Archive for February, 2009
In my post on How To Trade Options On Paper, I provided you with an update on my trading activity. That was about 10 days ago. Well, February expiries were today, so I thought to update you on what has been happening over this last few days.
Let me say from the outset that I have an overall loss for the month of $113. Quite a far cry from where I was just a few days back. Now, there are a number of reasons why the loss has arisen, some because of placings I had not thought through properly, but in the last three or four days because of deliberate strategy on my part. When I started to see the tide turning rather than attempt to correct at such a late stage, or close out with some indexes (where then I would have profited), I changed strategy to deliberately break all of the ‘do not’ rules to see what might happen with my own eyes. And .. at the end of it although a loss and despite total abandonment of all positions in that last week, it was not really significant – or something that would cause me a lot of distress! Before I move on – these were the results. IBM up $228 (who’d have believed such a swing!), EEM up $71, IWM down $332 (again who’d have believed such a swing!) and the SPY down $90 – with me $30 in profit on a DIA position I had put on for March.
So .. what were some of these things I deliberately did, so as to see for myself, whether what had been taught bore substance?
Firstly, I held off on closing out any positions at all. I wanted to see where everything ended up. Predictably, in that last five to seven days share prices were all over the place. For example the IWM had moved from 45.5 down to as low as 40.25, rallying a bit at closure today to around 41.0; the SPY from a high of 84.0 (it was 87.50 three days earlier) down to 75.5, closing out at around 77.00.
RULE 1: Do not wait it out till expiry day .. if you are in profit, do not hang around into the last week of expiry. Things can drastically change to affect your profit position.
Secondly, I put on more positions than was recommended. On one of the indices I had as many as six on. That does not make it easier when it comes to making corrections with adjustments, as I was to find out.
RULE 2: When starting out – limit yourself to a max of 2 positions on each stock. This will make it a whole lot easier for you to make adjustments when and if you feel under some pressure.
Thirdly, I did not have wide break even points on a couple of my indices. This meant that if price moved against me it could fast butt up against my breakeven points and give me limited room to make effective adjustments. Along with this I would add that I contented myself with less than perfect graphs where although my opening position was fine, I’d left myself with too little room to move. (With the two double calendar spreads, I had real difficulty with coming up with the two tent peaks which enable one to profit in two places. I kept getting just the one peak).
RULE 3: Ensure you have wide break-evens. Better this and a little less potential profit, than greater profit potential in a narrower range. Also .. really get to understand your spreads. You may find yourself more comfortable with just the one type on starting out. It is perhaps best to stick with this, until you develop a better understanding of another spread type.
Next, if price runs up against you very quickly in the first few days, as happened to me with the DIA for March .. and you have a small profit or even a small loss, better to get out and start out with a fresh position than try and adjust. I did this and managed to break even.
RULE 4: If price moves against you quickly in the first few days, get out. Why? Something out of the ordinary is happening in the market that you perhaps are not aware of.
I would also recommend you revisit points 1 to 6 which I have brought out in the How To Trade Options On Paper post.
For the month of March, I will probably stick with the indexes and IBM again .. but will be: documenting all placements very carefully, revisiting the videos, especially those on adjustments and closing out positions, taking a closer look at double calendars to ascertain where I may have been going wrong, and tiding up my charts .. they are starting to look a bit of a mess. Oh .. and I will also be further familiarizing myself with a number of the terms up on the Think Or Swim platform.
All in all I am very happy with this outcome. Given the bumbling that has occurred it is quite remarkable that I have not been hurt more badly, the more so, given that some of my latter ‘strategies’ were deliberately put in place, just to see how much I might get hurt. I am now more confident than ever that I need to know what I have to do, if I am to learn how to trade options profitably and I know with absolute certainty that anyone can set themselves up with a regular monthly income, if they just obey the rules.
I just thought to quickly give you folks an update on my paper trading activity. It is important when learning how to trade options that one learns by one’s mistakes.
The month of February has seen share prices dancing around all over the place. So what are some of the things I have learned from my paper trading activity?
1. If you live outside of the USA (we are here trading options based on underlying American indices and stocks) think out your time zones. Don’t go in to check your positions and make adjustments in the last half hour or so of trading. Better to know if a position you have put on has been accepted before days end.
2. If starting out it may be best to focus just on indices because they are inclined to less volatility than any one stock. Although there may be benefits in hedging with a stock which may run against the general tide with price, I feel it best to test the waters with just three or four of the indices to start. IBM has been tracking upwards this last couple of months or more but the release of the earnings report on Jan 20th saw prices move from around 81 to a high of 97, with me going into negative territory. I have however profited by the downwards move in the last day or so, pulling a profit of $110 just in this last day .. but the overall position for this stock is still a loss of $95, as at today.
Fortunately, I had wide breakeven points on both the SPY and the IWM. Although suffering a combined loss of around $46 on both these positions today, they are still looking pretty healthy, with an open profit of around $200. I will probably close out the SPY tomorrow because the rate of Theta decay is only around $2 a day .. and we are getting very close to expiry anyway. So better to get out now while I am ahead. The EEM posted a $65 profit yesterday bringing me out of a small loss situation into positive territory.
Theta decay? Volatility? More to come on these later.
3. I am not likely to see much of a profit arising in IBM before expiry date (indeed there may well be a small loss). But given my bumbling with adjustments (remember I am still learning and getting my head around these), and the fact that because of this I did at one point allow myself to get outside one of my breakeven points, I feel the lesson has not been too painful. Will I take IBM right through to expiry? I don’t know .. but will certainly be watching it closely over this next day or two.
