Trading Tops and Bottom s How To Trade Like A Professional Series II, Buying Debit Spreads
Why Do We Want To Trade Like a Professional? Leverage small sums of money can with potential to turn into large sums Trade products that enable the employment of capital in the most efficient manner possible
Why Do We Want To Trade Like a Professional? We can fish in a pond where the most explosive moves occur on a regular basis Options Penny Stocks Low Price Stocks Futures
How To Trade Like A Professional Program Objective In six months, develop proficient traders capable of selecting winning trades in penny stocks, low-priced stocks, defined-risk options trades and futures markets using a combination of chart patterns and a successful strategy and entry technique
Series II Objective Buying Debit Spreads What: Develop proficient debit spread option traders How: Provide traders with a blueprint for profitable trading that includes the use of position sizing, incorporating a method with a statistical edge, selecting the right stocks/futures, selecting debit spread strikes for option trades and hone basic skills to a razor-sharp edge
Agenda The Professional Trader s Profile Money Management Techniques The Statistical Edge Trader s Mechanics
The Professional Trader s Profile Money Management Velocity Position Sizes Employs a Statistical Edge Uses a Proven Method Applies Method to Right Trading Vehicles Masters the Basics Trading Platform Option Selection Order Entry
Money Management Techniques True Keys to the Kingdom Example technique from a business plan: Normal Environments: I will only commit < 35% of my trading capital to trades that meet my criteria and will commit no more than 1.5% of my trading capital on any trade. Take profits at 25% & 50%. Exit trade at a 50% loss.
Money Management Techniques Preceding example addressed the following: 1. Percentage of your trading capital allocated per trade 2. Where to take profits and where to take losses 3. How your money management program chnages in different trading environments
The Statistical Edge Use a method with a better than 50% win-rate For the Trading Like a Professional program we ll use Concept-1 (indicator- based) and Entry Technique-2 (chart pattern-based) Match the method to the appropriate vehicles; in this case it s stocks or futures with debit spreads
Concept-1 Trades with the trend Uses the MACD for trend identification and the CCI to measure the pull backs and rallies inside the trend MACD settings changes to 24,52,9 vice 12,26,9 CCI settings changes to 3-periods vice 14 and the line changes to a histogram
Concept-1 Example Bullish Setup, Betting that a Stock s Price will Rise In this chart, the MACD indicator is overlaid onto price. When the CYAN line is above the YELLOW line, a bull market is underway. Take only bullish trades. The trade setup for a bullish trade entry occurs when the MACD is in a bullish configuration and the CCI slaps the floor at -100. When this setup occurs, the setup is complete. Now you switch over to your favorite entry technique.
Concept-1 Example Bearish Setup, Betting that a Stock s Price Will Drop In this chart, the MACD indicator is overlaid onto price. When the CYAN line is below the YELLOW line, a bear market is underway. Take only bearish trades. The trade setup for a bearish trade entry occurs when the MACD is in a bearish configuration and the CCI slaps the ceiling at 100. When this setup occurs, the setup is complete. Now you switch over to your favorite entry technique.
Entry Technique-2 Entry Technique-2 (ET-2) is a chart pattern. You can use ET-2 with Concept-1 on any combination of timeframes. For our T&B service, I use a daily timeframe for the Concept-1 setup and a 15-minute chart for the ET-2 entry. Trading two timeframes is a multi-dimensional approach. The chart pattern for ET-2 is present at EVERY turn point in the market!
Entry Technique-2 Example Bullish Entry When Concept-1 triggers a set up in a bullish configuration, switch down to the 15-minute chart. Step-1 is to wait for the 15-minute chart to make a low. Step-2 is to let the market rally and put in a swing high. Step-3 is to place a bullish trade when price moves above the 15-minute swing high. Look at the example below. Top chart is the daily timeframe. Lower chart is 15-minute timeframe. Bullish setup on daily Step-2. Step-1. Step-3. Buy above the swing high (white horizontal line)
Entry Technique-2 Example Bearish Entry When Concept-1 triggers a set up in a bearish configuration, switch down to the 15-minute chart. Step-1 is to wait for the 15-minute chart to make a high. Step-2 is to let the market drop and put in a swing low. Step-3 is to place a bearish trade when price moves under the 15-minute swing high. Look at the example below. Top chart is the daily timeframe. Lower chart is 15-minute timeframe. Bullish setup on daily Bearish configuration Step-1 Step-2 Step-1. Step-2. Step-3. Buy puts or sell short below the horizontal line Step-3. Buy above the swing high (white horizontal line)
1. 2. 3. Mastering The Basics Understanding Expiration Cycles The three main expiration cycles we ll trade in: Short duration 7-14 days Used during volatile market periods Applies to all setups Avg duration 15-35 days Used when market is complacent Applies to all setups Long term 6 months 1yr Speculative Special setups & situations
Mastering The Basics What is a Debit Spread? Call debit spreads are bullish bets betting on higher prices; structured by buying a call and simultaneously selling a call further OTM both in the same expiration cycle Put debit spreads are bearish bets betting on lower prices; structured by buying a put and simultaneously selling a put further OTM both in the same expiration cycle
Mastering The Basics Why Use Debit Spreads? Trade expensive stocks very cash efficiently Structure trades for 50/50 bets Structure trades for long term lottery ticket trades
Mastering The Basics Debit Spread Characteristics Upside: Risk is defined to the price paid for the spread Downside: Maximum profit on trade is capped
Mastering The Basics Major Advantage(s) of Debit Spreads Over Call & Put Buying Debit spreads allow you to take positions in very expensive stocks or any other stock/futures contract where the price of buying a call or put prohibits you from making the options trade As long as the price moves to the short strike in your spread, you re at max profit at expiration
