Sunday, July 1, 2012
Traders Exclusive
Here's a great new trader's resource I wanted to option traders. It's called Traders Exclusive. It is a great new site that has market commentary from the trading industry's top trading gurus and investment advisers. There is a new trading video from the CME exchange trading floor every day. And there are lots of useful articles for traders to learn how to trade from. The site isn't just for option traders. It is also a great trading resource for stock investors, futures traders, forex traders, bond traders and more.
Take a look http://tradersexclusive.com. You'll be glad you did. And tell a friend too!
p.s. Here is the facebook page too http://www.facebook.com/TradersExclusive Be sure to "Like" them.
Wednesday, May 9, 2012
New Facebook Page
Hi, friends. Long time, no blog! Sorry. Busy, busy, busy. Market Taker Mentoring LLC has a brand new facebook page! you can interact with fellow traders, share trade ideas, and learn more about trading. Visit the page today and meet fellow option traders.
Market Taker Option Trading and Trading Education
Knowledge is power! Learn option trading techniques from each other.
Market Taker Option Trading and Trading Education
Knowledge is power! Learn option trading techniques from each other.
Monday, September 28, 2009
Vertical Spreads and the Blurred Line Between Delta and Theta: Part II
My last post (Part I of this same topic) discussed debit spreads and credit spreads, both members of the vertical spread family. It was shown how, because of synthetic relationships, a debit call spread is essentially the same as a credit put spread and a debit put spread is essentially the same as a credit call spread. The only real difference is the cash transaction--debit or credit--at the time when the spread is initiated. The potential risk and reward, however, is the same once interest and dividend issues are taken into account. This concept can have an important impact on the psychology of managing an ongoing vertical spread trade.
The Psychology of Trading Verticals
Imagine that a trader buys an out-of-the-money debit call spread, say a 50-55 bull call spread with the underlying stock at $49. This trader gains positive delta, positive gamma, negative theta and positive vega. Specifically, in this example:
Out-Of-The-Money Call Debit Spread
Delta = + 0.35
Gamma = + 0.09
Theta = - 0.01
Vega = + 0.04
The positive delta results from the call with the closer-to-the-money strike being purchased. Positive gamma, negative theta and positive vega result from the underlying stock being closer to the long (50) strike than the short (55) strike.
The trader wants the stock to move higher, to or through the short strike, and fast. Why? To avoid the impact of negative theta.
Now imagine that within a short amount of time, the underlying stock does, in fact, move up to, say, $56 a share. What are the trader’s new greeks?
In-The-Money Call Debit Spread
Delta = + 0.35
Gamma = - 0.09
Theta = + 0.01
Vega = - 0.05
Note the delta is still positive; however, the signs of all the other greeks are reversed. That is to say that now there is negative gamma, positive theta and negative vega.
Positive delta still results from the 50s having a higher delta than the 55s. But now the short strike is the dominant influence. With the stock closer to the 55 strike, negative gamma, positive theta and negative vega prevail. At this point, the trader will have made some of the maximum profit that resulted from the long delta, but will still have to wait it out to reap the remainder in the form theta. These greeks would incidentally be about the same as they would be for a 50-55 credit put spread.
The Blurred Line Between Debit Spreads and Credit Spreads
The new goal (presuming the trader doesn’t close the position to take a partial profit) is to wait it out and hope the stock remains above $55 a share until expiration. The trader would, in fact, need to manage this trade as if it were a 50-55 bull (credit) put spread.
This can be a big psychological leap for some traders. It’s not a credit spread; it’s a debit spread. But imagine for a moment, that the trader did not have the debit spread in inventory. If the trader believed the stock (again, now at $56) would stay flat or continue higher, he might consider selling a 50-55 credit put spread. The trader would monitor the trade and wait out time decay and perhaps hope for some gain from the positive delta if the stock continues higher. This is effectively the same position the trader holds with the ITM debit call spread.
Further, think back to the box. It has been shown in Part I of this two-part series that the two spreads are synthetically the same. It becomes a matter of recognizing the flip-flop that can occur from debit call spread to synthetic credit put spread that can help a trader manage the trade accordingly and see more clearly how to view the trade after the stock moves higher.
See more of Dan's blogs at www.tradingoptiongreeks.blogspot.com
The Psychology of Trading Verticals
Imagine that a trader buys an out-of-the-money debit call spread, say a 50-55 bull call spread with the underlying stock at $49. This trader gains positive delta, positive gamma, negative theta and positive vega. Specifically, in this example:
Out-Of-The-Money Call Debit Spread
Delta = + 0.35
Gamma = + 0.09
Theta = - 0.01
Vega = + 0.04
The positive delta results from the call with the closer-to-the-money strike being purchased. Positive gamma, negative theta and positive vega result from the underlying stock being closer to the long (50) strike than the short (55) strike.
The trader wants the stock to move higher, to or through the short strike, and fast. Why? To avoid the impact of negative theta.
Now imagine that within a short amount of time, the underlying stock does, in fact, move up to, say, $56 a share. What are the trader’s new greeks?
In-The-Money Call Debit Spread
Delta = + 0.35
Gamma = - 0.09
Theta = + 0.01
Vega = - 0.05
Note the delta is still positive; however, the signs of all the other greeks are reversed. That is to say that now there is negative gamma, positive theta and negative vega.
Positive delta still results from the 50s having a higher delta than the 55s. But now the short strike is the dominant influence. With the stock closer to the 55 strike, negative gamma, positive theta and negative vega prevail. At this point, the trader will have made some of the maximum profit that resulted from the long delta, but will still have to wait it out to reap the remainder in the form theta. These greeks would incidentally be about the same as they would be for a 50-55 credit put spread.
