The "Daily Call" From Option Alpha

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#480 - Trading Big Stock Moves With Options (The Right Way) Jan 15, 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 trading big stock moves with options the right way. This really comes down to what we've seen just in the last couple of months. It could be individual ticker symbols like SLV or GDX or TLT. They've had really big moves in the last couple of months.

And what people tend to default to do when they expect a big move in a stock is they tend to want to buy options and they think that buying options leads to potentially the biggest payout because they have limited risk and all this upside potential. What they fail to remember is that in all cases long-term, the buying power that options provides prices in the expected move that should happen in the stock. And so, what we see is that when stocks are about to make a big move or have already made a big move, all of that stuff is priced in and long-term, stocks underperform their expectation. Now, this doesn't mean that you couldn't find yourself in a situation where you buy an option and you make money because the stock moves more than expected. That happens all the time. But the long-term whole outcome of option buying is already pricing in the expected move. It's already pricing in the expectation that the stock is either going to make a big move or has had a big move and it usually never moves more than the expected outcome long-term.

The right way to trade big moves with options is to trade them by selling options around those big moves. Typically, we see this around earnings trades. We saw this just last year in 2018 when we actually sold a ton of naked options in UNG after a massive move in natural gas. We posted all those videos. They're all public and live on YouTube, so you can see all of our positions that we got into, but this was counterintuitive. Most people would've thought, "Why are you selling options? UNG just had this huge move. It's potentially going to make an even bigger move." But we knew that option pricing was way too expensive, had priced in a massive move that we expected not to happen long-term and we ended up trading around that situation and making some pretty good money. And so, that's the right way to trade some of these big moves, is not actually to buy strategies, but to use option selling strategies. Hopefully this helps out. As always, if you have any questions, let me know and until next time, happy trading.

#479 - Options Trading Golden Rule #11: Non-Emotional Expected Outcomes Jan 14, 2019

Show notes

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're finishing up our little miniseries here with options trading golden rule number 11 which is non-emotional expected outcomes. Hopefully you guys have enjoyed this little miniseries. If you are new to Option Alpha and you want to go back and re-listen to it again, I highly encourage you to do so. If you thought it was helpful, please let me know. Share it with somebody out there online. Share it with a friend, a family member, a coworker, somebody that you trade with, a trading buddy. Help spread the word about what we're trying to do here at Option Alpha. Today's rule is the most important one and I think the most important one because it ties in everything that we've talked about from position-sizing, to being a net seller of options, to understanding probabilities, not using stop-losses. All of these things that we have talked about in the previous 10 rules now kind of come to this peak, to this apex here with golden rule number 11. And what non-emotional expected outcomes means is that we should be trading a strategy that we know has a positive expected outcome. A lot of times, I see people that start trading options and they start buying options because they frankly just don't know any better. But they start buying options and buying options generally has a negative expected outcome which means that you can do it for a little while, but at some point, it's going to lose all the money in your account. You're going to lose everything that you have potentially in that account trading the same strategy over and over again.

Let's play a little game just to kind of highlight this point and just to use a little bit of an analogy. Let's say that I make $5,000 a month at my job and my expenses are $5,500. Every month, I make $5,000 and I take in income of $5,000, but I outlay $5,500. Well, I only made $5,000, so where does the other $500 go? Well, it goes on potentially a credit card let's say or let's say I borrow the money some other way. How long do you think that that cycle can continue to happen before I don't have enough money for my monthly expenses which is already happening and I start going into such severe debt that I start to go bankrupt? It's only a matter of time. The expected outcome on that type of situation when you spend more money than you earn (just to use a very simple personal finance analogy) ends up being a negative expected outcome. Yes, you can sustain yourself for a couple of months. Yes, you might have a couple of months where you reduce your expenses and you don't have to borrow on the credit card. But generally, as long as you have this negative expected outcome in your portfolio or your net worth, you're going to put yourself in a bad situation and it's just a matter of time before you end up going bankrupt. The same thought process can be applied to options trading. What I see people do all the time is they get themselves into a portfolio or a position or a strategy that has a negative expected outcome and all they're trying to do is hit a quick homerun or make a quick buck and this type of shortsighted thinking leads to a long-term life of misery and failure trading options because they don't have portfolios and strategies that have a positive expected outcome.

