The "Daily Call" From Option Alpha

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#590 - Penny Wise Pound Foolish May 05, 2019

Show notes

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to be talking about people who are penny wise and pound foolish. This is probably one of my, again, more favorite phrases or quotes. You've probably heard it a zillion times, but I think it's so powerful because not only does it apply to a lot of things that we can do on a personal level, potentially personal finance, relationship based, but also, it applies a lot to how people think about trading options and the actual actions that they do versus what potentially the actions they should be doing are in exchange.

Quick analogy or a quick example of being penny wise or pound foolish on the personal level might be something like saving $.10 and clipping a coupon for a two liter bottle of soda and then going right next-door to the furniture store and buying a whole new living room set of furniture and putting it on credit. That would be a classic example of being penny wise and pound foolish. You are clipping all these coupons to save $.10 and save all these little pennies which is great and saves you a little bit of money on the soda, but then you go out and you buy all this furniture for a new living room set on credit or you go on vacation using your credit card and you pay the minimum payments and have all these interest charges. That's a classic example of where people fail in this space.

When it comes to options trading, I think the same thing can be held true specifically when it comes to using stop losses. I think stop losses are the absolute poster child for those traders who are penny wise and pound foolish. People will use stop losses as a crutch, as a means to cut down on the potential loss of an individual trade. And on the granular level, that sounds like a good idea and it makes sense. It's penny wise at that very microscopic level, that individual trade. Why would I not want to cut my loss and lose $100 versus losing $500? But when you start to look at the bigger picture, you realize that many of those types of trading philosophies like using stop losses ends up being very pound foolish because what we know from research and what we know from back-testing is using stop losses creates more losing trades, that a trading strategy generally that has no stop loss will beat a trading strategy that has a stop loss. And so, you see the same thought process and behavior play out even in the world of options trading as in my example of using the $.10 coupon for soda, but buying furniture.

And so, it's a good reminder today to look back at some of the things that you're doing trading wise and asking yourself – "Am I being penny wise, but pound foolish? Am I trying to squeeze every nickel and dime out of a trade all the way up until expiration and losing side of the fact that I am taking on this huge Gamma risk that could wipe out a potential trade?" Yes, I could make an extra $5 on a trade, but if I can close it 15 days before expiration and bank a profit, that is the better alternative. In that case, if I was trying to squeeze just another $5 out, am I being penny wise, but pound foolish and missing this whole opportunity that I have to take a profit off the table? That's some of the things that I think you can revisit today and hopefully learn from. As always, if you guys enjoy these, let me know and until next time, happy trading.

#589 - "Everything Is Figureoutable" May 04, 2019

Show notes

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to be talking about why everything is figure-out-able. And I honestly love this quote. This is actually one of my new favorite quotes that I've had attributed to Marie Forleo which if you don't know who she is, look her up online. Search her on Google and YouTube and Facebook. She has a wonderful podcast, an amazing show, very entertaining and she recently said this and I don't know why it just, for some reason, struck a chord with me a couple of months ago, but she recently said everything is figure-out-able and it's just this idea that you have to have the mentality of understanding that every problem you're faced with has a possible solution.

And I can tell you, this is truly one of my best qualities. I recognize this and I know that this is one of the things that is my strongest quality, is this willingness to overcome a problem or to find a solution to every possible problem I'm presented with. And I know I get this from my dad, so I can 100% attribute it to my dad who's a lifelong mechanic and was a master mechanic for many years and he always seems to find a way to fix cars, like he has the magic touch when it comes to cars and engines and vehicles and I don't know how he does it, but he does and I've, in some ways, figured out how to do that, but just in the world of investing or business or websites or podcast, like I know that things are able and possible to be done and I figure out a way to do it. My wife often calls me MacGyver around stuff that we do just around the house with the kids and just our life and for those of you who don't know, MacGyver would take like a box of toothpicks and create an airplane which is crazy stuff, but he would figure out a way to get out of the situation or to find a solution. And man, I can't tell you how many times this has been so, so powerful just in my personal life with real estate that we do, with the website stuff, putting together Option Alpha over the last 10 years. I've always been presented I feel like with a lot of challenges on why this can't work and why that can't work and you can't figure this out and I truly have had this mindset, I just never called it figure-out-able which I love that terminology. But it's just this idea that – Look. There's got to be a way to do it. I just haven't found the way yet. And I don't know if you can teach this. I don't know if it's out there. I don't know if you can learn this skill. I truly don't. I'm just sharing my thought process on this today. But I know that in many respects, there's got to be a way to do things and sometimes it might take a little bit longer, sometimes it might be a little bit harder, but there's got to be a way to do it and you have to have that kind of mentality and mindset I think to be a successful trader.

