the May 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
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
it to your options trading friends.
To access previous issues of the newsletter, click here.
Buy in May or Sell in May? - May Newsletter
|First off, I apologize for getting this newsletter out a week late. I
had good intentions but too many things distracted me.
After beginning the month with an apparent continuation to the
rally we've seen since Feb, April ended pretty much where we started
making two months in a row we've ended nearly flat. With just over a
month of spring left, what will we see as we head into the summer
months? Will this be a
typical "Sell in May - Go Away" pattern?
In this edition we'll tackle that question, conclude our series on 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
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: Adjustments and Synthetics Continued
| 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 I've been discussing the notion of synthetics. At this point,
we'll focus on adjustment mechanics, but realize that the concept of
synthetics is at play.
To begin, let's review some of the synthetic basics covered in past
articles. I began by introducing the concept that synthetics is all
about using one combination of options to simulate the risk profile of
another. We talked about the fact that the combination of through the
use of the synthetic triangle, you can essentially use the combination
of any two of stock, calls and puts simulate the risk profile of the
One other concept I touched on briefly was that if you take away the
concept of 'opening' and
'closing' trades, the effect of buying a call
or put can have different effects depending on your starting point.
Let's say I have an empty portfolio. Buying a SPY 210 call results in
being long 1 contract of the SPY 210 call contract. But what if I
already had a short SPY 210 call? I'm flat again in my portfolio. What
happened though from a synthetic perspective? If you look at the risk
profile of a long call and over lay it with a short call, you would see
that the result is a neutral or flat risk profile - the same as if you
had an empty portfolio.
Where all this is going is that the risk profile is what we're looking
at. If you think of trades as overlaying a risk profile on top of
another, that's the principle of adjusting. This becomes more apparent
as you play around with the analyze tab on the thinkorswim platform.
Back to Adjustments
In the last issue, I gave
an example or two of synthetics for adjusting
a calendar spread into a diagonal spread. We did this by combining two
separate trades into a new position. Let's talk about a few more
One of my first exposures to using synthetics in this way for
adjustments was in a short vertical spread. I had a short call spread
that was being overrun by the underlying. With just a few weeks to go
before expiration, I knew that there was a high likelihood that the
continued move could cause my spread to expire at least partially in the
money. I also saw signs that the move was starting to run out of
momentum. Let's say in today's market this was a $212/210 short call
(the $210 strike is the short leg).
What if I could simply roll the 212/210 to a $214/212 spread? What I
have accomplished is that there is an additional $2 on the SPY to move
and that may just be enough to give me head room. Let's say I put
initial call spread on for $.50 credit. If I were to buy back the
$212/210 spread and sell the same number of strikes of the $214/212
spread, I'll likely have to pay more that the initial $.50 to buy back
the initial spread but I'll get some back by selling the new short
position. Let's say I do this for $.35 debit. In this case, I've
adjusted my position and reduced my maximum profit from $.50 to $.15.
However, this may have made the difference between having as much as a
$1.50 loss and being somewhat profitable. Note the risk remains the same
so my reward/risk ratio got worse.
Let's analyze the above adjustment. I bought back the $212/210 spread -
meaning I bought one contract of the $210 call and sold one contract of
the $212 call. Next I sold a new spread - meaning I sold one contract of
the $212 call and bought one contract of the $214 call to cover it. If
you add up the buying and selling, you end
up with buying one contract
of the $210, selling two contracts of the $212 and buying one contract
of the $214. This turns out to be the exact same pattern for a butterfly
spread. I haven't talked about this on the web site because it's not a
great money making strategy for me in most cases. However, by
decomposing my adjustment, I now know that by overlaying a butterfly
spread over a short vertical spread, I can adjust the position up or
down as desired.
For one final example, let me talk about another adjustment strategy
I've used based on the same above position. Let's say that my assessment
tells me that my original position would expire out of the money
(worthless) if only it had a little more time. Instead of rolling up, I
want to roll out to the next month. What would that look like? It would
mean buying the current short $210 and selling it in the next option
cycle and selling the current long $212
and buying it in the next option
cycle. The resulting trade cost me $.10 net debit, making my resulting
credit $.40 if it works out.
Does that look like the pattern for a calendar spread? I'm selling one
calendar spread and buying another calendar spread. The combination of
the two, when overlaid on top of the short vertical spread result in
rolling the spread out a month.
