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Success With Options - Monthly Review, Issue #43 -- July 2013 Edition
July 02, 2013

Welcome to the July 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.

Summer Thrills - July Newsletter

Welcome to the July newsletter. 

In May we saw some fairly heavy selling but yet the month itself was another gainer making 7 straight gaining months in a row for the S&P. This last month (June), we've seen a bit more of a roller coaster and the first negative month in quite a while. What does July hold in store? Will we see more buying? Selling? Flat? Read on...

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

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 Products

Trade Tutorial Summary

I have not entered any trades for a while but finally did so last Friday.  You may have noticed in general I'm not putting up as many tutorials as I have in the past due to time constraints. I'm willing do do more if folks are interested but I need to hear from subscribers to know if this is valuable.

New/ Closed Trade Gain/Loss Comments
Open SPY Put Vertical   I just entered this trade after going a while without any trade tutorials in place. We'll continue to monitor based on the rules I have in place for the trade.

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. Seriously, I think the tutorials would be much more valuable if folks weighed in on the trades.

Do folks find this section helpful? Let me know.

In the mean time, I will continue to do trade tutorials when I find time and the opportunity arises but not as frequently as before.

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

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Options Strategy Focus: From Strategy to Trading Plan

This section of the newsletter will focus more deeply on the details of some of the options strategies I use in the tutorials. This month I want to talk a little about getting from the point of understanding a trading strategy to having a trading plan for trading that strategy.

This is an important distinction. Let me take some time to outline what I mean

A strategy is a way of constructing a position such as a short vertical spread, iron condor, calendar spread, etc. It's really more about the mechanics than the how & when of the trade. I might trade the short vertical spread strategy but how do I select my strikes? When do I enter the trade? When do I exit? What adjustments will I make? How do I determine how large of a position to take? That's really what the trading plan is all about.

When I was first learning to trade options, the frustrating thing I found was that no one could tell me exactly what I should use as my criteria for the above questions. Then I realized that this is a very subjective process. It's important to know that there are many different choices that must be made that are all factors of the trade. Let me give you just one example.

For a short vertical spread, I have many different entry possibilities. I could enter the trade on a technical indicator such as a bounce off support or resistance. Alternatively, I could enter at any arbitrary time. Which approach should I use? That depends on factors such as how much time I have to devote to trade analysis, my objectives for return per trade and success rate or some other driver for me personally. So you can see that this is really a very personal decision.

The first step to creating a trading plan for a given strategy is to determine all the choices that are available to you as a trader. The next step is to begin to identify what rules you will you employ regarding those decisions. The rules you come up with need to be very specific. A good measure of the quality of your trading rules is whether you could give the rules to another trader and have them place and manage trades the same way you would. The final step is to write them down and print them out so that you can look at them all the time.

As a final component, you should be using a trade journal to capture your trades. Use this journal as a way to keep yourself accountable to follow your rules. If you faithfully log every decision to act or not act (and why), you'll soon begin to see how consistently you follow your trading rules.

Once you begin to identify and consistently follow your rules, you'll be surprised at how consistent your track record will become. I don't promise that following your rules will give you a stellar return. That's something only you can determine via back testing and testing out the strategy over time. However - this is an important step in your journey toward successful options trading.

In the recently released video, Mastering Short Vertical Spreads I talk quite a lot about what choices you have for one specific strategy - short vertical spreads. In addition, the video covers topics like selecting rules to fit your style, creating a trading system from those rules and back testing to validate the rules. Additionally, you can visit the website at the Options Trading Systems page where you will find useful but more general information about trading rules, trading plans, journaling, etc.

Stay tuned for the next options strategy focus as we return to more strategy related topics. I'm always looking for additional topics that are helpful to readers. Send them in via the newsletter feedback page or the Contact Me link.

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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!

Q: I notice you sell your short vertical spreads with the short strike fairly close to the current price. I've seen other strategies where you pick the short strike having a delta of around .10. Isn't your approach more risky?

A: I've been asked about this a number of times so it's worth taking time to answer that here. How convenient that I had already planned to cover part of this point in my Options Strategy Focus section anyway. Answering this question will give me a chance to provide a concrete example of what I was talking about regarding different choices that can be made around one specific trade element.

First, realize that for this and any strategy you are considering there are many different choices available to you for how you pick your strike prices. In the case of the short vertical spread, it comes down to how aggressively you want your trade to be as to how close to pick your strike. While I'm at it, I want to just take a moment to acknowledge different ways to pick the short strike (sort of a freebee from the Mastering Short Vertical Spreads video I just released)
  • Selection based on probability of expiring out of the money - The point here is to pick a strike that has an acceptable probability of expiring worthless. Therefore, this probability really represents the probability of success. Since we can't have both a high probability of success and a high return on risk, choosing an acceptable probability is a matter of both preference and back testing to ensure consistent returns.
  • Selection based on short strike delta - In a way, delta can be a proxy for probability. In this case, delta can be thought of as a rough approximation for the probability of expiring ITM by a penny or more. Therefore, it's the opposite of the probability of success. To get probability of success (approximately), you'd subtract the delta of a particular strike from 1. Therefore, if you were considering a delta of .1, that means you a probability of success of 90% (1 - .1 = .9 = 90%).
  • Technical analysis - This approach tends to be a little more subjective. Usually what this means is picking a value below support for a bullish trade and above resistance for a bearish trade. The idea is to choose a short strike you believe through technical analysis has a high probability of not being hit.

