of strike price! I blindly traded Calls and Puts with no probability thoughts at all. It's a great way to lose your cash fast.

In fact, at this late date, I would say buying "plain" calls or puts (without protecting them in a spread) is a sucker's game and one that the market makers are getting rich from.

I hope you 'get' this little lesson and continue with your studies. This should be an eye opener if you have ever had what looked to be an option that was in the money, but you made no profit. This explains why.

DEFINING RISK

Okay, if you're with me this far, you might wonder how then does a trader define risk? Probability is surely one factor, but are there others?

How much are you willing to Lose? When you go long on options (without doing a protective spread) your risk is limited to the amount you paid for the call or put. So the first question you should ask yourself when you look at the Ask Price. Am I willing to lose this much money? In the case of the Deep ITM call above, you would be risking $619.00 for ONE contract, with a 44% chance of winning. Ouch.

Comparing one trade to another

If you did a SPREAD, you could compute the difference between doing plain calls/puts and the risk and probability of having some protection.

In the plain Calls discussed above, your risk would be the cost of the premium:

Strike $134 - Risk $1.52 ($152 per contract)Probability of success 30%

Strike $127 - Risk $6.19 ($619 per contract)Probability of success 44%

But let's say we did a CREDIT SPREAD instead. If we were really feeling bullish, we would like do a credit spread on the Put side, but for example, let's do a bear call spread: Let's say we SELL the $137 Strike, and BUY the $138 Strike. The difference in the Bid of the Short Call and Ask of the Long Call would net us $.24 cents in our pocket, no out of pocket outlay at all. If I bought 10 contracts, that would be $240 in my pocket.

We want the stock price to stay BELOW our Short Call of $137. If it does, both options will expire worthless and I'll keep the $240. So what is the probability that I will get to keep that $240? The chain says that the Short Call at $137 has a 21.26% of going in the money. Well, this is CREDIT spread, so we don't WANT to go in the money. We want to stay out of the money until expiration. So that means there's a 78.74% (100 less 21.26%) probability that I will NOT go in the money, which is what I want. (just the opposite of going long on Calls)

How Do You Calculate the Risk on a Credit Spread?

Take the two Strike prices of your Vertical Spread: Difference between long and short strikes ($138 less $137)= 1.00 less the credit received $.24 = $.76 risk per contract.

Strike $137 (SHORT Call) - Risk $.76 ($76 per contract) Probability of success 78.74%



Now I ask you. When someone teaches you what a call and a put are, don't you think they should show you a few things first? Nobody showed me. I lost a lot of dough. I hope I can save you some.

P.S. If you don't use ThinkOrSwim software and don't have "probability %" on your option chains, don't despair. Just use the Delta as your gauge. It's close enough. These are not set in stone anyway, just possible outcomes given the history of this stock.

##

Monday, June 25, 2012

FIXING A BROKEN IRON CONDOR

T.D. Ameritrade has an education section that has the niftiest little video on how to fix/repair/adjust an iron condor gone bad. It is quick and simple and I'm impressed! (if you go to their Education Videos under Options, you will find it)

I have been trying to figure out the butterfly spread, and it hasn't totally jelled for me yet, so I was a little nervous when I saw that the butterfly spread is used to adjust an iron condor gone bad. But after watching the video, it was clear as day! I will use the butterfly this way, if not for any other reason!

Okay, let's take an example:

With an Iron Condor, you have a "channel" between the short option of the bear call, and the short option of the bull put. The stock can go up or down in that channel as long as it doesn't violate the short option strike prices.

So, here's an example of an iron condor.

The Bear Call (at the top of the chart) is a short of $28 and a long of $29. The Blue Line is the Long Option at $29, the Red Line is the Short Option at $28.

The Bull Put (at the bottom of the chart) is a short of $20 and a long of $19. The Red Line is the Short Option at $20 and the Blue Line is the Long Option at $19



So let's pretend that this stock FALLS down to the $20 Strike of the Bull Put, and thus, we would need to repair this Iron Condor. (The Bear Call is fine, so it's only the Bull Put side of the condor than needs to be fixed).

THE BUTTERFLY FIX

In essence we are going to REVERSE the Bull put, when we put on this butterfly trade.

The trade we will make is this:

Buy one $20 Strike (thus reversing the short put of your original bull put)
Sell two $19 Strikes (thus reversing the long put of your original bull put...AND setting up a new short at the $19 level.)
Buy one $18 Strike (thus creating a new Long option at the $18 level.)

