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Success With Options - Monthly Review, Issue #20 -- August Edition
August 04, 2011
Hello,

Welcome to the August 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.

Turbulent Summer? - August Newsletter

Welcome to the August newsletter! Well, I expected some degree of pullback but the entire month was pretty much up and down days ending by giving back much of June's gains. All eyes are on the news as we watch to see what happens with the vote to raise the debt ceiling. Will we see some confidence return to the market or will decision not to raise the debt ceiling cause more fear and selling? Read on...

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

Thanks to those who have provided feedback on the newsletter in the past. I'm always open to receiving feedback. 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

6) Featured Product
 

What's new at Success With Options

I've been on the road a lot and so, haven't had much chance to update the website. However, I did make some minor updates to the options education page. I entered July with a one active trade, which is now closed, and added another trade. Read on for details of the trades. It's now been two months since I released the 'Introduction to Options' video. See the end of this newsletter for details on that video..

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. The one trade I closed was a losing trade. 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 Vertical Spread $78 I chose to remain in this trade and it turned out ideally. This is yet another case where remaining in the trade seems to be a better approach.
Open DIA Iron Condor   The call side of this trade has closed leaving the put spread, which now appears to be at risk.

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 credit spread: "... As of this trade, I've traded 6 times using this new exit strategy. Of those trades, only one was a losing trade. As it stands, my gains in the successful credit spread trades this year almost exactly equal the loss amount of my one losing trade. Had I closed the trade as planned, then I would have been slightly negative on this strategy. I point this out because while it doesn't seem exciting to have 5 gains wiped out by one loss, I did a lot worse last year using my 2X exit strategy. Of the trades I've done this year, I would have exited two of them early had I followed my 2X rule. ."

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 recent issues, I've returned to topics more directly related to the trading systems. In the previous issue I talked about the use of a trade log. In this issue, I want to focus on a slightly different topc; the psychology of a trade.

I've mentioned this a time or two in some of the trade tutorials, but I want to spend some time here talking about understanding your thoughts and emotions when a trade goes against you.  I found when I first began to trade that my thoughts and emotions seemed to work against me in my trades

What I mean is that the rational part of me would set up a trade according to my rules, I'd enter the trade and then when the trade started going against me, I'd start to doubt the trade and would often bail out or adjust the trade. This kind of think gan wreak havoc on our trading and our confidence if we don't attempt to master it.

To begin, let's identify some of the key emotions we experience in situations like I decribed above. In any activity that involves our hard earned money (such as trading), we naturally experience two main emotions; fear and greed. I'll come back to greed in a moment. What is it that we fear when a trade is going against us? Usually our fear is that the trade will ultimately take our money. That fear is based on what we see at the moment, which is not a freflection of what WILL happen but what MIGHT happen.

The real question is... what makes us fearful? Is it because we have a lot of money at risk? Perhaps we have too much money at risk on a particular trade or set of strategies. Is it fear of being wrong? You know, some of us are just so competitive or are wired in such a way that having losing trade just kills us because we take that as a sign of personal failure.

Whatever the source is, it's important to try to identify it and understand what drives us in trades. Once we understand the source of our fears we are better equipped to take steps to address those fears. For example, if the fear is simply a fear of loss, perhaps we can reduce our risk in the trade to a level we are willing to live with. If it's fear of failure, perhaps we can work on re-defining our idea of success.

Perhaps we can develop new skills that allow us to make adjustments to our trades such that no trade is a matter of winning or losing but how much we win. The truth is our emotions have a powerful influence on us and can mess with our more rational thinking. We can't deny our feelings exist. Rather, we must understand the source of them and find ways to manage our emotions and maybe even get them to work for us.

How? What if we journal our feelings as well as our objective thoughts regarding a trade? There may be several benefits in doing so. First, using the medium of writing allows us to slow down and examine those feelings more objectively. Second, after we spend time doing this for a while, we can go back and review the journal entries against the results. We might just discover some interesting trends. Armed with this kind of information we might just be able to get our emotions working for us instead of against us..

While I currently don't have a page specifically on trading psychology, there is plenty of information on trading systems and technical analysis, which can help be better equipped. Feel free to visit the website and dig deeper!

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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 the use of weekly options.

Q: I have a trade that is going against me. Can you tell me what financials to consider when deciding whether to exit early?
A: This is a very interesting question. There are certainly a number of factors to consider including the financial aspects. I will get back to the financial question in a second but I can't pass up the opportunity to point out that there is a psychological aspect to this as well. The decision to stay in or get out can have a significant impact our trading psyche. Do we stay in and chance that the trade will turn around or do we get out and risk that the trade might turn around? You get the idea...

In terms of the financial considerations though, let's look at the various choices in front of us. Let's first consider what happens if we let the trade go all the way to maximum loss. In this case, you simply face the maximum loss, which should be your worst case scenario. In this case, you should have sized the position so as to not be too serious of a loss.

Let's now consider what happens if you leave the trade open and it straddles the closing price. In other words, what happens if the underlying price closes in between your long & short position. You risk assignment, which could have a serious affect on your portfolio. Worst case scenario, you may be assigned a short position or be forced to buy a long position of the underlying. This could leave you in a negative capital situation, which will require you to contact your broker to get it worked out.

Finally, if you were to close early, you need to consider the potential loss (or gain). In order to do so, you need to look at the current closing cost versus the entry. If you entered a debit trade, that means you would subtract your closing credit from the entry debit to determine the gain or loss. If you entered a credit trade, you would subtract your closing debit from your entry credit to determine your gain or loss. Closing early will generally result in a smaller loss than the max loss.

Those are the cold hard facts. Let's now return to the psychological aspect. You have to think about this: What happens if you close the trade early and the trade reverses only to have turn out as expected? Or... what happens if you decide to let the trade run only to have the worst happen when you could have gotten out early for a smaller loss? You are always going to be faced with the question of what would have happened if you had taken the opposite action. I've found that by managing my position size to keep losses minimal, it's easier to live with the worst case.

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.
 

July started out with a strong couple of days only to sell & bounce. The problem is the bounce was weak. This month started out with a lot of selling. The question is, what will happen the rest of the month. Last month I summarized my outlook as follows:

" It wouldn't surprise me to see a little pullback after such strong buying over the last week. This kind of selling could further build what is known as a cup and handle pattern, which is another pattern that could indicate some bullishness mid to late July. Of course there is nothing certain looking into the future. A failure from here would certainly indicate fairly strong bearishness. "

I have to admit this sell-off caught me off guard. Here's how the month played out.



After the first few days of continuing the rally from June, the market turned down. It actually looked like the cup and saucer pattern would play out as expected, but the first clue this wasn't going to work out is the lower high formed. The second clue was the break of support just a few days later. Notice the range between the most recent high near $1350 and the prior low around $1300.

As Dave Johnson is fond of pointing out, if you have a break of support or resistance, a likely next target would be an equal distance past the break. In this case, the target would be around $1250. I let things go a few extra days to see how it would play out. Today, it appears as if a bottom has formed. However, time will tell whether this is the case. If indeed a bottom has formed then this last candlestick pattern is a hammer formation that will require another day to confirm or invalidate the pattern.

As far as my trades are concerned, I'm going to look for a bullish trade or two (I know I said that last month as well). Of course I will wait for confirmation first. If we see a failed hammer pattern, I will look for bearish trades. I still have a put spread that is the remainder of an iron condor trade. I'll be looking for an opportunity to close that on any bounce.

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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