Trading Equity Options Week 4 - PDF Free Download

Disclosure All investments involve risk and are not suitable for all investors. The past performance of a security, industry, sector, or market of a financial product does not guarantee future results or returns. Prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options. Copies may be obtained from your broker or the Options Clearing Corporation at 1-888-OPTIONS or visit www.888options.com. Any strategies discussed here, including examples using actual securities and price data, are strictly for illustrative and education purposes and are not to be construed as an endorsement, recommendation or solicitation to buy or sell securities. The author of this presentation, and the content of the website www.tastytrader.net are in no way approved, endorsed, supported, or affiliated with tastytrade. We are a third party with interest in the tastytrade content, and the purpose of the information presented here is for education only. The ideas presented here are solely the views of the author, and are meant to enhance the ability of the individual investor in managing personal investments using the strategies and ideas set forth by tastytrade. 2

Discussion Questions from Week 3 When do you use a vertical debit spread vs. vertical credit spread and why? Which type of spread (credit or debit) has higher POP and why? Where does your risk lie when you sell an Iron Condor? Will Iron Condors perform best entered with low or high IV rank? How do Iron Condors make money if price stays stagnant? If you make the short strikes very far apart on the Iron Condor, do you get more or less credit? Have a better POP? What about your ROC? Do IC s get more or less credit at entry w/ large dist between short & longs? A variation of an Iron Condor is just a Condor. It is exactly the same trade using all puts or all calls. One of the verticals becomes a credit spread and one becomes a debit spread. Would you expect it to perform the same as an Iron Condor? Which is the better choice? Why? 3

Using tastyworks Durational Calendars Straddles and Strangles Butterflies Jade Lizard Continuing your Education Topic Summary 4

What are the unique features of tastyworks? Allows you to create options trades by dragging and dropping tiles onto a probability graph showing profit and loss areas. The Follow page allows you to follow the trades of notable tastytrade traders. The Grid page allows you to see curated list of notable stocks and ETF s. Portfolio page helps you view your portfolio to quickly see how each positions is progressing towards reaching your profit target. Analyze feature helps you keep track of your trades and ideas. Unique P50 feature lets you see probability of managing trade at 50% profit. 5

What are the metrics used in tastyworks? POP = Probability of Profit = Probability that the position will expire with at least 1 cent in profit. TROC = Tasytrade Return on Capital = Total amount of positive theta divided by capital used, divided by Days to Expiry assuming you have Reg-T margin. Extrinsic = Extrinsic value of option position (premium). IV Rank = Current level of Implied Volatility of Stock or ETF as related to itself. Grid Page = Curated list of stocks and ETFs highlighted due to predefined characteristics that may make them desirable to trade. Portfolio page lets you quickly see % of potential profit reached in each of your positions, as well POP, ROC for entire portfolio. 6

What are the limitations of tastyworks? No links to news or fundamental data No links to fundamental research Limited ability for detailed charts and technical studies Cannot yet be used to trade futures or forex No Paper Trading available 7

Screen Shot: Follow Page 8

Screen Shot: Grid Page 9

Screen Shot: Trade Page 10

Looking at POP and TROC on tastyworks Probability of Profit TROC = Return on Capital per Day Credit Received Extrinsic Value 11

Screen Shot: P50 Feature Probability of Reaching 50% of Max Profit 12

Screen Shot: Portfolio Page 13

Durational Calendars (not for earnings) Sell a near dated option and buy a longer dated option at same strike. Keep the time frames ~ equal between them; i.e. if short option is 30 DTE, long is 60. Use for products that have low IV rank; calendars are long Vega. Calendars make money when IV rises because the further dated option has much higher Vega than the near option, so an increase in IV will help the position. If you lean bullish, place the strikes slightly OOM to the upside and use calls. If you lean bearish, place the strikes slightly OOM to the downside and use puts. The short option has higher theta and will decay faster than the long option. When you price the calendar, make sure you do not pay more for the calendar spread than you collect from the short option. With different expiries, we cannot calculate max profit on this trade, but we can estimate it. Max profit occurs if price goes to the front month short strike at expiry. Calendars are pretty forgiving, but will lose if price gets far away from strike. Max Craig E. Forman loss www.tastytrader.net is debit paid; look to take profit at 25% return on debit paid. 14

Durational Calendars P/L Diagram The P/L diagram is always done at expiration of the near term strike. The peak of the P/L graph is always at the short, nearer term strike. There are two breakevens for the calendar, and max loss is debit paid to place trade. Calendar max profit is only an estimate because when the front month option expires we do not know what the IV of the back month option is (we can only estimate it). 15

Straddles and Strangles - Neutral The straddle and strangle are similar trades that are usually delta neutral but can be skewed for a little upside or downside bias. These use naked options so they have a lot of risk and use a lot of BPR. The straddle sells a put and call at the same strike, usually close to ATM. The strangle sells an OOM put and an OOM call (different strikes). These trades are placed for a credit, and max profit = credit received. For these trades, you want the stock to stay in a narrow range. These trades will be a winners if the stock moves less than expected. Since the straddle sells ATM options, theta decay is much higher, so the credit received is much higher than the strangle; take profits earlier. Max loss is undefined, so implement a strategy to close or adjust if loss exceeds your limits (i.e. twice what you received as a credit). 16

Straddles and Strangles P/L diagrams Delta Neutral Trades Straddle and Strangle Short Straddle Short Strangle 17

