Option Strangle Magic » Stock Option Trading http://optionstrangle.net Balancing out-of-the-money options for potential large gain Sat, 31 Jul 2010 15:56:36 +0000 http://wordpress.org/?v=2.8.4 en hourly 1 Stock Option Trading – Candlesticks & OHLC Bars Lose their Patterns on a Distribution Curve http://optionstrangle.net/stock-option-trading-a%c2%80%c2%93-candlesticks-ohlc-bars-lose-their-patterns-on-a-distribution-curve http://optionstrangle.net/stock-option-trading-a%c2%80%c2%93-candlesticks-ohlc-bars-lose-their-patterns-on-a-distribution-curve#comments Mon, 18 Jan 2010 09:17:13 +0000 admin http://optionstrangle.net/stock-option-trading-a%c2%80%c2%93-candlesticks-ohlc-bars-lose-their-patterns-on-a-distribution-curve Time-based charts (namely Candlesticks, OHLC Bars and Heikin-Ashi) fail to truly depict price.  This article will help you realize that time-based pattern recognition is an unreliable method for stock option trading.Some retail training firms like to popularize the myth that, “Everyone looks at these patterns in the charts”.  They are partly right.  Though, their use of the term “Everyone” applies to retail off-the-floor traders who collectively only make up ~ 15% at most, in some cases even less, of the total traded volume on exchanges, depending on which exchange it is.Which raises the question: What are the eyes of those on the floor moving 80+% of traded volume looking at?  Some of you have visited the exchanges organized through your broker.  If you’ve picked up the paper scattered on the floor, all you’ll find is quick math notation: addition, subtraction, division and multiplication. Nothing more.  No drawings of a Tri-Star Doji, Dumpling Tops or Frypan Bottoms.  It makes sense, because all that is in front of floor traders are screens with price data and price alone.  With truck loads of calls and puts to hedge, floor traders could care less how many times during the day, price touched the tail of a dragon fly doji.  They’ve already pre-planned to get more of; or, offload their inventory of calls/puts at a specific strike, for a given price.As a retail option trader, trading less than 10 contracts per trade, you are not exempt from tuning your eyes to focus only on price.  How do you simulate the observation of price alone from off-the-floor, if you remove the use of Candlesticks, OHLC Bars and Heikin-Ashi charts? Use Point & Figure charts instead.Why is it valid to only use Point & Figure charting for trading options? It is the only method that plots just one type of data – price alone without time – price is the only data element needed on a distribution curve.  The same distribution curve used in the Bjerksund-Stensland, Black-Scholes or Binomial pricing models in your options trading platform. What about other charting methods like Candlesticks and OHLC Bars?  Let’s take the Doji, a well known candlestick, as an example.  The Doji is characterized by it’s Open and Close at the same price, the High is a different price from the Low.  Remember with a Distribution Curve, it records Price on the Horizontal axis and Frequency on the Vertical axis.  To map the doji onto the relevant axis of the distribution curve, it needs to be flipped on to its side, for the doji’s price points to line up against the vertical axis.  So, a price that Closes at the same price it Opened, is recorded as 2 price points with twice the frequency of the High and Low.  With a distribution curve, you cannot leave the lines joining the dots of the doji on the graph.  All that is mapped is 4 dots representing the doji’s price points.  Take away the lines joining the dots.  Question: Where’s the doji? Not relevant anymore. Same logic applies to any candlestick (spinning top, hammer, etc.).  Candlesticks lose their characteristics, once they are mapped onto a distribution curve.  The implication is the same for the OHLC method used to count fractals in Elliot Waves and wave counts once price is mapped in its dispersion mode, the waves lose their characteristics. To visualize this problem with time-based charts, watch the video on Why Time-Based Charts (Bar/ Candlesticks/Heikin Ashi, etc.) lose their characteristics once mapped onto a Distribution Curve.Is it necessary to reconcile a charting method with the distribution curve? Yes, 68% is equal to one Standard Deviation (?).  –/+1? sets the parameters for the probabilities, which you construct an option spread around to test if the strikes will be touched or not touched, from the date a spread is filled till its expiry date.Bear in mind, changing the time frames in time-based charts be it Candlesticks, Heikin-Ashi, OHLC from minute/hour/day/week to reconcile conflicting patterns in one time-frame against another, does nothing to help you work out the Theta as decay in a debit spread; or, the positive Theta as premium sold in a Credit spread.  The only unit of time required to feed into a Theoretical pricing model is the expiration date, in turn affecting the probabilities per day for the number of days that passes.  As the units of time in time-based charts have no value in Theoretically pricing an option, it makes no sense to use them.So, what are time-based charts (Candlesticks, OHLC Bars and Heikin-Ashi) useful for? They are useful, for trading the underlying itself.  When you trade the underlying itself, aside from dealing with +/- Delta (directional risk), all the other Greeks (Gamma, Theta and Vega) are equal to zero.  Time-based charts are relevant for trading deep ITM options as a surrogate to the product for purely directional trading of the underlying itself.Do bear in mind with options, the deeper the ITM you go, the wider the Bid-Ask spread becomes compared to the narrower Bid-Ask spread differences in the ATM or OTM strikes.  Have you got enough capital in the account to keep trading at the ITM strikes only?  This is why many retail traders with account sizes below USD $25K look for increasing lower priced products, for e.g. $20 and below, as they search for ITM strikes that are affordable for them to trade using Candlestick/OHLC/Heikin-Ashi charts.  By virtue of being lower priced, these products often suffer illiquid open interest at their strikes, making you chase price for an uncompetitive fill, only to result in poor price-profit performance.  The other extreme is to over spend on ITM strikes of a higher priced product, for example $100 and above, as you found a trade candidate using some “special” pattern scanning software, only to breach the money management rule of 2%-5% per trade, in filling the order.Is there an example of a portfolio with consistent wins and limited losses that applies Point & Figure methods without the use of Candlesticks/OHLC/Heikin Ashi? Yes.  Follow the link below, entitled “Consistent Results” for a model retail option trader’s portfolio that only uses Point & Figure techniques.  Other than stock option trading, the portfolio includes option trades from non-equity asset classes.Light is needed to see; but, trading enlightenment will not come from a candlestick. And counting fractals within waves only serves to oscillate your pupils.

