The "Daily Call" From Option Alpha

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#460 - For Options Traders, This Is The Gift That Keeps Giving Dec 26, 2018

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 for options traders, this one thing is the gift that keeps on giving. And so, again, welcome back and happy holidays for those of you guys who are celebrating the holidays during this time. And so, I want to talk about gifts because it's around that kind of Christmas season. And so, for options traders, I was wondering what is the gift that options trading gives us and I the gift that options trading gives us that nobody can ever take away from us is the future and what I mean by that is not some mushy stuff about – "Oh, the future's bright, the future's this." I'm talking about the expectation of the future and the fact that the future is unknowable. And so, for options traders and particularly option sellers, the fact that the future is unknowable is truly the best gift for an options trading system, especially an option selling system because we know and we can prove that implied volatility or the expectation of future movement is always overstated compared to the actual movement or historical movement of an underlying over time. This future edge and this idea that we are really bad at predicting the future gives us a huge opportunity to consistently maintain an edge trading in every market environment long-term.

Now, this obviously means that some market environments, we're not going to have that edge or that edge will be as prevalent. Sometimes, the markets behave more irrationally than we thought. Maybe the markets move down faster than we thought or the markets move up faster than we thought. But long-term, the implied volatility edge is proven not only by us, but also by many other places, many other research sites, CBOE, ICC, all of these other places as well and this is the gift that keeps on giving because the thing that everyone always says about options trading and particularly option selling is that at some point, there's going to be an edge that's going to disappear. But the problem with that is that when you have a future that is unknown or unknowable, then it's very hard to predict that future and so long as the future is unknown or unknowable, it's going to be insanely hard to predict the future. And so, until the point at which the future is perfectly predictable, then the options trading edge for selling premium is going to be in place and this is the gift that keeps on giving because guess what? The future is always unknowable and we will always have black swan events. Black swan events keep people on their toes. They keep people guessing as to what might happen. And that extra little premium that's built-in, that extra little insurance that's priced into option contracts because of some unknowable event in the future allows option sellers to consistently make money long-term.

Hopefully this helps out. Again, this is just my kind of take and spin on gifts, but I think if you really listen to this podcast, you'll understand why the edge in options trading will always be here for a long time until the point at which we can predict the future and at that point, then we don't even need to worry about options trading. We can just predict where things are going to go. It'd be much easier anyway. Hopefully this helps out. As always, if you guys have any questions, let me know and until next time, happy trading.

#459 - Is There Any Validity To "The Trend Is Your Friend"? Dec 25, 2018

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 answering the question, "Is there any validity to "The trend is your friend"? If you've probably heard the term or the saying, "The trend is your friend" and the idea behind it is that we generally want to trade or move our positions in the direction of the overall or prevailing trend. The question of the day is – "Is there any validity to this trend is your friend talk?" And I think in many respects, there probably is a lot of validity to it when it comes to maybe longer-term trends as opposed to shorter-term trends. We all know that it's incredibly hard to predict where the market's going to be in an afternoon or a day or even a couple of weeks, but the further we go out in time, there's definitely trends that start to form. We have bullish trends, we have bearish trends, we have cyclical trends in markets and I think that those are something that you should definitely be aware of and you can definitely trade with and hopefully not against. I know a lot of people have actually put out some pretty good research on this as well. Meb Faber, some of these guys that run funds have put out some pretty good research on trend investing and how trends can actually improve investment returns if you just use some simple trend indicators.

As options traders, here's what I can tell you, is that I think about it a little bit differently. I think about it not necessarily as trading with the trend, but just having an awareness or an understanding of where the overall or prevailing trend is and the way that I actually refer to it oftentimes in coaching and on videos with other members is I talk about thinking about the markets as – Where is the market have the least resistance to move? So, where is the path of least resistance right now in the markets? Yes, there could be some economic news that's bad. Yes, there could be this thing that's bad and the trade war and this war and exports are bad or GDP is bad. There could be a lot of things, but is the path of least resistance lower or is it higher? And so, you could say that that's trend. I don't necessarily think it's trend. I think it's just an understanding of market dynamics. If things are known and there's no unknown or uncertain things coming up on the horizon or in the future, I generally think that markets rally. Even if bad news is known, we tend to see that markets rally or shake things off because it's now known information and we've talked about this in prior podcast. So, for me, it's just an awareness or an understanding of where we are kind of cyclically in some of these market movements and that's just again, whatever indicators you want to use, go ahead and use. If you want to use moving averages, you can use moving averages. I don't use moving averages, so you can use whatever you want, but just having the awareness of where maybe the market has the path of least resistance I think definitely helps out.

And we definitely want to keep our duration short enough that if the market does continue to move higher or continue to move lower, it doesn't really impact us. Now, remember, as options traders, because we're not holding onto these positions for a really long period of time, most of the time, our duration in holding positions is 20, 25-ish days depending on the strategy we're using, so not much is going to happen in 20 or 25 days that I can't readjust to in the next 20 or 25 days. As we continuously add new positions and slowly start to build portfolios, if the market's going higher, so are all of our strike prices and we're just naturally ebbing and flowing with the market and adjusting higher or lower. Hopefully this helps out. As always, if you have any questions, let me know and until next time, happy trading.

#458 - Which Options Have The Fastest Time Decay? Dec 24, 2018

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, "Which options have the fastest time decay?" This podcast comes on the heel of yesterday's podcast where we were talking about options with different maturities and why they were priced differently. Now, the question is – Okay. If there's options that are priced differently because of their time until expiration, which option contracts have the fastest time decay? And naturally, the options with the fastest time decay would be the options that theoretically are closing or expiring the soonest. That could be today if you're trading options during the week of expiration or during the day of options expiration. Those contracts would theoretically have the most possible time decay because there's only one day left or zero days left. They basically expire at the end of the day. Or if you're trading option contracts that are a week out, if those are the closest to expiration, they would have the fastest time decay, etcetera, etcetera as you keep moving out the time horizon.