None of this really answers the question, which is why I choose to select my strike prices a little more aggressively than others might or than what you may have heard about before. Here's the point I want to make - and it's one I often try to make in both the newsletter and in my trade tutorials.

Every choice is about tradeoffs. Think of probability of success and return on risk as two people sitting on opposite sides of a see-saw (some call it a teeter-totter). When one person goes up, the other always goes down. There's no way around it (unless the board breaks). That illustrates is that you are always giving up one factor to improve the other. The choice you make will be driven from a number of factors that are very personal, which is why I can't just spell out a set of numbers here. Let me wrap up this answer with the factors I consider worth considering.

  1. Rate of winning trades - In the end, you have to figure out how many winning trades you need to overcome one losing trade. The more conservative the trade, the lower the reward risk. That means you risk more per dollar you stand to make. Can your trading plan sustain several losses in a row? How many successful trades are required for every losing trade to just break even?
  2. Money management and exit rules - This will play a huge part of how the prior point plays out for you. If you are taking larger risks in order to make a trade 'worthwhile', it means one bad trade can wipe you out - not to mention make you a very emotional trader. Money management and exit rules determined ahead of time can help make you more objective and can improve your win/loss ratio to some degree.
  3. Stomach for risk and losing in a trade - Finally, you have to assess your own tolerance for loss and risk. How do you feel when trades become losers? If you take a more aggressive position, it means you will have more losing trades. That's just the way it works. However, when you are right, you make more per trade. If you have a harder time accepting losing trades, you may feel compelled to be more conservative. That means your probability of success is higher but also means your risk per trade is higher. That means you must adopt money management and trade management rules to compensate.
I hope that gives you a better understanding of why I use the approach I do for strike selection. I've gone through the process over many years of trading of determining a rule that I can live with for my short strike selection. It works for me. If it also works for you, great! However, feel free to come up with your own, test it and then implement and monitor for a while. If necessary, make minor modifications and repeat the testing process.

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, expectations may change if the charts indicate something different during the month.

We started to see the hints of selling back in May. This month we saw more follow through. While we did see our first official negative month, we're still up nearly 10% on the S&P for the year.

Last month, I summarized my outlook as follows.

"... I wouldn't be surprised to see a little more selling down to the 30 day moving average, or even farther down to the support level established by the prior breakout. This should be around $1600 or so. It also may be that this selling will be a trigger for some sluggishness as we head into the summer months. For now, I'm going to treat this as a pullback and an opportunity to enter bullish positions. However, I will wait a day or two more to see what develops.."

Here's how the month played out.

It looked initially like the 50 day moving average was going to act as support as the S&P fell through the 30 day MA and then rode the 50 day MA up for a few days. However, we saw another round of selling that sliced through the 50 day moving average and down to a level of support that is built off the congestion area established back in the March/April timeframe. Coincidentally, this corresponds to the 38.2% fibonacci retracement from the November low to the May high.

It still remains to be seen whether this will act as ultimate support or not. I see this as a fairly thick line in the sand. To break the level around $1560 means we could see even more selling down to the $1520-25 level. We could also expect more erratic buying and selling days over the next few months as the summer plays itself out. That will contribute to additional volatility and volatility is good for premium sellers.

By the way, even with the selling, some of my own put spreads worked out just fine. There were a few days toward the end of the options cycle when I was a little worried but things worked out. I just recently entered a SPY put spread. I think it's a good position so far as long as the S&P stays above that $1560 level. I may be looking for a corresponding call spread to create an iron condor as the S&P reaches the highs around $1650.

By the way, if you find this kind of up & down market hard on your stomach, you may just be better off sitting in cash. Take a vacation and enjoy the rest of the summer!

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 Products

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

As I announced earlier,  I just released the second for sale' video last week. The title of this video is "Mastering Short Vertical Spreads". I now have at total of two 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.

For more information or to purchase the video.

Mastering Short Vertical Spreads
The focus of the video is on one specific strategy, including all aspects of of the process. This includes:
  • Understanding the construction and the trade progresses over time
  • Selecting the long & short strikes
  • Planning entry & exits
  • Managing the trade once entered
  • Back testing
  • Creating a trading system with the strategy
I'm excited about this project. While a long time coming, it's been a labor of love. Many know this is my go-to strategy for options trading. After watching the video, I'm certain you will understand why.

For 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 total.

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