Now, let's say that you do have a positive expected outcome strategy. Maybe you're choosing an iron condor, iron butterfly, short strangle, credit spread option selling type strategy. This also means that you may not see profits right away. It may mean that you see potentially a couple of months of down months or a couple of flat months and you're trading everything correctly and you're doing everything the right way and you're using the right strategies and the right position size, but you're just not seeing success. That doesn't mean that the system is broken. It just means that you haven't traded enough, the numbers haven't worked themselves out in your favor yet, but they will. They will work themselves out in your favor. When you trade with a positive expected outcome, things will work out in your favor because that's how the numbers shake out. You just have to stick with the program, be persistent and consistent in using the right strategies at the right time, making sure your position size is appropriate, making sure that you're balanced, do all the things that we talked about in rules one through 10 and if you do that, you will find success and it may take a little bit more time than you expected, it may not happen initially, some people in might, but other people it might not and it may take a year or two years for you to find success in this business. Now, what we've seen and I highly encourage you to go back through the weekly podcast, show number 138 because I think that show in particular is not only one of the favorite shows that I've recorded, but also one that I think is very popular because we talk about this probability or expected probability paradox and this idea that everyone thinks options trading is a zero-sum game, but it's not. There's a lot of things that actually tilt the zero-sum game in favor of the option seller. And so, I think it's a great way to continue on this journey if you want to stop these golden rules and go to the next level and like what's the next thing. I think show number 138 on the weekly podcast is definitely one you should listen to. If you haven't already, listen to it again. But again, the whole idea here is that when we are trading, we have to be as non-emotional as possible. This means that when we take a loss, it should not really affect us and it should not stop us from trading.

Last year in 2018 during the middle summer part of 2018, we went through about a 6% drawdown in our account and a lot of people were like, "Oh, we should stop trading. These strategies now are broken. Aha! Got you, Kirk. This is a scam. I knew it. Here it is." And we just kept trading. We just kept trading through that whole situation. We kept doing the things that we know will work out in the long-term and we ended up the year positive, we ended up trading through the market decline at the end of the last quarter in 2018 by actually making money when the market was actually crashing and everyone else was losing money. We actually made money during that time period and we're going to be putting out a podcast that not only talks about that whole experience, but also shows you all of our accounts and portfolios, etcetera, so you guys can see what we were actually doing. But the whole idea and I said this back in 2018, the middle of 2018 when we're going through this drawdown, is I said, "Look. This is just fluctuation that's expected. We expect that we're not going to have a straight line portfolio and so, we got to stick with the program, we got to keep trading the same ticker symbols that we've been losing on lately because it's just a bad sequence of returns that we found ourselves in." We found ourselves in a sequence of returns that ended up being negative and that doesn't mean anything was broken. It doesn't mean that we were doing anything wrong. We just needed to keep trading through that situation as non-emotional as possible. Now, could I have thrown up my hands and said, "You know what? Forget it. I'm done." Sure. I could've done that. Could I have gone towards a more aggressive options trading strategy, so that I claw back and kind of fight back against the market because it gave me a drawdown? Sure. I could've done that. But I know intuitively now having done this for over 10 years that that's not the right way to go about it, that you have to stick with the program and sometimes as much as it hurts to just keep doing the same thing and it seems like you're not really making progress, you will be at the end of the day.

Hopefully this helps out. Hopefully again, you guys have enjoyed this little golden rules series that we did here at the beginning of the year. If you did, please let us know. Please share it. Again, give us a review and a rating. That's the best way that we get this into the hands of other traders and kind of spread the word about what we're doing here at Option Alpha. Until next time, happy trading.

#478 - Options Trading Golden Rule #10: Adjust To Reduce Risk Jan 13, 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 options trading golden rule number 10, adjust to reduce risk. This is one that I've had as kind of a rule for myself here for the last five or six years and it's this idea that when we make adjustments, we need to adjust to reduce risk and increase the probability of saving the position or losing less money. And this is really important because I see a lot of people are fearful of taking a loss. I don't care if I take a loss on a trade. I know that losses are part of the game. It's part of what I expect to happen every single month. I'm not going to be 100% profitable on every single trade.

