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Success With Options - Monthly Review, Issue #005 -- May Edition
May 03, 2010

Welcome to the May 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.

Is the run over? - May Newsletter

I'm getting this newsletter out just a little late. With a slightly shorter month and a short vacation to boot, I'm running a little behind.

A week ago as I was beginning this newsletter, I had a different title in mind. At that point, the question in my mind was "How high can it go?" With two strong selling days over the last week, I may have my answer. Stay tuned...

We're about two-thirds of the way through the year already. So far, it's been pretty good, although volatility has been a little on the low side, which makes it difficult to get good fill prices. As you'll see later in the newsletter, I've got a number of trades currently open and a few more successful trades closed. The great thing about options is that you can make money no matter what the market is doing.

After sending out 4 newsletters, I'm anxious to receive some feedback on the content and on ways I can make this newsletter more valuable for the readers. Last month, I made the same request and received very little feedback. 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 completely anonymously.


In This Issue

1) New on the site

2) Trade of the week summary

3) Options Trading Tip

4) Answers to your questions

5) Options Outlook

What's new at Success With Options

Other than adding some additional trade pages and updating a few others, there are no major site changes. However, I will be adding a few new pages over the next month on option volatility and options and taxation.

On the video front, I had intended to add to the video suite on the iron condor trade adjustments. However, I created and uploaded the first of a series on diagonal spreads instead. I will be returning to the iron condor trade adjustments as well as adding another video demonstrating trade entry and management of the diagonal spread. Here's the link to the latest video:

Watch for a few more videos and pages to be added in May...

Trade of the Week Summary

I was fairly active with trade tutorials for April. I've done a few different things this month. One is that I've had 3 iron condors on at one point due largely to my neutral stance early in the month. I also entered a call calendar spread, which I usually don't do. However, this and the long call vertical were put on for good reasons that I explain in the trade pages. 

Here are the trades I put on this month in a quick summary.

New/ Closed Trade Gain/Loss Comments
Open Diagonal spread on IWM   This is a one contract long diagonal spread. This is now an $8 wide vertical spread as I executed the final roll both up and out. I'm just waiting for enough time to pass so I can close for most of the $8 credit.
Closed SPY Iron Condor -$171 I put this trade on in conjunction with a video tutorial I also released. I did a fair amount of trade management and finally ended up closing the trade for a small loss.
Closed Short DIA put vertical +$288 I closed this trade the day the last newsletter went out for a nice little profit (1.4% portfolio gain).
Open SPY Iron Condor   Another iron condor spread on the SPY. The puts are closed and the calls are nearly run over at the moment. I have made one adjustment by selling a few contracts of a put spread to pick up some additional credit.
Open EWZ Iron Condor   Another iron condor spread. I was fairly neutral in the early part of the month. At the moment, the call spread is closed with just the puts remaining.
Open SPY call Calendar spread   I put this trade on partly as an adjustment to the SPY iron condor, which was being overrun on the call side. However, I also put it on in answer to the extreme bullishness I was seeing. I don't usually do this but it made sense at the time.
Open IWM call long vertical   This trade is a long vertical spread, also known as a debit spread. It's a bullish trade that gives me a chance to take a slightly more bullish trade than its short put equivalent.

It's probably too soon to tell how these trades will turn out since there are still 3 weeks until expiration. Patience is a key to this game. Some trades like the diagonal spread can last for months before you know how it will turn out.

With the recent selling last week, there's a good chance that I'll be able to close the remaining call spread from the SPY iron condor. However, I have a couple of bullish positions that are being hurt by this same move. Yet, the market often swings back and forth like a pendulum, which means both trades can still work out.

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

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Options Trading Tip of the Month

This month I want to expand on a question I addressed in the January newsletter regarding why I close trades early. The question was in the context of why I close 4-5 days prior to expiration; however, there was a larger question related to why I don't simply let my sold option spreads simply expire worthless.

One additional reason occurred to me while I was reviewing some of my open trades. I noticed I had a trade that required $1600 in margin (8 contracts on a $2 wide spread). I also noticed that I was within $.03 (or about $24) of my target exit price. What occurred to me was that I had $1600 in margin tied up waiting to lock in that last $24 while on the other hand, I could find another trade that could give me potentially $.40 in credit per contract ($320 net credit) with that same margin. There is an issue of opportunity cost that has to be considered.

