Options Trading Blog posts page 2


Thursday, March 9, 2017

Timing as They Say is Everything!

There is an old saying that many floor traders have heard: “Never wrong, just early.” It means if you are in a losing trade, hold on to it for days or weeks until it becomes profitable. 

Obviously, this is a dreadful approach to trading. Timing is a fickle thing and very difficult to quantify.  Markets trend or consolidate, move or coil, rest or run.  Either way you look at it, catching a trend early requires good timing.

My search for an answer began with 2 questions. Is the market ripe to run?  Has the market established a fair value area?  Markets tend to develop overlapping fair value areas over consecutive days before the onset of a trend. 

The 30-minute bar chart includes daily value areas for S&P futures from early to mid-February.  A value area is a Market Profile term and it covers a standard deviation of volume around the mean or high volume price.  It is deemed a fair area where buyers and seller agree on price most often.  In this example the value areas cover regular trading hours and are color coded to distinguish days of the week.    

The large green rectangle encapsulates 4 days of severely overlapping value areas.  Such periods of consolidation over 3 or 4 sessions frequently precede large vertical moves.  In this case the trend higher resumed after a respite.

So, for timing breakouts search markets that have below average day ranges that overlap over a few sessions.  When a market violates the top or bottom of a 3-4 day value area, volume tends to rise and a trend often ensues.

John Seguin

Senior Futures Instructor

Market Taker Mentoring Inc.

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Tuesday, February 28, 2017

A Couple Thoughts on Short-Term Credit Spreads

There are several ways for an option trader to approach selling credit spreads. But probably two of the most common, are comparing a shorter expiration to a longer expiration. In today’s blog, we will specifically focus on selling credit spreads that expire in about a week or less; essentially using weekly expirations.

Quickly let’s recap the two vertical credit spreads. The vertical call credit spread (bear call) is selling a call option and buying a higher strike call with the same expiration. The option trader believes the underlying will stay at or below the short strike by expiration for maximum profit. The vertical put credit spread (bull put) is selling a put option and buying a lower strike put with the same expiration. The option trader believes the underlying will stay at or above the short strike by expiration for maximum profit.

The goal of a credit spread is to sell premium and then be able to buy back the spread for less than it was sold or to have the options expire worthless to profit. In essence, there are two ways that this can be accomplished. One is from option delta and the other is from option theta. One or both of these option greeks can lead to profits. Delta on the other hand can also lead to losses.

Option traders that are familiar with theta will probably know that positive theta is higher for shorter expirations. In addition, theta is highest at-the-money (ATM) which means that if the underlying is staying above the short put or below the short call, the short option decreases faster than the long option which is beneficial for the spread’s decrease in value.

Delta and specifically how option gamma changes delta, is where many option traders become a little less clear when it comes to vertical credit spreads. When a credit spread is sold and the underlying is trading out-of-the-money (OTM), the spread’s delta will either be positive or negative. It will have a positive delta for put credit spreads and be a negative delta for call credit spreads. This means that the spreads value will decrease if the underlying moves in the direction of the delta which can lead to a profit.

Now here is where it sometimes gets a little tricky. I like to say that “gamma is never your friend when it comes to OTM credit spreads”. The reason is simple. When the underlying moves with delta, the spread’s premium decreases but so does the delta. This means that if the underlying continues to move in the favorable direction, delta will get smaller which means the premium will decrease at a slower rate. If the underlying moves towards the options, not only will delta increase the spread’s premium, it will also cause delta to accelerate which means the premium will continue to grow at a faster rate if the underlying continues to move in that direction. As expiration approaches, gamma becomes even a bigger potential threat to your spread because gamma is bigger leading to potential bigger delta swings.

Take a look at the recent option chain below of Apple Inc. (AAPL).

Let’s pretend an option trader believes AAPL will stay above $136 before expiration in less than four days. The trader sells the 136-strike put and buys the 134-strike put. This spread produces a credit of $0.30 which is the maximum profit if the puts expire worthless at expiration (at $136 or higher). The current delta (which is rounded for simplicity) is +0.21 (0.32 – 0.11). This means the spread’s premium will decrease by $0.21 if the stock moves $1 higher. Positive delta and a positive move in the underlying leads to a decrease in te spread’s premium.

But what is stock moved against the position? In this case that means lower. Not only would the spreads value increase by $0.21 due to delta (we are not including theta or option vega into this equation), the new delta would increase to +0.29 (0.21 + (0.15 – 0.07)) due to the difference between the long and short strikes. Now if the stock continued to fall another $1, the spread’s premium would increase $0.29 based on delta alone. As mentioned above, the closer to expiration, the more dramatic the increases or decreases may take place. Certainly this is something to consider for weekly or near-term credit spreads and for credit spreads that are heading closer to expiration.

