Archive for March, 2009
A couple of posts back I pointed out how critical it was that if we are to learn how to trade options profitably, then we must “manage by the numbers” and trade as a business. I also introduced you to the Greeks, which I went on to explain are the numbers you need to know in order to manage your portfolio of trades profitably.
Delta you may recall measures the change which occurs in an option’s value and Gamma measures the change of an option’s Delta.
Today we move on to explore another of the Greeks, Theta and in my next post we will wrap up the Greeks with a look at all important Vega and also touch briefly on Ro.
I have just set up new positions for the month of April, and so I will explain these in the light of two of these new positions I have on the IWM index.
As time approaches expiration, the option you have acquired is losing value on a daily basis. Theta is a measurement of that loss in value. The types of positions which we will be looking to put on with the Trading Pro (previously OptionSphere) program are all Theta positive positions. With an option losing value more quickly as it approaches expiration we see this reflected as an increase in the size of Theta. The nearer we get to expiration the greater the increase in size of Theta.
So .. back to the IWM position which I put on a couple of days back. This shows a Delta of -1.49 and a Gamma of -7.11 (both pretty neutral positions) and a Theta of 4.46. So, provided the price remains within a certain range this means that I should be collecting on average $4.46 for every single day I am holding this position through to expiration. The reality is though that price is usually constantly changing and so Theta and the other variables will change along with it. The higher we find Theta then the better it is for us, because that is how we make money when we are trading options.
Now, it goes without saying that you don’t want to find yourself in the position where you have negative Theta. For example, if the above was -$4.46 then this is the amount of money on average I would be losing each day and this loss would become even greater the closer I got to the strike price of the option I’m buying.
Now, in the case of the IWM position I had put on two positions using a double calendar spread. I had purchased a 45 call and a 39 put in the the month of May with the sale of the same in the front month of April. So, in making my selection, to ensure that I did not find myself in a loss situation I had to be absolutely correct with regards both timing and direction. Now, as I say .. almost certainly the price is going to bounce around a bit and I may well find myself having to adjust my positions. But that is no big deal .. and after all .. it’s all part of the art and science of knowing how to trade options with confidence.
Well I guess I could have opted for a couple more add-ons to the title, but then it would have ended up extra long and looking rather silly. I am holding off with the post continuing on with my discussion of the Greeks just for a day or two. Fact is I’ve broken some more rules .. and ignored some I’d covered earlier. Result .. not a good month! But .. fortunately still .. I am only paper trading. And .. I have learned once again .. how not to trade options.
Mistake No 1: I abandoned a multi-directional approach, preferring to just stick with the one type of spread .. the Iron Condor. The reason was because I was coming up with good starting positions, and having trouble getting the nice two peaks I wanted with Double Calendar spreads. Nothing wrong with Iron Condors but they are just a little less forgiving than Double Calendars. Rather than spread over 5 indexes I would have been better to have put my Iron Condors on just a couple until I’d got my head around the Double Calendars.
Mistake No 2: Greed!!! Rather than opt for a single position on each index, in some instances I opened with two or three. You know how it is. Just so any profit would be half way decent. Ha! Ha! Definitely not recommended when you start out. The problem is when you have to adjust (and in this market you do), that may mean you need to put another 3+ positions on each index in order to correct. And then later .. maybe a few more. Suddenly, you have exceeded your budget ending up with a higher margin than you intended. Ok .. so what .. if you are paper trading? It makes sense does it not to simulate the real world scenario? Why would you have a margin of $10,000, when trading for real you would limit yourself to $6,000. And .. then nearing expiry date you encounter something like the massive upswing we have seen in the market, which has seen me backed up against a fence, ill prepared to counter the late movement.
Mistake No 3: More greed!!! Hanging on in for that little bit more, when if I had exited a wee bit earlier things would have been quite different.
Mistake No 4: Settling for second best spread positions. By this I mean ‘so so’ spreads where the break even points were too close together, thus leaving little room to move. I made this mistake with two of the spreads I put on. The others were fine.
Mistake No 5: Still not getting up to speed with ALL possible corrective measures. That has meant I’ve been left in a bit of a spot this last 3 days. And .. there are still a few more days to expiry.
So .. it is back to the drawing board and time to fire up those videos again. On the positive side I know just where my failings lie. The next step though is to not keep on repeating the same old practices, but to stick with the tried, true and tested formula for ensuring that one can learn how to trade options with confidence.
When learning how to trade options, it is vital we understand that in order to trade profitably we must “manage by the numbers”; just as we would in any bricks and mortar business. You may have got the impression that trading options is just about placing spreads as opposed to individual trades; partly right, but there has to be a bit more to trading than that. And .. that does not mean that we have to go big on technical analysis using our charts and graphs.
Enter The Greeks! In a nutshell the Greeks are the numbers that you need to know in order to manage your portfolio of trades profitably. So let’s delve a little deeper. The Greeks which concern us are Delta, Vega, Theta and Gamma . In explaining these I will use as examples one of the paper trades which I have on for the month of March.
Fortunately, on the Think or Swim platform, I am able to set up The Greeks so that I have them showing in my Monitor Screen layout and at a glimpse I can see how things are shaping up.
Delta .. is the measurement of change which occurs in an option’s value. With regards the positions I have on in the EEM index, Delta reads at -23.32. In other words I am ‘short’ approximately 23 Delta. Now think of these 23 Delta as being 23 shares of stock which are short. In other words, 23 shares of stock which I have sold but don’t actually own, but which I have ‘borrowed’. In order to make a profit I want my shares to go down. If the price of the shares should go up, then for every $1 rise in the share price , I would lose approximately $23. If the shares should go down by a dollar, then conversely I stand to profit by approximately $23. Think of Delta in this light. Given the other Greeks which I will now turn to .. this is a relatively neutral Delta and is in fact not such a bad position to be in.
Gamma .. is the measurement of change of an option’s Delta, resulting from a 1 point move in the underlying stock. It is not a variable directly of the price of the option; it is a measurement of the change of the Delta. On the EEM, Gamma is -29.37. In other words I am short Gamma. The particular spread I have on is the Sale of an Iron Condor – involving the sale of a 24 call protected by a 26 call and the sale of an 18 put protected by a 16 put. So I’m short both calls and puts and therefore the last thing I want is for the market to move too much on me. We shall see.
In my next post I shall continue on examining both Theta and Vega which you will need to understand if you are to know how to trade options with confidence and I will also provide you with a brief explanation of another one of the Greeks .. Ro. You will also be given a look-in on my present trading activity, which has had its ups and downs this last few days. Fortunately, right now .. things are not looking too bad.