]]> http://optionstrangle.net/stock-option-trading-a%c2%80%c2%93-candlesticks-ohlc-bars-lose-their-patterns-on-a-distribution-curve/feed 0 Online Options Trading – Portfolio Measures and Trade Performance Metrics http://optionstrangle.net/online-options-trading-a%c2%80%c2%93-portfolio-measures-and-trade-performance-metrics http://optionstrangle.net/online-options-trading-a%c2%80%c2%93-portfolio-measures-and-trade-performance-metrics#comments Wed, 06 Jan 2010 21:52:50 +0000 admin http://optionstrangle.net/online-options-trading-a%c2%80%c2%93-portfolio-measures-and-trade-performance-metrics The Reward of Profit and the Risk of Losses for retail option trading needs to be managed at 2 related levels of performance: Portfolio and Trade Specific.At the Portfolio level for online options trading, there are 3 types of Targets that must be set, even before you trade.Maximum Return Target: complete achievement of the “ideal” measure. Dream of the “ideal” that stretches you beyond what is practical. For example, earn 2-3 times your monthly living expenses with the monthly trading profit. This is to stretch your imagination well beyond mediocrity. Even if you fail, you just might end up with more than your original target.Minimum Return Target: the lowest acceptable measure, achievable under most conditions, excluding a catastrophic market event. Use the historical annualized return of the S&P 500 between 10%-12% (prior to the 2008 financial pandemic), as the lowest acceptable boundary.  The S&P 500 being a widely accepted benchmark for trading equities is adequate to base the minimum target off, though your portfolio needs to be profitable – being ahead of the $SPX in negative territory does not count.  Below the historical annualized return range of 10%–12%, is the 3 Month T-Bill, presently near zero.  While the T-bill theoretically represents an “absolutely” zero risk investment, even the safest investments will still carry a residual amount of risk no matter how small that risk is.  The point is this.  You got into options and all that Greek terminology, not to make salads; but to beat the performance of equities as an asset class.  If your portfolio’s return is between what is near zero-risk and 10%–12% per annum, you are just delaying reaching a point of pain that marks failure in grasping the base-line ability to control risks.  If the returns of your portfolio are between 0%–12% and you plan to continue trading options, processes within your trading process will need to be re–engineered.”Halt Trade” Target: cumulative losses reach an absolute amount below the Minimum Return, making it necessary to stop trading altogether for a stated period.  10% of [(60% x Cash Balance at the start of the year); or Net Liquidating Value].  Example, for a $50,000 trading account, 10% x (60% x $50,000) = $3,000 of losses in total, is the absolute amount to halt trading.  Why 10%? Blowing up your self-funded capital is final.  There is no bail out package, as a home options trading business does not have access to bank loans; or, shareholders’ equity to finance your personal trades.Now, drilling down to Trade Specific performance measures.Even before you calculate the metrics, characteristically, what makes for a consistently managed portfolio are these traits:

Where can I see this step up function in a consistently profitable portfolio, with these portfolio measures and trade performance metrics? Follow the link below, entitled “Consistent Results” to see a model retail option trader’s portfolio that shows these traits.Moving onto the hard metrics.  There’s 2 ways to count the Return on your trading capital.

In both cases, you can minus the Total Cost of Commissions from Total Profit, to get a Total Net Profit number.  The, divide the Total Net Profit by the Start of Year Cash Balance; or, Net Liquidating Value.  Net Liquidating Value is how much your entire trading account is worth, which is equal to Total Cash + Options Value + Stocks Value + Commodities Value + Bonds Value. The Start of Year Cash Balance is straightforward – it is the money in the account at the beginning of that trading year. Cash increases when you are short securities; but, cash decreases, as you get long on securities.To review your performance, calculate these metrics using the Profit (wins) and Loss (losers) from your account:

The Average Win divided by the Average Loss measures how RESPONSIVE you are in taking profits and cutting losses.Combine the Accuracy ratio with the Responsiveness ratio to get your Performance Ratio.Performance Ratio = (Win/Loss Probability) x (Average Win / Average Loss).  Always aim to maintain the Performance Ratio above 1.00. Why?  The commonly known money management rule is to allocate 2%-5% of (60% x Net Liquidating Value of the account) per trade.  What is not commonly practiced is the discipline of moderating a +/- 1% in trade allocation between the 2%-5% allocation.

This is how to achieve a ladder effect in stepping up profits and stepping down losses. This mechanism of stepping up/down is an indispensable tool for rewarding profit and to discipline the risk of losses.  It forces you to improve both ACCURACY and RESPONSIVENESS before raising your position size.

Where can I learn more about portfolio measures and trade performance metrics as part of a total trading system? Follow the link below, for 55 hours of video-based learning of online options trading from home.