There are so many potential advantages to selling credit spreads with short expirations that were not discussed or not discussed with much detail like theta. But many option traders that do not understand how delta and gamma can alter a vertical credit spread, need to really explore this matter in greater detail. For premium sellers, it is practically mandatory!

John Kmiecik

Senior Options Instructor

Market Taker Mentoring Inc.

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Thursday, February 23, 2017

Setting Up Targets on Your Option Trades

If you know me and I think many of you do, you know how I feel about trade management. To me it is the most important aspect of trading. And if you think about it yourself, it probably should be one of the most important aspects in your trading as well. This is not going to be a big lecture on a trading plan or removing emotions from trading although it does fit into that realm, but more of a simple technique that should become a habit for you and most likely improve your results. There will be plenty of other blogs on trading plans and emotions again in the future…promise!

One of the things I do after entering any position is to set an exit for profit and usually for a loss as well. What this does for me, is to remove some of the emotions of trading. Instead of guessing when to exit a position for profit or loss and letting the emotions that come with trading factor into my decision, I have a pre-destined exit to do that for me.

Let’s look at an example. A trader is looking at the chart of Apple Inc. (AAPL) and he notices a bullish pattern setting up. At the time, the stock closed above a resistance level at around $134. The trader can choose to implement a vertical debit spread, in this case a bull call spread. The trader decides to buy the March expiration 130/135 call vertical. For simplicity sake, let’s say The March 130 call costs 5.00 and the March 135 call produces a credit of 1.50. The total cost of the spread is $3.50 (5 – 1.50) and that is the total risk and the maximum loss potential. The maximum profit potential is $1.50 (5 – 3.50) which is the difference between the bought and sold strikes minus the cost of the spread.

The trader decides that a $0.75 profit or 50% of the potential maximum profit seems to be a good target. In this case, he could use a sell limit of $4.25 to exit the position. This means the spread will be sold for $4.25 or better (130 call is sold and the 135 call is bought) if the value increases to that amount or above. In addition to removing emotions, the position will not have to be monitored maybe as closely as a trade without an exit order.

If the trader wanted to include a stop loss at the same time, he could do that with an OCO (one cancels other) order. This means when one order is filled, it automatically cancels the other standing order. Since the trader is trying to profit $0.75, he might deem it worthwhile to risk the same amount. In this case, he could add a stop loss $0.75 below the purchase price or at $2.75 (3.50 – 0.75). A market order to sell the spread will trigger if the spread drops down to or below the $2.75 level.  

Having a buy or sell limit order in place once a trade has been implemented can do wonders for your trading. Not only can it remove emotions from trading, it can also take profits and remove risk without you even watching your account.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring Inc.

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Thursday, February 16, 2017

Who is Controlling Momentum?

Probably the most common questions from traders pertain to order flow.  Who is controlling momentum?  Which direction is the market likely to go?  On the trading floor, we had the luxury of watching order flow in real time.  We could put a name on a trade.  In other words, we often knew who was buying and selling and how much.  Institutional traders, banks and fund managers are more long-term oriented and not as sensitive to short-term swings.  Momentum becomes apparent when they enter the market as a group.  If they bid or try to buy, higher prices follow.  On the other hand, if they offer or try to sell, markets go down. This valuable information is no longer available since nearly all trading is done electronically. 

However, when these longer-term, market moving traders enter the market they leave clues.  They tend to be active around opens and closes.  Volume is often highest early and late in the day.  This means the markets are liquid enough for traders to execute large orders.

Candlesticks are a popular technical tool used to determine momentum.   Simply, if a day closes above the opening price it is considered bullish and if a market settles below the open it is deemed bearish.

Another clue regarding momentum comes from the Market Profile school of thought.  Highs made in the first hour of regular trading hours often lead to lower prices the next session.  And higher prices are common the next session if the low is made in the first hour of the day. 

One of the most logical and reliable signals for reading short-term momentum depends on where a market closes in relation to the fairest price that day.  A close above the high volume price indicates bulls are in command and the market will likely probe higher in search of sellers.  Conversely, a settle under the fair price suggests sellers have momentum in their favor.  Thus, the market is apt to probe lower the entice buyers.

When setting up a trade we frequently need to make an assumption regarding direction.  If you see a first hour low and settle above the high volume price, odds favor rising prices during the next session.  On the other hand, if you see first hour high and a close below the fairest price, lower levels are apt to follow.

The recent price action in the equity indexes illustrates how positive short-term momentum reads led to continuation higher.

The S&P chart above shows the last 6 days using 30 minute bars.  The yellow rectangles highlight the first hour of regular trading hours.  The colored boxes cover daily value areas.  Note that during the rally the lows were made in the first hour and the closes were either at or above the fairest prices of the day. 

