How to Spot and Leverage Big Money Moves

Transcription

1 How to Spot and Leverage Big Money Moves 1

2 Copyright 2016 by Sir Isaac Publishing Inc. 37 N. Orange Ave Suite 500 Orlando, FL All rights reserved. Printed in the United States of America. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of Financial Media Corp. 2

3 Risk Disclaimer There is a very high degree of risk involved in trading. Past results are not indicative of future returns. Tradingpub.com and all individuals affiliated with this site assume no responsibilities for your trading and investment results. The indicators, strategies, columns, articles and all other features are for educational purposes only and should not be construed as investment advice. Information for futures trading observations are obtained from sources believed to be reliable, but we do not warrant its completeness or accuracy, or warrant any results from the use of the information. Your use of the trading observations is entirely at your own risk and it is your sole responsibility to evaluate the accuracy, completeness and usefulness of the information. By downloading this book your information may be shared with our educational partners. You must assess the risk of any trade with your broker and make your own independent decisions regarding any securities mentioned herein. Affiliates of tradingpub.com may have a position or effect transactions in the securities described herein (or options thereon) and/or otherwise employ trading strategies that may be consistent or inconsistent with the provided strategies. Privacy Policy 3

4 How to Get the Most Out of This Book Thank you for downloading How to Spot and Leverage Big Money Moves. This book is designed for beginning, intermediate and advanced traders. The authors in this book are leading experts in trading stocks, options, and futures. As you read this book, you will be exposed to multiple strategies that have high probabilities of success and/or high profit. Most of the strategies in this book are divided into three sections: The Game Plan An introduction to a charting technique. The strategy is then thoroughly explained along with illustrations and examples. The Movie - Once you have read the chapter, you can view the complete webinar on the strategy. You will gain a better understanding of the strategy along with multiple examples not covered in the chapter. In some cases, the presenter switches in to live trading to demonstrate the strategy in action. In many of the webinars, the presenter also fields questions from attendees. Special Offers If you really like a strategy, you can follow the presenter and the strategy. There are thousands of dollars worth of trading tools, indicators, training and mentoring services, books and videos available at steeply discounted prices. In short, you will have all of the information you need to trade your new favorite strategy tomorrow. Some of the things you will learn in this book are: How to Spot when Big Money is in the Markets Secrets to Trading Out-Of-The-Money Options How to Keep Big Money from Taking Out Your Stops How to Take Advantage of Fear in the Markets How to Put the Short Squeeze on Options And much more At TradingPub, it is our sincere hope that you take away several strategies that you can use when you are done reading this book. You will also learn about markets that you currently don t trade, and you will find out if they are suited to your trading personality. Finally, make sure to subscribe to TradingPub. We provide free ebooks, webinars, on-demand videos and many other publications for active traders in all of the markets. Our presenters are worldrenowned industry experts and our content is provided free of charge in a relaxed and friendly setting. Cheers to your trading success!

5 Table of Contents TRADING BIG MONEY BREAKOUTS AND FOLLOWING TREND WITH OUR FAVORITE TECHNICAL INDICATOR: THE ICHIMOKU CLOUD 7 By Andrew Keene, AlphaSharkTrading.com USING THE MARKET FEAR FACTOR TO PROFIT RIGHT NOW By Alan Knuckman, BullsEyeOption.com 19 PREDICTING MAJOR MARKET MOVES BY DETECTING THE SMART MONEY 33 By John Seville, AcornWealthCorp.com BUYING OUT-OF-THE-MONEY OPTIONS By Jonathan Rose, ActiveDayTrader.com 47 PUTTING THE SHORT SQUEEZE ON OPTIONS 61 By Mark Sebastian, OptionPit.com 5

6

7 Trading Big Money Breakouts and Following Trend with Our Favorite Technical Indicator: The Ichimoku Cloud By Andrew Keene, AlphaSharkTrading.com What is the Ichimoku Cloud? The Ichimoku Cloud is a technical indicator I first encountered while traveling through Asia in Talking shop with other traders I had met on my travels, I quickly realized that this Cloud they kept referring to was different from any other indicator I had ever used. I was also surprised at how simple and intuitive the Cloud was to use. While it may look confusing at first, the Ichimoku Cloud is actually one of the simplest indicators to use. Before we can approach the actual applications of the Cloud, let s discuss what the Cloud actually is. The Ichimoku Cloud is a technical analysis method that uses sets of moving averages to produce key levels in the past, present, and future. The Cloud helps traders identify at a single glance if a security or other financial product is trading in bullish or bearish territory. Ichimoku Kinko Hyo literally translates to One Glance Equilibrium Chart because it can be used for analysis using only a glance. For this reason, the Cloud is one of the most efficient technical indicators available. The Cloud is made up of 6 key components, each of which we will examine individually. When these 6 components are combined, they form the Ichimoku Cloud. Below is an image of the Apple Inc. (AAPL) on a daily chart with the Cloud. We can use the Cloud to identify key levels of support and resistance, determine trend, and determine the strength of the trend. As can be seen below, the Cloud is actually a forward-looking indicator. The Cloud is projected 26 periods forward, so the levels under the current price were formed 26 days ago. The Cloud is unique in that is uses both past data and forward-looking levels. Since the levels are forward looking they tend to be more reliable than simple moving averages. The lagging indicator component also provides confirmation of breakouts by looking 26 periods 7

8 back to determine if a stock is likely to break through levels. It is this concept of looking at the past, present and future that makes the Cloud so valuable. In the next section we will look at the individual components of the Cloud and how they are calculated The 6 Components of the Ichimoku Cloud The Ichimoku Cloud is made up of 6 individual components. Each is calculated and plotted differently and each one tells us something different. Here we will discuss how each component is calculated and what it is used for. The 6 components: 1. The Tenken-Sen Line 2. The Kinjun-Sen Line 3. Senkou Span A 4. Senkou Span B 8

9 5. Kumo 6. Chinkou Span Line Once calculated, these pieces form the indicator set known as the Ichimoku Cloud. In the image of the AAPL daily chart shown below, you can see the components clearly labeled. Calculating the Components of the Cloud The Tenken-Sen Line: Short term trend line similar to a 10 period moving average. It is known as the turning line and is a signal of a region of minor support or resistance. This component is calculated by taking midpoint between the highest high and the lowest low over the past 9 periods. The Kinjun-Sen Line: Known as the confirmation line. This component also serves as a signal for support and resistance levels. Many traders use this line as a level for a trailing stop. It also serves as an indicator of trend. If price is above the Kinjun-Sen Line then the stock is in bullish territory, likewise if it is below the line it is in bearish territory. This line is calculated by taking the midpoint between the highest high and the lowest low over the past 26 periods. 9

10 Senkou Span A: This line forms one of the boundaries of the Cloud. If the stock is trading above the line then the line will serve as a major support level. If price is below this line it will serve as a level of major resistance. This component is calculated by taking the average of the Tenkan-Sen and Kinjun-Sen lines. This line is unique in that the results of this calculation are plotted 26 periods ahead. This means that today s Senkou Span A line was actually plotted 26 days ago. Senkou Span B: This line forms the other boundary of the Cloud. This line serves as a second level of support or resistance and is calculated by taking the midpoint between the highest high and the lowest low over the past 52 periods. Like the Senkou Span A line, this is also plotted 26 periods ahead. This line is similar to a 50% Fibonacci retracement. Kumo: This is the shaded area, located between the Senkou Span A and Senkou Span B lines, that is used to form the Cloud itself. Chinkou Span Line: This line is also known as the lagging indicator. This line is the current bar s closing price plotted 26 periods back. The lagging indicator is often used as confirmation of signals and can also serve as a support and resistance level. The lagging indicator can also assist a trader in confirming the direction and strength of trends. Why Use the Cloud? With so many indicators included in charting packages, why should a trader focus on only one indicator? The Cloud is unique in the fact that it has current, past and future components that can be used as key levels, and can project potential future price action. Although this is the main reason I love the Cloud so much, there are other important reasons as well. One of the best things about the Cloud is that not very many people know how to use it. Everyone uses Bollinger bands and moving averages but the Cloud is used far less in practice. Why is this good you might ask? In the age of algorithmic trading, many highfrequency trading firms will try and run the stops of weaker traders. They target levels based 10

