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Success With Options - Monthly Review, Issue #013 -- January Edition
January 02, 2011

Welcome to the January 2011 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 websites and trading tips. If you find this newsletter valuable, pay it forward and send it to your options trading friends.

To access previous issues of the newsletter, click here.

A Whole New Year - January Newsletter

Welcome to the January newsletter! It's hard to believe it's been a year since this newsletter was started. It's been an interesting year in terms of the market action, lessons learned and changes to the website...

In this newsletter, I'll be reviewing the month in more detail and providing my outlook for December. Also, I'll update you on the video, review some trades, talk options strategies and more. Read on...

Thanks to those that have provided feedback on the newsletter. I do value and take into consideration feedback on the newsletter content and on ways I can make it more valuable for the readers.

Please feel free to voice your opinion. If you haven't done so already, please consider taking a few minutes to visit the newsletter feedback page and let your voice be heard. I don't require an email address to submit the feedback so you can do this anonymously.


In This Issue

1) New on the site

2) Trade Tutorial summary

3) Options Strategy Focus

4) Answers to your questions

5) Options Outlook

What's new at Success With Options

Since December was a rather quiet month overall - and since this newsletter marks beginning of a new year, I thought I'd utilize this section to review some of the changes to the site over the past year.
  • A year ago this newsletter was launched. I hope you've found it helpful to you in providing additional options trading information. Based on excellent feedback, there have been a number of changes. The newsletter will continue to evolve based on your feedback so feel free to let your voice be heard!
  • I've added several new topic pages including information on index options, ETF options, option greeks, and option volatility. I expect to be adding new topic items in 2011 as well.
  • I've updated several web pages, including reviews of the TD Ameritrade, and Thinkorswim broker pages.
  • I've created a number of free videos hosted on YouTube. I recently created a web page just to organize these videos and provide a quick summary.
  • The biggest news of all is the limited release of the first full length video 'An Introduction to Options Spreads'. While no longer available, I did receive some excellent feedback. Thanks to those who took the time to evaluate the video. The projected release date for the final version will be mid February.


Trade Tutorial Summary

I had a few trades going this month. The two trades that closed did so profitably.

Here's the complete list of trades I was active on this month in a quick summary.

New/ Closed Trade Gain/Loss Comments
Open GLD diagonal spread   The short strike has been rolled to January and in the process we picked up an extra $1 in the width of the spread. Still waiting for the spread to increase a little more but definitely heading in the right direction
Closed SPY vertical spread $222 I entered this trade with the idea there might be a little more bullishness and it turned out there was
Closed DIA vertical spread (put) $231 This trade closed the last day of the month and I was able to lock in the target gain for this trade.
Open DIA vertical spread (call)   This position is not far from being overrun. Given that the put spread has closed, it may be worth considering an adjustment strategy.
Open XLE vertical spread   This is the newest trade to be put on. I continue to be bullish until given a reason not to be. So far it's working out.

While I hate having losing trades, I find that I learn the most from them. Whether winners or losers, I'm going to start including some key thoughts/lessons learned from the past month's trade tutorials here. Here are the nuggets from last month's closed trades.

From the SPY put credit spread:
"...while the bounce behaved as expected, It could have easily gone the other way. In that case, I would have experienced my maximum loss. However, I contend that the keys to success in a trade are found in some very basic concepts.
  1. Good technical analysis to determine trend for desired timeframe
  2. Selection of a strategy that matches that trend and timeframe
  3. Having and following clear rules for entry, exit and money management
When I look back on the trades that have lost money, many of them were due to not following the rules in one way or another. ...

From the DIA put credit spread:
"... As I've mentioned before, it's a little more difficult to draw lessons from successful trades. However, I've said a few different ways that following my rules will pay off over the long term. If nothing else, think of it this way. A successful trade like this is the reward for consistently following the rules."

I want to conclude this section by reviewing the year end results. In 2010 I entered 36 trades of which 14 were successful (profitable) trades, 19 were failed trades and 3 are still open. In all of these trades, the portfolio only lost 12%, which is 1% per month. I say 'only' because many traders that lose as many trades as I did in these tutorials would have completely drained their account. The secret is good money management, one of three critical aspects to successful trading. My New Year's resolution is to improve the second of the three, which is good entries and exits. As I mentioned in the most recent trade tutorial, I am changing my exit strategy for vertical spreads so we'll see how that helps overall.

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

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Options Strategy Focus

Based on feedback, I have modified this section a little bit to focus more deeply on the details of some of the options strategies I use in the tutorials. The last few issues have dealt primarily with selecting a strategy. In this issue I will be talking about entry timing. That is, when to actually enter a trade.

What I'm talking about is using technical analysis to enhance the timing of the entry. In the trade tutorials I've posted, I don't always use technical analysis for anything other than trend analysis. In fact it isn't critical to time the entry for many of the options strategies I use. However as we'll see, using technical analysis to time entries can offer a bit of an edge.

There isn't really room in this newsletter to go into much detail on the various technical analysis tools and techniques. Instead, I'll focus here on some using simple technical analysis such as support and resistance to both improve the entry and select a strategy.

To better understand the value of technical analysis in entry timing, let's consider the the above chart. What we have is an up trending chart that has experienced a pullback. It appears to have established a strong support level around $117.50. The question is, which point in time offers the best opportunity to enter?

As we look at the chart, it may seem obvious initially that the best point is right at the support line. That's because we now can see that it was a bounce, but on the day this happened, we had no idea there would be a bounce. Support is only support until it ceases to be. In other words, it can suggest a possible bounce but there is no guarantee.

