Options Trading Blog

Friday, September 14, 2018

Using ETFs for Leverage

Stock prices for the highest rated companies are frequently too rich for retail investors. Trading futures can be expensive as well. Many choose to trade options on stocks and futures to keep costs down. Another alternative to trading or investing in blue chip companies is to turn to sector ETFs. There are ETFs that correlate closely to price action in commodities, such as USO and WTI Crude Oil, GLD and Gold, TLT and Treasury Bonds.

The list below shows some of the most popular ETFs and the companies that make up the largest percentage of holdings in that ETF. When these blue chip stocks move, the correlating ETF develops a similar pattern, usually at a reduced price.

The 2 charts below show monthly profiles of Amazon and XLY. Each week of the month is color coded, which helps us to recognize patterns and correlations. Note that the lows have been made in the first week (purple) of each month since April. The highs of the month are made at similar times (colors) as well. In each chart the high-volume or fair price increases at about the same pace. Also, monthly closes tend to be at or above the high-volume price, which is a sign that buyers are in control of momentum.

So, instead of paying $2000 per share of Amazon, you can ride the trend using XLY at $117.

ETFs allow us to ride trends in many AAA rated companies, often for much less money and more leverage.

John Seguin
Senior Futures Instructor
Market Taker Mentoring, Inc.

Leave a comment

Thursday, September 6, 2018

A Couple of Things About Gamma

A few weeks ago, I wrote that I was going to discuss the greeks and some key items I have learned about that I thought would help you as well. We started with delta, and today we will continue with gamma.

Gamma is the rate of change of delta based on the underlying. Keeping it simple, for every $1 the underlying moves, delta should change by the amount of gamma. Long options, both calls and puts, have positive gammas. Short options, both calls and puts, have negative gammas. But what does positive and negative gamma mean?

Positive gamma helps your delta both ways. In other words, if you have a position with positive delta and positive gamma and the underlying moves higher, the positive delta will increase and the gains will become incrementally larger. If the underlying moves lower under the same circumstances, the positive delta will decrease so the losses become incrementally smaller based on delta.

Negative gamma, in turn, hurts you both ways. If you have a position with positive delta but negative gamma and the underlying moves higher, the positive delta will decrease and the gains will become incrementally smaller. If the underlying moves lower under the same circumstances, the positive delta will increase so the losses become incrementally larger based on delta.

As with delta, if you have on more than one position at a time for the same strategy, you need to total up the gammas. If your positive gamma total is bigger than your negative gamma, delta will benefit from either a move higher or lower whether it is a debit or credit spread. If your negative gamma total is bigger than your positive gamma, delta will not benefit. Again, pretty simple and easy to remember.

Gamma tends to be one of those greeks that confuses option traders the most. If you remember these few facts about gamma, it can really improve your understanding of the greeks. Next time, we will cover a few points on theta.

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.

Leave a comment

Friday, August 31, 2018

Top Picking and Bottom Fishing All About Timing

Growing up in Chicago had plenty of perks: a beautiful skyline and parks, plus great food, entertainment and sports. But for the harsh winters, it is my kinda town. After college I had the opportunity to work at the futures exchanges, Chicago Board of Trade and Chicago Mercantile Exchange.

My first experience on a trading floor was horrifying and exhilarating. In my eyes it was total chaos with people in crazy colored coats running amok, while brokers and traders shouted with flailing arms in different arenas. The spheres of trading activity, also known as pits, were in seemingly constant motion from open to close. After that first day I was hooked, and the next 20 years were filled with many incredible lessons.

Over the years one thing I learned about short-term or day traders is that they are a defiant bunch. When prices fell they endeavored to pick the bottom or lowest price of the move. And when prices rose they looked to sell the high or top of the rally.

Top and bottom picking require incredible timing. But before markets get exhausted either up or down there is a pattern in price action that tends to precede change in direction. When a market moves methodically the trend tends to extend. A methodical move is when the day ranges are near average length during a rally or decline. A 20-day ATR (Average True Range) is my preferred benchmark.   

Often before a rally ends there is panic buying, which brings on an overbought signal. Conversely, an oversold signal frequently kicks in prior to the bottom of a trend.

If a day range is twice the norm during a rally, it is considered overbought. Thus, the odds for a reversal increase and top pickers emerge. On the other hand, when a day range spans two times the average during a decline a pace problem appears signaling an oversold situation. When this occurs, bottom fishers often surface.

Overbought and oversold situations are common just before extremes are made. Measuring the speed of a trend is an integral part in a trader’s tool box. There are many technical indicators meant to help traders top pick and bottom fish. Some of the more popular are RSIs, Stochastics and MACD.