But what I should do as an active trader is I should look to take trades that are going to lose money and figure out ways to lose less money and this means that sometimes we adjust positions and we roll positions in order to give ourselves more time and more premium to reduce risk. But I will never adjust a trade where I'm increasing risk in the position and this again, I think is a common mistake of many people who get started trading options or even active traders who have been doing this for a long time. They end up getting themselves into this false positive cycle of making adjustments that increase risk and when it pays off, they think that that's the right way to do it. They roll a position, widen the wings, double down on the position. They do all of these things that we know intuitively we shouldn't do, but when they actually end up being right for that instance and they end up making money, they think that's the way to go. And so, they start digging themselves into deeper and deeper holes and some time, it's going to come back around and bite them in the behind. It's going to bite them in the rear end because they're going to adjust the position and increase the risk and that's going to be the time when the market goes completely sideways or completely in the wrong direction than you thought it was going to go and you're going to have this massive loss on your hands.

Whenever you get into a position, you should know your probability of success, you should know your risk size heading into the position. Those are all controllable factors. And so, what you should do as a great trader is you should adjust to reduce risk in the process. Minimize risk as much as possible. Take a losing trade that should lose $700 and cut it down to a $500 loser. You start doing that consistently, I promise you that things will start working in your favor and you'll start seeing positive expected outcomes. As always, hopefully this helps out and until next time, happy trading.

#477 - Options Trading Golden Rule #9: Reduce Commissions & Fees Jan 12, 2019

Show notes

Hey everyone. This is Kirk here again at Option Alpha and welcome back to the daily call. Today, we're going to be talking about options trading golden rule number nine which is reduce commissions and fees. I think generally, a lot of people when they get started in options trading and open up a brokerage account are surprised that you could actually go in and negotiate with your broker or find brokers that offer cheaper fees. Now, I publicly said a little while ago that I think all brokers at some point will be going towards a zero-commission, zero-fee structure. I think it's the inevitable trajectory of this entire market. And although we are not there yet, I think many brokers are starting to gravitate towards no commissions and no fees for trading. And so, this is good for consumers and good for traders alike because commissions and fees are a cost of doing business. Now, I tell people all the time, even though commissions and fees might seem like they hurt, it's actually just a cost of doing business and your options trading strategy should more than compensate for the commissions and cost of doing business. It should make more money than the fees included.

Now, this doesn't mean that we shouldn't actively also look to reduce our commissions and fees. This could mean renegotiating your fee structure with your brokerage which we've often done before and we've posted about on the website at Option Alpha. You can see our transcript of how we've negotiated before with our broker. And this could also mean switching to a different broker like moving to a broker like Robinhood or Tasty Trade or some of these other low commission brokers. Now, again, you just have to make sure that their accounts and their type of platform is conducive to the style of trading that you want to be active in and that has all the features and functionality that you might like. I've said before that I think you pay for what you get. Sometimes with a cheaper broker or with a no-cost broker, you get much more of the barebones type functionality that doesn't actually give you a lot of value. If you go with a more higher cost and I say "higher cost" and relatively higher cost broker, you actually get a lot more functionality, a lot more tools that might actually help you end up generating more money more so than the commissions you get charged. In either case though, you want to actively reduce your commissions, look at your commission structure, know what you're paying in fees and make sure that you have a good understanding of it as you start your trading strategy. As always, if you guys have any questions, let me know and until next time, happy trading.

#476 - Options Trading Golden Rule #8: Ample Cash Reserve Jan 11, 2019

Show notes

Hey everyone. This is Kirk here again at Option Alpha and welcome back to the daily call. Today, we're going to be talking about options trading golden rule number eight which is ample cash reserve. This one again, is something that not a lot of people really understand and even if you understand it, you probably don't practice it and it really comes down to a simple factor of greed. A lot of people when they get started in options trading, they realize that options trading has the potential to generate money quickly for them and it's because we're using leveraged products that are leveraged against stock. And so, it's a little bit more risky, but they see a potential trade that they put $50 in generate $100 and so, now, they want to scale up and they want to throw a bunch of cash at it, but that's the wrong approach. And so, what we suggest here is that you definitely have ample cash reserves in your account. Somewhere between 50%, 60% of your account should be in cash pretty much at all times. Now, this does mean that you're going to have to leave that cash in your account sitting there earning nothing or potentially by a small ETF that's like a short-term bond ETF that pays a little bit of a dividend and doesn't really move. But the idea here is that you need to have cash reserve as a cushion and as a fallback against market volatility, black swan events and margin expansion because undoubtedly, it will happen again. What we saw at the end of 2018 will happen again and potentially even more severe in some cases or in some industries and sectors. You need to have this cash as a cushion, as a fallback to withstand these high volatility events. Even more so, the reason that we suggest having ample cash is because the math and the data suggest that when you over-allocate your account and your whole portfolio towards an option strategy, you leave yourself vulnerable and exposed to a bad sequence of returns that could cripple your account.

