Options Trading Blog

Tuesday, September 17, 2019

Trading an Iron Condor During Earnings

We are getting closer to another round of quarterly earnings, so this may not be the best time to talk about a relatively neutral strategy. But I think it is always a good idea to learn more about different option strategies.

An iron condor is a market-neutral strategy that combines two credit spreads. A call credit spread is implemented above the current stock price, and a put credit spread is implemented below it. The objective of any credit spread is to profit from the short options’ time decay while protecting the position with further out-of-the-money long options.

The iron condor is simply combining both the call and put credit spreads as one trade. The trade is based on the possibility of the stock trading between both credit spreads by expiration. Let’s use ABC stock as an example. If you have noticed that the stock has been trading between a range of $75 and $80 over the past few weeks, an iron condor might be an option with an expiration from about a week to about a month.

A call credit spread with the short strike call at 80 or higher would profit if the stock stayed below $80 at expiration. A short strike put at 75 or lower would profit if the stock stayed at $75 or higher at expiration. Both short options would need to be protected by further out-of-the-money (OTM) long options. Both spreads would expire worthless and both premiums are the traders to keep if ABC closes at or between the short strikes. The total risk on the trade is also reduced because of both premiums received.

Max profit is both credits from each credit spread. Max risk is the difference in one set of strike prices minus both premiums received. Maximum loss would occur if the stock is at or below $75 or at or above $80 at expiration. No matter what happens, one of the credit spreads will always expire worthless. This of course does not guarantee a profit though.

Now getting back to earnings, there is a trade-off as with everything about options. Expirations that take place after the announcement have higher IVs, which means the option premium is higher than it might be if the company were not announcing. Sine the iron condor is two credit spreads, this is a good thing. The trade-off is that the company is announcing, and there will most likely be a gap higher or lower that may pierce the call or put spread. The bottom line is there is a little more luck involved. But as long as an option trader understands the trade-offs and the risk/reward, this could be an option so to speak.

Iron condors are a great way to take advantage of time decay when it looks like the stock will be traveling in a range for a certain amount of time. The key is to have your profit and loss parameters set before entering the trade, but that may not be so easy when earnings are in the mix.

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.

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Friday, September 13, 2019

How to Trade 'in the Zone'

It was the mid-1980s and I was in my mid-twenties when I stepped on the CBOT trading floor as an employee. I was terrified, intimidated and eager. I got a jacket with team colors, a badge for access to the pits, and a warning to keep my mouth shut and do what I was told. I obeyed. It was easy, my parents demanded the same thing. I kept quiet, observed and learned. I quickly learned that a trading floor was as powerful as an athletic event, if not more. There were many days that had the intensity of a Super Bowl, World Series or U.S. Open. It was a chess match on steroids. Chaos comes to mind.  

Athletes talk of getting “in the zone.” The zone is that place where time slows down, noise becomes a hum and preparation pays off. It is when training and instinct take over. Traders, like athletes, can get in zones. Observation, groundwork and practice are essential to become good at anything.

It starts with preparation. Great traders always have a plan. Over the years I’ve learned that traders differ like snowflakes. There are no rules, but they all had a method.

To define your style and time frame, ask…

How much time can I spend looking at markets? Intraday, Day, Week, Month

  • Intra- and day traders should track 30-60 minutes chart patterns

  • Swing (3-5 days) use 5- to 20-day indicators

  • Long-term use 20- and 60-day indicators

No matter what time frame suits your style, it is a good idea to have a short-term directional indicator to identify the start of a longer-term trend.

If you prefer to catch short-term trends, search for markets that have below average day ranges over five sessions, along with below average ranges for the previous three weeks. Furthermore, a week of severe overlapping prices is common just before breakouts. When all the conditions are realized odds, increase for an abrupt vertical move or the onset of a trend.

John Seguin
Senior Futures Instructor
Market Mentor Mentoring, Inc.

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Thursday, September 5, 2019

Learning the Option Greeks

As summer comes to a close here in Chicago, I have spent more than the usual amount of time over the past few weeks reviewing the option greeks in our Group Coaching class. It is always important to know about the greeks when trading options, but many traders neglect to properly educate themselves. It has been a couple of years since I last talked about them as a whole, so I thought it would be a great time to review them for those who are still struggling. For the first part of this reference guide, let’s talk about what is positive and what is negative and what that really means for an option trader. Let’s begin with delta.

Delta

Option delta measures how much the option price should change based on a $1 move. Simply put, for every dollar the underlying moves higher or lower, the premium should change by that amount. Long calls and short puts have positive deltas. This means the position can profit if the stock moves higher. Keeping it simple, a long call can profit if the stock moves higher because the right to buy the stock becomes more valuable and a short put becomes less valuable with a move higher allowing the trader to potentially buy back the put for less.

