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Success With Options - Monthly Review, Issue #74 -- March 2016 Edition
March 01, 2016

Welcome to the March 2016 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 (nearly) 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.

The Ups and Downs of the Market - March Newsletter

What an interesting month. We ended the month pretty much at the point where we started. Is the worst of the market turbulence over? Is the next move up or down?

In this edition we'll tackle that question, begin to explore option synthetics and answer a question that was recently submitted by a reader. Finally, we'll close as usual with a Market outlook for you. For more details, read on...

I'm always interested in receiving feedback on the newsletter. If you haven't done so recently, please consider taking a few minutes to visit the newsletter feedback page and let your voice be heard. This can be done anonymously so please consider how you can help make the newsletter better.

In This Issue

1) Options Strategy Focus

2) Answers to your questions

3) Options Outlook

4) Featured Products

Options Strategy Focus: The Synthetic Triangle

This section of the newsletter will focus more deeply on the details of some of the options strategies I use in the tutorials. Last month, I introduced the topic of options synthetics, focusing on a specific example of simulating a long call position. In this issue, I want to continue forward with a further explanation of synthetics. However, my intent is not to present this as a purely academic exercise, but to show in a follow-on article some basic usages of synthetics applied to our options trading strategies.

The Synthetic Triangle
I mentioned in the last issue the notion of a synthetic triangle. The idea is that a synthetic position for any one element of the triangle can be constructed from the other two. I also showed some examples of creating synthetic long and short stock positions as well as creating synthetic long and short call and put positions as well. The following illustration shows the relationship between these three components. 

The point is that it's possible to create a long stock synthetic position from a call and a put. It's possible to create a synthetic call from a put and a stock and so forth. I won't bore you with writing them all out here. The point I'm trying to get to is understanding the basis for my next point.

If you take the concept of the synthetic triangle to it's logical conclusion, I should be able to describe a synthetic short put vertical (let's say a SPY 194/192 short put vertical spread. I do this in the following way.
  • Short $194 put = Short $194 call + short stock @ market
  • Long $192 put = Long $192 call + long stock @ market

Notice that in the process, you are buying a long stock and selling the stock (essentially short). These two would basically cancel each other out leaving just the 1 long $192 call and 1 short $194 call. I could say that synthetically a short $194/192 SPY put vertical is the same as a long $194/192 SPY call vertical. The evidence of this is in looking at the two P&L charts side-by-side. You can see that in terms of the profit and loss analysis, they behave exactly the same.

Thinking in terms of synthetics
Are these two trades exactly the same? No. While both are positive delta, the short put vertical spread is currently positive theta, while the long call vertical is negative theta. In addition, the long call vertical is positive vega (increases in value with increase in volatility), while the short put vertical is negative vega.

This means I can build the same risk profile in different market climates. This is the key point I want to get to in this issue. It's possible to construct approximately the same position synthetically but do so in a way that takes advantage of different market climates. To apply this, what would I do with a market that is high in volatility with an anticipated bullish bounce? I'd sell a short put vertical. In a different market where volatility is low but I expect sustained bullishness and possible even lower volatility? I'd buy a call vertical.

This is only one application of synthetics. It doesn't always work this way for all options positions. However, with a little careful calculation, you may find it's possible to construct many positions and adjustments using synthetics. If you find you're not sure if you've got the synthetic right, use a tool like thinkorswim's Analyze tab to confirm this.

In the next issue, I'll explore the use of synthetics for adjustments. In the mean time, you might take some time to play around with this yourself using your favorite analytics tool. If you use the thinkorswim platform, you may want to view their Analyze Tab tutorial to become more familiar with this powerful but sometimes intimidating feature.

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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!

l periodically receive emails about commission structures and how to profit with strategies such as I discuss on the website.

Q: I opened an account with <pick your brokerage> and this is the pricing structure says that options are $9.99 + $.75 per option. If my vertical only makes 41 dollars (@80%) then how can I make money if it costs $10.74 to open and $10.74 to close? On a $2 spread that is thin.

A: This is a great question and gives me an opportunity to visit this topic again. I want to address this question in two parts. First, explore the cost/profit potential of different commission structures. Second, I want to discuss options for possibly getting a better commission rate.

Let's tackle the analysis first. You are right in your initial analysis of P&L given a $9.99+ $.75 commission. You would make about $18.02 on one contract (recall, you usually have to pay $.75 on both contracts of a vertical spread). However, if you raise number of contracts to 2, your profit jumps to $56.02. When it jumps to 4 contracts, your profit is $132.02. A structure like you mention is skewed more toward larger trading sizes.