The Blurred Line Between Debit Spreads and Credit Spreads
The new goal (presuming the trader doesn’t close the position to take a partial profit) is to wait it out and hope the stock remains above $55 a share until expiration. The trader would, in fact, need to manage this trade as if it were a 50-55 bull (credit) put spread.
This can be a big psychological leap for some traders. It’s not a credit spread; it’s a debit spread. But imagine for a moment, that the trader did not have the debit spread in inventory. If the trader believed the stock (again, now at $56) would stay flat or continue higher, he might consider selling a 50-55 credit put spread. The trader would monitor the trade and wait out time decay and perhaps hope for some gain from the positive delta if the stock continues higher. This is effectively the same position the trader holds with the ITM debit call spread.
Further, think back to the box. It has been shown in Part I of this two-part series that the two spreads are synthetically the same. It becomes a matter of recognizing the flip-flop that can occur from debit call spread to synthetic credit put spread that can help a trader manage the trade accordingly and see more clearly how to view the trade after the stock moves higher.
See more of Dan's blogs at www.tradingoptiongreeks.blogspot.com
Thursday, September 3, 2009
Vertical Spreads and the Blurred Line Between Delta and Theta: Part I
Vertical spreads are one of my favorite subjects to teach. On the surface, they appear to be rather straightforward but, in fact, they are not. The overly simplistic view of vertical spreads held by many traders can lead to poor trade management and ultimately a heap of losers that should have been winners.
Vertical Spreads
Vertical spreads can be divided into two categories: debit spreads and credit spreads. Debit spreads, of course, are called such because when they are established, the trader’s account is debited; that is, the trader pays for the spread upfront in hopes it will gain in value and can be sold at a higher price later. Credit spreads, on the other hand, are called such because they are done for a credit; the trader receives cash upfront, hoping to buy the spread back later at a cheaper price.
While these two spreads seem to be very different animals, and are often traded as such, debit spreads and credit spreads are really not that different. In fact, they are essentially the same thing. To understand this, let’s look at another option spread called a box.
Understanding Boxes
A box is a four-legged strategy involving a call spread and a put spread on the same stock in the same month sharing the same strikes. A long box is established when a trader buys both a debit call spread and a debit put spread (again, sharing the same month and strikes). A short box is established when a trader sells a credit call spread and a credit put spread. Let’s look at an example.
For this example, a trader will buy the 40-41 box. To complete the box, the trader will:
Buy 1 40 call at 1.12
Sell 1 41 call at 0.60
Sell 1 40 put at 0.86
Buy 1 41 put at 1.34
Notice the first two legs of the spread listed here — buy 1 40 call at 1.12, sell 1 41 call at 0.60 — form a debit call spread. The second pair of legs — sell 1 40 put at 0.86, buy 1 41 put at 1.34 — forms a debit put spread. Both debit spreads.
The call debit spread is purchased for a total of 0.52. Let’s look at the maximum gain and loss of this spread at expiration.
Stock above 41: Max profit 0.48
Stock below 40: Max loss 0.52
The put spread was bought for 0.48. Let’s look at the put debit spread if held until expiration.
Stock above 41: Max loss 0.48
Stock below 40: Max profit 0.52
So if a trader bought both of these spreads for a total of $1 (that’s 0.52 for the call spread plus 0.48 for the put spread — incidentally the distance between the two strikes) and the stock settles above 41 at expiration, the gains on the call spread would be offset by losses on the put spread. Below 40, the losses on the call spread would be offset by gains on the put spread. And, in fact, if the stock ended between the two strikes at expiration, any gains on one of the spreads would be directly offset by comparable losses on the other spread.
(Please note, dividends, interest, the bid-ask spread, exercise style, and hard to borrow issues are all factored into the arbitrage of boxes. Because of this, it is common for boxes to trade at a price other than the distance between the two strikes as shown here with this $1 box.)
Looking at the box another way, the trader is buying synthetic stock at the 40 strike (buying the 40 calls, selling the 40 puts) and selling synthetic stock at the 41 strike (selling the 41 calls and buying the 41 puts) for a total debit of $1. The trader would be paying $1 for an asset that is worth, in arbitrage terms, $1.
While most active individual traders don’t trade boxes, an important lesson for vertical spread trading can be gained from this exercise. It has been illustrated, that buying a call spread is an exactly opposite position from buying a put spread — they offset each other (again, once interest and other influences are factored in). Therefore the logic must follow that buying a call spread must be synthetically the same as selling a put spread. And, indeed, it is.
Consider buying the call spread vs. selling the put spread.
Debit call spread at expiration:
Stock above 41: Max profit 0.48
Stock below 40: Max loss 0.52
Credit put spread at expiration:
Stock above 41: Max profit 0.48
Stock below 40: Max loss 0.52
Likewise, between the two strikes will show an identical arbitrage P&(L) at expiration. To be sure, the P&(L) diagrams of the two strategies — debit call spread and credit put spread — would be identical too for this example.
With this in mind, we can now study the psychology of a vertical spread trader, and how the trader must adapt as the spread moves more in- or out-of-the-money. This will be discussed in the upcoming Part 2 of this series.
Vertical Spreads
Vertical spreads can be divided into two categories: debit spreads and credit spreads. Debit spreads, of course, are called such because when they are established, the trader’s account is debited; that is, the trader pays for the spread upfront in hopes it will gain in value and can be sold at a higher price later. Credit spreads, on the other hand, are called such because they are done for a credit; the trader receives cash upfront, hoping to buy the spread back later at a cheaper price.
While these two spreads seem to be very different animals, and are often traded as such, debit spreads and credit spreads are really not that different. In fact, they are essentially the same thing. To understand this, let’s look at another option spread called a box.
