Mark Answers Commons Questions He's Asked

One of the questions that frequently comes up with option traders who have only done the equity side of options is how do I get into trading futures options and what do I need to know before I start?  There are several basic things you should know and understand about futures and their option before you get started with live trading of them.

What month should I trade?

One of the first characteristics to consider is that futures do not always have a new contract every month. Many futures, U. S. Treasury bonds for instance, have only a few contract months per year. Treasuries have March, June, September   and December only. All the months in between have options only that are traded derivative of the next futures month. Strategies, such as time spreads must be placed carefully to insure that you are trading off the same underlying contract month. Get to know your futures and options expiration periods before you start.  Not only the contract months differ from the equity world, trading hours do also so be sure to know when your underlying is being traded during the day and night.

What is the tick size?

Tick size for the different futures and options is different than many equities also. And the tick size of the options and the future itself can be different. Using the bond example again, the future tick size is $31.25 per tick and the options are $15.625 per tick. Futures trading can be larger and highly leveraged, it is important to understand how each tick movement is effecting your position.

What type of strategy should I trade?

Once you have a basic understanding of the future and its options you wish to trade you can begin to look at what strategies to employ.  Non-directional or directional strategies such as iron condors and calendars can be used but be careful with the time spreads that you are using the same underlying contract month as I mentioned earlier. From my own experience it seems iron condors either even on each side or sometimes weighted heavier on one side or the other can be a solid month-to-month trade.  Sometimes short or long straddles can be appropriate also.

Don’t trade without a PLAN!

Having a PLAN is the most important part of trading any underlying, whether you trade futures or equities. Before you enter any trade you should know and have a plan for how and when you will exit the trade at a profit or a loss and at what point you would adjust or reduce risk a trade that is going against you. In my experience mentoring new traders that is the most common mistake I see being made. You must also stick with your plan and try to control the emotions that would have you staying too long or not long enough in a trade. Your trading PLAN is fundamental.  Don’t trade anything without one.

If you follow these steps, you should have a good start to learning how to trade futures and futures options.  Trading always involves risk; learn to control it as best you can.

It seems like Apple (NASDAQ:AAPL) has replaced the Dallas Cowboys as “America’s team.” And yes, I know it is a great stock – one that might actually be undervalued. But at the risk of sounding almost un-American, I think it’s time to start getting short AAPL.

Sure, the company just announced record – heck, downright mindblowing – earnings thanks to iPhone 4S, iPad 2 and international sales. Even Wall Street analysts were impressed with the final numbers.

Unprecedented sales figures for the company aside, I’m a trader and, therefore, looking ahead to what the stock’s going to do next. With all the good news for the company, the stock has been climbing … but it can’t possibly go straight up without any down days.

In other words, even AAPL has to have a few days or weeks to act “human” … and you should get positioned to profit from the pullback when it comes.

As a trader, I am not concerned about AAPL long term. But here in the short- to intermediate-term, it’s quite reasonable and even wise to look for a little healthy downside trading action. Here’s a trade idea for the speculative part of my options portfolio.

Trade Idea: With AAPL trading here around $447, you can “buy to open” 1 April 430 Put (which would cost you about $12) and, at the same time, “sell to open” 1 April 410 Put (for which you would collect $7).

To enter this trade, which is a put debit spread (or a bear-put spread), your total cash outlay would be $5 per share, or $500 per option contract ($12 – $7 x 100).

You could simply buy the April 430 Put on its own, but by selling the $410 put against it, you instantly reduce the amount of money you would otherwise have at risk in the trade.

The spread is costing me $500 and the most I can make is $15 (the difference between the option strikes, or $430 – $410) if the stock is trading at $410 or lower at April expiration.

My total risk in a put debit (or bear-put) spread is the same as being long an option. Whatever I pay, which is $500 in this example, that’s the total risk. The cost of the spread at current prices is closer to $5.30, but I am going to be patient and let it come to me a bit. If the stock goes up a couple bucks from here, I should get filled.

Last week when I told you that it’s time to get a bit short, I also mentioned that you should enter your options trades by “nibbling,” or scaling in by buying your position in thirds.

Here, too, I am initiating this spread with 1/3 of my total intended position size. I am starting with one contract here and will work up to my total of three contracts as the stock increases.

