al-brooks-course
12 - Trading Options on Daily Charts
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Transcript 001
Time: 00:02
Bilingual Transcript
00:02 - 00:06
EN: This is Al Brooks, and this is my Price Action Trading Course.
00:06 - 00:11
EN: The current module is about trading options based on daily charts.
00:14 - 00:18
EN: So, why trade options on the daily charts?
00:18 - 00:23
EN: One obvious answer is traders are always looking for ways to make money.
00:23 - 00:30
EN: Day traders don’t like much overnight risk, and options allow day traders
00:30 - 00:34
EN: to take positions on patterns that they see on the daily charts
00:34 - 00:37
EN: – patterns that might take several days to reach targets,
00:38 - 00:43
EN: and the day traders can take those positions without much overnight risk.
00:46 - 00:50
EN: The absolute risk is smaller than on the underlying stock.
00:50 - 00:55
EN: So if you trade puts or calls or spreads, what you stand to lose
00:55 - 00:58
EN: if the absolute worse happens is always going
00:58 - 01:00
EN: to be much less than the underlying stock.
01:01 - 01:02
EN: I’m talking about if you’re buying options;
01:02 - 01:04
EN: I’m not talking about if you’re selling.
01:04 - 01:07
EN: Obviously, if you’re selling naked puts or naked calls,
01:07 - 01:10
EN: you could lose as much as you can trading stocks.
01:12 - 01:16
EN: Also, the cost of execution and the profit trading options
01:16 - 01:18
EN: is about the same as it is for stocks.
01:18 - 01:22
EN: Most importantly for most traders is peace of mind.
01:22 - 01:24
EN: The less you have to worry about money,
01:24 - 01:27
EN: the more objective you are about your decisions.
01:28 - 01:34
EN: And if you have a big gap against you in the morning and you have an option position,
01:34 - 01:35
EN: it’s going to be much less costly
01:35 - 01:38
EN: than if you were holding a position in the underlying.
01:42 - 01:45
EN: Traders always ask me about the Greeks when trading options.
01:46 - 01:50
EN: Professional option traders pay attention to certain things
01:50 - 01:55
EN: that they describe with Greek symbols, like delta, theta, gamma, and vega.
01:55 - 01:58
EN: You do not need them to trade profitably.
01:58 - 02:02
EN: If you’re a professional options trader, you’re trying to maximize your profits
02:02 - 02:08
EN: and you’re looking at the options all day long, and you can get slightly better
02:08 - 02:12
EN: or optimal positions/strategies if you pay attention to the Greeks.
02:12 - 02:17
EN: But most option traders who trade options profitably, pay
02:17 - 02:19
EN: virtually no attention to the Greeks whatsoever.
02:20 - 02:24
EN: You also don’t have to worry about taking the perfect option
02:24 - 02:28
EN: because all the different strike prices are arbitraged, one with another.
02:29 - 02:32
EN: Everything is just tightly arbitraged and it’s all done by computers,
02:32 - 02:35
EN: so nothing can get that much out of line.
02:35 - 02:37
EN: So as long as you pick something reasonable
02:37 - 02:41
EN: – for example, around At The Money and not too near.
02:41 - 02:45
EN: So if you’re looking for a trade that’s going to last 3 days, a week, or 2 weeks,
02:45 - 02:47
EN: make sure to pick an option that’s going
02:47 - 02:52
EN: to expire 4 to 8 weeks out and around At The Money.
02:53 - 02:57
EN: That’s all you have to do, and I would give no thought at all to the Greeks.
03:00 - 03:05
EN: You hear me many times in this course talk about trading small,
03:05 - 03:08
EN: especially when the stop has to go far away.
03:09 - 03:14
EN: However, for option traders, they can use stock replacement strategies
03:14 - 03:16
EN: as an alternative to trading small.
03:16 - 03:20
EN: For example, let’s say the market is in a strong bull trend,
03:20 - 03:24
EN: and the stock has to go three times further away
03:24 - 03:26
EN: than you normally want your stop to be.
03:27 - 03:30
EN: What an options trader will do or what a stock trader
03:30 - 03:35
EN: who also trades options will do is he’ll sell one of his stock
03:35 - 03:39
EN: and he’ll replace his stock with an options strategy.
03:39 - 03:45
EN: The most obvious and easy ones are you might buy a call or a call spread.
03:45 - 03:50
EN: If the market’s in the breakout phase of a bear trend and there are no pullbacks
03:50 - 03:54
EN: and the stop has to go far, far above where you are right now,
03:55 - 04:00
EN: an alternative to trading very small and putting the stop far away
04:00 - 04:06
EN: is to buy back your short and replace it with a simple options strategy
04:06 - 04:09
EN: – for example, buying a put or buying a put spread.
04:10 - 04:14
EN: Therefore, you’ve immediately greatly contained your risk.
04:14 - 04:18
EN: For example, if you buy a put, the most you can lose is the price of your put,
04:18 - 04:23
EN: and that might be 1% or 2% of the current price of the underlying stock.
04:24 - 04:31
EN: So your risk has become greatly smaller by replacing your stock position
04:31 - 04:33
EN: with a position in the options market.
04:34 - 04:36
EN: A lot of traders don’t trade options,
04:36 - 04:42
EN: but that is a very popular strategy for traders who trade both stocks and options.
04:42 - 04:45
EN: There are other, more advanced strategies, like collaring up,
04:45 - 04:49
EN: but I’m not going to go through them in this course.
04:52 - 04:58
EN: Sometimes there’s something going on in a stock that makes you want to be long,
04:58 - 05:00
EN: but the risk is too great.
05:01 - 05:05
EN: Option traders have an alternative to trading a very small size.
05:06 - 05:11
EN: So let’s say you have a very large open profit and the profit just keeps growing,
05:11 - 05:13
EN: and now your stop is very, very far away.
05:13 - 05:18
EN: The total dollars at risk is much greater than you’re accustomed to trading,
05:18 - 05:21
EN: so you know you have to reduce your position size.
05:21 - 05:24
EN: Beginners tend to look at their big open profits and say,
05:24 - 05:26
EN: “Hey, it’s other people’s money.” No, it’s not.
05:26 - 05:27
EN: It’s in your account.
05:27 - 05:29
EN: It’s your money.
05:29 - 05:35
EN: So you have to adjust your position size based upon your Actual Risk at the moment.
05:36 - 05:38
EN: You can either greatly reduce your position size
05:39 - 05:42
EN: – if that makes your position size so small that it’s not worth continuing
05:42 - 05:45
EN: to hold the position, you have an alternative.
05:45 - 05:48
EN: You could simply sell out of your entire position
05:48 - 05:51
EN: and replace it with an options strategy.
05:51 - 05:55
EN: The obvious one if it’s a bull market is to buy a call,
05:55 - 06:00
EN: or to buy a call spread if you’re expecting a move that will go up
06:00 - 06:04
EN: for 4, 5, or 10 more percent over the course of the next several weeks.
06:04 - 06:05
EN: Then go ahead and buy a call spread.
06:05 - 06:10
EN: If you’re expecting a more modest move or if you’re expecting a much faster
06:10 - 06:14
EN: or very sharp move up, just go ahead and buy a call.
06:15 - 06:17
EN: Other strategies, like collaring up,
06:17 - 06:21
EN: are beyond the scope of my intentions for this course.
06:21 - 06:26
EN: But right now, I do want to talk a little bit about what you do as an alternative
06:26 - 06:32
EN: to using a stop that’s just too far away and you don’t want to trade too small.
06:36 - 06:41
EN: Sometimes if you either own a stock and the stop is very far away
06:42 - 06:46
EN: or if you’re thinking about buying a stock and the stop is very far away,
06:47 - 06:50
EN: you can have an alternative to simply trading very small.
06:51 - 06:53
EN: Options offer a very good alternative.
06:54 - 06:55
EN: Let me give you two examples.
06:56 - 06:58
EN: One is let’s say you bought a stock somewhere down here,
06:58 - 07:02
EN: the SPDR on the daily chart, and now it’s up here.
