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Success With Options - Monthly Review, Issue #17 -- May Edition
May 02, 2011
Hello,

Welcome to the May 2011 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.

Bullish April, More in Store? - May Newsletter

Welcome to the May newsletter! The newsletter is going out a day or so late. Sorry, it was a busy weekend. As we went into April, we were approaching the overhead resistance and it wasn't clear whether the SPX would clear that level. In hindsight, it obviously did. The next question is what's ahead for May. Will the buying continue?  Read on...

In this newsletter, I'll be reviewing the month in more detail and providing my outlook for May. Also, I'll update you on the video, review some trades, talk options strategies and more.

Thanks to those who have provided feedback on the newsletter in the past. However, I haven't received any recent feedback though. Keep in mind I do value and take into consideration feedback on the newsletter content and on ways I can make it more valuable for the readers.

Please feel free to voice your opinion. 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) New on the site

2) Trade Tutorial summary

3) Options Strategy Focus

4) Answers to your questions

5) Options Outlook
 

What's new at Success With Options

In April, I had a number of active trades going (both opened and closed) and they were all successful to some degree. I mentioned last month that I had gotten the raw video recorded and was ready to work on the final product. However, I wasn't very happy with the quality of the audio that was recorded so I purchased a better microphone and re-recorded the material.

At this point, the raw content has been edited and cleaned up. The only remaining task is to put all the finishing touches on, which could take as long as editing the main content. I'll be doing a fair amount of traveling this month but plan to work on producing the final product as much as I can.

Stay tuned for updates as I will be making it available first to subscribers of the newsletter. As a way of saying thanks for being patient with this process, I'll be making available to subscribers for a 30% discount from the regular price (anticipated to be about $30). Remember, those who participated in the early access version last fall will get their copy free of charge.

As to the trades I opened and closed, see the trade tutorial summary below for additional details.
 

Trade Tutorial Summary

I had a few more trades going this month. So far, all trades closed profitably. Here's the complete list of trades I was active on this month in a quick summary.

New/ Closed Trade Gain/Loss Comments
Closed SPY Iron Condor $81 I ended up closing the entire trade for a profit. It wasn't nearly as profitable as I'd anticipated but I consider myself fortunate to have this trade turn out at all given the market strength in April.
Closed IWM Vertical spread $64 Another textbook trade that took advantage of the market bullishness.
Open GLD Diagonal spread   I've rolled the position once into a long vertical and again into a new diagonal spread. In the process, I've reduced the cost basis in the trade to just $2.36.
Open Put Calendar Spread   I may be exiting this one soon...
Open IWM Vertical Spread    

Win or lose, I find that I learn something from every trade. I want to include some key thoughts/lessons learned from the past month's trade tutorials here. Here are the nuggets from last month's closed trades.

From the SPY iron condor:
"... Could I have held out for a smaller debit? Maybe but I would also be risking the existing profit I could lock in if the market suddenly reversed again. Unfortunately as traders, we don't have a crystal ball to tell us what will happen at the right side of the chart. We can only surmise given the market action and technical analysis. We're always caught in a tension between exiting early and locking in a profit or loss versus waiting to get a better price but risking getting a worse price. For me the decision is clear when I have a trade that is in profit and time is running out. Take the money and run. There will always be another trade. "

IWM put credit spread:
"... I want to conclude with two thoughts. First of all, I should have exited the trade as planned since I had a rule to close the position if within 4-5 days of expiration. However, at that point, I had nothing to loose as the trade was near maximum loss. This leads to the second point, which is that it really was the flexibility to allow this trade to go to maximum loss that enabled me to take the trade to the absolute limit. Had this credit spread been something less that a total loss, the decision might have been to close sooner at some amount of loss."

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

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Options Strategy Focus

I have modified this section a little bit to focus more deeply on the details of some of the options strategies I use in the tutorials. In past issues, I've talked about how to select a strategy and using technical analysis to improve timing of entries and exits. In the last issue I talked about trade management. In this issue, I want to get back to a topic I hinted at a number of issues ago. Specifically, I want to talk about position sizing. I haven't delayed talking about it because it's unimportant. Rather, I simply wanted to get to some of the items that I haven't talked about much in my trade tutorials.

