Options Trading Blog

Friday, August 16, 2019

Reduce Anxiety by Decreasing Risk

Tariffs, China, Hong Kong, Russia, Iran, inflation, central banks, recession, negative yields, inverted yield curve: All these terms have dominated headlines, and they incite anxiety for investors. Even agile short-term traders struggle in an environment where unvetted stories and half truths move markets. Rumors and threats in social media have had more impact on prices than the facts, such as economic data and earnings.

One thing we can do to navigate such volatile times and reduce anxiety is to adjust risk and profit projection to more realistic numbers. When projecting profit or defining risk, I often use a percentage of ATR (average true range) to set those levels. The benchmark time frames I prefer are 20 days, 9 weeks, 7 months and 5 quarters. But when volatility rises so sharply, I cut those numbers in half to get a more accurate reading of potential market movement. For example, if we use the standard 20-day ATR for S&P to set profit targets or risk, there is a good chance we will be stopped out or are taking profits too early. The S&P average day range has doubled in the past 2 weeks. Subsequently, my risk has doubled and so has profit potential.

Adapting to current market conditions is something all great traders do. Identifying when a market has reached overbought/oversold status is instrumental when looking to take profits or countertrade a move that has reached exhaustion. A market is thought to have moved too far, too fast when the day range is twice the norm. Another good indicator for defining overbought/oversold is when a range spans the length of an average week in just 48 hours.

To reduce anxiety, decrease risk and increase profit potential. To do that, stay current with volatility to use as a guide to set price targets.

John Seguin
Senior Futures Instructor
Market Mentor Mentoring, Inc.

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Thursday, August 1, 2019

Consider a Collar as an Investor

Although this last round of quarterly earnings is almost in the books, I feel the need to remind investors that options can provide protection even when earnings season is not going on. Let’s face it, the market is going to move lower like it did suddenly last Thursday, so it may be time to take a look again at a potential protection strategy using options.

A collar is an often-misunderstood but rather simple option strategy that can particularly benefit investors. A collar is having a stock position and buying a put option and selling a call option on the stock. Usually both the call and the put are out-of-the money (OTM) when establishing this option combination. One collar represents one long put and one short call along with 100 shares of the underlying stock. The main objective of a collar is to protect profits that have accrued from the shares of stock rather than increasing returns.

When to Use 

An investor will usually implement a collar after accruing unrealized profits from shares of stock. Since the market has been on such a highly unusual bullish run, it might be a good idea to consider them. By buying a put, the investor has some protection for the unrealized profits in case the stock declines. The other part of the combination is selling the OTM call. By doing this, the investor is prepared to sell his or her shares of stock if the call is exercised because the stock has moved above the call’s strike price.

Advantages

The advantage of a collar over just buying a protective put is being able to finance some or the entire put by selling the call. In essence, an investor buys downside stock protection for free or almost free. Until the investor exercises the put, sells the stock or has the call assigned, he or she will retain the stock.

Volatility and Time Decay

Implied volatility has been really low over the past several months in the market, but volatility and time decay are not usually big issues when it comes to collars. The main reason is because the investor is long one option and short another, so the effects of volatility and time decay will generally offset each other.

Here's an example:

An investor bought 100 shares of XYZ at the beginning of the year for $26 a share. Now the stock has climbed to $43 a share and has pulled back. The investor is worried about the current market conditions, and maybe a pending earnings announcement. He or she would like to protect the unrealized gains as year-end approaches. The investor can consider utilizing a collar.
 
The investor can buy an August 40 put for 2.00. If the stock falls, the investor will have the right to sell the shares for $40. At the same time the investor can sell an August 45 call for 2.50. This will make the trade a net credit of 0.50 (2.50 - 2). If the stock continues to rise, it can do so for another $2 until the stock will most likely be called away from him or her.

Three Possible Outcomes

The stock finishes over $45 at August expiration. If this scenario happens, another $2 per share is realized on the stock and $50 on the net credit of the combination is the investors to keep.
 
The stock finishes between $40 and $45 at August expiration. In this case, both options expire worthless. The stock is retained and the $50 net credit is the investors to keep.
 
The stock finishes below $40 at August expiration. The investor can sell the put option if he or she wishes to retain the stock or exercise the right to sell the stock at $40. Either way the $50 net credit is the investors to keep.

Conclusion

You have heard me talk about collars in this blog before and if you are an investor and have still not considered using them, why not? Like everything about options there are risk/reward tradeoffs. Selling a call limits the upside of the stock and I get it. But without a long put to cover your position, the damage done could be far worse than taking a smaller gain in the underlying.

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.

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Friday, July 26, 2019

Big News From the Fed This Week

The Federal Open Market Committee has a mandate to promote full employment and keep inflation in check. It raises interest rates when the economy is overheating, and it lowers rates to promote spending or increase economic activity. Lately, Fed Chair Jerome Powell has taken a dovish or more accommodative stance. Many economists expect a 25-basis point rate cut after Wednesday’s FOMC meeting concludes. This could be one of the most critical meetings in years.

Recent data from the labor department reported far more jobs were created than expected. Retail sales were much better than anticipated, and CPI (consumer price index) was a tad higher than consensus estimates. Also, this past Thursday’s durable goods report was far better than expected. This does not sound like an economy that is contracting; in fact it is quite the opposite. So, why should the Fed lower rates?

