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Success With Options - Monthly Review, Issue #22 -- October Edition
October 02, 2011
Hello,

Welcome to the October 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.

More Turbulence In The Fall - October Newsletter

Welcome to the October newsletter. Wow! Talk about a turbulent few months (I know, I said that last month too). It was starting to look like we were going to see a rebound only to find lots of up and down trading. Will October be more of the same? Will things get better or worse for the market? Read on...

In this newsletter, I'll be reviewing the month in more detail as well as providing my outlook for October. 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 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

Late this month I added a trade adjustment page as I promised from last month's newsletter. This is actually the first new page other than trade tutorials I've added in quite some time. I'd like to add more useful pages to the site in coming months. Perhaps you have some topics you'd like to see covered. You can let me know using the newsletter feedback page.

I entered August with 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 SPY Put Credit Spread $80 More or less a textbook trade. I put it on, it went as expected and closed for a profit - just what we like to see.
Open SPY Diagonal 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 SPY Put Credit Spread: "...As I said when I set this trade up, I went with a credit spread because it does well in a short period of time (assuming the market goes as expected). Given that there were some pretty wide fluctuations in the market after I put the trade on, it's also a good thing there is a fair amount of fault tolerance provided!"

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

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Options Strategy Focus: Anatomy of a Credit Spread

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. I'm going to make a shift in topics and begin exploring the anatomy of various spread strategies.

I've mentioned many times that the credit spread (or short vertical spread) is one of my favorite strategies. I expect if you don't already know why that is, you may understand better following this discussion.

I want to start by reviewing the basic components of the short vertical spread. Like most spreads, the key components are a long and short position, usually of the same underlying and of the same option type (puts or calls). In the case of a short vertical spread, the position is made up of a short put or call somewhat out of the money and a long put or call a little farther out of the money. The trade profits in one of two cases. 1) The spread expires worthless ideally for maximum profit or 2) You buy back the spread for a smaller debit than what you sold it for.

How is the money made? The trade derives its profit from selling the short position. The long position exists merely to provide risk protection for the short position. Consider a naked call or put. What would happen if a major move against either the call or put happens? Conceivably, the risk would be unlimited. The long position exists to limit the risk exposure to a defined amount (the dollar width between the short and long strike). The cost of purchase for this long position is like an insurance policy and essentially comes out of the proceeds of the short call or put.

Let's take a look at how the greeks from each side of this position interact. Let's say we sell a $104 put and purchase a $102 put. The delta from selling a put would be positive but the delta from buying a put would be negative. The fact that these are two different strikes means the net delta is positive. The sold put has positive theta while the purchased put has a negative theta. Because the sold put is more ITM, the positive theta will be larger than the negative theta. You begin to get the idea. The short option's greeks will generally overcome the greeks from the long option. However, the long option acts as a subduing influence on the short option.



This interaction also affects the profit and loss characteristics both at expiration and at any point before then. Notice the below chart.  On expiration, the red line indicates a more binary character (either max gain or max loss). However, notice that as there are 20 days until expiration, the extrinsic or time premium component of the option's value smoothes out the line. Notice how we reach break even and even enter into a loss situation at a much higher underlying price, weeks before expiration.



As you can also see from the graph, you will need to be very close to expiration to realize either maximum gain or maximum loss. This is one of the reasons why I choose to exit the trade when I can lock in 80% of the initial credit or max gain.

I want to conclude this article by bringing all the pieces together. What makes the credit spread an attractive strategy is the interaction of the greeks that provides some degree of fault tolerance, at least earlier in the trade. Combine this with the positive theta and you get a trade that can reach target profitability in a very short time (1-2 weeks) if the market moves in the desired direction. Bullish credit spreads often perform even better because you have two greeks plus market movement working in your favor. Notice the above net vega, which is negative for this hypothetical trade. That means when volatility drops (a frequent effect of bullish markets), the extrinsic portion of the spread's price drops even more.

For more information on this strategy, visit the short vertical spread strategy page. Also, be watching for an exciting new video expected to be available early next year on this strategy. I'm expecting to include the above topics in greater detail and much more!

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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 comment I received via the newsletter feedback form. I'm turning it into more of a question for the purpose of this newsletter.

Q: Is there a way to create a login page on your website for newsletter subscribers so you can get access to content not available to the general public? It's kind of a hassle to have to use the email newsletters to get the link to that content.

A: First, thanks for taking time to provide feedback. This is a really good point, and one I have considered. I have considered special content for subscribed visitors and even content for monthly paying subscribers. There are several issues that have kept me from heading that direction. The first is that at the moment, I don't have plans to maintain content worthy of a paid monthly subscription. I think if one were to do that, the paying members deserve a certain quantity and quality of regular updates.

Most account management solutions require an incremental cost that doesn't really make sense unless I'm doing it for the purpose of the paid subscriber services. The other reason I haven't pursued this angle is because there is a responsibility that goes with having login information in regards to protecting subscriber data. This is a huge responsibility I don't take lightly and so I've not considered this too seriously at this time.

I do want to provide a low-tech solution though that may address the problem to some degree. While using bookmarks may seem like the obvious alternative, you may be interested in having access from your browser running on any system. You might consider Google Chrome (or the equivalent Firefox plug-in GBookmarks), which synchronizes your bookmarks with your Google online account. Of course, this presumes you have a Google account for things like mail, calendar, photos, etc.

While I know it may be easier to access directly from the website, my preference is to encourage viewers who want to read this content to be subscribers to the newsletter. I apologize if this causes undue inconvenience to newsletter subscribers. Thank you for remaining loyal to the site and to the newsletter.

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.
 

September looked like it was going to be the beginning of a new bullish run. However, it turned out to be more of the same as concerns from Europe and economic indicators from the US caused continued volatility in the market. Last month I summarized my outlook as follows:

" Based on the apparent double bottom and the higher high formed, 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."

Here's how the month played out.



Notice how the last 2 1/2 months have remained in this fairly wide $100 trading range. This means there is some consolidation that is going on that will ultimately be resolved one way or the other. When it does, I suspect there will be a strong $100 move above $1225 or below $1125.

The challenge is in determining which direction this consolidation will resolve to. If I was to guess, I'd say the next move is up and above the $1225 level. However, the market doesn't care what my expectations are. We'll have to ultimately wait and see. The one argument in favor of a bullish bounce is the fact that this consolidation came at the end of a heavy sell-off. There has been a prolonged bearish sentiment, which may give rise to a shift. This time, it may result in a shift to a bullish sentiment.

How does this outlook affect my position? I'm not going to take any action until the market tips its hand. If we see a clean break of the $1125 level, I'll close the diagonal spread. I also won't consider adding any new position until a direction is established. If we see a bounce, I may take a short term bullish position. Any guesses which one I'd select?

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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