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Success With Options - Monthly Review, Issue #48 -- December 2013 Edition
December 02, 2013
Hello,

Welcome to the December 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.

Finishing Out 2013 - December Newsletter

November offered an unusually bullish run leading up to the final month of the year. The question now remains whether we'll see December finish strongly as well.

I'm always interested in receiving feedback on the newsletter. 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.

Also in this newsletter, I 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.

I'd like to recommend this month that you go back and review the trade tutorials I've entered so far this year and see what you can learn. Look for a change in this section beginning next year.

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

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

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Options Strategy Focus: Calling it a Year

This section of the newsletter will focus more deeply on the details of some of the options strategies I use in the tutorials. This topic will be slightly different than the typical options topic usually covered here. I'm going to propose that as you have traded this year, if your trading year to date has been profitable (or even if it hasn't), perhaps it would be a good time to take the last month off for evaluation.

What do I mean by that? I'm suggesting that you use this time of the year to evaluate your current trading strategies. Which ones have worked? Which ones pose a challenge to you and may require tuning of your rules? What new strategy would you like to add in 2014?

There is a saying in the business world that "sometimes we're so busy chopping wood we don't take time to sharpen the ax". Is that you? Maybe December would be a good time to do that. Maybe instead of trading a lot this month, you cut back on trades. Then, use the time not spent setting up trades or managing trades doing a review.

In the coming year, I'm going to begin using this section to outline some strategies that I often propose on the website but I'm going to do it here by focusing on one strategy a month and providing references to all related material including website pages, trade tutorials, and related videos.

Don't wait for me to start providing these in the newsletter though. Feel free to go out and locate the content for yourself and begin sharpening your axe for 2014. In addition, do take time to review your trade logs and trade journals for your trades. You do use these, right? Of course you do because you are a serious trader who wants to become better every year.

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: I was watching the Mastering Short Vertical Spreads video and in the Strike Selection section, you had shown the probability of expiring out of the money on both the thinkorswim platform and OptionsXpress platforms. These numbers were different for the same strike price. You didn't really explain why they were different. Can you tell me why they would be different for different platforms?

A: Thank you for bringing that up. It's true I didn't really go into much detail on that in the video. I chose not to address that point for several reasons. First, it was a tangent in the overall topic of strike selection and second, because the explanation itself involves a fairly in-depth discussion of how theoretical prices are derived on options.

An option's price is made up of a combination of intrinsic value and extrinsic value. Intrinsic value is fairly straightforward - it's just the amount the option is currently in-the-money (ITM). Extrinsic value is more complicated and involves considering days until expiration, volatility, interest rates and more. A number of formulas have actually been created to allow calculation of a theoretical price plugging the above factors into the formula.

The most well known formula is known as the Black-Scholes model, named after the primary contributors to the definition of model. The formula is often used to calculate a theoretical price, but it can also be used to solve for one of the other factors such as implied volatility given a current option's price. With this volatility, it is possible to calculate the statistical probability of an option expiring ITM or out-of-the-money (OTM).

Here's where we come to the answer to the question of why the values may be different on various platforms. It turns out there are different models that can be used to calculate the theoretical option price. One issue with the Black-Scholes model is that it's based on European style options, which can only be exercised at expiration.

The thing is that most ETF-based options and stock options are what's known as American style options. That means they can be exercised at any time and that affects the model. In addition, many stocks and ETFs issue dividends, which also affects the model. For that reason, alternative models were introduced including the Bjerksund-Stensland model that attempt to deal with these factors.

So, while one platform may use Black-Scholes, another may use the Bjerksund-Stensland model, leading us to arrive at different implied volatility values and therefore different probabilities. That may initially seem like an issue. However, these probabilities shouldn't be taken as guarantees anyway. The best way to think of this probability is as a relative indicator.

Over time, you will become accustomed to having a range of probability values that will represent your ideal point for strike selection. I offer 65-70% as my recommended values but that may be slightly different on other platforms and indeed may be different for an individual trader.

I hope that helps answer the question. For more information on volatility and it's affect on probabilities, visit the option volatility page on the website. In addition, if you want to learn more about using probability for strike selection, either check out the Vertical Spread strategy pages on the website or get your copy of the Mastering Short Vertical Spreads training 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.
 

Even after the nice run in October, November has shown a nice additional move. The question is what will happen for the remainder of the year?

Last month I summarized my outlook as follows.

"...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.

Here's how the last month played out.



As the chart above shows, the SPX is still in an up trend with no signs of slowing down. I put a channel in so it's more clear the range the SPX has traded in over the last few months. Notice that for the month of November, the SPX mostly followed the upper side of the range. Last month I said it was possible that the SPX would trade down to the $1725 level before possibly rallying again. In fact, the selling only went to the $1750 level before triggering another rally.

This is the kind of setup that makes me a bit nervous. While it's possible for the SPX to continue to rally through December, it's also possible that there will be some kind of sell-off at least back town to the $1750-1775 level before continuing on. For now, I'm going to be watching for some kind of signal as to what's next. The key thing to keep in mind is that the dominant trend is still bullish.

In terms of my trading plans, I'm planning to hold off making any trades of significance for now. In fact, I may take my own advice and not trade much at all in favor of analyzing past trades and making some plans for 2014. The end of the year is always a good time to pause and reflect on your past trading year.

As you look at your past trades, what did you do well? What do you need to improve on? What strategies worked? What market trends worked?

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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