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Success With Options - Monthly Review, Issue #29 -- May 2012 Edition
May 05, 2012

Welcome to the May 2012 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.

What's Next for May? - May Newsletter

Welcome to the May newsletter. In April, we saw the first negative month of the year. The first few days of May look like more of the same. Is the old trading adage "sell in May, go away" true? Read on...

This newsletter is getting out a few days late as I was travelling and literally had no time to devote to the newsletter. Too bad they can't just write them selves! Some of the things I'm discussing in this newsletter include reviewing trades for the month and talking about some changes I'm making to the tutorial process, talking options strategies, answering your questions and more. 

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) 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 this month that closed early with a stop loss trigger. Some of you may have noticed that the number of trade tutorials has decreased quite a lot over the last year or so. This is partly because I've had less time to analyze, set up, and write up the trades.

In addition, since I've added the Facebook comment section to the tutorials, I've seen no comments being submitted. I had hoped this would be a much more interactive area - a place where trade ideas, questions, debates on entry & exit rules and so forth would be conducted. I'm left to wonder if this feature of the website is as valuable to visitors as I had hoped. Use the feedback form to let me know how you feel about this.

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 SPY Put Credit Spread -$42 This was another losing trade, although the amount of the loss was significantly limited by the stop loss order I had in place.

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 Vertical Spread:
"...As it looks now, placing the stop loss order to protect from further potential loss was a good idea. Any time there are good technical reasons to exit a trade early, I believe it makes sense to do so. Having a trading rule in place ahead of time makes it much less of an emotional decision. In fact, because it was simply a OCO order, the decision to close was pretty much made for me."

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

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Options Strategy Focus: Leveraging the Power of ETFs

This section of the newsletter will focus more deeply on the details of some of the options strategies I use in the tutorials. In past issues, I've talked about strategies, entries and exits, trading psychology and more. In this issue, I want to talk about the power (benefit) of trading options on ETFs.

There are four main reasons why I prefer to trade ETF options. Let me summarize them here.

  1. Diversification
    You often hear it said that you should diversify your portfolio. This can often mean many different things but one thing that is often referred to is having a diverse set of stocks (or options on stocks). The obvious reason is that your portfolio is less impacted by the performance of an individual stock.

    Most ETFs represent a basket of stocks for a particular market sector or could even represent a broad index like the S&P 500 or the Russell 2000. Is that diverse enough for you? If you wanted to trade the entire financial sector, or the entire retail sector, there are many ETFs that allow you to do so.
  2. Volume
    There are many traders that prefer to trade these ETF instruments so the volumes are higher on the ETF itself and also on the options on those ETFs. What this offers is liquidity - lots of buyers and sellers. That translates to narrow bid/ask price spreads and rapid order fills.
  3. Tighter strike increments
    I don't know if you've noticed this but on many stocks the strike price increments for $50-$200 stocks are in $5 or $10 increments. I've found this to be a little annoying because I've had a harder time selecting a short strike that is in my tolerance range for probability of expiring (ITM). A side effect of this is that the margin requirement for just one contract is also higher.

    As a result, I've found that the $1 wide increments offered by many ETFs really help me to find the optimal strikes. In fact, I've been using ETFs with $1 strike increments so long that I'm never really happy when I look at trades on stocks themselves any more.
  4. Access to commodities
    A fourth feature that just occurred to me as I'm thinking about why I prefer ETFs is that it's a great way to directly trade commodities like gold and silver. Think about it. If you wanted to buy an ounce of gold, you'd be paying about $1600 right now. You could buy in smaller increments at gold and silver dealers but you often get scalped on the transaction.

    Since there are ETFs for gold (GLD) and silver (SLV), I can take a position for a much smaller cost and only pay the standard brokerage fees.
I don't want to conclude this article without pointing out some of the risks of ETFs. First, realize not all ETFs are created equal. Before you trade any ETF, make sure you know how it works, what fees are built in, what instruments it represents and so forth. Also, not all ETFs have high liquidity. Check the ETF volume as well as the option's open interest before deciding to trade that instrument.
There is a lot more that could be said here related to trading ETFs, for example on how to research ETFs. For more detail, I recommend visiting the ETF page on the website for more information.

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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!

This month I received a question about some of my terminology and also about a new feature of the ToS platform.

Q: I was looking at your portfolio management video. You said you were going to sell a put. And then you said it was about 30% and then you said it had a chance of success of 68%. Can you explain. Also, how does this relate to the new Probability ITM in the newest ToS platform?

A: I believe there are several questions to be answered here. First, let me address the features of the platform (probability ITM and probability OTM).

Until several months ago, there was one choice on the thinkorswim trade page called 'Probability of Expiring'. This attribute expressed the option expiring in the money (ITM) by a penny or more. The problem with that is that many traders wanted to know the probability of the option expiring worthless (or OTM), which could also be thought of as probability of success for many premium selling strategies. Of course, it was a simple process of doing the math (100- ProbabilityITM).

Recently, the developer team for the trading platform decided to add the feature to do that calculation. As a result, you can now directly select as one of the columns on the trade page the probability of expiring OTM (or Prob OTM as it's called on the trade page).

Regarding my strategy for strike selection, when I talked about a probability of success of 68%, I was arriving at this percentage by doing my own math based on the probability of expiring ITM described above. For strategies like short vertical spreads, you could say that the probability of the short option expiring OTM (that is worthless) IS the same as the probability of success of the trade.

Keep in mind that the portfolio video was made BEFORE the new feature was available so I always had to refer to that value as the probability of expiring ITM and then do the math to get probability of success. I believe in the video I mention my goal is to find a probability of expiring (OTM) of 30%. In reality it is often a little different. In this case, the probability would have been 32% making my probability of expiring OTM (or the probability of success 68%).

I hope that helps clear up any confusion of my terminology

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

We didn't really see any resolution last month that would lead to a longer term outlook. Last month I summarized my outlook as follows.

"...Which direction will it resolve to? Keep in mind we are in a longer term (3-4 months) up trend. This means that until indications show otherwise, I'm going to maintain a cautiously bullish stance long term with a neutral outlook in the nearer term (10-15 days). If we see a break through resistance, I think we can expect even more bullishness longer term. If we see a failure of the support around $1375, I'd say we're in for some medium term (1 month or so) bearishness. "

Here's how the month played out.

The month started out right at the $1420 area before selling off again and then consolidating around the $1370 area or so. It turns out the area between $1350 and $1370 is a longer term support area that bears watching. A failure of this level probably means longer term bearishness where we could see selling all the way down to $1300.

On the other hand, we could see the support level hold as we continue to remain range bound for a while. Keep in mind that the adage 'sell in May, go away' refers to the fact that many traders aren't as active until the September timeframe. As a result, we could see some additional volatility through the summer months. Earnings season is almost over and there may not be may big market moving news in the next few months.

How does this affect my trades? I hinted last month that I may be looking for some good trades for range bound markets. I had considered a trade tutorial on an iron condor but didn't get that set up on the tutorial page. Had I done so, it probably would be doing quite well right now. I'll try to be watching for a similar trade to set up for this coming week.

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

Be sure to take time to provide feedback on the newsletter.

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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 recently released the first 'for sale' video. 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.

Expect more videos to be released in the months to come.

For more information or to purchase the video.

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