This is not an argument for closing all my trades early and settling for less profit. My trade plan calls for closing credit spreads when I can lock in 80% of the initial credit. I will continue to follow that exit rule for those kinds of trades. This exit rule was put in place by me after realizing that my win rate went up and my overall profitability went up when I closed the trade with a target profit that was less than the max gain. It turns out for credit spreads and many other spread trades, most of the value can be extracted in a relatively short time, but getting that last little portion of the trade requires holding to expiration, which imposes additional risk to the trade.

Returning to the original point... is it worth the additional risk and the opportunity cost for that last 15-20% of the credit? I don't think so. I'm not suggesting that the rules I've established for trading credit spreads are the ones everyone should use. However, they are the ones that work for me. Part of building your own trading plan is learning to consider all of these factors and coming up with a set of rules that fits your trading style AND allows you to improve your long term success.

Visit the website for a quick review of options trading systems including creating a trading plan and trading rules.
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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 is a question I've received several times...

Q: I'm curious how you find good stocks and ETFs to trade options on. Do you use any particular search tools or websites?

The short answer is that in the past I have used search tools to look for good stocks when I traded options more on stocks than ETFs and I traded other strategies besides premium selling strategies. I believe certain strategies rely more on fundamental analysis of the stock and industry. However, these days I trade options more on index-based ETFs such as SPY, IWM, and DIA.

With that said, I'll talk a little bit about tools I have used. One of the best tools I've encountered for searching for good, fundamentally sound stocks is on the Investools website. They have some really fabulous search and analysis tools that I think are unrivaled in the industry. However, access to the site requires a monthly subscription of about $25/month after some form of purchased education. Their education is also really good so if you go that route, I don't think you'll be sorry.

Another possibility is to use some of the other services on the web such as Barrons, Investor Business Daily (IBD) or others. These can at least provide a source to seed your watchlist. A lot depends on your trading style and expectations for trading. Some people are motivated to try to find an under valued stock they can make explosive gains on while others are content to find stocks that are in some kind of trend and simply execute options trades on them. It's difficult to provide a recommendation that will meet everyone's needs.

My personal preference is to find a number of ETFs that trade fairly large volume and have options with high open interest. By large volume, I mean ETFs that trade at least several million shares a day and have front and back month (i.e current month and next month out) option open interest that is at least 500. This guarantees that I get good fill prices on my orders and I can get in and out of the trade easily. I simply maintain a watch list of these options and look for potential trade setups daily.

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.

In the April newsletter, I summarized my outlook as follows.

"I'm still bullish but I'm starting to look at more neutral trades. I'll probably wait until next week to enter any new trades just to see if a move makes it more apparent as to the move the market will make. I will treat any pullbacks to the support level as opportunities to take more bullish trades like short put vertical spreads."

As it turned out, the month started out the first few days quietly but quickly turned bullish again. This has resulted in two breakouts pushing the SPX to fresh highs for the year. In fact, the highs are near the price where the SPX first fell off the cliff back in the fall of 2008. Meanwhile, the VIX was flirting with lows not seen since mid 2008. And yet in the last week, things have potentially changed.

SPX Market outlook

I haven't talked much about fibonacci retracements but it is often uncanny how these levels act as support and resistance. In mid March, we saw the break of a level that had acted as support in the past. I had marked that as the 100% level when the SPX started selling off in early January. The support level the SPX found was the 61.8% retracement level. Now that we've seen a break of the 100% level, the SPX pushes to the 123.6% level before apparently halting the upward run.

The question is whether this signals a sell-off or merely a pause before attempting a break of the 123.6% fibonacci level. The possibility is that the SPX could sell off to the 100% retracement level, which should act as support. There are the beginnings of a lower high/lower low being formed. I would prefer to see an even lower low before being convinced of a further sell-off. It is also possible that the SPX could resume a move up.

I also wanted to point out that the VIX has jumped from lows near 15.5 to 22. The combination of these things causes me to be more inclined to believe in a sell-off. I think we'll see the SPX test the $1150 level before it resumes any move back to the highs. It wouldn't surprise me to see range bound market action for a while following this.

In terms of the trades I have on already, I have one trade that will benefit from this selling and several that may be harmed if the selling becomes worse. This will require some close monitoring because I have several adjustments and bullish trades that I could exit early to save excessive loss. As for future trades, I will be looking for a bottom to form near the $1150 level before beginning to build more bullish positions.

Since we're at a kind of turning point at the moment, I'm going to look at the next few days to give me my signals as to my next move. Given the nature of the market at the moment, analysis should be done weekly at the least if not daily. I believe we're at a time that requires nimbleness.

More on technical analysis.

Options strategies I use

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