Testimonials

November 10, 2011

Stop Me In Time

Filed under: Uncategorized — Tags: , , , , — Dan Passarelli @ 9:59 am

 Options offer a number of unique advantages to the trader, but perhaps the single most attractive characteristic is the ability to control risk precisely and to do so with surgical precision. Much of this advantage derives from the ability to control positions equivalent to stock with far less capital commitment.

However, a less frequently discussed aspect of risk control is the ability to mitigate risk by the judicious use of time stops as well as the more familiar price stops more generally known to traders. Because time stops take advantage of the time decay of extrinsic premium to help control risk, it is important to recognize that this time decay is not linear.

As a direct result, it is not intuitively apparent the time course that the decay curve will follow.  A corollary of this is that option modeling software is essential to plan the trade and decide the appropriate date at which to place a time stop.

As a simple example, consider the case of a short position in AAPL established by buying in-the-money November 390 puts. A trader could establish a position consisting of 10 long contracts with a position delta of -608 for approximately $11,300 as I write this.

At the time of this writing, the stock is trading around $384.50; these puts are therefore $5.50 in-the-money.  Let’s assume a trader analyzes the trade with an at-expiration P&(L) diagram and wants to exit the trade as a stop loss if AAPL is at or above $387 at expiration. The options expiration risk is $8,300 or more. However, if the trader takes the position that the expected/feared move will occur quickly—long before expiration—he could implement a time stop as well.

Using a stop to close the position if the stock gets to $387 at a point in time around halfway to expiration would reduce the risk significantly. Because the option would still have some time value, the trader could sell the option for a loss prior to expiration, therefore retaining some time value and fetch a higher price. In this event, closing prior to expiration helps the trader lose less when the stop executes, especially if there is a fair amount of time until expiration and time decay hasn’t wreaked too much havoc.

Options offer a variety of ways to control risk. Learn and use all risk control maneuvers available; life is a risky business.

March 18, 2011

Learn to Adjust Options Positions

Filed under: Uncategorized — Tags: , , , , — Dan Passarelli @ 9:47 am

My Online Education Series this month has all been all about helping traders learn to adjust options positions. Adjusting option positions is an essential skill for options traders. Adjusting options positions helps traders repair strategies that have gone wrong (or are beginning to go wrong) and often turn losers into winners. Given that, it’s easy to see why it’s important to learn to adjust options positions.

Adjusting 101

Adjusting options positions is a technique in which a trader simply alters an existing options position to create a fundamentally different position. Traders are motivated to adjust options positions when the market physiology changes and the original trade no longer reflects the trader’s thesis. There is one golden rule of trading: ALWAYS make sure your position reflects your outlook.

This seems like a very obvious rule. And at the onset of any trade, it is. If I’m bullish, I’m going to take a positive delta position. If I think a stock will be range-bound, I’d take a close-to-zero delta trade that has positive theta to profit from sideways movement as time passes. But the problem is gamma. Gamma is the fly in the ointment of option trading.

Gamma

Gamma—particularly negative gamma—is the cause of the need for adjusting.

Gamma definition: Gamma is the rate of change of an option’s (or option position’s) delta relative to a change in the underling.

Oh, yeah. And, just in case you forgot…

Delta definition: Delta is the rate of change on an option’s (or option position’s) price relative to a change in the underlying.

In the case of negative gamma, trader’s deltas always change the wrong way. When the underlying moves higher, the trader gets shorter delta (and loses money at an increasing rate). When the underlying moves lower, negative gamma makes deltas longer (again, causing the trader to lose money at an increasing rate).

Wrap Up

Therefore, traders must learn to adjust options positions, especially income trades, in order to stave off adverse deltas created by the negative gamma that accompanies income trades.

March 12, 2011

Maximizing Fade Plays

Filed under: Uncategorized — Tags: , , , , , , , , , , , , — Dan Passarelli @ 9:50 am

Do you feel like you’ve seen this movie before? Trouble in the Middle East. People in the streets; panic in the market. Is this recent wave of trouble going to last forever? Not likely. Perhaps there is an opportunity to fade this fall. But how should an option trader play the fade to maximize chances of success and maximize option-trading returns?

The obvious starting point for a trader to fade this fall is to take a positive-delta position. This is fancy options speak for a bullish trade. There are lots of different ways to take a bullish stance given all the various types of option-trading strategies out there. So, the question really is: Which is best?

There are a few major considerations here. First, traders must strive to maximize reward by minimizing risk. In order to do so, option traders must define their expectations. Am I looking for an extreme turn around? A mild retracement? A dead-cat bounce? The more a strategy can be tailored to expectations, the more risk can be controlled and reward can be maximized.