]]> http://optionstrangle.net/online-options-trading-a%c2%80%c2%93-portfolio-measures-and-trade-performance-metrics/feed 0 Option Trading – As Risky As The Reputation?… http://optionstrangle.net/option-trading-as-risky-as-the-reputation http://optionstrangle.net/option-trading-as-risky-as-the-reputation#comments Thu, 17 Dec 2009 14:48:01 +0000 admin http://optionstrangle.net/option-trading-as-risky-as-the-reputation Options Trading has a reputation for being extremely risky, but this reputation is in large part undeserved. True, option trades are extremely risky – even dangerous if you have no idea what you are doing. However, that is true of all forms of offline or online trading, and trading in options is no exception.
While options trading has this reputation among laymen, it is often considered to be a form of risk limitation with professional traders. After all, in what other form of investment can you guarantee the maximum loss you can suffer right at the point where you enter the trade?
Options are contracts that give the purchaser the right to buy or sell an underlying security, such as a stock, a bond or a commodity, at a fixed price and for a fixed time period only. You can find options on underlying securities such as stocks, mutual funds, bonds, commodities, and more.
Option trading gives you the chance to exploit a whole range of market opportunities that are unavailable with conventional online stock or forex trading. For example, one class of option trade allows you as the buyer to make money if you expect the market to move strongly in one direction or the other, but you are not sure in which. If you are the seller of position, by contrast, you are betting that the market either goes nowhere directionally and/or the volatility declines.
Trading in options can actually lower your risk. For example, whenever you buy an underlying stock, there is always the extremely small, but non-zero, risk that the company can go bust and the stock price can first be suspended and then go to zero. That means that your potential loss is the point difference between the price you entered the stock trade and zero, multiplied by the number of shares you own! If you had done the corresponding option trade by contrast, i.e. buying call options on the stock, your loss would be simply the price you paid for the options.
Where options are very risky is where untrained traders go “naked short”, as it is called. In one common example, they sell put options on a stock index future and collect the option premium as payment. This gives the buyer the right to sell the stock index future back to the put option seller at a fixed price, called the strike price. This is fine as long as the underlying index continues to rally and the strike price is basically never reached. However, in one famous example, one hapless option punter, who had been happily selling put options on the FTSE index futures for years and collecting the cash, got badly caught when the entire stock market crashed in 1987, and the option buyers exercised their right to sell their positions at prices much higher than the current market!
However, such foolishness apart, option trading can be an extremely profitable way to trade in stocks, forex, bonds, currencies or whatever. When used properly, they can actually limit your risk drastically. Option trading can allow you to create positions and exploit market opportunities not otherwise available. Best of all, if you combine options with the underlying instrument, you get to create a whole range of interesting risk profiles.
The key to success in option trading is, as with anything else in life, to study the subject hard before trying to trade and, if possible, begin by paper trading the market. Once you are satisfied that you know what you are doing and have a valid option trading methodology, then you can begin risking real money. Even then, you only trade very small to start with and with money that you can afford to lose. Once you know what you are doing, and your account size show some nice profits, then you can afford to trade progressively larger size for progressively larger profit.

]]> http://optionstrangle.net/option-trading-as-risky-as-the-reputation/feed 0 Stock Option Trading Millionaire Principles http://optionstrangle.net/stock-option-trading-millionaire-principles http://optionstrangle.net/stock-option-trading-millionaire-principles#comments Sun, 13 Dec 2009 23:21:39 +0000 admin http://optionstrangle.net/stock-option-trading-millionaire-principles INTRODUCTION
Having been trading stocks and options in the capital markets professionally over the years, I have seen many ups and downs.
I have seen paupers become millionaires overnight…
And
I have seen millionaires become paupers overnight…
One story told to me by my mentor is still etched in my mind:
“Once, there were two Wall Street stock market multi-millionaires. Both were extremely successful and decided to share their insights with others by selling their stock market forecasts in newsletters. Each charged US$10,000 for their opinions. One trader was so curious to know their views that he spent all of his $20,000 savings to buy both their opinions. His friends were naturally excited about what the two masters had to say about the stock market’s direction. When they asked their friend, he was fuming mad. Confused, they asked their friend about his anger. He said, ‘One said BULLISH and the other said BEARISH!’”
The point of this illustration is that it was the trader who was wrong. In today’s stock and option market, people can have different opinions of future market direction and still profit. The differences lay in the stock picking or options strategy and in the mental attitude and discipline one uses in implementing that strategy.
I share here the basic stock and option trading principles I follow. By holding these principles firmly in your mind, they will guide you consistently to profitability. These principles will help you decrease your risk and allow you to assess both what you are doing right and what you may be doing wrong.
You may have read ideas similar to these before. I and others use them because they work. And if you memorize and reflect on these principles, your mind can use them to guide you in your stock and options trading.
PRINCIPLE 1
SIMPLICITY IS MASTERY
When you feel that the stock and options trading method that you are following is too complex even for simple understanding, it is probably not the best.
In all aspects of successful stock and options trading, the simplest approaches often emerge victorious. In the heat of a trade, it is easy for our brains to become emotionally overloaded. If we have a complex strategy, we cannot keep up with the action. Simpler is better.
PRINCIPLE 2
NOBODY IS OBJECTIVE ENOUGH
If you feel that you have absolute control over your emotions and can be objective in the heat of a stock or options trade, you are either a dangerous species or you are an inexperienced trader.
No trader can be absolutely objective, especially when market action is unusual or wildly erratic. Just like the perfect storm can still shake the nerves of the most seasoned sailors, the perfect stock market storm can still unnerve and sink a trader very quickly. Therefore, one must endeavor to automate as many critical aspects of your strategy as possible, especially your profit-taking and stop-loss points.
PRINCIPLE 3
HOLD ON TO YOUR GAINS AND CUT YOUR LOSSES
This is the most important principle.
Most stock and options traders do the opposite…
They hold on to their losses way too long and watch their equity sink and sink and sink, or they get out of their gains too soon only to see the price go up and up and up. Over time, their gains never cover their losses.
This principle takes time to master properly. Reflect upon this principle and review your past stock and options trades. If you have been undisciplined, you will see its truth.
PRINCIPLE 4
BE AFRAID TO LOSE MONEY
Are you like most beginners who can’t wait to jump right into the stock and options market with your money hoping to trade as soon as possible?
On this point, I have found that most unprincipled traders are more afraid of missing out on “the next big trade” than they are afraid of losing money! The key here is STICK TO YOUR STRATEGY! Take stock and options trades when your strategy signals to do so and avoid taking trades when the conditions are not met. Exit trades when your strategy says to do so and leave them alone when the exit conditions are not in place.
The point here is to be afraid to throw away your money because you traded needlessly and without following your stock and options strategy.
PRINCIPLE 5
YOUR NEXT TRADE COULD BE A LOSING TRADE
Do you absolutely believe that your next stock or options trade is going to be such a big winner that you break your own money management rules and put in everything you have? Do you remember what usually happens after that? It isn’t pretty, is it?
No matter how confident you may be when entering a trade, the stock and options market has a way of doing the unexpected. Therefore, always stick to your portfolio management system. Do not compound your anticipated wins because you may end up compounding your very real losses.
PRINCIPLE 6
GAUGE YOUR EMOTIONAL CAPACITY BEFORE INCREASING CAPITAL OUTLAY
You know by now how different paper trading and real stock and options trading is, don’t you?
In the very same way, after you get used to trading real money consistently, you find it extremely different when you increase your capital by ten fold, don’t you?
What, then, is the difference? The difference is in the emotional burden that comes with the possibility of losing more and more real money. This happens when you cross from paper trading to real trading and also when you increase your capital after some successes.
After a while, most traders realize their maximum capacity in both dollars and emotion. Are you comfortable trading up to a few thousand or tens of thousands or hundreds of thousands? Know your capacity before committing the funds.
PRINCIPLE 7
YOU ARE A NOVICE AT EVERY TRADE
Ever felt like an expert after a few wins and then lose a lot on the next stock or options trade?
Overconfidence and the false sense of invincibility based on past wins is a recipe for disaster. All professionals respect their next trade and go through all the proper steps of their stock or options strategy before entry. Treat every trade as the first trade you have ever made in your life. Never deviate from your stock or options strategy. Never.
PRINCIPLE 8
YOU ARE YOUR FORMULA TO SUCCESS OR FAILURE
Ever followed a successful stock or options strategy only to fail badly?
You are the one who determines whether a strategy succeeds or fails. Your personality and your discipline make or break the strategy that you use not vice versa. Like Robert Kiyosaki says, “The investor is the asset or the liability, not the investment.”
Understanding yourself first will lead to eventual success.
PRINCIPLE 9
CONSISTENCY
Have you ever changed your mind about how to implement a strategy? When you make changes day after day, you end up catching nothing but the wind.
Stock market fluctuations have more variables than can be mathematically formulated. By following a proven strategy, we are assured that someone successful has stacked the odds in our favour. When you review both winning and losing trades, determine whether the entry, management, and exit met every criteria in the strategy and whether you have followed it precisely before changing anything.
In conclusion…
I hope these simple guidelines that have led my ship out of the harshest of seas and into the best harvests of my life will guide you too. Good Luck.