11 on where they believe people will have stops in place. Since people tend to put stops in at levels derived from other, more common studies, it is easier for the high-frequency trader to take them out. If a trader uses the Cloud to set stops and targets, it is not likely there are a lot of other traders at those same levels. This means that stops won t be targeted as much as they would if a trader used more popular studies. The flexibility of the Ichimoku Cloud is also one of its greatest qualities. The Cloud is applicable to any product on any time frame. This means that any trader can use the Cloud effectively. The Cloud can be used for trading stock, options, futures, and currencies. All of the products will have a time frame that they work best on, but the Cloud can be used to trade any of them. Later on we will discuss what time frames work best for what asset classes. Trading Options with The Cloud I have been trading equity options for the past 12 years. While I often trade stock and other products like currencies and futures, I still consider equity options to be my bread and butter. When on the trading floor I didn t use charts. I would focus all of my attention on order flow and implied volatility. After I left the floor and moved upstairs I realized that my trading plan would benefit from an addition of technical analysis. The Ichimoku Cloud has proven itself to be the most effective technical indicator I can use as an options trader. Here we will discuss how I apply the Cloud to my proprietary trading plans and why it works so well. As an options trader, I base the vast majority of my trades on what I call unusual option activity. Unusual option activity is a large block trade that takes place at a multiple above the average daily option volume in a specific stock. These unusually large trades are placed by large institutional market participants and can represent the flow of the smart money in the options market. Simply put if I see big institutional players betting heavily on upside or downside in a specific stock, I try and follow that trade. 11

12 The key to trading unusual option activity is being able to infer what, if anything, the institutional trader s underlying stock position might be. Remember that the majority of options market participants are hedgers. This means that orders cannot always be taken at face value. If I see a large put buyer it s possible they are hedging a large long stock position rather than trying to get short. Likewise, when I see calls being bought, it is possible the trader is hedging a short stock position rather than trying to get long. Determining if a bet is speculative or a hedge is my number one goal when trading unusual option activity, and the Ichimoku Cloud helps me do this. The Cloud is an excellent indicator of trend and the strength of the trend, so when I am trying to determine the motives behind a large block trade, I see the Cloud as being extremely helpful. If the Cloud is indicating a strong bullish trend in a stock that I see puts being bought in, it is much more likely the institutional trader is hedging a long stock position. When I m trying to determine if a trade is speculation or a hedge, I need to perform my analysis very quickly, in a matter of seconds. The Cloud helps with this as well. Thousands of trades hit the tape in any given day so I am constantly looking at charts of stocks I am seeing action in. Being able to determine if a stock is in bullish or bearish territory at a single glance is essential to being able to analyze stocks very quickly. Using the Cloud for trading unusual options activity really boils down to a single concept: if institutional traders are buying puts in a stock above the Cloud, I do not want to get short. Alternatively, if they are buying calls in a stock below the Cloud, I do not want to get long. Using the Cloud to weed out all of the false signals and traps has greatly increased the profitability of my trading plan. The Cloud helps guide me into the best possible set ups. While I ve given only a handful of examples of how I apply the Cloud to my trading plan, I truly believe the Cloud is versatile enough to work for anyone. 12

13 Using the Cloud to Trade Stock When using the Ichimoku Cloud to trade stock, one of the most important considerations I must make is deciding what time frame I must use. Generally, I believe stock trades best with the Cloud on the daily chart. This is not to say intraday equity traders cannot still use the Cloud successfully. However, it will produce more traps when used on tighter time frames. The Cloud for the Day Trader: Using the Cloud on an intraday basis can show a trader where intraday levels of support and resistance are. A day trader can also use the Cloud to find the highest probability setups. The Cloud for the swing trader: Using the Cloud can help the swing trader avoid trading against trends and can help steer them away from stocks that are in neutral territory. Using the Cloud can also point them to stocks that are near breakout points. The Cloud for the long-term trader: Using Cloud pullbacks can point out opportunities to enter or add to positions. The long-term trader can use the Cloud to determine when it is time to exit a position. Since the Cloud is forward looking, the Cloud can also give a heads up before trend might turn the other way. No matter which of the above categories you might fall into, you will be able to benefit from using the Cloud. As a trader I mostly fall mostly into the first two categories. Most of my stock trades are either day trades or swing trades. Using a shorter time frame may change the way I use the Cloud but the basic concepts stay the same. I use the support and resistance levels the Cloud provides as levels for stops or profit targets. The Cloud also tells me when I should enter or exit a trade. Look at the image below and take note how the Cloud provides me with my entry and a level to place a trailing stop. 13

14 Look at this older setup in AAPL: These same levels can be used on any time frame. The chart above is showing AAPL stock on a daily chart, but I would be looking for the same things on a 15, 5, or even 1-minute chart. The time frame I m using can also depend on the product I am trading. Some securities trade much faster than others and require a shorter time period chart. Likewise, some securities are slower and produce too many traps on a lower time frame chart. In the next section, we will discuss how to determine the best ways to use the Cloud no matter what product you are trading. The Best Way to Use the Cloud The setup described above can be used to trade breakouts in any product on any time frame but a trader must understand which time frames they should be using for each individual product type. As we have explained previously, the Cloud is one of the most versatile technical indicators available. Its applications are wide and as long as a trader realizes what the best uses are for the Cloud they can easily apply it to their trading plan. Even though the Cloud can be used for trading any security it is not a one size fits all, indicator. If used on a less than optimal time frame for a specific product, the Cloud can produce many traps. A trader 14

15 must always consider what they are trading and how fast that security tends to trade. Below we will explain the use of the Cloud in several of the more popular products traders trade. Stocks - The best signals come from the daily chart. Using the daily chart will provide the best setups for swing traders and longer-term players. Stocks can still be day traded using the Cloud, but on an intraday time frame, using anything faster than a 15-minute chart will produce many traps. Currencies and Currency Futures - Trade best on a 4-hour bar. Currencies trade very well on the Cloud but as with equities, the Cloud produces the best signals on a longer time frame. The Cloud can be used for intraday trading of currencies but using anything faster than a 15-minute chart will have the potential to produce many traps. Crude Oil Futures - Trade very fast. When trading crude oil futures or any other fast moving product we can still use the Cloud on shorter time frames. A trader can use a chart as fast as the 5-minute bar and still be effective with the Cloud. Treasury Futures - Treasury Futures often trend well intraday. A trader can use the Cloud very well when trading these. Time frame depends on the specific product being traded. In general, products that tend to trend rather than sit in a range are the best products to trade on the Cloud. There are several considerations a trader must make when using the Cloud. The Cloud can be used on any product, but in general we want to focus on trending products. Keep in mind that one security might trade differently on a different time frame, and we must always consider this when using the Cloud. 15

16 Look at the short side breakout example below: SUMMARY We always say that there are no shortcuts in this game. There is no such thing as a sure thing. All we hope for is a way to increase our chances of success. After more than a decade of trading experience I have learned exactly what tools I am able to make the most of and which strategies and resources don t work for me. When I say the Ichimoku Cloud is my hands-down, most favorite technical indicator I am not joking. I ve been using it for years and regret having not discovered it earlier in my career. It is one of the most versatile tools a trader can have access to and its ease of use and overall accessibility make it a great resource for traders of all skill levels. 16 THE SPECIAL OFFER The AlphaShark Gold Package Learn how to use unusual options activity to trade like top hedge fund managers and other institutional traders. Check out our unusual options activity workshop for a HUGE discount as a special thanks for reading this article. We are also including a 1 month trial to our gold package subscription as part of this offer.