It's amazing how this can affect your trading when you begin to look
more holistically at your portfolio and analyze it in terms of what you
want to add or remove in terms of risk profile. You'll begin to look at
all your trades a bit differently.
I want to wrap this series up with one note of caution. Actually...
maybe several notes of caution. First, always, always paper trade before
applying to a real portfolio. When you are placing real money at risk,
you want to be
especially comfortable with the mechanics or you could
make matters worse. Second, any adjustment will have it's own associated
risk. In both the above examples, we gained either overhead room to move
in the current month or added additional time for the trade to work out.
In both cases, we gave back some of the credit, reducing the profit but
also creating a worse reward/risk profile.
Sometimes the simple answer is to close the trade and be done. However,
armed with the knowledge you gained from these last few articles, you
now have a few additional tools in your trading toolbox.
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!
This month I'm using part of a question I recently received on trade
Q: I really enjoyed reading your blog post about keeping your trade log. I am currently only unsure how do you maintain your trading log (which tools do you use)? Is there anything in particular that frustrates you in that process?
A: This is a great question and one I
have addressed recently. On the web site, I have covered a little bit
about some of the components of an option trading system, such as money
management, trading rules, trading plans and so forth. In addition, I've
talked about trade journals and trade logs but I haven't really talked
in detail about what I use specifically.
Part of the reason I haven't covered much detail on this is that there
are so many different ways to manage trades. Let me first talk quickly
about the difference between a trade journal and trade log. I use a
trade journal as a way to capture the events, decisions and factors that
go into a particular trade from start to finish. It's purpose is to
allow me to go back and analyze how well I'm following my rules,
evaluate decisions to see if there are trends that may indicate a
possible adjustment to rules and so forth.
By contrast, the trade log is more about capturing the trade
the context of a collection of trades. The main purpose is to determine
your overall wins and losses, gains or losses and general progress on
growing your portfolio. In this case, the only items I tend to keep are
the barest details of the trade (ex Short Call Vertical SPY 120/118),
the number of contracts, debit/credit on entry, debit/credit on exit and
commission. From there, I can calculate the gain on the trade as well as
monthly gains by adding up the individual gains for a month. From
there, I can calculate all sorts of additional metrics like average
gain, average loss, win/loss ratio, and more.
Currently, I do all of this using an Excel spreadsheet. There are in
fact many ways this can be done. For me personally, the spreadsheet
works well because I have the ability to do calculations that are
sometimes fairly complex and it allows me to enter and review trades
fairly easily. There are
of course many alternative ways this could be
done. Each will come with advantages and disadvantages. My focus is to
have a tool that serves me, not the other way around. I want entry and
maintenance of trades to be as easy as possible and this largely does
For more information on trade logs, check out the
trade log page on the web site as well as the overall
options trading systems topic that covers many other aspects of
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
or options. It
is simply my opinion of what I expect and how I plan to
expectations may change if the charts indicate something different
during the month.
What did we actually see accomplished in terms of market change from
beginning of month to end of month? Not much. In between a whole lot
In the April newsletter, I summarized my outlook as follows:
"...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)..."
Here's how April played out.
Granted, this newsletter is coming out a week late so we have a preview
of the month. However, let's take a look at the month. Notice that after
a quick rise to the highs established back in early November, there was
a bit of a pull back. The question now is which way we'll see the coming
What we saw last week (the first week of May) was additional selling to
a low and consolidation
area established in the early part of
April. This itself could act as support as Friday's action suggests. If
that fails, there are two additional levels of support. It's possible
the 200 day moving average might act as support around $2012. It's also
possible that the first fibonacci level might also act as support closer
to $2000. On the upper side, there are pretty much no real areas of
resistance until we get back to the November high around $2115. Given
the recent selling the odds may favor at least a short term rally. The
next logical movement is to attempt to break through the upper
resistance area. I'd expect that to be the move in May.
A few months back, I mentioned GLD. Last month I got a nice diagonal
spread in place toward the middle of the month. While I missed out on
the big move in the last week, it did offer a nice little return for a 2
week trade. Keep your eyes on some of the different
index tracking ETFs
like SPY, IWM, DIA and GLD. They all offer some potential opportunities
to trade in either direction using your favorite options strategies.
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
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
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
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table of contents