the May 2017 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.
Anatomy of a Trade Entry Part
4 - May Newsletter
|How about this last week? Suddenly all that short-term bearish
sentiment seems to evaporated. So, is it "clear skies ahead"?
We'll have answers to those questions, a continuation of Trade Entry
discussion, answers to your questions and more. 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: Anatomy of a Trade Entry - Trade Setup and Analysis
| This section of the newsletter will focus more deeply on the
details of some of the options strategies I use in the tutorials and
other topics related to options trading.
A subscriber recently submitted
newsletter feedback requesting coverage of trade entries and exits. As a
result, I'm kicking off the 2017 with a series of topics on just that.
we're focusing on trade analysis. For the overview, check out
Feb, 2017 article.
Key Elements of an Entry: Trade Setup and Analysis
you've made your market assessment and have selected a strategy, it's
time to do a trade analysis. For any given strategy (short vertical
spread, calendar spread, etc), there are any number of actual trade
entries that can be made. The biggest decisions have to do with the
placement of the long and short strike. Once chosen, it's key to analyze
your trade to determine if the reward and risk make sense. Let's look at
each of these in a little more detail.
On the surface, it might seem obvious that you'd use a $5 wide short
vertical spread, or a one month calendar. However, it's not
What short strike will you use? How far in or out of the money would you
like? Every strategy has decisions that have to be made about selection
of long and short strike. These affect and may be determined by the
Any selection you make for either short strike or long strike will
involve a decision around what option month to use and what strike price
to use. Depending on the strategy, the decision of one of these will
affect the other. For example, picking an option chain with 25 days
until expiration for your short strike on a short vertical spread means
you will end up picking a long strike in the same month.
- Trade duration
- Trade risk
- Target profit
- Fit within a larger portfolio strategy
Nearly every decision for a pair of options begins with the choice of
the short strike (at least for short vertical spreads, calendar spreads,
iron condors and diagonal spreads). From there, the selection of the
long strike is often a balance of profitability and risk.
To help make this concrete, let me use one strategy illustrate further.
Consider how the calendar spread is constructed. The short strike is in
a month relatively close in time (maybe 15-20 days) while the long
strike is in an option cycle father out in time but the exact same
strike price. With that in mind, let's look at the setup in a bit more
The short strike
In selecting the short strike, I need to consider the option cycle and
the strike price. The further out in time I look, the better the credit
will be for the short strike (generally). The farther away from the
current price I go, the lower the credit will be. I want to find an
option cycle and strike price that represent an optimal timeframe and a
good target price. The farther out in time
I look, the lower the odds
are that I can hit the strike price in the timeframe allotted.
The long strike
Once I've identified a short strike price and option month, I need to
select the option month for the long strike. The price is of course a
given. In terms of timeframe, if there is too little time between the
long and short strike, then the spread won't be that profitable. If too
far out in time, the cost of that long strike becomes more expensive and
thus, makes the spread more expensive.
Now that I have a potential trade, I need analyze it to make sure it
makes sense from a profit and loss or reward/risk perspective. The most
significant part of the analysis is determining risk and reward. For all
the trades we discuss risk is fixed. It's either determined by the width
of the strikes or by the debit (in the case of the calendar spread).
can be a bit trickier. It might be the initial credit, unless you
opt to close the trade early. It also could be more complex, like
calculating potential roll values on a calendar spread. Regardless, the
key objective is to arrive at a reward amount (what you stand to make)
and the risk amount (what you could lose if the trade goes bad).
At this point, it's time to make a go/no-go decision. What's an acceptable
reward/risk ratio? Is it worth the risk given the probability of
success? These are the questions that drive the decision. For me, I
often seek relatively medium probability of success. That means I need a
slightly higher reward/risk ratio - something better than 30% or so.
Whether it's a short vertical spread, calendar spread, iron condor or
other defined-risk trade, I want to make sure this is in line before I'm
ready to actually set up the trade.
I've talked about trade setup and
trade analysis as if they are two
separate activities but I think you'll find that the happen roughly at
the same time. That is, you may find yourself going back and forth
between a potential set of strike selections and analysis of the
resulting trade. That's a good thing. Also, you'll find that this
process gets easier the more you do it. You'll become pretty comfortable
with the process and it will be second nature as you set up the trade.
