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Success With Options - Monthly Review, Issue #001 -- Inaugural Edition
January 02, 2010

Welcome to the inaugural edition of this newsletter!

This is a monthly newsletter packed full of tidbits not found on the website. This is my attempt to stay connected with those who find value on the the website and want more.

Since this newsletter is published every month, you are always up to date and empowered to be a better trader. That's because I'll be sharing lessons I've learned over the prior month, answering questions from other viewers and providing a spotlight on useful books, websites and tips. If you find this newsletter valuable, pay it forward and send it to your options trading friends.

Happy New Year! - January Edition

What's your New Year's resolution?

In this edition, you'll see I still have a few lessons to learn. My number one resolution this year is to trade what I see. That means the majority of my trades need to be in support of the intermediate term trend.

How about you? Do you have some resolutions you need to make related to trading? Maybe it's to get more educated through seminars or reading a book or two. Maybe it's to improve you trading through better use of a trading system.

Whatever your resolutions are, I encourage you to jot them down and review them each month. Taking time to review your trades and your processes each month is a key to becoming a better trader.

That's what we're all after right?
 

In This Issue

1) New on the site

2) Trade of the week summary

3) Answers to your questions

4) Book review of the month

5) Options Outlook
 

What's new at Success With Options

  • Index Options page - I have traded index options in the past and continue to do so from time to time. Many people are interested in index options, so I put together a page that discusses some of the similarities and differences between index options and regular options. Check it out!
  • ETF Options page - For the past year or more, I have almost exclusively traded ETF options. Why? I answer this question and many more on this page.
  • Video tutorials - I've added several new videos to my YouTube channel recently. Unlike some of my first videos, these are more focused on topics such as premium selling strategies and portfolio management. Have a look.
 

Trade of the Week Summary

Over the last month, I've not put on as many trades as in prior months. Part of this was due to the sheer craziness I was experiencing heading into the holidays, but another part of it was due to my uncertainty as to what the market was doing. As I'll talk about in a later section, the S&P 500 went into a bit of a holding pattern that left me uncertain as to the direction.

That said, I put on several trades last month and closed several others. Here they are in a quick summary.

New/ Closed Trade Gain/Loss Comments
New Short put verticals $189 loss This was a pair of put spreads that were designed to offset the bearish trades I had going. One spread closed with a loss and the other had a modest gain.
New Short SPY put vertical open This is a new trade and is in keeping with my current outlook, which is bullish. 
Closed Short EWZ put vertical $504 gain This started out as a short put vertical that I added some call verticals to and it turned into a nice winner.
Closed SPY Iron condor $355 loss With SPY being unusually strong, this trade killed me. This is where I decided to stop fighting the trend.

The point isn't necessarily to make a handy profit on every trade but to trade every trade well (although profits are really nice). I don't feel I traded well for a number of reasons, but even still, I exited the month with only a modest loss - a tribute to good money management. That's the one thing I felt I really did well.

For more information on all of the trades I've posted as option trading tutorials, click here

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Answers to Your Questions

I frequently receive email from visitors to the site with questions that aren't answered directly from content on the site. Many of these are great questions and I think the answer would be valuable to all readers. Each month, I'll be posting one or two questions so stay tuned!

Here's the first one...

Q: I see that you and many others have a rule to sell or buy back 4-7 days before expiry. What is the reason that you do this?
A: I get this question a lot and when I first started trading, I didn't really see why I should give back money and pay extra commission to close early. I was first challenged on this point by one of the guys from Thinkorswim at one of the free workshops they offer in various cities. What helped me understand was to think through a trade.

   If I put on a trade (let's say a $2 wide spread) for $.50, that leaves $1.50 in risk if I don't use any other exits. Let's say that 2 weeks go by and the position is only worth $.10 (that means I have a $.40 profit). With more than a week to go until expiration, I could close the trade and lock in that profit or let it ride, holding on for the last $.10. That means I'm really risking not only the profit I already have but the amount I stand to lose for that last $.10. The question is... is it worth the risk? After having a number of winning trades turn into losers in that last week, I say no. Since then, I have rarely held until expiration.

  For a more technical reason, take a look at what happens to gamma in the last week of an option's life. It tends to cause prices of the option to swing wildly with only small price movement in the underlying. That means you could have an option that is almost worthless at one point and have it suddenly become worth quite a lot with only a $1 or $2 swing in the underlying stock or ETF.