]]> http://optionstrangle.net/stock-option-trading-millionaire-principles/feed 0 Option Trading Tip – Are You A Jack Of All Trades & A Master Of None? http://optionstrangle.net/option-trading-tip-are-you-a-jack-of-all-trades-a-master-of-none http://optionstrangle.net/option-trading-tip-are-you-a-jack-of-all-trades-a-master-of-none#comments Thu, 03 Dec 2009 21:49:46 +0000 admin http://optionstrangle.net/option-trading-tip-are-you-a-jack-of-all-trades-a-master-of-none I make a living out of trading options…and a pretty good one at that!

For a long time I couldn’t say those words as I struggled just to hold on to my capital, let alone make it grow.

Though there were several reasons why I struggled (including being grossly undercapitalized and at the same time placing too much of my trading bank on individual trades) the main reason for my struggle I believe was a lack of focus.

By ‘lack of focus’ I mean that I was constantly jumping around trying to implement too many different option trading strategies from basic call and put buying, to putting on multi leg spread tades, believing that the more complex the strategy, the greater my chance of success.

I had become a ‘Jack Of All Trades & A Master Of None’ and the only people that were making money from my option trading were my brokers.

One day a friend of mine (a very successful futures trader) said to me, “You don’t need to know everything about trading the markets to make money and be a success. You just need to ‘focus’ and become an expert in one or at most a few different trading strategies and know exactly when and how to use them. The rest is just practice!”

Those words rang loudly in my ears and from that point onwards I narrowed my focus.

I decided that I would go back to the very basics of option trading and only buy calls and puts with the intention of becoming very good at picking the short-term direction of stocks.

Today, almost 2 years later and after going through a steep and often expensive learning curve, buying calls and/or puts is what brings in the largest portion of my current monthly income.

I also use a couple different spread trading strategies when the market moves sideways, but my main ‘focus’ is on picking the short-term direction of a small number of stocks that I have gotten to know VERY well (through backtesting), and then buying the appropriate option based on risk vs reward and my short-term outlook.

The success I’m enjoying today (19 profitable months out of the last 24) is due to becoming proficient at reading stock charts and developing an option trading system that I am comfortable with and performs well and by applying my trading rules consistently.

Ultimately you only need to know a few different strategies to be able to trade any stock up, down, or sideways.

The options themselves are simply the ‘tools’ to make money from your ‘opinions’ and in my experience the tools that are the easiest to use, have also been the most profitable.

