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Success With Options - Monthly Review, Issue #47 -- November 2013 Edition
November 03, 2013
Hello,

Welcome to the November 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 and send it to your options trading friends.

To access previous issues of the newsletter, click here.

Strong October, Strong Finish? - November Newsletter

Welcome to the November newsletter. 

Summer is officially over! While the summer itself was relatively flat, September and October were much more interesting. As of today, the SPX is up 20% on the year. That's a pretty good run! With just two more months head, how will we finish?

Thank you to those who reported issues with providing newsletter feedback. The problem has been identified and corrected. If you haven't done so recently, please consider taking a few minutes to visit the newsletter feedback page and let your voice be heard. This can be done anonymously so please consider how you can help make the newsletter better.

Last month, I mentioned that I haven't been doing trade tutorials. For reasons why, see below. As for the rest of the newsletter, I do have answers to your questions, Options Strategy Focus and Market outlook for you. For more details on that, read on...

 

In This Issue

1) Trade Tutorial summary

2) Options Strategy Focus

3) Answers to your questions

4) Options Outlook

5) Featured Products

 

Trade Tutorial Summary

As you may have noticed, I have not been posting any trade tutorials. I have continued to place my own trades that pretty much follow the guidelines I outline on the website and have been teaching in the videos I've recently announced. These have been producing consistent gains over the last few months despite the ups and downs of the market.

Unfortunately, capturing the trading details and producing the tutorial pages has taken more time than I have at the moment. I've written quite a few tutorials on all of the strategies I promote and are worth going back and reading if you want to understand my thought process on evaluating, placing and managing these trades.

Do you have thoughts about the value of the tutorials or ways to improve them? Let me know.

In the mean time, expect periodic tutorials but only when I find opportunities that are interesting enough to write a tutorial on..

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

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Options Strategy Focus: Trading Weekly Options

This section of the newsletter will focus more deeply on the details of some of the options strategies I use in the tutorials. In last month's Answers to Your Questions section, I addressed a question regarding trading diagonal spreads using weekly options. I realized this month that I have been trading weekly options myself fairly regularly and wanted to spend a little time talking about them.

First, let me talk a little bit about what a weekly option is. Weekly options or 'weeklies' were first introduced about 2005 or so. They initially were introduced on the Thursday before their expiration and would expire the following Friday. Not all equities and ETFs have weekly options but many of the most liquid do, including the SPY, DIA and IWM.

Recently, there have been some changes to the rules such that 5 consecutive weekly options chains can exist for a given equity or ETF. As a result, weekly options behave like standard options with two notable exceptions. First, they expire on Friday at close of the market. Second, there are weekly options for every week of the month EXCEPT the week that standard monthly options expire.

What does this mean for the average trader? For me, I noticed that I often would be caught between an option cycle that had too few days until expiration and the next option cycle, which had more days until expiration than I liked. Check out the example chain below. Notice the days between standard options versus the days between weekly options. That means I have a lot more choices of options cycles.



In particular, when I'm trading short vertical spreads, I like to sell a spread in an option cycle having between 20 and 40 days until expiration. As you can see, that would mean November has too few days and December has too many. I might instead select the first December weekly options that have 33 days until expiration. As you can see, I do currently have a trade open in the 4th November weekly options.

Before you go off and start trading weekly options, make sure you do some due diligence. Check out the weekly options chain and make sure the volume and open interest are high enough to support your trading. This should be the same rule I outline in short vertical spreads page on the website as well as in the Mastering Short Vertical Spreads video. Also, make sure you know exactly when these options expire. Non-standard options expire on Friday at close of market, not on Saturday after the third Friday.

Look for a more in depth coverage of weekly options on the website in coming months.

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 or the Contact Me link.

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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!

Q: Given the current low volatility in the market, wouldn't it be better to buy a long vertical spread than try to sell a short vertical spread?

A: This is a great question and one I have only touched on periodically so let me take some time to address it here in a couple of ways. First, I want to talk briefly about the difference between a short vertical spread (or credit spread) and a long vertical spread (or a debit spread). Then, I'll talk about whether it makes sense to use long vertical spreads in the current market.

What is the difference between a short vertical spread and a long vertical spread? There are a couple of ways to explain it. Let me start by putting it this way. A short vertical spread is one where the short strike is more in-the-money (ITM) than the long strike. A long vertical spread is the opposite where the long strike is more ITM than the short strike.

Because of this, short vertical spreads are put on for a credit that you get to keep if the spread expires completely out-of-the-money (OTM). Long vertical spreads are entered for a debit that you will lose if the spread expires completely OTM. However, if it expires completely ITM your profit is the width of the spread minus the debit.

