Covered Strangle (Across Multiple Indices)

Here are the two major US equity index ETF's the SPY (S&P 500) or the IWM (Russel 2000). Now I have been considering the actualy value of say historical volatility, and I have come to a conclusion that I would rather use ATR than historical volatility which is a topic I should get into with a different post. However, my bullish for the next 5 days or so is slightly bullish to neutral. I am much more bullish IWM than I am bullish SPY (Completley Neutral), but I am witnessing the SPY seems to be a more suitable premuim sell in this case since the Implied Volatility is above the ATR (what I am using for historical volatility, but to reduce capital anything I sell will have wings on it.

 On the case of buying IWM stock, considering the 3 days down and 2 closes above the low of the day we have an extremley bullish upside historical criteria.

Below is a performance chart of the pattern described above. Bought on the first day the signal was intiated and sold 5 trading days later (1 week). The historical stock trade that included leverage in IWM had a 69% win rate.

A trade that I like is a covered strangle trade across indices for  a short duration of time possibly 2 weeks on the strangle (I will Iron Conderize it by buying some wings as protetion) so I can get a decent premuim at the 1 std dev move, and then I will either buy IWM stock or do a synthetic stock trade using options (Short ATM put, Long ATM Call) to reduce capital once again.

Besides this trade I have very few positions all based of statistical criteria in stocks I follow closely. There a few short premuim trades available at the moment, so I am playing directional and long premuim directional. Long stock seems suitable in TSLA, AMZN, and LNKD.


Thanks,
Alex

NQ Makes for a Different Story than Usual

NQ (NQ Mobile) not to be confused with the /NQ futures (Nasdaq futures) has been a interesting trading vehicle to watch latley. They have over and over again moved there earnings back and back. I have been watching the ATM strangle. I bought iton 7/2/14 before the expected earnings report that didn't come out. I had to pick it up beause it was extremley cheap trading for around .35 -.40 in front of earnings. The reason for this is nobody knew/knows when the actual earnings are/were going to come out. I had a chance intraday to actually sell the strangle for a decent profit, but most of my readers know what my deal with time decay is. Anyway, I have been watching it the day after the expected earnings report which hasn't come yet and the straddle/ATM strangle seems to price approximately the same thing everytime and rally from that level.

The next question is why would I be selling NQ volatility at a 97% IV Percentile. The reason for this is I really don't care. The first line in the sand is that look at the price movement. Implied Volatility hasn't been correct on this stock except for that short period of time in novemeber and back in July and August of 2013. But even that isn't the real reason. The reason is we have the market underpricing options around an even because of the uncertainty of timing of this event. However, we continue to make large unpredictable moves in the underlying paying for most of the decay.

Lets pretend we do but the atm straddle or strangle on 7/9 and the earnings come out. The market does not know if they really will come out or not, so it will be a cheap trade. This stock is either going to go bankrupt (near 0) or it might announce something really good and the stock will rocket. The stock rocketing is the potentially most profitable trade, but it is the least probable. Therefore, the shortside trade is the most probable to be sucsessfull, but it has the least profit potential. This makes the straddle or ATM strangle make a lot of sense.

However, if there is some announcement or piece of news that will end up making sure earnings are on a certain date the options will be over priced again. I prefer the selling put trade because it is the safest if you want to do it. The stock could rocket or go to 0 and your risk is defined with the put. In the case of the call side. The stock could just 100,200, or 300 % at any given moment for any give reason. In stocks like these the downside is always much slower often and the upmoves that are news drive can be huge.

I do warn people who go out and do this trade. Do not do it with large size. I do this in the context of my overal portfolio. The main risk in the trade is time decay, and that is the most important element of my portfolio. How much time decay over my directional risk I have. In a trade like this I will risk no more than 1% of my portfolio and probably about .4-.5% of my overall portfolio.