Butterfly - Neutral The butterfly is 3-legged spread that is usually delta neutral but can be skewed for a little upside or downside bias. Put on for a debit. The butterfly uses 3 put or 3 call options in a 1-2-1 ratio. You sell the 2 options in the middle (the body), and you buy the wings. This is called buying the butterfly ; you put it on for a debit. A butterfly is a relatively low cost, low probability, high ROC trade. Max profit is achieved if the stock expires exactly at the short strike, and is equal to the width between the body and the wings less the debit paid. Max loss is the debit paid, so this is a risk defined trade. Loss occurs if the stock expires too far away from the center strike. Best to put on with high volatility. Full profit cannot be realistically achieved. Making the wings wider increases cost, but you will have a higher POP. 18

Butterfly P/L Diagram Butterflies tend to expand near the expiration, so don t go out too far in time Variations are the Broken Wing Butterfly, Unbalanced butterfly, and some can be entered for a credit. The peak of the P/L graph is always at the short, near term strike. The butterfly can be done using two credit spreads, this is called an Iron Butterfly or Iron Fly. Similar to Iron Condor except squished together. 19

Jade Lizard Neutral to Bullish Jade Lizard is an OTM call credit spread with a short OTM put. The short put premium plus the call credit spread premium must be greater than the width of the strikes on the credit spread. This insures that there is no risk to the upside. On $1 wide credit spreads, we usually collect about $.70 from the short put and $.30 from the call credit spread. Max profit is achieved if the stock expires between the short put and the short call, and is equal to the credit received. Loss occurs if the stock expires below the short put, less the total credits. Takes advantage of Put Skew (by not buying downside put, you save $$). Lower breakeven (better) than naked put. You give up some upside profit. Can be used for earnings trades. 20

Jade Lizard P/L Diagram The P/L graph is similar to Iron Condor, but breakeven is lower on put side. There is only one breakeven for a properly constructed Jade Lizard. The credit is higher than for the Iron Condor because you are not buying the expensive OOM put. This adds unlimited risk to the downside. Notice Jade Lizard BE is lower than IC BE Higher Potential Profit for the Jade Lizard Loss at expiration is equal at this point 21

Watch these episodes: Homework Week 4 Best Practices 4/27/15 Calendar Spreads Know Your Options 4/20/15 Durational Calendars Mike and his White Board 8/11/15 Trading Strategy Long Butterfly Spread Market Measures 10/30/14 Premium Buying Butterfly Spreads Mike and his White Board 10/15/15 Trading Strategy Jade Lizard Karen the Supertrader (these segments are much longer than 15 minutes) Karen is a retail trader that started trading on TOS, and now manages over $300 million (other people s money). Her story is very inspirational. Unfortunately, her company is now under investigation by the SEC, but the story remains compelling. Search for karen supertrader tastytrade youtube on GOOGLE (not on tastytrade). A search on tastytrade will NOT pick these up. May, 2012 Karen s First Interview Oct, 2012 Feb, 2014 Aug, 2014 Karen s Second Interview Karen s Third Interview Karen s Fourth Interview 22

Developing as an Options Trader You understand risk management and are consistently profitable in all market conditions. Remember, markets change, so don t stop learning. You are making serious $$ and are building wealth. You are starting to develop a consistent positive P/L. You make a little, lose a little, make a lot, lose a lot. You experience large swings in your portfolio P/L. You now know more and you have some profitable trades, but you are still losing overall. You know enough to place trades but you generally lose money on most of them. 23

Continuing Your Education Continue your learning. You can take away something new from any free webinar that is offered. Don t commit to paying a lot for education unless you are sure that it answers your needs. Markets are not static; they change. So your trading must change also. Don t trade last month s chart. Find a trading buddy. Find a coach or a mentor that has more experience than you. Don t be afraid to continue to invest in your education. It doesn t take more than a couple of winning trades to pay for a course or mentorship that costs you a few hundred dollars. 24

Books and Blogs There are many popular books on trading derivatives. Here is my favorite: Mastering the Trade, 2 nd Edition, John Carter (a pretty easy read) Blogs are being used more frequently on a daily basis: www.shadowtrader.net Daily blog using market profile on the S&P futures. www.optionpit.com Mark Sebastian is an expert in volatility. He has a daily free video under the blog section of his website, talking about volatility and how to trade it. This is for more advanced traders. 25

Free Videos Many educators put out nightly videos, and then offer you a more detailed video each night if you pay a monthly fee. Try the free videos, and subscribe only if you like them: www.stockmarketmentor.com Dan Fitzpatrick (a great technical analyst) www.simpleroptions.com John Carter (author, trades stocks, options and futures) www.hubertsenters.com Hubert Senters (trades stocks and futures) https://theotrade.com Daily videos featuring Don Kaufman and Doc Severson. The ShadowTraders put out an excellent free video every Sunday evening, about 20 minutes long, summarizing the state of the market. Sign up at www.shadowtrader.net The Wallstreet Wrap-Up is an excellent 1-hour show recorded every Friday at 4:30 pm and covers the week just ended. Find it under Support/Chat Seminars on TOS. They are archived, so you can watch them over the weekend. 26

Class Feedback Please complete the class feedback form. It helps me and it helps the school. You are always free to provide any personal feedback (good or bad) to me at craig@tastytrader.net. All feedback is welcomed. I am happy to answer questions on anything as you continue your quest to become a successful personal portfolio manager. I also offer coaching and mentoring on one-on-one basis. Your first hour is free if you have taken my class. Email me if interested. GOOD LUCK IN TRADING! 27