How about the next day? Here, we see a nice jump up and in fact that move clears the near term overhead resistance. Would this be a good opportunity? Very likely so, but notice that the next level of resistance is at about $122.50, which doesn't leave much room for movement.

Obviously, if we had entered right at support, we'd have seen a short term bullish move. Waiting until clearing the near term resistance gives us more certainty of the move but offers less of the move to capture. I can't tell you which approach you should use. Everyone uses technical analysis a little differently. The key thing is to become aware of how the use of technical analysis can help us improve the odds of success and even the profitability of potential trades.

One other use of technical analysis is in strategy selection. Using the above chart and given the potentially short timeframe of a bullish move, which of the options strategies I've talked about in past newsletters makes sense? A diagonal spread might be too risky given the move may stall at $122.50. A put calendar spread might make sense if we expect a stall. We could buy a $122 call calendar or buy a $117 put calendar if we believe we'll see range bound movement. A put vertical spread might make sense if we're bullish and simply want to capture the short term move.

This raises the question of which comes first, the strategy or the technical analysis. In other words, do you pick the strategy and wait for an optimal technical setup or do you watch for a good setup and then select the strategy? While both approaches are viable ways to enter a trade, I submit that starting with a technical setup and then selecting the strategy is a more effective way to take advantage of entry timing.

This is an appropriate topic to begin the new year with. I mentioned earlier that my objective in future trades is to be better at entries and exits. My goal is to become more consistent in picking winning trades and in being more profitable in them. What's your New Year's resolution?

Be sure to check out the technical analysis page on the website for additional detail. One of my other favorite sites to visit is Chart Signals by Dave Johnson. He provides outstanding content and is a strong proponent of 'Keep it Simple' technical analysis. Remember, practice makes perfect so get out there and try using technical analysis on your future trades. Be sure to paper trade until you are completely comfortable with this approach.

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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 answers would be valuable to all readers. Each month I'll be posting one or two questions, so stay tuned!

Here's a question received some time back regarding trade management of iron condors

Q: Can you tell me if there is any information about adjusting iron condors when the short strike on either side is threatened?

This is a great question, and one that may have crossed a lot of traders' minds a time or two. 

I want to begin by talking a little about the natural psychological response a trader has to a position being overrun. If this is one of your first trades, your initial response might be sweaty palms and racing heart. In a situation like this the trader's first instinct is to look at trying to protect the position being overrun. This often keeps you from focusing on other trade opportunities.

In the case of the iron condor, let's say that the call spread is being overrun. Isn't the natural temptation to focus on trying to protect the call spread. Instead, what's going on with the put spread? As the call spread is being overrun, the put spread is becoming more profitable. If the move is strong enough, you might even be able to close the put spread completely and remove the downside risk. This is just one way to manage an iron condor being overrun on one side. Let's look at a few other ways.

You could buy a calendar spread near the area where the spread being overrun is. I often will buy a calendar spread right between the long and short strike of my $2 spread. The value of this strategy is that the calendar spread will help offset the loss of the vertical spread.

You could close the position altogether or simply lower my risk by buying back a few contracts of the spread. If for example you have 6 contracts of a call spread being overrun, you could close 2. You could in turn also sell a couple contracts of a put spread closer in and use the premium to offset the cost of closing the calls for a loss.

You could also buy back one or two contracts of the short strike. This leaves one or two uncovered long calls, which means that as the underlying continues to move up through the spread the increasing value of the long calls will help compensate for the loss of the spread.

Keep in mind that all of these strategies come with their own risk. By adding an additional position, you are committing yourself to the new market bias that goes with it. By doing so, you now have risk that the market could reverse and go against this new position. Remember that no adjustment removes risk but simply shifts it.

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

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Options Outlook

In concluding this newsletter, I want to provide 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.

After a calm to slightly negative November, we had a fairly bullish December to close the year out with a 12% gain overall on the SPX. At the end of November I wasn't too sure which way the market would go. I summarized my outlook as follows:

"There is a fair amount of good news but it's tainted by the economic situation in Europe. I believe the market wants to rally but needs a respite from all the bad news. The thing to watch out for is the support level right at $1173. There have several attempts to touch that level but each time has resulted in buying. As we've seen in the past few months, we could see the month begin with another rally. However, we could also see a failure of this support level and that would probably lead to a lot more selling. "

Here's how the month played out.

From the first day of December the market went straight up with hardly a pause. In fact within days of the beginning of the month, the overhead resistance was cleared. I went from being cautiously bullish to outright bullish, which is why I've since entered another bullish trade.

With such a strong move right to the end of the year, what's next? It's a strong possibility that we'll at least see a pause or even some selling right after the first of the year. Notice how far we are away from the 30 and 50 day moving average. Usually when there is that much of a move away from the moving averages there is a move to compensate.

There is also the possibility of break above the highs in an ongoing bullish thrust. Heading into the new year, it's pretty much anyone's guess what will happen for sure. Until the market tips its hand, we'll just have to wait and see?

How will that affect my trades? I'm going to wait a little bit to see which direction the market takes. I'm prepared to sell some call spreads above the market. If we see some selling, I'll look for an opportunity to re-enter bullish trades near the moving averages.

Remember to stay nimble and alert. Make a point of doing market analysis every day, especially if you have open trades. If you choose to enter any trades, be sure to do your own analysis and follow your rules for entry and exit.

More on technical analysis.

Options strategies I use

Be sure to take time to provide feedback on the newsletter.

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