]]> http://optionstrangle.net/option-trading-tip-are-you-a-jack-of-all-trades-a-master-of-none/feed 0 Options Trading Strategies – Intermarket Analysis in Brief for Retail Asset Allocation http://optionstrangle.net/options-trading-strategies-a%c2%80%c2%93-intermarket-analysis-in-brief-for-retail-asset-allocation http://optionstrangle.net/options-trading-strategies-a%c2%80%c2%93-intermarket-analysis-in-brief-for-retail-asset-allocation#comments Tue, 01 Dec 2009 14:17:31 +0000 admin http://optionstrangle.net/options-trading-strategies-a%c2%80%c2%93-intermarket-analysis-in-brief-for-retail-asset-allocation If you are trading a mix of Verticals, Calendars and Iron Condors across highly liquid indexes like the DJX, DIA, MNX, QQQQ, RUT, SMH, SPY and XSP, is your trading risk adequately diversified? No.In choosing the MNX, QQQQ, SMH, SPY and XSP, there is a duplication of stock components in these Indexes: for example, AMAT (Applied Materials) is a component of all 5 Indexes.  Bear in mind the MNX and the QQQQ are both smaller versions of the Nasdaq100 Index, the only difference being the MNX is an European styled cash settled Index and the cubes (QQQQ) is an American style stock settled Index.  Another example, Apple (AAPL) is a component of the MNX/QQQQ and SPY/XSP – both the SPY and the XSP track the S&P 500, the SPY is American style stock settled and the XSP is European style cash settled.  Duplication is not diversification.  Even if you allocated capital to the smaller versions of the Dow: DJX, the European style cash settled version of the DIA which is the American style stock settled version.  Moreover, if you extended capital allocation to trade the RUT, thinking you are diversifying into small-cap stocks and away from large-caps, you just sunk more of your trading capital into equities.  Again, you cannot achieve diversification by adding more capital in the same asset class.  You need to learn how to trade options without concentration risk in stocks.  Do not confuse asset category (market capitalization) with asset class.This is where there is a need to understand Intermarket relationships.  Intermarket analysis requires the simultaneous analysis of 4 main Asset Classes: Currencies (U.S. Dollar remains most liquid of all major traded currencies), Commodities, Bonds and Stocks.  Synchronizing the rotation of asset allocation within your own portfolio lies in getting a grip on how these four markets interrelate with each other.Here’s the synopsis of the relationships.  Commodities lead bonds, bonds lead stocks and stocks lead commodities.  The cycle holds true at least in a normal inflationary/disinflationary environment.  Other than itself, Commodities affects 2 markets (Bonds and Stocks); effectively, impacting 3 out of the 4 Intermarket relationships.  Even if you do not trade Commodity ETFs as part of your portfolio, you need to track Commodities as a leading economic cycle indicator.  The futures/Mini Futures that you see on news headlines/trading screens are relevant only as daily gauges for stock market behaviour.  They are not a cycle indicator across Asset Classes.So, you may already understand the criteria to define a “normal” economic cycle for the Directional Relationships to behave “ideally” (see below); BUT, how do you determine which Asset Class is driving the cycle? In other words, at a given point in the Intermarket cycle, how do you determine which Asset Class has the DOMINANT Relative Strength to trade? Follow the link below for a video-based course, to learn how Relative Strength – a rotational algorithmic measure is used to replace conventional Fundamental Analysis, as an asset allocation technique.Moving on, here’s the Business Cycle in brief.  Bonds lead stocks, to trend in the same direction – except during deflation when bonds rise and stocks fall.  On average bonds are 18 months ahead of stocks in rising to their peak or falling to their bottoms; thereafter, stocks follow in the same direction.  If bonds have not broken down yet, this extends the gains in the stock market, acting as support for prevailing stock market levels.  The real risk begins to build 5-7 months after the bond market peaks or bottoms, thereafter the next 6 months stocks accelerate in the direction bonds have set.Typically, commodities and bonds have an inverse relationship: as commodities rise, bonds falls but as commodities fall, bonds rise. Inflationary expectations affect bond prices. US Dollar movements which is tied into Monetary Policy changes affects commodity prices.  Commodities lead bonds 12–18 months in advance (it takes this long for Monetary Policy to come into effect) and 24–27 months before the economy fully absorbs the policy changes.Now, the relationship between commodities and stocks. Stocks tend to lead commodities. Commodities are a hedge against inflation, with price inflation and higher inflation expectations occurring towards the end of the business cycle.Money and company growth using credit (loans) takes time to make its way through the economic system, from making prices rise to raising expectations on inflation. Thus, commodities usually outperform at the end of the business cycle.Rising bond prices generally raise stock prices in recovery, with falling commodity prices confirming an economic expansion phase is in play. As the expansion matures and begins to decelerate, watch for bonds to turn down first (as interest rates rise), followed by stocks.Finally, it is after commodities outperform stocks and start turning down, this signals the end of an economic expansion with the probable start of activity decelerating, then slipping into an impending recession.Retail traders can keep reading about the economics of inter–market analysis and asset diversification. Though, they will not solve these key issues, every option trader trading with USD $25-$50K or less, must deal with for retail asset allocation purposes:

… if you can afford to diversify …

Where can I learn how to trade options profitably using Intermarket analysis with retail asset allocation methods? Follow the link below, entitled “Consistent Results” to see a profitable retail option trader’s portfolio that is set up to cycle in and cycle out of Intermarket relationships, between asset classes.Why is it possible? I’m using optionable ETFs (Commodity, Currency, Emerging Market and REIT), as well as optionable broad based/sector Equity Indexes, to trade the volatilities of each respective asset class. I do not need to trade Commodities and Currencies directly.  Remember, volatility can be added to/reduced from the portfolio, as not all Asset Classes or Sectors or Individual Companies or Countries move up/down in value ALL at the same time; and/or, ALL at the same rate.