17 Gold package includes: Both Best Selling E-Books Access to 100 s of Hours of Member Only Videos Webinars & Discounted Courses Twice Daily Alerts Entries & Exits via SMS Text in Real Time Click here to try the workshop and Gold Package! 17

18 ABOUT THE AUTHOR Andrew Keene is President & CEO of AlphaShark Trading, which he originally founded as KeeneOnTheMarket.com in Previously, Andrew Keene worked as a proprietary trader at the Chicago Board Options Exchange. He began his career in the prestigious Botta Capital clerk-to-trade program, and would eventually co-found KATL Group, where he was the largest, independent on-the-floor Apple trader in the world. Keene has earned millions in profits in the course of his trading career. He has traded profitably for six years straight and counting, and is profitable 11 of the past 12 years. Andrew currently actively trades futures, equity options currency pairs, and commodities. He is a regular guest market commentator on such networks as Bloomberg TV, CNBC, and Fox Business. Keene s first love will always be trading, but he is arguably even more well known for building one of the biggest live trading rooms in the world. Andrew is especially proud of having taught his personal strategies to over 50,000 students over the past 4 years. In 2015, Andrew began appearing as a regular guest on CNBC s Trading Nation, where he focuses on educating viewers on equity options markets and the trading insights they provide. 18

19 Using the Market Fear Factor to Profit Right Now By Alan Knuckman, BullsEyeOption.com There is opportunity in volatility, and the last months have been amazing times for those who were prepared to take advantage of volatility. There is a certain satisfaction in making money on high probability trades when others are coming unglued. The 2016 market pullback has scores of stocks trading at discounts of 75% and more. There couldn t be a better time to take advantage of the situation in the beaten and battered energy, metals, mining and crushed commodities stocks. Markets aren t good or bad they just are what they are. Amazingly, this strategy that I spell out in detail works in UP, SIDEWAYS and DOWN markets taking advantage of others fears. This strategy was originally a portfolio manager trick to enter the stocks they wanted at a lower level, we have turned this into a way to generate high probability cash flows every month. Here is a stock that had slid to decade plus lows as GOLD had fallen from the 2009 peak. A $10 stock was attractive because it had become inexpensive but that buy because it is cheap approach has cost investors a lot of money. A stock can always become cheaper. 19

20 The attack plan was to EITHER buy it 10% lower or get paid 5% not to in 30 days. A win/win situation if you are prepared in the worst case scenario to hold the stock for weeks or even months. Another trick actually can actually lower that price even more every month will be explained down below. Before I show you how, let me give you a little background on how this win/win strategy was developed. The financial markets have been around for hundreds of years with investors tying to unravel the mystery to success. Buying and selling stocks has created massive fortunes for a select few but also remained elusive to most. What to buy? When to buy it? How much to risk and when to get out? Option Wheel Strategy Options on stocks were developed only in the early 1970 s to protect portfolios and provide leverage, increase buying power and investment returns. An option on a stock would cost a small percentage of the share purchase but the rewards are significantly greater. 20

21 That is if the market does what you expect within a certain period of time. Too often the date that the option expires is before that movement occurs. Buying options requires this element of critical timing but the tactic does have limited risk. The good news is that you can only lose what you paid for that option; the premium price would expire at zero. So for most, that is exactly what happens, over 60% to 70% of all options expire worthless every month according to the exchange data. Something very interesting happened a few years after the options market development, over 5 years later they added PUTS to take advantage of downward market direction. I know it is hard to believe that they only had calls. Old timers from the floor will say that gentlemen didn t trade puts. Those who didn t eliminated half of the profit possibilities. I am not sure if that NO PUTS preference was bullishness just being eternally optimistic or not understanding the flexibility of the instruments. The ability to use both Calls and Puts opened up enormous mathematical possibilities. The Black Scholes model of option pricing received a Nobel Prize in 1997 and was developed by renowned Chicago economists. Now we don t have to be that smart to know that selling options that expire worthless can be a fantastic strategy. Many fortunes have been made by selling premium successfully and pay for mansions along the lake and the rows of exotic vehicles parked at the Chicago Board of Options Exchange. Too often novice option traders buy Lottery Tickets and provide the long shots that market makers love to sell. These cheap options with very little time to perform are gobbled up by Joe public looking to hit it big. There is a reason an option may be cheap, either it is very unlikely to be profitable or there is little time until expiration. Options are available monthly, so when an old series goes off the board with expiration the third Friday of every month new ones are created. That important feature is how floor traders that take advantage of time decay selling options over and over again. Anything can happen in the stock market, but the improbable outcomes of significant stock 21

22 moves in a short period of time are not one of them. It may only cost $150 for a cheap call option but the mathematical reality is that the stock has to rise let us say 20% in three weeks to get to break even. Two dollars on Number 11 to show in the 3rd race? No reason to gamble on the long shots my friends The comparison to the lottery that funds our schools and state programs is correct because that payout rarely if ever exceeds the money taken in. That risk is managed by the option sellers when in the rare event that grand slam home run is hit. Careers have been made selling cheap out of the money options and collecting money month after month from novice option trading gamblers that believe something big could happen but more often than not doesn t. Sometimes the unexpected mathematical improbability does happen and an inexpensive option can, as renowned investor Peter Lynch would say, become a ten bagger, ten times the investment. He brought investing to the masses with his Fidelity Magellan mutual fund becoming the largest in the world. That two grand slams and a double baseball analogy play is few and far between if ever... Who wants to count on that? A more consistent investment strategy is to hit singles with a very high degree of probability. Small returns add up over time and as the Tortoise and the Hare fable teaches: slow and steady can win the race. This is accomplished by selling options to the eager lottery ticket buyers. Best of all this strategy is a win/win with either outcome. The riddle is which option and when? Selling naked options is the riskiest strategy that exists and has unlimited exposure. Be careful what you do naked, it can get hurt or have unintended consequences I have always been told. CASH SECURED PUTS have the same risk profile as the commonly used covered call. 22

23 Importantly the money is in the account to pay for the shares in full if they get assigned buying the stock at a discount. No margin is involved so the stock is paid for in full if shares are assigned. We only want to sell CASH SECURED PUTS on stocks that we want to own. The worst case scenario is that the stock gets assigned at the strike price of the option we sold minus our discount. Each option represent 100 shares so the obligation to be long on an $8 put sold would tie up $800. Now the reality is that a stock can only go to zero, not a good thing, but the risk is limited to that price. I will show you how to add protection later. Use this strategy to build a portfolio at a discount. Again, only sell put options only on stocks that you are comfortable owning. 23

24 Example: GOLDCORP chart above stock was trading at $10 with the premium for selling the $9.50 put for $0.40 ($40 an option) for a 5% potential return on risk. The trade break even is $9.10, ($9.50 strike minus $0.40 taken in). Remember the decade plus low is $9.46 so IF put to you the entry is a 10% discount from where GG was trading and below the multi year lows. GG stock was above $9.50 thirty days later at expiration for a max profit on a high probability play. Do you see what I m talking about? Every month that the stock does not go down below that option strike sold you keep the money. And, when it happens you are buying a stock that you want to own a lower price. That is... On sale, at a discount, with a 10%, 15% or more OFF coupon. The fear and uncertainty can be used to get in lower for those who are at worst are comfortable holding on to an inexpensive stock to wait for a potential recovery. 24

25 Portfolio Strategy The straightforward Price Order to buy a stock at a lower level is common if it can be determined where it is comfortable to get in below current prices. Put in the buy below at X and wait for the dip to enter. Professional money managers have certain points at which they would buy a desirable stock but an option strategy lets them get in at discount or get paid not to. Selling a CASH SECURED put, remember has the same mathematical risk profile as a covered call, would assign the stock long at the option strike price. The true entry basis is actually even lower with the subtraction of the premium taken in. With the Put sale there is an OBLIGATION to buy at the strike price if it is assigned. The intention for the fund manager was to buy the stock anyway. However, if the stock is not below the strike at expiration the premium received is all profit. Get in the stock at a discount or get paid not to Small returns on high probability 30 day plays add up fast. Now I want to mention something that all investors should cherish, the RULE of 72. This is simple fact that small returns compound greatly over time. Take 72 and divide it by your annualized return and that is how long it take to double your money. So a 9% return would double in 8 short years. We ll talk about the much larger strategy returns below. The second part of this Option Wheel strategy is even better. Assume that you now have a stock that you are very comfortable owning for the long term. Selling short term covered calls against it lowers the cost basis. It is like taking in rent on an investment apartment complex that you own but no tenant hassles. When you sell the covered call, the premium will lower your stock basis price. This can be done every month to generate revenue on your stock position. A little rent money every month really adds up and increases overall returns. 25