07:02 - 07:05
EN: And let’s say your stop is down here, and you’ve been scaling out.
07:05 - 07:08
EN: So now you’re down to maybe 100 shares,
07:08 - 07:13
EN: but your 100 shares times $5 – that might be more than you care to risk.
07:13 - 07:15
EN: That would be $500.
07:15 - 07:17
EN: You might say, “Well, I don’t want to get down to zero.
07:17 - 07:23
EN: I still want to participate.” An alternative is to sell out of your SPDR shares
07:23 - 07:28
EN: and instead replace your stock position with an options position,
07:28 - 07:30
EN: and an obvious one would be a call.
07:30 - 07:34
EN: You just buy an At The Money call, 1 month out or 2 months out.
07:34 - 07:37
EN: So at this point you’d be long a call.
07:37 - 07:42
EN: If you’re looking to hold for 2 to 3 months, maybe for a 5% or 10% gain,
07:42 - 07:45
EN: you could go ahead and buy a call spread.
07:45 - 07:47
EN: But if you’re thinking the market might just go up
07:47 - 07:51
EN: another 2% or 3% over the next few weeks, just go ahead and buy the call.
07:52 - 07:55
EN: Let’s say instead of being long all the way down here,
07:55 - 07:56
EN: let’s say you’re flat for whatever reason
07:56 - 08:00
EN: and you decide you want to buy up in this area.
08:00 - 08:02
EN: You know your stop goes down here,
08:02 - 08:07
EN: and if that results in a risk that’s too big for you, don’t buy the stock.
08:07 - 08:09
EN: Just go ahead and buy the call.
08:09 - 08:14
EN: You might be able to buy an At The Money call 3 or 4 weeks out for $2.
08:14 - 08:19
EN: In other words, times 100 shares, your actual cost would be about $200.
08:20 - 08:23
EN: Yes, you won’t make as much as you would had you bought
08:23 - 08:26
EN: 100 shares of the SPDR, but risk will be less.
08:26 - 08:31
EN: If you buy the SPDR and your stop is down here, you’re risking $500 on 100 shares.
08:31 - 08:34
EN: If you buy a call for $2, your risk is $2.
08:34 - 08:39
EN: The most you can lose is $2, and yet you’ll still have a good gain
08:39 - 08:40
EN: if the market goes up here.
08:40 - 08:44
EN: So options provide an alternative to stocks
08:44 - 08:49
EN: whenever the risk is big – in other words, whenever your stop is far away.
08:50 - 08:54
EN: For those traders who did buy down here, if the market is up here,
08:54 - 08:57
EN: they can argue, “Well, I’m trading other people’s money,
08:57 - 09:01
EN: and therefore I don’t care if I lose $5.” That’s not true.
09:01 - 09:03
EN: Once the money is in your account, it’s your money.
09:03 - 09:04
EN: It’s not other people’s money.
09:04 - 09:06
EN: It’s your money, and you have to trade it
09:06 - 09:08
EN: as if you just put the trade on right here,
09:08 - 09:11
EN: not as if you put the trade on down here.
09:11 - 09:14
EN: You always have to mark your position to the market.
09:14 - 09:17
EN: So if you’re long, it doesn’t matter if you bought down here.
09:17 - 09:21
EN: If this is today and you’re currently long and your stop is down here,
09:21 - 09:22
EN: this is your risk.
09:22 - 09:24
EN: It’s not other people’s money that’s at risk.
09:24 - 09:25
EN: It’s your risk.
09:25 - 09:31
EN: You constantly have to be reassessing your position based upon your current stop,
09:31 - 09:34
EN: your current position size, and the current price.
09:34 - 09:34
EN: It’s your money.
09:34 - 09:37
EN: It’s always your money if it’s in your account.
09:40 - 09:46
EN: Here’s the 5-minute Emini chart, and let’s say for whatever reason,
09:46 - 09:50
EN: you did not get long earlier and you decide to get long up here.
09:50 - 09:54
EN: You know that your stop is below the bottom of the bull spike.
09:54 - 09:56
EN: You say, “Wow, that’s 8 points away.
09:56 - 09:58
EN: I can’t risk 8 points.
09:58 - 10:02
EN: And yet I only trade 1 Emini contract, so I can’t take the trade.”
10:03 - 10:06
EN: An alternative to doing that is to use options.
10:07 - 10:12
EN: You could simply go ahead and buy an At The Money weekly SPDR call.
10:12 - 10:17
EN: Or if it’s still too expensive, buy a slightly Out of The Money SPDR call.
10:17 - 10:20
EN: Options are a very good alternative to stocks,
10:21 - 10:24
EN: especially a big market like the Emini or the SPDR.
10:24 - 10:26
EN: SPDR calls have a tremendous volume.
10:26 - 10:29
EN: They’re excellent alternatives to taking outright positions
10:29 - 10:31
EN: in the SPDR or the Emini.
10:31 - 10:34
EN: Let’s give an alternate example here.
10:34 - 10:38
EN: Let’s say you happen to buy here, and you’re still long here.
10:38 - 10:42
EN: Your stop is now 7 points away and you don’t want to risk that much,
10:42 - 10:44
EN: yet you think the market is still going a lot higher.
10:45 - 10:49
EN: You should be reducing your position size to keep the risk the same,
10:49 - 10:53
EN: but if it’s too far away and you can’t reduce your position size,
10:53 - 10:57
EN: instead of continuing to hold your Emini and using a stop that might be too tight,
10:57 - 11:00
EN: like maybe below this bar, what you could do is simply sell out
11:00 - 11:05
EN: of your Emini position and go ahead and buy a SPDR call,
11:05 - 11:08
EN: an At The Money SPDR call, a weekly call,
11:08 - 11:09
EN: and that would be a very good alternative.
11:09 - 11:11
EN: Let’s say you bought it and it cost 80 cents.
11:11 - 11:13
EN: Let’s say you bought a weekly call.
11:13 - 11:18
EN: The most you can lose is 80 cents, which times 100 shares is $80.
11:18 - 11:23
EN: So the most you can lose is $80, and if the market goes up for a Measured Move
11:23 - 11:25
EN: based on the height of this spike,
11:25 - 11:29
EN: you probably will make $80 by the end of the day.
11:35 - 11:38
EN: There are stock replacement strategies for bearish positions.
11:39 - 11:44
EN: If a trader finds that his stop has to be so far above his entry price,
11:44 - 11:49
EN: the position would be so small it’s not worth taking, yet he feels the trend
11:49 - 11:53
EN: is strong and he wants to participate, he has a stock alternative,
11:53 - 11:55
EN: and that is in the options market.
11:55 - 11:58
EN: He could buy a put or he could buy a put spread.
11:59 - 12:02
EN: Let’s say he sold way up here and the market’s way down here,
12:02 - 12:06
EN: and his stop has to be much higher up than what he is comfortable using.
12:06 - 12:11
EN: He could just buy back his stock, his short, for a profit and then go ahead
12:11 - 12:15
EN: and put on an option position like buying a put or buying a put spread,
12:15 - 12:19
EN: and that will allow him to continue to participate on the downside.
12:19 - 12:22
EN: There are other alternatives, like ratio put spreads
12:22 - 12:24
EN: and calendar put spreads and put flys,
12:25 - 12:28
EN: but they’re beyond what I want to discuss in this course.
12:31 - 12:36
EN: Here’s an example of a bear trend in the SPDR on the daily chart.
12:36 - 12:39
EN: I want to talk about it in two different ways.
12:39 - 12:43
EN: Let’s say you are flat and you see this big bear spike occurring
12:43 - 12:47
EN: late in the bear trend, and you decide that the market is going down more.
12:47 - 12:48
EN: You’re correct.
12:48 - 12:50
EN: That makes sense whenever the trend is this strong.
12:51 - 12:55
EN: And you decide you want to sell, to go short,
12:55 - 12:58
EN: but your stop might be above the top of this bear spike.
12:58 - 13:01
EN: It might be above the most recent Lower High.
13:01 - 13:04
EN: It might even be simply above the beginning of this bear spike.