Using broken lines, I'm showing how the Butterfly trade is used to reverse the old bull put and put on a new bull put. Easy Peasy.


And here's a risk profile with the trades shown below it:



Oops, I just noticed I used $28/$29, instead of $27/$28 on my charts. But nevermind, it's the bull put we're adjusting in this example. ##

Sunday, June 17, 2012

IRON CONDOR WORKSHEET (CHECKLIST)

This is the worksheet I've made to try to utilize the checklist in the last two posts into my trading. (it's easy to forget things...like the Earnings date!) This will likely evolve with time and use, and I'll update it if I make any major changes.

Saturday, June 16, 2012

Iron Condors - PART TWO

This is a continuation of Part One, on Iron Condors:

7. TIMING THE TRADE


After Earnings?

a. Opening a credit spread right after earnings is an excellent strategy. You know by then whether it's a hit or miss, and if you are quick enough you can capture the collapse of the implied volatility.(which happens right after earnings are announced). You can realize as much as 50% return by the end of the post-earnings trading day.

A Perfect Day

b. Thursday is a perfect day to open a trade, so that by Monday you'll have profits. Think about Expiration days, the 3rd Friday of every month. Many traders let their credit spreads expire worthless (thus saving commissions), but it means waiting until Monday for the margin to be released (to buy into the next month's spreads) and by Friday, after expiration, the marketmakers have already shaved premium off the new trades. If you are trading weeklies, know that the marketmakers shave off premium between Thursday night and Friday morning, so you want to put on your trades on Thursday to maximize premium.
Better to get out of the trade the day before expiration (by buying back the short put/short call) thus releasing the margin; let the longs expire worthless, but you'll have the cash to buy the next month BEFORE it becomes the new "front month" on the following Monday.
Do I always put on the full Iron Condor?

c. Do you trade a bull put, a bear call, or an iron condor? Let the market be your guide. Look at the charts, look at the trend, and if the stock is bouncing off a resistance line, a support line, double bottom, double top, 50 or 200 day moving average, bottom or top of a regression channel -- the market is handing you the trade, up or down. If the stock is going sideways, an iron condor is obviously the choice. Remember if you do a bull put and the stock starts to go down, you can always add the bear call later, and vice versa.

Remember that option margin is held for only ONE side of the condor, so it's advantageous to trade both bear call/bull put together.

8. A Word on Weeklies

They require a lot more attention than the monthlies to make sure the stock is not going against you. But you can make a lot of money if you play them right.

Here's a list of possible candidates (check those charts!) for weekly credit spreads.

AAPL
AMZN
BIDU
CF
CMG
CRM
GOOG
IBM
ISRG
LNKD
MA
NFLX
PCLN
RUT
SPX

9. MANAGING THE TRADE

Track your premium - in and outs

a. Keep a daily list of the profits/loss of the trade. If you opened the trade for $.25, record at each day's end what the reverse of that trade would be. This is a great way to get familiar with how credit spreads move. Also, record the Delta of both short options, and track it.

Analyze what changed- Price or IV?

b. If the trade starts to move against you, your daily record will reflect it. If the delta goes to .15, it's a warning sign. You need to determine whether it's the IV that's affecting your option, or price change of the underlying. If's it's IV, it can possibly and probably bounce back. If there's been some event or news to affect the price, then that requires more attention. If both IV and price go against you, wake up!
If you weren't already in the Iron Condor, open the other side to offset the loss side when delta goes to .15. If the chart rights itself, you'll win on both sides. Otherwise you could neutralize the bad side, for starts.

Check your Deltas

c. If the delta goes to .20, this is the time for more action. Open the other side of the trade, if you didn't start with an Iron Condor. Get rid of the losing side of the trade, and take profit on the changed direction of the trend. If the price stays stagnant, of course, you'll win on both the call and the put sides. Worst case scenario is to get out of both sides at the breakeven point, and you'll only be out commissions. This is how to preserve your capital (your highest priority)

Let's say you get $.30 credit on the bull put, and $.30 credit on the bear call. The stock starts to move upward quickly, call delta goes to .20 and your premium on the bear call is now at $.60 (the cost to buy back the bear call). That puts you in a loss of $.30. 100% loss. If the bull put works out, you'll keep the $.30 credit from that side, and it will be a wash with the loss on the bear call. You'll be down only the commissions. So you must track your income and your daily profit/loss on both sides in order to manage this trade properly.