Understanding Boxes
A box is a four-legged strategy involving a call spread and a put spread on the same stock in the same month sharing the same strikes. A long box is established when a trader buys both a debit call spread and a debit put spread (again, sharing the same month and strikes). A short box is established when a trader sells a credit call spread and a credit put spread. Let’s look at an example.
For this example, a trader will buy the 40-41 box. To complete the box, the trader will:
Buy 1 40 call at 1.12
Sell 1 41 call at 0.60
Sell 1 40 put at 0.86
Buy 1 41 put at 1.34
Notice the first two legs of the spread listed here — buy 1 40 call at 1.12, sell 1 41 call at 0.60 — form a debit call spread. The second pair of legs — sell 1 40 put at 0.86, buy 1 41 put at 1.34 — forms a debit put spread. Both debit spreads.
The call debit spread is purchased for a total of 0.52. Let’s look at the maximum gain and loss of this spread at expiration.
Stock above 41: Max profit 0.48
Stock below 40: Max loss 0.52
The put spread was bought for 0.48. Let’s look at the put debit spread if held until expiration.
Stock above 41: Max loss 0.48
Stock below 40: Max profit 0.52
So if a trader bought both of these spreads for a total of $1 (that’s 0.52 for the call spread plus 0.48 for the put spread — incidentally the distance between the two strikes) and the stock settles above 41 at expiration, the gains on the call spread would be offset by losses on the put spread. Below 40, the losses on the call spread would be offset by gains on the put spread. And, in fact, if the stock ended between the two strikes at expiration, any gains on one of the spreads would be directly offset by comparable losses on the other spread.
(Please note, dividends, interest, the bid-ask spread, exercise style, and hard to borrow issues are all factored into the arbitrage of boxes. Because of this, it is common for boxes to trade at a price other than the distance between the two strikes as shown here with this $1 box.)
Looking at the box another way, the trader is buying synthetic stock at the 40 strike (buying the 40 calls, selling the 40 puts) and selling synthetic stock at the 41 strike (selling the 41 calls and buying the 41 puts) for a total debit of $1. The trader would be paying $1 for an asset that is worth, in arbitrage terms, $1.
While most active individual traders don’t trade boxes, an important lesson for vertical spread trading can be gained from this exercise. It has been illustrated, that buying a call spread is an exactly opposite position from buying a put spread — they offset each other (again, once interest and other influences are factored in). Therefore the logic must follow that buying a call spread must be synthetically the same as selling a put spread. And, indeed, it is.
Consider buying the call spread vs. selling the put spread.
Debit call spread at expiration:
Stock above 41: Max profit 0.48
Stock below 40: Max loss 0.52
Credit put spread at expiration:
Stock above 41: Max profit 0.48
Stock below 40: Max loss 0.52
Likewise, between the two strikes will show an identical arbitrage P&(L) at expiration. To be sure, the P&(L) diagrams of the two strategies — debit call spread and credit put spread — would be identical too for this example.
With this in mind, we can now study the psychology of a vertical spread trader, and how the trader must adapt as the spread moves more in- or out-of-the-money. This will be discussed in the upcoming Part 2 of this series.
Wednesday, May 6, 2009
Educational Option Trading Webinars
Generally I like to offer some free educational option trading tips. But this time I wanted to inform my readers that through my company, Market Taker Mentoring LLC, I'll be offering in-depth, interactive, educational option trading webinars.
These educational option trading webinars will cover a variety of topics. The first series, starting soon, will address the option greeks in a very hands-on way. The webinars are for option traders of all experience levels. Even basic-level traders can benefit greatly from the information in these presentations.
For more information, and to learn how to begin your educational option trading webinars, visit MarketTaker.com.
Dan Passarelli
These educational option trading webinars will cover a variety of topics. The first series, starting soon, will address the option greeks in a very hands-on way. The webinars are for option traders of all experience levels. Even basic-level traders can benefit greatly from the information in these presentations.
For more information, and to learn how to begin your educational option trading webinars, visit MarketTaker.com.
Dan Passarelli
Thursday, April 16, 2009
Entering a Trade
Nickels add up. It's true. If you're an option trader you realize this by now. Each nickel you make (or save) on an option contract is $5 in your pocket. That's $50 on a 10-lot; $500 on a 100-lot. Over the weeks and months and years, nickels are big money. Interested in learning how to save some nickels? Your method of trade entry may make a difference.
Bids and Offers
Typically, off-floor traders buy offers and sell bids. That is the nature of being a retail trader. But, what if you could get a better trade price? With some trades, I like to "middle the market". That means try to buy below the offer (but above the bid) or sell above the bid (but below the offer). That means, if I get filled, I get filled at a better price--sometimes saving the coveted nickels. But it doesn't always work. There's a trick to it. Here is one tip on middling the market on trade entry.
Middling the Market
Market makers like to reduce risk. It's their job. If they are making a trade, they'd prefer to make a less risky trade. In fact, they would be happy to put on a trade at a less favorable price if it has less risk. Spread trades have less risk. In many cases, market makers are willing to trade a spread between the market [i.e., buy (from you) above the bid or sell (to you) below the offer], in the process giving up precious nickels.
For example, imagine a call spread that you want to buy is .70 bid, offered at .85. Instead of taking the .85 offer, a trader may opt to bid .80 (above the bid but below the offer). In some cases, market makers will accept the bid shy of their offer. Sometimes not.
While there's no way to know for sure if your bid will trade, one guideline is that it is closer to the offer price--you have to meet them more than half way. The same would go for you trying to sell. Your offer needs to be closer to the bid than the market maker's offer.
