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Success With Options - Monthly Review, Issue #83 -- December 2016 Edition
December 17, 2016

Welcome to the December 2016 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.

The Calendar Spread - December Newsletter

Finally!! The newsletter is finally out for December. Chalk it up to busy schedules and end of year craziness. This will be the last newsletter until February, essentially skipping the January newsletter as I usually do.

Are we on one incredible bullish run or what?? Is the a Santa Clause Rally, a Trump Rally or both? Can this run continue? In this edition we'll tackle those questions, look at trading gold and answer a question that was recently submitted by a reader. Finally, we'll close as usual with a Market outlook for you. For more details, read on...

I'm planning on using some down time over the coming weeks to work on the "Mastering Calendar Spreads" videos. The goal would be to have this available early in 2017. Stay tuned for additional details. In the mean time, feel free to take advantage of the holiday special to purchase anything from the video store at 30% discount. Use the code holiday2016 at checkout to receive this discount on anything in your shopping cart. This code will be good until January 1.

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: Trading the Calendar Spread

This section of the newsletter will focus more deeply on the details of some of the options strategies I use in the tutorials and other topics related to options trading.

This month, I'll introduce (or review) the Calendar Spread strategy. I mentioned at the beginning of the newsletter that I'm going to working to complete the next video series, which will be on Calendar Spreads. This seems like a good time to kick that off by providing a brief introduction to them.

Quick Calendar Spread overview
I'd like to quickly discuss the construction of a calendar spread and talk about how it is different from the Vertical Spread. The big distinction with a Calendar Spread is that it will be composed of strikes that have different expiration months but exactly the same strike price. The short strike will be in a nearer term cycle while the long strike is in a farther out cycle. This offers some interesting characteristics in terms of how it behaves and profits. Notice that we still have a 'defined risk' trade where the long strike is used to cover or limit the risk from the short strike.

In the ideal case, the short strike will expire with the underlying right at the strike price. Actually, you want the option to be just barely out of the money (OTM). As a result, the short strike will be worthless on expiration but the long strike having some number of weeks or months until expiration will still be worth something. In fact, that's the whole way in which calendar spreads profit. When opening a position, you sell the short strike for a credit, which offsets the long strike that you buy for protection. The net result is a debit. As time passes, the short strike's time premium melts off faster than the long strike.

When you can trade
Calendar Spreads are quite versatile in that they can be traded on their own or used as a protection or adjustment strategy. Let's look at an example of each.
  1. Trading on it's own - One strategy I like to use with Calendar Spreads is setting up a trade following an extended bullish move. The volatility is typically low at that point, which makes the options cheaper for strategies that involve a net debit. I'll buy a put Calendar Spread below the current market. How far below depends on my outlook for a correction. Often it will be a support point. I buy the spread and then wait for the market to pull back. The longer this takes, often the more profitable this trade will be. because it allows time for the time premium of my short strike to melt off. This approach offers several key benefits. With put Calendar Spreads, you are expecting a selloff typically. With a selloff you usually see an increase in volatility (Vega). The combination of increasing volatility AND the market moving down to your short strike can act as a double benefit.
  2. Trading as an adjustment - Another case where I like to use Calendar Spreads is as an adjustment in combination with a Short Vertical Spread or Iron Condor. In this case, I want to use my Calendar Spread to offset the risk that may occur if the market moves against my short spread. In this case, the profit from the Calendar Spread helps to offset the risk or loss that may occur if a Short Vertical Spread goes wrong. In the best of all cases, I can win both on the Calendar Spread and in the Short Vertical Spread but that doesn't happen too often.
Quick Analysis of a trade setup
There are a few considerations when looking at Calendar Spread setup. These can all affect entry cost and potential profitability and are influenced by your objectives for putting the trade on. Let's look at a few of these considerations.
  1. Call vs Put Calendar Spread - This is usually a fairly easy choice. I typically want my spread to be entered as an OTM spread. As a result, if I'm considering a bullish trade, I'll put on a Call Calendar Spread. If I'm considering a bearish trade, I'll put on a Put Calendar Spread.
  2. How far out of the money the strikes are - This is a more difficult choice and is based on a few factors. Largely, this is based on your target price where you expect the market to be around the expiration date of your short strike. One of the things I like about the Calendar Spread is that you can be a little bit wrong and still profit. One of the tougher parts of this though is that it's a lot harder to calculate profit and in fact, you can't know exactly what it will be ahead of time.
  3. How many options cycles between long and short strikes - This will be based on your objectives for entry. Using Calendar Spreads for adjustments means I'll usually ensure I have it on for the duration of the trade I'm protecting. If I'm entering the trade on its own, then the number of options cycles usually has something to do with my outlook and the timeframe for that outlook. If I'm expecting a period of movement within a tight range, I may put more cycles in between because I have opportunities to roll the short strike from one cycle to the next. This basically allows me to recoup some of the credit and may increase the profitability of the overall trade.
  4. What's a good entry price - Entry price is often linked to the prior two decisions. How far out of the money and how many cycles will have a direct affect on the price of both the long and short strike. Overall, you are looking for around 30-40% target ROI. Calculating that can be a little tricky but there are tools both on the thinkorswim platform and at the Options Industry Council (OIC) web site that can help with this. The allow you to roll time forward and an analyze the impact of time passing, price changing and volatility changing to project a potential future price.
This is a quick introduction to Calendar Spreads. Be watching for the release announcement early next year. In the mean time, also have a look at the Calendar Spreads page on the website. There, you will also find links to some older tutorial videos on Calendar Spreads.

