Options Trading Blog posts page 2

Thursday, October 25, 2018

How to Read Market Sector Sensitivity

In the daily futures class, we search many markets for patterns that typically precede the start of a trend, as well as the setups that often occur when a trend is near an end. Our approach to trading is determined by pattern probabilities and relationships among commodity sectors.

Recently the stock market has taken some big hits. Such extreme moves frequently reveal relationships in the financial markets. When equities fell due to a rise in inflationary expectations, havens such as interest rate, currency and gold futures, and ETFs did not respond with big rallies. However, the usual safe-haven markets do rise when equities decline due to political unrest, tough tariff talk, border conflict and terrorist threats.

Gold has been a hedge against the dollar for quite some time. Currently, that inverse relationship has changed. Gold has strengthened lately and so has the U.S. dollar. The explanation for this may have to do with the European Central Bank’s issue with Italy, Brexit and border conflict with Mexico. Using the ETF GLD as a hedge against a falling DIA can work in the right environment. Buying GLD and selling the dollar is not a good hedge for the time being.

A move in one financial asset often has a trickle-down effect. Interest rates are connected to stocks, and a move in stocks may affect precious metals, which may alter exchange rates. And a change in currency will have an impact on commodities such as grains, coffee, sugar, etc.

Being technically sound does not always refer to reading charts with skill. We can learn to be fundamentally proficient using technicals to identify changes in economic relationships. Pay special attention to price spikes when event risk is high. Check your calendar for reports that include employment and inflation numbers. These data have had more impact than housing or sales reports. And of course, check for Dow 30 stocks earnings reports. They affect the indexes, and big moves in them have really caused a stir in other financial assets. 

John Seguin
Senior Futures Instructor
Market Mentor Mentoring, Inc.

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Thursday, October 18, 2018

Support and Resistance Works on All Time Frames

Support and resistance are an integral part of how I teach technical analysis to my group coaching students. The general premise is that support and resistance have better odds to hold than be broken. If you keep this in mind as a trader, you can increase your odds for success. But I notice that many traders just focus on the daily chart and not the smaller time frames. Let’s take a look.

As a swing trader, a normal time frame is usually about two to five days to be in a trade. Clearly that is not a hard and fast rule with many trades lasting a lot less or more time. So many option traders consider themselves to be swing traders, so they pay no attention to smaller time frames like the 15- and 60-minute charts, which happen to be two of my personal favorites.

After the recent market decline, we examined opportunities for when the market might stop moving lower and eventually higher. Take a look at this recent 15-minute chart below on the SPDR S&P 500 ETF Trust (SPY).

When the market was trying to hold from moving lower, potential support held. If the SPY broke that support level in which it tested twice on the 15-minute chart, the market may have moved lower. Clearly there was resistance (tested many times) overhead, and I wanted to see the market break that resistance before taking some bullish trades. It eventually did.

At the time of this screenshot, the SPY was testing the 200 moving average on this 15-minute chart but failed to move above it. This is an area I would watch to see if the SPY was going to continue to try to move higher.

This was just a quick but effective example of how I like to use smaller time frames despite being a “swing trader.” As I like to say, it never hurts to look!

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.

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Friday, October 12, 2018

How Liquidity and Time Indicate Trends

Trends occur when institutional traders enter in force. They push markets higher when their bids outweigh offers. And markets go down when large traders liquidate or sell. Wouldn’t it be nice to know when and where professional traders enter the market? If we knew that, we could catch trends earlier. Profit potential rises and risk decreases the earlier we catch a breakout or onset of a trend.

Large trades tend to be entered when liquidity is at its highest. Typically, the first and last regular trading hours are the highest-volume periods of the day. On most days, the high or low for the session is made within the first hour of trading. An early low and an extension higher after the first hour are a strong indication that professional traders are buying. Conversely, when the high of the day is made in the first hour of trade and the market extends below that first hour low, it indicates that sellers are in control of momentum and lower prices are likely over the next day.

Another method of detecting which way the institutional traders are leaning is to check the close relative to the first hour range. A close above the first hour high signifies a bullish bias. Conversely, a close under the first hour low is a bearish indicator.

The combination of a low made in the first 60 minutes of the day session and a close above the high of that first hour is very common at the onset of a rally. Demand outpacing supply.

When the high is made in the first hour and the close is below that first hour low, prices are apt to weaken. This type of price action is common when a downtrend begins. Supply surpassing demand.

To enhance the timing of catching a trend we need to find patterns that frequently precede breakouts. That will be our topic next time.

John Seguin
Senior Futures Instructor
Market Mentor Mentoring, Inc.