That's ultimately where a lot of the research comes from, is just this willingness and this desire for me to learn and understand what's going on in the market and how I can be a better trader. It started with the Signals Research which was all technical analysis based. I didn't see anything out there that actually back-tested a lot of these technical analysis indicators for many, many years and I had to think to myself – Well, the data is there, so how can we do it? How can we figure it out? How can we make a system or build a system that can run these tests and figure out if these indicators actually work? And then we used that as a springboard to start doing more of the profit matrix type research which we did two years ago now and finished that and that was a culmination of – Okay. Well, now, we can start back-testing and we did it on a smaller scale with technical analysis. How can we do it with options trading, so that we can figure out what the best strategies are and what strategies work in better environments and better market conditions and better setups? That's all really cool stuff for us. And so, now, where I'm taking that now is – How do we transition again in the future to auto-trading? Now, we know a lot of the empirical data and evidence that suggest we do one thing in one market environment. How can we now put that into an auto-trading platform? And you wouldn't believe how many people have told us even still… And we have the technology built. We're now just building the UI and the functionality and the integrations. But how many people have told us before or told me that'll never happen or we couldn't do that or there's nobody out there who can do that, but there is and it's really cool. But it's just this consistent mentality I believe that everything is figure-out-able. Like Marie said, there's got to be a way to do it and if there is a way, I'm going to figure out a way to do it. Hopefully this helps you out today to get you over that hurdle, but again, it's a really, really cool mantra, something that I've definitely adopted and embraced wholeheartedly on my end and I hope it helps out. Until next time, happy trading.

#588 - You MUST Outgrow Your Problems May 03, 2019

Show notes

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to be talking about why you must outgrow your problems. And this is a new one for me. This is something that I've read recently in a book and I've just been digging and marinating on this topic in my own mind over the last couple of weeks and I truly stand behind this. I think this is a really interesting concept and something that everyone can take away from just a very quick, simple statement and it's this idea that we need to outgrow our problems.

And ultimately, if we want to become a better trader, better investor, better parent, better father, better husband, etcetera, you input your better whatever, you have to let the problems be smaller than you because if you let problems become bigger than you, then they take control of you and that's ultimately where a lot of people end up falling victim in the market, is they let trades become bigger than they are and they ultimately let that trade dictate their actions and their emotions, they start doing things they wouldn't rationally do. And so, if you want to become a better trader, I think you do have to outgrow your current problems. If you have a trade that's going against you and it's losing $200 and you're losing sleep over it and you can't breathe and you're hyperventilating because this is a $200 trade you're losing, I mean, that to me is not a problem that somebody who's trading a $2 million or $3 million account would have. And so, you have to act like that's not that big of a problem and ultimately, get through that scenario, so that you can move onto bigger and better problems and that's what growth is all about, is moving from one level of consistency and activity and problems to the next level. They often say that steel is hardened by fire. That steel, in order for it to form, has to be put under immense pressure and immense heat in order for it to solidify and that's what I think we have to be as traders and investors. We have to embrace these problems that we have, these trades that go against us, these market environments that we didn't see coming and we have to learn to let those solidify the core strategy of what we're trying to do, so that we can overcome them quickly and move onto bigger and better problems.

Hopefully this helps out. Hopefully it struck a chord. This is again, something that has been top of mind for me for the last couple of weeks, is – How can I outgrow my current problems? What problems do I have that are taking control of me, that I need to rise up and take over and not let them take over my emotions or my control or where I am in my life? Like I said, hopefully this helps out a lot. If it does, let me know. Shoot me an email, add a tweet. Send us a message on Facebook. Whatever you can do to get in touch with us and share what you're doing right now, we would love, love to hear. Until next time, happy trading.

