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Success With Options - Monthly Review, Issue #72 -- December 2015 Edition
December 05, 2015

Welcome to the December 2015 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 (nearly) 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.

Wobbly Year End - December Newsletter

Well, the last 6 months have certainly been a lot more interesting than the first half of the year.

In this edition we'll tackle that question, explore an interesting trading strategy for this market and answer a question that was recently submitted by a reader. By the way, I apologize (again) for getting this newsletter out a few days late. It's been a another busy month. There will be no newsletter next month (January 1) due to the holidays.

Finally, we'll close as usual with a Market outlook for you. For more details, read on...

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.

In This Issue

1) Options Strategy Focus

2) Answers to your questions

3) Options Outlook

4) Featured Products

Options Strategy Focus: Volatility - Friend or Foe?

This section of the newsletter will focus more deeply on the details of some of the options strategies I use in the tutorials. Given the large fluctuations in the market and underlying volatility, I wanted to explore this a little bit.

Let me start by posing a question. Do you prefer high volatility markets or low volatility markets? For options traders who make their money from selling premium, I'd hope the answer is that you prefer higher volatility markets. But... that means markets that are much more turbulent and prone to strong and sometimes unpredictable selling.

As options traders, we're caught between to seemingly opposing desires. If we are still firmly entrenched in the traditional market mentality, we are happy when the market goes up and concerned with it goes down. To take joy in a market selloff seems, well, a bit unnatural. As option traders of the premium selling variety, we need to learn to become a bit more ambivalent to the ups and downs of the market.

I say that because as a trader who employs many different strategies, I know that I can make money in any market, regardless of the volatility or bias. Let me give you a few examples of what I mean by this by evaluating some different market conditions, both in terms of bias and volatility.

One thing I want to point out before jumping in is the use of the terms 'lower volatility' and 'higher volatility'. I use a more relative comparison because the current volatility at the moment is simply relative to the volatility that may exist for the prior weeks. In the bigger picture, higher volatility for a point in time where recent volatility was low (ex VIX=15) may suggest a short term selloff. Whereas higher volatility in a time where recent volatility was already high may be suggestive of a continuation. These two scenarios may call for a different strategy to be employed.

Long term bullish - lower volatility
Usually when we've had a longer bullish run and volatility is lower, we'll find that it's really difficult to sell a typical put spread. Remember, short vertical spreads are vega negative. You benefit when selling in a high vega and buying in a low vega climate. From here, you have a couple of choices of trades but the thing to keep in mind is you are wanting to leverage a trade where volatility is lower (or at least relatively similar) on entry than when you exit. Here are a few examples of what you could trade based on your shorter term bias.
  • Short term bullish - Consider a long call spread. The low vega characteristic means it can often be less expensive to enter, and that means a better profit if the trade expires fully ITM.
  • Short term bearish - Consider a put calendar spread or long put vertical spread. In both cases, you get the bonus of benefiting from a move in your selected direction AND a spike in volatility.
Long term bullish - higher volatility
Some time during a bullish trend, you'll see some selling where volatility spikes. In this climate, what you do will depend on your outlook. Consider though that you may be more interested in a vega negative trade (ex short vertical spreads, iron condors, etc).
  • Short term bullish - Consider a short put spread. If volatility is still fairly low, a long vertical spread may still be more appropriate.
  • Short term bearish - Consider a short call vertical. This gets tricky because by the time you find a spike in volatility, it may be too late for a decent entry.
  • Short term neutral - Sometimes you may find a period where its looking like a sideways trend. In this case, you may be able to capitalize on spikes in volatility to enter an iron condor.
Long term bearish - higher volatility
This is probably one of the toughest climates to trade in. In a longer term bearish market, when volatility has spiked even higher, it can be hard to determine if there will be more of the same or a sharp reversal. Usually though in higher volatility markets, you will likely focus more on vega negative trades, which are typically your premium selling strategies, such as short vertical spreads.
  • Short term bullish - I like these because they are easer to catch with technical analysis. My favorite in this climate is to sell a short put vertical.
  • Short term bearish - Given that volatility is high, it can be an opportunity to sell a short call vertical but I usually tend to stay away unless technical analysis gives me a good entry.
Long term bearish - lower volatility
This scenario presents some more interesting possibilities. With higher volatility, most of the premium selling strategies are possibility depending on your outlook in the short term.
  • Short term bullish - A short put spread can be a great trade in this circumstance. In this case, 'lower' is still higher than usual. If you spot a shorter term bullish bounce, you can slip in & out with this kind of trade.
  • Short term bearish - Even with relatively lower  volatility, there's still a decent opportunity for premium selling strategies like short call vertical. However, if you believe the volatility will increase, it may be a decent opportunity to buy a put calendar as well.

These are just a few examples of different market climates. What I hope you see from this is that we don't have to consider volatility a friend or a foe but rather, an indicator that can help us better select the strategy we should be using in any given climate.

For more information on the VIX and technical analysis, check out the technical analysis page on the web site.

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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!

I'm going to paraphrase a question I recently received by email.

