Trading with Spreads - Looking for Advice

[aijourneyman]

Hi-

This is my first post here, and I hope its not too much off topic. I have been studying trading for two years, have made and lost money trading equities, though nothing drastic on either side. I have been studying options for about 9 months now, and to be sure, I have only made real trading decisions in the OnDemand feature of TOS.

Yesterday I sat in on a free options trading presentation/mini-seminar, buy someone who has a lot of experience (being a market maker at the CBOE with over 20+ years in options). Some take-aways from the seminar, which I am interested in pursuing more, were:

1. Retail investors typically only by long calls or long puts or do simple covered calls, and for the most part lose most of their money in time decay.

2. The only real way to trade options and remain in the game is to play spreads, offsetting as much time as possible with selling and buying various spreads.

3. Most option traders dont care much about direction like retail investors.

The main focus for me is the spreads piece. He did a lot of examples of showing how to basically ride some upside movement but by paying much less premium by playing with selling the opposite side. It was fancy, fast and hard to follow - I later fond out this was a pre-cursor to being canvassed to pay for his course, which I am sure is very good.

How do I learn more about this way of playing options? Are there any good books that focus on this? I have actually read quite a few options trading books, but the way this presenter used options yesterday, I have never seen that or at least gleaned it from the books I have read.

Heres a hypothetical scenario - see attached images of google. I have never played google, so I have no idea what happens in the next few weeks - the images are taken from within OnDemand of TOS.

At this point price could go either way. I know one trade, which would be expensive, is a straddle. But I am wondering what other trades could be considered here to take advantage of the situation without losing everything blindly. And maybe there isnt a trade, I dont know.

I realize there are many things that could be said here, and I apologize if this is a silly or simplistic question for the traders here.

Thanks,

AIJ

 

[Put_Master]

I'm not the expert here, so I'll let others address your issues.
I'll simply say do NOT take his course, which i assume will cost you hundreds of dollars.
And do NOT start off doing straddles, strangles, IC's or other type spreads, that potentially put all your cash at risk of a total loss, if the stock moves too little or too much in the wrong direction.
It's too early for you to consider trades, that rely of a stock either staying inside or outside a specific trading range, during a specific unit of time.
That stuff comes later.
Start with selling OTM cash secured puts and covered call type trades.

However, if you are going to disregard my suggestion and do spread type trades, do them on low priced stocks while you are learning. Not stocks with high strikes like AAPL, GOOG, ect.
Strikes under $20.

 

[oldnemesis]

Instead of GOOG let me try Waste Management:

which is more reasonably priced.

Let me start out with the most simplistic issues:

Lets say you think WM will go back up to at least 35 by Jan and want to use options to play that.

Lets also say that you don't want to spend money on the possibility that WM will go above 36. You think that possibility is nil.

Also lets assume the probability of WM going below 31 is also nil.
(that's a lot of assumes)

Lets look at two trades:

WM Jan Long 32 call vs WM Jan 32/36 spread
(i.e. form a spread by buying the 32 call and selling the 36 call)
.....................Call.............................Spread...........
Cost..............160..............................145
Price.............P/L..................................P/L
25................(160)....(100%)..............(145)....(100%)
30................(160)....(100%)..............(145)....(100%)
33.60..............0...........0%..................15.........10%
35.................152..... 95%..................158.......108%
40.................641......400%................255.......175%

The straight call will cost you $160 while the spread will cost $145 because you made $15 back by selling the 36 call.
In the stated range of 31 to 35 the spread does better than the straight call. Also if WM drops below 31 you will lose less money on the spread than the call.

That's the basics and that's probably 75% of what the course will cover.

