the April 2016 edition of this newsletter!
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Back to Where We Started - April Newsletter
|The last few months have certainly been interesting. Here we are right
at the place we started at the beginning of the year. Is the short term
bearishness over? What can we expect for the remainder of the spring?
In this edition we'll tackle that question, continue exploring 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
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
feedback page and let your voice be heard. This can be done
anonymously so please consider how you can help make the newsletter
Options Strategy Focus: Synthetics and Adjustments
| This section of the newsletter will focus more deeply on the details
of some of the options strategies I use in the tutorials. In the last
few issues of the newsletter, I've been discussing synthetics. In the
last issue, I talked
about how you can create the same synthetic
position a variety of ways. I want to continue this series by talking
about how you might use synthetics in your adjustment strategies.
Recall from prior issues that the whole point of synthetics is to
create a position using alternative means and that there multiple ways to create a
position that has the same risk profile. Where I'm going with this is
that you want to get to the point where you begin to think about
positions in terms of their risk profile and imagine how one risk
profile might be blended with another to create a new position or a
Let's say that I have an existing trade on that is a $2 wide short put
vertical spread. Let's also say that I have two contracts of this
position. Total risk is $400 minus the credit. I put this trade on
because I was bullish. If I begin to change my
bias, I may consider
putting on a short call spread in response. I could even select
approximately the same strikes. Of course they'd be calls, not puts.
However, recall from our prior issue that the short call spread and the
long put spread have roughly the same risk profile. If I'm going to
enter a short call spread on the same strikes, wouldn't simply buying
back the spread have the same effect?
What's the big deal you might ask? Wouldn't I be better off selling a
call spread and collecting the credit than paying a debit to close the
existing put spread? Yes and no. You have to consider both the max
profit and max loss. A $2 wide spread with a $.50 credit has a $1.50
risk. Which is riskier then? Selling a call spread for $.50 or buying
back your put spread for $1.50 (or perhaps less)?
begin to see that you have multiple choices in how you might adjust your
position. One is to
add another position. The other is to close an
existing position. Both have roughly the same risk profile, but may have
slightly different profit/loss profiles. It's worth looking more closely
at each to determine both your best possible outcome as well as worst
Synthetics for adjustments
With this basic idea in mind, let's move on to one other concept.
Synthetics can be used to create alternative positions. I don't just
mean closing a position but creating a completely different position.
You may already be familiar with the basic building blocks of short
vertical spreads, long vertical spreads, and calendars. Have you
considered that a diagonal spread is just a calendar spread combined
with a short vertical spread? Or that an iron condor is really just a
short call spread and a short put spread?
What this means in this context is that you can turn an existing
position into a completely different position synthetically. Let me
provide a couple an example.
Let's say that I bought a SPY March/Apr 202 put calendar spread. That
means I have a short March 202 put and a long Apr 202 put. Let's also
say I put that on for $1 debit. The idea would be for the market to come
down and end at 202 near expiration of the March options. That leaves me
with a risk in the trade of $100/contract. As time goes by, I realize
that the market isn't going to come down to $202 and I may lose the $100
in the trade. I decide to sell a March 204/202 put spread (that is short
$204/long $202). What does that do to my position? I effectively have
bought a $202 March put, closing the existing $202 short put (remember:
long = I bought it, short = I sold it). The remaining inventory is now a
short March $204 put and a long Apr $202 put. Wait - that's a diagonal
what I did was sell a short vertical spread over the top
of a calendar spread. Because the long put of the vertical was the same
as the short put of the calendar, the two cancel each other out (as long
as the number of contracts is the same). The result is a diagonal
spread. What is the benefit? I now have a bit more time for the trade to
work out AND I just got back some credit through the sale of a short
vertical spread. Let's say I was able to sell the vertical spread for
$.45. My current investment in the trade is now $.55. However, I've just
added an additional $2 in risk. That means my actual risk is $2.55
Let's say some time passes and the market does come down a closer to the
$204 level. What if I bought back the March $204 put and sold an
Apr $204 put? That's basically selling an Mar/Apr calendar spread,
right? What's the resulting position? I now have an Apr short $204 and
Apr long $202, which is
a short vertical spread. If I did that roll for
$1, I've now turned that $2.55 risk into $1.55 risk. In the mean time,
I've received $1.45 in credit. My reward/risk is close to 50/50.