You'll be able to know if a trade makes sense without even having to run
the calculations because you recognize what falls within an acceptable
range of target profit for a given risk.
For additional detail trade setup and analysis, check out the
Option Trading Strategies page on the
website. Also have a look at the individual strategy details because
much of the details of how
you calculate risk and reward and how you
select strikes is covered there.
As always, please
send me feedback with any requests for topics or thoughts on what has
already been published.
Happy trading this month!
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
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!
I frequently get questions about the list of stocks I trade from.
Recently, a sharp eyed reader caught a mistake in one of my trade
tutorials that I used to do some time back. In the process, he had a
follow-up question that interestingly ties in with the topic of the
Options Strategy Focus for this month.
Thanks for the EXCELLENT tutorial on credit spreads:
In the section "Choosing the right strike prices", in the last paragraph, where you say "....need to buy a 123 long out"...did you mean to write 119...or am I missing something?
Also, I forgot to ask - how do you decide if the premium is worth the risk that one wants to take?....
A: Thanks again for the catch (it's fixed now) and for your kind
feedback on the tutorial.
To your other question, my decision on acceptability is based on
reward/risk. If you can get $.45 on a $2 wide spread, that's $.45 reward
for a risk of $1.55 ($2 - .45). So, that's a reward/risk of 30% or so.
That's about the limit for me given the probability. In reality, there
are probably a few items to trade off. One is reward/risk and the other
is probability of success (spread expiring worthless in this case).
I've traded a few different strategies around short vertical spreads and
have generally found the sweet spot for me to be right about here. I
look for credits of between $.45 and $.50 as the ideal credit - assuming
probability of success is about 60% or better. In the older tos options
chains, you could only show
probability of expiring in the money so that
would translate to a probability % of 40% or lower. Now, you can choose
either so, for me, it's a lot easier to see my Probability of Success (PoS) quickly because
'Probability of Expiring OTM' is my PoS.
If you have any thoughts or suggestions on topics that should be added
to the web site or topics that should be covered in video, please use
feedback link or
contact me link to let me know.
Help me ensure we have an interesting question or two to respond to
next month. Submit your questions at this
Back to the
|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 trade.
expectations may change if the charts indicate something different
during the month.
The market continued to digest the strong bullishness of the past 4
months. However we finally saw some action in this last week of March.
In the April newsletter, I summarized my outlook as follows:
"The real question is; what next? While there has been a bit of a bounce from the 50 day MA, I wouldn't say that was definitive. In fact, you can see that there have been a series of lower highs that could indicate more bullishness. At the very least, I wouldn't be surprised to see more sideways action. (Note: 7 days into the month, that appears to be playing out so far). The two things to keep an eye on to get a better idea of what happens next are that support level of the 50 day MA
and the current progression of lower highs. If either of these gets broken, that could indicate a change and that should cause you to change your trading posture...."
Here's how April played out.
As mentioned, the slow down trending highs and lows continued through
most of April and in fact, broke through the 30 and 50 day moving
averages. This also formed a short term bearish trend as indicated by
the pattern of lower lows and lower highs. However, this last week we
finally saw some movement and you can see in the chart above that the
down-trending resistance from the lower highs was broken. Not only that,
but the SPX is now back above the 30 day and 50 day moving averages.
This seems to be fairly bullish. That turned out nice since my bullish
trades I put on
last month all worked out quite nicely.
So, what's next? Given this new bullishness, I'm inclined to expect more
bullishness. However, we are also near the all-time highs established
back in February. It's possible we might see one more test of the
support around the moving average before breaking through to new highs.
Obviously we'd need to watch support and resistance for any clues as to
the next moves.
I'm taking a "wait and see" approach at the moment because we're far
enough from support at the moving averages and a little down from the
highs. More selling to the moving averages may provide a nice entry with
a very clear exit as well if support turns out to not hold. A similar
but more risky play could be made near the highs where a bearish trade
might be made. I'm taking a VERY cautious stance on all of this at the
moment and have my trades closely monitored.
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
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 cart
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table of contents