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Success With Options - Monthly Review, Issue #009 -- September Edition
September 01, 2010

Welcome to the September 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.

The Big Fake-out! - September Newsletter

Well, the market did tip its hand. The way the market action was behaving, I really expected continued bullishness. As it turned out, right after the newsletter went out, the market turned (again) and started selling off. In the end, why may not matter that much. However, there's a lot of fear in the market and it doesn't take much to bring out the sellers. I'd expect more of the same for the next month or so.

I'm going to be changing a few things in the newsletter this month. While I'm still going to review some of the trades, I want to focus more on the lessons.

In regard to the video I've been talking about, I have both good news and bad news. Stay tuned.

I'm still anxious to receive feedback on the newsletter content and on ways I can make it more valuable for the readers. Please feel free to voice your opinion. I've received a few responses, but I'd really like to receive more feedback before considering any more changes. If you haven't done so already, 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 Trading Tip of the Month

4) Answers to your questions

5) Options Outlook

What's new at Success With Options

The big news with the site is the ongoing progress on the video I've been talking about. For more details on the content, check out last month's newsletter.

First, the good news. I've been making a lot of good progress on the video. In fact in the process I've been challenged to take the content up a notch. As a result, I've come up with some good ideas to add interactivity to the material. I believe this is going to help make the information easier to consume.

The bad news is that the video won't be out as planned the beginning of this month. My best guess is that it will more like the middle of October. While I really want to get the video out as soon as possible, I want to make sure that the video is the best it can be (within reason).

One thing I'm contemplating is making a preview available on YouTube. Look for an announcement via the RSS feed.

Watch for a few more updates in September...


Trade Tutorial Summary

I had a few trades going this month but none of these turned out that well given the sudden changes in market direction. Yet... every trade offers an opportunity to learn something.

Here are the trades I was active on this month in a quick summary.

New/ Closed Trade Gain/Loss Comments
Open SPY Iron Condor   Still open... sort of. The main trade has closed but the adjustment (a long call) is still open.
Closed DIA Call credit spread $4 This trade made money, but not nearly as much as it could have if it wasn't over traded.
Closed IWM Diagonal Spread -$387 This trade got crushed in the recent sell-off, but it could have been managed using technical exit rules.
Closed EWZ Put credit spread -$326 Another failed trade. I mentioned at the conclusion of this trade the importance of trading psychology.

While I hate having losing trades, I find that I learn the most from them. I'm going to start including 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 call credit spread:
"... There are two important concepts to grasp when it comes to adjusting trades:
  1. Any hedge or attempt to limit risk comes at a cost - usually in the form of giving up some of my potential profit. In this case, I made 3 adjustments and ended up doing a little better than break even (worse if you take into consideration commission).
  2. For some (myself included) there is a temptation to fiddle with a trade to adapt to every shift of the market. This can be dangerous to the trade as this trade illustrates. We have to be able to step back and look at the original rationale for the trade and the money management/exit plans that were in place when the trade was entered."
From the IWM diagonal spread:
"...While I've been following more of a 'set it and forget it' model lately, I believe this market is too volatile for that. If the past few months have shown us anything, it's that you have to constantly monitor the trend and the trades that are based on it. This has to be balanced with a tendency of acting too soon..."

From the EWZ put credit spread:
"...In order to stay in the business long term, a different approach is required. The questions to ask are... what can I learn? What can I do better? Sometimes, it's best to step back and look at a set of trades over a longer period of time. Are there any flaws in the technical analysis? Could different strategies have been chosen? Are there any flaws in execution?"

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

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Options Trading Tip of the Month

This month I want to throw out a concept I've mentioned a few times in some of the trade tutorials. It's the idea of synthetic positions. This won't be an in-depth discussion given the space, but should provide some food for thought. I'll be putting together a page on the website in the coming months with more detail. In the meantime, this will be a preview (a bonus if you will) for those who subscribe to the newsletter.

The idea of a synthetic position is to use a combination of other instruments to simulate the characteristics of another instrument. As an example, I can simulate a long stock position by selling a put and buying a call with the same strike price on the stock or ETF I want to create a synthetic position for. Likewise, I can create a synthetic short stock position by buying a put and selling a call with the same strike price. This is different than a spread. I'm not creating a spread, I'm using the characteristics of a call and a put to simulate a different kind of position.

Why would I want to create a synthetic long or short position? One reason might be the cost of entry. Let's say I want to own 100 shares of GOOG, currently trading at $450 a share. That's $45,000 to purchase the stock. By contrast 1 contract of a synthetic long position (1 short put + 1 long call) would require roughly $11,000 in margin, depending on the broker's margin requirements. With that position I realize the same benefits of owning the stock. If GOOG goes up $10, I can close the position for roughly a $1000 gain. A $1000 gain on a $45,000 investment is only a 2% return. A $1000 gain on a $4800 investment is about a 9% return.

