The Ultimate Guide to Layups By Simon Curio Spill The Beans Research LLC.
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Welcome to the exciting world of Layup Spreads! If you have never heard of Layup Spreads before you are in for a life changing experience. If you already know what a Layup Spread is, you are now going to learn the A to Z way to trade them for maximum profits with as little risk as possible. YES, it is possible to make a living trading Layup Spreads! And Yes, you can do it as well. You do not need any formal education, or a genius IQ, or a ton of money, or any specialized information or tools. Anyone can do this. This includes you. The goal of this book is to get you up to speed as quick as possible and making profits quickly. There are plenty of courses out there selling for thousands of dollars that cover less than what I cover in this book. I am not holding anything back. All you need to make a living trading is contained in this book. Boom. Mind. Blown. This is so exciting I just want to get straight into it. But before we do that, you might be wondering, Who the heck is this guy and how can he make such claims? Well then, let me tell you. Why You Should Listen To Me Hi there. My name is Simon Curio and I am the head trader at
Cute website name huh? Simon Says Options. My name is Simon. Get it? As the head trader, I am responsible for all the trades we share with our members. I am also in charge of making sure the trading system I use continues to work. I do that by trading a lot, and doing a lot of testing to be the best Layup spread trader I can be. Lucky for me, and you it doesn t take a genius to trade Layup spreads. Heck, I dropped out of college twice, and if I can do this, you can do this. I got started with options a few years ago. I was tired of the 9-5. Actually it was more like 7-7 since I had to fight traffic going to and coming back from work and staying late most nights. Life was good. I was making a good income and my wife was making good money as well. But then she got pregnant. It was our first child. And I wanted to be totally part of the process. So I would accompany her on her prenatal doctor visits. It was amazing. Hearing the heartbeat for the first time is something I will never forget. But guess what? My boss wasn t so excited. And so when the economy slowed down and costs had to be cut, I was one of the first ones laid off. How s that for loyalty? That s when desperation set in. So I started searching online for ways to be my own boss.
No more was I going to let the man push me around. It was time to join the 1%. I wanted to become the man. I bought lots of courses and products that promised online riches. Most were rubbish. Some were good. The ones that interested me the most were the ones on trading. Trading for a living? Wouldn t that be cool? Heck, yes! Luckily I happened across a site called OptionGenius.com. I became a member and devoured everything in the members area. I would ask Allen, the owner of the site, questions almost daily for 3 straight months. I am surprised that he actually took the time to answer them all. I also researched everything I could on Layup spreads and began testing. Testing, testing, testing. I became a master of the thinkback feature on the thinkorswim platform. (it lets you do backtests). After months of papertrading and backtesting I started trading with real money. I was successful out of the gate. But I still had losses. So I kept testing and coming up with ways to avoid/minimize the losses. I found that when trading Layup spreads there are three major elements to focus on: Trade Selection Trade Management Capital Allocation I will be covering all three in detail in this book.
After almost a year of learning, I finally achieved the dream of being able to make enough from trading to take care of our monthly expenses. That was freedom! Fast forward to today. We lead a simple life. I don t have my own jet with my name on it or anything, but I am happy. I work from home. Can drop and pick the kids (we have two now). Meet friends for lunch, read, learn, explore my other interests and more. Since then, I have continued to evolve my trading style. I like to keep things as simple as possible. So although I know 15 different ways to adjust a Layup spread, I don t use any. I use the simplest method possible and it has provided me with excellent results. I love options. They have given me the opportunity to take care of my family and live the life I dreamed of. I wish the same for you. Welcome to the journey. If you put in the time and effort to learn, you too can achieve all your goals/dreams. I d love to hear from you. Please let me know you story. If you have any questions or concerns, let me know at help@simonsaysoptions.com Cheerio! Simon Curio
Chapter 1: The Basics of Layup Spreads I apologize in advance. This part of the book is a little dry. If you already know the basics of options and Layup spreads, then skip ahead to the end of this chapter to the section called: RECAP. If not, then stick with me and try not to fall asleep. It s important that you understand the basics. Oh, and there is a quiz at the end. Just kidding. What the heck is an option anyway? An option is a contract that gives its owner the right (but not the obligation) to buy or sell shares of a stock or some other asset at a certain price, regardless of the current market price. Here are some basic terms you need to know: An option to buy shares is a Call Option. An option to sell shares is a Put Option. The stock that the option is based on is referred to as the UNDERLYING. The price at which you have the right to buy or sell the underlying is the STRIKE PRICE. Option contracts represent 100 shares of the underlying. (There are mini options now, which are only 10 shares but we are not going to deal with those.) So one call gives you the right to buy 100 shares of the underlying at the strike price. And one put gives you the right to sell 100 shares at the strike price. An underlying can be a stock, ETF, index, or futures contract. All Options Have an Expiration Date
All options have a limited life span. Every option expires on a certain date. You can buy (or sell) options that will expire in a week, a month, six months, or two years. The more time until expiration, the more an option costs. How Do You Make Money with Options? There are two ways an option increases in price. 1. The underlying moves in the direction you want. 2. The volatility in the underlying increases. In general, when you buy a call, you make money if the price of the underlying rises. When you buy a put, you make money if the price of the underlying falls. You can also sell options. In that case, they work pretty much in reverse. For example, if you sell a call, you make money if the price of the underlying doesn't rise. In essence, you are short the underlying. What Determines the Price of an Option? The overview below is not meant to give you a complete explanation of option pricing. There are books devoted to this subject that you can read if you ever have trouble sleeping at night. What I want to share with you are the basics to get you started as quick as possible. There are several factors that affect an option's price. Some of the most basic ones are: The price of the underlying The strike price of the option The amount of time left to expiration One thing about options that may be confusing at first is that factors affecting option prices sometimes work in opposing directions.