#587 - Can I Trade Options With Low Volume And Open Interest? May 02, 2019

Show notes

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to answer the question – "Can I trade options with low volume and open interest?" And the short answer to this question is yes, you can trade options even if it has low volume and open interest, but the real question is – Do you want to be trading that particular product on an ongoing basis? The problem that I see a lot of times when people send over trades to me or over to our team to take a look at, is that they're generally trading underlying stocks and ETFs that have very low, in many cases, no open interest or volume for the option contracts. And what that creates is that creates a huge spread in the bid ask spread and it creates a really tough time to get fills into the market. Now, does this mean that we can't make a trade if the trade is let's say an amazing setup that comes once in a blue moon? Of course not. We can still enter the position and try to get it filled, but it's just going to be that much harder to trade in something that is a non-liquid, non-active product. You really have to entice somebody off the sidelines to make a position with you and to take the opposing side of your trade and many times, that comes in the form of a very wide bid ask spread.

For example, I'm actually just looking at just a random ticker I know that has very low implied volatility, very low open interest, almost no volume. At the time I'm recording this today, it's about 2:38 in the afternoon, so we've been open for a couple of hours now and still today, this particular stock in this contract month has exactly four contracts of volume today and that's it on one single strike price. Everything else, the 20 or so different strike prices that are available have no open interest, no volume. There's nobody there. Only four contracts were traded at one strike price and the bid ask spread is 730 to 840, almost $110 wide in bid ask spread. Now, does that mean that you're going to get the worst possible fill on either end of that? Potentially. Because there's only four contracts out there, I highly doubt that you would get something exactly in the middle. You might actually gravitate towards one end or the other if you try to get in and out of that contract pretty quickly because frankly, there's nobody there who wants to trade with you. There's no other partner on the other side of the trade that wants to take the opposing position. Again, just to wrap up here, again, if we wanted to trade things with lower volume and open interest, we can always do so, but we just have to, in my opinion, do it sparingly and not use these ticker symbols as a regular course of business or as core positions in our portfolio. Hopefully this helps out. As always, if you have any questions, let us know and until next time, happy trading.

#586 - What Are Low Cost Index Funds? May 01, 2019

Show notes

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to answer the question – "What are low-cost index funds?" Low-cost index funds are exactly what they sound like. They are index or ETF funds that offer the lowest possible expense or expense ratio fee cost to the end investor.

Now, many of the lowest-cost providers right now when it comes to funds and ETFs that track global indexes and global markets charge as little as 0.03%. Yes, that's not a typo. That actually is their fee. It's a very, very small fee to put the fund together and to basically do all the reporting and tracking essentially. In addition to that, many of the brokers nowadays, including TD Ameritrade and Schwab, etcetera, offer the ability for investors to purchase these low-cost ETFs and index funds for no commission or commission-free. And so, this is a huge advantage that many investors have in today's market that frankly just was not available even five or 10 years ago. Not only the combination of commission-free or close to commission-free trading, but also the low-cost ETF and indexes that are out there, give investors a much better leg up compared to the world of say mutual funds. Most of the mutual funds out there, on average, charge .51% or more. Some mutual funds still charge as high as 2% or 3% per year in just expense ratios and fees, so that means you really have to have an outsized gain, not even including the tax consequences of how mutual funds are setup to really have a chance at outperforming the market.

And so, when you look at the expense ratio of a low-cost ETF at .03% versus say the average mutual fund at 17 times higher at .51%, it's almost a no-brainer that you get a much better product and a much better cost basis by going with a low-cost ETF or index fund. Now, again, this doesn't even start the whole discussion of if index funds or if trend trading or passive index investing is the way to go in the future, but at least it's a good starting point for those of you who are interested in learning more about cost and how cost are derived and how they flow back to the end-user or end investor like yourself. I highly encourage you if you are in any of these products or even if you don't even know what you're in and you want to take a look at them, it would be really cool homework for you to go out and look at your statements and see what the actual fees you're paying and see if you can move or shift capital from say a higher-cost fund or a higher-cost mutual fund into a low-cost index or ETF fund. Hopefully this helps out. Hopefully it saves you a little bit of money and until next time, happy trading.