]]> http://optionstrangle.net/options-trading-strategies-a%c2%80%c2%93-intermarket-analysis-in-brief-for-retail-asset-allocation/feed 0 Options Trading Strategies – Book Review – Guy Cohen, The Bible of Options Strategies http://optionstrangle.net/options-trading-strategies-book-review-guy-cohen-the-bible-of-options-strategies http://optionstrangle.net/options-trading-strategies-book-review-guy-cohen-the-bible-of-options-strategies#comments Sun, 29 Nov 2009 21:16:59 +0000 admin http://optionstrangle.net/options-trading-strategies-book-review-guy-cohen-the-bible-of-options-strategies Most trading literature on option strategies tend to lean towards mathematical formulas to define the construction of a spread.  Guy Cohen has chosen to use pictorial logic, even with the Greeks unique to a particular strategy, to piece together the legs of a spread with diagrams.Diagrams that connect with each other are a much more intuitive way to learn for those less inclined to numerical formulas.  Still, the logic of the math remains robust and intact. The layout of the book makes it easy to navigate around the text.  In addition to strategies being listed by the chapter and page there is a reference to the strategy’s main category with sub-categories, which are:

Guy Cohen has extensive experience of both the US and UK derivatives and stock markets.  He specializes in trading and analytics applications ranging from real estate to derivatives and has developed comprehensive business, trading and training models, all expressly designed for maximum user-friendliness. There are adequate reader reviews on Amazon and Google Book Search, to help you decide if you will get the book. For those who have just started or are about to read the book, I’ve summarized the core concepts in the larger and essential chapters to help you get through them quicker.The number on the right of the title of the chapter is the number of pages contained within that chapter. It is not the page number.  The percentages represent how much each chapter makes up of the 302 pages in total, excluding appendices.1  The Four Basic Options Strategies.  20, 6.62%.2  Income strategies.  68, 22.52%.3  Vertical Spreads.  30, 9.93%.4  Volatility Strategies.  56, 18.54%.5  Sideways Strategies.  44, 14.57%.6  Leveraged Strategies.  20, 6.62%.7  Synthetic Strategies.  54, 17.88%.8  Taxation for Stock and Options Traders.  10, 3.31%.Focus on chapters 2, 4, 5 and 7, which makes up about 74% of the book. These chapters are relevant for practical trading purposes.  Here are the key points for these focus chapters, which I’m summarizing from a retail option trader’s perspective. Chapter 2: Income Strategies. These strategies construct spreads where part of the spread sells Theta as premium within a shorter term (typically 30-45 days), to collect income.  In its entirety the strategy may result in a Net Debit or Net Credit spread.  There are 13 types of spreads in this category: Covered Call, Short (Naked) Put, Bull Put Spread, Bear Call Spread, Long Iron Butterfly, Long Iron Condor, Covered Short Straddle, Covered Short Strangle, Calendar Call, Diagonal Call, Calendar Put, Diagonal Put and a Covered Put (a.k.a. Married Put).Chapter 4: Volatility Strategies. These strategies use spreads that are indifferent to price direction, so long as price explodes out of range.  For a given explosion in price, the volatility of the spread needs to rise for a Net Debit spread and fall for a Net Credit spread,.  There are 11 spread types are defined in this category: Straddle, Strangle, Strip, Strap, Guts, Short Call Butterfly, Short Put Butterfly, Short Call Condor, Short Put Condor, Short Iron Butterfly and Short Iron Condor.Chapter 5: Sideways Strategies. These strategies involve non-directional spreads, requiring price to drift within a confined range. As price remains range bound, the volatility of the spread needs to rise for a Net Debit spread and fall for a Net Credit spread.  There are 11 types of spreads in this category: Short Straddle, Short Strangle, Short Guts, Long Call Butterfly, Long Put Butterfly, Long Call Condor, Long Put Condor, Modified Call Butterfly, Modified Put Butterfly, Long Iron Butterfly and Long Iron Condor. Chapter 7: Synthetic Strategies. Synthetic strategies mimic the risk profile of a stock, futures or other option position by combining calls, puts with or without stock.  Though typically, most synthetic positions are either long or short stock.  If you have a 401K plan or employee stock purchase plan that is long stock, then it may make sense to consider synthetic strategies, as you are already long Delta.  There is unlimited risk for some synthetic spreads, regardless if the strategy involves stock or not.  There are disadvantages to using synthetics.  12 spread types are defined in this category: Collar, Synthetic Call, Synthetic Put, Long Call Synthetic Straddle, Long Put Synthetic Straddle, Short Call Synthetic Straddle, Short Put Synthetic Straddle, Long Synthetic Future, Short Synthetic Future, Long Combo, Short Combo and Long Box.From a retail option trader’s viewpoint, I prefer to establish positions without the use of stock.  Using stock synthetically in a position makes each trade more capital intensive than it needs to be.  Especially, if your trading account is below USD $50,000.  The use of stock in configuring these positions does not add material merit in controlling risk and there is no added monetary benefit in tying up available trading capital in a stock-dependent synthetic position that could otherwise be achieved without the use of stock.  As an options trader in the first place, you want as little to do with the stock itself as possible, other than to configure the required option position around the underlying product, which can be substituted with a cash-settled Index instead of a stock-settled Index.Out of a total of 56 strategies covered in the book, I have reduced the list down to 35 Limited Risk Spread types that do not need to include stock as part of its original construction.  Limited Risk means there is a cap to the maximum loss – “Capped Risk” is the term used in the book. This should always be the starting point of any strategy you choose to construct. Do not just look at the unlimited profit (Uncapped Reward) side of the strategy without realizing that there is an unlimited loss (Uncapped Risk) side to same strategy.Limited Risk Spreads with “Unlimited” Reward and their Directional outlook.1. Long Call.    Bullish.2. Long Put.    Bearish.    3. Put Ratio Backspread.    Bearish; reverse Bullish.4. Call Ratio Backspread.    Bullish; reverse Bearish.        5. Straddle.    Indifferent/~Neutral.6. Strangle.    Indifferent/~Neutral.7. Strip.    Bearish.8. Strap.    Bullish.    9. Guts.    Indifferent/~Neutral.    1-9 are Debit spreads: IV needs to rise.10. Bull Put Ladder.    Bearish.    10-11 are Credit spreads: IV needs to fall.11. Bear Call Ladder.    Bullish.    Limited Risk Spreads with Limited Reward and their Directional outlook.12. Bear Put Spread.    Bearish.13. Bull Call Spread.    Bullish.14. Long Call Calendar.    Bullish; Indifferent/~Neutral.15. Long Put Calendar.    Bullish; Indifferent/~Neutral.16. Long Call Butterfly.    Indifferent/~Neutral.17. Long Put Butterfly.    Indifferent/~Neutral.18. Long Box.    Indifferent/~Neutral.19. Long Call Condor.    Indifferent/~Neutral.20. Long Put Condor.    Indifferent/~Neutral.21. Long Iron Butterfly.    Indifferent/~Neutral.22. Long Iron Condor.    Indifferent/~Neutral.    12-22 are Debit spreads: IV needs to rise.23. Bear Call Spread.    Bearish.    23-35 are Credit spreads: IV needs to fall.24. Bull Put Spread.    Bullish.25. Short Iron Butterfly.    Indifferent/~Neutral.26. Short Iron Condor.    Indifferent/~Neutral.27. Diagonal Call.    Bearish.28. Diagonal Put.    Bullish.29. Modified Call Butterfly.    Bearish to ~Neutral.30. Modified Put Butterfly.    Bullish to ~Neutral.31. Short (Naked) Put.    Bullish.32. Short Call Butterfly.    Indifferent/~Neutral.33. Short Call Condor.    Indifferent/~Neutral.34. Short Put Butterfly.    Indifferent/~Neutral.35. Short Put Condor.    Indifferent/~Neutral.Other than the 35 Defined Risk Spreads that do not require stock as part of their original construction for entry, there are 6 Defined Risk spreads that need stock to configure their positions. The 6 positions that I have deliberately excluded from the list above are the Long Call Synthetic Straddle, Long Put Synthetic Straddle, Synthetic Call, Synthetic Put, Collar and Covered Call.In conclusion, for new to intermediate traders do not be overwhelmed by the 56 strategies in the book.  It’s entitled the “Bible of Options Strategies” for a reason. What is critical is to get a deep understanding of the Long Call, Long Put, Short Call, Short Put, Long Vertical Call/Put, Short Vertical Call/Put and the Long Calendar Call/Put. That is the 4 Basic Options Strategies, plus the Vertical and the Calendar – the only 2 strategies that floor traders define as true spreads. The other combinations are a mixture of the basics with or without stock.

