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Success With Options - Monthly Review, Issue #011 -- November Edition
November 03, 2010

Welcome to the November 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.

Two Months In a Row! - November Newsletter

Welcome to the November newsletter! I'm getting this newsletter out a little late because I was putting the finishing touches on the video I've been talking about for several months. It's surprising how much work goes into getting the video produced and packaged.

Who would have thought we'd see two months in a row of gains? Certainly in more bullish times this isn't as surprising. However, given current economic conditions and the uncertainty of upcoming elections, I'd have expected more selling. I'll be reviewing the month and providing my outlook for November toward the end of the newsletter.

Also in this newsletter, I'll cover some of the events from this month, update you on the video and review some trades. Read on...

This month I'll be slightly revamping one of the sections I've produced in the past. Based on suggestions from readers I'm going to provide a little more of a an options strategy focus. In fact, I'm going to rename the section 'Options Strategy Focus'. Clever title, huh? The goal of this section will be to provide more detail about various aspects of options strategies.

Thanks to those that have provided feedback on the newsletter. 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, 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

What's new at Success With Options

The big news with the site is the release of the video I've been talking about for several months. I'm very excited to have this finished and to be announcing availability here first in the newsletter.

In summary, here are some quick facts about the video. For more details about the video and to purchase it, please visit the video promotion page.
  • The video is just over 30 minutes long and is packed with information on buying and selling options and how to use the two concepts to construct spreads.
  • The video has several quizzes to test your understanding of what was covered
  • I've included an interactive tool to allow you to see dynamically the impact of price, time until expiration and volatility on the option price
  • Since this is an initial release that I want to get feedback for, I'm only releasing 50 copies of the video. Once the feedback has been incorporated, I'll provide an unlimited release.
  • I'm announcing the video here first to newsletter subscribers to give you first opportunity to purchase the video and take advantage of the special offer.
  • The offer is first a low price - only $20. Second, I'll refund 1/2 of this price for those who provide feedback on the video. Third, for those who provide feedback, I'll also provide a free copy of the final product with feedback incorporated.
You can also check out the video promotion for this on YouTube. If you are newer to options spreads, you'll definitely want to check out this video.

Trade Tutorial Summary

I had a few trades going this month but so far, the results are mixed. Yet... every trade offers an opportunity to learn something.

Here are the trades I was active on this month in a quick summary. I only did a few since I was focused on other things.

New/ Closed Trade Gain/Loss Comments
Closed DIA Iron Condor -$375 With the bullishness of October, the call side of this spread was overrun. I stated when I entered, I wasn't going to adjust this trade at all. That's not a bad strategy in a neutral kind of market but not a great idea in a trending market. I did this mainly to provide a contrast to the adjusted trades I've done in the past. In this case, you can see when unsuccessful, the trades lose more.
Closed SPY Put Spread $245 This trade was put on at the same time I closed the call spread from last month for a small loss. The profit from this trade more than covered the loss of the previous trade. This emphasizes the value of being willing to switch sides when the market dictates.
Open IWM Put Spread   This was another bullish trade I entered shortly after switching to a more bullish stance. At the moment, I'm nearly ready to close this trade for the target profit.
Open SPY put credit spread   This is another bullish trade I entered after wanting to take a more aggressive trade. It turned out a diagonal spread on the SPY was too expensive so I went with another put spread.
Open EWZ diagonal spread   Shortly after entering the SPY put spread, I found an opportunity to enter this diagonal spread. The risk is limited by my plan to close the position.

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 iron condor:
"... Does the fact that this trade lost money mean that I should continue adjusting? Certainly some of my prior trades also lost money even with adjusting. The key point is that one trade isn't enough to evaluate the effectiveness of a management strategy. Before implementing a full scale management strategy, many trades are required using the same rules in order to evaluate the long term effectiveness..."

From the SPY call credit spread:
"...I mentioned this as a lesson on the call spread tutorial as well but it's worth repeating. It is important to have clear signals to trigger exits. Furthermore, it's critical to take action on these because to delay might be costly - both in terms of potential loss in a trade as well as opportunity cost..."

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

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Options Strategy Focus

Based on feedback, 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. As you've perhaps followed some of the tutorials, you might wonder why I chose one strategy vs. another. This month, I want to talk in a little more detail about selecting the strategy to trade.

For newer traders, it may not be quite so obvious how one determines the strategy to select when entering a new trade. Like many other aspects of trading, there is no one hard and fast rule about strategy selection. For me, I believe it comes down to the following.

  1. I have several strategies I understand well and have trading plans for.
  2. When selecting a strategy, I have an outlook on the market in terms of trend, strength and duration.
  3. I have guidelines or expectations on how bullish or bearish I want my overall portfolio to be.
In a recent trade tutorial (10/5/2010), I talk briefly about some of the decisions in the strategy selection section. Some of the characteristics to understand about each trade are
  • How bullish or bearish is the strategy?
  • How fault-tolerant is the strategy?
  • What kind of impact is there on my portfolio (greek impact)?
  • Can I afford to employ this strategy (margin or outright cost)?
The objective in selecting a strategy to trade is to match up a strategy with your expectations and objectives. Here's an example. In many of the trade tutorials, my objective for selecting a strategy is to adjust my portfolio delta. Let's say my portfolio has gotten rather positive and I'm not as bullish as I was. What are my choices?