#585 - Can I Sell Options On Expiration Day? Apr 30, 2019

Show notes

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to answer the question – "Can I sell options on expiration day?" And the answer to this question is – It depends on the broker. Some brokers do not allow you to open new sell order positions on the day of expiration. In particular, I know that Robinhood, at least at the time of this recording, does not allow you to get into a brand-new position on expiration day. Some other brokers, depending on the account that you have and where it's located, like TD Ameritrade or Tastyworks, may offer the ability to open new positions on the day of expiration and a lot of people actually try to do this as a means to potentially generate quick money, but I don't think it actually works out pretty well. We're going to be doing some research on this in the future just to see for sure if the numbers support my theory, but I would highly, highly doubt that trading options during the day of expiration, given the insane Gamma risk and the very, very fast time decay that those options have, would actually be profitable, not to mention the fact that a very slight move in the underlying stock could basically knock the position out pretty quickly. Again, the answer here is you really have to check with your broker and see if your broker allows it, but even if it did, I don't know if I would necessarily suggest that you go out and sell a bunch of options on the day of expiration, hoping to make a quick buck. Hopefully this helps out. As always, if you have any questions, let us know and until next time, happy trading.

#584 - What Happens When An Index Option Is Exercised? Apr 29, 2019

Show notes

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to answer the question – "What happens when an index option is exercised?" Today's question really still revolves around this topic of exercise and assignment, but it's more targeted towards index option contracts. And so, today, I'll use two as my examples. The first would be SPY which is an ETF index option contract based on the S&P and then we have SPX which is the bigger, more pricier index option contract of a more true form and is cash settled. In both of these cases, when you go through any exercise process, you would have to notify your broker of the deliberate intent that you have as the option contract owner to exercise your contract and take delivery of the underlying. But the difference is between these two contracts is that one is actually cash settled and European-style settlement and the other is settled to the underlying and is American-style settlement.

The younger cousin or the younger brother of SPX is SPY and this smaller contract is actually settled to the physical ETF and is American-style settlement which means that somebody could choose to exercise their option contract any point up until expiration. But when you start looking at more of the traditional index options like SPX, RUT, NDX, VIX, etcetera, you start to find that those option contracts are what's called European settlement and they settle to a cash value. Because you can't deliberately just go out and buy shares of the S&P 500 directly through the SPX contract, they choose to make those cash settled which means that at expiration, it just basically settles to the value of the contract at expiration if there is any value and you just get that cash into your account. Now, this also means that you can't just deliberately go out and exercise earlier than expiration. There's no benefit to doing that because you don't really take delivery of anything. They just push all settlement for basically accounting and logistic purposes to the end of the expiration cycle and that's what's called European settlement. They settle at the end. There's no chance to settle upfront before expiration. Now, this doesn't mean that you can't trade your way out of that option contract. You just can't convert it into the value of cash or potentially trying to convert it into some underlying value which there is none on SPX. You can't convert it before expiration.

Hopefully this helps out. I know it can sometimes be a little bit confusing. But unless you're trading those bigger, bigger products like SPX, RUT, NDX, etcetera, you probably are in the wheelhouse of letting the option contract go to expiration if you want to get exercised. If you want to exercise early, you notify your broker and let them know that you want to exercise your contract early for some reason. Otherwise, the best way to go is just to simply sell back or buy back the option contract and remove the position by trading your way out of the contract. It also saves you a lot of commissions to do it that way if you choose to. Hopefully this helps out. As always, if you have any questions, let me know and until next time, happy trading.

#583 - Do Futures Contracts Pay Dividends? Apr 28, 2019

Show notes

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to answer the question – "Do futures contracts pay dividends?" And the simple answer to the question is no. Futures contracts do not pay dividends. They don't necessarily benefit directly from the payment of dividends. You would really have to own the underlying stock in order to collect those dividends or own an option contract that would benefit from the dividend being paid. Futures contracts are at a little bit of a disadvantage in that sense compared to owning the underlying stock because they don't benefit directly from the dividends. That being said, many of the futures indexes or commodities or underlyings by which these contracts are based are already pricing in a future price which may or should potentially include the expectation of dividends if dividends are being paid over the course of a year or a quarter or a month or whatever, etcetera. If you're looking at a stock or a commodity or a certain index and they are paying a dividend on an ongoing basis, well, that's going to already probably be factored into the future expected price of the futures contract, the fact that the value of that contract or that underlying is going to be higher, given the fact that they're going to pay a consistent stream of dividends moving forward. Again, it's a little bit tricky, but again, directly, they do not pay dividends on futures contracts. It's just based on the future price of the underlying as you move forward towards the end of the expiration. Hopefully this helps out. As always, if you have any questions, let me know and until next time, happy trading.