13:04 - 13:08
EN: In any case, let’s say it’s further away than you want to risk,
13:08 - 13:11
EN: yet you want to participate on the downside.
13:11 - 13:15
EN: A good alternative is to simply go ahead and buy a put.
13:15 - 13:18
EN: You can wait for a pullback and buy the put at the market,
13:18 - 13:19
EN: or you can wait to see if the market trades
13:19 - 13:23
EN: below the low of the prior bar and at this point buy a put.
13:23 - 13:27
EN: If you buy a put here and the market goes up here, that’s $2 on the SPDR.
13:27 - 13:30
EN: You might be very nervous if you shorted the SPDR,
13:30 - 13:34
EN: but if you bought an At The Money put, maybe you paid $2 for it here.
13:34 - 13:37
EN: At this point it might be down to $1.
13:37 - 13:40
EN: But your risk is still $2.
13:40 - 13:43
EN: Even if the put goes to zero, you lose no more than $2.
13:44 - 13:47
EN: It allows you to hold on, and at this point you might be able
13:47 - 13:50
EN: to exit your put for $3 and have a $1 profit.
13:50 - 13:55
EN: You might not be comfortable emotionally as you shorted here, the SPDR,
13:55 - 13:59
EN: if the market ran up a dollar or two above your entry price.
13:59 - 14:02
EN: But the put is a good alternative to that.
14:02 - 14:07
EN: The other alternative that I was talking about is instead of being flat down here
14:07 - 14:11
EN: and wanting to get short, let’s say you were short from up here
14:11 - 14:13
EN: and now the market’s down here, and you think,
14:13 - 14:15
EN: “Gosh, my stop has to be above the bear spike
14:15 - 14:18
EN: or above the Lower High, and that’s far more than I want to risk.
14:18 - 14:21
EN: Let’s say it’s five times more than I want to risk.”
14:21 - 14:24
EN: You can reduce your position size to a 20% size,
14:24 - 14:29
EN: but if the position size is so small that you don’t want to continue to hold,
14:29 - 14:34
EN: you can replace your stock position, your short SPDR position, with a put.
14:35 - 14:38
EN: You simply buy back your stock for a profit
14:38 - 14:40
EN: – if you sold it up here, you have a big profit.
14:40 - 14:44
EN: You can then go ahead and buy a put or a put spread
14:44 - 14:47
EN: to try to capture any additional gain that the market might offer you.
14:52 - 14:53
EN: Abbreviations.
14:53 - 14:55
EN: These are probably familiar with everyone.
14:55 - 14:57
EN: At The Money, ATM.
14:57 - 14:59
EN: Out of The Money, OTM.
14:59 - 15:01
EN: In The Money, ITM.
15:01 - 15:06
EN: So if a stock is at 100 and you buy a 100 call, it’s At The Money.
15:06 - 15:09
EN: If you buy a 100 put, it’s At The Money.
15:09 - 15:12
EN: If you buy a 90 put, it’s way Out of The Money.
15:12 - 15:15
EN: If you buy a 90 call, it’s way In The Money.
15:16 - 15:18
EN: AIL, Always In Long.
15:18 - 15:21
EN: It means it’s a clear bull trend.
15:21 - 15:23
EN: Always In Short, a clear bear trend.
15:26 - 15:28
EN: And how long should you hold options?
15:28 - 15:32
EN: Day traders are always looking for a quick profit.
15:32 - 15:37
EN: When I trade options, most of my exits are usually within 1 to 3 days,
15:37 - 15:41
EN: although sometimes I’ll hold positions for several weeks.
15:41 - 15:45
EN: For example, if I’m trading based on a pattern on the weekly chart,
15:45 - 15:49
EN: I may be trading an option that expires 2 or 3 months out,
15:49 - 15:52
EN: and I’m willing to hold the option for several weeks
15:52 - 15:57
EN: if I think that’s how long it will take for the option to reach my profit target.
15:59 - 16:02
EN: Which option to use, an At The Money put or a call?
16:02 - 16:04
EN: Monthly options?
16:04 - 16:04
EN: Weekly?
16:04 - 16:07
EN: In general, I use At The Money puts and calls.
16:07 - 16:11
EN: I also do a lot of spread trading, and I usually use monthly options
16:11 - 16:15
EN: and not weekly options when I’m planning on holding trades overnight.
16:16 - 16:18
EN: The weekly options expire on Friday,
16:18 - 16:20
EN: so you don’t want to be taking an overnight position
16:20 - 16:25
EN: if today’s Wednesday because you’ll lose too much due to time decay.
16:25 - 16:30
EN: I usually trade the nearest option that has at least 2 to 3 weeks remaining.
16:30 - 16:35
EN: I usually prefer 1 to 2 weeks remaining in case I get into the position
16:35 - 16:39
EN: and the market starts to go sideways, yet I still think my position is valid.
16:40 - 16:44
EN: If the option expires in 2 weeks, the time decay is too great.
16:44 - 16:48
EN: I lose too much every day, and it makes it harder to make a profit.
16:51 - 16:54
EN: How much does a $1 call really cost?
16:54 - 16:58
EN: If I pay a dollar for a call, that call entitles me
16:58 - 17:02
EN: to buy 100 shares of stock at whatever strike price it is.
17:02 - 17:06
EN: So let’s say it’s a stock that trades at $50,
17:06 - 17:12
EN: and I buy a $50 call and I pay a dollar for that call.
17:12 - 17:17
EN: I’m entitled to buy that call for $50, even if the stock goes up to $60.
17:17 - 17:22
EN: So in other words, I can pay $50 for it even though it’s currently $60,
17:22 - 17:26
EN: so I immediately have a $10 profit, and I paid $1 for the option.
17:26 - 17:29
EN: My net profit is $9.
17:30 - 17:33
EN: If the call costs $1, that’s $1 per share.
17:34 - 17:38
EN: One option, one call, controls 100 shares of stock.
17:38 - 17:42
EN: So if I pay a dollar, if the price on my computer says
17:42 - 17:47
EN: that it’s a dollar for the call, I’m actually paying $100 for that call.
17:48 - 17:54
EN: If I pay a dollar for the call and sell it for $2.50, I made a $1.50,
17:54 - 17:58
EN: but that’s times 100 shares, so my actual profit is $150.
18:00 - 18:04
EN: Execution costs: you can usually find brokers
18:04 - 18:07
EN: that will charge you a dollar commission to buy
18:07 - 18:10
EN: and then another dollar commission to sell.
18:10 - 18:16
EN: So if you buy 10 calls, your round trip commission would be $20.
18:16 - 18:18
EN: $10 to enter, $10 to exit.
18:20 - 18:24
EN: And there’s also a bid/ask spread to consider.
18:24 - 18:28
EN: Any time you buy anything – a stock or a future – there’s always a bid/ask spread.
18:28 - 18:32
EN: The bid/ask spread is very big on thinly traded options,
18:32 - 18:36
EN: and because it’s so big on options that don’t trade very actively,
18:36 - 18:38
EN: it’s better not to trade them.
18:38 - 18:44
EN: In huge markets like the SPDR, the spread is usually only 1 tick,
18:44 - 18:49
EN: which is 1 penny, times 100 shares is $1 per call or per put.
18:51 - 18:54
EN: The bid/ask spread can be huge.
18:54 - 18:57
EN: When Apple’s trading around $600,
18:57 - 19:01
EN: the bid/ask spread can be 10 cents, sometimes 20 cents.
19:01 - 19:05
EN: You can say, “I don’t want to pay 10 cent spread on a call.
19:05 - 19:08
EN: That’s way too much.” But on a percentage basis,
19:09 - 19:13
EN: a 10 cent spread on a $600 stock is exactly the same
19:13 - 19:18
EN: as a 1 penny spread on a $60 stock, and that’s a very good spread.
19:18 - 19:20
EN: Very small spread for traders.
19:20 - 19:24
EN: So when Apple has a 10 cent spread or even a 20 cent spread,
19:24 - 19:27
EN: that’s actually a very good deal for traders.
19:31 - 19:33
EN: What are the execution costs?
19:33 - 19:35
EN: Let’s say you’re talking about the SPDR
19:35 - 19:39
EN: and you bought a call and paid $1.70 for it.