John Seguin
Senior Futures Instructor
Market Taker Mentoring, Inc.

Leave a comment

Friday, August 24, 2018

A Couple of Things About Delta

Over the next few weeks, I am going to talk about a few points that have helped me learn the greeks and have benefitted my trading throughout the years. For me, once I understood and comprehended these points, option trading was a little simpler to understand. Let’s start with delta.

If you don’t know by now, delta is the rate of change of an option based on the underlying. To keep it simple, for every $1 the underlying moves, the option premium should change by the amount of delta. Essentially there are only four things you can do with options: buy a call, sell a call, buy a put or sell a put. Long calls and short puts have positive deltas and can benefit from a move higher in the underlying. Short calls and long puts have negative deltas and can benefit from a move lower in the underlying.

If you have on more than one position at a time for the same strategy, you need to total up the deltas. If your positive delta total is bigger than your negative delta, a move higher will benefit the position whether it is a debit or credit spread. If your negative delta total is bigger than your positive delta, a move lower will benefit the position. Simple and easy to remember.

The other thing that has helped me and many traders as far as delta goes is to know how the premium and deltas will change. I like to say calls and puts will react the same way depending on the underlying. What I mean is that call option premiums will always increase (keeping everything else constant) as well the deltas if the underlying rises and vice versa. Put option premiums as well as the deltas will always increase if the underlying falls and vice versa. Many option traders get confused on what is positive and what is negative and, for me, this is an easy way to remember how the premium and delta will change. Obviously, it just depends on if you are positive or negative delta whether or not you are benefitting from the move.

There is so much more to delta than just these few points, but understanding them can help you understand delta tenfold. Next time we will cover a few points on gamma.

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.

Leave a comment

Friday, August 17, 2018

Using Futures as ETF Price Swing Hedge

Financial futures and correlating ETFs are sensitive to economic data, not just in the U.S. but abroad as well. When we wake up to trade each morning, a trade idea may have already played out and the overnight price action forces us to adjust strategy. Recently, the Turkish lira collapsed, and the impact reverberated around the globe. Equity indexes and many European currencies declined. In response, safe-haven buyers turned to U.S. interest rate futures and the dollar. Treasuries typically rally when there is conflict or economic adversity.

Economies are connected around the globe and news travels fast these days. ETFs such as stock indexes (SPY, DIA, QQQ, IWM), interest rates (TLT, IEI), precious metals (GLD, SLV) and foreign exchange (FXE, FXY, etc.) are considered financial instruments and do not trade overnight. The correlating futures give traders around-the-clock access to hedge a position or enter a new position.

Futures can be used as a hedge against big price swings outside regular trading hours. There are often price gaps in ETFs and stocks that do not occur in futures. For this reason, it may prudent to have access to a futures account to avoid exposure to large gaps in price from the close to the next open. The charts below illustrate this point.

Futures were originally created for farmers to hedge against adverse price movements. Another strategy to keep your risk of exposure low is to buy options because risk is defined upon entry.


John Seguin
Senior Futures Instructor
Market Taker Mentoring, Inc.

Leave a comment

Tuesday, August 7, 2018

How Contract Size Affects Option Greeks

Understanding the option greeks is pivotal to truly understanding and trading options. As I like to say, the greeks are like the controls on a car. They give you an idea of how the trade should perform based on the underlying, time and volatility. But one thing about the greeks that is often overlooked is how they multiply based on contract size. Let’s take a quick look below.

Here is an example of an options chain. Let’s say an option trader buys one contract of the October 185 calls because he is bullish on the stock.

The current delta is approximately 0.51, which means for every move of $1 on the stock, the option premium should change by that amount. Gamma would change delta by approximately 0.02 for every $1 change. One day of time passing would currently reduce the call premium by about $0.06 based on the theta and a 1% change in implied volatility would increase or decrease the option premium by about $0.33 based on the current vega.

But what if 2 contracts were purchased? Now an option trader needs to consider that all the greeks get multiplied by 2 for the overall position. A $1 move higher based on delta alone (keeping gamma constant at this point) would increase the premium by $1.02 (0.51 X 2) or $102 in real money. This would be true across the options chain as well. A day passing now results in the overall premium for the position to drop $0.12 (0.06 X 2). So, if an options trader is worried about being exposed in some capacity, he needs to consider position size and/or consider a spread that may limit his exposure.

Knowing what the greeks are and how they can affect your position is paramount for an options trader. Just don’t forget that increasing your position size can affect your profit and loss as well.

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.

Leave a comment


Options Trading Blog

Archives

Tags