Options Trading Blog posts page 2


Thursday, May 11, 2017

Overbought and Oversold

The goal for most traders is to catch a trend early and ride it to the end. To accomplish that requires incredible timing on both entry and exit. This article will focus on recognizing when a market has moved too far too fast and is therefore likely to stall out or reverse direction.

Markets often telegraph an end of a trend by simply going through a period consolidation. Markets were created to facilitate trade. When a market moves in a direction and the day ranges and volume decrease, it is not facilitating trade. Subsequently, a reversal often occurs.

Another type of reversal comes when a market is over extended. This is commonly known as overbought or oversold. Many analysts use technical indicators to track the speed of a move, the most popular are RSI and Stochastics. When either of these indicators get above 80, a market is thought to be overbought.  On the other hand, a reading below 20 signals an oversold situation. One problem with these indicators is that a market may hang around that 20 or 80 level for weeks. This makes timing a reversal difficult.

A trader can become more skilled at picking tops and bottoms by becoming familiar with market dimensions, mainly average ranges over a few time frames. If we track benchmarks regarding range we can define when odds have shifted to favor an end or reversal of trend.

For example, if a day range spans more than 150% of the average in a 24-hour period, it is considered overdone, thus odds favor a rest period or reversal. Currently, an average day range for S&P futures is 16 points. If the range during a day session extends 24 points, probability favors a reversal. Such large ranges during a trend are often called exhaustion moves.

In the crude oil chart below there is a bracket that spans the length of an average week. For a longer-term barometer refer to the average week range. In this example, oil surpassed an average week range in a 48-hour period.  Generally, if a market moves the length of an average week in just 2 days, it is considered overdone and due for a reversal or period of consolidation.

 When riding a trade, it is difficult to time when and where to take profit. A severely overbought/oversold signal can help with picking off extreme high and lows for both entry and exit trades.

John Seguin 

Senior Futures Instructor

Market Taker Mentoring

Wednesday, May 3, 2017

Calendars Held Over Earnings

Continuing on from a couple of weeks ago when we talked about an option strategy that pertains to earnings, here is another strategy option traders can consider. In this blog, we will talk about a trade that can profit when held over the announcement. Although many option traders will naturally steer away from earnings because of the volatile nature which is usually not a bad thing, the risk/reward of this option spread can be very tempting. The strategy is a long calendar and it is pretty simple to implement. First let’s take a look at what a calendar is below.

A long calendar is selling an option and buying a longer-term option with the same strike. Generally, all calls or all puts are used. A calendar is a time spread because it benefits from the passing of time. The short option will have a bigger positive theta than the long option which will have a smaller negative theta. The maximum profit is realized if the stock closes right at the strike price of the short expiration. That option expires worthless and the long at-the-money (ATM) option will have time premium left. The max profit and the break evens are all hypothetical because there are two different expirations. Using the P&L (profit and loss) diagrams that your broker probably provides, is the best way to estimate them.

The key component that can enhance potential profits is an implied volatility skew. An option trader prefers to sell higher IV and buy lower IV. For the long calendar, a higher IV is naturally preferred on the short option with a lower IV compared to the short strike on the long farther out expiring option. Many times, this can be difficult to find and we talk about this scenario all the time in Group Coaching. But when there is an earnings report that is scheduled to be released, the IV for the options that expire closest to the report will have a higher IV than expirations that take place even further out. In essence, it is a perfect opportunity for an IV skew!

Let’s take a look at a recent example. Advanced Micro Devices (AMD) that was scheduled to release its earnings on a recent Monday after the close. Calendars can be used for neutral and directional outlooks. Remember an option trader wants to set-up the calendar where he thinks the stock will be trading at the short expiration. Let’s assume a neutral forecast was expected after the announcement. Taking a look at the chart below, A trader can sell the 13.5 strike for Friday’s expiration and buy the same strike for the following expiration. Note that the short expiration has an IV over 107% and the long expiration is just below 77%. That means he or she would be selling more expensive premium than he or she would be buying.