The additional things will probably encompass short puts and short put spreads plus a few ideas like buying a long term (like a year or more) option and then selling multiple short term options, and 'rolling' the trade up or down. (something we hate)

The ideas of market neutral or delta neutral strategies like the
Straddle:
http://www.investopedia.com/articles/optioninvestor/08/straddle-strategy.asp#axzz275sBOyBx

The Iron Condor:
http://www.investopedia.com/terms/i/ironcondor.asp#axzz275sBOyBx

The Butterfly spread:
http://www.investopedia.com/terms/b/butterflyspread.asp#axzz275sBOyBx
http://www.investopedia.com/terms/i/ironbutterfly.asp#axzz275sBOyBx

The Strangle:
http://www.investopedia.com/terms/s/strangle.asp#axzz275sBOyBx

May or may not be covered in enough depth to be worth while.


The only way to know ahead of time if the course is worthwhile is to get a more detailed description of what is covered and to what depth... preferably from someone who has taken the course.

Whether or not taking a course in these things is 'worth it' to you depends on your circumstances: How much money and time do you have??

How good are you in doing your own research and testing things out on paper??

It's just my opinion but I don't think you can learn to trade from a course.

 

[aijourneyman]

Put_Master,

Thanks for the response. I understand what you are saying and appreciate your time tellig me to be careful.

Doing cash secured puts and covered calls sounds like a good place to start - what would you say if I ask, after spendingtime with these simpler trades, what should I *really* walk away with, knowledge and experience-wise? I assume there is some deeper knowledge that will come from spending time with these types of options, and curious for some guidance. For example I could just chart play and then have a guess withcash secured puts. Or I assume I could look more at the greeks, the prices around different strike levels and expirations, and get a feel for just how the greeks work (I read somewhere that greeks arent necessary to be successful with options trading).

I am a sponge right now, and I am open to any help suggestions. I have a detail-oriented mind, and learning more about options and greeks is not something that I am afraid of.

Thanks for the advice on spending money on a course - I wont be doing that (it was thousands too).

Thanks,

AIJ.

 

[aijourneyman]

Hi oldnemesis,

Thank you for your response, and sharing details on that spread trade example; very helpful. May I ask, after pondering your example, when would not buying a spread be the better trade - such as just going long? Do people just go long or short, or does one always look to offset downside risk through some sor tof spread?

Another thing that was mentioned, but sparingly, was looking at IV and standard deviation, using this to work out where to formulate ideas on price movement probability moving forward, and which strikes to look to buying. Looking at this type of information is something I havent done at all, coming from an equity swing trading style of part time trading.

I am a little OCD when learning new things, andI normally do very well when doing my own research on a topic (I am self taught in equities and forex andI am sure I can pick up options). Having a mentor is not something I would shy away from,but for thousands of dollars, it may be better to use that to cut my teeth in the markets.

Thank you for the response,

Aij

 

[optionbull]

Quote from oldnemesis:

Instead of GOOG let me try Waste Management:

which is more reasonably priced.

Let me start out with the most simplistic issues:

Lets say you think WM will go back up to at least 35 by Jan and want to use options to play that.

Lets also say that you don't want to spend money on the possibility that WM will go above 36. You think that possibility is nil.

Also lets assume the probability of WM going below 31 is also nil.
(that's a lot of assumes)

Lets look at two trades:

WM Jan Long 32 call vs WM Jan 32/36 spread
(i.e. form a spread by buying the 32 call and selling the 36 call)
.....................Call.............................Spread...........
Cost..............160..............................145
Price.............P/L..................................P/L
25................(160)....(100%)..............(145)....(100%)
30................(160)....(100%)..............(145)....(100%)
33.60..............0...........0%..................15.........10%
35.................152..... 95%..................158.......108%
40.................641......400%................255.......175%

The straight call will cost you $160 while the spread will cost $145 because you made $15 back by selling the 36 call.
In the stated range of 31 to 35 the spread does better than the straight call. Also if WM drops below 31 you will lose less money on the spread than the call.

That's the basics and that's probably 75% of what the course will cover.