Next traders need to consider implied volatility. This is where option traders can get an edge in their options positions. If implied volatility is high (overpriced), option traders should consider option-selling strategies. If implied volatility is low (underpriced), option traders should consider option-buying strategies.

In the current market scenario we have a situation where if the turmoil in the Middle East subsides, the market should rally somewhat, but it’s not likely to go to the moon. Further, with the VIX at its current nose-bleed levels and implied volatility of individual stocks following suit, it’s easy to find overpriced options. Any clever fader trader should be looking for put credit spreads to sell. Put credit spreads have positive delta and take a short position on implied volatility. Great candidates for this sort of play are indexes and ETFs like SPX, SPY, DJX, DIA, et. al. Traders are best off staying away from oil stocks and precious metals that might be adversely affected by Middle East stability.

August 6, 2010

MTM Joined Blog Catalog

Filed under: Uncategorized — Dan Passarelli @ 10:31 am

We at MTM are proud to announce that we have joined Blog Catoalog http://www.blogcatalog.com/directory/business/investing/

Thanks for reading!

March 31, 2010

Get 25% off April’s Online Options Education Series

Filed under: Uncategorized — Dan Passarelli @ 6:56 pm

Get 25% off Now!

March 24, 2010

The Road Goes On Forever And The Party Never Ends

Filed under: Uncategorized — Tags: , , — Dan Passarelli @ 9:58 am

One of the effects of the seasonality of options (that I talk a lot about with my students) is that premium sellers see the most dramatic erosion of the time value of options they have sold during the last week of the options cycle. Most premium sellers strive to keep the options they have sold short (also known as options they have “written”) out of the money (OTM) in order that the entirety of the premium they have sold represents time (extrinsic) premium and is subject to this rapid time decay.

With 12 monthly cycles, there historically have been only 12 of these final weeks per year in which premium sellers have seen the maximum benefit of their core strategy. The recent advent and widespread use of weekly options has changed the playing field. Options with one week durations are available on SPX and OEX indices. For variety, they also come in flavors of a mini contract (SPX) and European style (OEX). These options have been in existence since October 2005 but only in the past 12 months have they gained widespread recognition and achieved sufficient trading volume to have good liquidity.

Standard trading strategies employed by premium sellers can be executed in these options. The advantage is to gain the “sweet spot” of the time decay of premium without having to wait through the entirety of the 4 to 5 week option cycle. The party never ends for premium sellers using these innovative vehicles.

Traders interested in using these weeklies MUST understand settlement procedures and be aware of last days for trading. An excellent discussion of details is provided on the CBOE website: http://www.cboe.com/micro/weeklys/introduction.aspx

March 15, 2010

Get a Free Excerpt From the Book Trading Option Greeks

Filed under: Uncategorized — Dan Passarelli @ 8:31 pm

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March 2, 2010

Naked Puts on TGT STock

Filed under: Uncategorized — Tags: , , , — Dan Passarelli @ 7:10 pm

The Strategy
Let’s take a look at an option strategy that involves the selling of a put, often referred to as an uncovered put write or a naked put write. A naked put write is when a trader sells a put that is not part of a spread. This strategy is generally considered to be a bullish-to-neutral strategy.

The maximum profit is the premium received for the put. The maximum profit is achieved when the underlying stock is greater than or equal to the strike price of the sold put. Though this allows for a lot of room for error (The stock can be anywhere above the strike at expiration), note that the maximum loss is unlimited and occurs when the price of the underlying stock is less than the strike price of the sold put less the premium received. So, executing this trade in the right situation is essential. To calculate breakeven, subtract the premium received from the sold put’s strike price.

The Example
For our example we will use discount retailer Target (TGT). For this example we will assume the stock is trading around $50 a share. A trader sells the March 50 put, which carries a bid price of $1.00 (rounded to make the math a bit easier). Should TGT stock be trading above $50 a share at expiration, the March 50 contract will expire worthless and the trader will keep the premium collected. (Do not forget to take any commissions the trader may pay from the equation.) All is good, right? Well, what if the stock falls?

If TGT falls to, say, $45 at expiration, the put would expire in-the-money and would have to be purchased back to avoid assignment. This could cost the trader a rather hefty sum. Assigning values, our investor collected $1 in premium. The 45 put expired with $5 in intrinsic value. The trader loses the $5, less the $1 premium collected results in a loss of $4, or $400 of actual cash.