19:39 - 19:42
EN: You’re buying it at the asking price.
19:42 - 19:45
EN: If you immediately turned around and sold it
19:45 - 19:50
EN: and the SPDR itself did not move a single tick, you’d have to sell it at the bid.
19:50 - 19:51
EN: Let’s say it’s $1.69.
19:51 - 19:58
EN: So you’d immediately lose $1, that 1 penny spread times 100 shares.
19:58 - 20:02
EN: But you would also pay $1 to buy, $1 to sell in commissions,
20:02 - 20:06
EN: so your total loss would be $3.
20:06 - 20:10
EN: So even though the SPDR did not move a tick, it would cost you $3.
20:10 - 20:14
EN: And if you were trading 100 calls, that would be $300.
20:18 - 20:24
EN: At The Money volume can be huge, and that creates the tightest bid/ask spread.
20:24 - 20:28
EN: With very big volume stocks and ETFs,
20:28 - 20:31
EN: that allows you to use market orders – like the SPDR.
20:31 - 20:36
EN: You can usually use market orders when you’re trading At The Money
20:36 - 20:38
EN: calls on near dated options, like weekly options
20:38 - 20:41
EN: or options expiring just a few weeks out.
20:45 - 20:47
EN: What exactly is At The Money (ATM)?
20:47 - 20:51
EN: The stock is really exactly at the options strike price.
20:51 - 20:55
EN: For example, let’s say the stock is 140.25.
20:55 - 20:57
EN: There is no strike at that price.
20:58 - 21:04
EN: There’s a 140, there’s a 140.50, a 141, but no 140.25.
21:04 - 21:08
EN: One nice thing about the SPDR is a lot of times they’ll have strikes
21:08 - 21:12
EN: that are 50 cents apart, so on the weekly options,
21:13 - 21:16
EN: a lot of times they’ll have a 140.50 call or put.
21:17 - 21:23
EN: If the SPDR’s at 140.40, you’re not forced to buy the 140 call or the 141 put.
21:23 - 21:25
EN: You can buy the 140.50.
21:26 - 21:32
EN: So At The Money to me is the approximate nearest strike price to the underlying.
21:33 - 21:36
EN: I prefer slightly In The Money to Out of The Money
21:36 - 21:40
EN: because the In The Money option will have a broader range
21:40 - 21:45
EN: than the Out of The Money option, and that gives me more opportunity for profit.
21:46 - 21:50
EN: When you can’t decide In The Money or Out of The Money, doesn’t matter.
21:50 - 21:51
EN: Just choose either.
21:53 - 21:54
EN: An example.
21:54 - 22:00
EN: Let’s say a stock is at somewhere in the range between 99.80 and 100.70.
22:02 - 22:04
EN: I would trade the 100 calls.
22:05 - 22:10
EN: Even 99.80, the 100 calls would be slightly Out of The Money, but only slightly.
22:11 - 22:14
EN: At 100.70, the calls are way In The Money,
22:14 - 22:19
EN: but I would still probably trade the 100 calls instead of the 101s.
22:20 - 22:26
EN: If it’s at 99.40, I would trade the 100 puts even though that’s way In The Money.
22:26 - 22:29
EN: But I’d rather do that than trade the 99s, which is Out of The Money.
22:34 - 22:38
EN: Here’s an example comparing Out of The Money and At The Money calls.
22:38 - 22:41
EN: On the left, here’s the SPDR.
22:41 - 22:43
EN: It’s a line chart, not a bar chart.
22:43 - 22:45
EN: This is what took place today.
22:45 - 22:46
EN: We had a 90 cent range.
22:47 - 22:51
EN: The market opened up – At The Money was 141 earlier in the day.
22:51 - 22:53
EN: That’s the closest strike.
22:53 - 22:55
EN: So At The Money is 141.
22:56 - 22:58
EN: Had I bought an At The Money call
22:58 - 23:00
EN: at the absolute low tick – well, let me put it this way.
23:00 - 23:03
EN: The 141 call had a range of 59 cents today.
23:04 - 23:06
EN: The SPDR itself had a range of 90 cents.
23:06 - 23:09
EN: But if I instead bought the Out of The Money call,
23:09 - 23:12
EN: the next strike up, the 142, it’s a lot cheaper.
23:13 - 23:16
EN: It’s 20 cents instead of 60 cents to buy it.
23:16 - 23:19
EN: But the range was only 32 cents.
23:19 - 23:22
EN: If your commissions are a penny in and a penny out
23:22 - 23:28
EN: and the spread is a penny in and a penny out, that means your overhead is 4 cents.
23:29 - 23:33
EN: When your range is 32 cents and you have 4 cents’ built-in overhead,
23:34 - 23:37
EN: it’s very hard to make much of a profit because you’re not going
23:37 - 23:39
EN: to be buying the low tick you’re not going to be selling the high tick.
23:39 - 23:45
EN: You’ll be buying somewhere in here, 30 cents, and you’ll be selling here, 40 cents,
23:45 - 23:50
EN: and then you have 4 cents’ overhead, so you’re making 6 cents’ profit on a win,
23:50 - 23:53
EN: and you’re losing 14 cents on a loss.
23:53 - 23:58
EN: It’s impossible to make a living when your losses are two times
23:58 - 24:00
EN: or more greater than your wins.
24:01 - 24:04
EN: On the other hand, if you have a 60 cent range, 59 cent range,
24:04 - 24:06
EN: it’s much easier to make a profit.
24:06 - 24:09
EN: You buy down here around 70, you sell up here for around a dollar,
24:09 - 24:12
EN: and you can make 30 cents on a good move.
24:16 - 24:19
EN: So use the chart of the stock to make your trading decisions.
24:19 - 24:23
EN: I don’t look at the chart of the options when I’m deciding,
24:23 - 24:26
EN: should I buy or should I sell?
24:26 - 24:30
EN: To me, the options are a reflection of what’s going on with the underlying stock.
24:31 - 24:34
EN: I place my entry orders in the options market.
24:34 - 24:38
EN: I can exit with limit or market orders, but I’m making my decisions
24:38 - 24:42
EN: based upon what the underlying stock is doing.
24:42 - 24:46
EN: So for example, if the SPDR looks like it’s a buy and I’d rather buy options,
24:46 - 24:51
EN: I immediately buy at the market or with a limit order, an At The Money call,
24:51 - 24:55
EN: assuming that I’m trading the options today instead
24:55 - 24:57
EN: of the SPDR – which I sometimes do.
24:58 - 25:02
EN: Sometimes I’ll take swing trades in the SPDR calls or SPDR puts,
25:02 - 25:07
EN: day trade swing trades, holding for an hour or two or three,
25:07 - 25:11
EN: and I’ll take scalps in the Emini, the futures contract.
25:14 - 25:18
EN: Usually when I’m trading options, I’m doing it for a trade,
25:18 - 25:19
EN: trading options on the daily chart.
25:19 - 25:26
EN: And a trade means that my goal is to reach a profit target within 1 to 3 days,
25:26 - 25:27
EN: and then I get out.
25:27 - 25:31
EN: So I get out with a profit or with a loss within 1 to 3 days.
25:32 - 25:35
EN: I rarely lose more than half of the cost of the option,
25:35 - 25:40
EN: but I also never hold on to the option and hope that the option goes my way,
25:40 - 25:42
EN: and I never get greedy.
25:42 - 25:47
EN: Once my goal is no longer likely, I just take my loss and get out.
25:47 - 25:50
EN: And once I achieve my goal, I take my profit and get out.
25:53 - 25:56
EN: Profits disappear very, very quickly in options.
25:56 - 26:00
EN: So if you get a surprisingly big profit within a day or two,
26:00 - 26:04
EN: it’s usually better to exit most or all of your position.
26:04 - 26:09
EN: In general, if the value of the option doubles in price, take at least half off.
26:10 - 26:13
EN: So if you paid a dollar for the option and then yesterday
26:13 - 26:17
EN: and today it’s worth $2, take at least half off,
26:17 - 26:20
EN: if not all off if it’s achieved your goal.