Q: I've been attempting to follow your trade strategies outlined on your Website. We have some months of small success only to give it back during big market corrections. We had been hoping to generate enough of a return to provide a decent monthly income to live on. Do you have any suggestions for how to achieve more regular positive returns?

A: First I certainly understand your frustration with getting the hang of things with your trading. One thing I learned the hard way is to not let your need to generate sufficient income be the thing that drives your trading. I did that early on and got burnt pretty badly.  I see trading sites that offer to help you make 5% per month on your trading but most have some fairly serious setbacks on a bad month. I trade fairly conservatively and am happy with steady gains over the year. However, I too have losing months.

The key to having a longer term positive portfolio growth comes down to two key points in my opinion.
  1. Consistent money management
    What I mean by this is that you should consistently follow your money management rules. This amounts to using a consistent risk % for every trade. For me, that's 2% of my portfolio. Every trade I enter has this same risk profile - no exceptions!

    Related to this is a consistent overall risk/month. By this, I mean taking maybe 4 trades at 2%/per trade means I'm risking approximately 8% per month in trades. I personally find this hard to do without forcing myself to take trades I'm not comfortable with. However, when I look at my monthly returns, I can see inconsistencies in my returns that are directly related to this lack of consistency.

    Let me provide a concrete example. Let's say my trades vary from 2-6 every month. Since I never know on a given month which trades will be successful, it's very possible that my winning months might be the ones I take just 2-3 trades and my losing month could be that one month I take 6. With more trades, I also have more at risk in that month. Can you see how this inconsistency can affect your portfolio over the year?
  2. Consistent trade setup/management and habits
    By this, I mean is that I am consistently reviewing the market (daily perhaps) to evaluate trade opportunities, changes in market outlook and potential early exits. I find when I am more consistent with this part of my trading, I am also more consistent in my month-to-month trade risk and therefore, monthly returns.

    With my busy schedule, this is the one I personally find hardest to achieve. It's a struggle to discipline myself to take the time to evaluate the market, look for good trade setups and make the entries. I find I'm either too busy and don't do it at all, or I feel compelled to enter a trade, even when it may not be the best setup, simply because I happen to be looking and know that I may not have time to re-evaluate at a later time.

    I find that when I make the extra effort to be more consistent in my disciplines in this area, that my trading outcomes are more consistent as well. There are some tools I make use of that help me in this area. One is a trade journal. The trade journal is used to capture details of a trade, including the circumstances that let me to enter, details of the trade and so on. I also capture decisions made later on during the trade like why I decided to stay in, exit or adjust. This forms a nice record you can step back and read at the end of the month or year to see how your decision making is and what can be improved.

    I also use a trade log to capture my overall trade information. I like to capture the trades on a monthly basis so I can see my month over month returns. This can be used to evaluate your longer term performance and allow you to set goals for improvement from one month to the next or one year to the next. As a subscriber to the newsletter, you should have received a free download that included both of these. I highly encourage you to make use of them, whether paper trading or trading with real money.

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.

Sure enough, we did see some selling in the early part of November as expected. I didn't necessarily expect selling all the way to the 50 day Moving Average.

In the November newsletter, I summarized my outlook as follows:

"...The main thing that jumps out at me is that we are pretty strongly overbought. It's quite unusual to see the price running well over $50 above the 30 day moving average. At the moment, we're closer to $80 above the 30 day moving average. It's hard for me to see any continuation without some sort of regression back to that moving average. Looking back recently, we can see a very brief test of the 50 day & 200 day moving averages as support. As a result, we could see a test of any of these. In fact that's what I hope for because they will offer great entry points for bullish trades. ..."

Here's how November played out.

Sure enough, almost within the first few days of November, we saw a fairly sharp snap back. I had expected the 30 day or 200 day moving average to be the support level, but the SPX actually sold off all the way down to the 50 day moving average before bouncing back to an equilibrium just short of $2100. A lot of this has been news driven as the market absorbs news about terrorist attacks and potential for raising the Federal interest rate.

At this point, the market is likely to swing either way. We have a range established between recent highs and recent lows that form support and resistance levels. Given that this is written several days into December, we already can see that the first move was down with a sharp rally on Friday. As we head into the last few trading weeks of the year, the market will likely be more bullishly biased as is typical for this time of year. However, this year feels a little different, so we may not see the typical strong finish we've been used to seeing at year end.

I'm definitely more inclined to look for bullish trade opportunities in the next week. I may look to see if Monday continues the rally we saw on Friday or whether we'll retrace some of that. Either way, there may be some good bullish entries to be found. I'm also wanting to keep my trade cycles short as the market seems to change bias fairly quickly these days.

As always, do your own analysis and whatever trades you enter, use good money management and have exit strategies in place in case you are wrong in your analysis. It's a good practice to be prepared with trades in either direction but not to act without confirmation.

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.

One of the more recent additions to the portfolio of services and products is the Live Web sessions. These sessions are recorded and and available for a very reasonable price of $12 per session. I've created a Newsletter Special. If you add all 4 sessions to your shopping cart, you can get 4 sessions for the price of 3 by using the discount code: WebEx4Pack

Some time back, I released the second for sale video. The title of this video is "Mastering Short Vertical Spreads". I now have a total of two strategy training 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 how 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. 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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