26 Remember these are stocks that you want in your portfolio and the calls that you sell monthly that can expire worthless; remember again nearly 70% of ALL options do end up with nada, none, zilch. This is extra money in your account. Well guess what happens if that call you now sold starts to be valuable? You are completely covered by your stock position and the worst that can happen is your profits are limited. Let me say that again, limited profit is the downside. Your stock would get taken away but the profit is the difference between your cost (lowered by selling options) and the strike price sold. The not devastating bad news is you only made XX$. So no matter how high it goes your profit is capped by the option that you sold on the underlying stock. Option Wheel in Action with U.S. Steel : December 21st Sold January $7 $0.45 The US Steel January $7 Put was sold for $0.45 to either get a 7% return on risk in less than a month or buy the stock 17% lower. 26

27 Shares were slammed in the next 30 days with expiration at $6.89. The entry was $6.55 when assigned which was still solidly below the stock price EVEN when shares had gone completely the wrong way. A dramatic down move heightened volatility and made option prices even more inflated. December 19th Sold February $7 $0.75 A covered call is sold against the long stock position from $6.55. The February $7 call is sold for $0.75 to lower the stock cost break even to $

28 Shares of US steel are taken away at $7, the covered call strike sold, against a cost basis of $5.80. PROFIT is 20% in two months. February Expiration $ % PROFIT in Two Months CONCLUSION Rinse and repeat. Repeat selling puts to start the Option Wheel process again. Sell cash secured put, get assigned shares or not, sell covered call, get shares taken away REPEAT Slow and steady with the high probability of success should appeal to everyone. This can be done to generate monthly income in addition to other investing. A modest conservative return on this strategy of 5% in a month certainly adds up. That is over 50% annualized. GO BACK TO THE RULE OF 72 if modest consistent profits are not what you think you are looking for. Where are you in 5 years? So to recap, we identified a solid stock to own for the long term. Selling naked puts generates monthly revenue income until the point that the stock is bought at a discount. When assigned the stock at the low price then sell covered calls against it. Continue to sell covered calls each month and get more income until the stock is taken away at a healthy profit. The basis for the strategy is taking advantage of the fear in the marketplace. Use that volatility to sell options and get high probability premium payments. 28

29 Every month, we pick the options and update the list of positions that meet criteria used by the market money men that has provided the lavish lifestyle to which they have become accustomed. As options sellers, we are writing the insurance policy for others to sleep at night. That insurance that we sell is expensive and lets us get into the stocks that we choose at much lower levels. The bigger the stock market decline or the greater the economic uncertainty only means more money for selling options. Build that portfolio at a discount and generate money also. The bigger the stock market decline or the greater the economic uncertainty only means more money for selling options. Build that portfolio at a discount and generate money also. Fear is Good, not Greed. THE MOVIE WATCH this video here to see the Option Wheel in US Steel in action. THE SPECIAL OFFER $7 One Month Trial Bulls Eye Option Inner Circle Membership Click Here to take advantage of this Great Offer! Hit the Bulls-eye with High Probability Options Learn how there s money to be made in ANY and ALL market conditions. Learn how options provide a better way to trade stocks while limiting your risk. Get at least six option trade alerts each month that show potential for high profit. 29

30 Receive expert advice and education in daily videos and market commentary Introducing BullsEyeOption An Options Trade Alert Service and more I ll admit it. I m an eternal OPTIMIST. Regardless of where the markets are right now, I KNOW there is money to be made using the right strategy. And, I m convinced the right strategy is also a better way to trade stocks. I ve spent my entire career analyzing the markets, and have learned how options (and not stocks) let you hit the target with a greater chance of a successful trade. Options can limit your risk. They are the best way for traders to create higher probability trades with leverage to produce greater returns. Options strategies can be simple. The market can only move in three directions (up, down, or sideways), so you don t need a fancy technique to make money. Options trading does not require constant attention. A well-thought out and disciplined trading plan lets you step away from your computer and puts you in position for long-term success. Included in Your Membership: Every morning an hour before the market open a morning update summarizes the action in the previous session and stocks on the move that day. Each week, receive TRADE RECOMMENDATIONS via . Every trade alert comes with a DETAILED EXPLANATION explaining the strategy and why I m recommending it. 30

31 I will help you fine-tune your knowledge of the markets with DAILY EDUCATIONAL VIDEOS that analyze markets (and real trading possibilities.) ABOUT THE AUTHOR Alan Knuckman started his career at the Chicago Board of Trade as runner/clerk, then moved his way to trading futures and futures options in the Treasury pits. With strong broadcast media skills in analyzing the markets, Alan is a frequent expert for major news organizations where he appears regularly on CNBC, Bloomberg TV, Fox Business Network, CNN, Sky Business News in Australia. 31

32

33 Predicting Major Market Moves by detecting the Smart Money By John Seville, AcornWealthCorp.com In today s economic climate, investors are faced with a multitude of different sources of information, from Facebook, stock twits, business news, stock newsletters and anyone who is willing to give you their opinion which is everyone. Unfortunately, statistics show that over 85% of investors generally lose money. In fact, in a recent documentary I watched discussing the value of experts, it was reported economists have studied the wrongness rate in economic journals and have concluded it s very close to 100%. In conclusion, virtually all the studies published in economic journals are wrong. Therefore, how does an investor know how to find the true story of what is going on? More importantly how can you find good investment ideas knowing that the likelihood is that 85% of them will be wrong? The most valuable method I have found to predict major market moves and capture significant profits is by tracking the smart money, how it moves and the key indicators signaling which way the money is flowing. In this e-book we will discuss the ways in which we do this and key elements and checkpoints. A complimentary workshop discussing the concepts and patterns discussed in this e-book will be provided at the end. MARKET STRUCTURE AND DYNAMICS Firstly, to set the premise of the ideas set out in this article, we must first look at the nature of how money moves through the stock market in today s modern age. It is currently estimated 33

34 that as much as 80% of volume in the stock market is accounted for by buy and sell decisions made my computerized trading. These powerful systems of algorithms make investment and trade decisions almost entirely based on certain patterns. These patterns occur in the charts of a stock and follow extremely precise pre-determined buy and sell targets based on the relative rules for the algorithm being used. Often fundamentals won t be factored into the decision making at all. Love it or hate it, we therefore feel that regardless of what opinions we may have of the fundamentals of the market, or what we feel SHOULD happen next, it is far more important to track what the patterns are saying. Once we know the pattern we can then utilize quantifiable indicators to look at what the smart money is doing. Based on this approach, we can observe how some of these techniques predicted the market crash of 2008 long before so called experts even started talking about it. We will break down the reasons into several categories. THE POWERFUL PATTERNS Upward Channel Break The most easily identifiable pattern on the S&P 500 is that of the longer term upward channel which can be observed by looking at a monthly chart dating back to the lows of While this is an upward moving pattern the rules almost always dictate that after three touches of the support line there is a very high probability of a breakdown correction to occur. As indicated in the chart below (fig 1) it can be seen that we have indeed touched three times and on the fourth touch on the week ending Friday Aug 21st, we broke through support and have confirmed this bearish move by rallying back to this line and being unable to break above it. This Rule of Three not only applies to upward channels but also to other highly traded patterns such as ascending and descending triangles, head and shoulders, rising and falling 34

35 wedges and almost all other oscillating patterns. Often investors are sucked into buying support they have seen touch multiple times feeling the more times support has been respected the better, however, it is quite the opposite. By understanding this rule, we can anticipate when big money is about to step in and short the stock and avoid getting sucked into buying into perceived support at the worst time. Head and Shoulders While this pattern is harder to recognize for many beginner traders, this pattern is one of the most highly probable and profitable bearish patterns to occur in a bull market. Normally signaling the top of the market is what makes it so effective. This is a pattern designed to fool investors and traders into thinking the stock is making new highs resulting in investors being lured into buying the stock right before it begins its downward decent. A head and shoulders pattern is characterized by a stock creating a symmetrical triangle up and down forming the left shoulder. This is followed by a larger symmetrical triangle representing the head and then a final right shoulder triangle usually of equal size and shape as the first. When this forms, it is assumed the stock/index will then breakdown to the amount of at least what the measurement of how large the head was. Also note that the breakdown occurs after three touches of the support line. 35

36 In the market meltdown of the top of the market was characterized by a series of this exact head and shoulders setup. (see fig 3 below) In other words, experts and news aside, the chaotic breakdown of 2008 was in fact a drop that was highly predictable and in fact where it dropped to and where it reversed from were levels that were almost exactly what the pattern of the head and shoulders had predicted. This illustrates how vital it is to understand the role such a powerful pattern plays in predicting big money moves. An example of how this pattern can be applied in current markets we can use it to observe the way the S&P 500 has been currently moving in recent times. As you can see in the chart it appears to be forming the beginning of yet another head and shoulders pattern and is perfectly timed with the other factors we will discuss later. If this were to continue, we have projected out what this would look like over the months to come. This would mean a likely 1600 target level on the S&P 500 at some time during the first or second quarter of These are rough measurements used but a prediction of what a head and shoulders would look like if this pattern were to confirm by breaking down from the area displayed in the chart. 36 A break much above the 2000 level would indicate a failed head and shoulders and that smart money is going a different direction. This would indicate us to go long and could see a test of the 2,100 level or a retest of the upward channel at 2,250 as it extends upwards to the right.

