How to Set Options Trading Goals

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As traders many times we tend to only look to the short term and what trades we have on or are about to enter. To be successful with any longer term goal you not only have to know where you are headed but how best to get there. Having a plan and setting mile posts to mark progress along the way is fundamental to a successful trading business.

First, we want to determine our long term goal. To give two trading examples perhaps you either want to generate a certain monthly income or build a certain dollar value in your account. Whichever of these you choose, it is important to set a monthly goal to track how you are doing in reaching the goal. That way if things are getting off track you can address any problems before you get too far off your success path.

Secondly, setting realistic goals is key. Let’s say for instance that you want to generate a monthly income of $5000. If you are trying to reach that amount using a $100k account size, it will be easier than trying to reach it with $20k account size. A simple illustration to understand is: The lower the percentage of your return on capital you require, the easier it will be to succeed. So be realistic in what you set for goals to give them a better chance of attainment.

Finally, what trading strategies and portfolio allocation of them will I use each month? With option trading you can utilize both monthly and weekly option expiration chains in your plan. You may for instance want to do a weekly calendar or butterfly as well as a monthly calendar or butterfly and also employ iron condors, etc as part of your over all strategy.  Try to have a mixture of these strategies each month to take advantage or hedge the changing volatilities in the marketplace.  To properly understand and have good risk management, as well as deployment of a plan, you will find that proper education from an experienced mentor and trading education program can help reduce your learning curve and give you better accountably in your trading business. Taking advantage of the trial and error that another experienced trader has been through, helps you avoid many pitfalls traders often fall prey to. Putting all of this together is what separates the successful trading business from the failed one.

Mark Fenton
Senior Mentor

Interesting VIX Trade

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If you believe that the VIX is going to go a lot higher from here, one interesting trade is to sell a put vertical to help lower your cost of buying calls. Over the next, month I don’t think it is a stretch to say that the VIX could go a lot higher, as the market appears to be topping out and ready for a pullback.

An interesting trade, currently, is selling two put verticals, selling the 14 strike and buying the 12 strike on the VIX for the September expiration 42 days from now, and then using that money to buy two calls at the 17 strike for September. You could put this trade on for about $626 for a two lot on each, and you have great potential for reward on the upside while limited downside. See the graph attached for how this play would look in an analysis screen. You have limited downside and unlimited upside. Consider something like this, if you think the market will have increased volatility over the next month, as we head into September.

Mark Fenton
Senior Mentor

Protecting Portfolio for Downside Moves

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    Sometimes in a long bull market trend as we’ve been experiencing it is easy to overlook protecting options trades and stock portfolios against downside moves. It is easy to get complacent whenever you see the market shake off any negative news and maybe only with a pause it goes back up, but eventually the market will have a correction it always has.  Of course one of the best ways to protect yourself is to have some protective measures on head of time and not beginning to scramble to protect yourself once the move is in play. In my mind one of the best ways to do this is to consider purchasing long verticals or long calls in the VIX options two to three months out in time. Considering VIX options currently in September or October or even November I think can be attractive. What I like to do is maybe wait for a day whenever the VIX pulls back a bit and then look at buying options at maybe 2 to 3 points out of the money and maybe a few more points out of the money for instance the VIX is at 11, you may want to consider buying 13 call options and also calls at maybe 17 or 18. I think that those are all attractive levels to look at to protect yourself. You will see the Vicks moves very quickly whenever the market makes down moves and often you have many chances to be profitable in these options on the market pullback, particularly a quick one. And you can do this by either purchasing long calls or long call verticals, your choice. Of course long call verticals can lower the cost of the trade but with slightly more brokerage fees.

          When you have individual strategy option plays on such as butterflies or calendars you can also consider buying an out of the money put below a position to protect yourself some if the market makes a quick pullback. Once the down move is underway look for an opportunity for a slight pause or like I said a pullback in the VIX to make your entry, you can still protect yourself even on some slight spikes. And this is just a few of the ways you can give yourself some peace of mind against the coming downtrend or a quick bearish market move. We at Sheridan Options Mentoring are prepared to help with this and further developing your options trading business.