But there is some risk in this technique. The market can change. If you bid .80 (a nickel away from the offer), and the market for the spread rises to being .90 offer, your chances of getting filled just got worse. Now, if you really want the spread, you have to pay up.
There's a knack to entering orders; and there is certainly a bit more to it than what is discussed here. But it's a start! Good luck trading. And if you haven't visited MarketTaker.com in a while, check it out. I've made a few changes.
Dan
Bids and Offers
Typically, off-floor traders buy offers and sell bids. That is the nature of being a retail trader. But, what if you could get a better trade price? With some trades, I like to "middle the market". That means try to buy below the offer (but above the bid) or sell above the bid (but below the offer). That means, if I get filled, I get filled at a better price--sometimes saving the coveted nickels. But it doesn't always work. There's a trick to it. Here is one tip on middling the market on trade entry.
Middling the Market
Market makers like to reduce risk. It's their job. If they are making a trade, they'd prefer to make a less risky trade. In fact, they would be happy to put on a trade at a less favorable price if it has less risk. Spread trades have less risk. In many cases, market makers are willing to trade a spread between the market [i.e., buy (from you) above the bid or sell (to you) below the offer], in the process giving up precious nickels.
For example, imagine a call spread that you want to buy is .70 bid, offered at .85. Instead of taking the .85 offer, a trader may opt to bid .80 (above the bid but below the offer). In some cases, market makers will accept the bid shy of their offer. Sometimes not.
While there's no way to know for sure if your bid will trade, one guideline is that it is closer to the offer price--you have to meet them more than half way. The same would go for you trying to sell. Your offer needs to be closer to the bid than the market maker's offer.
But there is some risk in this technique. The market can change. If you bid .80 (a nickel away from the offer), and the market for the spread rises to being .90 offer, your chances of getting filled just got worse. Now, if you really want the spread, you have to pay up.
There's a knack to entering orders; and there is certainly a bit more to it than what is discussed here. But it's a start! Good luck trading. And if you haven't visited MarketTaker.com in a while, check it out. I've made a few changes.
Dan
Thursday, March 19, 2009
Fact or VIXion
The CBOE Volatility Index®, or “theVIX®”, has been at historically high levels for a while now. The question for today is: How long can it stay this high? To answer, let’s first examine what the VIX is and why it rises or falls.
Basically, the VIX is a measurement of the implied volatility on the S&P 500. More specifically, the VIX measures the implied volatility of hypothetical 30-day options listed on the SPX, which is the index contract that represents the S&P 500®.
Implied volatility, as many of us know, is the volatility component embedded in option prices. When option-market participants buy up options—usually in expectation of future volatility—implied volatility (and therefore the price of the option) rises. Likewise, when market players sell options—usually in expectation of waning volatility—implied volatility (the price of options) falls.
A comparison of the “market volatility” of fluctuations in the S&P 500 index and the embedded “option volatility” or the VIX can be easily done mathematically. These figures are both stated in terms of annualized standard deviation of daily price changes. The actual standard deviation of the S&P index is calculated by past price fluctuations, while the implied volatility represents expected price volatility.
For example, if the annualized standard deviation of the value of the S&P 500 is, say, 43 and the VIX is 43, that means over the next 30 days the volatility of the SPX is expected to remain constant. If the VIX is higher than the calculated standard deviation of the S&P, the market expects volatility to be higher in the future. If the VIX is lower, expectations are for lower actual volatility in the S&P.
For the VIX to remain at this lofty level, the S&P 500 needs to remain volatile. Otherwise, the options will be mispriced creating an arbitrage scenario. The moral to the story: when the market stops moving as much as it has been, the VIX will fall.
Dan Passarelli
Market Taker Mentoring LLC
Basically, the VIX is a measurement of the implied volatility on the S&P 500. More specifically, the VIX measures the implied volatility of hypothetical 30-day options listed on the SPX, which is the index contract that represents the S&P 500®.
Implied volatility, as many of us know, is the volatility component embedded in option prices. When option-market participants buy up options—usually in expectation of future volatility—implied volatility (and therefore the price of the option) rises. Likewise, when market players sell options—usually in expectation of waning volatility—implied volatility (the price of options) falls.
A comparison of the “market volatility” of fluctuations in the S&P 500 index and the embedded “option volatility” or the VIX can be easily done mathematically. These figures are both stated in terms of annualized standard deviation of daily price changes. The actual standard deviation of the S&P index is calculated by past price fluctuations, while the implied volatility represents expected price volatility.
For example, if the annualized standard deviation of the value of the S&P 500 is, say, 43 and the VIX is 43, that means over the next 30 days the volatility of the SPX is expected to remain constant. If the VIX is higher than the calculated standard deviation of the S&P, the market expects volatility to be higher in the future. If the VIX is lower, expectations are for lower actual volatility in the S&P.
For the VIX to remain at this lofty level, the S&P 500 needs to remain volatile. Otherwise, the options will be mispriced creating an arbitrage scenario. The moral to the story: when the market stops moving as much as it has been, the VIX will fall.
Dan Passarelli
Market Taker Mentoring LLC
Sunday, March 1, 2009
The Battle of the Brain
No matter how long you've been a trader, it's easy to slip into bad habits. Among the worst habits for traders new and old is to be undisciplined.
Though there are many different trading philosophies, strategies and methodologies, all traders need to have a plan, and just as importantly, they need to follow it. It's easy to forget the plan when you're in the thick of it. But when you deviate from the plan, emotions can get in the way, clouding judgment and leading to bad decision making. It's the age-old battle of the right brain versus the left brain.
The left brain is the mathematical, logical side. It's the side of your brain that crunches the numbers in your analysis that lead up to a trade. It can methodically lay out the quantifiable steps that make sense to follow. And measure potential profits and losses and deduces ways to curtail losers and make the most out of your winners. The left brain is a trader's friend.
