Back to Back Issues Page
Success With Options - Monthly Review, Issue #41 -- May 2013 Edition
May 04, 2013

Welcome to the May 2013 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.

Another 'Sell in May' Year? - May Newsletter

Welcome to the May newsletter. First, I want to apologize that this newsletter is getting out a little later than usual. All I can say is that it's been a busy month. 

So far, it's been four straight bullish months (6 if you count the last two months of last year). That's getting to be close to a record - at least for the last few years. Month after month the market seems to ignore negative and tepid market news. Will this be the month were we see some kind of a correction or will we see more bullishness? Read on...

As usual, I'll be reviewing my trades this month, talking options strategies, answering your questions and more.

I want to provide what I hope will be the final update on the Vertical Spreads video I've been talking about in the last few  newsletters. As I mentioned last month, this has been much more time intensive that I had anticipated so there still is a little more work to do. A number of subscribers took advantage of my offer last month to download an early access copy and provide feedback for a 30% discount. Stay tuned for an announcement in the next few weeks regarding the release of the final product.

If you haven't done so already (or recently), 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) Trade Tutorial summary

2) Options Strategy Focus

3) Answers to your questions

4) Options Outlook

5) Featured Product

Trade Tutorial Summary

I had one trade going when I entered the month. This is a calendar spread I entered late last the month. The short put expired and I had made an adjustment. That trade has since closed and I have a new trade going. See below for more details. You may have noticed I'm not putting up as many tutorials as I have in the past due to time constraints.

I do want to encourage you if you are a fan of the trade tutorials and have a Facebook account to participate in the tutorials by commenting, asking questions, or suggesting alternative strategies. I'd like these to be more interactive than they have been historically.

In the mean time, I will continue to do trade tutorials but probably not as frequently as before. Here's the trade I was active on this month in a quick summary.

New/ Closed Trade Gain/Loss Comments
Closed DIA Put Vertical $60 This turned out to be a nice trade that went exactly as expected and returned a profit just as expected.
Close DIA Call Vertical -$30 This trade didn't work out as expected but my early exit rules triggered an exit that limited the loss to just $30.

Win or lose, I find that I learn something from every trade. I didn't close any trades this month so, no lessons learned. However, the lesson I'm focusing on this month is responding to changing market conditions. The trade I put on this month is an example of this.

From the SPY Put Credit Spread
... This trade worked out pretty much as expected so there's not too much to say regarding lessons learned. However, the one point I'd make is that consistency is the key to seeing these trades work out. Having a set of rules consistently applied for entry and having consistent rules for exit is what makes this strategy work. Of course there will be losing trades (as my last one was) but over all, the gains are steady.

From the SPY Call Credit Spread
... Why did this trade make sense when I entered it? At the time, I was thinking there was a top about to be formed. I still think that but you never know about the timing. As it turns out, having that technical stop in place saved this trade from being a larger loss. Any time there is a clear technical indicator that your assessment is wrong, it's not a bad idea to use it as part of the exit strategy.

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

Back to the table of contents

Options Strategy Focus: What Is My Favorite Strategy?

This section of the newsletter will focus more deeply on the details of some of the options strategies I use in the tutorials. I'm often asked what my favorite or preferred options trading strategy is. I'm always reluctant to answer this because I don't want people preferring my favorite strategy just because it's mine. That said, I thought I'd take a little time in this column to talk about my favorite strategy - and why it's my favorite. Can anyone guess what it is ???

If you've been following my tutorials and even some of the past newsletters, you will already know that my favorite strategy is the short vertical spread. Why is this? Let me give you 5 reasons why it's my favorite.
  1. It's easy to understand the max profit/max risk - Without going into the mechanics of this strategy here, the max profit  is the credit received and the max risk is the width of the spread minus the credit. Pure and simple. I like it because I can quickly evaluate a trade and determine if it makes sense based on these two factors.
  2. It's a fairly short term trade - By nature, the short vertical spread is typically a 20-40 day trade. However, in many cases, it can be finished in two weeks or less. These days, the market seems to change directions fairly frequently. As a result, if timed correctly I can be in and out within these cycles.
  3. It's directional in nature but fault tolerant - Short vertical spreads are directional by definition. A short put spread expects the underlying to go up, a short call spread expects the underlying to go down. That said, there is usually room for you to be wrong somewhat, both in the direction of movement (to some degree) and in how fast it happens. A well constructed short vertical spread can tolerate the market going absolutely nowhere and still profit.
  4. It's easy to manage - By manage, I mean when I put the trade on I can define some very specific rules about when I exit. I can have rules to lock in profit, rules to limit loss, rules to trigger an exit for technical reasons and more. What's more, once I have my rules defined, I can implement them on the platform with an exit order. That makes them easy to "set and forget", letting my rules work for me.
  5. Bonus reason - Let me give you one more reason I love short vertical spreads. They can often be turned into an iron condor. By that, I mean that if the market moves as expected (away from my short strike on my existing vertical spread), I can place an opposing short vertical spread in the other direction (assuming I expect somewhat range bound movement). The result is an iron condor, which functions like two independent vertical spreads - one call spread and one put spread. However, most brokers will only hold margin for one of the spreads (assuming same option month and position size). That means I get approximately twice the credit for the same margin and risk in my portfolio.
These are my reasons why I prefer this strategy. You may have others - or - you may simply prefer another strategy. The beauty of options trading is that each trader is free to select the strategies that work for them. I know a trader who is a master at diagonal spreads and I suspect that's his preferred trading strategy. I also am comfortable with most of the trading strategies - at least the ones I talk about on the website and will use them when it makes sense. So, just because I have one favorite doesn't mean I don't use others as well. I encourage you to understand many of these strategies and gain experience with them before determining your own preferences.