Short calls and long puts have negative deltas. The position can profit if the stock moves lower. A long put can profit because the right to sell the stock becomes more valuable with a move lower and a short call becomes less valuable. The seller can potentially buy back the short position for less than what it was sold for.

Gamma

Option gamma measures how much delta should change based on a $1 move. Keeping it simple once again, gamma changes the delta based on a dollar move higher or lower. Negative or positive gamma confuses many option traders, but it is fairly simple to understand. Long options, both calls and puts, have positive gamma and short options have negative gamma.

Simply said, positive gamma increases the delta when the stock moves in the intended direction and lowers the delta when the stock moves against you. Negative gamma increases the delta against you when the stock moves against the position and decreases the delta when the stock moves in the intended direction.

Theta

Option theta measures how much the option price will decline due to the passage of time. For every day that passes, the option price should decrease by the theta amount. Long options, both calls and puts, have negative theta. Short options, both calls and puts, have positive theta. The thing to remember is that options are always losing value due to time. If an option has positive theta, the passing of time benefits the position. If the position has negative theta, time passing hurts the position.

Vega

Option vega measures how much the option price will change due to changes in implied volatility (IV). For every 1% change in IV, the option price should change by the amount of vega. Like gamma, long options, both calls and puts, are said to have positive vega. An increase in implied volatility will benefit the position and vice versa. Short options, both calls and puts, are said to have negative vega. A decrease in implied volatility will benefit the position and vice versa.

Lead Dog

Many option traders trade spreads. This is where the “lead dog” comes into play. Option traders need to add up the long greeks and short greeks, and whichever one is bigger for that particular greek becomes what I like to call the lead dog. For example, if you have a long call with a gamma of positive 0.03 and a short call with a gamma of negative 0.05, the position would have a negative gamma of 0.02 (0.03 – 0.05). If the delta on the position was positive 0.10 and the stock moved a dollar higher, the new delta would be positive 0.08 (0.10 -0.02).

I hope this clarifies a few things for you. The key to getting more familiar with the greeks is repetition. Quiz yourself often as I do in my class and over time, you can be an options greek guru.

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.

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Friday, August 30, 2019

Smart Traders Check Commodity Chains

In previous blogs I introduced a checklist of technical tests that I utilize before making a trade or writing my daily newsletters. A consistent approach is important to professional traders. Many investors are purely technical traders, some follow fundamentals, while others employ a combination of both schools of analysis. Fundamental data are the main source for market movement. But frequently we must interpret price action and make trades using technicals between fundamental events.

Fundamental reports include employment, sales, inflation, supply and demand, weather and earnings to name a few. But, the relationships between sectors can also be considered fundamental. I watch correlations closely because movement in one market may be the catalyst for the movement in many.

Traders are analysts, and we have to use every resource available to gain an advantage. I begin each day by reviewing which reports will be released and which markets those reports are likely to affect. Next I recommend pinpointing support and resistance levels depending on whether the reports are bullish, bearish or neutral. By doing so I am prepared to react depending on the situation.  

I also check the “commodity chain,” which is the connection or correlation between various sectors. The recent connection chains are as follows. Interest rates, gold and Japanese yen tend to move in sync, while equities and energies tend to move together and opposite the interest rate chain. 

I have made trades in gold because of a breakout in yen led the way. I have taken profits in a long 30-year bond position because the stock indexes were showing signs of strength. And stocks tend to move opposite bonds.

So, when you are prepping for the day be sure to check the fundamentals, technicals and chains. A prepared trader is more likely to make great decisions.

John Seguin
Senior Futures Instructor
Market Mentor Mentoring, Inc.

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Friday, August 23, 2019

What Has a Better Chance of Happening?

When it comes to technical analysis, there are certain indicators traders rely on. For me, monitoring simple support and resistance is the main way I feel I am putting the odds on my side.

Support and Resistance

Support is a level that keeps the underlying from moving lower. Resistance is a level that keeps the underlying from moving higher. It can come in several different forms, including pivot levels, moving averages and prior areas the underlying has traded to. The more the underlying has visited the area, the potentially stronger the support or resistance may be.

The Simple Fact

Just knowing that support and resistance have a better chance of keeping the underling from moving any further gives the trader an advantage. So, when I say “what has a better chance of happening,” this is what I mean. For example, if a stock has been in a decline and now has come down to its 200-day moving average, a trader should think that despite the drop in price, the stock has a better chance percentage-wise to not move lower because of the potential support from the moving average.

Remember…

Trading is difficult. If there is a way to make it a tad easier, traders should consider doing it. So next time you look at a chart, look at potential support and resistance areas. If the underlying is close to one, you have to give the odds to support or resistance to hold. I promise you will improve your odds for success.

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.

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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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