The nemesis of the left brain, however, is the right brain--creative, qualitative and, oh yes, emotional. This side of your brain tries to wreak havoc on your trading every chance it gets. "Hey, maybe we can make a little more on this trade if we just hold it a little longer," it may tell you. Or, "For God's sake! I've got to get out right now. I just know it's going lower, "it may say at other times. Knee-jerk reactions to fear and greed are all a product of the evil right brain sneaking into your trading trying to topple the even-keeled left-brain trading machine.
Don't listen to it! When that right brain starts speaking up, play it some music, take it to a movie, a museum, maybe. But when it comes to quantitative trading decisions of picking your entrances and exits for a trade, leave it up to the professionals. Let that left side of the gray stuff do it's thing. Keep it tight. Logically map out the smartest course, and follow it unwaveringly. Stick to the plan.
Though there are many different trading philosophies, strategies and methodologies, all traders need to have a plan, and just as importantly, they need to follow it. It's easy to forget the plan when you're in the thick of it. But when you deviate from the plan, emotions can get in the way, clouding judgment and leading to bad decision making. It's the age-old battle of the right brain versus the left brain.
The left brain is the mathematical, logical side. It's the side of your brain that crunches the numbers in your analysis that lead up to a trade. It can methodically lay out the quantifiable steps that make sense to follow. And measure potential profits and losses and deduces ways to curtail losers and make the most out of your winners. The left brain is a trader's friend.
The nemesis of the left brain, however, is the right brain--creative, qualitative and, oh yes, emotional. This side of your brain tries to wreak havoc on your trading every chance it gets. "Hey, maybe we can make a little more on this trade if we just hold it a little longer," it may tell you. Or, "For God's sake! I've got to get out right now. I just know it's going lower, "it may say at other times. Knee-jerk reactions to fear and greed are all a product of the evil right brain sneaking into your trading trying to topple the even-keeled left-brain trading machine.
Don't listen to it! When that right brain starts speaking up, play it some music, take it to a movie, a museum, maybe. But when it comes to quantitative trading decisions of picking your entrances and exits for a trade, leave it up to the professionals. Let that left side of the gray stuff do it's thing. Keep it tight. Logically map out the smartest course, and follow it unwaveringly. Stick to the plan.
Thursday, February 12, 2009
Black Gold, Texas Tea
A friend of mine emailed me today inquiring about oil. "it's at it's lows", he said, "looks like it bottomed out; gotta rally from here". Well, I don't know if he's right or wrong, but (for our purposes) that's not important right now. What IS important (and interesting regardless) is how one capitalizes on such an outlook.
There are a few ways, all different in their own right. First--and for a lot of securities options traders, the one that comes to mid initially--is to buy calls on or shares of an oil-services fund-of-sorts like OIH, the oil-services HOLDR. (BTW, a HOLDR is similar to an ETF with small [for most people, insignificant] differences).
While putting a bullish position on an oil-services HOLDR seems like an obvious play for a bullish-on-oil trader, it may not be a perfect trade to match the bullish oil-play objective. Why? First, buying an oil-services HOLDR--by definition--is a position in the stocks of companies in the oil services industry. Among the highest weighted stocks in OIH are Transocean, LTD (RIG), Schlumberger Limited (SLB), Haliburton (HAL), and Baker Hughes (BHI). While these companies have a strong interest in the price of oil (crude), they are companies with costs and revenues and strategies that can effect profits independent of the price of oil. For a more pure, speculative play on oil, just buy the future.
A crude oil future is about the next best thing to filling your garage with barrels of the black stuff. A long futures contract is technically a contract to buy the "spot" (in this case crude oil) at a specifies point in the future. (Don't let this intimidate you. Simply selling the contract to close it eliminates the obligation to buy. This way, you don't end up with a garage full of barrels of crude!) If a trader is truly bullish on the price of oil, buying a futures contract is the most practical way to do it. Of course, practicality doesn't come without problems.
Securities and commodities are governed differently. Securities (and securities options) are overseen by the SEC--Securities and Exchange Commission. Commodities (and their options) are overseen by the CFTC--Commodity Futures Trading Commission. So, your broker may not be able to offer you both. In order make a commodities trade you either need a broker who can do both, or in addition to your online securities broker open an account with an FCM--Futures Commission Merchant. For those with online securities accounts, first look into your firm's offerings. Do they allow futures? If not, do some research. Talk to your investing friends. See if they can recommend an FCM. You can even do commodity options through them.
Dan
http://www.markettaker.com
There are a few ways, all different in their own right. First--and for a lot of securities options traders, the one that comes to mid initially--is to buy calls on or shares of an oil-services fund-of-sorts like OIH, the oil-services HOLDR. (BTW, a HOLDR is similar to an ETF with small [for most people, insignificant] differences).
While putting a bullish position on an oil-services HOLDR seems like an obvious play for a bullish-on-oil trader, it may not be a perfect trade to match the bullish oil-play objective. Why? First, buying an oil-services HOLDR--by definition--is a position in the stocks of companies in the oil services industry. Among the highest weighted stocks in OIH are Transocean, LTD (RIG), Schlumberger Limited (SLB), Haliburton (HAL), and Baker Hughes (BHI). While these companies have a strong interest in the price of oil (crude), they are companies with costs and revenues and strategies that can effect profits independent of the price of oil. For a more pure, speculative play on oil, just buy the future.
