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Success With Options - Monthly Review, Issue #21 -- September Edition
September 05, 2011

Welcome to the September 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.

No Doubts About a Turbulent Summer - September Newsletter

Welcome to the September newsletter. Wow! Talk about a turbulent few months. Just when it looked like maybe there was a chance the market would rebound, August began with another round of selling followed by lots of choppiness. How did that affect my trades? What's up for the month ahead? Read on...

In this newsletter, I'll be reviewing the month in more detail as well as providing my outlook for September. I'll also, review my 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. I entered August with a one active trade, which is now closed, and added another trade. Read on for details of the trades. It's now been three 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 DIA Iron Condor -$240 While the call side of the spread closed successfully, the put side was almost a complete loss. This resulted in an overall losing trade.
Open SPY Put Credit 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 DIA iron condor: "...Following the closing of the call side of the spread in the middle of July, the market rallied for almost a week. While not reaching the target closing price, I could have closed the trade for a profit. Of course at the time, it wasn't clear the big sell-off was coming. However, the indications were there.

When selling continued heading into the end of July, I considered an adjustment strategy of buying back one of the short put strikes. This creates what is called a back spread and has the benefit of offsetting the losses encountered by the other part of the trade. However, it requires a fairly deep move to be of benefit. I hesitated in making such a move on my virtual account but did in fact employ this strategy on one of my own trades.

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

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Options Strategy Focus: Trade Adjustments

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 psychology of a trade. In this issue, I want to focus on something related to trade psychology and that is trade adjustments.

Specifically, I want to talk about three key points: Whether to adjust, when to adjust, and how to adjust.

I mentioned in last month's column about trade psychology that one can make adjustments as one way to cope with a trade gone bad. However, the wrong mental state (i.e. driven by fear of loss) can cause us to adjust when it's not necessary. Let's start with a premise, which I hope is true of all your trades. I have a position that is sized to sustain maximum loss without seriously affecting my portfolio. This frees me up to make a decision in a more rational manor.

Keep in mind that any adjustment will help remove risk from the trade in one particular direction but will often add risk in another - or it will limit my existing gains as the price for adding insurance. As a result, the decision to adjust should be based on whether the resulting position accurately reflects an updated market outlook. For example, I recently talked about the decision to adjust the put side of an iron condor trade. The consideration to buy back a short put should reflect the fact that I expect the market to move far enough to the down side to make such an adjustment profitable.

Next, let's consider the point of when to adjust. In many cases, time is of the essence in making a decision. A decision can sometimes be made too early before all of the signals have been received. For example, on August 2 a hammer candlestick appeared to have formed. If I had taken some sort of action on that hammer without waiting for conformation I would have been wrong (in that case) and made an existing position worse.

Likewise, we can't wait too long to make a decision either. If I had a put spread on when the candlestick pattern appeared on August 2, the following few days would have indicated a failure of that pattern. I would have needed to take action immediately to have benefitted from any adjustment. In fact, the following day when the candle didn't confirm and the market sold off, I should have probably acted at the point where there was a lower low formed. Waiting too much longer would have rendered the adjustment less effective.

Finally, there's how to adjust. Determining how to adjust requires a degree of comfort with a number of strategies. Often an adjustment from one strategy to another alters the overall trade construction. For example, buying back one or two contracts of a larger vertical spread creates a back spread. The effect is the important part though. It is synthetically like buying one or two contracts of a put contract (in my example) that happen to exist at the same place as my spread. This gives me negative delta but also negative theta. It will benefit if the market moves downward but in a strong and fast movement that can offset the negative theta component.

I want to conclude this article by providing a brief table summary of trade adjustments that can be employed. Of course this is not an exhaustive list. Use your own creativity but be sure to determine both the beneficial result as well as the risk.

Original strategy Adjustments Effect
Short put spread
  • Buy back partial short puts
  • Close trade
  • Sell call spread
  • Creates a back spread that can benefit from a strong bearish move.
  • Remove all risk but no chance to benefit from opposite move.
  • Can help offset some loss in put spread. Depending on bias, you can sell more of the opposite spread.
Iron condor
  • Many of adjustments for short spread apply
  • Buy a calendar spread in direction of move
  • A calendar spread can provide a positive theta position that can help benefit from the negative move.
Calendar spread
  • Close trade
  • Buy back short contract
  • Roll calendar to short vertical or diagonal spread
  • Alternative would be to roll the contract. Either results in limiting the loss in the trade.
  • Creates a long option position, which adds negative theta.
  • This helps pick up additional credit but adds risk of a reverse move.

While I currently don't have a page specifically on trade adjustments (look for one coming soon), there is plenty of information many of the trade tutorials. 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 calendar spreads in this current market (I've re-phrased the question a little)

Q: I'm looking at a way to try to take advantage of moves related to earnings announcements. Is there a way to structure a calendar spread, or a double calendar spread a little farther out of the money that can profit from some of these moves?

A: This is a really good question. Ordinarily a calendar spread is constructed by selecting a short strike only a few strikes away from the current price. Alternatively, you could pick a short strike having a probability of expiring of around 60% or you could even pick a short strike at a price where you expect the underlying to be at expiration.

Realize though that the farther away from the current price you pick your short strike, the lower the credit for the short strike. This means the resulting cost of the calendar spread will be higher. This is one of the risks of taking a trade of this sort.

Trying to take advantage of a move resulting from an earnings announcement can be a tricky thing. In a case where you expect a move but don't know the direction, you can buy a calendar on each side (i.e. a call calendar and a put calendar). This is often referred to as a double calendar as you mentioned.

If you are expecting much of a move from the announcement, a better strategy might be a straddle. I don't talk about this strategy much, however it can be an effective strategy in cases like this. You are essentially buying a long call and a long put at the same strike with the expectation that the profit from the move will overcome the cost of buying both a call and a put option.

While I am a fan of the calendar spread, I find trying to play earnings announcements a little risky. Regardless, it's always a good idea to explore various strategies but make sure you back test the strategy thoroughly first. With tools like thinkback (from thinkorswim) or think onDemand.

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.

August started out looking like a hammer pattern would form, which is a bullish indicator. However, the hammer was not confirmed. In fact, the selling really took off. The question is, will September include a resumption of selling or a transition to a bullish trend. Last month I summarized my outlook as follows:

"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."

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

It turned out that the hammer pattern that started to set up was not confirmed. In fact, the 'non' confirmation was so opposite that the SPX shed more than $100 points in a matter of days. As I pointed out last month, it's no surprise that once the support level was broken that the SPX sold to at least $1150 (actually $1100). The subsequent bounce retraced nearly half the loss before forming what looks like a double bottom. This may have been confirmed by the recent higher high.

With that review of last month, what is the outlook for next month? Based on the apparent double bottom and the higher high formed form it, I'm thinking the odds favor a more neutral to bullish trend for September. It may be that we will likely see more volatility as indicated by the first few days of this month. Keep in mind if we see additional selling down to the recent lows, there will likely be more to follow.

As far as my trades are concerned, I've already got one bullish trade on and will likely be looking for another more neutral trade such as an iron condor. If we see a reversal of the last few days I may actually look for a bearish trade to balance the portfolio out a little.

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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