The additional things will probably encompass short puts and short put spreads plus a few ideas like buying a long term (like a year or more) option and then selling multiple short term options, and 'rolling' the trade up or down. (something we hate)

The ideas of market neutral or delta neutral strategies like the
Straddle:
http://www.investopedia.com/articles/optioninvestor/08/straddle-strategy.asp#axzz275sBOyBx

The Iron Condor:
http://www.investopedia.com/terms/i/ironcondor.asp#axzz275sBOyBx

The Butterfly spread:
http://www.investopedia.com/terms/b/butterflyspread.asp#axzz275sBOyBx
http://www.investopedia.com/terms/i/ironbutterfly.asp#axzz275sBOyBx

The Strangle:
http://www.investopedia.com/terms/s/strangle.asp#axzz275sBOyBx

May or may not be covered in enough depth to be worth while.


The only way to know ahead of time if the course is worthwhile is to get a more detailed description of what is covered and to what depth... preferably from someone who has taken the course.

Whether or not taking a course in these things is 'worth it' to you depends on your circumstances: How much money and time do you have??

How good are you in doing your own research and testing things out on paper??

It's just my opinion but I don't think you can learn to trade from a course.

Curious... how do you "work" a spread on your platform.. wich do you use, do you like it ?

for example, you only get filled on one leg if other leg gets filled...

 

[Put_Master]

Quote from aijourneyman:

Put_Master,

Thanks for the response. I understand what you are saying and appreciate your time tellig me to be careful.

Doing cash secured puts and covered calls sounds like a good place to start - what would you say if I ask, after spendingtime with these simpler trades, what should I *really* walk away with, knowledge and experience-wise? I assume there is some deeper knowledge that will come from spending time with these types of options, and curious for some guidance. For example I could just chart play and then have a guess withcash secured puts. Or I assume I could look more at the greeks, the prices around different strike levels and expirations, and get a feel for just how the greeks work (I read somewhere that greeks arent necessary to be successful with options trading).

I am a sponge right now, and I am open to any help suggestions. I have a detail-oriented mind, and learning more about options and greeks is not something that I am afraid of.
Thanks for the advice on spending money on a course - I wont be doing that (it was thousands too).
Thanks,
AIJ.

The more you know about the GREEKS, the better a trader you will become. But not all Greeks are equally important or as relevant as others may be.
A lot really depends on the type strategy(s) you are comfortable with and prefer to specialize in. But the more you know about how they work the better. There are a lot of ("if's, and's and but's"), when it comes to option trading, and not all of them are as obvious as you might think.

I'm the least expert of all here, so keep that in mind when evaluating my comments. But my suggestion is to start with an area you are comfortable with and strong in.
For example, if you are a good stock picker when it comes to price value and quality, consider a strategy that plays to that strength.
If you are good at selecting stocks that are range traders, consider spread type strategies. Or perhaps you are good at trading volatility and making adjustments.

Don't do things just because you see others doing them, or because you think it's a "cool" strategy, or because you want to impress others with your sophistication.
You really have NO IDEA how quickly you can lose all your money trading options. What may seem relatively safe and predictable on paper, can wipe you out faster than you can imagine in the real world of option trading.

If there is one thing you need to learn above all else, it is RISK MANAGEMENT.
And how to manage that risk, will be different for different strategies.
Different (if's and's and but's), for different strategies.
And avoid using excessive margin leverage, until you are ready for that responsibility. That is what kills a lot of investors. Very easy to be on excessive margin with options, and not even be aware you are even using margin at all..... until your account is wiped out because of it.

Personally, I would suggest selling OTM cash secured puts instead of buying calls, at the moment, as you want theta working for you. Not against you.
But just as important, is waiting for the right time to initiate a trade, what ever your trade strategy preference is.
Getting in too early or getting in too late can be a big mistake.
Wait for opportunities.

As for paper trading, it really doesn't work. Most people make money paper trading. Unfortunately, you will make different decisions, or you will "time" those decissions differently, when under the STRESS of real time/real money/real margin risk management.

Post the trade you are thinking about doing, or after you have done it, so it can be discussed, debated, argued, challenged, and perhaps even insulted. There is no better way to learn...... and it's free.

 

[aijourneyman]

Hi Put_Master,

I appreciate your time in responding so informatively, thank you. I will spend this weekend studying the OTM PUT Trades you refer too. I assume Cash Secured is simply mehaving enough money in the account to cover the losses (margin) should the trade go wrong, rather than owning the stock ona covered call. Is this something that you do now? What should I be looking for in a good setup?