BUT - if I was more bullish anyway, this means I've turned a potentially
losing calendar spread into a fairly profitable trade.
We're starting to get into an area where the concept of synthetics is
blending with simple trade adjustment.
However, this is where I find myself using synthetics the most. In the
next issue, I'll discuss more examples of how I've used synthetics to
perform adjustments on various positions.
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.
Back to the table of contents.
Answers to Your Questions
|I frequently receive email from visitors to the site with
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!
Q: I only do option pairs. I've been working on this for a year.
Does analyze tab and thinkback work with option pairs ?? ie:strangle on "sds" and strangle on "spy" at same time as one trade also can pairs options be both and sold as one trade ??pairs adjusted for for price and strength of underlying?
A: This is certainly a question I
haven't received before. I don't personally do pairs trading. However,
what you're asking isn't out of the ordinary for the thinkorswim
I won't provide a detailed step-by-step set of instructions, but I
will give you the high level overview and that should be enough for you
to figure this out. Neither the analyze tab, nor thinkback work
specifically on pairs in the way you might think from the charts.
However, both allow you to enter simulated positions. So, it's possible
to have a strangle on SDS and a strangle
For the analyze tab, this is simply a matter of setting up the portfolio
being analyzed. You have to first realize that the you can analyze
simulated or real positions (or both) AND you can analyze a single
position or all positions. The key to being to set up a scenario as you
suggest is to hide positions (a simple pull down on the positions and
simulated trades list) AND select 'Portfolio, Beta weighted' (another
pull down). You can now set up your simulated pairs trade for analysis.
You can do something similar with thinkback as it's really just a pair
of positions. Hopefully for you or anyone else who may be wondering how
to do this, this explanation helps.
Help me ensure we have an interesting question or two to respond to
next month. Submit your questions at this
Back to the
table of contents
|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
is not a recommendation to buy or sell stock, ETFs
is simply my opinion of what I expect and how I plan to trade.
expectations may change if the charts indicate something different
during the month.
Here we are, back where we started the year. Over the course of the
first quarter of this year, we've seen a month of selling where we shed
nearly $250 S&P points followed by two months of recovery.
In the March newsletter, I summarized my outlook as follows:
"...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. ..."
Here's how March played out.
I half expected there to be a little bit of pull back to the 30 day
moving average but right out of the gate, the SPX started gaining. There
were a few minor pullbacks but none really touched the moving average.
At this point, we've seen quite a lot of strength in the market.
The SPX and the market as a whole are definitely becoming much more
bullish. We can see several indications of this, including recovery of
nearly all of the fibonacci retracement, breaching a down trending
resistance line I'd drawn some time back from prior highs and the $50 or
remaining to fully recover all that was lost in late 2015 and
January of this year. The one risk is that we are currently at the highs
near the end of last year and early January. That seems to be to act a s
a bit of a head wind.
I think it's possible to see some sideways movement as the market
digests the current strong up trend before making a further push to the
past highs. I'd treat pullbacks as a buying opportunity (or an
opportunity to enter bullish trades). That's my plan for now.
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.
on technical analysis.
Options strategies I use
Be sure to take time to
feedback on the newsletter.
Back to the
table of contents
|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.
more information or to purchase the video.
Short Vertical Spreads
The focus of the video is on one specific strategy, including all
aspects of of the process. This includes:
I'm excited about this project. Many know this is my go-to strategy for
After watching the video, I'm certain you will understand why.
- Understanding the construction and how the trade progresses
- Selecting the long & short strikes
- Planning entry & exits
- Managing the trade once entered
- Back testing
- Creating a trading system with the strategy
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
Back to the
table of contents