For example as time passes and an option's expiration date grows nearer, the option will tend to lose value. But if the price of the underlying is moving in the right direction (up for a call, down for a put) the value of an option can still increase over time. Intrinsic Value and Time Value The value of an option is made up of two components: INTRINSIC VALUE and EXTRINSIC VALUE also known as TIME VALUE. The intrinsic value of an option depends entirely on the relationship between the strike price of the option and the market price of the underlying or, in other words, whether the option is IN THE MONEY or OUT OF THE MONEY. An option that's in the money has intrinsic value. An option that's out of the money has no intrinsic value. But all options have time value. The time value of an option depends on how much time is left to expiration, as well as how far the option is in or out of the money. There are some other factors, as well, but for now, just remember this: the time value of an option goes to zero at expiration. Example: IBM is trading at $100. A Call option with a $95 strike, has an Intrinsic Value of $500. How do I know? Because it is $5 In the Money. If you buy this option, you can buy the shares at $95 each which you can then sell in the open market for $100. This Call also has time value. So its total value is more than $500. A Call option with a $101 strike price has ZERO Intrinsic Value because it is Out of the Money. But it still has time value. In The Money or Out Of the Money: Calls
Let s define what "in the money" means for a call. When the strike price of a call is below the current market price of the underlying, that call is in the money, because it gives you the right to buy shares of the underlying for less than the current market price. Here's an example. If you own a call on Facebook stock with a strike price of $90, and that stock is currently selling for $95 a share, your call is in the money by $5 a share. That's because it gives you the right to buy a $95.00 stock for $90.00 a share. Think about it this way. You could "exercise" your call to buy 100 shares of Facebook stock for $9,000, then turn around and sell that stock on the open market for $9,500. In the language of options, that call has $500 of intrinsic value. But as a practical matter, you don't have to exercise an option to cash in on its value. In fact, it's better to just sell the option. Here's why. If you own an option with $500 of intrinsic value, the option itself will be worth more than $500 right up until the day it expires. That's because the option also has time value. Conversely, when Facebook stock is selling for less than $90, a call with a strike price above $90 is out of the money because you could buy the underlying on the open market for less than the strike price of the option. So an out-of-the-money option has no intrinsic value, but it will have some time value right up to expiration. In The Money or Out of the Money: Puts Now let's discuss puts. Puts work in the opposite direction from calls. A put gives you the right to sell shares of the underlying at the strike price. So a put is in the money when the strike price is above the market price of the underlying.
For example, if you own a Facebook put with a strike price of $90 and the market price of Facebook stock is $85 a share, you could buy 100 shares of Facebook stock on the open market for $8,500, then exercise your put to sell those shares for $9,000. Once again, the intrinsic value of that option is $5 per share or $500.00. And, once again, because of time value, the option itself would be worth more than its $500 of intrinsic value until expiration. Time Value and Out-of-the-Money Options As you've seen, the intrinsic value of an option depends entirely on the relationship between the strike price of the option and the current market price of the underlying. An option doesn't necessarily have to be in the money to be profitable. If you buy an option and then the price of the underlying moves in the right direction (up for calls, down for puts), the option will gain value without being in the money. But, remember, the time value of an option tends to decrease over time. And as expiration gets nearer, it decreases faster. All options have some time value right up to expiration, but on the day an option expires, time value goes to zero. Essentially, the value of an out of the money option reflects the likelihood that it will end up in the money before expiration. Volatility and Options The 2 nd way an option can gain in value is if the volatility of the option increases. Volatility can spike up and down depending on what is expected to happen or what people are afraid of.
So normally, when a company is going to report earnings, the volatility increases and the options cost more. As soon as earnings is announced, the unknown is now gone and the volatility crashes along with option prices. Volatility also increases when there is a decline in price of the underlying. The most known instrument of volatility is the VIX, which is the ETF that tracks the volatility of the SPX (S&P 500 Index). When the S&P 500 drops, the VIX spikes higher. When the S&P 500 increases in value, the VIX moves lower. Normally with Layup spreads, we don t worry about volatility as much. That is because it does not affect the p/l of the trade much. It is commonly reported to sell options in times of high volatility. That s when you get the highest premiums. For Layup spreads, it doesn t matter. If we get a higher Layup for the sold option, we will have to pay a higher price for the long option so it works out only slightly to our benefit. When volatility is high, we do have the ability to sell farther away from the money. On the other hand when volatility is high, the underlying s price is probably bouncing around up and down much more than normal. Directional Trades vs. Non-directional Trades When you simply buy a call or put, you re making a directional trade because, for the trade to be successful, the price of the underlying has to move in a certain direction. When they work out, directional trades can be very profitable. But it is super hard to win on a consistent basis when buying options. You have to be right on: 1. Direction of the move 2. How much the move is going to be in $ terms 3. When the move is going to occur
If you are wrong on ANY one of these, your options will expire worthless and the trade loses. To make money consistently with directional options trades, you have to be a very skilled trader. Many new traders start with directional trading, but that Is probably why most traders quit options and feel that they are too risky. On the other hand, non-directional trades don't rely on the price of the underlying to move in a certain direction. In fact, they don t require the price to move at all. Be Cautious with Directional Trades When you buy an option, you can't lose more than you paid for it. And it's possible to make large gains very quickly. But correctly predicting the timing and direction of stock price moves is more difficult than it may seem. To be consistently profitable buying calls or puts, you need to be a very astute trader. There are three things that can happen to the price of the underlying after you buy an option. It can go higher, it can go lower, or it can stay pretty much where it is. Two of the three will cause you to lose money on your option. Even if the price of the underlying moves in the right direction, you can still lose money if it doesn t move far enough before the options expire. Introducing Vertical Debit Spreads
One way to minimize your losses on a directional trade is to reduce the cost of your position. You can do that by using a pair of options called a vertical debit spread. In the example from the previous section, you bought the Facebook (FB) May 100 call for $3.25. Here s how you could make that call part of a vertical debit spread. Instead of just buying an FB call, you would also sell an FB call with the same expiration date, but with a strike price that is farther out of the money meaning farther above the current price of FB stock. So, to create the vertical spread, in addition to buying the FB May 100 call for $3.25, you could sell a May 105 call for a credit of about $1.85. That Layup would reduce the net cost of your position from $325.00 to $140.00 (325-185=140), excluding commissions. Here s another bit of terminology you need to know. In the debit spread described above, you would be LONG the 100 call and SHORT the 105 call. (A vertical debit spread with puts would be set up exactly the same way, except that the strike price of the short put (the one you sell) would be lower than the strike price of the long put (the one you buy). This type of vertical spread is called a debit spread. Since the option you buy costs more than the option you sell, your broker will debit your account when you open the position. We ll get into Layup spreads shortly. What's the Catch? Of course, you don t get to lower your cost without giving up something. And what you give up by using a vertical spread is part of the potential gain you would have with a long call. When you buy an option, your maximum loss is limited to the cost of the option, and your maximum gain is theoretically unlimited. When you buy a vertical spread, your maximum loss is still limited to the cost of the spread, but as you ll see shortly, there s a cap on your maximum gain.
