Options Trading Blog

Thursday, October 10, 2019

Positive Theta Should Be Your Friend

This market has been particularly volatile over the past several months. I am sure most of you have noticed that. Finding directional or even neutral trades that last for more than a session or two has been extremely difficult. But what if there was a way to help offset some of your delta risk? There can be and there is a way to do it with a proper long calendar spread.

A long calendar involves selling a call or put and buying the same strike call or put with a longer expiration. This position can have a positive, negative or essentially neutral delta depending on where the stock is trading in regard to the short strike. The key ingredient to the trade is usually positive theta. The short strike will have a bigger theta (which is positive) than the long strike (which is negative).

As time passes, positive theta can increase the spread’s premium. But in addition, it can offset some delta risk too. Take a look at the long calendar spread below.

The 57 call is sold and the following week’s 57 call is bought. The delta is essentially neutral (+0.5214 versus -0.5168) with the stock currently trading at $56.96. The best-case scenario for this trade is for the underlying to stay around the $57 level as close to short expiration as possible. Positive theta for the position (+0.1890 versus -0.850) is the key.

With the current positive theta close to 0.10, time passing would increase the spread’s premium by about $10 a spread. If the stock moves higher or lower, delta will become positive or negative. But because of the positive theta, it can offset some of the delta risk. In a market like we have seen this is possibly invaluable.

Fast forward two days.

The stock has cooperated and it is still trading close to $57 ($56.80). Delta is a tad more positive because the short expiration expires in a day. But check out the positive theta. It has ballooned from about +0.10 to over +0.40 (0.5050 – 0.0890). Not only is that bigger positive theta offsetting your delta risk, it is increasing the spread’s premium, which could lead to an eventual profit.

Clearly, a long calendar spread cannot perform miracles. If the stock moves far away from the short strike, delta will grow, and positive theta will not be able to offset the delta loss. But if the stock hangs in the general area of the short strike, positive theta will be your best friend as it should be.

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.

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Friday, October 4, 2019

To Find Money Flows, 'Follow the Sun'

A week ago, we finished the first of 2 MTM Mastermind sessions. On the last day we had a visit from a very good friend and colleague, CNBC’s Rick Santelli. He and I worked together in the ’90s where we compared notes often. We each had our own personal style and technical approach to analyzing price action. However, he was and is far more adept at the fundamentals than I am. I’ve learned a lot from him.

Rick works long hours and his research goes deep. He is always prepared to answer questions regarding the effects fundamentals from around the globe have on financial products…interest rates, equities, precious metals, energies and forex. He taught us much during his visit.

With all the unvetted stories out there and media agenda, I asked him what sources he thinks can be trusted these days. Rather than rely on media Rick said he checks in with reliable sources within the industry from here and abroad. He has a daily routine, and here at MTM we promote having a routine or checklist to tackle each day.

An informed trader is prepared to react to any situation. It is a good idea to have a bullish, bearish or neutral plan dependent on the economic data. To become well-informed, Rick said, “follow the sun.” An event in the far east could affect the Japanese yen, for example, and the yen frequently moves in the same direction as our treasury futures and even precious metals. A move in those markets may also impact stock prices. The point is, a ripple abroad may make waves in America. Rick is great at breaking down the information and how news may impact different sectors.

To find the money flows, follow the sun. Quite often U.S. futures markets make highs and lows outside of regular trading hours. Now more than ever traders must be aware of outside influences and global events.

Bank of Japan (BOJ) and European Central bank (ECB) policy moves frequently set the tone for the U.S. markets. And our monetary policy often affects interest rates around the world. One of my weekly tasks is to view economic calendars for employment, inflation and sales data from the major economic powers. I recommend you do the same. A well-informed investor is bound to make more bank.

John Seguin
Senior Futures Instructor
Market Mentor Mentoring, Inc.

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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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