Happy trading this month!

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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: On several of my trades after the first day I got a Regulation - T call notice in my position statement. What is a Regulation - T call notice and why am I getting it?

A: Regulation T is a series of regulations created by the US Federal Reserve Board and govern various aspects to how accounts are managed for investing. This is particularly important to understand when it comes to regulations relating to margin accounts, which is why you might have received a Regulation T call notice.

There are several aspects to these regulations that you should be aware of.
  • Borrowing money to fund a stock purchase - For example, let's say you had $2500 in your brokerage account. You wanted to buy 200 shares of SPY at $200. However, that would cost $4000. You could use a margin account to fund part of the purchase by borrowing money from the broker at their standard rate. Regulation T allows you to borrow up to 50% of the purchase price of the stock.
  • Using margin for uncovered options - This means for nake puts or calls that are not secured with your own cash, you would need to borrow from your margin. The amount you borrow is more difficult to determine and may be up to your broker to define. However you are required to maintain at least $5,000 in your account (as opposed to the $2,000 minimum required for purchasing or shorting stocks). Generally, this can be pretty risky and complex and more so when using a margin account.
  • Frequent trading - Options traders can open and close positions frequently without realizing that it actually takes a few days for the trade to finally settle. If you perform too many trades in a short period of time, it might be that more of your margin is required than you realize.
Why might you receive a Regulation T call notice? If any above activites cause your margin to drop below required amount, you could receive a Regulation T call notice on your margin. The typical approach to resolving this is to add more money to your account. There is actually a regulation that limits how many times you can resolve the call by simply closing one or more positions.

In general, I'd say you are at relatively low risk of encountering this situation if you follow some basic rules.
  1. Make sure you have sufficient cash in your account. I'd recommend at least $20,000.
  2. Use defined risk trades (Vertical spreads, Calendar spreads, etc)
  3. Limit your risk per trade to 1-2%. That means risking no more than $200-400 per trade.
  4. Limit the total risk to 10% or less (this will only tie up about $2000 and you won't need margin anyway).
I hope that helps you better understand what Regulation T calls are and why you might receive one. For more information, consult your broker's margin rules to find out how they manage margin accounts.

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.

And... as quickly as that, the selloff is over.

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

"...Now that we've broken that up trending support line, it's time to look for the next level of support. Right now, there is horizontal support pretty much right where we're at (give or take 10-15 points). If that fails, there's always the 200 day moving average. I frankly wouldn't be surprised to see the 200 day moving average tested. Currently there isn't any kind of wide spread panic so the selling may likely just be more election jitters......"

Here's how November and the first half of December played out.

Sure enough, the SPX sold off right down to the 200 day moving average, which coincidentally was very close to the 50% retracement point from the prior lows back in July to the highs in August. With the election over, the market has rebounded hard and fast and at the end of Nov, actually broke over the prior highs. That makes these all time highs people. Furthermore, we're now at more than 7 years of bullish behavior since the lows of 2009.

It's very possible that we could see the projected high from the Fibonacci chart be tested. There is a school of though in the technical analysis world that if you break the 100% retracement level, the next target high is at 161.8%, which would be $2320 or so. That's really only about $70 more. However, keep in mind that this time of year traditionally sees a kind of bullish rally often referred to as the "Santa Clause Rally". What follows in January is often some selling. With as strong a rally as we've seen it is also quite possible we could see selling at least back down to the support level around $2200.

Do you have trades on right now? If so, watch them carefully. As for me, I'm trying to close my trades and wait this out. If opportunity offers a chance, I'll try to sell above the 161.8% fib level. Otherwise, I'm looking for an opportunity for a bullish entry.

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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