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Saturday, February 23, 2013

Probabilities Work!~!

Since I've been able to increase my trading fund somewhat, (nothing very major), I have enough collateral/buying power/limited margin to do the kind of trades that give one higher probabilities, (and also high risk).  Unfortunately "high risk" has become a boogie man in trading parlance, but you need to be aware that rewards are in proportion to risk, in terms of improving your probabilities.

One of the most important things I've learned recently is that if you want to make more money, increase your RISK, not the number of contracts you buy.  (what this means is that ONE OTM naked put COULD offer you THE SAME premium and a HIGHER PROBABILITY OF SUCCESS than 5 or 10 Iron Condors on the same underlying.  While the risk is defined as "Unlimited" and "Infinite" on naked options, if you look at the margin that the broker withholds on these plays, you'll have a much clearer vision of just how much risk you're in for. Brokers are NOT going to take unlimited risk on you; they have a pretty good idea of how much you will likely lose if the trade goes against you, and they put that aside, just in case.  Putting the fear of naked puts into new traders' heads is the single worst injustice of teachers/mentors and programs who are reaching the public about options.  Just as there as teachers out there who put the fear of assignment in students' heads as well.  THERE IS NOTHING TO FEAR IF YOU EDUCATE YOURSELF.  And it does not take a mental giant to learn this stuff, just some hard work and comittment. If you don't know what you're doing, paper trade!!!!  Until you do.

I've done very well with a limited number of trade strategies:  Credit Strangles, Naked Puts, Iron Condors,
Credit Verticals, and Covered Calls.   As Liz and Jenny (on Tasty Trade) would say: "winner, winner, chicken dinner."

I have noticed something however that I was never conscious of before.  I have studied so many different options programs that my head was pretty much stuck in "rules" and  struggling through the fog of not completely understanding how professionals were able to tape read, match strategy to underlying, market level and volatility.   Now suddenly it's as if a switch has been tripped, and options trading seems to be like a very longgggg process of learning the mechanicals, but then the Wizard finally steps out from behind the curtain and all seems logical and even less mysterious than balancing your check book.  Which is to say that the element of utter fear seems to have finally gone.  I don't have the old highs of winning, nor the old lows of losing.  It's just a business now.  Some days it's good, some days you are bound to lose.  The point is that the winners outnumber the losers.  Or so it seems to me right now.

Tasty Trade has made the final and most significant difference (although without earlier basic education, it would not have "taken" quite so quickly.   The basic "Advanced" information is not all that hard to get:

1.  Trade often, and trade small.  No need to do 10 contracts and lose your shirt.  Do 5 or 10 diverse, high probability trades instead.  Quantity of trades is what puts the odds in your favor, like coin tosses.  Duration of trades is what gives you time to reassemble and manage trades.

2.  Sell volatility.  When IV is high, sell premium.  When IV is low, change gears and think directionally.
I'm learning to use dr. verticals and calendars for directionals,  iron condors for neutral positions, and credit strangles and naked puts for high vol. situations.  Of course there's no rules here.  You can mix it up, but the experience of trying different things is key.  I haven't learned yet how to short stock, but I suspect that's next on my list of new adventures.

3.  DO use underlyings that have volume in excess of 1Mill or 2Mill+ so that there's a chance of volatility.
Yes, AAPL, GOOG, NFLX seem like scary underlyings, but a lot of money is available there if you know what you're doing.  Smaller stocks can also be lucrative, but experimentation is key, I think.

4.  Look for volatility squeeze on earnings plays, and check out the TOS volatility percentile to see if the
underlying is really worth trading. (under Today's Options Statistics on the TOS trade page).   There are some wonderful "Market Measure" segments about this in the Tasty Trade archives.  Learn how to read IV percentages, differentials, and percentiles.  It can really make a difference in your trading.

The things I notice that Tom Sosnoff and Tony Batista check before they do a trade are this:

1. High Volume (the higher the better.  (We want really active stocks)

2.  High Open interest on the options.  (We want really active options)

3.  Narrow spreads between Bid and Ask.  (We want efficient options, fairly priced) (anything over 5 cents spread is likely not a good trade)

4.  Duration.  (We want enough time for adjustments and changes, in case the trade goes against us, so 25 to 40 days out to expiration is a loose rule).  (this does not mean you can't trade weeklies, but have a good reason (like overnight earnings) for doing so.)

5.  Enough premium.  If you can get a 3 to 1 ratio between risk and reward, on credit spreads, that's excellent.  If you can get a 1 to 1 ratio on debit spreads (risk one to make one), that's usually good.  But there are lots of ways to tweak more premium with ratio spreads, naked options, etc.  Just make sure that the premium received fits your trading plan.

Happy Trading!