Of course, the stock needs to cooperate and in this case, not move much after the announcement. The IV for the short and long options should drop after the announcement and that is where the option trader realizes his or her potential profit. The short option should decrease more than the long option percentage-wise which should increase the value of the spread if the underlying trades relatively close to the short strikes the next day. Although maximum profit is potentially earned at the short expiration, with an earnings calendar, it may be worth exiting some if not all of the position the morning after the announcement.

Long calendars held over earnings can be relatively low risk high reward trades. Like most trading, there is always an element of luck involved. You want the stock to move or stay near your strikes and you just don’t know exactly what will happen despite having a P&L diagram. As I like to say about earnings calendars, sometimes I am surprised I made money and sometimes I am surprised I lost money. Good luck!

John Kmiecik

Senior Options Instructor

MarketTaker Mentoring Inc.

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Wednesday, April 26, 2017

Different Risk/Reward Scenarios

If you have heard me before, you have often heard me say that options have so many moving parts. There are so many more areas to learn and understand than there is for say just trading stocks. As an option trader, you have so many different strategies and risk/reward scenarios to think about before initializing a trade. Many of my students in my Group Coaching class as well as my one-on-one students ask me all the time how do you decide between buying a debit spread and selling a credit spread as one example. Let's take a look at a scenario below and some things for an option trader to think about.

Risk and Reward

A debit spread such as a bull call spread or a bear put spread is considered to have a better risk/reward ratio then a credit spread such as a bull put spread or a bear call spread depending on how it is initiated. Usually the reason is because the debit spread is implemented close to where the stock is currently trading with an expected move higher or lower. A credit spread is usually initiated out-of-the-money (OTM) in anticipation the spread will expire worthless or close to worthless with the underlying barely moving. Let's look at a theoretical example using ABC Corp. (ABC). Let's say the stock is currently trading at $187.50. The stock looked like it could drop lower. The trader could consider buying a bear put or selling a bear call spread.

If the option trader expected a move lower into the close of Friday, he or she could have considered buying a 185/187.5 debit spread for December expiration (let's say 4 days from now). If the 187.5 put cost the trader 2.25 and 1.15 was received for selling the 185 put, the bear put (debit) spread would cost the trader $1.10 (also the maximum loss if the stock is at $187.50 or higher at expiration) and have a maximum profit of $1.40 (2.50 (strike difference) – 1.10 (cost)) if the stock was trading at or below $185 at expiration. Thus the risk/reward ratio would be 1/1.27.

If the option trader was unsure if the $187.50 stock was going to move lower but felt the stock would at least stay below a resistance area around $190 by December (4 days from now) expiration, the trader could sell a 190/192.5 credit spread with December expiration. If a credit of 1.00 was received for selling the 190 call and it cost the trader 0.50 to buy the 192.5, a net credit would be received of $0.50 for selling the bear call (credit) spread. The maximum gain for the spread is $0.50 if the stock is trading at $190 or lower at expiration and the maximum loss is $2 (2.50 (strike difference) – 0.50 (premium received)) if the stock is trading at or above $192.50 at expiration. Thus the risk reward ratio would be 4/1.


The risk/reward ratio on the credit spread (4/1) does not sound like something an option trader would strive for does it? Think of it this way though, the probability of the credit spread profiting are substantially better than the debit spread. The debit spread most certainly needs the stock to move lower at some point to profit. If the stock stays around $187.50 or moves higher, the puts will expire worthless and a loss is incurred from the initial debit ($1.10).

With the credit spread, the stock can effectively do three things and it would still be able to profit. The stock can move below $187.50, trade sideways and even rise to just below breakeven at $190.50 (190 (sold call) + 0.50 (initial credit)) at expiration and the credit spread would profit. Of course if it closes at $190 or lower, the maximum profit of $0.50 is achieved because the spread expires worthless. A loss is only realized if the stock closes above the breakeven level of $190.50. I like to say OTM credit spreads have three out of four ways of making money and debit spreads usually have one way of profiting especially if the underlying is basically around the long option when the spread is initialized.


