Archive for April, 2009

April 17, 2009

Well .. I am delighted to say that last months trading produced a 24.4% return on margin .. not an outstanding outcome by some standards, but a healthy yield on investment for that one month, just the same.  But do remember .. I am still paper trading.

As I have previously mentioned, knowing how to trade options with confidence involves a number of factors.

I thought to share with you today some of my own perceptions when I came to close off trading for the month of April. I stress .. these are just a few things which got me to thinking, as a newcomer to the world of online options trading.

It is recommended that one does not try to extract maximum profit by holding on right through to expiry. It is not uncommon to see quite  a lot of price volatility in the last week of trading and so it is strongly recommended that for most situations you close off no later than a week or so before expiry date. So effectively that is around 7-10 days before.

With April trading I decided to close off  on the Thursday before Easter figuring that by holding off to when trading re-opened on the Tuesday I might strike problems with price movements. In retrospect a good move, but I had also placed some opening positions on for May a couple of days earlier.

I won’t pretend that I have mastered the Think Or Swim trading platform fully but I’m getting there by degrees. One of the first things I observed was that trading results for the two months were scrambled together in the listing of positions on and I was left to guess which keystrokes to use to highlight the spreads I wished to close out (my fault solely, as I should have familiarized myself with that first) . That was after I had to put on my thinking cap to establish just which of the trades showing up, I wanted to close out.

On the day before (The Wednesday) I’d seen quite a profit hike but the trend was to be reversed on the Thursday as prices moved against me. No great drama because I was well ahead for the month as I said .. but hassles I’d have preferred not to encounter when things started to heat up.

It is recommended that when trading options for any given month you set up your spreads between 30 to 40 days before expiry. I had put the May spreads on nearer the 40 days and this gave rise to the overlap. Next month, I will place my opening positions on, nearer the 30 days and after I have closed out May. This is something I would be recommending to newbie traders, at least until they feel they have completely mastered the TOS platform.  This will overcome any prospect of confusion when it comes to closing out and putting on the new trades. Another reason for doing this is because shortly after placing the positions I had price move quite quickly up on me and I was forced to adjust.  Then followed a few days of sideways movement so I made the decision to add a few more positions across all of the indexes. And now again I see price creeping up a bit .. so the next few days may prove interesting.

My journey through the world of online options trading I find increasingly fascinating, with each day bringing  just a little more newfound knowledge and a ton of excitement as I master the art and science of how to trade options profitably and with confidence.

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Over this last couple of posts I’ve attempted to provide you with an overview on a couple of the Greeks, indispensable indicators in showing you how to trade options “by the numbers”.

I will today wrap up our introduction to the Greeks by discussing Vega and Ro and with regards the former, we”ll return and take another look at the IWM index.

Of the variables which affect the price of an option Vega is certainly one of the most important and is without doubt the most powerful of the Greeks. Vega measures how much an option will change in value because of a one point change in volatility. You may well see a significant change in your position because of a change in volatility.

Back to the IWM. Several days have now elapsed since we last looked at Delta, Gamma and Theta. As at today these are reading at 39.38, -20.03 and 5.15. Do take a look back at the last two posts should you require an explanation of these readings. In this post our focus will be on Vega. Vega shows up as 23.33. So, this is telling us that for every $1 change in increase in the Vega, (or volatility of the market) we will gain an additional $23.33 in profit. 23.33 is a relatively neutral figure which is what we want to see.

We can observe the measure of volatility in the market by tracking the $VIX index. This reflects the measurement of the number of puts being purchased on the CBOE (Chicago Board Options Exchange). As a general rule of thumb, when volatility goes up stocks go down and conversely when volatility goes down then stocks go up. Volatility is a reflection of fear in the market .. when we see more people buying puts that is because they fear that prices will decline .. the more puts purchased, the greater the increases in the levels of volatility. If we compare the graph of the $VIX with that for the IWM (or indeed any of the other indexes) we will see that volatility runs in exactly the opposite direction of market activity. When the $VIX drops back .. the market is seen to be going up and when it goes up, the market moves down.

The IWM positions I have on – a double calendar spread, are short positions – where I am selling in the front month and protecting myself with the calls and puts purchased in the following month. The Vega positions I have on mean that as long as the market continues to rise I will make money and if it drops back I will lose money.

Just a very quick word on Ro. This is not an “active” Greek like the others, but is simply the measurement of the change in value of an option relative to a one point change in interest rates. Interest is used as a comparative because when you purchase an option you are spending money which might otherwise be sitting in an account earning interest.

With a little less volatility in the market things are settling a bit and “touch wood” I will not have to make any further adjustments. As at today, on the spreads I have on – current profit is $752.50 for the month, on a margin of $3,800. If I should be able to hold this position, maximum potential profit is $1,640.44, although sensibly I will be closing off most of the positions over this next 4-5 days. Strange things have been known to happen during the week leading up to expiry!

Even if this current figure of $752.50 was to remain unchanged (and yes, it could go down) that is a 30.47% return on margin .. not for a year .. but for a month! Gotta be better than leaving you money in a bank account getting a paltry 5% a year don’t you think?

Do remember that here we are learning how to trade options as a business and that means managing by the numbers. And, to whom do we turn to get the numbers .. yep, you guessed it .. the Greeks!

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