Results of the Vertical Debit Spread Trade Remember, we re assuming here that you bought a May 100/105 vertical call spread on FB stock. That means you bought the 100 strike call and sold the 105 strike call, with both options expiring at the same time. Now, let s start by assuming the price of FB stock is $105 a share at expiration as we did for the long call we looked at earlier. With the spread, as with the call, your long 190 strike call would have $500 of intrinsic value at expiration. That s because the market price of the underlying is $5 a share above the strike price of the option, and your call allows you to buy 100 shares at the strike price. Your short 105 strike call would expire worthless because it s just at the money (i.e., the strike price equals the market price of the underlying). As you saw earlier, the cost of this spread is $140 plus commissions. Lower Cost = Lower Risk + Better Returns (Up to a Point) By reducing the cost of your position with the vertical spread, you lowered your risk AND increased your rate of return. What you lose with the debit spread is the ability to capture additional gains if the price of FB rises above $105? For any price above $105, your short 105 strike call would be in the money, and any additional gains on your long call would be offset dollar-for-dollar by losses on your short call. Vertical Credit Spreads Now that you know what a debit spread is, we need to get into the meat and potatoes of this book. When you open a debit spread, you are BUYING the spread, so your broker debits your account for the net cost of the pair of options in the spread.
But you can also SELL vertical spreads. When you sell a vertical spread it s called a CREDIT SPREAD, because instead of a debit your account receives a credit when you open the position. Selling a vertical spread still involves buying one option and selling another on the same underlying, with the same expiration date. But with a credit spread, the option you sell is more expensive than the option you buy, because it is closer to the price of the underlying. The Layup Spread The layup, is essentially a credit spread but with a special twist. I call them layups because in basketball the layup is the shot with the highest probability of success. From now on I am going to refer to credit spreads as Layups and I will show you how I trade them. I will get to the twist I put on them in latter chapters. The way you make money with layup spreads is completely different from the way you make money with debit spreads. To begin with, when you open a layup spread, your broker will actually add cash to your trading account. But as you can probably guess, that s not the end of the story. That s because when you sell an option or a spread, you incur an obligation. Before we get into that, let s talk about the advantages of layup spreads. More Ways to Win Simply put, Layup spreads give you more ways to win. With a debit spread, the price of the underlying has to move in a certain direction by a certain amount by a certain time to make the trade profitable. With Layup spreads, you don t need the price to move in a certain direction. In fact, you don t need the price to move at all. That s why Layup spreads are called NON-DIRECTIONAL trades.
With a Layup spread, you make money whether the price of the underlying moves up, down, or doesn t move at all. UNLESS it moves far enough in the direction of your spread to put your short option in the money. As you'll see later on, the way we use Layup spreads, we make sure that is lowprobability event. As a net seller of options in a Layup spread, you benefit from time decay. Time decay is the fact that options lose value over time. When you buy options or debit spreads, time decay works against you. But with Layup spreads, time decay works in your favor. That s a significant advantage. The Risk in Selling Options Before you can really understand how Layup spreads work, you have to understand the risk involved in selling an option. When we buy an option, it gives us the right to buy or sell shares of the underlying at the strike price of the option depending on whether we buy a call or a put. If the trade doesn t work out, the most we can lose is the amount we paid for the option, plus commissions. But when we sell an option, we incur an obligation to buy or sell shares of the underlying at the strike price of the option, IF that option is exercised by the owner. By selling a call, we give someone else the right to buy shares of the underlying from us at the strike price of the option. By selling a put, we give someone the right to sell shares of the underlying to us at the strike price of the option. As long as our short option (the option we sold) remains out of the money, there s no danger that it will be exercised. And when the option expires, our obligation expires with it.
Once the short option expires, the premium we received for selling it is ours to keep. That's our goal with a Layup spread. Earlier you learned that when we own a call that s in the money, it gives us the right to buy shares of the underlying stock or other asset for less than the current market price. Well, if you think about it, someone has to take a loss for selling those shares below the market price. That someone is the person who sold the option. Similarly, when a put goes in-the-money, the owner of the put can exercise it to sell shares of the underlying for more than the current market price. And whoever sold the put has to make up the difference. When we sell an option, we are being paid a premium to assume that risk. If the option we sell is far out of the money, the risk is low and the premium is fairly small. If the strike price of the option is closer to the market price of the underlying when we sell it, both the risk and the premium would be greater. When we sell a Layup spread, we can choose the strike price of the option we sell. And we know the statistical probability that an option with a certain strike price will end up in the money at expiration. Plus, the other option in the spread, the one we buy, limits the amount of our potential loss on the trade. So we limit our potential loss and give ourselves a high probability of success. That s why Layup spreads work so well. More on Layup Spreads I'll start with an example that illustrates why we use Layup spreads instead of selling naked options. Let s say we sell a naked out-of-the-money call on "XYZ" stock with a strike price of $100. We collect $3 for selling the call, (that means $300 total since you got $3 per share and an option ties up 100 shares), then we sit back and wait for it to expire.
Since the call is out of the money when we sell it, that means the price of XYZ stock is somewhere below $100 at that time. Then, let s assume that just before expiration, some unexpected good news about XYZ Company suddenly causes the stock price to shoot up to $150 a share overnight. Oh oh. At that point, our short option would be in the money by $50 a share, because the call we sold gives someone else the right to buy XYZ stock from us for $100 a share. At expiration, assuming we don t already own 100 shares of XYZ stock, our broker would buy those shares in our account for $150 each and sell them to the option holder for $100 a share. Our loss on that one option would be $5,000 ($50 X 100 shares) minus the $300 of premium we collected for selling the option. Such an extreme move in the stock price is highly unusual, but anything can happen in the stock market. Exposing yourself to that level of risk will catch up with you sooner or later. How Layup Spreads Limit Your Risk If we sell an option as part of a Layup spread, our potential loss is limited. And we get to choose exactly how much risk we are willing to take. Here s how it works. In a Layup spread, we sell one option, and at the same time we buy another option on the same underlying with the same expiration date but farther out of the money. The option we buy limits how much we can lose on the trade. But there's always a trade-off. So in exchange for that protection, we receive less premium for selling the Layup spread than we would for selling a naked option.