37 Understanding the Patterns of the chart is one of the most vital aspects of trading in being able to determine where the money is moving and also tells us the key levels at which the pattern dictates us to buy and sell with highest probabilities. THE SMART MONEY Money Flow There are two critical factors that we as technical analysts observe to track where the smart money is going. The first is an indicator called Twiggs Money Flow and is similar to Chaikin Money flow with a few adaptations to account for gapping and some other factors. Developed by Collin Twiggs, it is a method of tracking if a stock has the key factors that define a true uptrend. These qualities include: price making higher highs and higher lows higher amounts of money or volume trading in the stock each day closing higher and higher in its daily trading range whether the range is expanding or contracting If all of these qualities are in play traders agree this confirms an uptrend is truly in place and therefore the smart money is likely accumulating a position in the stock/index the indicator is applied to. If this is taking place the indicator will rise in value and continue to make new highs along with the stocks movement. However, if we see that the levels of the market or a stock is increasing and this indicator is in fact going the opposite way, it could quite likely indicate that a bubble is building. This is called the distribution zone and means the rally that the stock or index is enjoying is likely the smart money off loading their positions to the public before a big drop takes place. 37

38 Inversely, if we see that the price levels of a stock or the market are dropping but the Twiggs Money flow is moving opposite this, in the upwards direction, than this indicates accumulation is going on an a possible strong reversal could be coming in the stock. So let s apply this indicator to the previous scenario discussed regarding the Head and Shoulder pattern during the market crash of See below a chart of the S&P 500 with the Twiggs Money Flow indicator charted underneath the stock. Note, that as the market climbed higher and higher, eventually going into a sideways movement and then the head and shoulders pattern, the Twiggs Money Flow indicator was actually making substantially lower highs and lower lows and diverging (moving the opposite way). Now if we compare that to a weekly chart of the S&P 500 you will notice a strikingly similar image. 38

39 Of course we do not only apply this to the market but also for also for finding highly potentially powerful moves in stocks. We will discuss some recent trade setups we alerted our students to recently where the Twiggs Money Flow played a key role in being able to predict the major move in the market. In the below example you can see a chart of BBOX where you will notice a strong downtrend in place from the 21st of October 2015 onwards and you will notice that the money flow was dropping along with it. However as of the 17th of December all of sudden the Money Flow takes a sharp change to the upside and continues to make higher highs and higher lows as the stock continues to decline. This divergence tells us that accumulation is going on and that the smart money is starting to shift in the bullish direction. Now of course the trick is to pick the right timing for entering this trade. This perfect entry point occurred on the 2nd of February. Not only did the Money flow continue to diverge, but it also crossed above 0 making it an even stronger signal. At the same time we also had perfect pattern confirmation with the stock breaking its downtrend line as well as the 9 day exponential moving average and the 20 day simple moving averages that were previously holding this stock down. The resulting move produced almost a 50% profit for anyone entering the trade. 39

40 This divergence can also occur over a shorter period of time. For example below is a trade we took on BCRX. After a massive drop the stock was going sideways yet the money flow was going up sharply. We therefore took advantage of getting into the trade on the 2nd of March. If you were a stock trader and entered in at the open this would of a resulted in a 20% intraday profit. Instead we opted to go for the June $2.00 calls which had a 60% intra-day move. 40 Now let s take a look at a short setup. In the chart below we see a similar type of setup on LGF but with the opposite occurring. As you can see from the 23rd of June 2015, LGF continues to climb higher and higher in an upward channel. Now of course as we discussed earlier in this book we have already identified that an upward channel while it movies in an upward trend actually warns us of an impending break to the downside making it in fact a bearish pattern. Notice as the stock climbs higher and higher in its channel the smart money is in fact moving completely the opposite way. Once again the key is timing the trade and what you will notice in the chart below is that LGF touches the bottom trend line a total of three times (re-enforcing the value of the rule of three) before breaking below it strongly along with the Twiggs Money Flow breaking below 0.

41 This was not only a great potential stock trade but a trade where we alerted our students to the value of purchasing long dated put options on the stock that have since moved over 1000% as the stock dropped from $38.00 to its recent low of $18.00 Bond Traders The second key factor we look at when determining big moves of smart money is following the High Yield Corporate Bonds using one of the relevant ETFs HYG. Typically speaking in a strong bullish market money will flow into corporate high yield bonds showing confidence in Corporate America. If you observe the chart below you will notice that HYG indeed correlated with the S&P in 2008 perfectly. 41

42 It followed the market down in 2008 during the crash and reversed with it from the lows of However, in the middle of 2013 while Quantitative easing pumped more and more money into stimulating the market, the big money started to move the opposite way. This divergence was a key factor in how we predicted the crash of 2008 on June 6 along with the recent crash of the S&P back in July of Watching for when HYG is moving in the opposite direction of the S&P 500 is a fantastic way of predicting when big money moves are about to come and reversals in either direction of the indexes. OPEN RANGE One of the most incredible pieces of the puzzle to predicting big money moves in the market is one of the best kept secrets of stock traders but one of THE MOST POWERFUL methods I have ever discovered. So much so that it is up to 80% accurate in predicting the direction of the S&P 500 and major indexes for a 1-3 week period! The strategy is called Open Range. While there may be other interpretations of this term as it applies to the stock market this specific strategy is applied by observing the daily range of trading on the S&P 500 on the first trading day of the month as well as the monthly options expiration Friday. After the range on one of these days is set we are then watching for where the market closes in the days following to determine the bias of direction for the market. In the days following the Open Range day we are looking to see if the S&P 500 closes more than 3 points above or below the range set. Whichever direction this occurs in first will set the bias for the market direction until the next open range day occurs. So for example let s take the month of February of On February 1st the trading range of the S&P was a high of and a low of The following day the S&P 500 closed at , more than a 3 point close below the open range. 42 What this signal means in practice is that the markets bias should be negative. This could mean the market could continue dropping straight down, or at the very least it should close below the top of the range set by the 1st of the month i.e. close below

43 When the next Open Range day occurs on the third Friday of the month the Open range is considered to be reset and we are now looking for whether the market breaks higher or lower than this new Open Range to determine the bias for the next leg of the market between Options Expiration and the first trading day of the following month. This is a key signal to us to decide which direction we will scan for high probability setups in for the immediate trading days/weeks following these breaks. Our research over the last several years shows this to be up to 80% accurate in prediction market direction. 43

44 SCANNING FOR THE PERFECT STORM Of course in this book we started off by discussing the critical importance of understanding the pattern is in order to know how to trade it. Ultimately trading should never be about guess work or going to bed stressed over positions that feel more like unhinged gambles than educated, well managed trades. Of course this is the whole purpose of understanding how to correctly identify what pattern a stock is in, and then of course to be able to decide whether that pattern is one of the highly probable and profitable patterns worth trading, or a more unreliable one we are better of passing over. This is where scanning becomes an extremely powerful asset in our trading arsenal. Once we know what the highest probability patterns are we can scan specifically for only those. However this is only the very beginning, we can also build into the scan all of the above conditions discussed throughout this book to search for opportunities where we not only have one of the highest probability patterns, but where all the other factors discussed are coming together in a perfect storm to predict a major money move. By utilizing scans it allows us to therefore specialize in only the highest probability setups and strip away all the noise that distracts us into bad trades. We can also then become highly effective in knowing the exact rules of how to trade a small handful of patterns rather than trying to be an expert at everything, which is almost impossible. 44

