Archive for the 'how to trade options' Category
A couple of months back I made the decision to move slightly outside of my comfort zone, fulfilling a long held desire to know how to trade options. I guess the catalyst for this quantum leap was the massive economic downturn affecting all world economies. I finally resolved that I did not want to be caught up as a helpless victim in a world where essentially all control had been wrested from me. And .. so I asked myself, “What if I could find just the right business venture that will offer me reasonable certainty of great profits, irrespective of what is going on in the world economy?”
Around twelve months earlier I had started to take a look at one of the options trading programs being touted, but for an ‘every day’ guy like me it was one thing being able to meet the high cost of buying into this program, only then to find myself undercapitalised for trading purposes. As much as I wanted to learn how to trade options, I could see no immediate prospect of me doing that. And so .. it went no further.
Two of my online marketing colleagues then drew my attention to an options course with a difference being promoted by internet marketing guru, David Vallieres. David has been trading for some 20 years but it was not until about 2-3 years back that he finally stumbled on a marketing method totally unlike anything available elsewhere.
I am being taught trading as a business, rather than place ‘one off’ speculative bids which amount to little more than gambling. And .. the beauty of this is that I can profit from my business irrespective of whether the markets are moving up, down or sideways. And although the markets may change over time, the underlying principles of this method of marketing never will. They are something which I can hand down to my children and grandchildren.
The purpose of this blog is three-fold. First, to let you share the experience of trading options with an outright newbie trader, so that you can gain an insight into the basics of trading, (you will see what I’m achieving on the paper trading platform first); second .. to offer you a business that does not depend on marketing and third .. to use the blog as a focus point to channel the outcomes of my daily trading activity and reflect on what I have learned. In that way I can chart my daily progress as I master all of the fundamentals before taking a look at some of the advanced techniques shared in this exceptional video based course.
Once mastered, trading as a business need take up no more than 15 minutes of your time each day .. placing positions and making adjustments as necessary. Learning how to trade options has to be the ultimate business model. Starting with my next post you will soon see why.
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.
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!
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.