New Option TraderLearning how to be a successful option trader and blogging about it

A collar provides maximum downside protection at a reasonable price because the
premium received from the sale of the call will partially offset the cost of the purchase of the put.

– Options University

The chat is about to begin, I’ll post my notes but these things move pretty fast so I’m not always able to get everything. I’m also just posting things that I think are significant, so I recommend if you want more detail listen/watch it on the chat archive at the Think or Swim site.  They now are archiving the video as well!  So, though it’s not live it’s still incredibly valuable as a recording.

These notes may be Think or Swim specific in some areas but hopefully are standard enough to be available at most brokers.

Today’s chat was basically about how to trade in market like this one (volatile, unpredictable, holiday weekend.. yada, yada, yada..) And, what they we’re saying is that this not a bad time for covered calls and naked puts (naked puts — only if you want the stock anyway.  I have a post coming up about naked puts).

Covered Calls

1. Show Covered Return column on Trade Tab.  “Covered Return” is the return you would get if you sold that covered call every month (annualized) — not the return for this particular month
2. Find a stock that’s been under a lot of selling pressure or reached a level of support.  Also, look for a reasonable level of volatility.
3. Buy the nearest OTM call in the nearest month with at least 20 days to expiration

Naked Puts

1. Same criteria for covered calls above but check the “covered return” for selling naked puts instead.  It may be significantly higher and/or the trade may end up costing you less since you’re not buying the stock but tying up capital in case you’re assigned.
2. If you’re not assigned you get to keep the premium — love that!
3. If you are assigned then you got the stock at cheapo price and the premium you received pays for part of the stock — not a bad deal if you ask me..

Candestick patterns should be considered in conjunction with the preceding trend.  For instance, a Bullish Engulfing pattern is significant AFTER a downtrend.  A Bearish Engulfing pattern is significant AFTER and uptrend.  In other words, these are not significant following a sideways movement.

Bullish Candlestick Notes:

• Dojis mean the stock is neutral — they’re not a confirmed signal to sell short
• Hammers are bullish but need a confirming indicator
• Shooting Stars are bearish especially if you see two in a row
• Bullish Engulfing pattern (1st on left) definitely need a preceding trend to interpret — see above paragraph

A few things to remember when doing Bull Spreads. This helped me a lot in keeping straight what this type of trade is doing and why…

The leg to focus on is the position with the more valuable leg. The short position is in effect a hedge!  Having this hedge reduces the cost and risk of the trade. Isolate the more valuable option — that’s what is driving the trade.

So, how do you decide which bullish option strategy to use?  Run the numbers…  The trade with the higher potential return and the lower potential loss is the winner.  Both are bullish option strategies but one uses calls and other puts.  And, one generates a credit to your account; the other a debit from your account.

Bull Call Spread Calculations (Debit Spread)

Max Profit =  Difference in strikes -  the premium
Max Loss =   The premium
Breakeven =  The long leg + premium (remember the short leg is basically a hedge)

Bull Put Spread Calculations (Credit spread)

Max Profit =  The premium (credit you received)
Max Loss =   Difference between the strikes – the premium received
Breakeven =  Strike price of the short put – premium received

This isn’t ALL there is to evaluating which vertical spread is right for a particular trade. But, it will get you most of the way there and is often enough on it’s own.

I am a devoted Think or Swim chat attendee.  It’s one of the things I love about this broker.

Dan Sheridan is a guest speaker today and the topic is, “Spread Criteria for Complex Option Trades and Position Management”

Will post notes during the chat.. Won’t be comprehensive just anything that really stands out.

If you like these notes and want more info, hook up with Dan Sheridan at Sheridan Options Mentoring

General Trading Tips:

1. Don’t JUST check the trade, look at how the WHOLE market is doing (indices, futures, VIX, etc.)
2. Don’t place trades the night before, let the market open and see what happens.  You can queue it but check the open before submitting the trade.  After hours trading could affect the opening in a way you didn’t expect.
3. Volatility may have skewed overnight, or otherwise become expensive making it the wrong time for the trade.
4. Set alerts if you want to know when the trades moves to a particular point so you can act right away.

Criteria for High Probability Iron Condors

• One month out (so in this case, December)
• Call delta between 7-9
• Put delta between 7-9 (but negative)
• Good trade for RUT
• This will be a credit spread
• Sell into market rallies
• Don’t leg into it — put the whole thing on at once
• Risk/Reward: Lower risk, so lower reward — but higher probability of success
• Sell when trade is @ 70% of maximum profit
• How to adjust:  When delta of short put gets to 20, take off some of the puts, roll them down

64% probability condor

• Stay in it for about 14-17 days
• When profit is around 15% of max profit start looking to close it
• In two weeks, theta starts kicking in to benefit of the trade
• Use front month – 30 days to expiration
• Use index product with volatility skew
• 20 delta options, both sides

Long term success in trading is driven by completely understanding the strategies you’re using

Hedge
Reducing the risk of loss by taking a position through options or
futures opposite to the current position they hold in the market.