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Success With Options - Monthly Review, Issue #24 -- December Edition
December 06, 2011

Welcome to the December 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.

Strong Finish For 2011? - December Newsletter

Welcome to the December newsletter. Well, it seems as though November ended almost at the same point as it started. However, it was anything but a tame month. Will we end the year positive (both in terms of the market and in terms of the tutorial portfolio)? Read on.

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 continue to solicit feedback on the newsletter. 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

While it's been a busy month in other areas, I have managed to make some small changes. In particular, you will note the addition of a Facebook 'like' button immediately below the left navigation menu. If you have a Facebook account and find the website helpful, I encourage you to take the opportunity to 'like' the site. In the near future, the plan is to provide a comment area to the trade tutorial pages. In this way the trade tutorials can be made more interactive, allowing you to have your say on each trade I set up.

I also continue to look for new topics to expand the information on the website. Perhaps you have some topics you'd like to see covered. You can let me know using the newsletter feedback page.

I entered November with one active trade, which is now closed. I added another trade right as the month was coming to a close. Read on for details of the trades.

It's now been six months since I released the 'Introduction to Options' video. In celebration of the Christmas season I'd like to offer a special limited time discount on the video. See the end of this newsletter for details on that video. Now until Dec 31, use the discount code 'christmas2011' when you check out and get $10 off the price of the 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 Iron Condor $36 The original iron condor didn't go all that well as the call side of the trade was overrun. However the calendar spread adjustment I put on helped offset the loss and then some.
Open DIA Put spread    

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 iron condor: "...The reason this trade worked out as it did was for two reasons.
  1. I didn't close the put spread as planned (when I could have done so for $.25 debit. I chose to disregard that rule because of the strength I was seeing in the underlying SPY. I offset the risk of having my calls overrun by letting my puts remain to deplete more of the premium there.
  2. I added a calendar spread adjustment. As it turned out, I came pretty close to hitting the short strike dead center with just 3 days until expiration. As a result, the spread widened out perfectly and the gains there offset the minor loss in the iron condor."
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 a Calendar 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 looked at the the iron condor strategy. This month, I'd like to move on to the calendar spread.

The calendar spread is a slightly different animal than the last two strategies I've covered. Whereas vertical spreads and iron condors have their long & short strikes in the same option month, a calendar spread (as the name might imply), spreads the strikes across multiple months. The typical construction is to buy a long option several months out and then sell a short option with same strike price but in a nearer month.

Now, the actual strike selection is often determined by what strategy is being employed. One strategy is to select strikes a few strikes from the current price (either above or below). Another is to select a short strike with a probability of expiring (ITM) of around 35% or so. Yet another strategy is to select a strike price where you might expect the underlying to land near on expiration of the short strike.

One interesting aspect of calendar spreads is that they are entered for a debit. The ideal scenario is to have the short strike expire exactly at the money, or maybe a penny less. Calendar spreads make money as the short strike drains of value while the long option that is farther out in time retains much of its original value. If the calendar spread spans multiple months then additional credit is derived from rolling from one month to the next.

Let's take a moment to examine the interaction of the greeks. The below example is a put calendar spread. Notice that the farther out long put has a negative delta while the nearer short strike has a positive delta. It's not surprising that the net delta is negative since we want the underlying to drop from its current $126 to $123. Also, notice the vega. While the credit spread and iron condor have negative vega (they benefit from a decrease in volatility), the calendar spread has a net positive vega, which means it benefits from the increase in volatility.

Calculating maximum profit on a calendar spread is rather difficult. The main reason is that the profit is dependent on where the underlying is when the trade closes or expires. Notice the P&L graph below. If you are fortunate enough to have the short strike expire exactly at $123, the maximum profit would be realized. You'd pay about $110 per contract and realize around $200. However, notice the range of overall profitability. The key thing to observe from this is that calendar spreads are pretty fault tolerant but hitting the max profit is more challenging.

When does it make sense to use a calendar spread strategy? I like to use them when the market has made a nice run up and the volatility has dropped. I'll usually sell a put calendar spread several strikes below the current price and then wait for a sell-off. The combination of increased volatility from the selling and the underlying approaching the short strike causes the trade to experience a pop in profit. The closer this happens to short strike expiration the more profit that is realized.

For more information on this strategy, visit the calendar spread 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 actually related to a service provided by thinkorswim, now TD Ameritrade.

Q: I notice now that the Red Option trading strategies are now only available to clients of the thinkorswim platform. As I recall, this service used to be available to many other brokerage firms as well. Is this truly the case?

A: The short answer to your question is yes. As stated on the Red Option FAQ, you must have a TDAmeritrade account in order to autotrade the Red Option strategies. It would seem that there has been a change recently. I know roughly a year ago or more it was possible to autotrade with a number of different brokerages.

I don't know if it would be interesting to you but I imagine one could simply manually trade from the email notices. I realize there would potentially be somewhat of a delay, which might affect the trade. However, at least one could still follow the trade suggestions while trading any brokerage account you like.

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:

"...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! "

Here's how the month played out.

It looked like the rally was going to continue. However, the economic concerns in Europe and in the United States weight heavily on the market. Notice though that the selling halted right at the 68% fibonacci retracement level. It's interesting that in very liquid markets, certain retracement percentages can act as a support level.

So, will we see the continuance of the strong move over the last few days? It actually wouldn't surprise me to see the $1300 level tested, with a pause before breaking completely trough. As a result, it may be near the end of December before we see the SPX break completely through the $1300 level. A final point to consider is that if the SPX fails to reach above $1250, this could signal perhaps another round of selling.

How does this outlook affect my position? I recently added a bullish position selling a DIA put spread below the equivalent pivot point on the DIA. I also am looking to add another bullish position in the next week or so.

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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