Email me with questions at alex.optionstrading@gmail.com

Interesting Markets

These make for some very interesting markets at all time highs and low volatility. However, the general feel of the market has been very much different than last year which is good. First of all small caps (TF/RUT/IWM) and Nasdaq (NQ/QQQ/NDX) have been very weak lately. The NQ just rallied with the ES, but it has been a great scalping vehicle, and it also has been a very good vehicle for strangles while the ES/SPX has not been nearly as good. The cyclical action has been okay in the ES but we still are having the grind higher tendency which is something I do not care for. However, we have seen quite a bit of volatility in major names (TSLA, NFLX, AAPL, GOOG, TWTR, etc). Those names have been pretty good, and macro markets have been good. Even if I have not had a focus on some of these bonds, currencies, and commodities have all had decent trading volatility.

As for the US indices, I think we are going to need a catalyst to get some volatility going. I have been long a few Vix calls, but I am going to dump those positions if we do not catch something within the next week. However, I will be selling calendar spreads in the VIX. Vix options are based of the futures so when volatility goes up front month vol will go up much more than back month vol, and these calendars can trade at huge credits when we get vol expansion. I will sell these as cheap protection, but I am remaining long theta and long some vega. My net portfolio Prob of Profit has been lowered by the long vix but the analzye tab/models do not take some of these things into account. The premium sale for a while is going to be IWM. I have a relatively large position in IWM, but it is skewed to the downside for the purpose of protection. This continues to be of interest as volatility percentile in IWM is consistently above the vol in SPY/SPX lately, so the options are relatively expensive, so I am selling them. However, do keep in mind that ATM premiums as a % of the SPX price are at 5 year lows.

 I also see some interesting trading in bonds and currencies. Trading the fear in the euro for example is acceptable and even if the ECB meetings on Thursday take a bad I am still trading euro from the long side via calls in FXE or the 6E futures options. I am buying options in this case because considering what kind of move could happen the longer term options (108 days to expiry) seem cheap. Bonds will also have some interesting movement because I see slowly these assets creeping up as market participants lose interest in equities and move into less risky safer assets such as bonds. I will be buying the dip and playing options is going to depend on vol and binary events that can occur in these markets.

Lastly, commodities are also of interest. Agriculture could also be in play in the coming months and into the harvest season and summer. I am thinking about a direction, but go with the weather trend. I think Corn could be a buy as we are heading into the summer months, and if we have a hot summer then it will get interesting. I prefer directional trades in this case because all the options seem to be fairly priced. I am also going to be selling premium in oil when I can. It is more cyclical than people give it credit for and right now it is out of the picture of news.

Interesting Markets

Interesting markets, still down some money because of crap I had to carry over from 2013, but the horizons are set for good returns. We are back in a traders market. Range bound and cyclical. I have a feeling the next few months are going to be like this, but this is the market forming a long term top.

The chart above is a weekly chart, and as you can see it takes months for tops to form. However, be careful because even before the collapse we see extreme volatility, and this is why we tend to maintain a slightly short delta bias. Long VIX calls are always decent hedges considering the tail risk. Sometimes pairs trades work; selling QQQ volatility and buying SPY volatility which was a great trade last week if you skewed the pair to the short side enough is a good example. I personally though have been keeping the large positions in the indices. If you have followed my trades on dough.com you will see many trades being QQQ trades, and that is just me maintaining basic short strangles. If we see the VIX fall anymore you will likely see me begin buying QQQ volatility including puts, straddles, and long bearish diagonals. The reason for this is when we get a bad downside explosion the Nasdaq tends to explode to the downside at a faster rate. If we see the 12/11 print in the VIX,  I will begin initiating parts of the trade

As for my personal stuff it has been indices and lots of weekly or shorter term trades. They have been working for me much better. I have put out several weekly ratio trades along with a few other custom orders. These have been extremely profitable. My large positions have generally been in the QQQ and a few in the SPY. Strangles have been doing well lately, but I also have to do wide iron condors because of the capital requirements with strangles. The weekly trades have been undefined risk because that is what works for me. In larger stocks I will buy a strike wide out to define the risk, but undefined is my wheelhouse.

