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Success With Options - Monthly Review, Issue #75 -- April 2016 Edition
April 02, 2016

Welcome to the April 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.

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 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: 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.

Applying synthetics
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 modified portfolio.
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)?

Hopefully you 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 possible outcome.

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 spread.

Stepping back, 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 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!

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 platform.

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 on SPY.

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 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.

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 so points 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.

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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