If you've followed any of my trade tutorials, you know that position sizing is a key component of every trade I enter. I can't stress the importance of this enough. As I've mentioned on some of the tutorials and on the home page on my website, the key thing about trading is not being wiped out by one trade that goes bad. Last year, I entered 36 trades of which the 19 were losing trades. Yet, I only lost 12% of my total portfolio. That is a testament to the value of position sizing,.

How does one size a position? Ultimately, it's based upon how much you're wiling to risk in each trade. There are a variety of opinions out there about how much to risk. These vary from the very conservative 1% to more aggressive 5% or more per trade. Each trader has to decide for themselves what they are willing to risk. The critical thing is to pick a percentage and stick with it. The worst thing you can do is waver, constantly changing the value. Your results will be inconsistent as well.

When I talk about a percentage of portfolio, it occurs to me that some may wonder about the basis I use. Is it available cash? Is it portfolio value? Something else? Again, how you calculate this is up to you. What I've used is actually the cash value of my portfolio. That means trades that are entered for a debit will decrease the basis I use to calculate from. Trades entered for a credit will increase the basis I used to calculate from.

The final point I want to make is regarding calculating the actual position size. This might seem like an obvious point but let me elaborate. Let's say I'm using 2% of my portfolio value and that results in a risk amount of $350. Let's say I'm considering a trade that has a risk per contract of $120. The math then is simple. I divide 350 by 120 and come up with 2.91. So, what do you do with a fractional amount that's so close to the next whole number? You could certainly take the chance and round up. You could also chose to ignore the proximity to that next number and stick with the next lower whole number. For myself, I've chosen to take a more conservative route and will almost always take the next lower whole number. Again, whatever choice you make, remain consistent.

Position sizing is part of a larger topic on Trading Rules. Be sure to check out this and other topics related to option trading systems.

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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's a question I've received recently on options strategies. Perhaps you've wondered the same thing.

Q: I notice you use a number of different options strategies in the options tutorials. Which  do you consider to be the strategy of choice?

A: It's hard to say which strategy is the strategy of choice. It depends on what's important to you. Are you one who prefers strategies that yield higher returns? Do you prefer strategies that are more immune to minor ups and downs of the market? Do you like to get your credit up front?

All of these choices help dictate the 'strategy of choice'. Of course, I have my preferences. My favorite strategy is the short vertical spread. I like it because I receive the credit up front AND because of the relative resilience the trade has in the face of adverse movements of the underlying.

As you can tell, I hesitate to make an actual recommendation because such a choice is pretty subjective. There is no single strategy that is THE strategy. There are preferred strategies but one should be able to execute the basics such as the vertical spread, calendar spread, iron condor, etc.

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.
 

April started out as a bit of a question and ended up strongly bullish right to the closing bell of the last day of the month. Last month I summarized my outlook as follows:

"I wouldn't be surprised to see the SPX consolidate at the highs... even up to the highs near $1340. If we see the SPX remain near the highs, I'd expect eventually to see the resistance broken. However if we see the $1300 level broken significantly again, I wouldn't be surprised to see even lower lows be established... perhaps even down to the 200 day moving average."

Here's how the month played out.



The SPX did hang out near the highs for a few days before coming down to test the $1300 level before bouncing up again. Notice that it appears to have formed a reverse head & shoulders. If that's the case, then the projected target price for the SPX would be $1380 or so. How did I come by this projection? It's kind of a long story but if you follow Dave Johnson's Chartsignals blog, you may have hear him talk about this more than once.

Given the strong move recently, I wouldn't be surprised to see some sideways trading while the market consolidates before making another push up. I also wouldn't be surprised to see the $1340 level tested in the process. If this level fails to act as support, my outlook would change to be more bearish short term.

I currently have a GLD diagonal spread that's doing well and was just rolled into a new position. I'm not too worried about his one at the moment. I have a calendar spread open that I'm considering closing due to the bullishness I'm seeing. The remaining IWM position will do well if the market consolidates or moves up. I may be looking at another bullish position soon in the energy sector (possible the XLE).

If I were to enter XLE, what kind of trade should I set up? It's your turn to make a suggestion on a trade. Send me your thoughts and I'll set up one or more trades. If you send a suggestion, let me know what strategy you'd enter, position size (given a portfolio size of $16900) and what your exit rules would be. If you'd like credit for the trade, let me know and I'll use your first name in the trade setup discussion.

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

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