I will go into a specific article later about what my weekly trades look like. A few other guys that have really good weekly trades are the Shadow Traders. I do not get anything at all for promoting them, but they do have some interesting stuff. You can find them at shadowtrader.net or Shadow Trader uncovered on tastytrade.com

Why I Chose Trading and My Grind to Profitability

I haven't written an article in a little while, so I decided to write something different. So why did a choose trading?

I have always been very entrepreneurial. The first thing I started with was an allowance. I had a choice I could receive all the change in my dads pocket everyday or I could receive an allowance. This brought me to thinking about risk versus reward. Do I want a steady income or something less reliable with more upside. I took the upside. Why you ask? I was FIVE what risk did I really have. If I wanted something I could just ask my mom to buy it, and I wouldn't have to spend a dime to buy it. Now to be fair, I don't think I was necessarily thinking through all of this at that age, but I think I grasped the idea.

3 years later after I got out of the being "King of the World" stages I became interested in business and finance. I was fascinated about how you could make money. Therefore, I started my own business. Now at age 8 I was a little shy and had limited resources, so I was kind of stuck with illiquid and unfair markets....my parents (they could charge any price the wanted). However, I decided to start with dish washing. I was making a $1 a day from this at dinner time. Okay great that is $365 a year which went into my savings. Then I decided to have a lawn watering business. Okay great no cost and plain revenue takes 20 minutes. That brought in $282 (140 days a year of watering * $2 per job). Then, being the evil child that I am, I sold "information" to my mom of the daily happenings at school, which I probably made $.50 a reports, and I sold about 3 reports a week (begining, middle, and end of the week) which ends up at $78 a year. So we are at a minimum of $726 a year + the income I was making from my dads change (which if you think about is a lot like options income investing, if the insurance doesn't pay I don't get my premium). So, I was making pretty decent for a 8 year old at this point. I decided to package this into a "giant" conglomerate, so I could use cash from one company to fund another company. Then the question came up. What do I do with the extra cash?

This shot me right into the trading world. Within a few weeks, I had decided I needed a brokerage account, and I had to invest. I spent a 1/2 year learning and not doing as single trade until January 2009. In January 2009, with a $500 trading account, I bought shares of 5 shares of INTU at $ 52. I ended up scratching the trade, but it was a great experience. So, at the end of 2009 I ended up going through some decent pain, and I scratched the year. I also decided from just that volatility that I couldn't make big returns from such a small account, but I could prove that I could consistently the outperform the market, and I did making 20 % + with relatively small draw downs in 2010 and the same in 2011 of less than 10% unfortunately it was to difficult to leverage in such small accounts. Today, I have learned to simply use more leverage for a higher return

Now by the end of 2011 I had decided that I am going to learn options trading. I also began trading longer term and mostly macro markets in 2012 with a $2500 trading account. By the summer of 2012 I was almost solely trading macro directional options buying ITM options, and a pretty non strategic approach. I was basically managing winners and playing the trend, in my dads IRA account, and my own account. After the summer of 2012, I began taking on a strategic approach, and I was also doing pretty well with that, and I ended the year in my dad's IRA in + 15% with a max drawdown of 3% (My dad has a limited risk tolerance so I cut down on leverage big time), and I made just a little in my small account ending with $4500, but I put in contributions. I think I had the best year ever here from a risk to reward standpoint. To put it in perspective, in a higher risk trading account I would use 3x leverage of a low risk IRA with a return of 45% and a draw down of 9%.

Now I am going to fast forward into summer of 2013. At this time I was up 4% on the year in a higher risk margin account that I was willing to take more risk in. Then I got whipsawed on deltas, volatility sucked, and I got overly short deltas. It ended up being the first year the market tested me into losing money, but I learned 100x what I did before all the previous year because nothing teaches you more than being tested.

Now in 2014, I have been doing much better. My portfolio volatility has decreased and returns have been much more consistent. My goal is to beat my 5/1 risk to reward in 2012.