26:22 - 26:25
EN: Time decay erodes profits.
26:27 - 26:31
EN: Let’s say you buy a SPDR call and the SPDR stays the same.
26:31 - 26:33
EN: It does not move a tick up or down.
26:33 - 26:36
EN: Well, tomorrow, your call will be worth 10 cents less.
26:36 - 26:39
EN: The next day it’ll be worth 10 cents less.
26:39 - 26:43
EN: So there’s a certain amount of time decay, usually about 10 cents a day,
26:43 - 26:46
EN: in the SPDR, and you have to be aware of that.
26:46 - 26:48
EN: So don’t hold options too long.
26:50 - 26:56
EN: If you buy an option, a put or a call, while the market is moving up very quickly,
26:56 - 27:00
EN: the option price usually goes up faster than expected
27:00 - 27:05
EN: because a certain amount of uncertainty gets built into the cost of the option.
27:06 - 27:09
EN: The increase in volatility increases the uncertainty
27:09 - 27:12
EN: and the risk to anyone selling the option,
27:12 - 27:16
EN: so the price of the option goes up faster than the market.
27:16 - 27:21
EN: If the market suddenly reaches your target and then starts to go sideways,
27:21 - 27:27
EN: the value of the option will shrink very fast as volatility shrinks.
27:27 - 27:31
EN: So if you have a big profit on a very quick move,
27:31 - 27:35
EN: the option is extra inflated because of the quickness of the move.
27:35 - 27:40
EN: You should always take at least part, half, and sometimes all of the position off.
27:42 - 27:43
EN: And what about the spreads?
27:44 - 27:47
EN: Spreads take a big move to become profitable.
27:48 - 27:55
EN: If, for example, let’s say the stock is at 100 and you buy a 100-105 spread.
27:55 - 27:57
EN: For you to make a profit on that spread,
27:58 - 28:01
EN: you need the market to move up close to 105.
28:01 - 28:05
EN: And if it does not get close to 105, you’re not going to make much profit.
28:05 - 28:09
EN: If your goal is to get out in 1 to 3 days – in other words,
28:09 - 28:14
EN: if you think the stock is going to go to 101 – don’t buy a spread, 105 spread.
28:14 - 28:16
EN: Don’t even buy a 100-101 spread.
28:16 - 28:21
EN: Simply buy the call outright, because if your goal is short term
28:21 - 28:25
EN: to get out in 1 to 3 days, the spread will not have enough time
28:25 - 28:28
EN: and the market will not move enough for you to make a profit.
28:28 - 28:35
EN: Also, you’re paying double commissions, you’re paying double bid/ask spread costs.
28:35 - 28:37
EN: So if you’re buying a call spread or a put spread,
28:38 - 28:40
EN: you have to be going for a much bigger move,
28:40 - 28:44
EN: like a 3% or a 4% or 5% move in the stock.
28:44 - 28:47
EN: If you’re just looking for a little 1% move,
28:47 - 28:51
EN: just go ahead and buy the call outright if you think the market’s going up.
28:51 - 28:54
EN: Or if you think the market’s going to fall 1% tomorrow,
28:54 - 28:56
EN: you just go ahead and buy a put.
28:59 - 29:03
EN: In general, if you’re buying a spread, it’s only going to be worthwhile
29:03 - 29:06
EN: if you’re expecting a move of about 5%
29:06 - 29:09
EN: or even 10% at some point over the next several weeks.
29:11 - 29:15
EN: For example, let’s say you buy a 3% to 5% spread.
29:15 - 29:17
EN: The strikes are 3% to 5% apart.
29:17 - 29:22
EN: So let’s say the SPDR’s at 140, and you buy a 140-145 call spread.
29:22 - 29:27
EN: So you buy the 140 call and you sell the 145 call
29:27 - 29:30
EN: to help finance the cost of the purchase.
29:33 - 29:37
EN: When you’re buying a spread, you want the space between the strikes
29:37 - 29:40
EN: to be two to three times bigger than the cost.
29:40 - 29:42
EN: If you’re buying let’s say a put spread
29:42 - 29:46
EN: – let’s say you’re buying a 140 put and selling a 135.
29:46 - 29:49
EN: The difference in price is $5.
29:49 - 29:53
EN: So if you’re going to buy the 140, sell the 135 put spread,
29:53 - 29:57
EN: you don’t want to be paying more than 170 for it.
29:57 - 29:59
EN: 170 is good.
29:59 - 30:04
EN: A lot of times it’ll be as high as 250, but never pay more than 250.
30:04 - 30:08
EN: So never pay more than half of the distance in the spread.
30:09 - 30:13
EN: Sometimes if you want to make the ratio 3:1,
30:13 - 30:15
EN: you have to go a little bit Out of The Money, which is okay.
30:17 - 30:20
EN: But if you’re expecting a big move, 5% to 10% move,
30:21 - 30:25
EN: going a little Out of The Money is okay because you’re expecting the move
30:25 - 30:29
EN: to go well beyond your short strike price anyway.
30:32 - 30:35
EN: Let’s say the SPDR’s at 140 and you think it probably
30:35 - 30:41
EN: will fall to 135 – in other words, about a 4% move in the next couple of weeks.
30:41 - 30:46
EN: You might buy a 1 to 2 month out 140-135 put spread,
30:46 - 30:49
EN: and you can usually place it as a spread order.
30:49 - 30:53
EN: Most brokers allow you to place that as a spread order using limit orders.
30:53 - 30:56
EN: For example, you might buy it at 170 or better.
30:57 - 31:00
EN: So you get filled – let’s say you get filled at 170.
31:02 - 31:06
EN: I’m sure you’ve read about more complex options strategies,
31:06 - 31:09
EN: and if you watch television, there are shows
31:09 - 31:12
EN: that sometimes discuss options strategies.
31:12 - 31:15
EN: Every now and then, an options trader on television will talk
31:15 - 31:20
EN: about a strategy that will have a payout much bigger than the risk.
31:20 - 31:26
EN: So for example, he might buy a put fly, a put butterfly trade,
31:26 - 31:31
EN: which is basically buying a put spread and then selling a lower priced put spread.
31:31 - 31:36
EN: So for example, let’s say he buys a put fly and he pays $1 for it.
31:36 - 31:41
EN: He’ll argue that, hey, you might be able to make $5 on your $1 investment.
31:41 - 31:44
EN: The most you can lose is $1,
31:44 - 31:48
EN: and the most you can win is $5, so why not take the trade?
31:48 - 31:51
EN: In fact, why not take all kinds of butterfly trades?
31:51 - 31:55
EN: Besides the obvious problem of four legs to the trade
31:55 - 31:58
EN: and four times the commissions and four times the spread,
31:58 - 32:01
EN: there’s a much more important problem.
32:01 - 32:05
EN: Remember, there are no perfect trades, and any time you see a trade
32:05 - 32:08
EN: where the reward is much greater than the risk,
32:08 - 32:12
EN: you know that you’re going to lose most of the time.
32:12 - 32:16
EN: The Trader’s Equation tells you the probability will be very low.
32:16 - 32:19
EN: Remember, you’re trying to take money from institutions,
32:19 - 32:22
EN: and they’re not going to smile and happily hand you their money.
32:23 - 32:26
EN: So any time they’re going to dangle a big reward
32:26 - 32:30
EN: in front of you with very little risk, you have to be aware
32:30 - 32:33
EN: that you’re going to lose most of the time.
32:34 - 32:37
EN: If you don’t mind losing most of the time, then go ahead,
32:37 - 32:41
EN: take those strategies like put flys or call butterflies
32:41 - 32:45
EN: and occasionally make five times your risk.
32:45 - 32:50
EN: But that means you’re probably losing three or four times every time you win,
32:50 - 32:53
EN: and you have to also consider the emotional factor.
32:53 - 32:58
EN: Are you going to be happy losing 70% of the time, 80% of the time?
32:59 - 33:03
EN: I’m personally not that way, so I usually avoid trades
33:03 - 33:05
EN: where the reward is so much greater than the risk
33:05 - 33:11
EN: because I know that the only way that can happen is if I lose most of the time.
