the August 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
it to your options trading friends.
To access previous issues of the newsletter, click here.
The Bulls of Summer - August Newsletter
to the August newsletter.
Well, we had one bearish month this summer and we're back to more
bullishness. If you count May, that's two bullish months this summer. Will
August be another bullish month or will there finally be a decent round
of bearishness? 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.
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
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.
SPY Put Vertical
This one made a nice little profit simply by following the rules I
had in place.
Win or lose, I find that I learn something from every trade. I didn't
close any trades this month so, no lessons learned. However, the lesson
I'm focusing on this month is responding to changing market conditions.
The trade I put on this month is an example of this.
SPY Put Calendar
... That fact is that as we are making decisions we don't know what will happen past the right edge of the chart. In this case, the
market continued to rally and I could have done better. HOWEVER - the market could have just as easily sold off from here and my
unrealized gains could easily have turned into a loss.
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
tutorials, click here
Back to the
table of contents
Options Strategy Focus: Back Testing
| 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 focus on back testing. I may have covered this at some point in
the past but it's a good idea to revisit this important topic.
First, what is back testing? I define back testing as a
formalized process by which you can go back to a period in time and
replay price action against a very specific set of trading rules. As you
can see, I did not specify a particular tool. There are a lot of
different ways to back test that range all the way from manual
approaches to automated methods.
Before I go into more detail about different back testing methods, I
want to talk about why back testing is important. The main reason is
that it allows you to test your rules against a variety of different
past circumstances. While past performance doesn't guarantee future
results, robust testing over diverse past price behavior can give you a
pretty good idea of how profitable your rules might be.
Another benefit of back testing is that it forces you to think through
your rules to see if you are specific enough. I'll talk shortly about
the process of back testing but as you work through that process you'll
begin to see if you've been specific enough. It can help expose areas
where you have left too many decisions open to subjective decision
Ok, let's take a look at some ways to back test.
The manual approach - The manual approach is just that.
You really have little to no help in going through the steps of your
trade. As a result, it can be quite time consuming. However, doing this
at least a few times really helps you to appreciate the process.
In the manual approach you will begin with some kind of charting tool or
way to walk through historic price action. I've found most trading
platforms will allow you show chart with opening and closing prices over
a range of dates you are interested in. I like to begin by looking at
the large scale for a trend I want to test. It may be an up trend, down
trend, choppy trading or whatever. Then, I'll zoom into a fairly tight
timeframe early in the date progression.
I'll use the scroll bar to move forward in time. The key is to make sure
that you are simulating unknown aspect of real trading by not 'peaking'
at future price action. Once I pick an area to start, I then use my
rules to pick the entry trigger. Now, it's pretty difficult to calculate
individual option prices let alone spread prices manually. As a result,
I usually use this approach primarily to test entry & exit rules related
to technical analysis.
Note: I should mention that there are tools that can be used to
calculate option prices based on a number of factors that are part of
the option pricing model. In addition, I added a quick ad-hoc pricing
tool as part of the
Introduction to Spreads video I released some time back. This tool
allows you to arrive at an option price by adjusting a few quick factors
like underlying price, days until expiration and volatility.
Assisted back testing - This refers to testing using tools
that can help you both accelerate the testing process and perform a more
thorough test. Here's what I mean. A few tools available on the
thinkorswim include the thinkBack tool and the onDemand
The thinkBack tool is a little more limited in what can be
tested, only capturing closing price for each day. Here's how you can
use it. First, pick a starting date (perhaps from the charting approach
mentioned above). Select a spread according to your rules using the
trade page on the onDemand tab. Enter it as you would on the actual
trade page. Note that there is a date box called P/L Date that you can
now use to spin forward. Use this in conjunction with your manual
charting tool to advance day by day. Be sure to make sure no action is
taken that isn't documented as a rule. Notice as you advance day by day
the price of your position increases or decreases and your P&L is also
With the onDemand tool, you can approach an automated back
testing approach. It's almost like entering a time machine to go back
and test your strategy against a specific timeframe. If only you could
do it with real dollars. Entering onDemand converts your thinkorswim
platform into a virtual trading platform where you can pick a starting
date and then enter your trades as if it were live. I should mention
that the entry of orders is still a manual process. However, the beauty
of this tool is that you can catch inter-day price action and enter
limit & stop orders that can be triggered as price action plays back.