Thank you again,

AIJ

 

[JJacksET4]

Quote from aijourneyman:

Hi oldnemesis,

Thank you for your response, and sharing details on that spread trade example; very helpful. May I ask, after pondering your example, when would not buying a spread be the better trade - such as just going long? Do people just go long or short, or does one always look to offset downside risk through some sor tof spread?

Another thing that was mentioned, but sparingly, was looking at IV and standard deviation, using this to work out where to formulate ideas on price movement probability moving forward, and which strikes to look to buying. Looking at this type of information is something I havent done at all, coming from an equity swing trading style of part time trading.

Aij

Aij,

I wanted to respond a bit to your comments and questions here and see if I can be of any help as well.

You asked why would a person just go long? The reason is there is always the unlikely chance a stock will move up (or down) big. Many people like to hedge and make a spread assuming that won't happen, but occasionally it does.

For example, you might be somewhat bullish on a $48 stock and see the following prices say for a few months out:
50 call - $300
60 call - $100
You might predict the stock could get near $60, but really don't see it going higher, so you buy the 50 call and sell the 60 call for $200. Now, say the stock is at $58 near expiration - you will have a spread worth $800, which is a good profit, and you only paid $200 for the spread instead of just buying the call which would have cost $300. The downside is the rare time when the stock just runs away. Say after a day or 2 it was already $58 and then jumps to $75 and $90 over the next few days or weeks. That 50 strike call would be worth ~$4000, but now the 60 call against you is around $3000. So you can close for about $1000, but just buying the call would have been much better. In the book McMillan on options, he mentions a specific example of a time that happened to a trader he knew.

If you are a beginner learning about IV, I think the important things to know are that each stock has its own general IV based on how volatile the stock normally is, and to realize that that exact IV of a stock will fluctuate back and forth, often peaking the day or so before earnings, and then falling back hard after earnings. Higher IV means higher call and put prices. Stocks like PG, MCD, etc. generally have much lower IVs then stocks like BIDU, NFLX, etc. however all stocks will have IVs that go up and down during different periods of time. I use the charts from ivolatility.com to see the current IV compared to what range a given stock normally goes around.

BTW - In your first post, I am guessing the strategy the guy was mentioning might have bee something like this:
Sell an OTM put
Buy an ATM or OTM call spread.

Some people like to do this, because you finance the cost of the call spread with the put sale. The downside is if the stock falls, the call spread will lose its value AND the put will gain value against you. You could go ahead and accept assignment of shares if you wanted to, but a person should understand the risks before doing such a trade.

JJacksET4

 

[Put_Master]

Quote from aijourneyman:

Hi Put_Master,

I appreciate your time in responding so informatively, thank you. I will spend this weekend studying the OTM PUT Trades you refer too. I assume Cash Secured is simply mehaving enough money in the account to cover the losses (margin) should the trade go wrong, rather than owning the stock ona covered call. Is this something that you do now? What should I be looking for in a good setup?
Thank you again, AIJ

Cash secured put means you have enough cash to buy the stock, if it drops below your strike.
You don't have to own the stock if you don't want to. You can either close the trade early, or sell the stock anytime you want to.
But cash secured simply means you have enough cash to buy it.... if it gets put to you, and if you don't mind owning it.

Investors who trade spreads often don't have the ability to buy their stocks if it drops below their strikes.
Why?
Because of the ability to use excessive margin leverage with spreads.
Thus, those trades are NOT cash secured.
Since they don't have the ability to buy those spreads if put to them, they must close a deteriorating trade early.
But if the trade is cash secured, they have the ability "consider" buying a stock that drops below your strikes.

If you never want to consider the possibility of owning a stock that drops below your strikes, then don't worry about it being cash secured.
But if you want that choice, make sure you don't use excessive margin leverage.
Nothing wrong with margin. It's a great tool when used intelligently.
It's only excessive leverage that creates problems for investors.