Although it is now more difficult to gauge order flow than it used to be, there are still plenty of clues traders can find. You just simply need to know where to look.

John Seguin

Senior Futures Instructor

Market Taker Mentoring Inc.

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Wednesday, February 8, 2017

What is Fair Value and How Does Volume Play a Part?

Over the past 30 years, 20 of which were on the trading floors of the CBOT and CME, I have been a broker, analyst and educator for many types of traders.  Whether they were speculators, hedgers or fund managers they were asking similar questions.  Where is fair value or where has most of the volume traded?  Are bulls or bears in control of momentum?  What is a good price to buy or sell?  Is the timing right for a trend?  What is the risk once in a trade?  What is the profit potential?  How do I protect my profit?  Markets are in constant flux, so it is imperative to have methods to answer and react quickly to the questions traders ask.  In these first few articles I will focus on such inquiries.  

In order to address the most common questions I created an acronym called V.E.R.T.E.X.  I refer to it when creating strategies or writing daily commodity market updates.  The V stands for Value, E is for Energy or Momentum, R means Risk, T is for Timing, E is for Entry and X is for eXit.

In this article, I will focus on ‘V’, defining the Value area and high volume price.  The high volume price is simply that price which buyers and sellers agree upon most often.  Time at this price allows volume to accumulate.  Therefore, we can use time as a proxy to measure volume (Price + Time = Value).  Many data providers and platforms show actual volume at price but for our purposes time will suffice.

Market Profile has been my technical tool of choice since the mid 80’s.  It displays the required dimensions to implement a logical approach to trading.  Most charts have price bars that are parallel to each other.  This tool tracks time at price using 30 minute periods.  Each period is assigned a letter and when stacked on top of each other a bell curve or profile forms (see fig. 1 and 2). 

 This structure allows the user to determine fair value.  The high volume price, also known as the ‘point of control’ is shown in fig 3.  It is that price that has traded in more 30 minute periods than any other.  From that point of control, we can construct a fair value area which is one standard deviation of volume around that mean.  It covers roughly 70% of the volume around that high volume price.  Generally, any price that has 4-5 letters in the day profile holds value.  Why is value important?


High volume prices and value areas help us determine momentum.  Momentum is defined as the movement away from a fair price.  In addition, value areas are useful when defining risk.  The top of the value area defines risk when prices are declining and the bottom of value defines risk when prices are rising. 

In the next issue we will focus on reading momentum.

John Seguin

Senior Futures Instructor

Market Taker Mentoring Inc.

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Thursday, February 2, 2017

Picking Your Favorite Stocks for Options

We all have favorites. Favorite foods, favorite places to go and sometimes even favorite family members. You might laugh when I mention family members but let’s be honest, most of us have family we like to avoid and others we look forward to hanging around. The same can be absolutely true for option traders when picking stocks or ETF’s that they want to trade and also want to avoid.

There is no specific way to form a favorite stock list and to be honest with you, you might have one already and you did not even realize it. This was certainly true for myself. Before I realized which stocks I really loved, I realized there were a few stocks I should probably avoid. I know we talked about getting some “revenge” when it comes to certain stocks. You might have lost money on a trade and you wanted to get even so you put on another option trade on with that stock and most likely lost again. To me that was a good reason to stay away. Additionally, you might have run into some bad luck trading options on a particular stock that had nothing to do with revenge. For me, that is a good enough reason to leave those stocks alone and avoid trading them. Two I can name off the top of my head would be Starbucks Corp. (SBUX) and Facebook Inc. (FB).

As mentioned above, sometimes traders do not even know they have favorites until they look at their trading journal. Either they have traded them often in a particular span of time or they notice that every time they traded a particular stock, they had success. Once you have identified those stocks that are deemed your favorites, make a list. Every morning before I start searching for opportunities, I look at my favorite’s list first before I run scans or start searching in other places looking for opportunities based on technical analysis.

I have a list of about 15 stocks that I trade on a regular basis. The list includes Apple Inc. (AAPL), Alphabet Inc. (GOOGL), Amazon Inc. (AMZN) and Netflix Inc. (NFLX) just to name a few. Not only have I been successful trading these stocks in the past on a regular basis, I also like their charts, strike prices and bid/ask spreads because they fit my criteria according to my options trading plan. To me, these elements are just as important as being profitable trading these stocks in the past. I like to estimate that about 75% of all my option trades are within those 15 favorite stocks.

Like it or not, we all have favorites. This is probably true of the stocks you like to trade as well. Consider compiling a list of stocks that you feel comfortable trading, that fit your criteria and you have had some success with. Sticking to what you know and are comfortable with, can go a long way in your options trading career!

John Kmiecik

Senior Options Instructor

Market Taker Mentoring Inc.

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