Neutralizing the Delta d. Another move is to sell additional "good" side contracts to neutralize the delta of the "bad" side of the Iron Condor. This is tricky and should be papertraded! You would do this when you firmly believe that the bad side is going to reverse, and that you will ultimately win both sides, if you just hang onto that bad side.

Example: If the "short" strike of the bad spread has reached a .20 delta, then the long position is trailing behind is usually around .10 or greater delta. It is this delta "difference" that is causing the increasing loss.

If it is a .10 delta difference, count the number of open contracts and multiply those two numbers: .10 Delta times 5 contracts = 50 deltas against you.

Go out to next month's options and find a .50 delta strike and buy it. (call or put) That option will neutralize the bad delta in your losing spread.


My "home base" Options Animal has their own "Secondary Exits" for bear calls and bull puts, namely letting the short be assigned, and turning the trade into a Collar trade. It is a little more "generalized" in their teaching, (plus I don't have a fund large enough to risk assignment) so I appreciate John Kelly's more detailed and remarkable "repair" strategies explained in a way I can get it.

As always, if you have questions/comments, please reach me at bevjackson@gmail.com or reply in the comments section, below.

P.S. My next post will be a "Worksheet" for using this methodology for doing Iron Condors. A checklist, if you will. :-)

##

In Search of the Iron Condor - PART ONE



In the options world, Iron Condors are as common as "hawks" in the pit of the NY Stock Exchange.



But to beginners, the very words conjure some hugely complex trade with an ominous name--one that should be pushed aside for years until one is professional, or nearly so. Pshaw!

Iron Condors are simply two basic credit spread trades (the Bear Call and the Bull Put) put on at the same time. That's it. No funny business. No secret handshakes or decoding rings needed. Unintelligent traders put on these trades all the time, but the way to make money is to do it the smart way. And that, as all things in options, takes some knowledge and some study. If you don't have the will to learn, this is not the trade for you. BUT IT'S NOT DIFFICULT.

BUT HOW DOES ONE GO ABOUT FINDING SUCH A TRADE?

I had the good fortune to be invited to a week of free online classes presented by a very savvy group called ProEdgeTraders.com. Our speaker was John Kelly who discussed...what else? Credit spreads and Iron Condors. It was a really good class and while I thought I knew credit spreads, I realized how much more there is to learn. (endless). I wrote down as much as I could, and I'm hoping this will be helpful.

John Kelly is a former airline pilot and believes strongly in "checklists" and I love checklists myself, so this was right up my alley. And I discovered that he has an entirely "different" way of trading credit spreads and iron condors than the ways I've learned on Options Animal. It's heartening to know that there are so many different ways to do the same trade, but also a bit daunting.

1. Earnings

Before you even think about doing the trade, check for Earnings.If you are within 20 days of Earnings, find a new stock.

2. Volatility

a. You want the Implied Volatility (IV) percentage to be higher than the Historic Volatility (HV)

b. The lower the Realized Volatility, the better. WHAT is Realized Volatility?

Average True Range Technical Indicator (ATR) is an indicator that shows volatility of the market, and can be added beneath your charts. If you set the ATR for 10 days (I think the default is 14 days) and then divide the current ATR by the stock price, you get the Realized Volatility.

Example: ATR is $14.58 and the Stock Price is $51.00, ($14.58/$51.00)= 29.20% RV (Realized Volatility).


I assume that as you compute more and more of these, you will begin to get an idea of what constitutes the "high" or the "low" of realized volatility.

3. The VIX index

VIX is the symbol for the Chicago Board Options Exchange's volatility index. It is a measure of the level of implied volatility, not historical or statistical volatility, of a wide range of options, based on the S&P 500. When the VIX is at 20 and below, the market sentiment is complacent; no fear. When the VIX is above 20, you can tell fear sets in, selloffs begin and premium gets expensive. (usually when Bernake speaks!)
So for this Checklist, you want the VIX = 20 and below for Bull Puts, and above 20 for Bear Calls.