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Thursday, October 4, 2018

What You Should Know About Vega

We have previously discussed a few things I think you should know about the option greeks. In weeks past, we have looked at delta, gamma and theta, which now brings us to vega.

Vega measures the impact implied volatility (IV) has on option premiums. Keeping it simple, for every 1% change in IV, vega will change the premium by that amount. If IV rises 1%, option premium will rise by the amount of vega, and if IV falls 1%, option premium will drop by the vega amount. Because of this, long options, both calls and puts, have positive vega. Short options, both calls and puts, have negative vega. How can we use this as part of our option trading?

Buy low and sell high applies to IV as well. As an option trader, you want to buy premium when IV is considered cheap. Once in the position, you prefer IV rises to increase your premium. As a premium seller, you prefer IV to be high when premium is sold. Then you prefer IV to decline once the position is initiated.

This also applies to multiple legs on your option trade. If your positive vega is bigger than all of the negative vega, an IV increase helps the position whether it be a debit or credit spread. If your negative vega is bigger than all of the positive vega, an IV decrease hurts the position for either a debit or credit spread.

Just like gamma and theta, vega is highest at-the-money (ATM) and smaller in-the-money (ITM) and out-of-the-money (OTM). But unlike gamma and theta, vega gets bigger further out to expiration. So a longer expiration means a larger vega number.

I hope these past four blogs have shed some light on the option greeks. Learning about them and understanding them can be quite the process. I promise you if you learn these few points I have made over the past few weeks, it will help your option trading immensely.

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.

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Sunday, September 30, 2018

Using ATR as a Market Speedometer

At the end of every quarter I make it a point to update a spreadsheet that displays average ranges in most commodities, indexes, ETFs and Dow Jones 30 stocks. This information is crucial when projecting how far a market is likely to move over a variety of time frames.

It is imperative to identify benchmark ranges to recognize if a market is overbought or oversold, or if it has consolidated enough to favor a breakout or onset of a trend. The vertical dimension is the speedometer of markets and is known as average true range (ATR).

When is the speed of a rally or decline too quick? There are many indicators that were created to signify when a market is overbought or oversold.  RSIs and stochastics are probably the most popular technical gauges for speed.

In our daily futures class, we discovered a method for regulating speed. If a day range spans 175% of the benchmark ATR, it has traveled too fast. Thus, odds favor a couple of days of sideways trade. Premium decays in a sideways trade. We also found that if a market moves the length of an average week in a 48-hour period, three to four days of consolidation often follows. If you like to sell premium, find markets that have moved too far, too fast.

The spreadsheet is a cheat sheet and something I keep handy. If you want to enhance your ability to time trends or breakouts, look for markets where the recent ranges are far below the norm.  And if you like to sell volatility or counter trade trends, find markets that exceed the average speed.

The data below should help navigate Q4. Benchmark time frames are calculated as follows: 23 days, 9 weeks, 7 months and 5 quarters.

John Seguin
Senior Futures Instructor
Market Mentor Mentoring, Inc.

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Thursday, September 20, 2018

What You Don't Know About Theta

As our journey of taking a look at the greeks in a different light continues, we have come upon theta. Theta, for many, might be the easiest to grasp. That being said, here are a couple of things to think about that you might not have realized about this greek.

Theta measures the rate of decline in the value of an option due to time passing. Keeping it simple yet again, for every day that passes, theta should decrease the option’s premium by the amount of theta. Long options, both calls and puts, have negative theta. Short options, both calls and puts, have positive. How can we use this as part of our option trading?

Time passing will always decrease option premium keeping all other variables constant. Long options have negative theta, so time passing will decrease the premium. To make a profit on a long option, the trader needs to sell it for more than it was purchased. That is why theta is considered to be negative because it will be decreasing the premium. Short options have positive theta because premium is decreasing and that is beneficial for a short position. A profit is made if premium is sold and bought back at a lower amount or it expires worthless.

But what if there are multiple legs on your option trade? If your positive theta is bigger than all of the negative theta, time passing helps the position whether it be a debit or credit spread. If your negative theta is bigger than all of the positive theta, time passing hurts the position for either a debit or credit spread.

Just like gamma, theta is highest at-the-money (ATM) and smaller in-the-money (ITM) and out-of-the-money (OTM). Theta also gets smaller further out to expiration. So a longer expiration means a smaller theta number.

Theta is one of those greeks that may be easy to understand on paper but a little confusing when it comes to whether it is hurting or helping the position, particularly when spreads are concerned. Let’s hope this little clarification has helped and we will wrap up with vega next time.

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.

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