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Success With Options - Monthly Review, Issue #14 -- February Edition
February 01, 2011

Welcome to the February 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.

As Goes January? - February Newsletter

Welcome to the February newsletter! You may have heard the saying 'As goes January, so goes the year'. The percentage of years this has been true is pretty high. However, last year this was not the case. We had a negative January but the year ended with a 12% gain on the SPX.

In this newsletter, I'll be reviewing the month in more detail and providing my outlook for February. 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

January has been a quiet month for several reasons. I spent several weeks dealing with computer woes, which has distracted me from entering many new trades. I was able to do some work on the video script, which I believe is ready to go. That means the next step will be recording the raw content. Realistically, this means I'm probably about a month behind in the final release. At this point, the release will likely be closer to mid March to the end of March.

The only other activity at the website has been closing trades and opening new ones. See the trade tutorial summary below for additional details.

Trade Tutorial Summary

I only had a few trades going this month. Two out of the three trades closed profitably. The losing trade was the DIA trade, which was the other half of the DIA put spread that closed profitably.

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

New/ Closed Trade Gain/Loss Comments
Closed GLD diagonal spread $13 Unfortunately gold has been beaten up pretty badly over the last month or so. As a result, I was forced to close this trade at barely better than break even.
Closed DIA vertical spread (call) -$252 This trade ended up being a losing trade but was somewhat paired with the DIA put spread, which closed profitably.
Open XLE vertical spread $70 This trade worked out exactly as expected... actually slightly better. Lower gain is due to new position sizing approach.
Open IWM vertical spread   A new bullish trade I've entered this month.

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 GLD diagonal spread:
"...What could I have done differently to improve the profitability of this trade? First of all, when I considered the roll, I talked about the tradeoff of rolling directly across to the same strike vs rolling up and making the spread wider. To do so, I gave up some of the credit on the roll. In fact if I'd simply rolled across I could have kept an additional $.50. Another place where I could have improved my profitability is closing a day earlier when it was clear a lower high was forming. In fact going back to the beginning of January, there was a failure (for the third time) to make a new all time high. "

From the DIA call vertical spread:
"... I neglected to add an alert that would have reminded me to take action. I could have been more disciplined to review my trades relative to my exit rules, which were well embedded farther up this page. The critical thing to remember when using exits that aren't enforced by any kind of automated exit is that some means must used to enforce these exits with the same rigor that would be used by a stop loss order. For me that is typically the alert I mentioned. This at least offers a reminder to go back and review the rules. "

From the XLE vertical spread:
"... I sold just 2 contracts in keeping with my new trading rules concerning credit spreads. As a result, the profit in this trade is $70. That doesn't seem like a lot compared to some of the trades I entered last year but my expectation is that I'll have more winners because I can stay in longer. Time will tell on this."

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

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Options Strategy Focus

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. In past issues, I've talked about how to select a strategy and using technical analysis to improve timing of entries and exits. l In this issue, I want to talk a little bit about trade management. It may seem just a little out of order since I haven't yet talked about position sizing.  Hang on and I'll get back to this in a few issues.

By trade management, I'm referring to the idea of how one manages the trade after it has been entered. I'm really talking about being able to answer two key questions; 1) What do I do if the trade goes as expected? 2) What do I do if the trade doesn't go as expected?

The answer to the first question may seem obvious. However, the real issue is knowing when to take profit. You may have heard the phrase "Cut your losses and let your winners run". That sounds easy in theory but is more difficult in practice. Have you ever had a profitable trade turn into a loser because you didn't take your profits? What about the other side of the coin? Have you ever exited a trade to lock in profit only to see even more profit left on the table?

The key is to have a target profit in mind and use that as one of your exits. If you follow the trade tutorials I put on the website, I always have an exit rule that is designed to lock in profit. In the case of the short vertical spread, I usually target 80% of the initial credit. That's not a hard and fast rule, it's simply my rule. Another trader could settle for 70% or push for 90%. 

These target exit points can come in different styles. A variation on the prior exit example is exiting when my trade shows a certain percentage return. I often use this on debit trades like calendars and long vertical spreads. Another exit might be having a rule to exit on a price trigger. For example, I will close when stock XYZ reaches $100. This is often will be tied some form of technical analysis.

The important thing is to think through these rules. Most strategies have a best case or ideal scenario. However, it isn't necessarily a wise move to hold out for this case. I think you'll find too many winners will turn into losers. In thinking this trough, here are some points to consider.

  • What are your profit targets (ROI, profit percentage, etc) for this strategy?
  • What is your objective for success rate? In other words what percentage of your trades of a particular strategy do you want/need to be profitable?
  • What is your trading personality? Does having some losing trades have a negative affect on you?
Think this through as you are planning your trading rules for your various strategies. Use paper trading as a way to test out various rules. Do this until you are confident the rules will work for you.

In this column I've focused on one particular aspect of trade management, which is setting rules for exiting a successful trade. Next month I'll be focusing specifically on exit rules for trades that don't go as planned, which is worthy of a column (or two) all by itself. Stay tuned and get out there and practice!

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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 recently received on other ways to do analysis on calendar and diagonal spreads.

Q: In your tutorial on diagonal call you did calculations based on theoretical value of a calendar spread using TOS platform. Are there any other tools I can use to achieve the same roll value calculations?

A: As most followers of the trade tutorials know, I've done most of my analysis of trades like diagonal spreads and calendar spreads using the cool features of the thinkorswim by TDAmeritrade plaftorm. However, it may be that for some reason you can't use this trade platform. 

While not nearly as handy as the thinkorswim analysis tools, there is a tool available from the Options Industry Council (OIC). This tool is called the Position Simulator. I actually used this tool in discussing roll analysis for the calendar spread strategy and the diagonal spread strategy. As a result, I won't go into step by step instructions here.

There may be other tools out there as well that I haven't run into. Preferably, the tools would be free or incorporated into a trading platform you may be using. If anyone is aware of another tool that can be used to analyze roll values, let me know and I'll pass the information along in the next newsletter. Simply use the same link you would use to post a comment or question.

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.

January makes for the second bullish month in a row. At the beginning of the newsletter, I mentioned the old saying about January being a predictor of the remainder of the year. We'll have to see about that. For now, let's just focus on the month ahead. In the last newsletter, I summarized my outlook as follows:

"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. . "

Here's how the month played out.

January started out a lot like December but after the first gap up day, simply consolidated for a week or so. Following the consolidation, the SPX pushed up above the highs of the consolidation area and then spent a few days consolidating again (testing the former resistance - now support). Last Friday was a heavy selling day that took the SPX back down to that support area. Fortunately the final day was another buying day leaving the month positive and further establishing the $1275 area as a support level.

The next question is, what does February hold in store? The recent pullback also took the SPX down to the 30 day moving average. This adds strength to the bullish argument. Whenever a stock pulls too far away from the moving average, I start to expect a snap back.

On the other hand, if you look at the stretch from mid September to just a few days ago, we've seen a pretty long bullish run. There was a minor correction in early November but it seems like there may be more to come. In fact, I'd say if we see the SPX fall below $1275, we may see a correction all the way down to the $1250 level or lower.

How will that affect my trades? I'm going to wait to add any more trades until I see either a follow-through to the up side or further selling. A failure of the support level would be an opportunity to enter bearish positions. A push above $1300 to me would signal another bullish move, which would be an opportunity to enter additional bullish positions.

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

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