33:11 - 33:12
EN: And I like to win.
33:12 - 33:13
EN: I don’t like to lose.
33:13 - 33:16
EN: So I usually avoid very low probability trades.
33:30 - 33:33
EN: Remember, if the stock falls a dollar,
33:34 - 33:38
EN: the value of your call will fall 50 cents.
33:39 - 33:41
EN: If you look at the bid/ask spread, you’ll see
33:41 - 33:45
EN: that the bid/ask spread is 50 cents below the price that you paid.
33:45 - 33:50
EN: However, unless a trade takes place in your particular call,
33:51 - 33:52
EN: the stop won’t get triggered.
33:56 - 33:57
EN: Let me give you an example.
33:57 - 33:59
EN: Let’s say Baidu is at 100.
34:00 - 34:04
EN: You buy the At The Money call, the 100 call, and you pay $3 for it.
34:05 - 34:07
EN: You say, “Well, I don’t want to lose more than 20 cents.
34:07 - 34:11
EN: I’m going to put a stop to exit at 2.80.
34:11 - 34:15
EN: So if my call falls to 2.80, I’m going to get out and take a 20 cent loss.”
34:16 - 34:17
EN: There’s a problem with that.
34:17 - 34:22
EN: Let’s say Baidu starts to sell off and it falls down to 99.
34:22 - 34:27
EN: That means the value of your call is probably now worth about 2.50,
34:27 - 34:29
EN: and if you look over at your positions,
34:29 - 34:34
EN: you might find you’re still holding that 100 call and it’s now worth 2.50.
34:35 - 34:39
EN: How could it fall to 2.50, well below your 2.80 stop,
34:39 - 34:41
EN: and your stop not get filled?
34:41 - 34:45
EN: Well, it’s because the Baidu options are not actively traded,
34:45 - 34:49
EN: and it’s possible that no trades took place in the Baidu calls,
34:49 - 34:54
EN: even though Baidu fell a dollar and the value of the call fell 2.50.
34:54 - 34:58
EN: Your stop at 2.80 only gets hit if there’s a trade
34:58 - 35:02
EN: that takes place in that call at 2.80 or below.
35:03 - 35:07
EN: So right now you’re looking and you’re saying, “Huh, Baidu’s at 99.
35:07 - 35:11
EN: My call is at 2.50, and I’m still long and the market’s falling.
35:11 - 35:12
EN: What am I going to do?”
35:16 - 35:20
EN: If someone finally places a trade in that call at 2.10
35:20 - 35:25
EN: – if someone buys the call, sells a call at 2.10 – remember, you bought it at 3.
35:25 - 35:27
EN: It’s way below your 2.80 stop.
35:28 - 35:34
EN: So somebody finally buys a call or sells a call and the trade takes place at 2.10.
35:35 - 35:39
EN: This is the first trade that took place at or below your stop price,
35:39 - 35:42
EN: so now your 2.80 stop becomes a market order.
35:43 - 35:48
EN: You’ll get filled at the bid, but the bid might be 1.90.
35:48 - 35:53
EN: There might be a 20 cent bid/ask spread in the Baidu 100 calls,
35:53 - 35:57
EN: so now you’ll get filled at the bid, which is 1.90.
35:57 - 36:00
EN: So your 2.80 stop got filled at 1.90,
36:00 - 36:02
EN: 90 cents worse than you thought it should be filled.
36:05 - 36:09
EN: That’s why you cannot use stops when you trade options,
36:09 - 36:10
EN: or why you should not use stops.
36:10 - 36:14
EN: What you do instead is you look at the underlying.
36:14 - 36:17
EN: You look at the chart of Baidu, the stock itself,
36:17 - 36:23
EN: and if it looks like the premise is no longer valid, if it looks like your premise,
36:23 - 36:27
EN: your thought that the market was going up, is wrong, you get out.
36:27 - 36:31
EN: So you quickly go to Baidu and you get out with a limit order
36:31 - 36:34
EN: at the best price you can, which usually means at the bid.
36:35 - 36:36
EN: Don’t be greedy.
36:36 - 36:37
EN: You’re wrong.
36:37 - 36:38
EN: Just accept it.
36:38 - 36:41
EN: You’re going to be wrong a lot in trading, and when you’re wrong,
36:41 - 36:44
EN: just accept it, get out, and look for the next trade.
36:44 - 36:45
EN: Take your loss.
36:45 - 36:47
EN: Don’t get greedy and try to minimize your loss,
36:47 - 36:50
EN: hoping that the market will go your way a little bit
36:50 - 36:52
EN: so you can get out with a smaller loss.
36:52 - 36:53
EN: When you’re wrong, just get out.
36:57 - 37:01
EN: So once you decide that you’re wrong and that your underlying premise
37:01 - 37:06
EN: is no longer working, place a limit order that gets you out within seconds.
37:07 - 37:10
EN: You can exit at the bid or even a little bit worse.
37:11 - 37:12
EN: Just get out.
37:12 - 37:13
EN: Don’t try to save a couple ticks.
37:13 - 37:15
EN: Just get out when you’re wrong.
37:17 - 37:20
EN: So, when should you enter an option position?
37:20 - 37:22
EN: As soon as the setup is clear.
37:22 - 37:26
EN: You look at the daily chart, the weekly chart, the 60-minute chart.
37:27 - 37:29
EN: I typically enter just before the close of the day.
37:29 - 37:34
EN: Sometimes I’ll enter at any time during the day if the market action
37:34 - 37:36
EN: seems like it warrants putting on an option position.
37:36 - 37:40
EN: But a lot of times, if I’m trading the daily chart or even the 60-minute chart,
37:40 - 37:43
EN: I wait for just before the close of the day
37:43 - 37:47
EN: because I want a strong signal bar before I enter.
37:52 - 37:54
EN: When to exit an option?
37:54 - 38:00
EN: Usually when the position on the underlying tells you that the trade is over.
38:00 - 38:04
EN: For example, you stay in until the Always In direction reverses.
38:05 - 38:07
EN: If a stop on the underlying would have been hit
38:07 - 38:10
EN: had you taken a position in the underlying,
38:10 - 38:13
EN: then you just go ahead and exit the option immediately.
38:14 - 38:17
EN: If you had taken a position in the underlying
38:17 - 38:21
EN: and the profit would’ve reached twice your risk,
38:21 - 38:24
EN: or if the option itself doubles in price,
38:24 - 38:29
EN: that’s a good time to take half off or sometimes even your entire position off.
38:30 - 38:33
EN: So if you buy a call for a dollar and it’s now worth 2 dollars,
38:33 - 38:35
EN: take at least half off.
38:35 - 38:38
EN: If the underlying risk was let’s say a dollar
38:38 - 38:43
EN: and the underlying has moved 2 dollars, twice the size of the underlying risk,
38:43 - 38:47
EN: then you could take half of your option position off.
38:50 - 38:54
EN: Let’s take an example of the SPDR at $140.
38:54 - 38:57
EN: The cost of 100 shares is $14,000.
38:57 - 39:00
EN: If you bought a 1 month out monthly call,
39:00 - 39:05
EN: At The Money call or put, you might pay $150.
39:05 - 39:07
EN: In other words, $1.50.
39:07 - 39:12
EN: That’s your maximum loss on the call, even if the market crashed.
39:14 - 39:18
EN: On the other hand, if the SPDR rallied 1% today,
39:18 - 39:22
EN: the profit would be $140 if you bought 100 shares of the SPDR,
39:22 - 39:25
EN: and it might be $50 if you bought one call.
39:28 - 39:32
EN: If the SPDR fell 2% today and you had a call,
39:32 - 39:36
EN: the loss on the SPDR would be $280 in the SPDR,
39:36 - 39:40
EN: and only $50 if you bought the call, approximately.
39:43 - 39:48
EN: If the SPDR fell 5% today and you owned 100 shares of the SPDR,
39:48 - 39:52
EN: you’d lose $700 if you bought the SPDR,
39:52 - 39:55
EN: but you might only lose $65 if you bought one call.