A crude oil future is about the next best thing to filling your garage with barrels of the black stuff. A long futures contract is technically a contract to buy the "spot" (in this case crude oil) at a specifies point in the future. (Don't let this intimidate you. Simply selling the contract to close it eliminates the obligation to buy. This way, you don't end up with a garage full of barrels of crude!) If a trader is truly bullish on the price of oil, buying a futures contract is the most practical way to do it. Of course, practicality doesn't come without problems.
Securities and commodities are governed differently. Securities (and securities options) are overseen by the SEC--Securities and Exchange Commission. Commodities (and their options) are overseen by the CFTC--Commodity Futures Trading Commission. So, your broker may not be able to offer you both. In order make a commodities trade you either need a broker who can do both, or in addition to your online securities broker open an account with an FCM--Futures Commission Merchant. For those with online securities accounts, first look into your firm's offerings. Do they allow futures? If not, do some research. Talk to your investing friends. See if they can recommend an FCM. You can even do commodity options through them.
Dan
http://www.markettaker.com
Wednesday, January 28, 2009
What to do? What to do?
What do we do when it turns around?: A great question that is on the minds of many traders these days. But I've got a better one: When what turns around? Many traders focus (maybe too much) on the obvious. Yes; the "market" (i.e. the S&P 500 index) is down at a relative extreme low. This, arguably, presents an opportunity for long-term investors who believe that one day, the market/economy will turn around and erase its recent problems. But there is another index that is sitting at a relative extreme as well: the VIX.
The VIX is the CBOE's volatility index which (in a round about sort of way) measures the market's expectations for future volatility in the S&P 500. Specifically, the VIX measures the 30-day implied volatility of the SPX (the tradable option index on the S&P 500). The VIX has been over 50 lately, which is a very high level at which to be spending so much time. In years past, a more typical level for this index was in the low 20s.
Implied volatility buffs often refer to "reversion to the mean". This is the situation in which implied volatility makes a move away from its typical range and then reverts back to its "normal" level. Looking at the VIX now, it's hard not the think, "what goes up, must come down". To profit from falling implied volatility, one must sell options.
But it's a little bit tricky, this volatility game is. First, We don't know when implied volatility will decline. To be sure, it could be months. With the wily market we've seen lately, most traders don't want to be short options for an extended period of time.
Second, probably, after it's all over, the VIX will not return to the levels seen earlier in 2007 and 2008. It will likely remain a bit higher for a while as the sting felt by traders remains at the back of their minds.
Bottom line: the VIX will likely fall (one day) but it's not likely to collapse. To take advantage of this decline, traders need to be proactive, but careful. Cautious traders will watch volatility closely and wait until just before it looks like it is starting to wane to sell. And then, traders must monitor positions closely looking to exit if their wrong. Capturing a downward move on implied volatility can be profitable, but the risk of being short (naked or covered) can outweigh the potential gains.
Face it. If trading was easy, everybody'd do it! To succeed, one must look for opportunities, where others don't. Implied volatility is something that common traders often overlook. But this trader says it's worth keeping an eye on.
Dan
Market Taker Mentoring LLC
The VIX is the CBOE's volatility index which (in a round about sort of way) measures the market's expectations for future volatility in the S&P 500. Specifically, the VIX measures the 30-day implied volatility of the SPX (the tradable option index on the S&P 500). The VIX has been over 50 lately, which is a very high level at which to be spending so much time. In years past, a more typical level for this index was in the low 20s.
Implied volatility buffs often refer to "reversion to the mean". This is the situation in which implied volatility makes a move away from its typical range and then reverts back to its "normal" level. Looking at the VIX now, it's hard not the think, "what goes up, must come down". To profit from falling implied volatility, one must sell options.
But it's a little bit tricky, this volatility game is. First, We don't know when implied volatility will decline. To be sure, it could be months. With the wily market we've seen lately, most traders don't want to be short options for an extended period of time.
Second, probably, after it's all over, the VIX will not return to the levels seen earlier in 2007 and 2008. It will likely remain a bit higher for a while as the sting felt by traders remains at the back of their minds.
Bottom line: the VIX will likely fall (one day) but it's not likely to collapse. To take advantage of this decline, traders need to be proactive, but careful. Cautious traders will watch volatility closely and wait until just before it looks like it is starting to wane to sell. And then, traders must monitor positions closely looking to exit if their wrong. Capturing a downward move on implied volatility can be profitable, but the risk of being short (naked or covered) can outweigh the potential gains.
Face it. If trading was easy, everybody'd do it! To succeed, one must look for opportunities, where others don't. Implied volatility is something that common traders often overlook. But this trader says it's worth keeping an eye on.
Dan
Market Taker Mentoring LLC
Wednesday, January 7, 2009
Living on the Edge
Edge. "What's edge?" you ask. Basically it's like crack for option traders. It is what you just can't resist! Experienced option traders trade when (an only when) they see edge. They just can't help themselves.
It's like this. None of us has a crystal ball. As much as many of you may like to think you know where a stock is going, you simply don't. Face it. Trading is statistical. So what makes for a good trade? Having the odds are stacked in your favor. Edge. So we look for the fine details of the trade that indicate trader edge. Alas, these are the details that are tough to find!
Any hack trader can look at a chart of a stock, see it's in a trend and jump on the band wagon (and half the time they will be wrong). But the traders who have the real potential to out-shine their peers go a step (or maybe a few steps) further and study option premiums and other market data to swoop in on the good trades and skip out on the traps.
Much of the edge in an option trade can be found by studying its volatility. Option volatility isn't a predictor; it's better. It helps indicate whether an option is cheap or expensive. This is truly useful information.
Want to maximize your trading performance? Learn to recognize (and trade on) edge.
