Options Trading Blog

Thursday, November 7, 2019

Fed's Stance Sparks Fundamental Shift

Over the past week we saw a subtle fundamental shift, but sometimes that is all it takes to get a trend rolling. It started with the Fed hinting at a more neutral stance. A fourth interest rate cut had been widely expected in the December FOMC meeting. That may not happen now as some members believe the accommodative stance has run its course. Furthermore, the recent data support moving from a dovish position to neutral. Last week’s job report was stronger than expected, and the revisions showed even more job growth than was previously reported. That news incited a rise in rates and stocks, while gold, yen, and interest rate futures and ETFs fell.

Normally, the nonfarm productivity and unit labor cost report has little if any impact. But this week’s report saw a big unexpected uptick in labor costs. That may be a sign of impending inflation. For this reason alone, the Fed might take a bit more hawkish stance. On top of this, Chicago Fed President Charles Evans mentioned that after three rate cuts, policy has been accommodative enough. To add to the euphoria, talks with China have improved, and there were some rollbacks of recent tariffs.

Looking ahead to next week, we get inflation and sales data. If these numbers come as expected or higher, stock indexes should remain steady to firm and the usual ETF havens (TLT, IEI, GLD, SLV, FXY) should either stabilize or continue lower.

Option spreads are probably the best approach for this environment because the speed of the recent moves in many markets is well above the norm. When markets get overbought/oversold, shoot for some theta.

John Seguin
Senior Futures Instructor
Market Mentor Mentoring, Inc.

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Friday, November 1, 2019

Is Option Trading Easy?

Let’s answer that question right now before we go any further…no! It takes a lot of work and patience to be a profitable option trader. Getting started by putting some cash into a trading account is easy. But that is where the easy part ends. Not only do you have to learn about calls and puts and the different strategies, you also need to know the option greeks. Then comes management. Managing a trade and the psychological aspects of trading are, in my mind, the hardest part about trading.

As humans we are not particularly designed to be traders. The emotional aspect of trading is huge. Many traders and investors are not prepared for it, and most do not overcome it. I hired a trading psychologist myself, and it was the best money I ever spent. So aside from what options can give and not give you, one needs to ask oneself, can I handle trading? That being said, options can lower an investor’s or trader’s risk and produce profits and losses as well.

Options cannot perform miracles, and you definitely can lose money trading them. But options allow you to hedge, use leverage and generate income.

Hedge

Hedging essentially reduces risk. Options can protect individual trades or your whole portfolio if need be. To me, that is invaluable.

Leverage

Options also provide leverage. You can use less money to have more exposure to a stock’s piece movement, especially an expensive one such as Amazon Inc. (AMZN). This in turn gives you more flexibility.

Income

And lastly, options can generate income. Reducing risk is the most important attribute to options, but being able to increase your profits is not such a bad thing. The best part about options is that there is a strategy for whatever your outlook may be. With stocks, you simple can’t make money from a sideways position solely on the underlying.

Yes, trading is difficult and especially option trading because there are more moving parts with options than, say, buying and selling stock. But if you are disciplined, option trading opens so many potential profitable and protection scenarios that, in my opinion, are well worth it.

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.

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Friday, October 18, 2019

How Will Brexit Affect Markets?

I was writing my daily commodity market updates early Thursday morning and just as I was ready to hit send, stock indexes and interest rates rose abruptly. The euro and pound rallied while the dollar dipped. Gold fell as well. These immediate reactions were reversed later in the day when it appeared not everyone in the Brexit deal with the European Union was on board.

Even though the market reversed there is a valuable lesson here. When and if Brexit becomes a reality, we know that it will likely be bullish for equities and bearish for interest rate and precious metal ETFs as well as the dollar index.

For months we have endured sudden sharp moves in many markets when China trade talks have supposedly improved or been postponed. When we are told the negotiations are going well, stocks do fine while the usual safe havens (ETFs TLT, GLD and Japanese yen) falter. After reality sets in and the truth comes out that nothing new has been agreed upon, the markets often do an about face. Again, the lesson here is that news, true or not, moves markets and teaches us how the markets will likely react when the fundamentals become clear.

When you see sudden spikes in price either up or down, check the headlines. By doing so you will prepare yourself to make the right trade in each sector quickly when a major fundamental event occurs. Rapid responses save time and money.

John Seguin
Senior Futures Instructor
Market Mentor Mentoring, Inc.

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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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