Here's a sample $VIX chart:



4. Find Support and Resistance

There are different support and resistance lines on a chart. You want your credit spreads to fall OUTSIDE OF SUPPORT AND RESISTANCE.

a. Pivot Points

If you use Pivot Points (an indicator on many chart programs) on the chart, you'd see R1 and R2, and S1 and S2. These are based on standard deviations, and usable for our purposes. But that's just for starts.

b. Linear Regression Channels

John Kelly uses Linear Regression Channels (both 50 day and 100 day) which provide more support and resistance lines. (These indicators are available on ThinkOrSwim platform, but not on all platforms. StockChart.com has them in the "drawing" mode, but you have to place them yourself)
I didn't know what Linear Regression Channels were, so I asked. They are the "bell curve" turned on its side, and how the stock trades in regard to 2 & 3 standard deviations. I had to have my friend Linda explain standard deviations to me. "The Standard Deviation is a measure of how spread out numbers are." (huh?) But she helped me. Think of a "mean" middle line, the "average" and then equal-width lines on either side, like channels which deviate from the mean in equal distances. That is a linear regression channel. It's a mathematical equation but all you need to know is that you want your short options OUT OF THE 2 Standard-Deviation lines.


The point is that you want your credit spreads to be placed OUTSIDE of the regression channels - OUTSIDE of Support and Resistance.

c. Moving Average Lines

And of course the 200 day, 100 day and 50 day Exponential Moving Average lines also provide an idea of support and resistance.

d. Draw a Channel!

You can draw your own lines top and bottom on your chart, making a channel touching the highest candle above and the lowest candle below for the time period that you are trading.

e. Even your 52-week high and low show resistance/support. So get familiar with them all.

Depending on how long you are going to be in the trade, you would pick your support and resistance accordingly. (obviously if you're in a weekly trade, you'd be looking to see how much your stock moves (the range) in a typical week. If you're doing a 90 day trade, you'd be looking at the movement for 90 days, and use Support and Resistance based on that time frame.

This requires you to study the chart, and be careful of where you place your shorts. You do not want your short call or short put to EVER go in the money on these Iron Condors. The point of this trade is to keep the credit you get, and let the trades expire worthless (or reverse them before expiration for 90%+ of your credit received).

f. ATR Multiplier

ATR is an indicator which can be added beneath your chart. It stands for Average True Range. This is perhaps a less scientific approach to support/resistance, but can be a confirmation of Strike price choices. The same ATR indicator mentioned above can be multiplied by 2.5, 3, or 4 (the higher the better) and compared to the Support line and Resistance line you've decided on.

For example: A stock is trading at $561.28. You may have chosen a bull put of 495/490, and a bear call of 615/620. How can we verify if those strike prices are in a "safe ranges"?

Well, multiply the ATR of $16.82 times 3 = $50.46.

Subtract $50.46 from the stock price ($561.22-$50.46=$510.53) Our $495 short put in way below this support line.

Add $50.46 to the stock price (561.28 + $50.46=$611.45. Our $615 short call is ABOVE this resistance line.

So this confirms our support/resistance "safety" zones. You can never be too sure. Never have enough redundancy when you are risking money.

So if we look at the chart...


6. Probability & Premium

Final requirements are probability and premium. This was a tough one for me to get. John Kelly uses .05 to.10 Delta to pick his strike prices for both the Bear Call and the Bull Put!

This Delta translates also to a 5% or 10% probability of going into the money, which means it's also 95% and 90% probability (of success)!



This gave me pause as there's not much premium at those delta levels. But John does not look for high premium. He looks for (on a monthly trade) 3% minimum return after commissions and fees, or 1% (on a weekly trade).

As an example: on a $5 spread (between strike prices), for every $.05 nickel of premium, that is a 1% return. on a $10 spread, you're looking for $.10 dime of premium.

You need to sit down and do the math. (or let your trade calculator do it for you).

There are trade calculators on your broker's platform which compute probability on your trade. My own trading plan counts on an 80% to 85% probability of success. John's is higher. But I have a smaller fund, therefore I can't do as many contracts because of the margin freeze.

If you use the Delta as a measurement of probability (.05 Delta is 5% probability of going in the money (or 95% chance of being safe), you don't really need a calculator, but the software on most platforms has other bells and whistles that make it very helpful in trading. I would encourage you to learn how to use the software available to you on whatever platform you choose: OptionsXpress, Trade Monster, Think Or Swin, to name only a few of the top ones.

A snapshot of OptionsXpress's calculator:


A snapshot of TradeMonster's calculator:


This is getting pretty lengthy, so I think a second chapter is needed here: See the next post for Timing and Maintaining this Trade!

##

Friday, June 1, 2012

Month of May....Go Away~!

