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Success With Options - Monthly Review, Issue #23 -- November Edition
November 05, 2011

Welcome to the November 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.

Straight Up in October! More to Come? - November Newsletter

Welcome to the November newsletter. Well, it finally happened. Wow and did it! We went from a low of $1075 to a high of over $1275. That's more than a $200 move over the month. We'll look at what this might mean toward the end of this newsletter.

Also in this newsletter, I'll be reviewing the month in more detail, 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

Nothing really new with the site. I'm looking both for some new topics and the time to create them. Perhaps you have some topics you'd like to see covered. You can let me know using the newsletter feedback page.

I entered October with one active trade, which is now closed, and added another trade. Read on for details of the trades. It's now been four 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 Diagonal Spread -$337 I put this trade on expecting perhaps there would be a nice rally, however the market wasn't cooperating.
Open SPY Iron Condor   Put side is closed and another adjustment is in place as well.

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 Diagonal Spread: "...I always hate it when I have a trade that loses money. However, I hate it even more when I lose a lot of money. In this case, we limited the loss...
...A week after exiting this trade, it looks like the market may reverse once again. In retrospect one might be tempted to consider this early exit as a mistake. While it's still too early to tell, this trade may in fact have worked out as planned. Yet, you can't second guess every trade or exit rule just because one doesn't work out.

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 an Iron Condor 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.

Last month I began with the short vertical spread. This month, I want to move onto the iron condor, which is somewhat related to the short vertical spread.

Let's start by talking about the building blocks that make an iron condor. An iron condor is really just a combination of both a short call vertical spread and a short put vertical spread. In that context, much of what I discussed last month about vertical spreads applies here as well. This strategy is one that seems complex on the surface but when you break down the components becomes easier to understand. You start by selling a both a short call vertical spread above the market and a short put vertical spread below the market. You will usually do this all in one trade.

There are a number of ways of determining where to select the short strikes of this trade. Some people (myself included) prefer to use the thinkorswim probability of expiring value. A higher probability of expiring will mean a higher premium but a lower probability the trade will be successful because you end up picking short strikes too close together. I've said in my tutorials I use a probability of expiring of about 35% or so but you could go with an even lower number for a higher probability of success but a lower profit.

Once the short strikes are selected, the choice of long strikes (both call and put) are determined by how wide you want each spread to be. A standard iron condor will have equally wide spread. My preference is to use $2 wide spreads on each side. This makes for a very affordable spread (from a margin perspective) and yet can provide a good return as well.

With a short vertical spread the expectation is that the underlying would expire above the short put spread or below the short call spread. Since an iron condor is made up of both a call vertical and a put vertical, the expectation is that the underlying expires between the short put and short call strikes. In that regard, this strategy works best in a fairly neutral market. However, it can work in up choppy markets as well. Regardless, it's rarely the case that you would let the options expire completely worthless. You will either buy back one side of the iron condor (either the call side or put side) at a time or buy back the entire trade for less than you sold it for. 

In the last newsletter I talked about the interaction of the greeks between the long and short strike of the vertical spread. With an iron condor this gets even more interesting. With both a call spread and a put spread, you'd expect the sum of all deltas to result in a roughly neutral delta value. When the total delta becomes more positive, it means you would prefer the underlying to increase. The opposite is true when the total delta is more negative. The good news is that the theta values of the call and put spread are added together (twice the profit potential). The theta will start out being relatively small but gets larger as you get closer to expiration.

Like most positive theta trades, there is a fairly large gap between the ideal ending scenario and the current profitability at some point weeks before expiration. Notice below that the white line (showing current profit range) is quite a bit lower than the ideal (indicated by the red line). The white line will become more like the red one as you approach expiration (as extrinsic value drains off).  Notice also the unique shape of the ideal profit graph. This shows that maximum profit is found within the range between short strikes and tapers off to a break even point and finally to max loss.

There is one other key point that makes an iron condor interesting. In a typical short vertical spread, your broker will hold enough margin aside to cover your max loss, which is the width between the short and long strike. When you have both a short put spread with a short call spread to create an iron condor, most brokers will NOT hold twice the margin. This is because at expiration the underlying will either be completely through the short put spread or completely through the short call spread (but not both). Therefore, you receive the credit for both spreads but only hold margin for one side. Cool huh?

I wanted to conclude this article by addressing the two other points on the profit graph above. First, notice the break even points are wider than the max gain points. The reason for this is that the break even is the short put minus the total credit received and the short call plus the credit received. Of course the maximum loss is the width of either the put or call spread minus the total credit. What makes this trade interesting is the fact that it offers additional option premium with the same amount of margin. However, this strategy doesn't make sense in all market conditions. This strategy can work in neutral or choppy markets but doesn't do as well in strongly trending markets. 

For more information on this strategy, visit the iron condor strategy page.

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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 received recently related to management of vertical spreads.

Q: I have a question related to management of vertical spreads. Is there ever a scenario where you would close out 1 leg of the trade like you might with an iron condor or do you always close out as a combo?

A: This is a really good question. I typically don't buy back part of a vertical` spread. When you say one leg, I presume you mean the short strike. When I refer to 1 leg of the iron condor, I usually mean the call spread or the put spread. While I don't generally close 1 leg of a vertical spread (i.e. the short option) in total, I do sometimes buy back 1-2 contracts of a multi-contract spread.

For example, I might buy 1 contract of a 3 contract spread or 2 contracts of a 5 contract spread. What I'm trying to do is hedge my bets so to speak by creating a back spread. By the way, I mention this on the new trade adjustment page. I'm usually very cautious about using this strategy because it leaves me essentially with a long option, which is negative theta and has all the other disadvantages of a long call.

There are a number of other adjustment strategies that are listed in the above trade adjustment link. One of my favorite adjustment strategies for iron condors is to buy a few contracts of a calendar spread in the direction of risk. Have a look at the details in that trade adjustment page.

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.

After remaining range bound (in a very large range) for most of August and September, the market broke out in a big way in October. Last month I summarized my outlook as follows:

"...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. "

Here's how the month played out.

After spending the first two days of the month selling off to shake out the last of the bulls, the market suddenly reversed and moved almost straight up for nearly two weeks before pausing at the $1220 level. After a few days of consolidation, it pushed above the $1225 resistance level and began reaching for $1300.

With such a large move in a relatively short time, it wouldn't surprise me to see some additional consolidation before pushing higher. However, this is the traditional time period of what is often called the "Santa Clause Rally". That means we could see some degree of bullishness into the end of the year, but we'll have to wait to see that confirmed. At least we are currently back in positive territory for the year!

How does this outlook affect my position? I currently have the remainder of an iron condor in place with the call side currently being threatened. I have made an adjustment, which I've talked about in the trade update. I will be looking for an opportunity to enter another bullish trade of some kind very soon.

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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