45 SUMMARY As market technicians we are basing the ideas of the book on rules and measurements drawn from practices that have proven to work over 1000 s of other setups just like this, however the key to any long term success in this market also relies on the ability of an investor or trader to know when the idea has been proven wrong and never lock oneself into any one mindset that can t be changed if the data goes the other way. We are therefore always watching closely to how the markets perform and key dates such as Open Range to anticipate whether we are on the edge of another large drop or a huge rally. Once again, for those of you wanting to learn more about the charting techniques and smart money calculations we use along with other key techniques to track smart money activity, you can simply follow the link below to receive instant access to our workshop on this topic along with ways to profit from a major market correction. THE SPECIAL OFFER If you have liked John s approach, CLICK HERE TO VIEW his Market Madness: My Favorite Strategy To Trade The Current Environment class. 45

46 ABOUT THE AUTHOR John Seville is the Master Stock Trader of the Acorn Wealth Corporation. John grew up in a family very much involved in the mining arena that spent a great deal of time discussing fundamentals and stocks over the dinner table. John became exposed at an early age to the stock market and would watch the massive rise and falls of many of the mining companies he was observing. It became evident at this point that despite fundamental research there were terrific moves in stocks prices both up and down that the fundamentals didn t seem to be able to account for. Since then, John has spent the last 11 years mastering the art of technical analysis as a method of finding trading opportunities in the North American equity markets. Using such techniques John and the other Senior Traders at Acorn Wealth Corporation were able to identify exit points on the market prior to the crash in June 2008, again in April 2010 and most recently in July Acorn Wealth Corporation opened in 2007 to become one of the few places where students could go to learn such powerful techniques directly from their mentors. 46

47 Buying Out-Of-The-Money Options By Jonathan Rose, ActiveDayTrader.com I have heard it all when it comes to buying out-of-the-money options. Some of the most common things I hear are I was taught never to buy OTM options, they are too risky People who buy OTM options always lose money I only sell options- that way I win most of the time When I hear things like this (which is more often than you may think), it validates my affection for these trades. Why? I have two particular reasons: 1. If a large group is afraid to make a certain trade that creates opportunity for others who know how to value these instruments. 2. If the selling of options is commonly seen as the safe, reliable, or easy trade, then it will naturally depress the price of the options (the crowd prefers to sell rather than buy). Option market makers know this and price them lower to take advantage of the crowd s bias towards selling. I completely understand this thinking and up until 2011, I was not a consistent buyer of outof-the-money options either, but then something happened that had a drastic effect on my approach. In 2011, I started working as a market-maker on the Chicago Board Options Exchange (CBOE.) As a market-maker, you re required to make prices on a minimum number of stocks. For me, I would make markets on over 100 names and on every strike within those 100 names. Some quick back of the napkin math stocks, 10 strikes for each stock, calls and puts, 47

48 and at least 3 expirations that s 6,000 active markets all day, every day. I think you can see that valuing options to the $.01 is a key element for survival as a professional market-maker. The opportunity to be a market maker was special at the time and making money was somewhat easy. I do not want you to misunderstand when I say easy, I mean in relation to other trades or markets. A market-maker s job is to ensure that all strikes have a market so customers of the exchange can trade freely. When an option contract is particularly illiquid, the market-makers can price themselves in an extremely wide spread. By wide, I mean they re only willing to buy and sell at extremely advantageous levels. In 2011, if the last trade in a given strike was at $1.00, the market-makers would be $.60 $1.40. At the time, market makers had an implicit understanding (not formal) that we would keep the markets somewhat wide (in this example $1.40). We knew that if markets were tighter we could lose our edge and thereby cannibalize our business. It was in everyone s best interest to protect the wide spreads. The table below shows how the bid/ask spreads narrowed over the years. In the column to the far right you can see who benefits and how the edge has shifted from the professional market maker to the retail customer. Here is another example: If the last trade in an option is $1.00, and I m the best bid for $.60 another market maker could easily be $.65 bid. If I wanted to be the best bid I could go $.70 bid and we could do this dance until the markets are $.99 bid at $1.01. The result of market-makers competing against one another would be destroying the business. 48

49 Then something drastic happened the robots came and they didn t play fair! Who are the robots? The robots are automated market-makers that use algorithms to make markets more efficiently than humans. The effect is an increase in volume for the exchange and better markets for the retail traders. The machines were content trading for a small EDGE in each transaction whereas the humans need wider markets to compensate them for the risk. All this change is good because the markets were evolving and creating opportunity for those who can properly value options. So now, what s a professional option trader do? Independent market-making was no longer a viable option because the robots were backed by the deep pockets in the industry. It was time for a change, and if the market-makers were losing edge someone had to be capturing edge. Do you know who was grabbing that new found edge? Retail Trader: An individual investor who buy or sell securities for their personal account, and not for a company or organization. Professional Trader: An individual who makes their living from trading as their primary business. You, The Retail Trader! And now Me, the retail trader. (because those who hang around are doomed to failure). A trading EDGE is an observation or approach that creates an advantage over other market players. For long term success, traders need to find their EDGE and when it s lost- it s time for a change. EDGE is a trader s lifeline! In trading, I always follow the edge because if you stick with a bad trade long enough, it s just a matter of time before Mr. Market wins. In this business, when trades fundamentally change, you have two choices: either change and adapt, or, find another market to trade As retail gained the edge, I headed in that direction- and here is the reason as the bid/ 49

50 asks tightened in the options market, names that had wide (untradeable) markets in the past were now TRADEABLE. Names that used to be $.80 wide on every strike, now had bid/ask spreads that were down to $.20 and sometimes $.10. And that s great for the retail trader and now it s great for me too! Here is an example: $PACB (Pacific Biosciences of Ca. Inc.). As you can see, $PACB is an extremely volatile biotech stock. I ll speak from personal experience because I would NEVER make a market that s $.20 wide on a name this volatile. Never. Ever. Ever. Thanks to automated market-making, we can now pick our side on high flying stocks like $PACB. Let s look at the 12.5 strike: $.60. That s a great market for the retail community. It is fair and it is tradable (we can transact if we choose). The 7.5 Puts look good too. Notice how the markets get wider further from strike ($15 strike: $.40) this makes sense to me because even automated market makers have no interest in selling little out-of-the-money options on an extremely volatile Biotech stock. Maybe in a few years (if we re lucky) those will alsobe $.10 wide 50

51 Over the last couple of years, I have become laser focused on finding out-of-the-money options that the market has priced inefficiently. By inefficiently I mean the option prices are too low for how much movement there is- or the options are priced in a way that is too disconnected with how the stock historically behaves. I no longer have an obligation to make markets on 100 s of stocks. I now have my pick of the litter and can trade any option I choose. Here s what I like to do: I sift through 100 s of stocks, 1000 s of strikes using the skill-set I learned as a market-maker and apply that to finding out-of-the-money options on speculative stocks. This is where the automated market makers are making poor markets and this is the area I try to exploit. Let me walk you through an example using $ABC stock: What do we know about $ABC stock from its chart? 51

52 1. $ABC is trading at its highest level of the year. 2. $ABC s range of the last 3 months: High Trade $45, and a low trade of $18 so the range in the first 3 months of the year is $ This stock is extremely volatile based on the 3 months of data in the chart. $ABC actually doubled in price in the last 14 days of trading. Let s look at $ABC again but this time instead of looking at the last 2 months of data, let s dig deeper and answer these important questions. 1. How much does $ABC move per month? 2. How much does $ABC move every 10 days? 3. How much does $ABC move per day? The above chart breaks $ABC into different time-frames. It is the same as the previous chart but it provides more data. From this data we know the range (the difference between each month s high and each month s low): 52