What do I mean by this? If you're trading 50%, 60% of your account, you could run into a situation where you actually run through a sequence of trades that end up generating losses, sometimes 15, 20 trades in a row. Now, that's not the probable high probability outcome, but it is a probable outcome. There is a potential for you to run into a position that has 15, 20 losses in a row. And so, when you have too much money allocated, that can severely impact the portfolio to the point at which it cripples it and it never recovers. What you need to do is you need to have ample cash. We suggest allocating on average during the year, somewhere between 20% and 30% of your account towards options trading strategies. And yes, that can fluctuate. Sometimes it might be lower. Sometimes it might be a little bit higher. But generally around 20% to 30% is what we've seen in back-testing and research ends up being about the sweet spot of allocation to generate returns that not only beat the markets, but are also pretty smooth and stable. And so, that's what we're all after anyway, is smooth and stable returns and this means that we have to be less greedy, we have to be more risk adverse, we have to make sure that we have ample cash reserves in our account. And again, I see this is all the time in coaching, all the time on forums, other websites, other services out there. They're suggesting way too much cash allocation and at some point, they're going to blow themselves up. It's just a matter of time. It's not a matter of when.

#475 - Options Trading Golden Rule #7: Opportunistic Profit Taking Jan 10, 2019

Show notes

Hey everyone. This is Kirk here again at Option Alpha and welcome back to the daily call. Today, we're going to be talking about options trading golden rule number seven which is called opportunistic profit-taking. Opportunistic profit-taking is a little bit different style of trading and we've been doing this for a long time, actually before many people who are popular for talking about options trading and taking profits early actually started to come on the scene. And what we realized earlier on is that when you start taking profits early and you start being opportunistic with your trades, you actually end up reducing the volatility in your account and reducing the risk that the stock moves against you. Now, this means that sometimes you have to wait all the way until the end of expiration to take profits. Sometimes they might come early in the expiration cycle. But the reality is that rarely does holding all the way to expiration lead to the most profits. Now, what we have seen recently in our research last year which is the profit matrix, we saw that generally holding positions a little bit closer to expiration helps, just not all the way to expiration.

What we've started doing in our trading and this is a change that we made about a year and a half ago is we've started holding positions sometimes a little bit longer than our initial profit targets and we usually will do this when the position is middle-of-the-road, meaning it's right in the middle of our potential breakeven points or the range that we want it to be trading in. If it's trading in there and it hits its profit target, we might just hold it a little bit longer. Especially if our portfolio overall is pretty balanced and everything is going our way, let's squeeze a little bit more premium out of some of these positions. But again, the reality is that we don't want to be overly-aggressive with profit-taking, but we want to be opportunistic, meaning we don't need to take the first profit that we get, but when the market does move favorably, if that move happens early or later in the cycle, we want to be able to take positions off and remove the risk. Now, again, you can use our toolbox and our profit matrix software to take a look at the different strategies that end up profiting at different expiration points and when you should take those positions off based on strategy, time until expiration, implied volatility levels, etcetera. As always, if you have any questions, let me know and until next time, happy trading.

#474 - Options Trading Golden Rule #6: No Stop-Losses Jan 09, 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 options trading golden rule number six which is no stop losses. This one's a little bit counterintuitive and it always seems to stir up a little bit of controversy, but the results are what the results are and the numbers speak for themselves. When we go back through and we back-test hundreds and thousands of option strategies using stop losses and not using stop losses, there's no doubt that overall, not using a stop loss on your trade ends up generating more money. Yes, I said it. Do not use stop losses as a general course of business. What you should be doing is you should be properly position-sizing like we talked about in some of the previous golden rules, making sure that you allocate a small amount to whatever ticker symbol or sector you're trading and then let the position on to work itself out, let the probabilities work themselves out. We know that we're going to be challenged, we know that stocks move as they go towards expiration and just because your position is being challenged now doesn't mean that the stock is going to stay challenged or that it could potentially turn around and become a profitable trade. We see this time and time again and I've posted live videos on all the trades that we've done, so you can see how we have positions that initially were challenged and then the stock made a move and it came back inside of our range.