40:00 - 40:06
EN: Most daily stocks have a range of about 1% a day, and often more.
40:07 - 40:11
EN: Most move 2% to 10% within the next several days.
40:12 - 40:15
EN: The options tend to move about half as much.
40:15 - 40:22
EN: If the SPDR’s at 140, it very often would be 5% higher
40:22 - 40:23
EN: over the course of the next week.
40:23 - 40:27
EN: It might be 145, and the option might move up, if you bought a call,
40:27 - 40:30
EN: it might move up $2, $2.50.
40:32 - 40:37
EN: Let’s take an example of a stock that’s currently trading at $100
40:37 - 40:41
EN: and let’s say you bought a 1 month out At The Money call.
40:41 - 40:42
EN: At The Money, 100.
40:42 - 40:47
EN: So you paid $2 for an At The Money call, a 100 call.
40:47 - 40:52
EN: $2 is 400 shares of stock, so one call controls 100 shares of stock.
40:52 - 40:56
EN: You actually paid $200 for that call.
40:56 - 41:02
EN: If the stock rallies 3% over the next 3 days, 3% would be $3.
41:02 - 41:04
EN: The stock would be $103.
41:04 - 41:08
EN: The call would probably be up about $1.50.
41:08 - 41:12
EN: You could sell it for $3.50, approximately.
41:12 - 41:14
EN: Maybe a little bit less, maybe a little bit more.
41:14 - 41:19
EN: So you would have made $1.50 on your $2 call.
41:19 - 41:22
EN: That $1.50 is times 100 shares,
41:22 - 41:28
EN: so you would’ve made $150 on your Initial Risk of $200.
41:32 - 41:34
EN: Let’s take an example of Apple.
41:34 - 41:40
EN: Let’s say today it’s trading at $600, and you thought it was going to fall,
41:40 - 41:43
EN: so you went ahead and you bought a 1 month out At The Money put.
41:43 - 41:46
EN: You might’ve had to pay $27 for that put.
41:46 - 41:51
EN: Remember, that’s times 100 shares, so your actual cost,
41:51 - 41:54
EN: what you actually had to pay, was $2,700.
41:55 - 42:01
EN: If Apple falls 3% over the next 3 days, 3% is $18.
42:01 - 42:04
EN: The put would move about half as much.
42:04 - 42:08
EN: It would increase in value about $9, and you could sell
42:08 - 42:13
EN: that put for $36, approximately, and you would’ve made $9 on your put.
42:13 - 42:19
EN: That’s $9 times the 100 shares that each put represents,
42:19 - 42:24
EN: so you would’ve bought the put for $2,700 and you would’ve sold it for $3,600,
42:24 - 42:28
EN: and you would’ve had a net profit of about $900.
42:32 - 42:34
EN: Some stocks are fantastic.
42:34 - 42:39
EN: For example, Apple, the At The Money options for the nearest contracts
42:39 - 42:44
EN: on the monthly options, the volume is often 3,000 options a day,
42:44 - 42:46
EN: which is very good volume.
42:46 - 42:52
EN: In general, better to enter and exit monthly options with limit orders,
42:53 - 42:57
EN: although with huge markets like Apple and the SPDR,
42:57 - 43:00
EN: you usually can enter and exit at the market.
43:02 - 43:06
EN: And the bid/ask spread on stocks like Apple is really good.
43:06 - 43:12
EN: It might be 10 cents when Apple’s trading at $600, which is very good.
43:12 - 43:15
EN: If it was a $60 stock, that would be a penny,
43:15 - 43:17
EN: and that’s a very tight bid/ask spread.
43:17 - 43:19
EN: So you get very good fills.
43:22 - 43:23
EN: Which stocks do you use?
43:23 - 43:29
EN: You can use any stock or any ETF, and you want the open interest
43:29 - 43:35
EN: of the options to – of the At The Money options in general to be 1,000 or more.
43:35 - 43:36
EN: Sometimes less.
43:36 - 43:42
EN: 5,000 or more is better because the more actively traded the options,
43:42 - 43:47
EN: the tighter the bid/ask spread, so the less your execution costs.
43:48 - 43:52
EN: Also, you want the options to be traded fairly actively
43:52 - 43:56
EN: so that if you’re trying to get out, you want your order to be filled quickly.
43:56 - 43:59
EN: You don’t want to place an order, a limit order to get out
43:59 - 44:02
EN: and it just sits there for an hour or two or three,
44:02 - 44:06
EN: because then you’ll end up having to change it to make it a better price
44:06 - 44:09
EN: for the person on the other side, which is a worse price for you.
44:09 - 44:11
EN: So you either make less money,
44:11 - 44:15
EN: or if you’re trying to get out of a losing trade, you lose more money.
44:18 - 44:20
EN: Which stocks do you trade?
44:20 - 44:24
EN: You can look at the daily or 60-minute charts for setups.
44:24 - 44:26
EN: You look for best trade setups.
44:26 - 44:30
EN: If you see a setup, a Best Trade type of setup on the daily chart
44:30 - 44:34
EN: or 60-minute chart, then you should consider trading put
44:34 - 44:38
EN: or a call or a spread on that particular underlying stock.
44:42 - 44:49
EN: Examples in 2012 of stocks that have very reliable options – SPDR, Apple, Amazon,
44:49 - 44:53
EN: Google, Goldman Sachs, IBM, gold.
44:53 - 44:54
EN: There are far more than that,
44:54 - 44:57
EN: but those are the ones that I look at pretty regularly.
44:57 - 45:02
EN: Just about any stock can be good on any day if it moves enough.
45:02 - 45:05
EN: So if there’s a special situation, some news event,
45:05 - 45:10
EN: some very boring stock can suddenly have very big daily ranges
45:10 - 45:13
EN: and huge volume in the options.
45:16 - 45:22
EN: Stocks with small option volume, sometimes they become very active
45:22 - 45:25
EN: and the bid/ask spreads then become very small,
45:25 - 45:28
EN: and the options can be traded extremely well,
45:28 - 45:31
EN: just like any other big volume option stock.
45:34 - 45:35
EN: Here’s an example.
45:35 - 45:43
EN: The daily chart of TLT, which is the ETF that follows the 30-year Treasury Bond.
45:43 - 45:47
EN: Let’s say you have a possible Major Trend Reversal, a top.
45:47 - 45:51
EN: You could look to buy one month out At The Money puts.
45:51 - 45:55
EN: Once the price of the puts doubles, you can take half off
45:56 - 46:01
EN: and then you could swing the balance as long as the TLT chart remains
46:01 - 46:06
EN: Always In Short, and you can hold until expiration if your thesis
46:06 - 46:09
EN: is still correct that the market is still Always In Short.
46:14 - 46:16
EN: Here’s the daily chart of TLT.
46:16 - 46:22
EN: The market’s clearly in a bull trend and had a very strong bear spike,
46:22 - 46:25
EN: and then it went sideways for about 20 bars or so.
46:25 - 46:27
EN: It broke the trend line by going sideways.
46:27 - 46:29
EN: It tested the Moving Average.
46:30 - 46:32
EN: Traders can look to sell a reversal down
46:32 - 46:37
EN: from a test of the high of the bull trend for a possible Major Trend Reversal.
46:41 - 46:43
EN: Here we have a rally.
46:43 - 46:46
EN: We tried to reverse here, but below a bull bar,
46:46 - 46:49
EN: and after 5 or 6 bars up, I would not take that short.
46:50 - 46:54
EN: Here we’re around a Double Top, and this would be a second entry short,
46:54 - 46:57
EN: this being the first, and we have a decent bear bar.
46:57 - 47:01
EN: You can argue that the Micro Channel is extremely tight, and it is.
47:01 - 47:03
EN: It’s a very, very Tight Channel.
47:03 - 47:08
EN: We had a Micro Channel here, a breakout, now a pullback back into the channel.
47:08 - 47:10
EN: This is an extremely Tight Channel.
47:10 - 47:14
EN: In general, whenever the market is in a very Tight Channel
47:14 - 47:19
EN: and I’m looking for a trade in the opposite direction, I wait for a second signal.