Is it possible to shop around for  better rate? Sure. Is it possible to negotiate a rate with your broker? Sometimes. Some brokers will actually offer a few different structures. You can occasionally contact the accounts department and ask if they offer different structures. Before you make a change, be sure you run some example trade scenarios that reflect your trading habits to see how the commission affects your net profit.

I can't leave this topic without touching on the topic of brokers & commission. I made a point of stating this in the options brokers page on the website. While it may not always seem like it, commission isn't everything. There is sometimes a tradeoff between how low the commission is and the service and support you get from your brokerage. Discount brokers often don't provide the breadth of services you would typically expect from higher fee brokers. In other words, you sometimes get what you pay for. Don't use the commission as the sole deciding factor in your broker choice.

Help me ensure we have an interesting question or two to respond to next month. Submit your questions at 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, expectations may change if the charts indicate something different during the month.

We certainly saw a lot of volatility through December and into January. It's actually quite a bit more than I had anticipated.

In the February newsletter, I summarized my outlook as follows:

"...I think it's always good to step back at the end of a year and get the big picture. For that reason, I included an inset showing the 2 year monthly chart. You can see that where we found a bottom recently around $1800 is pretty close to the October 2014 low. In the longer term, we are still in bullish territory. However, in the medium term (6 month timeframe), things look a lot more neutral. Of course near term (4-6 weeks), things are much more bearish.

We saw a bit of a rally on Friday that may signal more bullishness. However, given the climate, I'd approach any rally with a bit of skepticism. There are still a number of head winds, both technically and fundamentally in the market. ...

Here's how February played out.

We haven't really seen much resolution over the past month... or have we? Notice that this month showed more selling to test the low established in January. This was followed by a rally all the way to the 50% retracement level and then a bit of consolidation. That leaves us with the question; will the next move be up or down?

The bullish argument suggests that with the double bottom and subsequent rally, there is a likelihood that in March, we may see additional bullishness. The bearish argument considers the near term weakness and the fact that any rallies we've seen recently haven't been on high volume. It's possible we'll see both scenarios. In the coming weeks, we may see the first move as down to test the 30 day moving average again. If this holds, my outlook becomes much more bullish.

I currently have some bearish trades from last month that I'm looking for an opportunity to close. Additionally, any selling would also offer an opportunity to enter some more bullish trades. I'm watching the market closely realizing that it's very news driven and pinned to oil prices. Keep an eye on this. If you are one who likes bullish opportunities, what's the flip side of oil? Check out GLD!

As always, do your own analysis and whatever trades you enter, use good money management and have exit strategies in place in case you are wrong in your analysis. It's a good practice to be prepared with trades in either direction but not to act without confirmation.

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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Featured Products

I'm adding a new section to the newsletter. Feel free to disregard if you aren't interested in product information.

One of the more recent additions to the portfolio of services and products is the Live Web sessions. These sessions are recorded and and available for a very reasonable price of $12 per session. I've created a Newsletter Special. If you add all 4 sessions to your shopping cart, you can get 4 sessions for the price of 3 by using the discount code: WebEx4Pack

Some time back, I released the second for sale video. The title of this video is "Mastering Short Vertical Spreads". I now have a total of two strategy training videos for sale . Here is a quick summary of each.

An Introduction to Options Spreads
This video provides a good coverage of the basics of options spreads, including why they are preferable to other options strategies like buying options and selling naked positions. What I believe makes this video valuable is that it combines presentation with interaction. Once you have the basics down, you will be well-prepared to start digging deeper into some of the options strategies employed on this website.

For a relatively small cost of $29, you can own this video, which offers over 40 minutes of material. This package is very easy to install and use.

For more information or to purchase the video.

Mastering Short Vertical Spreads
The focus of the video is on one specific strategy, including all aspects of of the process. This includes:
  • Understanding the construction and how the trade progresses over time
  • Selecting the long & short strikes
  • Planning entry & exits
  • Managing the trade once entered
  • Back testing
  • Creating a trading system with the strategy
I'm excited about this project. Many know this is my go-to strategy for options trading. After watching the video, I'm certain you will understand why.

For more information or to purchase this video

Special Discount offer:
If you'd like to own both videos, you can do so for a bulk discount. Simply add both videos to your shopping cart and then enter the discount code 'combo10' to receive $10 off your shopping cart total.

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