Put another way, a bullish credit spread is a put spread where you hope your spread expires worthless while a bullish debit spread is a call spread where you hope your spread expires completely ITM. You can probably guess what the bearish equivalents are.

Why would you select long vertical spreads over short vertical spreads in a given situation? To understand this, let's take a little deeper look at how you create and profit from each type of spread. A short vertical spread is a credit generating spread where the short strike is more ITM than the long strike. The maximum profit is the credit. In this type of spread, you want to get the most credit up front possible.

There are two ways to accomplish this. One is to take a position closer to the money so you are selling a more expensive short strike. However, that makes the overall trade riskier. The other is to sell the spread when volatility is higher, hoping that volatility might drop as the spread matures. Remember that part of an option's pricing is tied to volatility and measured by a greek called vega. A short vertical spread is negative vega meaning that the spread benefits from a drop in volatility.

On the other hand, long vertical spreads are entered for a debit by buying a long strike more ITM than the short strike. In fact the long strike is often selected to be ITM when entered. Your maximum profit in the trade is the width of the spread minus the debit to enter. So your optimum entry cost should be as low as possible.

When overall volatility is low, option prices are low. Therefore, an optimum time to enter a long vertical spread is when volatility is low. With volatility low, you have a better chance of buying your spread at a lower debit, which means potential profit will be larger. Long vertical spreads are also positive vega, meaning they benefit from an increase in volatility.

Ok, now we can get to the original question. Is now a good time to be using long vertical spreads? The answer is yes. If your outlook suggests that volatility is relatively low and is likely to increase, any positive vega trade makes sense (including calendar spreads).  In the context of long vertical spreads, let's consider what types of trades to enter.

If your outlook continues to be bullish, then a long call vertical spread is a good choice. You would ordinarily select a long option that is ITM by at least a strike and select a short option that is OTM by at least a strike. While you won't necessarily benefit from a decreasing volatility, given that volatility usually drops when a market goes up, the trade can still be profitable.

If your outlook is bearish, a long vertical put spread would be a good choice. In this case, the long put would be ITM by at least one strike and the short put would be OTM by at least one strike. In this case, the spread profits when the market or underlying sells off. But, because volatility typically rises when markets sell off, you benefit from both an increase in volatility AND the bearishness of the underlying.

If some of the concepts I've covered here don't make sense, be sure to review the Vertical Spread strategy pages on the website. In addition, I cover the basics of both short vertical spreads and long vertical spreads in the Introduction to Spreads video.

Help me ensure we have an interesting question or two to respond to next month. Submit your questions at 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, expectations may change if the charts indicate something different during the month.
 

October turned out to be a pretty strong month after some initial selling.  As a result, the S&P is currently up over $100 from the low of the month and 20% overall  for the year!

Last month I summarized my outlook as follows.

"...At this point, it's not entirely clear how the market will work itself out. It looks like there is still some room for the S&P to move down to the $1675 level without breaking any kind of serious support. On the other hand, there is the convergence of the 50 day and 30 day moving averages in the same approximate area. I'm still bullish overall but we may still see some churn in the near term.

Here's how the last month played out.



As you can see in the chart above, the SPX did indeed move down to $1675 and even lower. I have to admit that I was starting to think about changing my bias as the SPX was flirting with $1650. However, notice the dominant trend line I drew last month is still in effect.

At this point, it appears there is some pause that's taking place. This could turn into selling but I'd only expect that to bring the SPX down to the $1725 support level or worse case, down to the dominant trend line currently at $1700. We'll have to see if Santa Clause brings a rally in December but it wouldn't surprise me to see a pause in the earlier parts of November. Keep in mind the VIX is in a fairly low area of the chart, which could indicate a potential for increased volatility and with it some selling.

In terms of my trading plans, I've started entering bearish trades tentatively but will also look for a stronger dip as a sign to enter bullish positions. In the mean time, waiting might be a prudent action until we see a clear move one way or the other. What about you? Do you have some bullish and bearish ideas in place so you can act when the opportunities present themselves?

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 Products

I'm adding a new section to the newsletter. Feel free to disregard if you aren't interested in product 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 each.

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.

For more information or to purchase the video.

Mastering Short Vertical Spreads
The focus of the video is on one specific strategy, including all aspects of of the process. This includes:
  • Understanding the construction and the trade progresses over time
  • Selecting the long & short strikes
  • Planning entry & exits
  • Managing the trade once entered
  • Back testing
  • Creating a trading system with the strategy
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.

For more information or to purchase this video

Special 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.

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