When is There Not An Edge to Sell Premuim?

In the financial industry, the likelihood of outlier moves has been a constantly argued subject. This is especially true when it comes to derivatives products, specifically options. How often do the 3 std deviation, 2 std deviation, or even 25 std deviation events occur? Now I do not want to turn this into a mathematical article at all. In fact the way I will look at this just might make a mathematician cringe. However, lets take a look into some of the facts.

1. When volatility is above its mean to is a time to sell volatility.
2. The seller of the options wants implied volatility to forecast greater moves than realized volatility will be.
3. Not all stocks are good products for premium sellers because implied volatility is consistently wrong in predicting the actual moves/volatility.

Therefore, lets take a look at the opportunity this presents us. As we all know, many individual stocks are much more volatile than the stock market indices. This means historically indices have performed well for the short premium side not including some large outliers (i.e 2008-2009 crisis). Despite this, historical volatility tends to stay above implied volatility most of the time. This means volatility is low and continues to contract. The large opportunities in indices come only when there are large discrepancies in the volatility. However, this is looking at it on a long-term level.

However, if we were to expand our range to more range bound volatile indices like emerging and global markets we have more risk, but we have much more decent opportunity of implied volatility outweighing realized volatility.

If we were to sell premium in global indices we would overall have the edge. Even statistically index short premium works (You would especially know if you have ever watched the Karen the Super trader interviews). However, in individual stocks, commodities, currencies, and extremely volatile markets these rules do not always hold true. In fact, we will often see outliers where long premium makes sense. These are often the high flying stocks like TSLA or NFLX. Sometimes they are even commodities such as Natural Gas. However, overall short premium still wins, but the premium sellers (usually me) can get burned severely in these underlyings that have such large moves.

What we also must understand is that stocks/markets that behave this way take a long time to mean revert. For example, TSLA has consistently had a discrepancy of realized volatility being much higher than implied for months (you are looking at weekly charts BTW). It is also the same with NFLX. These stocks are premium buying stocks, and these are stocks that I try to avoid selling volatility in. However, when the discrepancy goes the other way their is opportunity.

This is also how I like to use historical volatility in conjunction with IV Rank. I try to look at both before I make a decision. This is especially true when I try and enter a core position where I plan to be short for a while because their is a large discrepancy. My point in all of this is simply "make sure you being paid for the risk you are taking." I always prefer short premuim and even with "undefined risk", but I don't want to be caught in those scary outliers.

Also, I suggest you read this article from Al Sherbin. It is some very interesting views on AAPL historical distributions.
 
Al's Calls of the Day

Patience in the Options Markets

Trading options is quite a bit different than any other trading instruments. In most trading instruments you are looking for more of a instantaneous profit or loss, or in other words instant satisfaction (instant being more quickly). However, the options markets are much more about the likelihood of the move (volatility) and time.

Options decay with time going by, but that is just it. Time takes time. Traders have to wait for time to go by. This is the opposite for the premium buyer, but this person simply wants to bet on direction, and therefore is not a strategic trader (not necessarily a bad thing if it makes money). However, strategic options traders need either volatility to kick in their way, or time to go by. Both of these takes time has volatility grinds down and theta takes time. With undefined risk these factors tend to come in very quickly because you are taking more risk. However, with spreads you have to be very patient. Most spreads that have defined risk will take much longer for both volatility and time to come in because the trader of the spread is taking much less risk, so they give up the risks that come with being naked(Quiet strange minds!). Therefore, you have to be patient when trading options simply because of the factors involved.

 The general rule when it comes to spreads is MANAGE YOUR WINNERS, and be very patient. However, if you trade with spreads being core positions I would say BE SLOW TO ADJUST TRADES. The trader has to give time to let an options spread work for them, and follow their exact rules. If you take the trade off at 50% of max profit then do that. If you repair the trade be slow to do so; therefore, time can work in your favor while you are waiting.