53 Let s analyze further, what s the movement if we look at $ABC in 10 day increments? We have an idea of how $ABC has behaved over the last 60 days and we re going dig further but we need to cover straddles because that s going to be the key to how we value $ABC s options. STRADDLES The first thing when looking at a new options chain is to value the straddle. Definition: Purchase or Sale of an equal number of puts and calls with the same terms at the same time. A straddle buyer would buy at-the-money calls and at-the-money puts on the same stock. If the underlying stock significantly increases or decreases and the new value of the call or put is more than the cost to purchase the original two positions- you profit. The 53

54 opposite of the buyer is the straddle seller. The seller shorts the at-the-money call and the at-the-money put. Why does someone buy straddles? Here are a few reasons: 1. In anticipation of an implied volatility increase. 2. Betting that either the call or the put goes far enough in the money to make it intrinsically worth more than the call and the puts originally cost. If everything is held constant, then the option will lose value has time moves closer to maturity. This rate of decline is known as THETA, it s also referred to as time decay. 3. You can never lose more than the cost of your straddle and your upside is unlimited. 4. Time (theta) hurts the trader that s long the straddle. They need movement and they need it NOW! 5. When the underlying moves, long straddle holders get long stock on the rally and short stock on the break. Example: $ADT stock is trading $10. The closest month expiration is 5 days away and the $ADT at-the-money straddle is trading $1.00 (the 10 strike calls are trading for $.50, and the 10 strike puts are trading at $.50). In this example, the market is telling us that $ADT is priced to move $1.00 in the next 5 days. If we buy the straddle for $1.00, we are betting that $ADT moves more than $1.01, either 54

55 up or down before these options expire in 5 days. The seller of the straddle is betting on no movement. Here is a trick I use when looking at a new options chain and it s actually the first thing I do. Figure out the value of the straddle and use that information as a 50/50 bet of the underlying expected movement until expiration. Let s look at the example below. Above is the option chain for Facebook stock last trade in $FB is $ What can we learn? 1. Options expire in 338 days: Jan 20, The expected movement within 338 days is roughly $29.50 a. $100 straddle: $16.00 for $100 calls and $13.50 for $100 puts. 3. Buyers of the straddle need $FB to move $29.50 higher or $29.50 lower. a. Time passing hurts (theta) b. Stock movement helps (volatility) 4. Sellers of the straddle need $FB to stay within the straddles range: $ $ a. Time passing helps (theta) b. Stock movement hurts (volatility) 55

56 What about delta? Delta shows the amount of movement we get in the option if the underlying moves $1.00. The $110 calls have a delta of.4926 if $FB rallies $1.00, $110 calls rally $.49. Here s a trick for delta it can be used as the percentage chance the option has to expire inthe-money. For the $110 calls, these options have a 49% likelihood of landing in-the-money and the $85 puts have a 25% chance to expire ITM. Now that we have an understanding of straddles, let s go back to our example of $ABC stock. Earlier we established the 10-day range for the last 60 days was: $10, $11, $13, $10, $14 and 9: The average for these periods = $ Next, using those 10 day increments we broke the movement down into average daily movement of $ABC. And here s the average daily movement numbers: $1.00, $1.10, $1.30, $1.00, $1.40 and $.90: The average daily move using this data = $1.12. So our findings show us this: Using the last 60 days of data from the $ABC chart, the average 10-day range: $11.17 Using the last 60 days, the average daily range was: $1.12 Now for the fun part Let us look at $ABC s straddle (last trade $45) 56

57 Straddle = $6.00 $3.00 for the 45 calls + $3.00 for the 45 puts Straddle seller needs $ABC between $39 and $51 Straddle buyer needs $ABC higher than $51 or lower than $31 Do we think $ABC will trade over $51 or under $39 in the next 10 days? We know this: Over the last 60 days $ABC s average daily range = $1.12 The Average move for each 10-day period for the past 60 days is $11.17 If $ABC continues its $1.00 range and it goes up $1.00 every day for 10 days that s a $10 move. If $ABC moves up $.50 every day for 10 days that s a $5.00 move. So, moving $6.00 in 10 days when the stock only moves $1.12 a day does not seem very likely. It doesn t seem like its 50% likely either, which is what the straddle is suggesting. This information tells me $ABC s straddle is excessively expensive. Stocks gyrate back and forth even when making big moves. If $ABC moves $1.00 a day, then a $3.00 straddle would be a much more appropriate value for the straddle. 57

58 If presented with this trade: I would aggressively sell straddles in ABC. THE MOVIE CLICK HERE to watch Jonathan value options against the live markets. THE SPECIAL OFFER ADT PREMIER MEMBERSHIP Premier Member Only ADT Week Ahead Every Sunday evening ADT Premier Members receive Jonathan s Week Ahead spreadsheet and video. This is Jonathan s game plan for the week. The plan includes actionable trade ideas in stocks and options covering many different strategies. Members can expect 10 or so trades every week. Premier Member Only Videos Monday - Friday Get daily insight into how Jonathan is managing the Week Ahead trades. include Premier only education, and market commentary. Videos also Friday Week in Review In this video Jonathan reviews the trades for the week. He answers these important questions: what worked, what didn t, and can we get better? This is the time to review and improve. Weekly Trade Alerts Throughout the week, Jonathan shares trade alerts. These alerts include fresh ideas, and how Jonathan is managing his open positions. Discounts 58 Premier Members receive discounts on all workshops.

59 Webinars Once a month, we offer info-packed workshops where Jonathan delivers the knowledge to make you a successful trader. TRY IT OUT FOR 30 DAYS! JUST $7. After 30 days you will automatically be billed the normal membership rate of $97. You may cancel at any time. ABOUT THE AUTHOR In 1998, Jonathan Rose began his career on the floor of the Chicago Mercantile Exchange. As a pioneer of computer based trading, Jonathan was a key player in providing liquidity to the young Globex market. After 5 years trading the Nasdaq Futures he was recruited to join a technology-focused, fixed-income trading firm. From 2003 to 2010 Jonathan was one of four Senior Partners at a proprietary trading firm in Chicago. Later on, from he became an Equity Options Market Maker on the CBOE. He developed and managed his own portfolio, actively trading 100 plus stocks concurrently. In 2014, Jonathan joined a private Family Office (Hedge Fund) in the suburbs of Chicago. He worked with the firm s investment team designing and implementing a pair trading investment strategy that focuses on Closed End Funds. Jonathan graduated in 1997, from University of Miami, FL with a B.S. He is a 2015 Level 2 CFA Candidate. He spends his free time with his beautiful wife, two boys and his guitar. 59

60

61 Putting the Short Squeeze on Options By Mark Sebastian, OptionPit.com One of the most profitable ways to trade is to spot a short squeeze in a stock, commodity, or index. They happen somewhat often in individual names, less often in commodities, and rarely in an index. Thus we are going to concentrate on looking at stock short squeezes which happen extremely often. In this chapter I will discuss what a short squeeze is, how to spot one, and finally how to trade a short squeeze using option trades in the simple form with a follow up in the form of a video that walks through a complex option approach. What is a short squeeze? Think of a name that makes no sense to the average trader. The valuation of that company is WHAT??? So what? traders might ask themselves. The trader reads online that the company is grossly overvalued based on where the company s revenues and growth are at current levels. However, there are pundits and fanboys that are ecstatic about the name. What this company is doing is creating a totally new space that will change millions of lives! The long side might say, sometimes, but rarely, this explanation is right. Think of names like Facebook or Amazon that have faced doubts and proven themselves to be worth the hype. More often than not though the non-sensical valuation turns out to be true. Thus, a short squeeze is really created by two sides; on one side is a fundamental, if nonsensical demand for the company s stock. This side truly believes in the vision and is willing to buy the stock up on this vision. On the other end is the widespread fundamental view that the company is not worth its current trading price and should be significantly lower. The result ends up, typically, crushing both sides of investors and making traders a lot of money if they know how to trade it. 61

62 Now that we know the fundamentals behind a short squeeze let s discuss what causes the squeeze to happen. It all starts with stock loan. Recall the basic definition of a short selling (or shorting) from Investopedia: 62 Thus, basically a short seller is selling stock that he or she doesn t own, but rather borrowed. This is where things get interesting. The process for borrowing stock is not as simple as it might seem. Here are the steps: 1. Have a portfolio margined account with a clearing firm that will allow me to engage in borrowing stock (no easy task especially given new regulations). 2. The trader tells the clearing firm that he or she would like to short stock XYZ. 3. The clearing firm then finds a locate on the stock, matching the short seller to someone that is willing to loan out his or her stock (this is where things get tricky) 4. If the stock is widely available, the clearing firm lets the trader borrow the stock, the stock is sold, the net proceeds are placed in an interest-bearing account 5. If the stock is NOT widely available, the clearing firm may charge a short rate on the stock. The short rate can be over 50% of the value of the stock. The higher the rate, the less stock is available to loan. These types of stocks are called hard to borrow. 6. Hopefully the stock goes down 7. The trader covers the stock he or she bought, and returns it to the loaner.