Will I wait till April options expiration to get out of this? No way! Once we get a little pullback and the put spread gains some profits, I’ll head for the exits.

I’d like to make a minimum of $2 on this spread. By getting in at a good price, by scaling into the spread at less than my maximum size, and by using options with an April expiration date, I have lots of time to wait for a small pullback. That’s my plan and I’m sticking to it!

If, after I get up to three contracts and there is no pullback, I plan to show you in a future article how you can cut your total risk in half. (Hopefully, I won’t have to show you this adjustment as anything other than a strategy that’s good to know for future trades.)

Whatever happens, I will follow this trade to completion with you. Stay tuned to see if AAPL is really human. I’m betting it is!

He drank the Kool-Aid

I know the title sounds  a bit bold, but stay with me. Where is most of your money stashed? I’m not trying to get personal, I promise! But for  most of you,  I bet it’s in your retirement account. Another question, will the stuff in your retirement account be happy if the market goes up or down? The answer for most of you is up! Your portfolio has a strong bullish bias for the majority. 2008 hurt so much because most of your assets were in the market when everything fell apart between September 2008 and March 2009 ( 8 months of torture). Do I know something you don’t know about the market? Of course not. What I do know is that your portfolio is probably leaning long, the market is in the upper end of the range, and I’d personally like to start having a few puts around.

I’m going to focus on the SPY. Currently trading at 131.54. The 1,2 and 3 year high is around 135. You still have to respect the trend, which is up, but I’m starting to get some bearish soldiers ready to help out all my bullish soldiers who are getting a bit excited about the upside.

SETUP: Because the trend is up I would scale into some puts. What does that mean?  If my size is 9 contracts, I might buy 3 to start , then buy 3 more maybe at 133 in the SPY, and work up to 9.

STRATEGY: With SPY at 131.54, I might start nibbling and buy the March 127 puts at $2.00. Why March expiration? I want to give myself time and the option premiums are cheaper than they usually are. March is over 50 days from expiration.  Nibbling means buying maybe 30% of my intended size. You say, “ Dan, the March 127 puts are trading at 2.28, how are you going to get $2?”  There is a phrase that says “ let it come to papa”, what does that mean? It means if the market is in a bit of a trend  don’t be aggressive with the price. When  would this order get executed?  Probably when SPY hits between 132 ½ and 133. I might use a GTC order when entering this trade. What do you mean?  Because I am entering my price below the market, it make take a few days to execute, so a good till cancelled order means my $2.00 bid will stay active and I don’t have to put in a fresh order every day. What if the market goes down before I make my put purchase? We miss it! That’s part of the game. This is more of a passive put purchase plan, if I wanted to be more aggressive, I’d pay more. I’d be a little passive, respecting the trend.

Indicator to watch : If VIX hits 24-25 area, start evaluating your retirement account to see if you need some downside help. Not going to really elaborate on the VIX today, and don’t want you to stop enjoying the upside bliss. But I want you to be aware of when the wind might be changing to the downside. Remember Mary Poppins !  24-25 area would be an indicator the market is starting to move down, but not out of control yet. Merely a warning worth looking at!

If the trade goes against me, I will discuss a few adjustments I usually use to fix a put gone bad.  Have a great day!

Dan just recorded a video of an SPX Time Bomb Butterfly.  This trade has low risk and a potential good return.

It means that the market’s fear level of a downside move is the lowest it’s been since the beginning of August. Tomorrow may bring a different story, but for today we will welcome the stability. Reasons for this stability may include some resolution to European problems and anticipation of a Santa Claus rally that we usually get. Let’s take a look at how this may impact the different parts of my Complete Options Portfolio and maybe throw out a trade idea for each part. SPX is currently around 1217 and we haven’t been south of 1160 since October 7, stability usually brings lower VIX levels!

Speculative: Putting on trades based on Directional opinion.

With some of the market craziness temporarily waning, I would allocate less dollars to this part of my options portfolio. Still opportunities out there, but nowhere near the movement of beginning of August to beginning of October period.

Speculative Trade idea: SPY slightly Bearish Calendar , Buy 1 February 120 put and sell 1 January 120 put for around $1.50 debit.