Again, what we see over and over again is that using stop losses ends up generating more losing trades. They should be called loss generating trades because they end up generating more losses. And so, you can even go back and we did a really in-depth long case study on this on show number 67 of the regular weekly podcast where we back-tested 10 strategies using stop losses versus not using stop losses and in almost every single case, what we saw is that using a stop loss ends up generating more losses. Now, this all being said, does this mean that there are certain instances where you should have a stop loss? Of course, but it probably is when you have over-allocation in your portfolio. A stop loss might help if you're allocating 30% of your account towards a ticker symbol, but we don't suggest that. We suggest allocating less than 5% of your account towards each individual ticker symbol or sector. Hopefully this helps out. As always, if you guys have any questions, let me know and until next time, happy trading.

#473 - Options Trading Golden Rule #5: Net Option Seller Jan 08, 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 options trading golden rule number five which is that I believe you have to be a net option seller. There's no doubt that we have the most comprehensive research and database on option selling strategies and option buying strategies. In fact, when we released our profit matrix research which was arguably the most in-depth analysis of different option strategies, different variations and settings, tickers and industries, what we found is that most of the time when you are using an option selling strategy over an option buying strategy, you end up generating more money long-term.

Now, this isn't to say that option buying strategies can't work in a vacuum. They could work in a particular month or a particular market event and I see people all the time touting these 75%, 50%, 100% returns as the baseline scenario for what you should do, but I highly doubt that they're actually achieving those results on a compounded basis, meaning they might have a really good month or they might have a really quarter or year, but it's highly unlikely that they're actually going to hit those numbers year after year, month after month because at some point, compounding wise, you'd basically own the world. You would be as big as some countries or as big as some corporations just from these option buying strategies and they never work out long-term.

What we do see is that option selling premium and becoming more of an insurance type company in this business by selling premium and collecting the volatility edge that's embedded in option prices ends up being more successful long-term. Does this mean that you should only use option selling strategies? By no means, no. There are definitely times where you could use an option buying strategy to potentially take advantage of a market situation or a drop in implied volatility or a big move in an underlying stock, but what you should do is you should focus on net option selling as the core basis of your portfolio. This means that most of your capital, most of your cash should be allocated towards option selling strategies and option selling strategies where you are a net seller of options as part of your positions. Hopefully this helps out. As always, if you guys have any questions, let me know and until next time, happy trading.

#472 - Options Trading Golden Rule #4: Balanced Portfolio Jan 07, 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 going through options trading golden rule number four which is having a balanced portfolio. As we have done over the last couple of days, we're building on top of all these golden rules that we've started to develop. Number one, small positions, number two, trade count, number three, diverse tickers and now, number four is balanced portfolio. Again, this makes logical sense. If we started going through rules number one through three, the argument could've been made – "Okay. I can trade a bunch of small positions, I can do it a lot and I can do it in diverse tickers, but which direction do I choose? Do I always trade neutral? Do I always trade bearish? Do I always trade bullish?" And so, when you only trade in one direction or build a portfolio that is built in one direction, you dramatically increase the probability of success that a bad sequence of returns or a bad sequence of trades again, blows up or creates a huge drawdown in your account. My thought process on this has always been that we need to have a generally balanced portfolio around the market and this is an interesting concept because if you really think about it and listen to what I'm going to go through here in this podcast, it makes complete sense which direction you should be trading or which trades you should be adding in different market scenarios. Let's assume that we start and our portfolio is 100% balanced which means that wherever the market is right at this exact moment, we are generally going to make money within a range say up or down 5% of where the market is. And so, if the market rallies 5% or if it falls 5%, anywhere in that range, we should generally make money and that's how most portfolios for option sellers are built. They're built with a typical bell type curve or bell looking curve around the market which designates that it's pretty neutral or Delta neutral in its balance.