The committee must see something down the road that will put a drag on the U.S. economy. It widely thought that the tariffs will eventually have a big impact and slow spending to a trickle. Thus, if the Fed lowers the Fed Funds rate on Wednesday, it is being preemptive, which is not its directive. 

It is for this reason that Powell’s press conference (2:30 p.m. ET, July 31) may be groundbreaking. Not long ago, Powell hinted that the Fed would be data dependent and not make any policy changes until more data were available. Well, apparently that is not the case. A rate cut is expected, and I don’t think it is completely clear why. The Fed may have information that foretells a decline in economic activity soon. Let’s hope this will be clarified next week. I don’t believe the Fed has changed its mandate, but we may hear differently on Wednesday.

A rate cut of 25 bps is anticipated and should have no big impact on stocks or bonds. No move at all would indicate that the economy is in fine shape and more data are needed. In this case, stocks and bonds would likely fall.

In addition to the FOMC meeting, we also get the employment on Friday. Next week could set the tone for the rest of the year.

John Seguin
Senior Futures Instructor
Market Mentor Mentoring, Inc.

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Thursday, July 18, 2019

Support and Resistance on the 15-Minute Chart

If you know me even a little as a trader, you know how I feel about support and resistance when it comes to trading. I feel knowing that support and resistance has a better chance to keep the underlying advancing gives the trader a much-needed “edge.” As traders, we want to put the odds on our side as much as we can to be successful. Counting on support and resistance to hold is just one way to do it.

Many option traders swing trade, which means the expected length of time is anywhere from two to five days as a rough average. Clearly that is not a hard and fast rule with many trades lasting a lot less or more time. Because many option traders consider themselves swing traders, they pay no attention to smaller time frames like the 15-minute chart, which happens to be my favorite.

Take a look at the three charts below:

Each one is a 15-minute chart meaning that every candle represents a 15-minute time frame. Each one has very distinctive potential support (below where the underlying is) and potential resistance (above where the underlying is) levels. How could this not be beneficial for option traders? Whether you are looking for areas to manage the tradeoff of for targets or stop loss exits, or mapping out an area for a time spread, this smaller time frame could be just what you need!

Once again, this was just a quick but effective example on how I like to use a smaller time frame despite being a “swing trader.” Adding this to your technical analysis arsenal could really improve and help define your management.

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.

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Friday, July 5, 2019

A Helpful 'Cheat Sheet' for Average Ranges

Around holidays, especially in the summer, the participation rate often decreases, and subsequently so do volume and ranges. The typical seasonal lulls and end of each quarter are ideal times to do research and update statistics. I keep a spreadsheet with statistics covering average ranges over the most frequently analyzed time frames: day, week, month and quarter.

The spreadsheet (cheat sheet) helps me project how far a move is likely to extend once momentum (direction) has been determined. These vertical measurements can be used to define when a market is overbought/oversold. I frequently use a percentage of the average ranges to define risk and set profit objectives.

Generally, if the range over a 24-hour period spans 175% of an average day range, it constitutes an OB/OS signal. Or when the range over a 48-hour stretch extends the length of an average week, the pace is too great and thus favors a period of consolidation or sideways choppy trade. On the other hand, when the ranges over a few days are well below the norm, odds increase for a vertical move.

We use these stats often during the daily futures class. They can be used to time breakouts, as well indicate when a trend has run its course.

The spreadsheet below shows average true ranges in a few time frames for most commodities, some popular ETFs and Dow Jones 30 stocks. It can be a handy guide when creating strategy.

John Seguin
Senior Futures Instructor
Market Mentor Mentoring, Inc.

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Thursday, June 27, 2019

Go-To Strategies for Any Market

As you probably know, there are several option strategies available to option traders depending on what the trader thinks the market and underlying will do. Of course, there are market risk, implied volatility bid/ask spreads and other factors to take into account as well. But every option trader should have a few go-to strategies depending on the outlook. Here are a few to consider.

Bullish

If you are bullish on the market or underlying (let’s hope both), consider long calls, bull call spreads and bullish calendar or diagonal spreads.

Bearish

If you are leaning toward bearish and a move lower for the market or underlying, look at long puts, bear put spreads and bearish calendar or diagonal spreads.

Neutral

One of the benefits of using options is to be able to capitalize from a neutral outlook on the market or underlying. Certainly, that cannot be done with a long or short stock position. Here you can consider iron condors (and condors), butterflies (and iron butterflies), calendar spreads and vertical credit spreads. Investors can think about covered calls and cash-secured puts.

Non-Bullish

For this outlook, you might not be bearish, but you don’t think the market or underlying will move in a bullish manner. You can consider bear call spreads or time spreads like a put calendar or diagonal. In addition, investors might look at covered calls.

Non-Bearish

For this outlook, you might not be bullish, but you don’t think the market or underlying will move in a bearish manner. You can consider bull put spreads or time spreads like a call calendar or diagonal. Investors might use cash-secured puts effectively too.

By no means was this supposed to be a thorough breakdown of all the option strategies. But your trading plan should have at least one for every conceivable environment out there. It will go a long way toward your potential success if you do.

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.

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