]]> http://optionstrangle.net/options-trading-strategies-book-review-guy-cohen-the-bible-of-options-strategies/feed 0 Stock Option Trading (Basic Information) http://optionstrangle.net/stock-option-trading-basic-information http://optionstrangle.net/stock-option-trading-basic-information#comments Sat, 28 Nov 2009 10:31:09 +0000 admin http://optionstrangle.net/stock-option-trading-basic-information It is no secret that 2008 was a terrible year for most stock investors, and most probably things are going to get worst in the future. The US and the World economy are in a recession that will probably last at least for the rest of 2009. The recession translates into less demand for products sold by companies, which means less profits from companies and then lower stock prices. In very simple terms this is the summary of why the stock market is going lower.
If you are an investor that is loosing money on your stock portfolio, maybe you should take a look at another market that can help, the Option Market. Most investors don’t know anything about stock option trading, or stock option strategies, or what is a Call or a Put option. The truth is the Option Market is a sophisticated market mostly used by professional investors. But this does not mean individual investors should stay away from it. There are many firms that will offer you advise on this market (for example www.teofutures.com), others will offer you newsletters and education so you can familiarize with this market.
It is not my intention to explain in full detail about the option market, but these are some of the most important characteristics about stock option trading:
1.- You don’t need a lot of money to trade this market. In general terms you should open an account with minimum $10,000 in order to be able to diversify that money into different stock option strategies. Some firms allow you to open with less than that, but based on experience accounts that start with small amounts of money generally loose 100% of their investments.
2.- When trading stock options you can bet that the price of a stock will go higher or lower in the future. This means you still can make money even though the markets are down.
3.- Stock option investing is a fast investment. You don’t buy and hold when trading options. You buy and sell, sometimes even in the same day. When purchasing options, usually the more time you keep a position the higher your chances of loosing money.
4.- Trading options is considered risky because you can loose 100% of your investment capital and with some stock option strategies you can even loose more money than your original investment.
5.- Be very careful whom you open an account with. Preferably follow strategies where you only buy Options (Calls or Puts) or spreads. Stay away from firms that will offer you guarantee returns or spectacular profits. As a rule of thumb anything between 0% and 120% return a year is an actual real return to obtain from Option trading. Returns of 500% a year, or turning $15,000 into $200,000 in 18 months, or 100% returns in the first 6 months, it is better to stay away from those offers. Maybe you can obtain those returns but the risks are very high so chances are you most probably loose all your money trying to obtain that type of results.
As mentioned before, stock option trading could be a very good alternative to help investors during these difficult times. Don’t invest all your capital in this market and be very careful whom you work with. Specially stay away from guarantee returns.