Now, when the market starts to go down and the market starts to trade lower, if you remember, our portfolio is centered right over top of where the market is before it starts to move lower. When market starts to move lower, where is our center of our portfolio now? Our center of our portfolio has never changed. Most people, they don't think about this when markets start to go down and they start trading neutral and they understand it, but then the markets go down and they don't know what to do. But remember, the center of our portfolio has never changed. It's still at the price at which the market was before it started moving lower. This means that our portfolio as the market is going down, is becoming more and more bullish and tilt and it's naturally happening. It's a natural event that happens. As the market goes down, we become by de facto of the fact that our portfolio is still centered at the higher prices, more and more bullish on the market. Now, why do I talk about this? Because what most people default to when the market starts to go down is they start to become buyers and they start to go long the market at these lower prices, but that's the wrong decision and it's the wrong decision because you don't need to become a new net buyer, a new bullish person when the market goes down. If your portfolio was balanced before the market started heading down, then your portfolio is already tilted, so that if the market goes back up, you make money because you need it to go back up to get back to center. What the problem is, is that with most people when they start trading, the market starts to go down, they become more and more bullish on the market because that's just what you do when markets go down, you become more bullish, you look for a rebound and they start trading for that rebound, but the problem is they start digging themselves into a deeper and deeper hole, so that if the market say doesn't rebound or it doesn't rebound as quickly or as violently in the same percentage move as they expected, they end up digging themselves into a deeper and deeper hole that ends up creating more and more losses.

What should you do instead? Well, think about this. If the market starts to go down and you were neutral before the market movement and your portfolio is naturally becoming more and more bullish as the market goes down, you actually need to add more bearish positions to counteract to the fact that your portfolio is becoming more and more bullish as the market goes down. As markets go down and starts to move away from the center of your portfolio, you need to add more and more bearish positions and this is again, counterintuitive because most people would assume – "Well, how would I be adding bearish positions in the middle of a down move? The markets maybe are overextended. It looks like they could rebound, they could bounce, so why would I basically be trading right in front of this possible freight train?" And the reason is because you need to adjust and move the center of your portfolio lower with the markets and the only way to move the center of your portfolio lower is to add more bearish positions, more directionally bearish positions to your account. The case could be made then in a crash that where the markets just continue to move lower and lower and lower, you actually should be getting more and more bearish during the market crash. In fact, there's probably a case where you don't add any bullish positions and so, you only trade what the market is giving you. You trade the direction of the market in my case. That's the way I think about it. I think about trade the direction of the market move, so if the market's going lower and I'm neutral at the beginning of the move, I need to make directionally bearish trades that trade the direction of the market. To flip this on its head and use the other example just so that we cover our bases here, if we are balanced and the market starts moving higher, then our portfolio is naturally becoming more and more bearish. We need the market to move back down to get back to the center of our portfolio. When the market moves higher, most people assume you sell and you go short the market at these higher price points, but I would argue that to move the center of your portfolio higher with the market, you need to actually start adding more bullish trades to your portfolio, trades that move the center of the portfolio higher because the core of it is already becoming more and more bearish as the market moves higher. You're naturally becoming bearish, so you need to counteract that by adding more bullish positions slowly over time.

Again, golden rule number four today is just to keep a balanced portfolio, to keep your eye on your portfolio balance. It doesn't mean that you always have to trade everything neutral. It doesn't mean that you always have to trade directionally bearish at sometimes or directionally bullish. I don't care what the make-up of your trades are, but you should know where the center of your portfolio is at any given time. When you go in to review your portfolio on a weekly basis or biweekly basis, having an idea of just knowing where the center of your portfolio is clears the field, so that you can more accurately see what positions you need to add because there's probably going to be a lot of trading opportunities that look really good, but the question comes down to – "Does my portfolio need it? Do I need this position or will it create me to be even more unbalanced than maybe I am at this exact moment?" There's a lot of opportunities in 2018 to add a lot of positions, a lot of which I passed on because adding that position would've been great for that individual trade, but would've been bad for the portfolio. And so, that's one thing that I always harp on, is getting back to what is good for the portfolio, what creates more balance in my portfolio and if sometimes that means passing on a trade or sometimes that means doing something that feels a little bit uncomfortable at the time because I'm trading bearish and the market's moving down or I'm trading bullish and the market's already had such a huge move higher, that's okay because what we're doing is we're protecting the whole core portfolio and making sure that everything is balanced. That's really the golden rule today. Again, making sure that you understand and you're aware of your portfolio balance. As always, we have so much training on this inside of Option Alpha particularly in track number two and number three on the website when you guys get a chance to take a look at it. If you have any questions, let me know and until next time, happy trading.