It's like this. None of us has a crystal ball. As much as many of you may like to think you know where a stock is going, you simply don't. Face it. Trading is statistical. So what makes for a good trade? Having the odds are stacked in your favor. Edge. So we look for the fine details of the trade that indicate trader edge. Alas, these are the details that are tough to find!
Any hack trader can look at a chart of a stock, see it's in a trend and jump on the band wagon (and half the time they will be wrong). But the traders who have the real potential to out-shine their peers go a step (or maybe a few steps) further and study option premiums and other market data to swoop in on the good trades and skip out on the traps.
Much of the edge in an option trade can be found by studying its volatility. Option volatility isn't a predictor; it's better. It helps indicate whether an option is cheap or expensive. This is truly useful information.
Want to maximize your trading performance? Learn to recognize (and trade on) edge.
Sunday, December 21, 2008
Holiday Shopping
It's bad enough fighting the crowds at the mall, but try shopping for option trades this time of year! Trading options can be a little trickier during the holiday season because of some unique seasonal anomalies.
First, it can be slower. Professional traders take time off. There are less market players, which means less business transacting. This has two seemingly contradictory implications. On the one hand, the market tends to have fewer big moves because, traders with an ax to grind are using it on the Christmas goose and not on knocking out 10,000 lots in the market. But, because there are fewer liquidity providers, the small moves that occur can be more erratic because there is less size on the bids and offers in both stocks and options.
Second, there is the fabled Santa Clause rally. Traders cite the Santa Clause rally whenever the market runs up this time of year. Do I believe in the Santa Clause rally? Hmmm... If I don't, do I stop getting presents? Maybe it's better to believe than not!
But lastly, and most importantly is the theta risk of having the market closed for two extra days. These are days in which options loose value from time decay, but there is no trading that might lead to potential profits--very bad for longs. We tend to see traders taking the day out early this time of year as options get cheaper faster as traders anticipate the holiday.
Have a safe (and, hopefully, profitable) holiday season.
Dan
First, it can be slower. Professional traders take time off. There are less market players, which means less business transacting. This has two seemingly contradictory implications. On the one hand, the market tends to have fewer big moves because, traders with an ax to grind are using it on the Christmas goose and not on knocking out 10,000 lots in the market. But, because there are fewer liquidity providers, the small moves that occur can be more erratic because there is less size on the bids and offers in both stocks and options.
Second, there is the fabled Santa Clause rally. Traders cite the Santa Clause rally whenever the market runs up this time of year. Do I believe in the Santa Clause rally? Hmmm... If I don't, do I stop getting presents? Maybe it's better to believe than not!
But lastly, and most importantly is the theta risk of having the market closed for two extra days. These are days in which options loose value from time decay, but there is no trading that might lead to potential profits--very bad for longs. We tend to see traders taking the day out early this time of year as options get cheaper faster as traders anticipate the holiday.
Have a safe (and, hopefully, profitable) holiday season.
Dan
Tuesday, December 9, 2008
The Golden Age of Option Education
Remember about seven or eight years ago when the bid-ask spread in a typical option contract was so wide you could drive a proverbial truck through it? When I was a market maker on the CBOE trading floor back then, most of my bids and offers were around 20 cents apart. I must say, it was a good time to be a market maker.
But as the late George Harrison once said, all things must pass. Changes in the industry forced markets tighter and tighter. Market makers had to take on more and more risk for less and less reward. It got to the point where the options market was more liquid than the underlying market (this is still the case in some securities options). That is when I left the floor and stopped being a market maker in favor of trading as a market taker. And I wasn't alone. Lots of traders left the floor at that time. I believe it is still a great time, comparatively, to be a "retail" trader.
But tight markets aren't the only benefit of this exodus of professional traders from the trading floor. A handful of ex-market makers--present company included--have moved into option education. Now anyone serious about learning options can reap the benefit of years of experience from the trading floor.
When my peers and I were learning options, formal education administered by professionals was not commonplace. We had to earn our education in the school of hard knocks--on the trading floor--and the price of success was often high. Now potential traders can arm themselves with formal option education from an ex-market maker and learn how to avoid costly and painful trading mistakes.
I encourage my readers to visit my Web site, MarketTaker.com, and consider the benefits of personalized one-on-one option mentoring from a floor trader.
Dan
But as the late George Harrison once said, all things must pass. Changes in the industry forced markets tighter and tighter. Market makers had to take on more and more risk for less and less reward. It got to the point where the options market was more liquid than the underlying market (this is still the case in some securities options). That is when I left the floor and stopped being a market maker in favor of trading as a market taker. And I wasn't alone. Lots of traders left the floor at that time. I believe it is still a great time, comparatively, to be a "retail" trader.
But tight markets aren't the only benefit of this exodus of professional traders from the trading floor. A handful of ex-market makers--present company included--have moved into option education. Now anyone serious about learning options can reap the benefit of years of experience from the trading floor.
When my peers and I were learning options, formal education administered by professionals was not commonplace. We had to earn our education in the school of hard knocks--on the trading floor--and the price of success was often high. Now potential traders can arm themselves with formal option education from an ex-market maker and learn how to avoid costly and painful trading mistakes.
I encourage my readers to visit my Web site, MarketTaker.com, and consider the benefits of personalized one-on-one option mentoring from a floor trader.
Dan
Thursday, November 20, 2008
Remembering Theta Bara-ly
A theta trade? What's that? There was once a day when 80 percent of the traders I'd talk to at my trading seminars traded nothing but credit spreads, iron condors, time spreads and butterflies: i.e. theta spreads. With the volatility in the market these days, theta spreads have gone the way of long forgotten silent film stars, like Theda Bara. Theda Bara, the infamous sexy vamp of silent film is barely remembered by movie goers today. She never made a film with sound; she had her time and place.