-Mark Fenton
Senior Mentor
Mark@SheridanMentoring.com

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AAPL Trade Idea

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Oh, how I miss the expensive AAPL stock price before the split, let me name the ways: More premium for credit spreads, less commissions because I didn’t have to do as many contracts with a $500 stock price. Any positive things about the split? Yes, liquidity, which was great before the split, should be better. Why? Option bid/ask spreads will be narrower and more folk will be trading options with these cheaper stock prices. Option Volatilities are a bit higher, maybe 15%, than before the split. At-the-money Implied volatilities are around 20 now and they were around 17 before the split. This is pretty normal when stocks get less expensive after a split, moderate increases in Implied Volatility usually result.

Range Bound Trade with great risk/reward? Iron Butterfly (2 Credit Spreads). AAPL price around $91.90

Using the July 3 expiration, Buy one 95 call and sell one 92 call. In the puts, buy one 89 put and sell one 92 put. Total Credit around $210. The total risk if AAPL goes to zero or up to a billion is $90. How did we get $90 Maximum loss? If AAPL goes to zero, I did a 3 point wide put credit spread that will max out at a $300 loss. Subtracting the credit of $210, that leaves us with a potential $90 loss. Great risk/reward to bring in a potential profit of $210 with risk of only $90. I like Iron Butterflies for shorter term trades, (the July 3 expiration for this trade is about 16-17 days from expiration). Where would I worry a bit about this trade and either exit or adjust the trade? Near the expiration Breakeven points of roughly $90 on the downside and $94 on the upside. How much money would you probably put up at your Broker for this trade? Depends on your Broker, but the number should be around $90, the risk of the trade. Should I try to make the entire Credit? No, that would require AAPL being exactly at short strike of $92 in about 17 days, tough to hit the Bulls eye like that. I would shoot for maybe 25% of the credit or $50 per 1 Contract . That would give us about $50 profit on $90 of risk or capital if I did this 1 contract.

Work on the Craft and have a great day!
Dan Sheridan
dan@sheridanmentoring.com

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AAPL June Bullish Play

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This is a Bullish play in AAPL for the June expiration. It is inspired by one of the Sheridan mentoring resident AAPL experts and my friend , Leo Andrade. With AAPL at around $518 , I am going to take a bit of a bullish bias as I look out to June. The strategy is a Bullish Butterfly: Buy 1 June 530 call , Sell 2 June 540 calls, Buy 1 June 550 call for a total debit around $70. The good the bad and the ugly: if the stock goes to 540 over next 30-66 days, great! If it goes to $540 over next week, we yell ” Where’s the beef”! In bullish Butterflies, we want the stock to go near the short strike, but closer to expiration , not right away.Total risk is $70 cost, just like a long option. Directional Butterflies are very forgiving. If we go outside profit area of 530 and 550 over next 30 days, the spread doesn’t go against us nearly as bad as if we go out side our profit area of 530 and 550 near expiration. This is a cheap speculative trade of $70. If I did it 3 times, 3-6-3, it would cost 3 times $70 or $210. My plan is to make 50-60% on the cost of the trade.

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Can I trade an Iron Condor with VIX at 12?

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Answer is yes! The question posed in the title implies that you might trade Iron Condors some months and possibly not others.

Maybe when the implied Volatility is up a bit you will sell the Iron Condor, but when it’s  low you won’t. That’s what Volatility Trading is all about, selling high volatility and buying low volatility. Though in last few years, option volatilities have basically been low consistently. I teach Retail traders to trade Iron Condors in the same vehicle every month or every week, depending on your preference of Weekly versus Monthly Iron Condors.

The Iron Condor is a Probability trade and when you have probabilities in your favor , you need to play every hand and you expect to win over time. So the long winded answer is yes, we sell Iron Condors when VIX is 12, 15, 18, 24, etc. How we manage them when VIX is 12 versus 25 may be a bit different, I will explain. I will look at an example of an Iron Condor in SPX for the February Expiration( 42 days from expiration). With SPX at $1836 I am looking at the 1890-1900 Call credit spread and the 1745-1755 Put credit Spread. I am picking the strikes in this example by selling the strikes at about 16 delta, making this roughly a 1 standard deviation Iron Condor.Combining the two spreads to make an Iron Condor, the current credit for this would be around$2.60. Is this a little lower than a normal 42 day Iron Condor with the short strikes sold at about 16 delta?