#582 - How Does Volatility Affect Option Prices? Apr 27, 2019

Show notes

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to answer the question – "How does volatility affect option prices?" Volatility is this thing that most people really don't understand when it comes to option pricing in the options market. And it's really as simple as this. When implied volatility or the expectation of volatility in an underlying stock increases, option prices on both sides, calls and puts, increase as well. When implied volatility or the expectation that the underlying stock is going to see a decrease in volatility, then the underlying option contracts on both sides, calls and puts, decrease as well. And another way of just looking at this is just to use maybe a real estate analogy. And if you're going to buy a property in New York or San Francisco or Miami or one of these hot markets right now, there's a pretty good chance that you're going to see a wild swing in the price of that property and therefore, the price of that property is very high because there is an opportunity, maybe not a good opportunity, depending on how you look at it, but there's an opportunity that you could see or realize a huge profit potential in an underlying property that you're buying because of the real estate market continuing to go up, but at the same time, you could see a huge swing to the downside. There's a lot of risk involved in this, but obviously, those real estate markets have the highest prices of properties because the value is in the expected growth in the future, this baked in or embedded growth potential or growth expectation that people have about the area, the real estate market, this suburban urban area, etcetera, etcetera. Now, you look at a piece of property, say where I'm from, outside of Pittsburgh in Pennsylvania and pretty much no man's land and property prices don't really move. There's low volatility in property prices. We might have a house that'll sell for $115,000 and the next month or year, it might sell for $113,000. It's just not a big move in housing prices and that's because there's really no expectation of a massive increase in prices for some economic event in the future. There are towns and our towns that we live in are pretty stable, pretty small, rural areas and so, there's not a lot of expectation of these big, huge price swings, so real estate market prices reflect that.

In the world of options trading, the same thing is held true in the sense that if you're trading options on an underlying stock and there's a huge expectation of some volatile event happening in the future, it could be earnings, it could be an FDA announcement, it could be a number of different things, but there's an expectation that we're going to see prices go up or down dramatically which creates an opportunity to potentially make a lot of money, depending on which side of the contracts you're on, that in and of itself is valuable. Volatility is a valuable commodity. If you're going to trade something and there's an expectation that it could have a huge swing in price which could lead to a huge potential profit, well, then that underlying contract is more valuable than a similar contract where there's not a big expectation that the stock is going to make a huge move. Typically, like a utility stock or say an industrial stock that's just such a big corporation or such a big underlying product and it's not going to have these huge moves, well, you're not going to have option contracts that are priced at these exaggerated levels because the stock really isn't going to move. Maybe it fluctuates a couple percent every month, but it's not having these run-ups of 10% and drawdowns of 20% and run-ups of 30%. Option prices are absolutely affected by the expectation of volatility. When the market expects a lot of volatility, option prices get bid up because that is valuable. And when the market has low expectations of volatility, then option prices fall because there's no perceived value in buying those contracts when the market is not really going to move. Hopefully this helps out and again, I wanted to use a little bit different analogy because we talked about this concept a couple times before, but I wanted to try something a little bit different and hopefully it helps out. If it did, let us know in the show notes or over on Option Alpha, Facebook, Twitter, YouTube, etcetera. Just let us know. Add a comment and let me know if this helped out. Until next time, happy trading.

#581 - Can Open Interest Be Negative? Apr 26, 2019

Show notes

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to answer the question – "Can open interest be negative?" The simple answer to this is no, open interest cannot be negative. Open interest for options trading purposes is always going to be a positive number if it's not zero and the reason is because there can never be an imbalance of negative contracts in the market. Open interest is meant to judge how many open contracts are still left in the market.

To use an overly-simplistic example, let's say that a buyer comes in and a seller comes in and there's no other liquidity in the market. They choose to enter into an option contract where one party buys and one party sells. This creates now, a new option contract in the market and open interest rises from zero to one. Now, let's say later on, that same buyer and that same seller come back and choose to close their position. They reverse their trades and create more trading volume, but now, they have removed an option contract from the market and open interest goes back to zero. At no point can open interest go now below zero which would create an imbalance in the market. That would not be possible.

Hopefully this helps out. Again, this is a very simple question, but we did get this question quite often, so if you have other questions like this, head on over to optionalpha.com/ask and leave us a message and we'll get it queued up here for the next daily call. Until next time, happy trading.

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