Theta spreads, while sexy in their own time and place, have been usurped by the new stars of this golden era of trading, like volatility plays. Theta spreads involved selling options and were attractive for two reasons: 1) They profit when stocks DON'T move, and 2) They usually produce more winners than losers. The problem, though, occurs when stocks DO move. This is when losers are produced. And when theta spreads lose, they can lose big. In fact, with many theta spreads, often $4 or $5 is risked for the chance to earn $1. Sometimes that ratio is even higher like $10 or $20 risked to make $1.
Traders who were introduced to options in the less volatile periods thought these strategies were manna from heaven. They'd have profitable trades month after month, never seeing a loser. Nirvana! But, when the volatility kicked in everything changed. The first losing month came as a shock to many newbie traders. "How could this happen!?!" It can. And, it does.
To be good at trading options requires versatility. One-trick ponies don't last in the long run. A deeper understanding of options helps traders adapt to ever-changing market conditions. This is the most important thing that I try and instill in my students at Market Taker Mentoring LLC. Understand the product. Don't just try and get good at one trick, even if it's a good one.
Though silent film and theta strategies are both fun nostalgia, their eras are over. Time to move on.
Dan Passarelli
http://markettaker.com
Theta spreads, while sexy in their own time and place, have been usurped by the new stars of this golden era of trading, like volatility plays. Theta spreads involved selling options and were attractive for two reasons: 1) They profit when stocks DON'T move, and 2) They usually produce more winners than losers. The problem, though, occurs when stocks DO move. This is when losers are produced. And when theta spreads lose, they can lose big. In fact, with many theta spreads, often $4 or $5 is risked for the chance to earn $1. Sometimes that ratio is even higher like $10 or $20 risked to make $1.
Traders who were introduced to options in the less volatile periods thought these strategies were manna from heaven. They'd have profitable trades month after month, never seeing a loser. Nirvana! But, when the volatility kicked in everything changed. The first losing month came as a shock to many newbie traders. "How could this happen!?!" It can. And, it does.
To be good at trading options requires versatility. One-trick ponies don't last in the long run. A deeper understanding of options helps traders adapt to ever-changing market conditions. This is the most important thing that I try and instill in my students at Market Taker Mentoring LLC. Understand the product. Don't just try and get good at one trick, even if it's a good one.
Though silent film and theta strategies are both fun nostalgia, their eras are over. Time to move on.
Dan Passarelli
http://markettaker.com
Monday, November 17, 2008
Bull Call Spread to Hedge Volatility
On the one hand, it seems like a good time to be an option buyer: limited risk, leveraged reward, etc. But on the other hand, they're just so darn expensive! Right now implied volatility is at historic highs. That means, when you're buying a call or a put for a directional bet, you're paying up because of volatility.
One way to combat high implied volatility is to trade a spread. A spread involves buying one option and selling another. Rationale? While you're buying an expensive option, you're also selling an expensive one, too. That means it's possible to net out some of the potentially adverse effects of high implied volatility.
In terms of greeks, with spread trading all the greeks are lower. But vega is usually much more reduced than delta. That means there is still a fair amount of the wanted directional sensitivity without as much implied vol risk.
There are a couple of tricks to this technique. First, it should go without saying, that since this is a directional play, you have to be right on direction to make money. But what's important in setting up the trade is strike selection--especially on the short strike. The short strike should coincide with the price point in the underlying conducive with expectations. That is, sell the strike that is as high (low) as you think the stock will go.
Example:
A trader thinks XYZ stock will go from 50 to 60 over the next month but wants to hedge implied volatility risk. He'd buy 1 30-day, 50-strike call and sell one 30-day, 60-strike call. This is what traders call a bull call spread, or a debit call spread. Here the trader retains a lot of the directional sensitivity (delta) but spreads off most of the implied volatility risk (vega). If he's right and the stock goes to 60 in 30 days, he reaches his maximum profit (in this case $10 minus the cost of the spread). If the stock exceeds $60 a share, though, profits are limited. If, however, the stock falls, the trader can lose up to the amount paid for the spread.
In times like these, where volatility rules the market, traders need to trade smart and use everything they can to gain as much edge as possible. Spreading off volatility risk is one technique that all traders should consider.
Dan
markettaker.com
One way to combat high implied volatility is to trade a spread. A spread involves buying one option and selling another. Rationale? While you're buying an expensive option, you're also selling an expensive one, too. That means it's possible to net out some of the potentially adverse effects of high implied volatility.
In terms of greeks, with spread trading all the greeks are lower. But vega is usually much more reduced than delta. That means there is still a fair amount of the wanted directional sensitivity without as much implied vol risk.
There are a couple of tricks to this technique. First, it should go without saying, that since this is a directional play, you have to be right on direction to make money. But what's important in setting up the trade is strike selection--especially on the short strike. The short strike should coincide with the price point in the underlying conducive with expectations. That is, sell the strike that is as high (low) as you think the stock will go.
Example:
A trader thinks XYZ stock will go from 50 to 60 over the next month but wants to hedge implied volatility risk. He'd buy 1 30-day, 50-strike call and sell one 30-day, 60-strike call. This is what traders call a bull call spread, or a debit call spread. Here the trader retains a lot of the directional sensitivity (delta) but spreads off most of the implied volatility risk (vega). If he's right and the stock goes to 60 in 30 days, he reaches his maximum profit (in this case $10 minus the cost of the spread). If the stock exceeds $60 a share, though, profits are limited. If, however, the stock falls, the trader can lose up to the amount paid for the spread.
In times like these, where volatility rules the market, traders need to trade smart and use everything they can to gain as much edge as possible. Spreading off volatility risk is one technique that all traders should consider.
Dan
markettaker.com
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