Finally, at the risk of turning this column into a shameless plug for the up coming video, let me mention that the short vertical spread is a great foundational strategy for newer traders to learn. As a result, it's the first video in a series I'm planning on releasing that goes into much more detail on the mechanics, different kinds of entry & exit rules, trade management, back testing and building a trading system around it. If this sounds interesting to you, stay tuned because the project is nearly complete and I'll be sending out an announcement with a special offer to subscribers of the newsletter.

Stay tuned for the next options strategy focus as we return to more strategy related topics. Any suggestions for topics? Send them in via the newsletter feedback page.

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!

This month I received a question that has come up from time to time. I'll paraphrase it a bit.

Q: I would like to know from a conservative stand point what the delta of a position would be to make an adjustment. Or, use the delta of the short option being threatened. Would the option value be a more accurate gauge in determining action?

A: First of all, thank you for your question. This is a variation of a question I get asked a lot and I've avoided giving a straight answer in many cases. In fact, several issues back I talked instead about alternatives to adjusting, determining whether to adjust and so forth. I want to start by saying that the real answer is really only something you can decide for yourself but let's take some time to think through the process and hopefully it will help you come up with your own adjustment rule.

Using Option Delta - You asked about the position delta and the short option's delta. In theory, either one could work as an indicator. However, keep in mind that in the case of most spreads, the delta of the long option negates some of the delta of the short option. These will change somewhat over the life of the option but I've found it not as helpful.

Let's consider the short option delta. Often when you enter the trade, this delta value will be somewhere in the range of .25-.35. Remember, one of the ways to interpret delta is the approximate probability that the short strike will expire ITM by a penny or more. Let's say the trade has gone against you and now the short strike delta is somewhere between .50-.70. That means your probability that the short strike expires ITM has just doubled. That could be a reasonable adjustment rule then. However, before making such a decision, I'd encourage you to write out a clear set of exit rules or adjustment rules and back test them over several different time periods.

Using the option value - An alternative adjustment strategy could indeed be the price. While you could use the price of the short strike, I have often used the total price of the spread. In the past, I have had rules like exiting the spread if the value of the spread reaches twice the initial credit. However, it doesn't have to be exactly twice. It can be whatever threshold you decide. Obviously, using a mechanism such as this can affect how you position size as long as you take into consideration what impact your adjustment strategy has on your risk in the trade.

As to your question about which can be a more accurate gauge, that one is harder to say. Option delta is an indicator of probability. I'd say if you were using a probabilities-based strategy for entry and strike selection then that might be a better indicator for you. One thing about option pricing is that it will behave differently depending on how close to expiration you are. The farther out from expiration you are the less affect price fluctuations will have on the option value.

That is also somewhat true of the delta as well but we're comparing the delta of a single short option versus the price of a spread. Another factor to consider is that option price is directly tied to your risk in the trade (in most cases). You will need to take that into consideration if you are using delta as your adjustment strategy.

Finally, I just want to mention that when you say adjustment, I really think of three ways of adjusting. Exiting, rolling and converting. I think this is an interesting enough topic that I'll address it in the next newsletter under Options Strategy Focus.

Please use the Contact Me link to send a quick mail to me indicating your preferences on format (video vs web site page), desired details to cover (questions you may have about using the greeks) and so forth. I'll begin working on a plan to address these questions in more detail.

Help me ensure we have an interesting question or two to respond to next month. Submit your questions at this page.

Back to the table of contents

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.

Now that we've had four bullish months in a row, one has to wonder if the trend will exhaust itself soon. I said that last month as well. The longer this trend goes the higher the likelihood of the correction coming.

Last month, I summarized my outlook as follows.

"... We are at an interesting point. The SPX has broken out above the consolidation area on average volume. This is currently the highest close EVER but we're about $6 away from the all time high for the SPX. I'd be surprised if we don't fail the first attempt to break above that level but the consolidation area is now going to provide some support. Notice also that the 30 day moving average is moving up to add more support into the $1540-1550 area. It's possible that there may still be a little more bullishness in this market."

Here's how the month played out.

In April, we did see a bit of a pull back down to near the 50 day moving average. That would be a reasonable place to find support. Following this selling, we had another round of strong buying taking the SPX all the way up to the prior resistance level at near $1600. In fact, we ended the month at an all time high at $1597. We've already got 3 trading days in May behind us and initially, it looked like May would begin the selling. However, Friday we saw a breakout over the highs and closing at $1614 - another all time high.

Given this initial behavior, I'm guessing we won't see the strong selling I was expecting. However, it's still possible we'll see some weakness heading into late May and June as is typical for that time of year. That said, there is still a lot of cash not in the market that may be looking at pullbacks and an entry. Clearly we don't have a double top so my outlook is more bullish than before. A potential medium term target might be $1650 given the range between prior highs and the recent low around $1550.

How does this affect my trades? I currently don't have any trades in my trade tutorials. I may look for an opportunity to enter a bullish trade if there is another pullback. Given the bullishness, it's probably too risky to try selling calls above the market. That said, I remain vigilent as the trend could change at any point.

Remember to stay nimble and alert. Make a point of doing market analysis every day or so, 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.

Back to the table of contents

Featured Product

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

For those that aren't aware, I released the first 'for sale' video about a year ago. The title of this first video is appropriately "An Introduction to Options Spreads". I say it's appropriate because this will be the first of several videos I'm working on that really are a labor of love. My goal is to provide a more in-depth and comprehensive coverage of options spreads.

To that end, this first 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.

New Video Coming
I am also in the final stages of the next video, which I'm very excited about. It features my favorite strategy - the credit spread, or short vertical spread. This video will cover everything from how the spread is constructed to how to create a trading system around it. Be watching for this video in the coming months.

Back to the table of contents

Back to Back Issues Page