47:19 - 47:23
EN: I wait for the market to go sideways a little and then have a second signal.
47:26 - 47:27
EN: And that’s what we had.
47:27 - 47:28
EN: We had the channel.
47:28 - 47:34
EN: We broke through the Tight Channel for a few bars, so we had some Selling Pressure,
47:34 - 47:35
EN: and now we have another bear bar.
47:35 - 47:38
EN: So now we have a Higher High Major Trend Reversal,
47:38 - 47:40
EN: and we have a decent second signal.
47:40 - 47:42
EN: This bear bar was a first signal.
47:42 - 47:45
EN: I would not call this bull bar a decent signal.
47:45 - 47:47
EN: I would say this is a signal, this is a signal.
47:48 - 47:50
EN: It’s still in a fairly Tight Channel.
47:50 - 47:53
EN: Maybe it’s better for it to round over some more.
47:53 - 47:56
EN: In fact, it probably is when the channel is this tight.
47:57 - 47:59
EN: That means the momentum up is so strong.
47:59 - 48:02
EN: But I would not be opposed to taking this short.
48:02 - 48:05
EN: Since we’re talking about options, buying puts.
48:10 - 48:12
EN: Let’s say you bought puts and were willing
48:12 - 48:15
EN: to let the market go against you a little bit.
48:15 - 48:19
EN: You’d still be holding your puts when the market did this.
48:19 - 48:22
EN: If you did not buy puts and you were waiting for a second signal
48:22 - 48:28
EN: and you saw the market fall below that bar and then had a strong bear close,
48:28 - 48:32
EN: you might go ahead and buy the one month out August At The Money put.
48:32 - 48:38
EN: Right now, the TLT is around 131, so the At The Money put would be 131,
48:38 - 48:41
EN: and you probably could’ve paid about $1.50 for it.
48:43 - 48:45
EN: You have a Micro Double Top.
48:45 - 48:48
EN: The market went up and down, up and down.
48:48 - 48:51
EN: A second signal, and it’s a Higher High Major Trend Reversal.
48:51 - 48:54
EN: My concern would be the tightness of the channel,
48:54 - 48:59
EN: but we’re starting to turn down repeatedly here – one, two, three, four.
48:59 - 49:03
EN: I think the chances are pretty good of making a profitable trade.
49:06 - 49:09
EN: So you bought your put there and then you got this gift,
49:09 - 49:13
EN: a big gap down and a big, big bear bar through the Moving Average.
49:14 - 49:17
EN: Your put now is over $3, so it doubled in price.
49:18 - 49:22
EN: In general, I don’t like to get greedy with options
49:22 - 49:24
EN: because option profits disappear very quickly.
49:24 - 49:28
EN: Even if the market goes sideways, your profits disappear.
49:28 - 49:30
EN: So I always take at least half off.
49:32 - 49:35
EN: So here, option, you bought it for $1.50.
49:35 - 49:36
EN: It’s now $3.
49:36 - 49:38
EN: I would take half off or even all off.
49:42 - 49:47
EN: If you took half off and planned to exit, if TLT went above your signal bar
49:47 - 49:52
EN: and then you were going to let the rest swing, you might’ve taken some off here.
49:52 - 49:53
EN: Tight Channel.
49:53 - 49:54
EN: I probably would hold.
49:54 - 49:57
EN: Here we have a third push down – one, two, three.
49:57 - 49:59
EN: We fell below the bottom of a trend channel line.
49:59 - 50:00
EN: I don’t have it drawn in.
50:01 - 50:06
EN: The puts expired over here on this day for $9.50,
50:06 - 50:10
EN: so $9.50 would have been in your account.
50:10 - 50:12
EN: You paid $1.50.
50:12 - 50:14
EN: The puts expired at $9.50.
50:14 - 50:16
EN: Your profit was $8.
50:16 - 50:20
EN: You would’ve ended up with $800 profit per put.
50:24 - 50:28
EN: Alternatively, let’s say you had taken the earlier entry
50:28 - 50:32
EN: when the TLT was at 130 and you bought the 130 put.
50:32 - 50:35
EN: You would’ve paid $2 for it at that time.
50:36 - 50:43
EN: When the option expired over here, the TLT fell $8 from your entry price to 122,
50:43 - 50:49
EN: so your 130 put would have a value of $800 when it expired,
50:49 - 50:53
EN: and since you paid $2 for it, it’s now worth $8.
50:54 - 50:56
EN: Your total profit would’ve been $600.
50:56 - 51:02
EN: $6 on the put times 100 contracts or 100 shares of the underlying.
51:04 - 51:07
EN: If your premise is no longer valid, get out.
51:07 - 51:11
EN: Never hold on to a position and hope that it will once again go your way.
51:11 - 51:14
EN: Just exit, take your loss, and move on.
51:14 - 51:15
EN: Look for another trade.
51:15 - 51:18
EN: Remember, you’re going to lose a lot as a trader.
51:18 - 51:21
EN: If you’re good, you’ll win 60-70% of the time.
51:21 - 51:24
EN: If you’re really good, you can win 80% or 90% of the time.
51:25 - 51:28
EN: If you’re winning 60% of the time, be happy,
51:28 - 51:31
EN: but that still means you’re going to lose 40% of the time.
51:31 - 51:34
EN: So never, never get upset by a loss.
51:34 - 51:35
EN: Just take it and move on.
51:35 - 51:37
EN: Look for another trade.
51:39 - 51:40
EN: Here’s Apple.
51:41 - 51:45
EN: We have a bull trend and a very strong break below the bull trend line
51:45 - 51:47
EN: and a test of the Moving Average.
51:47 - 51:51
EN: We fell well below the Moving Average, so you probably would start
51:51 - 51:55
EN: to look for a reversal down on any test of the high.
51:55 - 51:59
EN: So in other words, you look for a Major Trend Reversal Top on the next rally.
52:03 - 52:04
EN: Here we have a rally.
52:04 - 52:09
EN: It has three pushes up – a bar up and then down, up and then bear bar and then up.
52:09 - 52:14
EN: So we have a Lower High Major Trend Reversal in the shape of a Wedge bear flag.
52:14 - 52:16
EN: So that’s a decent setup.
52:16 - 52:19
EN: A bull body for the signal bar, not ideal.
52:19 - 52:21
EN: So if you don’t take the first entry, you could take the second.
52:21 - 52:28
EN: At The Money, 380, so you can buy a one month out At The Money 380 put,
52:28 - 52:32
EN: September in this case, and you might pay $15 for it
52:32 - 52:35
EN: for this Lower High Major Trend Reversal.
52:38 - 52:47
EN: And then you see a few days later, Apple fell $25 and your 380 put rose $12 to $27.
52:47 - 52:50
EN: You paid $15, it’s at $27.
52:50 - 52:56
EN: It’s not quite two times your cost, but it’s close, and it’s closing on its low.
52:56 - 52:59
EN: It’s reasonable to hold for more.
53:03 - 53:05
EN: But this is what you got instead.
53:05 - 53:10
EN: So instead of the market going down and hitting your initial target
53:10 - 53:13
EN: of two times the cost, the market reversed up quickly.
53:14 - 53:17
EN: The market had 6 consecutive bull bodies here,
53:17 - 53:19
EN: and you’re well above the entry price.
53:20 - 53:25
EN: At this point the Major Trend Reversal is unlikely and the bull is resuming.
53:25 - 53:28
EN: If you held through all of this – most traders
53:28 - 53:31
EN: would not have held through 4 big bull bars like this,
53:31 - 53:33
EN: but had you held through it,
53:33 - 53:38
EN: you could have sold your put for $11 just before the close.
53:38 - 53:41
EN: So you paid $15, you’d sell for $11.
53:41 - 53:45
EN: You’d lose $4 times 100 shares; you would lose $400.
53:46 - 53:50
EN: Most traders in fact probably would have bought calls in here.
53:50 - 53:52
EN: Bull trend, looks like it’s resuming.
53:52 - 53:54
EN: Or here, or here.
53:59 - 54:05
EN: And that is the end of my module on trading options on daily charts.