I would use rallies to enter out of the money put time spreads to take advantage of temporary downside moves we should get even if we move higher. I would enter these spreads after the market has gone up a few days, and would put in a price below the mid prices a bit. Let it come to you. Don’t chase it. My plan would be to stay in the spread for about a week and get out for profits over 10% yield. My aim is to benefit from a price move and volatility increase if we have a few days of declining prices. If I’m wrong I could re-position the calendar and move it to a higher strike.

Monthly Income: Putting on range bound trades with probabilities in my favor like an insurance company. I would allocate near normal levels of capital to this part of the portfolio because the market is pretty range bound.

Monthly Income Trade Idea: AAPL Iron Condor, Buy 1 January 425 call sell 1 January 415 call , buy 1 January 345 put , sell 1 January 355 put for total credit of $3.50

AAPL has been in a range between roughly 350 and around 420 since middle of July. This spread has breakeven points at expiration of around 350 and 420. If I think this range will continue over the next 25-30 trading days , and so this would make sense to me. The risk is $6.50. The credit of $3.50 subtracted from the strike width of 10, little less than 2:1. If the stock goes outside of my projected range, I would get out.

Long Term Monthly Income: Stocks I really like for next 2 years that don’t usually have crazy volatility. Preferably a little lower beta than the market. If I’m dealing with stocks that have been very strong, I might decrease my capital allocation a bit or get more downside protection if I think they will retrace a bit.

Long Term Monthly Income trade idea: IBM slightly bullish Diagonal: With IBM around 187 ½ , Buy 1 July 160 call for around $32 and sell 1 January 185 call for around $7 for debit of $ 425.
IBM has been strong like bull! It may be a bit overextended but I like it for the long term. This trade I’m selling an in the money call to get a bit more downside protection over the next 25-35 days. The stock has been on a run and I think it may have a bit more to go down over the short term.

Dan Sheridan taught the second class of “How to Trade a $100,000 Portfolio in Today’s Market” on Saturday. Here’s the video of this class:

Download the PowerPoint Slides

Students of this class have a FREE TRIAL of OptionNET Explorer Software as part of the class! Students can subscribe to OptionNET Explorer when their trial expires.

For more information, or to sign up, please visit:

http://info.sheridanmentoring.com/how-to-trade-a-100000-portfolio-in-todays-market/

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Here is the First Class from November 30th:

Dan Sheridan taught the first class of “How to Trade a $100,000 Portfolio in Today’s Market” yesterday. Here’s the video and PowerPoint of this class:

Download the PowerPoint Slides

Students of this class have a FREE TRIAL of OptionNET Explorer Software as part of the class! Students can subscribe to OptionNET Explorer when their trial expires.

For more information, or to sign up, please visit:

http://info.sheridanmentoring.com/how-to-trade-a-100000-portfolio-in-todays-market/

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For those who are regular readers, I want to call your attention to a topic that is notable for its absence in my musings of the view from an option trader’s desk. A quick perusal of recent topics of discussion reveals a number of beasts such as condors and butterflies, but not a trace of the elusive single legged long option can be found swimming in our blog stream.

The seemingly basic maneuver of simply buying a put or call as a single trade position is rarely discussed. Is it that option traders are by nature attracted to complexity or is there a fundamental reason this simple single legged strategy is not the topic of more discussion?

The answer to this basic question brings us back to the fundamental reason for trading options. We live in an uncertain world; our task as knowledgeable option traders is to construct and select trades with the highest probability of success within an acceptable risk/reward environment.

The purchase of a put or call is rarely the highest probability trade available. The reasons are several and include the inevitability of time decay of premium and the exposure to changes in implied volatility.
The current market conditions are particularly difficult for traders using the simple “long premium” strategy. Implied volatility is currently in its highest quartile for most issues. As a result of this elevated implied volatility, option time premium is rich. This has the result of making the usual headwind of theta decay even stronger. In addition, the strong tendency of volatility to revert to its historic mean leaves the trader at significant risk of collapsing time premium for which he has so richly paid.