The maximum potential loss on a Layup spread--and the amount of the Layup we receive--depends on how far apart we place the strike prices of the short and long options. For example, if the strike price of our long option is $5 away from the strike price of our short option, the most we can lose on that spread is $500 ($5 X 100 shares) minus the credit we receive for selling the spread. In the case of a call Layup spread, when we open the position we would place the strike price of the short call well out of the money--that is, well above the current price of the underlying. That reduces the probability that the option will end up in the money before it expires. Then, we set the strike price of the long call at least one strike higher. The farther apart we place the strike prices, the more premium we collect AND the more risk we re taking. In the event that the price of the underlying does rise above the strike price of our short call before the options expire, we would start to lose money. And our losses would increase if the price continues to move higher. But if the price of the underlying rises far enough to reach the strike price of the long call, our losses stop increasing. That's because when the long call goes in the money, it gains a dollar for every dollar the short call is losing. So, the long call caps our potential loss on the trade. Put Layup spreads work the same way, except in reverse. We would start with the strike price of our short put well below the price of the underlying when we open the position. And the strike price of the long put would be lower yet. The risk with a put Layup spread is that the price of the underlying will fall below the strike price of the short put before the options expire. The long put limits the potential loss on the put Layup spread exactly the same way as the long call limited the potential loss on the call Layup spread. Wait. How Do I Sell Something I Don t Own?
This is something most new traders have a hard time wrapping their brains around. We are selling an option without owning it. We create it. We bring it into existence kinda. Think of a life insurance company. When they sell you a policy did they take one off the shelf and give it to you? Do they manufacture policies in their Chinese factory? Nope. When you want one, they create it for you. Same thing here. When we want to sell an option, we place an order in the stock market. If there is a buyer, our order goes through and the trade is live. Boom. A new option is born/created/conjured or whatever you want to call it. That s why I look at selling options as creating money out of thin air. What happens at expiration? Two things can happen at expiration. 1. The option can be exercised. 2. The option can expire. As Layup spread traders we like options to expire. When they do they go POOF! And disappear. Just like magic. Actually it s more like a grocery coupon, but still who doesn t like magic? But they can also be exercised. What that means is the person who bought the call or put wants to use the option to either buy the shares (Call) or sell the shares (Put) to the person who sold him the option. The possibility of this usually scares newbie option sellers.
Fear Not. It s not a big deal. Options rarely get exercised before expiration. Why? Because the options still have time value. It makes more sense for the option buyer to go into the market to buy or sell shares instead of going through the exercise process. And even if you do get exercised/assigned, all you have to do is place an order with your broker to exit the shares. If you are given shares, just sell them. If you are short shares, just buy them back. I limit how much this happens to me, by not letting my short option get into the money. We will cover that later in the chapter on adjustments. Trading Layup spreads is a probability game. The goal is not to hit home runs. The goal is to make consistent gains, month after-month and avoid big losses Why Do We Like Layup Spreads Again? (Recap) The versatile Layup spread is designed to collect credit premiums when a stock moves up, down or sideways. Layup spreads are one of the most powerful tools a trader has in his arsenal. Why? Because it can be used no matter which way a stock is moving. Even if you are wrong about direction, you can still win. Let's see how. A Layup spread is a simple option trade in which the trader sells one option and buys another option farther away from the money. This results in a credit to the trader. This credit is the max amount that can be made on the trade and is deposited into the traders account as soon as the trade is made. Example: XYZ stock is currently trading at 100. A trader feels XYZ is a good candidate for a Put Layup Spread. This trader think XYZ is a great company and the stock is going to continue its uptrend. So he sells one 90 strike Put, and buys one 85 strike Put. The credit he receives is 60 cents.
In this trade the highest premium the trader can keep is 60 cents or $60 because each option is made up of 100 shares. The most the trader can lose is $440. This max loss is also the margin requirement the broker will require to be in the account to make the trade. We can calculate the margin/ max loss by subtracting the credit from the difference between the strikes. In this case 90-85 = 5. So $5 is the max loss per share. But the trader already got paid.60 per share for the trade so the max loss really is $4.40 per share or $440 per option spread. We calculate the return on our Layup spread options trade by dividing the potential profit by the amount used for the trade. 60/440 = 13.6% potential return on this trade. Ok so now we have the trade. But how does it work? Since we are short the 90 Put, we want XYZ to stay above 90. If it is above 90 at expiration (30 days in our example) then we get the keep the whole credit. XYZ could go up or it could stay around 100 or even down 10% and the trade still makes money. Even if XYZ goes below 90, as long as it stays above our breakeven point of 89.40 we still make money. In our example the trader thought XYZ was not going to go down. But if he thought instead that it was going to drop, he could have done a Call Layup Spread using Call options instead. The idea is the same except that he would not want XYZ to rise above the strike of the call option that he sold. In Summary: 1. With a Layup spread you choose a strike price that you think the stock will NOT move to. If your stock is trading at 100, and you sell the 90/85 Put spread, you win as long as the stock is not below 90 at expiration. The stock could move up, sideways, or even down a little and you still win. 2. Layup spreads limit your risk. You will know in advance how much you can lose if the trade goes totally against you. 3. Layup spreads can be set up to have a high probability of winning. I prefer to trade spreads with an 80% or greater probability of winning.
4. Layup Spreads are super simple to execute. Even those who have never traded options get the hang of it after practicing a couple times. 5. Layup Spreads offer very nice returns. I look to make at least 10% on every trade. Since each trade only lasts about a month, that can become a very nice monthly income stream. 6. You can get started with as little as $100 and scale it up to millions. There is no need to tie up capital owning stock. Cool thing about options: Options suffer from time decay every day. That includes weekends. All things being equal, an option will be worth less on Monday morning than it was on Friday afternoon because it is now 2 days closer to expiration. For an option seller, that is awesome. It s like being paid for two days without any risk since the markets are closed.
