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May 8, 2014

Developing a Watch List

If you are a hockey fan you probably know that we are smack dab in the middle of the NHL playoffs. Teams are gathering information about their opponents and trying to gain the upper hand over them which ultimately could lead to a victory. Just like in option trading, a well though out and well kept watch list can help a trader in a variety of ways including scoring profits. First and foremost it can help keep track of the underlyings and keep them all in one place so it is easy to reference them. Potential trade opportunities are often discovered by scanning and searching charts and options from stocks that are on a watch list just like determining potential strengths and weaknesses of a hockey opponent. Here are a couple of ways a trader might go about building a watch list or creating a better one.

Familiar Ones

If a person is relatively new to trading there are probably a few stocks that he or she is familiar with. To gather more names to add to the list, a trader can scan through an index (like the S&P 500 for example) and find more stocks to potentially add to the list. Some of the stocks listed may not be conducive for a variety of reasons. It makes perfect sense to check out the symbols and see if the charts and the options are at acceptable levels for the trader’s personality and plan. Things a trader might want to consider when deciding whether to put a stock on his watch list are the stock price, the stock’s volatility, option prices, bid/ask spreads and option volume just to name a few. When this process is complete, a trader should have a decent watch list in which to work with. This list may grow and sometimes shrink over time depending on the trader.

Services

There are numerous trading services (free and paid) out there that not only might introduce traders to stocks to add to the watch list which may lead to potential trade opportunities. The Market Taker Live Advantage Group Coaching is one such service that MTM offers. As mentioned above, the reason a watch list is created in the first place is to find potential trades. A service can not only introduce traders to new symbols but also provide trade ideas that can turnout to be profitable. But if the trade concept is unclear or deviates from a trader’s plan regardless of the source, it should be avoided until the concept is understood. In any case, if the trader thinks there may be an opportunity on the stock in the future it can be added the list.

List Categories

Once a trader has a watch list of stocks, it may be prudent to separate the list into different categories. There can be a list for stocks that are ready to trade now or very soon. Keeping this list the shortest might make sense for a couple of reasons. First a trader should probably not be trading more stocks than he or she can handle and secondly if there are too many on this list, some trade ideas might get lost in the mix. A short list makes it easier to monitor potential trade opportunities. There can also be a category for stocks that have trade potential in the near future (a day to a week for example). This list can be monitored maybe a little less frequently than the previous list. Another category to consider for the watch list are stocks that have no potential now but may in the future. For example, maybe a stock is trading in the middle of a channel and if it ever trades down to support a bullish opportunity may arise. Stocks should be moved up and down in these different categories as needed.

What’s Important

These were just a few ideas about how a trader can go about developing and monitoring a watch list and searching for potential trade opportunities. The most important part about having a watch list is not how it was acquired but that there is one. A well-refined and updated watch list can yield plenty of potential money making opportunities in option trading. Go Black Hawks!

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

April 15, 2014

Ever Consider a Bear Put Spread?

The market has been on quite a run lower lately since the S&P 500 hit its all-time high earlier this month. Maybe the market will reverse and move higher at some point but traders need to be prepared like Boy Scouts just in case there is another move lower not only now, but for in the future as well. Options give traders a plethora of options so to speak for a trader with a bearish bias. Bearish directional option strategies are certainly an option but sometimes buying a put option can be a little bit more risky than maybe a trader wants because of potential price swings. A bearish option trader may want to be a little more cautious especially in this current volatile atmosphere.

An Alternative

A better alternative than the long put may be to buy a debit spread (bear put). A bear put spread involves buying a put option and selling a lower strike put option against it with the same expiration. The cost of buying the higher strike put option is somewhat offset by the premium received from the lower strike that was sold. The maximum gain on this spread is the difference in the strike prices minus the cost of the trade. The options trader will realize this maximum gain if the price of the stock is lower than the short put’s strike expiration. The most the options trader can lose is the cost of the spread. This maximum loss will occur if the stock is trading above the long put’s strike at expiration.

An Advantage

An advantage of a bear put spread is that if the stock pulls back, the spread will lose less than just being long puts because of the spread typically has smaller delta and initial costs due to being long and short options. The trade’s delta is smaller because the positive larger delta of the long put option is somewhat offset by the smaller negative delta of the short put option. For example, what if XYZ stock is trading at $40 a share and an option trader purchases an ATM put option ($40 strike) with a delta of 0.50. For every dollar XYZ goes up or down, the put option should increase or decrease by $0.50. If a bear put debit spread was created by adding a short put with a lower strike price of 35 and delta of 0.20, the delta for the spread would now be 0.30 (.50 – .20). Now the spread would gain or lose $0.30 for every dollar the stock went up or down.

Trade-Off

It is probably obvious to a great many of you how a smaller delta might be a disadvantage for the trade. If the trader is correct on the movement and the stock decreases in value, potentially a larger profit could be realized with just being long the put option because of the potential higher delta. But once again a trader needs to determine if a lower overall cost using the bear put and possibly a lower overall risk is worth the trade-off versus the long put.

Finally

Understanding current market conditions (especially now) and applying and managing the proper options strategy is crucial for success at all times. Deciding when to implement a bear put spread instead of buying puts for a bearish bias is just one example of this.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

June 13, 2013

Moving Averages, Volatility and the Man of Steel

We’ve identified a recurring pattern in the market that could end up being one of the best market predictors yet.

Take a look at a daily candle chart of the S&P 500 (or the SPY ETF) for the past 12 months overlaid with the 50-day moving average. As you can see, the index has been in a solid up trend for the past year. There were six pullbacks during just the last six months alone where the SPY pulled back down to the 50-day moving average and bounced higher to continue its assent. It has been a tried and true support line.

But as far as support lines go, moving averages are pretty weak in representing actual trade information—compared to a horizontal support line at a specific price. A horizontal support line shows where the buy orders have been in the past for value investors. For example, if a stock dipped down to $50 a share several times in the past, then rose back up, it shows that that level ($50 a share) is where the demand pressure is—value investors bought the stock at $50 which forced the price back higher.

But, moving average support lines are merely psychological. Because the line is not at a constant price, it doesn’t represent a price where demand occurs. Traders only buy it there because it is a moving average. It’s essentially a self-fulfilling prophecy.

In the case of the market today, one of two things can happen technically over the next few days. 1) Support at the 50-day moving average will hold once again and the SPY will continue higher, or 2) Support at the 50-day moving average will not hold and the SPY will continue lower.

But if the SPY ends up closing below the 50-day moving average, we could see a free fall similar to the eight-percent drop we saw in October of last year when the 50-day moving average did not hold.

This potential drop is compounded by the fact that we’re seeing the implied volatility of the S&P 500, or the VIX, illustrating investors’ jitters. The VIX above 18 says the market is scared. Even the Man of Steel himself (Ben Bernanke of course) won’t be able to keep the market up as he has thus far this year if the levy breaks.

So, we need to sit and wait. I think any move resulting in a close below the 50-day moving average warrants strong selling. But a bounce higher from here probably means more of the same. Up, up and away!

Dan Passarelli

CEO

Market Taker Mentoring