I should have paid attention to that little Wall Street slogan and quit trading in the month of May~ and today, June 1st, has only underlined that. Oy, what a mess~

Looks like I might lose ALL those wonderful gains I've made from Jan through April. (and so has the rest of the Market.)

However. No losses are without gains, and I'm learning, learning, learning. All those "boring" things they tell you about managing risk and doing the math became very, very, very important in the month of May.

There are certain rules in OptionsAnimal's education. One very important one is doing the math beforehand, and KNOWING YOUR PRIMARY AND SECONDARY EXITS before you pull the trigger. I got very clear this past month that I have a strong "belief system" that my trade is always going to work out...according to my primary exit. A win. Poor deluded woman. Not always the case, and I got caught with no secondary exit in place on three different bull put spreads where the market took the rug out from under me. I did NOT consider secondary exits. I SHOULD HAVE had enough cash to get assigned, buy the stock and put on a collar trade. Of course, I did NOT have that kind of cash, so instead I will be close to my maximum loss on all three trades. An expensive lesson.

However, I am learning more and more and more about trade adjustments ( Collaring the trade above is only one adjustment of many). I may go broke before I learn it all, but damn~! It never gets boring.

Friday, May 11, 2012

Vertical Debit Spreads - the Pitfalls

As mentioned at the bottom of my previous post,thanks to Kris Maynard, debit spreads do have some drawbacks: Too often when these spreads are taught (or you read a lesson online), the pitfalls of a strategy are not STRESSED.

I want to be sure that new traders understand that in order for a vertical debit trade to be successful,

1. THE TRADE HAS TO MOVE DIRECTIONALLY (VERY BULLISH or VERY BEARISH) to make a profit. If the stock remains stagnant or moves only slightly in the direction you need, by expiration, you will have a loser.



2. In order for your expectations on the stock price to materialize, and your long call to go in the money, you need to be sure that you have bought out far enough in time for that movement to happen, so TIMING becomes important.

3.You need to look at your charts and determine just how fast/or slow that stock takes to move that much, so the MOMENTUM becomes an issue. Which means you better know your stock's volatility pretty well.

As an example:

You might hear on TV that Amazon stock is doing wonderfully, and decide "oh, I think I'll do a Call on Amazon!" But then you remember that you have lost a LOT of money doing calls, and decide instead to do a Bull Call spread. Meaning that you'll buy your Call, but ALSO sell a call at a higher strike price in order to reduce the cost of that call, since the cost is your total Risk amount. Thus reducing your risk.

So, if we look at a chart of Amazon, you can see that it has indeed gone up. In fact it GAPPED up almost $30 on April 26, 2012. If you wanted to buy the $230 call and sell the $235 call, (see chart below), do you think you have a good grasp of the three pitfalls? Is that trade really going to be very bullish or is it going to "fill the gap" and go down shortly? Do you have enough information to time it properly? And we already know the stock is capable of big jumps, but is it just an event that made Amazon gap up, or does it do this regularly and why?



The point I'm making here is two-fold. Some people feel that debit trades are "safer" because (unlike credit trades) there's no option requirements by the broker, and the risk is only the cost of the net options (Long call minus short call premium). And I want to remind you that a losing trade is not safer by any standards.

The other point is that you really need a Watch List of stocks that you follow diligently. To trade unknowns is asking for trouble. When you trade the same stocks day in and day out, CHANGING YOUR STRATEGIES, depending on the trends, you will undoubtedly have more success than if you just use the same strategy and go out looking at any old stock that might fit the pattern you're after. That's like throwing darts at the stocks and having no knowledge of their fundamentals and historic technicals. It really does help to avoid pitfalls if you KNOW the stocks you're trading.

And it really helps to know the pitfalls of whatever strategies you're using as well.

##

Sunday, May 6, 2012

Debit Spreads - ROI (Return on Investment Calculation)

One of the things you often read when studying Options is that an acceptable exit from the trade is to predetermine the percentage you would like to make on your investment. Otherwise referred to as R.O.I.



WHY DO I CARE?

When I first heard about R.O.I., I thought to myself: Hey, I'm a beginner. I'm not looking to find out high faluting information on my profits just now. I'd just like to learn how to trade! And so I didn't pay much attention until I noticed that OptionsAnimal included such calculations on ALL of their lessons where R.O.I.was the primary exit strategy on the trade. And it was included because it was important and an integral part of the trade.