What's the catch? There are several.

  1. If I trade the October expiration cycle, then the move must take place in the next 45 days. If I'm uncertain as to the timeframe this strategy may not make sense.
  2. I can't take advantage of the leverage benefits of this type of trade in my IRA account. In other words, most brokers will hold the same amount of margin as I might spend in purchasing the stock outright, which makes this strategy useless as a substitute for owning the stock.
Why do I mention synthetic positions? First of all, they can be handy as an additional tool in your arsenal of trading strategies. Second of all, it's important to realize that in terms of behavior, different combinations of stock, calls and puts can create similar positions.

As an example, let's say I have 100 shares of XLF stock and I decide to sell covered calls against them. This combination will be similar to a naked put on the XLF. This is important to realize when I may be potentially putting both trades on thinking they are two different trades when in reality they are different flavors of the same position (in terms of greeks and characteristics).

In addition, it's possible to use synthetics to convert an existing type of position into a completely different position. This is one way to adjust positions when they may be going the wrong way.

Has this topic piqued your interest? You can read more about this in a number of excellent books including Option Volatility and Pricing and Fundamentals of the Options Market. In addition, stay tuned for additional content on the website.

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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 past month, I received a question that is probably a direct result of the recent churn in the market.

Q: Is it even possible to make money trading options in this current market climate?

I will say that the current market climate is difficult and frustrating. There may be some who are thriving in the current market but I'm finding it difficult with my current entry and exit rules to stay flexible enough to respond to the the constant changes.

Here's the thing though. While it's important to recognize the state of the market had acknowledge that it is difficult, we ultimately need to decide what we're going to do about it. The way I see it, we have several choices.
  1. I can simply stop trading options altogether. I can choose to believe that nobody is making money with options and I can chase the next cool sounding investment/trading strategy that comes along.
  2. I can throw myself harder at trading, trying to figure out how to make money with options by simply trading more. I might begin to continuously second guess every trade and react immediately when a trade starts to go against me.
  3. I can acknowledge that this market is difficult and set myself on the task of studying my past performance relative to the current market and look for ways to improve (tested of course by back testing and paper trading). I can realize that to be successful requires my commitment and effort to be a student of both the market and myself.
Which one sounds good to you? I'm sure there are many additional responses. These are just the three responses I've caught myself in. To answer the original question, I don't know if it's possible to make money in the current climate. I do know it's possible to trade and not lose much when I'm wrong by using proper money management. I've found that by doing this, I fall less into the first two responses and more into the third response.

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.

What happened?? Last month I summarized my outlook as follows.

"What we saw over the last few days could be simply a pause and pull back before making another attempt at breaking this resistance OR it could be a cause to turn around and test the support levels at $1050 or below.

That may sound a little wishy-washy but until the market reveals its bias, we can't project our expectations on the charts. If we see a nice break of resistance, then I'm prepared to become much more bullish. In the mean time, I'm neutral to mildly bullish. I'll remain so until one of two things happens. 1) The SPX breaks out above the resistance level at $1125 or 2) the SPX falls below the last low at around $1050.

I really was reasonably sure the market would continue to rally by breaking out over the overhead resistance around $1125. As it turned out we never really saw a move higher than that. As I mentioned in the introduction to this newsletter, we might justify this move as due to fear but the technical analysis associated seems to be a powerful correlating indicator.

With the failure of the SPX to break above resistance and the subsequent selling, we now have a lower high and a lower low established. On top of that, the VIX has gone from the low 20's to the high 20's. Does this mean more bearishness? Possibly or maybe not.

I believe we may remain within the range of $1040 to $1125 for a while. It's likely we'll see some attempts to reach the $1125 but it may not break through in a single attempt. We are heading into September, which historically has been one of the worst months. That means we should be prepared for the worst but trade what we see. If $1040 support holds and we see a rally from there, I'll be more neutral over the near term. If we see a break of the $1040 support then look out below!

How will that affect my trades? I'm nearly out of all existing trades. If we see a short term rally, I'd be looking to sell some iron condor spreads that can benefit for strong moves up and then back down again. In addition, I might look for put calendar spreads that would benefit from an volatility expansion along with the selling. If we see a break of the support level, I'll be selling some call spreads. 

Remember to stay nimble and alert. I was asleep part of last month and my trades did very poorly. As I mentioned on one of the closing trade summaries. This is not a market for 'set it and forget it' trades.

More on technical analysis.

Options strategies I use

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