In addition, you can set a trade up with exit orders and then just let
the price action play at normal speed or accelerated speed.
Automated back testing - In this category of tools you can
pretty much automate all aspects of the trade process once you've
entered in your trading rules. This obviously is a more complex style of
tool and will usually require purchase or subscription in order to use.
One such tool I'm aware of that can be used to test options strategies
is AmiBroker. I'm sure there are others out there as well that I haven't
In the recently released video,
Mastering Short Vertical Spreads
I have a section on back testing covering some of these techniques.
There is also a nice demo of using the onDemand tool from
thinkorswim. 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
Contact Me link.
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!
Q: What would you
recommend as a good starting portfolio size for trading strategies like
you recommend on your website?
A: This is a really good question but one I can't easily answer
with a simple dollar amount. Instead, let's walk through the thought
process for how you would come up with this amount.
- Money management - As followers of the website and this newsletter are aware, I am a strong
proponent of consistent position sizing. I think you have to start
there. What risk percentage can you live with per trade? Let's start
with an assumption of 1% risk per trade. Keep in mind that newer traders
should start with a smaller risk amount until you prove you have a
decent track record.
- Risk per trade - Next, you need to look at the risk
you are taking in a trade. For vertical spreads, this will be dictated
by the width of the spread. As a minimum, you might have a $1 wide
spread with an average credit of $.25 leaving a risk of $.75 per contract
With a 1% risk, you must have at least $7500 just to sell one contract
of this spread.
Other strategies will have more risk. For example, a typical calendar
spread might have an initial debit of between $100 and 200, which
represents the maximum risk. In this case, you'd need $20,000 minimum to
- Number of active trades - This may not directly impact
your portfolio amount, but you should consider how many trades you have
going simultaneously and how having several of them go bad might affect
- Draw down tolerance - What will be the impact to your
trading if you have a draw down? If you start with the bare minimum, it
might be that one failed trade means you can't trade and still remain
within your risk tolerance. As a result, any amount you arrive at above
should take into consideration a buffer of some sort to allow you to
sustain trading even with a few failed trades.
These are important considerations to think through before ever
getting started with a real account. Another key aspect is that whatever
portfolio you allocate to these kinds of strategies should be a fairly
small percentage of your overall trading capital. In other words, if you
allocate $20,000 to this kind of trading, you should have much more than
that set aside for other, types of trades like stocks, indexes, bonds,
etc. Different people have different rules of thumb, but one I can live
with is that my option trading capital is no more than 20% of my overall
investment capital I allocate.
Obviously, I didn't provide a
fixed dollar amount because I think it's pretty hard to provide a number
that would suit everyone's circumstances. Use your own judgment and if
possible, err on the side of being more conservative to begin with. For
more detail on some of the points I've mentioned above, check out the
money management page on the website.
Help me ensure we have an interesting question or two to respond to
next month. Submit your questions at
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 trade.
As such, expectations may change if the charts indicate something different
during the month.
If you blinked, you may have missed the selling in June. July saw a
rally back to the highs set in May and then go even higher. Did any
buyers go away for vacation in the summer or was June's selling it for
Last month, I summarized my outlook as follows.
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..."
Here's how the month played out.
Interestingly, the low that was set in June did indeed act as a
bottom. In fact, we had three straight weeks of nearly non-stop buying
before we saw any kind of pause and then we have started seeing more
buying. However, we are now getting to a little bit of an overextended
state as the current price moves away from the moving average. The
current distance is just over $50 S&P points (sorry, I just noticed I
used the SPY chart this month).
I'm expecting one of two things to happen in the next month. We will
either see a quick push higher followed by some bearishness down to
re-test the support at $167.50 on the SPY chart or we'll see some
sideways consolidation that will give the moving average time to catch
up to the price.
How will this affect my trading? I currently don't have any trades on
but I am looking for an opportunity to sell a call spread above the
market somewhere in the $173-174 range for the short strike. That
should give some room for continued buying without overrunning the
position. I'm actually hoping for a fairly strong round of selling so I
can find some good bullish entries. I missed my chance a week ago with
that little pause. Now,
we'll have to wait a little to see the market tip its hand for the Fall
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 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
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.
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. 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.
- Understanding the construction and 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
For more information or to purchase this video
Special Newsletter Subscriber 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.
Back to the
table of contents