On October 4 when VIX was around 17, a similar 42 day Iron Condor with shorts sold at around 16 delta, the credit was around $2.80, a bit higher than the current day $2.60 credit, but the short  strikes I would be selling on Oct 4 were 15-25 points farther out-of-the money, giving more price protection also. So on October 4, would we get more credit and room for a 42 day Iron Condor in SPX than we would today? Yes.  But does that mean we shouldn’t trade Iron Condors when Implied Volatility is low? No, I advocate trading every week or every month. I also advocate having a profit and loss plan when you start. But how might I trade an Iron Condor a bit differently when VIX is 12 and premiums are low? 3 Choices: #1 Just do the call side  #2  Do both sides, but if we start going down , and I need to adjust, would grab a long put. This would really help me survive a further Volatility expansion and big price decline.  #3  Don’t do the Iron Condor. I would choose #1 or #2, probably #2,and buying a put if we start declining. The key is to trade Iron Condors every week or month, but how we adjust or tweak them depends on the price and Volatility levels in the market.

Covered Writes for the Downside?

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    2013 has been a banner year for Covered Writes. The market is up big and this bullish strategy has been like an ATM machine. The S and P’s have climbed from the 1400 level to its current peak around 1800. That’s an increase of over 25%!

What are your expectations for the rest of 2013? How about 2014? Maybe you are still bullish, but you would like to have a little less exposure on the downside in 2014? If you did 4 covered writes per month in 2013, maybe you’d like to cut back a bit and take a little capital off the table? How can I diversify my covered write risk? One way is to have a few covered writes for the downside to diversify my exposure in my retirement portfolio. Most stocks are in the upper end of their 12-24 month price range. I will show you an example of a covered write type strategy for the downside that doesn’t involve stock. This will keep the cost and margin down significantly.

Before I give an example for the downside, let me give an example of a covered write and Long Diagonal for the upside to lay the proper foundation. Using XYZ stock at $100 as our example, a covered write example would be to buy 100 shares of stock at $100 and sell 1 January 110 call at $1.00. This would be very expensive in an IRA account with your broker because of the cost of the stock. To do this strategy using an in-the-money call instead of the stock purchase would be called a Long Diagonal, and it would reduce the margin at your Broker significantly. The Long Diagonal alternative might look like this: Buy 1 March 85 Call and Sell the same January $110 call. Because the cost of the long call would be much cheaper than the cost of the long stock, the margin on the Long Diagonal would be much cheaper than the Covered Write. The graphs would look similar.

The following example is a Put Diagonal with a covered write type graph, but on the downside:

Put Diagonal example in AMZN: $390. Amazon started the year around $250 and is currently around $10 from the highs of the year. The stock is up around 55-60% for the year. Not all stocks are up this much for the year but many are up significantly. Even if you still like AMAZON, you might not expect similar returns next year, and might even think it could pull back a bit. A Put Diagonal would fit the bill. With the stock around 389-390 level, I might buy 1 April 440 put for $62 and sell 1 January 385 put for $13. The net debit for this put Diagonal would be $49. If I did this 1 time at my broker in an IRA account, it would cost about $4900, the cost of the debit. On the downside, at expiration, I could make from around $1000 at the short strike of $385, to around $600-$800 if we go down even near the $300 level. On the upside, we have an expiration Breakeven around $401, which I would use as a trigger to either take off or adjust. One adjustment idea if we are wrong, as we approach $400 level on the upside would be to roll the short 385 puts up near the 400 strike in the same expiration month.

Conclusion: This is a timely strategy to discuss in this market environment because many people might want to lighten up a bit on their long exposure with covered writes and cash secured puts, and this is one way to do it.

Have a wonderful Day!

Dan Sheridan

Call Sheridan Options Mentoring to learn how we can help you. 800-288-9341

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