Chapter 2: Your Trading Account Now that we have covered the basics of Layup spreads, we get into the sometimes confusing world of online brokers. There are dozens of brokers out there. Most are good. But none are perfect. If you do not like yours, or if they limit what you can do in your account get another broker. For example, many brokers will not let you sell options in your IRA account. They claim it is against the IRA rules. LIE. You can sell Layup spreads in your IRA. I do it all the time. When choosing a broker, among other things you want to pay attention to costs as well as customer service. The more hand holding you need, the higher the cost. But if your broker provides a lot of educational material on their site including videos on how to use and enter orders on their order platform you won t need much hand holding. You do not need any sophisticated software to trade Layup spreads. I personally like the software offered by thinkorswim which is owned by TD Ameritrade. All you need to use it is an account. It does not have to be funded. If you want live quotes then you need to fund the account. $50 should be enough. Any broker that has the word option in its name is considered option friendly. Some of the brokers I have experience with are: OptionsHouse an autotrade partner of Eoption an autotrade partner of TradeKing an autotrade partner of TD Ameritrade (thinkorswim) Charles Schwab (OptionsXpress) Interactive Brokers You can trade options at places like Etrade, TradeStation, and others. But options are not their focus and their customer service reps usually cannot answer questions regarding options.
Opening an Account In order to trade Layup spreads you will need an account that is approved for Options Trading. There are actually several levels of trading ability. You want your account to be approved for the highest level of options trading, which is usually Level 4. You can trade stock and ETF layups at a lower level but the higher the better so that you are not limited in what you want to do. In order to determine what level to give you the broker will ask you a series of questions. They will ask about your stock trading experience, option trading experience, net worth, liquid assets, and risk tolerance. They do this primarily to protect themselves. If you have no experience and no money they will not allow you to trade at the highest level. Brokerages have been sued many times by people who lost all their money and then blamed the broker to allowing them to do so. I am not sure if answering the questions dishonestly is a crime, but I am pretty sure they do not verify what you tell them. If you are denied a high enough trading level it is because of your answers. Margin Make sure to have your account enabled for margin trading as well. We will not be using margin (borrowing) but it is required for Layup spreads. Unless you have an IRA, then you don t need a margin account. Commissions Every broker is different. Some charge a lot. Some charge a little.
I have a broker that charges me 50 cents per option. Another charges $1.00 When you are trading thousands of options that can add up. You can either get per option commissions, or a trip charge plus per option charge. In the beginning when you are trading just a few contracts, the per option commission is usually lower. Then when you trade in greater volume you can switch. And you can always negotiate your commissions. The more money you can put in your account and the more contracts you trade the better deal you can make with your broker.
Chapter 3: Layup Spread Math Ready for some math? Oh don t worry it s very easy stuff. Plus you ll want to know this math because this is how you will calculate how much you can make on a trade. By the end of this chapter you will know: 1. How to calculate the margin / max loss of a Layup spread. 2. How to calculate the potential return on investment of a Layup spread. Here is a potential trade: Sell March 490 Puts Buy March 485 Puts for.57 credit 490 and 485 are the strikes. We are selling the 490 strike and buying the 485 strike option. Thus we want the stock to stay above 490 for this trade to work. If we subtract the strikes we get 5 (490-485 = 5) This is what is meant by the difference between the strikes Keep in mind that each option contract is for 100 shares and so the amount involved in this trade is $500 Difference between strikes (5) x 100 = $500 Max Loss To find the maximum we can lose on this trade, we need to take the credit and subtract it from the difference between strikes.
Max Loss = Difference between strikes credit 490-485 = 5 -.57 = 4.43 If we multiply 4.43 by 100 we get $443 which is our max loss. Something to keep in mind: The max loss is also the amount required by your broker to enter this trade. You must have $443 in your account in order to make this trade. Max Gain The credit we received, (.57) is also the maximum you can make on this trade. In dollar terms.57 is $57. So the trade can make up to $57 and can lose up to $443. Potential ROI: To find our potential return on investment we divide the max gain by the max loss. Potential ROI % = Max gain/max loss 57 / 443 = 12.8% Risk/Reward? Wait a second. Did I just say we will be risking $443 to make $57? Yes. Isn t that a messed up risk/reward ratio? By whose definition?
What we haven t covered yet is probability of profit. But the above trade has over an 80% chance of winning. On the other hand, the person buying this spread can make a whopping 87.2%. Wow. But he has less than a 20% chance of it working in his favor. If you were playing blackjack, that s like having a 19 and hitting. Not a very smart move if you want to win in the long run. But still, if you lose $443 once, it will take 8 winning trades to get back to even. Right? Yes, BUT Who says you have to lose the whole $443? Just because that is the max loss, does not mean you should lose that amount every time you have a bad trade. If a trade was losing money and was not going to work out, you d be a bozo not to do something about it. The trick is to keep your losses smaller than your wins. NEVER Suffer a Max Loss. Later on, in the adjustment chapter we go over ways to make sure that does not happen.
Chapter 4: Finding Things to Trade So now you know what a Layup spread is and the basics of how it works. You also have an options account opened and funded as well as how to determine how much you can make and lose on a trade. Let s move on. Finding Underlyings To Trade In order to trade, we need to find an underlying to trade options on. Remember, an underlying is a Stock, ETF, or Index. Stock and ETF options are considered American Style Options. These can be assigned/exercised. Index Options are European Style Options.. These CANNOT be assigned early. These are cash settled which means that no stock changes hands. These options also get preferential tax treatment by the government. Make it Easy You can look for trades the easy way, or the hard way. The hard way is to constantly be on the lookout for trades. Watching financial TV, listening to financial radio, reading stuff all over the net looking for the stock that is going to be a great trade. I don t bother will all that. Why? Because after you hear about a great stock that is going to go straight up, up, up, you have to determine if it makes a good tradable stock. Does it have options? Are the options liquid? Do the options have enough volatility?
Are there enough strikes? Etc. The WatchList I have about 100 symbols that I watch. These have been pre-screened to make sure they have enough movement, enough strikes, offer enough premium, and more. I then follow the news on these and the charts. I trade these only when they are either: Moving in an uptrend Moving in a downtrend Or moving sideways (least preferred) And I never trade them in a month when their earnings are coming out or they have some large news event planned. This makes it crazy simple. During earnings season, when most companies share their quarterly earnings, I stick to trading ETFs. I could do that all year long, but I like the variety of trading stocks and ETFs and even Indexes (for my larger trades). The Charts As I mentioned before I only trade a symbol when its chart is moving in one of three directions. Straight up, Straight down, or Sideways. I am not a super-technical analysis junkie. I find that technical analysis is wrong just about as much as it is correct.