There are several more factors to consider when choosing between a debit spread and a credit spread like time until expiration, implied volatility and bid/ask spreads just to mention a few. We will talk about these other factors in future blogs. The risk/reward of the spread and the probability of the trade profiting are just a few to consider mentioned above. A trader always wants to put the odds on his or her side to increase the chances of extracting money from the market. The credit spread can put the odds substantially on the trader's side but it comes at a cost of a higher risk/reward ratio.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

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Thursday, April 20, 2017

Market Reversals

Fundamentals trump technicals. Economic and supply and demand reports often alter sentiment and are frequently responsible for changing trends or extending them. When there is no data to affect a market, many traders rely on technical signals to interpret momentum, pinpoint entry /exits levels and define risk.

In this issue, we will focus on market turns and how to spot when reversals are likely. During rallies, markets tend to make lows very early in the day and highs are often seen late in the session. During declining trends, highs tend to be made early and lows late in the day. So, when this type of price action ceases, anticipate a pause in trend or possibly the end of one.

Markets tend to consolidate before reversals and there are subtle changes that often telegraph change. The most liquid times of the trading day are during the first hour and last hour. It is during these times that big ticket orders are often executed, in order to be discrete.

In the Japanese Yen chart below the first hour of regular trading hours is highlighted in a yellow rectangle.  Note that during the rally, lows were made very early in the day session.  Also, note when the market turned down highs were made in the first hour of the session.  

When markets are ready to turn they frequently leave clues.  A high or low made during the most volatile time of the day is often a subtle change, a change nonetheless.


John Seguin

Senior Options Instructor

Market Taker Mentoring


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Wednesday, April 12, 2017

Earnings are Coming!

The market has been relatively quiet over the last several weeks. Occasionally there has been some volatile days mixed in but as a whole, there has not been much volatility. Sooner or later, volatility will reenter the picture and the upcoming earnings season might just give the market a nudge. Although there is no official start to quarterly earnings, Alcoa Inc. (AA) which is expected to announce on April 24th is widely regarded as the start.

There are plenty of option strategies for option traders to consider where the position is meant to be held over the announcement and we will talk about in futures blogs. But there is also a strategy to consider that is meant to be closed out prior to the announcement that most option traders are familiar with. It is buying a straddle or strange ahead of earnings. Let’s take a look below what a straddle and strangle is if you are no familiar with them.

Keeping it fairly simple, a straddle and strangle is buying both a call and put with the same expiration on the same underlying. A straddle is buying the same strike call and put and a strangle is buying to different strikes. Naturally the position is a debit to your account since both a call and put are purchased. There are two ways in which to profit. Either from delta or vega or both.

Since both a call and put are purchased, it is beneficial for the stock to move distinctly in one direction. Then you will have either positive or negative delta and the trade will benefit from a continued move in the direction of the delta. Up and down action is not beneficial usually. Vega effects option premium based on the implied volatility. Options increase in price when IV rises and vice versa. Since the position is long a call and put, it is beneficial for IV to increase.

What hurts the position is vega sometimes and theta always. A decrease in the IV level would decrease the premium by the amount of vega. And since options are a decaying asset, time passing will always decrease the premium by the theta amount.

A straddle and strangle is implemented when there is an expected move in the underlying and the direction is unknown. In addition, IV is expected to increase. Earnings may be a perfect time to consider this option strategy but there are a few things to consider.

The plan for buying a straddle or strangle based on earnings is to put the position on ahead of earnings and exit the position (hopefully for a profit) before the actual announcement. Of course, the position can be held over the announcement, but a big move is probably needed to profit because the IV will drop and so will the option premium after the announcement.