63 Step 5 is where things can go off the rails, and step 5 is what creates a short squeeze. Almost unilaterally, stocks that are hard to borrow are the ones that create short squeezes. To the point that if a stock is easy to borrow, I do not bother looking for a short squeeze set up as they are so few and far between. The Short Squeeze If a traders truly believe that a stock is toast, they typically do not mind paying the short rate on the stock because they are very certain the stock is going to go down. However, the danger is in that it means there are very few shares to borrow. Worse yet, clearing firms do not operate fairly. If a trader does a ton of business with the clearing firm or has more money with them, the trader s access to stock will be better than a less profitable customer. This puts the short in a position to get beat... badly, creating the squeeze. The squeeze begins with the trader getting a phone call that he is on the hook for short stock. This means that a customer that WAS loaning out shares is considering selling his or her position. On the hook, means I might get my short position taken away from me. In this case I have two options: 1. Cover the stock myself and return it 2. Close my eyes and hope I don t get bought in by the clearing firm Typically most people would rather choose the former. This increases buying demand in the stock, typically driving the stock higher. At the same time the general public and day traders start buying up the stock as its now a hot stock and a mover. They may or may not put their stock up for loan. The stock being higher, also typically causes the customer to sell rather than hold, and the stock that was loaned is off the market, met with typically less supply. Given the rally in the stock others step in to try to sell the rally in the name, or the trader moves to sell the stock the next day again. Thus, the supply of stock to borrow is lower and the supply of short traders is higher. 63

64 This can turn into a nasty cycle of a stock moving higher and higher and higher. Especially because smart firms can take supply off borrow and not actually sell the stock. At the end of the squeeze, all of the short stock sellers that do not have the capital to stay short cover the stock. The stock can be double its price or more...thus crushing the shorts. Then, the squeeze over, the firms that took their stock off loan dump the stock. This crushes the guys that jumped into the hot stock as the underlying drops and drops and drops. Typically below where the short squeeze begins, until all of the hot stock longs are out thus crushing the uninformed longs. Spotting the Short Squeeze: The short squeeze is easy to spot from a chart perspective. If one is looking for them to trade, start by asking your broker for a list of stocks that are hard to borrow and what the rates on that hard to borrow might be. The higher the rate the harder that stock is hard to borrow. The next piece is to look at the stocks daily volume. In this case we are looking at Transocean: RIG Source: LivevolX Next look for a day where the volume is well above the average daily volume followed by another. In conjunction with a nice increase in the stock s price, typically coming off of a tough couple of days, or some days of choppiness in the stock. 64

65 Here is RIG on the 1st: Source LIVEVOLX Then RIG on March 2nd SOURCE LIVEVOLX Then the following morning there will be a HUGE increase in volume that leads toward a volume day amounting to likely near double the stocks normal average daily volume. In addition the stock will likely be up BIG on the open but despite the pop is likely to keep going. The is shorts getting squeezed out by margin calls and stock buy-ins. 65

66 RIG on March 3rd Source LIVEVOLX This is the time to make the point to go long the stock. However, one might want confirmation of a squeeze. It s actually easy to confirm, take a look at the option implied volatility of the options. At the first move, the IV may go down as hedger and other market participants adjust risk on a rally. Additionally, IV has a natural inclination to fall when stocks start to rally. However, after an initial drop in IV, the IV will start to rally. See the structure of RIG below: LivevolX Notice IV is ticking up with volume and the stock, this is unusual. One can then see what the IV does the next day. Intuitively, what does one THINK happens to the stock? Below is the full chart for this data set notice the price action of RIG: 66

67 LivevolX This is the classic short squeeze, price action, volume and implied volatility all align to show that there is a major squeeze on. The key is to be patient and not to try to jump in too early, wait until all 3 factors happen: 1. Stock Rallying 2. IV Rallying 3. Stock Volume up well above ADV 2 days in a row and exploding on the opening of the 3rd day LivevolX Once this happens it is usually time to buy the underlying or set up a long trade using options. 67

68 Looking at GPRO, it s time to get out once the volume starts to dissipate in the name (one could look for a short set up but that is an entirely different chapter). Setting up the trade with options One of the beautiful things about a short squeeze is that it will allow the trader to set up a long trade that is somewhat simple. The IV tends to go up and up and up. And the stock tends to rally and rally, with intermittent random drops, but the IV will be stable on drops. The beauty is that if one gets in on the beginning of the 3rd day, often the option market has not fully figured out what is actually going on. There has yet to be a true rush for options. This makes call options look favorably However at option pit we typically hedge everything. Thus we will apply a directional delta to a straddle or strangle. In a name like RIG let s look at how we might have set up a strangle on March 2nd Take a look at the Option Montage from LivevolX We might look at RIG 10.5 straddle with about 3 weeks to expire. We might pay.87 and.55 for the strangle adding up to 1.32 debit for the straddle. Now recall this is the end of the day snapshot, not even the cheap levels that were available in the morning. This allows for the trade to do well if the stock moves back from whence it came (below 9 dollars) or if the stock completely explodes. Now let s look at how the directional delta works out the following day. 68

69 LivevolX While the S&P was up about 4 on this day RIG was up 17%. There is something going on in the energy sector. Now that the straddle has been a home run, the trader would typically dump all of the calls (looking in the huge win) selling them at The IV still has room to run, so the trader might then set up a new trade buying 13 calls (this time just out of the money) for about.75 or so. The trade now owns the calls and the existing puts and has a credit in his or her pocket. If the trade slows down for even a second, unwind the whole trade. A whole new short squeeze trade may set itself up. It can happen over the ebb and flow of trading multiple times. THE SPECIAL OFFER: Now you have seen how to set up a standard short squeeze, you might consider signing up for Option Pit Live. We are offering a special trial to Option Pit Live: Our subscription chat room and strategy letter for new and budding professional traders. This subscription is normally $ a month, but you can give it a try for just $ Even better, after your 1st month rather than $125, you pay $97 a month for this amazing subscription. This chat room will give you special access to Option Pit live traders that are considered 69

70 among the best in the world. Additionally, the subscription comes with some amazing education that only subscribers get for free. Non-subscribers pay big dollars for the same information. Option Pit Live Includes: The Option Pit Strategy Letter full of daily actionable ideas, adjustment & risk management strategies Free access to our Monthly Saturday classes when we delve deep into a subject, these classes sell for on our site at $ Daily Recorded lessons on management: The Pit Report 2+ Hours to Option Pit s Professional Traders All day access to Option Pit s Chat Room Special deals and free goodies from Option Pit Access to special deals on software and brokerage This offer will only be available for a short period of time. In order to make sure the chat room does not become diluted, this offer will be removed once the first 88 members sign up! CLICK HERE AND JOIN THE TEAM FOR A TEST DRIVE! 70

71 ABOUT THE AUTHOR Mark Sebastian is a former member of both the Chicago Board Options Exchange and the American Stock Exchange. He is also the author of the popular trading manual The Option Traders Hedge fund. He is a frequent guest on CNBC, Fox Business News, Bloomberg, First Business News. Sebastian has been published nationally on Yahoo Finance, quoted in the Wall Street Journal, Reuters, and Bloomberg and is an all-star contributor for TheStreet.com s Option Profits Team. Mark has spoken for The Options Industry Council, the CBOE, the ISE, The CME, and is a co-host on the popular Option Block Podcast and Volatility Views podcast. Mark has a Bachelor s in Science from Villanova University. 71