So please don t try to convince me a stock is going to move up because Fibbonacci or Bollinger say so. I use cups and handles for drinking and head and shoulders when I have dandruff. I don t use them in trading I use simple lines: resistance, support, channels. And I like to have the moving averages on my side: 30 day, 50 day, 200 day. That s It That s about it. When I want a trade, I go through my watchlist. I look at the chart for each, and look for the movement of the underlying. The ones that make my shortlist are the ones that are trending higher, trending lower, or moving sideways. I then check the 30, 50 and 200 day moving averages. If I am going to sell Puts, I want the averages below the stock price. If I am going to sell Calls, I want the averages above the stock price. Then I check to see if any news/earnings is listed to come out before the next expiration date. If not, then I love into determining what strikes to trade. Let s Test Below are several screenshots of stock charts. (these are daily charts) By looking at the chart, determine if the underlying is worth trading. Remember we only want the trending ones.
#1: Answer: This one seems to be moving up to sideways. I might take a stab at this one if I could not find a better one. Most likely a Put Spread.
#2 Answer: No way. This stock jumped/gapped up for earnings and there is no telling what it will do now. I would give this stock at least a month before I would consider it.
#3 Answer: No to this one. It looks like it was slowing trending down, then something happened and it jumped up. That would make me very cautious. Next.
#4 Answer: It looks like it is moving sideways in a defined channel. I see that the 3 moving averages (blue, purple, and pink lines) are all above the stock price. So if I were to trade this one, I would go with a Call Spread since it looks like the path of least resistance is to the downside.
#5 Answer: Another sideways mover. It did drop a few months ago and then recovered. But it looks like it is very close to resistance. Once it goes above the 133.97 price, which was it last high, I would consider it.
#6 Answer: Not really sure what this one is doing. It broke up, made a new high at 86.07 then faltered then got back close to the high, then faltered. Too confusing: Pass.
#7 Answer: This one looks ok to sell some Puts since it looks like it is moving sideways to up. I would like it to move above the 202.87 high first though.
#8 Answer: Need to wait on this one. It just made a high at 559.04 then dropped back to support. But is now trading below the moving averages.
#9 Answer: No Way. Had a huge gap down on earnings. Stay away for a couple months.
#10 Answer: If It breaks above 95.67 then yes I would sell some Puts. Otherwise this one might be breaking down. I like the way it bounced off the 200 day moving average (pink line). That is a bullish sign.
#11 Answer: Moving up to sideways. I would ve considered it except that the moving averages are not in synch.
#12 Answer. Nice one to sell Puts. Looks like it fell in price but has hit a low and is now making an upward move.
#13 Answer: Can t really tell. It s been a bit choppy moving up and down and up and down. I don t like it. Next.
#14 Answer: Looks like this stock had a reversal of fortune. It was moving up until it switched direction. Perhaps the drop is over and it is now stabilizing. But since I cannot predict the future and this one is too cloudy, I would skip it.
#15 Answer: Finally, a nice one. What a smooth uptrend. But wait, see that blue question mark? That symbolizes earnings. There is not enough time left until the 5/15/15 expiration and earnings is before the 6/19/15 expiration, so I will have to pass on this one. Results: I showed you the first 15 charts of symbols on my Watchlist. Out of 15, 3 are possible trades. This is the exact process I would go through to find suitable symbols. You can get more complicated by adding in other technical analysis tools. Good luck with that. I have found that using those tools leads to underperformance. I also do not look at the implied volatility of the options. Normally when an option has a high volatility it is more expensive than normal. You can look at that in your
search, but then you would need a lot more than 100 symbols on your watchlist and you end up trading companies you have no knowledge of. Not that you had any knowledge of these companies. But over time you would develop a sixth sense. You will be able to tell if a drop in a stock if legit or not. You will be able to tell if a stock is behaving properly or not. There are a couple charts above (ones that I passed on) that I would feel comfortable entering trades in because I know the stock and I have seen it act this way before. Also notice that I did not tell you anything about what these above symbols did. By that I mean that we did not use any fundamental analysis. That s because we don t need it. We will only be in the trade for about a month and the only thing that matters is the price action of the stock.
Chapter 5: Picking the Trade In this chapter we move past finding the underlying and choose the actual components of our trade: Expiration, strikes, risk/reward/ pop, etc. Expiration With options, there are set expiration cycles. There are weekly, monthly, quarterly and LEAP options. Weeklies last one week about. Monthlies come every month. Quarterlies come every three month LEAP are long term options that expire in January. You can trade any of these at any time. If it is January 1 st and you want to trade an option that is for the March expiration cycle, you can. The longer away from expiration you sell, the more credit/premium you will receive but the longer you will be in the trade and thus at market risk of something bad happening. Strikes A strike is the option that corresponds to a stock price. For example, the 50 strike Put means a Put that has 50 as its strike. If the stock is trading below 50, the Put is in the money. Risk/Reward The less risk you want, you less your reward. That is why Layup spreads don t make 100% gain. Because they are in essence too safe.
You actually can trade Layup spreads with a higher percentage potential profit but then the risk of losing is greater too. The closer you are to the money the greater the reward (profit potential) but the greater the risk of losing (ending in the money). For example: If IBM is trading at $100, and you sell the 105/110 Call spread you are only $5 away from the money. You will be paid a much higher premium than if you sell the 150/155 Call spreads which is $50 away from the money. Probability of Profit Using statistics, traders use models to determine the probabilities of different strikes ending in the money. You can easily look up the probability for any option using your broker s software platform. Or you can do the math yourself. I have traded hundreds of thousands of Layup spreads (live and testing) and I have never done this by hand. So I am not even going to bother to cover it. But there is a shortcut I will share with you. Every option has several greeks. These are different values that give an idea of how the option will behave if things change. For example, theta, is the greek for time decay. If an option has a theta of 1, that means that, all things being equal, the option will lose $1 of value everyday because of time decay. Delta is also an important greek for our topic. Delta tells you how much in value an option will lose or gain if there is a $1 price move in the underlying. An at the money option has a delta of 1. That means if the underlying gains $1 in price, a 1 delta Call option will also gain $1 in value. An at the money Put would lose $1 in value.