Although past performance is not indicative of future behavior, it might be beneficial to look at a stock’s previous earnings to gauge if it may be a good candidate. The goal is for the stock to move decisively before the actual announcement. Consider buying the position anywhere from about a month to about a week prior to the announcement. Remember time decay (theta) is a concern so be sure to allow enough time and maybe not just pick the expiration that takes place right after the expected announcement.

What usually benefits this pre-earnings position is vega. Since IV generally rises as the earnings date nears, option premiums should rise as well minus any time decay. If the stock moves decidedly higher or lower after the position is put on and IV increases, it is a win-win for the position. Consider managing the position for profit based on an expected return like a certain percentage. Consider managing the position on the stop loss side of things based on two criteria. An exit at a certain point (like before the announcement) and/or a certain percentage of risk just like for profit.

A straddle and a strangle can be very effective option positions. Using them ahead of an earnings announcement may greatly increase your chances for success if the guidelines above are considered. In future blogs, we will go through an example of this option strategy.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring Inc.

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Thursday, March 30, 2017

Delta Can Still be Your Friend

As I have said many times in the past, delta is probably the first greek option traders learn after mastering the basics of call and puts. Of course as an option trader advances, he or she also learns the importance of theta, gamma and vega. When an option trader gets to the level of understanding the other greeks, sometimes the importance of delta and direction is forgotten. Let’s take a look at a trade idea we initially talked about a couple of weeks ago in Group Coaching. The trade was meant to profit from theta but delta did the heavy lifting.

When the SPDR S&P 500 ETF (SPY) was trading in the $237 to $238 area a couple of weeks ago, a trader asked me if I knew of a low risk with a potential high reward strategy that he could implement if he thought the market was going to drop at some point over the next month. So in class, we took a look at a long directional put butterfly. Before we go further, let’s take a look at a directional butterfly spread.

The long butterfly spread involves selling two options at one strike and the purchasing options above and below equidistant from the sold strikes. This is usually implemented with all calls or all puts. The long options are considered to be the wings and the short options are the body of the butterfly.

What some option traders don’t realize is that butterfly spreads can be used directionally by moving the body (short options) of the butterfly out-of-the-money and using wide strike prices for the wings (long options). This lets the trader make a directional forecast on the stock with a fairly large profit zone depending on the size of the wings. In this case, the forecast was for a move lower so a long put butterfly makes sense.

Of course, theta is crucial to make this trade work. If the stock closes at (where max profit is earned) or close to the short strikes at expiration, theta (which is highest ATM) increases the spreads premium up until expiration. But what many option traders neglect when it comes to directional butterflies is the possibility of profiting from delta. When a butterfly is configured OTM, there will generally be a delta greater or less than zero.

We talked about implementing a long 225/230/235 (long the 225, short 2 230’s and long the 235 puts) put butterfly for April monthly expiration. The $230 area was chosen as the body of the butterfly because it acted as previous resistance (target). The cost of the spread and the total risk was 0.50 (or $50 in real terms) which means the max profit would be $450 (5 – 0.50) X 100 if the ETF closed right at $230 at expiration.

The original delta of the spread was -0.11 which means for every dollar the SPY dropped, the spread should increase by 0.11 ($11) based on the delta alone. At the time theta was essentially zero. This past Monday, the SPY dropped over $4 from when the trade was initiated and was trading at $233.75 close to the end of the day. The bid price on the spread increased to 0.95. That means the spread could have been sold for a 0.45 (0.95 – 0.50) profit or $45 in real terms with still 26 days until expiration. In fact, since the drop, the negative delta increased to -0.16 because of gamma. The profit was made almost entirely from a correct move lower and a negative delta as theta was barely positive (just over a penny) and contributed next to nothing to the profit.

Theta is a huge component when profits and a long butterfly are discussed. That there is no doubt. A big advantage of a directional butterfly spread is that it can be a relatively low risk and have a potential high reward depending on how the spread is designed. And as we have seen, an OTM butterfly gives an option trader an opportunity to profit because of delta based on a correct directional forecast even if theta has not joined the profit party as of yet because of too much time left until expiration.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring Inc.

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