I need a strategy that offers me negative delta, preferably positive theta, and isn't too long term. What strategies fit these criteria? A short call vertical spread, a long put vertical spread, a one month put calendar.

What strategy makes sense? How bearish am I? If I were a little more bearish, I might simply enter a short call vertical spread. If I simply expected some medium term weakness, I might select a put calendar spread. The calendar spread might give me a little more tolerance if the market continued with more buying whereas the vertical spread would potentially force me to act if it were overrun.

In many cases there is no one perfect strategy. Selecting a good strategy is really a matter of understanding the characteristics of the strategy combined with the trading rules you employ and mapping to your objectives. I believe once you have a solid understanding of how your strategy behaves, you are better able to select a strategy that can help achieve the objectives you have for the next trade you enter.

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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 is related to an exit strategy I often employ in my trade tutorials.

Q: Do you have a rule of thumb on the percentage of maximum profit for trades such as iron condors, butterfly, or vertical spreads?

Thanks for asking this great question. Many followers of the trade tutorials may see me mention that I have a percentage that I target to lock in profit. However, they may not be familiar with why I use that amount. Additionally, the percentages I use may not be what others want to use so I'll first talk about what my trading rules are and then I'll briefly talk about the thinking process behind defining this percentage.

For most of the vertical spreads I enter, my trading rule for exiting to lock in profit is to close when I can lock in 80% of the initial profit. Similarly, my exit rule for iron condors is to exit when I can lock in 60% of the total credit when closing the entire trade.

Why limit the profit instead of holding out for the maximum? The main reason has to do with the risk involved in holding out for that last percentage. I talked about this in a fair amount of detail in last May's newsletter. The key point is that holding out for the last percentage of the maximum gain can be rather risky. By risky, I mean potentially risking the unrealized gain (say 80%) for the last 20%, which usually can only be realized in the last few days of the option cycle.

The real question then is what percentage to use? The key principle to keep in mind in choosing a percentage value to target is that there is an inverse relationship between profitability and risk. Any time I attempt to lower risk (as in closing early to make sure I have more successful trades) I trade off the profitability of that trade. That means I can choose a rule like closing to lock in 70% of the credit or target profit and I'll be successful in more trades but make less profit than if I were to hold out for 80% or 90% of the maximum gain. However, more of my 80% or 90% trades are likely to fail since I must often hold them longer to realize this gain.

What rule will you use? That has to be up to you. Experiment around, but make sure you try enough trades at a given target percentage before evaluating the effectiveness. By "enough", I mean at least 10-20 trades over a period of a year or so. You might decide to back test the exit rule you are considering using a tool like thinkBack or OnDemand on the thinkorswim from TD AMERITRADE platform.

Whatever percentage you decide to use, make sure you've tested it and that you follow that rule on all your trades of that strategy.

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.

This month shouldn't have been too much of a surprise if you read the outlook from last month's newsletter.  In it I summarized my outlook as follows:

"I believe we may see a little consolidation before another round of buying, possibly taking us up to the $1175 or even 1225 level. However, it is also possible to see some selling down to the moving average support levels, which could be as low as $1100. I'd consider these buying opportunities though. We are heading into the fall timeframe with a lot of factors in the mix, including elections, and the Christmas buying season. This may add some volatility."

I expected a rally up to 1175 and it went even farther before beginning another period of consolidation. Yet volatility is nearly where it was at the start of the month.

Notice this pattern that has developed over the last couple of months. After a strong move up there is a week or two of consolidation before continuing. Could we see that pattern repeat itself this month?

Possibly, however there are some factors to consider for November. First, this first week is election week and the results of the election may stimulate a move one way or the other. Also, there is talk of further stimulus programs from the Fed that could move the market. Finally, we are heading into the final months of the year, which are often bullish (but not always so).

Here's what I suspect may happen. We may see some short term selling in the next week or so followed by another attempt to push to higher highs - maybe up to $1200. In the end though we may see November end up pretty much where it started.

How will that affect my trades? I currently have on three bullish trades. The two put spreads will soon close as either more buying takes place or time passes. The only risk is a strong sell-off. I also have a diagonal spread that has not moved up as strongly as I'd prefer and any weakness in the EWZ may force me to close the trade.

As for new trades... I won't be entering any more bullish trades unless there is a clear break above the consolidation area we currently have. I fact, I may use further buying as an opportunity to sell some December call spreads or buy a put calendar spread.

Remember to stay nimble and alert. Make a point of doing market analysis at least every week or even every few days. 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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