Call options have positive delta. Put options have negative delta. But for our purposes here you can ignore that. Let s say we sell a Call that has a delta of.25 That means that if the underlying move up $1, the option will gain 25 cents in price. This option is said to have a delta of 25. (In trading jargon the decimal is ignored.) The Probability of Profit shortcut is to take the other side of this delta. An option with a 25 delta, has a 75% chance of expiring out of the money/worthless. For you math geeks, that means that the option will expire out of the money 75% of the time with a 68% degree of confidence. (One standard deviation) You can go even further away from the money and get a 95% degree of confidence which is a 2 standard deviation move, but the premiums are very tiny. So 1 SD is enough for us. An option with a -.10 delta has a 90% probability of expiring out of the money. Simple right? It s not exact, but it is close enough if you don t have the capability in your broker s software. Only worry about the option you are selling (the Short option). You don t need the delta of the long option. The Simon Says Options Way At the site I stick to monthly options. But you can apply all that you learned here to weeklies as well.
Many people prefer weeklies because if you sell 4 weeks of spreads you can make a higher return than by selling a monthly spread. But since you are selling less time, you have to be much closer to the money and that increases your risk. The Simon Says Options Formula: - Monthly options - Trading stocks and ETFS. I love indexes too but I don t trade them for the service. - Choose from my predetermined Watchlist. - Uptrending or Downtrending in the charts. Sideways if I cannot find anything else. - I start a trade 25-45 days to expiration - Do not want earnings or any major new event before expiration. - Choose strikes at least 75% POP (Probability of Profit) - Look for at least 10% potential return on investment (ROI) - The spread (difference between strikes) should be at least 2 points. 5 is preferred. This cuts down on contracts and commissions. Can you deviate from these Rules? Sure. Create your own formula. Maybe you want to take more risk or less. Maybe you want to be in the market for fewer days. These rules work for me and are the result of thousands on trades. But they are for my temperament. Feel free to adjust to suit your own trading style.
Chapter 6: The Ins and Outs We covered the rules in the last chapter. Now I want to talk about getting into and out of trades. Getting in is easy. Just go through the formula/checklist in the last chapter. Step 1: Go through the charts of the stocks on your Watchlist to find a good one. Step 2: Open up the option chain for that stock and look for the appropriate month to trade. Make sure there are no new events coming. (The option chain is the page listing all the strikes and their prices.) Step 3: Based on the charts look at the Calls or Puts and look for the options that have a delta of 25 or lower. Step 4: Determine what is going to be the difference between spread. This is based on the strikes available. Higher priced stocks will only have strikes in 5 or 10 point increments. I prefer 5 points wide. Look at the spread and see if you can get a Layup that is at least a 10% ROI. If the spread is 2 points, the Layup should be.20 or more. If the spread is 5 points, the Layup should be.50 or more. Here is a sample of an option chain from the thinkorswim platform:
This particular underlying is the ETF for Gold with the symbol GLD. As you can hopefully see the strikes are listed in one dollar increments. So we will look for a spread that is at least 2 points wide. For the sake of this example I will just look at the Puts. Notice the strikes from 109 and lower all have a delta of lower than 25. These are the ones I will look at to sell.
Here are the four choices of spreads. We have the 109/107 selling for.34 cents The 108/106 selling for.27 cents The 107/105 selling for.21 cents The 106/104 selling for.17 cents. Right away I can rule out the 106/104 spread because it is giving me less than 10% ROI. The 108/106 spread is giving me an 80% probability of profit. That s probably the one I would go for unless I wanted to be a little more conservative. Then I d go with the 107/105. By going with the 108/106 I get.27 cents. Which is a potential ROI of 15.6%. That means that if the trade goes my way and I am up 10%, I can actually exit the trade early before expiration. With the 107/105 spread I almost have to wait until expiration to get 10%. That s 43 days away which is a long time. Enter the Trade Now that I have decided on my spread, I enter it into the broker platform. If you notice above, the credit is shown for the spread. Your broker may or may not show it like that. The amount shown is called the mid price. To get this they take the middle of the short option and the middle of the long option.
For example, look at the option chain above and look at the Bid and the Ask prices for the 109 Put. The Bid is.98 and the Ask is 1.00. So the mid price would be.99. And that is what we would enter as out limit order. When you sell a spread the amount of the sold option will be greater than the amount for the bought/long option and so you will get a credit (money given to you). This credit is the most you can make in the trade, but is given to you as soon as you enter the trade. When entering your trades always enter them as a LIMIT order. If entered as a Market order you will get awful prices. If you do not get filled right away you can either wait, or cancel and adjust the credit down. Try waiting for a couple minutes if you have the time. This applies only during market hours. If you are entering an order when the market is closed you will still need to check in during the day to see if you got filled. And you may have to cancel/replace your order to adjust to the current pricing. To do a cancel/replace - just cancel your present order and resubmit it with a penny less credit. If that does not fill, try 2 pennies. Then three. Keep going until you are filled or you cannot get enough credit to make you happy. Remember I don t do a trade unless I can make at least 10% potentially. What your minimum % number is, is up to you. You may want to sell farther away from the money than I do. In that case you will need to accept a smaller % ROI. Once the trade is filled. That is it. You are done. Now just monitor the stock daily and see how your trade is doing. A Word About Margin The ROI is determined based on the amount at risk. The amount at risk is also the maximum you can lose on the trade.
This is also the amount your broker will require you keep in your account as long as the trade is active. It s called margin but it s not the regular margin that you might be aware of. We are not borrowing money. You will not be paying interest. You must have the Max Loss amount/margin in your account or else your broker will not let you do the trade. The credit is yours to keep. You get that right away and can do whatever you want with it trade it, withdraw it, leave it alone, etc. Exit the Trade You get the greatest ROI if you let the spread expire. If at expiration, your trade is still out of the money, then the options will expire. They go away poof like magic. That s when you get the potential ROI. And it does not cost you extra commissions either. If you exit the trade early, then you will make less ROI because the options till have some time value left. Why would you exit early? 1. Because the trade has made the majority of gains it can and there is a lot of time left to expiration. 2. Because you think the trade might turn into a loser and you want to exit before it does 3. The underlying is not behaving properly 4. Something happens in the world that might affect the trade 5. You want to go on vacation My point is that you can exit the trade whenever you want. You have that flexibility. But exiting early can also be a risk limiting behavior.