Consider the real world situation of the trader who chooses simply to buy options ahead of what he predicts to be the increase in price of AMZN. During the current month of November, AMZN has traded down from prices above $220 to its current price of $182.57. As a result, the implied volatility of the current front month call, the December 185 strike, is 49.9% and can be bought for $9.90. The trader buying a 10 lot position expecting AMZN to trade higher during the remaining 21 days of life of this contract, has encountered some brisk headwinds. He is exposed not only to the current daily premium decay of $206.48 but is also negatively impacted by the ever-increasing decay rate as expiration approaches.

In addition to reliably predictable factor of time decay, the value of the options will almost certainly be reduced by decreases in implied volatility if the trader’s price hypothesis proves to be correct. Implied volatility is virtually always negatively correlated with price movement. If volatility were to contract from current levels, and it is important to understand that this would be the expected reaction to an increase in the price of AMZN, and return to the recent mean level of 43%, the option would lose $1.40 as a result of this factor alone.

As a general rule, simple is almost always better than complex. In option trading what appears to be the simplest trade, buying a put or a call, rarely results in the best risk/reward ratio.

Dan had a webinar on Saturday where he went over how to fish for trades. He used IBM as an example and showed several different types of trades. Here’s the video of the session:

Dan announced the new class that starts at the end of the month:

How to Trade a $100,000 Portfolio

This class is the 1st time OptionNET Explorer software will be available outside of the mentoring program! All students of this new class get a free 6-week trial of the software, with the option to purchase it after the trial is over!

For more information, or to sign up, please visit

http://info.sheridanmentoring.com/how-to-trade-a-100000-portfolio-in-todays-market/

Subscribe to our YouTube channel to get notified when we upload new videos!

3 Trading Idea Buckets

Trade Idea Bucket #1 - Long Term Monthly Income

An example would be AMZN, currently trading around $215. The stock dropped a bit on recent earnings and has started to work its way up a bit. The stock has traded as high as $246 on October 14 and as low as $198   October 26 after earnings were released. If I think AMZN will continue to work its way up to pre-earnings levels of around $235, I can sell the December 190 puts around $4.00. This 40 day plus trade would allow me to buy AMZN for $186 if the stock dropped under $190 over the next 35-40 days. Premium levels aren’t what they were before earnings, but they aren’t bad at around the 46 level for the December 190 puts. If AMZN doesn’t drop under $190, I collect the premium. I would not consider this if I wasn’t absolutely giddy about buying AMZN stock if I got assigned!

Trade idea Bucket #2 – Monthly Income Non-Directional

An example would be an iron butterfly in SPX with the index currently around 1245.  This trade might consist of selling the 1245- 1285 call credit spread in December and selling the 1245- 1205 put credit spread in December. At these prices today, the total credit would be around $3400 with maximum risk at $600  (spread strike width minus the credit). One possible adjustment I would employ in this market would be to roll up the credit spread on the bad side if the market starts moving too far. For example, if the SPX started moving up over the 1265 level, I would consider rolling the call side up. On the downside, I would wait a bit longer to roll because of the slightly bearish profile of an at-the money iron butterfly. I might wait till SPX drops to around 1210 to roll the put side.  The risk/reward on this trade is a potential maximum reward of $3400 and a maximum possible loss of $600, so in this volatile market, this spread has a risk/reward profile that I would consider very palatable. This is a mouthful to digest, just wanted to give you a taste of how I look at Monthly Income Trading. If this approach seems interesting to you and you would like more information, just shoot me an e-mail.

Trade Idea Bucket #3 – Speculative Trade

An example might be in IBM, currently trading around $185.5. The stock over the last year has soared from the low 140 levels to its current price, just short of its yearly highs of 190 reached on October 14. If I believe the stock might be in a range between 173 and 192 over the next 40 days or so, slightly bearish perspective, then I might put on a slightly bearish trade. Here it is:  sell 1  December  190 call  and   buy 1 December 195 call,  sell 1 December 175 put  and  buy 1 December 170 put. The call credit spread would be a bit closer to the current price of $185 than the put credit spread. This would give the trade a bearish flavor. I am looking at a credit of around $2.50, with total risk at $250 (difference between the strikes  5   minus the credit $2.50).

This is a business and a craft, and if you want to be successful long term, I believe you have to have this mind set.

Have a great day!

Dan Sheridan
dan@sheridanmentoring.com