One good reason for it is the discipline to keep your trading a business and not a gambling event. If you are willing to limit your profit to a percentage, and then close the trade at that limit, you will also control your greed. (Don't forget that Fear and Greed are the trader's biggest enemies, and the very things that will/can do you in if you don't plan in advance.>

Then I discovered that it's not ONLY an exit strategy that all spread traders need to know, but that it's a calculation done in advance of the trade TO DETERMINE WHETHER YOU SHOULD EVEN BE IN THE TRADE! In other words, if you like to make (for sake of discussion) 50% profits on your trades, can your underlying equity move enough to even get you to the desired return on your investment? You won't know unless you do the math. Most conservative traders shoot for 25% to 35%, by the way. Oink oink here! I, of course, thought of 50%. But it's your business, make it what you like. But do the math!



SO, WHAT ARE THE STEPS?

What Return Do You Want?

1. Decide what return% you would like on your investment. For the sake of a lesson, let's say 25% would be enough to keep you happy. (that's a lot more than the banks are paying, right?)

What Trade Do You Want?

2. So, you decide on a trade. Let's say we think that IBM is going to go up, and we would like to put on a Bull Call vertical debit trade. So after looking at the chart and the fundamentals, you are fairly certain this stock is going to go UP. So you pull up an option chain and look for the premium it will cost you to do a spread.



The stock is currently selling for $200 per share. So we plan to buy a LONG Call (Buy to Open) (our primary instrument) at the Strike Price of $205 for $4.05.

We plan to sell a SHORT Call (Sell to Open)(our secondary instrument that reduces our cost) at the Strike Price of $210 for $1.97.

So, our investment in this spread is $4.05 minus the credit we get from the sale of $1.97 which equals $2.08 Investment. That is how much I will pay for this spread. It is my total maximum loss amount as well. It represents the cost for one contract which means that $2.08 x 100 shares (per contract) that I will have $208. taken out of my fund when I pull the trigger on this trade.

How Much Does My Spread Have to Be Worth To Win?

3. If we want to make 25% on this trade, ($.25-a quarter-for every dollar we put into it,) then add 100% to 25% and you get $1.25 as your multiplier. Always just add 1 in front of your desired ROI.

We are planning on spending $2.08 on the spread, right? So multiply $2.08 times $1.25 and you get $2.60. So that is what our spread needs to be worth at the time we reverse the trade. It will be our Net Credit after Selling to Close the Long Call, and Buying to Close the Short Call. $2.60.

Check my Math: Investment: $2.08 x ROI desired 25% = $.52 profit. Add profit to cost basis (which you want back too!) $.52 plus $2.08 and you get $2.60. In other words 52 cents represents 25% of our investment. In this trade, we want to get back our $2.08 plus $.52; that figure to reach is $2.60.



If you look at the Option Chain at the time of the trade, you can see that this spread is already depreciated. We paid $2.08 but if we reversed the trade right this minute, we would only get $1.93. Sell to Close the Long Call for $3.95 less Buy to Close the Short Call for $2.02. The difference is $1.93.

So this tells us that we need our option spread to increase in value from $1.93 all the way to our ROI figure of $2.60. The option spread has to increase in value by $.67 cents.

Well, do we just sit here and wonder if it will, and how it will or do we figure out how this thing works?

HOW MUCH DOES THE STOCK HAVE TO MOVE FOR MY OPTION TO MAKE MY ROI? Isn't this the real question? How do we know if this stock will cause that option spread to reach our goals?

The answer is another calculation. (Nobody told you that option trading was easy, did they?)

You probably know that DELTA is what tells you how much the option moves versus every dollar the stock moves. And both your long and short calls have Delta. The Long Call delta is positive, and the Short Call delta is negative. So let's take a look at that.

NET POSITION DELTA

Trade Monster has neat option chains where you can configure the columns any way you want. So I'm using their chain to show the Delta on this trade. Remember that the SHORT is negative delta, so we will subtract it from the LONG to get our Net Position Delta:


So this shows us that our spread will move .18 cents for every dollar that the stock moves. In order for our spread to increase by .67 cents before expiration, we divide .67 by .18 = 3.72. Therefore, the stock has to go up $3.72 in order for us to reach our R.O.I.

Does this stock move that far? Does it move fast enough to make this much by expiration? Look at the Historical price quotes and your Chart to see just how fast it does move.

If the answer is Yes, then let's do it! Not really. I think IBM's going down. :-)

## Disclaimer: Everything in this blog related to options is for educational (hopefully) purposes only and is NOT any kind of trading advice or recommendations.

Thursday, May 3, 2012

Debit Spreads vs. Credit Spreads - Vertically speaking

I finally had another big Aha! in Options Trading.

It takes SO long to learn this stuff, as in knowing it right off the top of the head. At least it does so for me.

I've pretty much got the Credit Spreads down pat, but then I began to ponder the Debit Spreads. Mind you, these are Vertical spreads with the same expiration months. (I'm not ready to tackle Calendar spreads in depth just yet).

I couldn't quite figure out WHY you would want to do a Debit spread (instead of a credit spread) when it

1. costs money to do so, and

2 you need to buy out in time (theta works against Debit spreads)

3. then you have that wait for things to happen. (depending how far out your expiration).

Whereas Credit spreads are wham bam~! One week or one month and it's all over, and you've got the money in your pocket to begin with.

So what's the point? Why would I use one and not the other? Why doesn't anyone ever compare them?

So I had a pow wow with one of my trading divas today, Linda, and she's very smart and we got into it and figured it out. I learned a lot out of the session and I want to share what I learned. (it probably isn't the whole of it, but it's a start).

It makes the whole picture SO much simpler if you just compare them. In both trades you buy one option and sell another.

CREDIT SPREADS

Primary Instrument: (option) The Short Call or Put

Secondary (insurance) The Long Call or Put

The Short is sold out of the money,(OTM)the Long is bought further out of the money,(OTM) thus the premium for the Short is in excess of the cost of the Long, so you pocket the difference. A credit in your account when you put on the trade.

Maximum Gain: The credit in your account when you put on the trade.

Maximum Loss: (The Strike Price of the Short ) minus (The Strike Price of the Long) less the Credit in your account when you put on the trade. (the broker holds this maximum loss as margin until the trade is over).

Expiration choices: Theta works in favor of Short instruments, so the shorter time, the better. Weekly or Near Month are the best.

_____________________________________________________________________________________

DEBIT SPREADS

Primary Instrument : The Long Call or Put

Secondary (insurance) The Short Call or Put

The Long is sold at the money,(ATM),even in the money,(ITM) and the Short is bought one level away out of the money, thus the premium for the Long is in excess of the cost of the Short, so you PAY the difference. You are charged for the difference in premiums.

Maximum Gain: (The Strike Price of the Long) minus (The Strike Price of the Short) less the Cost of the debit to your account when you put on the trade. (there is nothing held by the broker for margin).

Maximum Loss: The debit taken from your account when you put on the trade.

Expiration choices: Theta works against Long instruments, so the longer the time, the better. Minimum of 45 days to 90 days is best. (you do not have to hold the trade that long, but that will keep Theta at bay until the last 30 days.)

----------------------------------------------------------------------------------------------------------------------------

You will notice that things work in reverse between these two trades.

But take a closer look at a comparison of the Maximum Gain. You can earn MORE with Debit trades. It just takes longer.

Take a look at the Maximum Loss: The losses are HIGHER with Credit trades if they go wrong.

So, it would appear that debit trades make more sense than credit trades, but do they?

Not at all.

Would you like to take a chance on Priceline (PCLN) with a trade that didn't expire until July? The world could blow up (or down) with that crazy stock in that time. But it pays great premium and has a lot of action. There's money to be made there.

Whereas a steady stock like Intel (INTC) with its gradual uptrend for many months might be a perfect candidate for a debit trade that ended in July.

I would rather do a weekly credit trade on PCLN, grab my money and run, and do a debit trade on INTC and make more, risk less, and sleep well over the long weeks it takes to get there.In other words, there's a use for both trades, depending on the stock and your expectations of it.

As I said, I have a lot more to learn, but at least this question is now much clearer. Why on earth would I want to use a debit spread in some cases instead of a credit spread? Well, isn't it obvious?

If not, send me questions, please. I learn by answering them.