Let s say you enter a trade where you can make 15%, 35 days from expiration. Something happens the next day and the stock gaps in your favor. Your trade is now up 7%. You just make 7% in one day. What do you do? - You can exit the trade, take the 7% and wait for the stock to settle down. - You can exit the trade, take the 7% and sell more options at different strikes on the same stock. - You can stay in the trade hoping to make the other 8%. It s not an easy decision. But what if instead of 7%, the trade was up 10%? I would take it off. I would take my money and run. I got what I wanted. Everyday that I stay in the trade is a day that the stock could reverse and the market could take back the 10% it already gave me. There is no worse feeling in trading than losing money on a trade that was up money before. Ask me how I know. I ve done it a bunch of times. And it hurts every time. Have some discipline. Take the profit.
Chapter 7: Adjusting the Trade When It is in Trouble When it comes to adjustments, there are three main camps or groups. Ideology #1: The first group says Don t adjust. Just let the probabilities work in your favor. You don t need to do anything after you get in a trade. Just let the spread expire. Now, this works most of the time. But some of the time you will have a loss and even a max loss. Most traders cannot emotionally handle this. They would not be able to just sit back and watch a trade lose money even if it had a great chance of working out in the end. Ideology #2 The second group says to exit the trade with a stop loss. Know in advance how much you will lose and give the trade as much room as you can until you hit that amount. No adjustments for this groups. Just get in, sit around, and exit at either your profit target or your max acceptable loss. I belong in this camp. I know all the adjustments and many times they can help turn a loser trade into a winner. But many times they just add to my stress levels and make things much more complicated than they need to be. I believe in keeping things simple. If a trade hits its acceptable loss amount, I just exit and move on. I look at is as if my trade entry was flawed somehow and it just didn t work out.
Do I want to spend time, energy, and commissions to fight the trade? Not to mention that I will probably have to add more capital to a trade that has already hurt me. No thanks. Next trade please. Ideology #3 This group makes adjustments. By an adjustment I mean they make changes to the original trade to give it a better chance to turn out a winner. This group still has an acceptable loss amount at which they will exit, but they will try to salvage the trade before it get there. I could probably write a separate book just on adjustments. But here I want to cover the most common and the ones that work the best. When to Adjust Deciding when to adjust a trade is crucial. Do it too soon and you might just cost yourself part of your gain and some commissions. Do it too late and it just might be too late for the trade. You can get a good idea of when to adjust in one of two ways. The first is from your p/l. You can adjust when you are down a certain percentage. If your stop loss is set at 25%, perhaps you adjust when the trade is down half of that. That normally works well. Or you can use delta as a measure.
If you use delta, you have to make a note of the delta of your short option when you initiate the trade. So let s say you normally enter a trade when the short option is at 20 delta. You would adjust when it gets to 30 delta or ten points higher. If you enter at 15 delta you can adjust at 25 delta. The Roll Down/Up This one is the most basic and probably the one you will be using the most. When your call spread gets in trouble you buy back your current spread and sell another Call spread further away from the money. When your put spread gets in trouble you buy back your current spread and sell another Put spread further away from the money. Example: You have sold the 100/105 Call spread. The stock is moving up and it is time to adjust. You originally sold the spread when the 100 Call was at.20 delta and it is now at 31 delta. So you buy back the spread and you look to sell the Call that is now trading at 20 delta. That is the 110. So you sell the 110/115 Call spread. Normally in this situation it will cost you more to buy back the 100/105 than you get for selling the 110/105 so you might have to increase the size of the trade. Back to the example: Original trade: Sell the 100/105 for a credit of.55 Buy back the 100/105 for a debit of 1.15 So you are now down.60 The 110/105 is now selling for.40 That s not enough. You need a greater credit.
So instead of selling just one of the 110/105, you sell 2 of them for a total credit of.80 This allows you to still make.20 on the trade. Of course you now have twice as much at risk, but you are further away from the current stock price. Why would you do this? Because of the theory of reversion to the mean. This basically says that a stock cannot move too far away from the middle. The middle is normally referred to as the moving averages. When a stock runs too much too fast in one direction, it has to either stop and take a break or fall back to the moving average. And this generally works most of the time. Let s look at this graphically. Here is a sample Put Layup spread. I am going to make it sideways so you can see everything.
Now here it is after the Roll
The Roll Out This is another roll, but this time, we are not going to roll in the same expiration cycle. We are rolling out further in time. This gives us a greater credit than if we rolled in the same month. This way, you do not need to add more capital to the trade. But you do need to stay in the trade longer. You can stay at the same delta you prefer but since you are moving out in time you get the greater theta of the new spread.
The Iron Condor The Iron Condor is another option strategy that is based on Layup spreads. Normally a Layup spread is either Puts or Calls. An Iron Condor is 2 Layup spreads: both Puts AND Calls. The cool thing is that a condor does not increase your risk margin. The amount of risk in the trade stays the same. This is because you can only lose on one side. If you are going to lose, only one spread can lose. Both cannot. The idea is that you want to make a box around the stock price. You want the price to be in between your two short options. So if you sell the 100/105 calls and 90/85 puts you want the stock to stay in between 90 and 100. Now you can start the trade as in iron condor but I prefer not to. It adds an element of risk: now the trade is two sided. So here is how it works: You start a normal Layup spread. When it hits your adjustment point, you add the other side. This gives you a lot more credit/premium. This additional credit give you staying power to stay in the trade longer and let it return back to the mean. Example: Sell the 100/105 Call spread for.55 Stock makes you adjust so you sell the 90/85 Puts for.55 You now have 1.10 in credit which is $110 and you can lose $390. If you are going to exit when down 30%, that means you can exit when either spread is at a debit of 1.17. If you never hit the point where you have to exit you stand to make 28.2% ROI. Here is the Layup Spread after converting to an Iron Condor:
The Calendar In this adjustment we turn the simple Layup spread into a simple calendar spread, also known as a time spread. You use this adjustment when the stock has moved closer to your short strike but you do not think it will go much higher and you also do not think it will retreat much. By turning the Layup spread into a calendar you want the stock to come to and basically stay close to your short strike until expiration. To implement, you sell the long option, and you buy a long option in the next month at the same strike as the short option. If you sold the October 105/110 Layup spread, to turn it into a calendar, you would sell the October 110 and Buy the November 105. The best way to do this is as a spread (called a diagonal spread) if you don t have enough capital in your account. Why? Because if you buy the 110 first. You now have a naked 105 position which will require a lot more margin. By doing the diagonal, you don t need any more margin. Here s what the Calendar looks like: