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

Yes, I know, I’ve been absent.. Sorry about that.  Had a few things going on such as getting laid off (Yes, it’s a good thing, wanted to leave anyway), and the Options University Live Mastery classes started (very consuming, very intense).

So, anyway, this market has really been a shift for me because as long as I’ve been interested in the markets things have for the most part been pretty strong.  But, from everything I’m hearing we are in a bear market.  There may be rallies here and there but between the credit crisis, housing disaster, and falling dollar — it’s a bear market.  Let’s just face it.

However, there are bull markets in mining, agriculture, oil, and just about every currency except the dollar. Talking about the dollar gets into forex pairs, so I won’t go there… but the point is that the dollar is very weak.

Gold:
I think mining in general is pretty strong, but gold is seriously going through the roof!

gold

Agriculture:
Can anyone say Potash?  It’s at an all time high and this thing doesn’t look like it’s going to stop.

Oil:
And then we have oil which has broken through $100 a barrel — yikes!

I can hear it now.. naked puts are risky and dangerous — never use naked puts! Ever! That’s what we’re told when we’re first learning how to trade options, right? I know I’ve heard it more than once.

Well, there is a place for naked puts and it’s a good place — in an IRA. But, as long as you understand why you’re
buying them and what you’re trying to accomplish. Naked puts are a great way to acquire stock — stock that you want to buy, you’re GOING to buy anyway — at a lower price and a ultimately a higher ROI on the trade.

Normally, I’m not that into stock; too expensive. But, IRAs are a good place for stock and it’s still just as important to get the best return possible. You might hold a stock trade a little longer, but the purpose is still the same — to make a profit. So, getting the stock when it pulls back is a good thing because it increases your total return.

Key Points:

• If you’re going to use this strategy, you must want the stock — just at the cheaper price.
• You must have the cash in your account to buy the stock in case you get it at the cheaper price.
• This is a bullish stock acquisition strategy and not a bad way to to continually acquire stock that you intend to hold for a while.
• If you’re wrong about the direction of the stock, this trade can go against you because now you’ll be buying a falling stock on it’s way down. The goal is to buy a rising stock on a pullback but that is still in an uptrend.
• Your ROI will be higher due to two factors:
  1. The premium you receive from the naked put offsets the price of the stock
  2. Plus, you’re getting the stock when it pulls back, so it’s cheaper

How to Sell Naked Puts to Establish Long Stock Positions

1. Find a stock you like.  Use all your technical analysis skills and understanding of the company to determine to if it’s a good stock to own
2. Find the nearest available expiration date that has at least 23 calendar days to go. That may be the front month or it may be the next month.
3. Find the put option one strike OTM with a delta of 30-40
4. Sell that put short using a limit order. Selling this put short will give you the quickest rate of decay (in this case a good thing) relative to the highest probability of success.

By the way, I got this info from taking a free Options Planet class called, Options in Your IRA.  Options Planet is run by Think or Swim and they give these free classes because  they believe that an educated option trader is a successful option trader — what a concept!

One last thing… if your broker won’t let you do this, find another broker.  Think or Swim has no problem with it because they know this strategy is using cash secured puts and is just a more cost effective way of buying stock.

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

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

I’ve been focusing on mastering spreads for a while now because every other strategy is either a combination of spreads a just another type of spread. So, really understanding how spreads work and why is key to understanding all the other strategies.

Now, I know that there are bullish spreads and bearish spreads, and that some are credit spreads and others are debit spreads.  I also know that generally we’re talking about going long with two options in the same month but different strikes.  Or, going short with two options in the same month but two different strikes.

But what I don’t yet feel comfortable with is deciding between a bull call spread or a bull put spread (if I’m bullish that is). Or, if I’m bearish should I go with the bear call spread or the bear put spread?  Also, what are the general rules for what strike to buy, where should the greeks be, and how far/close to expiration I should place the trade???

Here are some of my notes from a recent class about spreads:

What is a spread?
An option strategy where you buy and sell options in a 1:1 ratio — as one trade. It’s a “vertical spread” because the options are spread between two different strike prices.  On the quote board  (back in the olden days) prices would be listed vertically –> hence the term “vertical spread”

Why use a spread?

1. They’re cost effective. Because you’re selling one of the options, it’s offsetting the cost of the one you’re buying and thus reducing the whole cost of the trade.  This is good way to trade the more expensive stocks/options.
2. It’s also good premium collection strategy

Two types:

1. Long vertical spread: call spread  — this will also generate a debit
2. Short vertical spread: sell the put spread  — this will generate a credit

General Rules:

• Buy the options in a spread always in a 1:1 ratio
• Have a directional bias for the stock and a reason for that bias

Construction:

Bull call spread: Buy low, sell high…

• Buy the lower strike call
• Sell the higher strike call

Bull put spread: same thing but with puts

• Buy the lower strike put
• Sell the higher strike put

… just remember BLSH = Buy Low, Sell High    … which sounds like BULLISH