Why Sell Naked Puts?
We have already discussed the profit potential of selling naked puts, but there is another reason to do so – owning the stock. Selling naked puts is a good way to purchase at a specific price by choosing a strike near said target price. Should the stock price drop below the put strike and the puts are assigned, the trader buys the stock at the strike price minus the option premium received. Again, should the put not reach the strike price, the premium is pocketed at expiration.

February 15, 2010

WMT Put Spread

Filed under: Uncategorized — Tags: , , , — Dan Passarelli @ 1:38 pm

Implied volatility (IV) – simply put, it is the estimated future volatility of a security’s price. More often than not, IV increases during a bearish market and it decreases during a bullish market. This reasoning stems, in part, from the belief that a bearish market is more risky than a bullish market. It is a general trading principle that high IV is a signal to sell credit spreads and low IV is a signal to buy debit spreads. Let’s focus on selling a bear put spread during a time of high IV.

Selling put spreads during a period of high IV is a can be a wise strategy, as options are more expensive and you will receive a higher premium than if you sold the put spread during a time of high or average IV. Let’s look at the basic transaction first. Selling a put spread occurs when a trader sells a put option on an underlying, then at the same time buys a put on the same underlying at a lower strike price with the same expiration. Both sides of this contract are opening transactions and they always involve the same number of contracts.  The maximum loss for a put spread is limited to the difference between the strikes less the premium received for selling the put spread. What about the part we all want to know about, the maximum profit? The max profit is limited to the premium received for selling the spread. The break-even-point is the higher strike price less the premium received.

Let’s take a look at this example with a particular stock. In the current current environment, IV is high across the board. Let’s say a trader is farily bullish on Wal-Mart Stores (WMT). The trader decides to sell a put spread on WMT, which is trading around $53 in this example. To sell a put spread our trader might sell one put option contract at the 55 strike and buy one at the 52.50 strike. The short 55 put holds a price of $1.90, in this example, and the 52.50 is at 40 cents. The net premium received, therefore, is $1.50 ($1.90 less $.40). Using these price points, the trade would break even if the stock is below $53.50 ($55 – $1.50) at expiration. Therefore, the stock must rise, but only slightly to produce a winner.

February 4, 2010

COST Short Iron Condor

Filed under: Uncategorized — Tags: , , , , — Dan Passarelli @ 10:30 am

In last week’s edition of the Market Taker Edge newsletter, we took a look at a short iron condor on Costco Wholesale (COST) [Which is proving to be a nice little trade, BTW]. One of the rationales behind selling the March 50/52.50/60/62.50 iron condor was that COST’s implied volatility (implied volatility is – simply defined – the volatility component of an option price) were inflated to roughly 22% (meaning the implied volatility has pushed the option price higher) , which lifts the premium values for option sellers. In addition, the profitable range on the short iron condor is $51.90 to $60.60.

Before we delve any further into the trade, let’s take a look at the strategy. A short condor occurs when a trader combines a bear call spread and a bull put spread. The trade is executed by buying a lower-strike out-of-the-money put and selling an out-of-the-money put with a higher strike. Then the trader sells an out-of-the-money call with a higher strike and buys another out-of-the-money call with an even higher strike.

A short iron condor consists of four legs and results in a net credit received.  As for profit potential, the maximum potential profit is the initial credit received upon entering the trade. This profit will occur if the underlying stock price, on expiration date, is between the two middle (short) strikes. As noted before, the max potential profit for the COST trade would occur it the stock was trading between $52.50 and $60 by expiration.

One of the benefits of a short iron condor (and potentially options in general) is limited risk. For short condors, the maximum loss comes when the underlying stock price drops below the lowest strike or above the highest strike. If you want an equation for max loss, think of it as the difference in strike prices of the two lower-strike options (or the two higher-strike options) less the initial credit for entering the trade. In the case of COST, the max potential loss was limited to $1.90. Not bad, right?

Well, we now have to look at the stock and the aforementioned rationale to the trade. COST is a warehouse retailer, allowing customers to pay for membership and then purchase any of their daily needs (and sometimes wants) at a bulk discount. Retail has struggled thanks to the recession and all, but COST has traded in a range between $51.90 and $60.60 (the aforementioned profitable range on this trade) since September. With the market kicking sideways, expect COST to do the same – making this trade strategy ideal for the current market.

It’s best to take profits when able on this short iron condor, mainly because the company posts earnings on March 4. This date would be ideal to exit the trade by because this event has a chance of pushing the COST out of its range. Again, we suggested this trade in our newsletter, the Market Taker Edge, because COST has such a wide profit range and a potential return on risk of roughly 32%. The short iron condor is a logical way to play COST in this scenario.

(Try a one-month free trial of the Market Taker Edge on us http://markettaker.com/market_taker_edge/)

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