If you would like to submit  a question, comment or feedback on the website, please visit this page.

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Book Review of the Month

When I first started getting interested in trading, I was hungry for every book I could get on trading of any kind. I went to the library, I went to bookstore and any place I could to find good books. The book I want to spotlight this month is one I bought early on and I'm glad I did.

The book is called "Fundamentals of the Options Markets" by Amy Hoffman and Michael S. Williams.

When you are first learning about options, all the related concepts can be pretty confusing. What are all the Greeks? What is the difference between historical volatility and implied volatility? Why is options pricing so complex?

I really liked this book because when I encountered it, I was new to options and many of the concepts still weren't fully understood. This book is very readable and offers great explanations on the topics of options pricing, options Greeks, volatility and more. The authors were former options market makers so they understand these concepts inside and out. They do a pretty decent job of explaining things so a novice can understand. They even introduce the idea of synthetic positions, something I hadn't hear much about until then.

My favorite sections of the book:
  • Pricing Options (Chapter 4) - They cover all the details of how options are priced, including intrinsic and extrinsic value. They also introduce option pricing models, which helped me understand how the various factors interplay to affect price.
  • Option Volatility (Chapter 5) - The difference between historical volatility and implied volatility and how it affects option pricing. This relates back to the previous chapter on pricing models since implied volatility is so closely related.
  • Synthetics (Chapter 6) - I read this early on and skipped it because it was too confusing. I went back and read it later when I was more comfortable with options and found it to be much easier to understand. I'd have put the chapter much later in the book. That said, synthetics can really be helpful in understanding ways to adjust risk. I actually use the synthetic short (i.e. long put/short call) fairly often.
  • The Greeks (Chapter 7) - Finally... I'd have preferred this chapter be much earlier in the book.That said, I particularly found the explanation of the meaning and the different implications of delta helpful as well as the discussion on theta. It helps you understand why buying options can be riskier than selling them.
  • Market Making (Chapter 10) - I thought this chapter was quite interesting as it gives you a picture of what is going on with the other side of your trade. This chapter combined with listening to the Thinkorswim instructors talk about their days in the pits really helped me.
The only part I didn't find that helpful was the section on Option Strategies (Chapter 9). I didn't like the organization and their explanations of the trades, but your mileage may vary.

That said, I still recommend this book for your library, particularly as a stepping stone to reading "Option Volatility and Pricing" by Sheldon Natenberg. I'll be reviewing that book next month.

For more on this book or to purchase, click here.

To see other books in my library, click here.

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Options Outlook

I'm concluding this newsletter with a brief outlook for what I'm expecting for the next 20-40 days. Before I do, I need to insert the following disclaimer.

 
This is not a recommendation to buy or sell stock, ETFs or options. It is simply my opinion of what I expect and how I plan to trade. As such, it may change if the charts indicate something different.
 

For those that have followed my option trading tutorials (trade of the week), you know I've been fighting the trend because I have a hard time believing that this rally can be so long lived without any sort of correction. The result is that I've had more failing trades than I've liked. Repeat after me... "Trade what you see!". Yes, I'm repeating it to myself as well.

So, I put it to you... If you are a chart reader, what kind of trend to you see?

SPX options analysis

That's right! I think it's pretty bullish, although there was a consolidation period that lasted about a month. At that point, the consolidation could have either resolved to the up side or to the down side. In this case, it resolved in the bullish direction and I wouldn't be surprised to see testing of 1200 early in 2010.

However, I also wouldn't be surprised to see a nice correction after the first of the year. If it happens soon, then we may see a nice fat correction down to the 1000 level. That may seem wishy washy, so let me be more precise.

Given the above two possibilities, I believe right now, it is more likely for the S&P to continue up to 1200 before retracing. Since that is the case, I'm going to be looking at putting on more bullish trades... mainly put vertical spreads. I may start looking at a diagonal spread or two.

What might change my opinion? IF we see the S&P fall back down into the range it was trading in for most of November & December then I'd be a little more cautious. If we see the S&P fall below about 1080, then I'd expect a little more bearishness and I'd look at buying put calendar spreads and selling call vertical spreads.

For more on technical analysis, click here.

For more on options strategies I use, .

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