4. Have a solid plan in place. Watch your margins carefully. I have thrown a bit more “cash” into the pot .. with margin now being around the $3,000 and profit to date of around $900. Not a bad return I am sure you would agree, but in a real life situation I would probably not have started out with quite so much – so try and stick with what you would do when you come to trading for real.
5. If prices are moving around a bit and your profit position looks good, don’t be afraid to close down your position and take your profit. I should have probably done that with the SPY today.
6. Put the time in to studying your charts. Although I have done this, placing in my channel lines and support and resistance points (yep .. I will cover this soon), positions may have been improved upon, with a little more time taken for analysis.
Tomorrow I will be looking at the March options. But this time round I will be documenting everything I do, setting a margin limit, focusing solely on indices, and analysing carefully the effect of each and every adjustment made. Then, I know I will be well on the right way to learning how to trade options as a business.
Well .. you could be forgiven for wondering about the unusual title for this blog post. But you may recall in the last post I warned of the dangers of selling an option whether a call or a put, unprotected. The term for that is naked. Hence me varying the usual title of ‘how to trade options …”
For example, lets say I make the rather foolish ploy of selling a call option, assuming I am allowed to do this. The reality is that short of exceptional circumstances, I would not be permitted to do so. But .. as a theoretical example… Yes .. the potential exists to make a very good profit if the price goes down (remember I sell a call option in the expectation that the share price will drop below the strike price) but in the event of it swinging the other way .. I stand to incur literally unlimited loss .. why would I dare want to go there? Same thing applies on the puts side when the price moves in the opposite direction.
The secret is to hedge your ‘bets’. And that is done by placing ‘covered’ positions known as spreads. Remember that the share price cannot be in two places at the same time. So, if the intention is to sell a call option, such as was the case with the May 120 call illustrated in my last post, you would protect this with the purchase of another call at a slightly higher strike price (say a May 125 call). You sell the May 120 call on the basis that you expect the share price to go down but you purchase the May 125 call to ‘hedge your bet’ just in case the share price goes up. Because the share price cannot be in both places at once you will always be in profit on one side of the transaction. Yes, overall you may sustain a loss, but it will be much less than if you had sold the option contract naked. And .. the potential still exists to make a very healthy profit. Exactly the same thing applies on the puts side.
With the OptionSphere course we place spreads for both calls and puts, thus ensuring the best possible starting point for setting up our positions. Remembering thought the two inviolate rules of the market place that options and their underlying shares go up and go down and that they expire, the chances are that at least with some of our spreads we will need to make adjustments .. to bring our positions back into line. More about that shortly.
These vertical spreads form the basis for how we go about trading as a business. Specifically, although not exclusively, our focus will be on the sale of Iron Condors (two vertical spreads – one with calls, the other with puts) and the purchase of Double Calendar spreads (the purchase of a call and put in the ‘front’ month together with the sale of same in a subsequent month). Other types of spreads occasionally used .. Single Vertical Spreads (more often than not with adjustments) and Straddles with Protected Wings. It is not important that you try and remember these terms right now though, just know that with whichever spread chosen there is a strategy in mind.
This multidimensional and multidirectional approach to options trading, ensures that we trade with minimal risk at all times, that we know the extent of that risk before we go ahead and put the position on, and it ensures that we learn how to trade options with confidence. Next post? An introduction to the Greeks!
Wow . . second time round. The last post I put up with this title mysteriously ‘disappeared’. I am mystified! This may be a little thinner on content, but I promise you that you will be none the worse for it. You will see that as this blog unfolds I will have plenty more to share with you on how to trade options as a business.
But first off .. just what is an option? Essentially it is a contract which gives the purchaser the right (but not the obligation) to acquire shares at a given price (known as the strike price) any time up until the expiry date of the option. For the most part, traders do not bother to exercise this right, preferring instead to gain greater leverage on any movement in the share price, by trading the option contract itself.
Integral to options trading are two terms which we need to get to grips with. Calls and puts.
Lets take some examples to better explain the nature of calls and puts. I buy say a March 125 call (strike price $125) which expires in the 3rd week of March. The current price of the underlying shares is $124.25. I do this because I believe the shares will go up.
If they go up to say 135, then that 125 call has just become that much more valuable. I can sell it and pocket the premium – or I can go in and buy the shares at 125 and immediately flick them off for 135, pocketing the profit. But note .. any profit I receive is of course reduced by the price I paid for the call.
If the price goes down .. I will have a loss.
If I sell say a May 120 call, then I am immediately credited with the premium which I get to keep if the shares go down below 120, before expiry date. In other words I am selling these on the basis I expect the share price to go down. The premium is ‘credited’ to me and that will always be the maximum profit I can receive on that trade.
If the shares go up, I can have an unlimited loss. Do not be concerned on reading that, because in practice you will never sell an option without protecting yourself .. in the same way that you might hedge a bet at the races. More about that in the next post I put up.
Now, lets look at the scenario where I buy a March 85 put, also expiring in the 3rd week of March. The current price is $87.62. I do this because I believe the shares will go down. If they go down to below 85 .. the contract has now become that much more valuable and I can make an unlimited max profit . Wow! Whoopee, I hear you say! But as with the call, any profit I make has to be reduced by the price I paid for the put.
If the shares on the other hand go up, I incur a loss.
Should I sell a Mar 90 put, let’s say current share price is $86.55, I do this because I believe the shares will go up in value. Should the shares go up beyond $90 I make a profit, (the premium credited to me) and if they go down bear an unlimited loss. But as I said before .. don’t freak out on reading that. Easily remedied!
Next up I will explain how to trade options as a business by placing on spreads rather than individual positions and the reasons we do this, cover some of the types of spreads we are using with this program and why you must never sell an option unprotected, or “naked”. I will also update you on how my own positions are holding up.