#471 - Options Trading Golden Rule #3: Diverse Tickers Jan 06, 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 going through options trading golden rule number three which is diverse tickers. Again, just building right on top of rule number one and rule number two from the last two days, our third rule here is you have to be trading a diverse set of tickers. Now, this again, is investing basics 101 in my opinion, but this idea that we should be super highly focused on a few set of tickers is absolutely nonsense. We should have a diverse set of tickers in our portfolio at all times.

And I think where people maybe have missed the mark here over the last couple of years is that there's been a lot of talk about high implied volatility trading, only trading ticker symbols with high implied volatility. And while I definitely like doing that and subscribe to that methodology, what I've also said over the last couple of years is that we have found through our research that by adding in and by filtering for also diversity in our portfolio, we ended up seeing some better returns for portfolios that have a diverse set of ticker symbols than we did for portfolios that were highly focused in one or two sectors or industries. The problem that I see is that a lot of people think to themselves – "Well, if I can just trade high implied volatility, I'll only wait for those high implied volatility scenarios and I'll only trade those stickers that have high implied volatility because that generally ends up being more profitable long-term." Well, that's true in a vacuum. In a vacuum, when we just kind of figure out the numbers in which strategies end up working out the best, in which setups work the best, high implied volatility setups work the best, no doubt, but the problem is that it happens in probably the same sector across the same industry all at the same time. A classic example of this has recently been the oil and energy markets which at the end of 2018, experienced a pretty hard financial crash and during that time period, we saw a lot of tickers, all oil and gas and energy-related that had high implied volatility. When you use the rules that we had talked about in number one and two which is just small positions and high trade count, the argument could've been made that we traded a lot of these different ticker symbols, we kept our position size under 5% per symbol, we had a high frequency of trade count, but the problem now is that we were over-allocated into one sector or one industry. You could've traded five or 10 different oil and gas-related ticker symbols. Yes, they would've all been different tickers. Yes, you would've kept your position size in check, but it would've been basically trading the same underlying or fundamental product which is oil or natural gas in many cases. And so, when you do that, you actually pigeonhole yourself without even knowing it.

What do I mean by diverse tickers? I mean generally having a set of tickers and it doesn't have to be the same in every single month. You can mix it up. You can choose whatever set you want, but a set of tickers that has as much un-correlation as possible. We know that when markets are volatile, things tend to be more correlated. I'm just talking about having as much un-correlation as we can possibly have. Now, it doesn't mean that we're going to be perfectly uncorrelated, that we're going to have this diverse portfolio that is 100% non-correlated to each other. It doesn't exist. It's not out there. But we want to be as uncorrelated as we can possibly be. This means trading things like emerging markets, maybe currencies, maybe hard metals like gold and silver. Commodities could definitely be thrown into the mix. You could do retail, homebuilder. The other major one that we always do is bonds, so things like TLT or HYG. You want to try to have some of these industries and sectors that you can use in your portfolio to help create some diversity and this means that sometimes you're going to be trading things that don't have insanely high implied volatility and that's okay because what that ticker symbol is used for is to add balance and add diversity to the portfolio. Last year and actually, well, we're doing this in 2019, so 2017, our best-performing ticker symbol was TLT which for almost all of 2017 had insanely low implied volatility, but it was our best-performing ticker symbol and we traded it every single month and we still trade it every single month because we want exposure to bonds in our portfolio. Now, is this going to be perfect exposure, so that when the markets go down, bonds always go up? Of course not. Bonds are typically actually more correlated with the markets than they're not, but we want something that trades not in lockstep with the S&P. We want something that has a little bit more of an un-correlation to the markets to add some diversity to our portfolio.

Again, golden rule number three today is to have diverse tickers and this could again, be anywhere between eight to 12 different industries and sectors for every single month that you're trading. Again, this can rotate. It doesn't always have to be the same, but just try not to trade the same underlying products in the same sector. Again, to go back and use that oil and gas analogy, you could've easily at the end of 2018, traded OIH, XOP, USO, XLE, etcetera. Those would've been all fine trades, but the problem is that all four of those ticker symbols were in the exact same industry and sector and so, they probably behaved very much the same which means you needed to add other things to combat those, so that they didn't drag down your portfolio during the bear market that oil and gas had. Hopefully this helps out. As always, if you have any questions, let me know and until next time, happy trading.

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