]]> http://optionstrangle.net/stock-option-trading-basic-information/feed 0 Is Option Trading Gambling? http://optionstrangle.net/is-option-trading-gambling http://optionstrangle.net/is-option-trading-gambling#comments Wed, 25 Nov 2009 22:20:20 +0000 admin http://optionstrangle.net/is-option-trading-gambling We have seen it way too often, haven’t we?
Advertisements that tout making thousands of percents in profits within days and millionaires made within weeks, all by option trading! Such advertisements usually draw hordes of hungry, indebted gamblers who need that “one big win” to recover their debts or losses elsewhere to their unusually expensive seminars.
95% of those who walked into such seminars, paid for it and actually traded options, lost all their money. 3% will make some money within the first few trades and then lose it all subsequently. 1% will really make some sustainable money and a final lucky 1% will make the 1000% a month on their first month (again, just to lose it all within the next month). Anyone who has been in this predicament usually think that option trading is nothing more than just a gamble on an instrument that has no value of its own.
Yet, many professional traders and fund managers are making a good, consistent profit from option trading! These professionals don’t make 1000% a month in profits, neither will they ever, but they continue to make a living in the markets month after month, year after year (me included)!
So, what makes option trading a real investment and trading activity to these professionals and a mere gamble for those who lost all their money attending option trading seminars?
The difference is in ATTITUDE. Attitude governs decisions and actions. Anyone who approaches option trading with the “get-rich-quick” attitude will also soon find themselves “getting-poorer-quicker” simply because these punters hoping to “make-it-big” on their next trade, totally rejects any semblance of a trade management strategy, totally cast aside sensible analysis in favor of a 50/50 “bet” and take totally senseless out of the money positions that either make it big or expire completely worthless!
A real option trading professional utilizes sensible money management strategy on every trading opportunity, weighted against the potential risk of non-performance. This means that a real option trader will never put all his money into one big out of the money position! A real option trading professional utilizes trade analysis methods based on proven methodologies so as to put the odds of performance in their favor and never treat every trade as a 50/50 bet. A real option trading professional calculates the amount of options leverage to be used on every trade so that his portfolio is never over-leveraged. A real option trading professional do not expect to make it big on his next trade and he is not aiming for one huge home run but a series of small wins that eventually adds up. A real option trading professional never allow one loss to wipe out his portfolio because he treats the market with respect knowing that no matter how much analysis has been conducted, there is always a chance that the market will work against him.
In a nutshell, a real option trading professional (and an option trading winner who stays in the game for years) differ from a gambler (who rarely survives for more than a month) mainly in terms of mental attitude! The wrong mental attitude transforms option trading from the sensible and sophisticated financial instrument that it is into nothing more than lottery tickets.
The problem with most option trading seminars today is that they don’t put these critical elements of successful option trading together! All they teach are how option trading can make anyone rich very quickly! It is like teaching someone how to queue up for a lottery ticket! A real option trading system incorporates all the critical elements to successful option trading; From looking for trading opportunities systematically, to analysis of that opportunity in view of the trading horizon required, to selecting the correct option based on the requirements of that opportunity to risk balanced trade management and more! One such option trading methodology is the Star Trading System that I have taught online for years.
So, isn’t it time you reviewed your attitude and approach towards option trading?

]]> http://optionstrangle.net/is-option-trading-gambling/feed 0 Options Trading Strategies – Treat Implied Volatility of Calls Separate From the IV of Puts http://optionstrangle.net/options-trading-strategies-a%c2%80%c2%93-treat-implied-volatility-of-calls-separate-from-the-iv-of-puts http://optionstrangle.net/options-trading-strategies-a%c2%80%c2%93-treat-implied-volatility-of-calls-separate-from-the-iv-of-puts#comments Tue, 24 Nov 2009 21:31:28 +0000 admin http://optionstrangle.net/options-trading-strategies-a%c2%80%c2%93-treat-implied-volatility-of-calls-separate-from-the-iv-of-puts The Implied Volatility (IV) of Calls needs separate treatment from the IV of Puts. Also, for specific options trading strategies treat the IV of both Puts and Calls as a combined bundle.Each option at each strike implies its own individual percentage value of the underlying product’s future volatility. This makes it unique from any other option within the same chain of a given expiry month. The individuality of an option’s percentage value at each strike is what draws the “smile” in the IV’s Skew.So, while an ITM Call has a corresponding OTM Put sharing the same strike, conversely an ITM Put has an OTM Call counterpart at the same strike, the Call must be treated uniquely as a Call and the Put uniquely as a Put. The more ITM an option becomes, its intrinsic value becomes higher and its extrinsic value is lowered. Conversely, at the same strikes where an ITM Call (or Put) gets deeper In The Money, the corresponding Put (or Call) becomes further OTM. The more OTM an option becomes, its extrinsic value rises higher and its intrinsic value is lowered. Even with ATM options, where the Call’s Delta is exactly 0.50 and the Put also has a Delta of exactly 0.50, the Implied Volatility on either side of that same ATM strike is different.While Calls and Puts appear side-by-side for a given strike, they are not identical twins to simply trade places. Think of it this way, each option has its own Intrinsic-Extrinsic fingerprint that makes that Call or Put identifiable only to itself.The logic for treating the Implied Volatility of Calls separate from the IV of Puts becomes obvious in the construction of specific spread types. Let’s break down the components making up the following spreads.

Now, let’s compare the above spreads with these other types of spreads.

Clearly, there are more spreads that require the Implied Volatility to be differentiated between Calls versus Puts, compared to the use of a combined IV. So, in choosing a data provider of Implied Volatility, make sure you get the IV data of Calls that is set apart from the IV of Puts; as well as, data that combines the IV of Calls and Puts together. That means 3 sets of IV data in one service.We have just established the structural logic for decoupling the IV of Calls from the IV of Puts. How do you apply this to a trade? Here’s how.

Is there a working example of a consistently profitable portfolio that treats Implied Volatility of Calls separate from the IV of Puts? Yes. Follow the link below, entitled “Consistent Results” to see a model retail option trader’s portfolio that applies this logic.To conclude, I’ll use an analogy. Though an egg comes in one shell, the yolk is separated from the white, for a different purpose that distinguishes the individual parts of that same egg. Treat Implied Volatility of an option’s anatomy in the same way.

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