Archive for the 'option trading strategies' 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.
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!
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.
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.
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.