PS. My mentor Kris Maynard, upon reading this post, added this very important information: I would only add one little, but important, item: In a debit trade one must be correct about three things - the trend of the underlying; the timing, and the magnitude of the move. A credit trade, I find, is a bit more forgiving in that you can make money in a stagnant market. Positioned properly, one can even make money if the trend goes against the trade. This is why I much prefer credit trades. ##

Tuesday, May 1, 2012

4/27/12 Weekly Trade results

Okay, here's the final results on last weeks credit spreads. I've republished the originals below to see the ones that were not successful. It is VERY difficult to adjust weekly trades, so I have made attempts here to roll said losers into montly trades. Not at all sure it will work, and the WEEKLY trade status makes it very, very much more difficult. But we shall see.
Week 3 was too crazy. I made monthly trades and didn't touch the weeklies. But I'm back, (and a little late posting). Here's my 4/27/12 Weeklies. (note that one of them (BIDU) is already failed; I adjusted it to monthlies which IF they succeed will reduce my losses to $49.50.
If you are looking at the schedule, I.C. stands for "iron condor" which I've placed on Apple. It simply means a Bull Put and a Bear Call put on at the same time (thus reducing fees). ##

Friday, April 27, 2012

Interview on r.k.vr.y literary journal website

I was pleased to be interviewed by poet Elizabeth Glixman in conjunction with the poem "The Red Car" that was published this month in r.k.vr.y magazine. Here's a link to the interview: Beverly Jackson

Wednesday, April 25, 2012

Options - More Baby Steps

I'm earnestly trying to reduce a very complicated system of trading into some simple steps for beginners to follow. My trading group, The Trading Divas, has newcomers who have never traded an option before, and so I'm trying to make things very understandable. Please write to me if you have questions.

In my last post Options- Baby Step Introduction, I tried to introduce the Call and Put, the two instruments used to trade options.

In this post I'd like to put down some additional information for the trade itself, and then in my next post discuss what options are used for. (Making money, right, but how and what else?)

The most important thing to an option trader is the Option Chain. Every option broker website will carry the chain which is constantly changing price list of options (Calls on the Left, Puts on the Right) but is also full of much more valuable information. As a beginner, you should go into your new trading account and find the Chains and start getting familiar with them.

YOUR "MAP" to trading options - THE OPTIONS CHAIN

I have marked up the Chain for the things that are important to know.

1. The Ask Price (premium) is the amount you PAY when you go long (buy) an option.

2. The Bid Price (premium) is the amount you RECEIVE when you go short (sell) an option.

3. You can click through the links for Expiration dates, and get a new chain page for each month (or week.) This sample happens to be June 2012. When you try it yourself, note that the premium goes higher, the further out in time you go.

4.(Most) options on stocks expire on the third Friday of every month. Weeklies begin on Thursday and expire the following Friday.

5. OpInt represents the total number of options (both longs and shorts) open on that particular option. The "open" interest in that option should beat least 100 before you trade it--otherwise not enough interest to move the price. After all, you need someone on the other side of your trades when you are both buying and/or selling.

6. The Strike Price runs down the middle of the chain and applies to both side of the page. It's the Strike Price for Calls and Puts on each line. The chain for the Put is difficult to get used to because it runs "up" the page, while the Calls run "down" the right of the page. You will soon get used to it.

7. The chains are usually shaded in some way (on this sample, it's the yellow areas) to help you discern the three types of options: In the Money, At the Money (or Near the Money), and Out of the Money. Take a close look at how the prices change as you go from ITM options to OTM options. This will have a great deal to do with how you decide a trade. Not only how much spend (or receive) on an option, but what the risks and rewards and probabilities are, depending on the Strike Price you choose. At the Money is the most traded strike of all. But that doesn't make it necessarily the best choice. It depends.

OTM - Out of the Money

When an option is "out of the money," the stock price has not yet reached the strike price. The option has no intrinsic value, only potential value based on time remaining before expiration, expectations of underlying stock price movement, etc.

ATM - At the Money

An option that is "at the money" has a strike price that is the same (or close to) the stock price.

ITM - In the Money An ITM call option refers to any strike prices that are below the stock price. Its called in-the-money because when you exercise, for example, the 75 strike option, you would make $5: you have the right to buy at $75 and sell at $80



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Different brokers have slightly different option chains. The one above is from OptionsXpress (where I have an account). I also have a small account at Trade Monster because I like their tools, and frankly, I like their chains because they show Delta and Theta. (two of "the Greeks") as well as Implied Volatility. The nice thing about these TM chains is that you can configure them with the columns you want.

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Delta and Theta and implied volatility are entire subjects unto themselves, (a later post) but I would like you to notice how the Delta and Theta changes as you look at the different options. Delta is the amount of money the option makes with every $1 that the stock price moves. Theta is the amount of money that the option "decays" for every passing day. Both of these figures change, as the underlying stock changes and the option prices change.

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