Mastering The Basics Structuring the ATM Call Debit Spread We want to make a bullish bet in GOOGL. We have a Concept-1 setup and Entry Tech-2 triggered. The stock trades for $1105 per share. Instead of buying stock, we buy a call debit spread with 30 days to expiration: 1. Buy the 1105 calls - Sell the 1110 calls; same expiry cycle; about 30 days to go 2. Your net debit (meaning what you pay) is 2.35, or $235 for every spread 3. Your max profit is $265 and max loss is $235 for each one of these spreads This is an ATM debit spread Notes: 1. Never pay more than half the width of the debit spread for ATM debit spreads. If you have a $5 wide spread like in our example above, never pay more than 2.50 2. Always try price discovery when putting the trade on; meaning try and place the order at the mid price or slightly below 3. ATM debit spreads have 50/50 odds and rely on your setup method to improve the odds of winning 4. ATM debit spreads are best used in trades with 20-45 days to expiration
Mastering The Basics Structuring the OTM Call Debit Spread Betting on Higher Prices We want to make a bullish bet in DUK. DUK has been pummeled. We believe that 6-months from now the stock, trading at $78 will trade back to $90. Instead of buying stock, we buy a call debit spread with 6-months to expiration: 1. Buy the 85 calls - Sell the 90 calls; same expiration cycle; 6-months or more to go 2. Your net debit (meaning what you pay) is.53, or $53 for every spread 3. Your max profit is $447 and max loss is $53 for each one of these spreads This is an OTM debit spread Notes: 1. These debit spreads are considered speculative because the probability of success is low 2. Always try price discovery when putting the trade on; meaning try and place the order at the mid price or slightly below 3. OTM debit spreads have less than 50% chance of making a profit 4. 6-months to 1-year is how much time you should give your spec plays to work 5. Always try and risk a minimum of 1 to make 8 or more in these trades
Mastering The Basics Order Entry Buying to open call debit spreads // Buying to open put debit spreads is the order entry jargon Always trade at the mid price or below when placing the trade Price discovery is when you get the trade on for < mid price Day orders are only good for the trading day. GTC orders are in effect until either you cancel them or the market fills your order
Mastering The Basics Calculating Debit Spread Prices BLUF-treat debit spread prices like stock prices. Debit Spread trades are displayed as a debit. For this example, we ll use 2.00 as the trade price for the spread. If you set an automatic exit price for your spread at a 50% profit, then the formula would be: 2.00*1.50=3.00. $3.00 is where you would set your Limit Order to exit at your profit target. If you want to exit your debit spread at a 50% loss, the formula is: 2.00-(2.00*.5)=1.00.
Mastering The Basics Structuring the ATM Put Debit Spread Betting on Lower Prices We want to make a bearish bet in DIS. We have a Concept-1 setup & Entry Tech-2 trigger. The stock trades for $110 per share. Instead of selling the stock short, we buy a put debit spread with 30 days to expiration: 1. Buy the 110 puts - Sell the 105 puts; same expiry cycle; about 30 days to go 2. Your net debit (meaning what you pay) is 1.21, or $121 for every spread 3. Your max profit is $379 and max loss is $121 for each one of these spreads This is an ATM debit spread Notes: 1. Never pay more than half the width of the debit spread for ATM debit spreads. If you have a $5 wide spread like in our example above, never pay more than 2.50 2. Always try price discovery when putting the trade on; meaning try and place the order at the mid price or slightly below 3. ATM debit spreads have 50/50 odds and rely on your setup method to improve the odds of winning 4. ATM debit spreads are best used in trades with 20-45 days to expiration
Mastering The Basics Structuring the OTM Put Debit Spread Betting on Lower Prices We want to make a bearish bet in SPY. SPY ia at all-time highs. We believe that 6-months from now the stock, trading at $280 will trade 10% lower, down to $255. Instead of selling the stock short, we buy a put debit spread with 6-months to expiration: 1. Buy the 260 puts - Sell the 255 puts; same expiry cycle; 6-months or more to go 2. Your net debit (meaning what you pay) is.69, or $69 for every spread 3. Your max profit is $431 and max loss is $69 for each one of these spreads This is an OTM debit spread Notes: 1. These debit spreads are considered speculative because the probability of success is low 2. Always try price discovery when putting the trade on; meaning try and place the order at the mid price or slightly below 3. OTM debit spreads have less than 50% chance of making a profit 4. 6-months to 1-year is how much time you should give your spec plays to work 5. Always try and risk a minimum of 1 to make 8 or more in these trades
Mastering The Basics Debit Spread Trade Management You can exit the trade any time; selling to close is the terminology used to exit a debit spread Your objective is to exit at a profit target prior to expiration If you go into expiration, understand what happens if you re at Max Loss / Max Profit / or between the Long & Short strike At Expiration Notes: 1. Max Loss. You have nothing to do. Long strikes and short strikes cancel each other out 2. Max Profit. You have nothing to do. Long strikes and short strikes cancel each other out 3. Between long strikes and short strikes. If you go into expiration and you re between the two strike prices (i.e. you bought the 150 call, sold the 155 call to create the debit spread and the stock is trading at 152.37 going into expiration) you need to exit the position prior to the close on expiration Friday. The reason being is that you could be assigned stock
Summary Trading Debit Spreads Buying call or put debit spreads are directional trades We choose debit spreads over call and put buying to allow us to trade high-dollar stocks ATM debit spreads are 50/50 propositions OTM debit spreads have less than a 50% chance of success