Now, as a reminder, when we start talking about time decay, time decay is visual that happens with option premium. Option premium is generally higher as you go out further in time and as you start to get closer and closer to expiration, the value of options or as a factor of time, so the Theta value of contracts starts to slowly decay in that contract. Until you get to around the 40, 45-day ish point, at which point, it starts to really accelerate and what I mean is that the time decay or the value of time starts to quickly erode in the option contract around the 40 to 45-day period at a much faster pace and that's because basically, the contract is running out of time. At that point now, time decay is starting to accelerate at a faster and faster pace and it just continues to accelerate up until the point at which we reach expiration. When you think about the fastest time decay, of course, it's the option contracts that are the closest to expiring, but also remember that option contracts that are 40 to 45 days are now starting to reach the point that their Theta decay and their time decay is accelerating in a much more rapid pace which means that the underlying stock has to make a greater or bigger move to compensate for the time decay that it lost. Hopefully this helps out. As always, if you have any questions, let us know and until next time, happy trading.

#457 - Why Are Options With Different Maturities Priced Differently? Dec 23, 2018

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, "Why are options with different maturities priced differently?" The reason that options with different maturities are priced in really is simply because of time. All other things being equal, when you have more time until expiration, you generally get more value in option contracts and the reason is simply because there's more time for the position to move in a favorable direction or a direction that you want it to move. For that reason, there's an added time premium the further and further you go out in time. Now, this has a little bit of a diminishing effect when you go say two years out versus three years out. There's not that much of a difference compared if you were say five weeks out versus two years out. As you get closer and closer to expiration, the time value of option contracts starts to diminish at a much more quick pace and so, that's reflected in the price of different option contracts at different maturities.

But again, options with different maturities, say 30 days from 60 days would have different prices all other things being equal simply because the 30-day contract has less time until expiration compared to the 60-day contract. If you're trading an option contract with 30 days, there's only 30 days for the stock or underlying security to move in the direction that you need it to move to make a profit. If you're trading options 60 days out from expiration, you get another 30 days potentially of favorable or possible favorable movement in the underlying security which means that you have to pay some sort of additional time premium for that extra duration that you get in those contracts. That's it. That's the only reason why different contracts have different maturities and as a result, priced differently. As always, if you have any questions, let us know and until next time, happy trading.

#456 - Beta Neutral vs. Delta Neutral Options Trading Portfolios Dec 22, 2018

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 Beta neutral versus Delta neutral options trading portfolios. And I think this is really important because I think that a lot of people actually do not understand the difference between a Delta neutral portfolio and a Beta neutral portfolio. And while they sound very similar, there's actually a big difference between the two. Let's start with a Delta neutral portfolio. When we look at a Delta neutral portfolio, what we're talking about is we're talking about the net Deltas of the underlying options positions that we're trading. If we've got some iron butterflies and credit spreads and strangles, maybe naked options, basically just totaling up all of those Deltas and then trying to figure out – Okay. What are the total Deltas in my portfolio? Now, many times, people will say, "Oh. Well, I want to be Delta neutral which means that I want to have a portfolio that has an equal balance of positive Deltas and negative Deltas." And what that will do is that means that that portfolio generally will make money in any market direction because the Deltas are balanced. If the market goes down, it's completely offset by positions that make money when the market goes up and then you just capture time decay and volatility decay as the kind of edge or premium. And that works to a certain degree, but the problem is that not all Deltas are created equal because what we find is that we find if we trade products that have either high correlations to one another or high inverse correlations to one another, a Delta on one product is not the exact equivalent as the Delta on another product.

So, to use pretty much the standard case study for this, we could look at TLT and SPY which S&P is the broad S&P 500 index ETF and then TLT is the bond market 20-year bond ETF. The bond market ETF, TLT is not the same as the stock market. Bonds are not the same as stocks which means that when the stock market goes up, that does not always mean that the bond market goes up the same exact amount. If you have a positive Delta portfolio and your positive Deltas or Delta neutral on your portfolio of stocks and bonds, that doesn't really mean much. That doesn't mean that you're actually neutral to the market because TLT has a Beta, a Beta that tracks how likely TLT is to move for every dollar or $1 move up in the market. It has a negative Beta of .17 right now and that's that the time I'm actually recording this. It has a –.17 Beta which means that if the market goes up, TLT is likely to go down. If you've got positive Deltas or neutral Deltas in both of these positions, that doesn't necessarily mean that you're neutral to market movements. It means that you could be tilted one direction or the other.

Introducing now Beta weighted Deltas which is how we Beta weight our portfolio, now we take our portfolio and we say, "Okay. Let's Beta weight, use these Beta metrics like the –.17 in TLT and all the other different Beta metrics that we can calculate and figure out and let's Beta weight our portfolio to some broad based index like the S&P and we use SPY." Now, what it does is it runs the analysis and it says, "Look. If your portfolio was hypothetically one big position in SPY, then how would the portfolio curve look? How would your P&L diagram look if everything was Beta weighted and then adjusted for a position in SPY?" That means that negative Betas and super high positive Betas would be adjusted to their SPY kind of correlation and coefficient. And so, now what we see is we see a much better representation. When you use Beta neutral or Beta weighted Delta neutral trading, we see a much better representation of what your portfolio is actually going to do, all positions included, negative Beta stocks, high Beta stocks, negative Beta ETFs, high Beta ETFs, what the whole portfolio is going to do, including all the positions and the likelihood of their correlation to the overall market that you're using. This is a really fascinating area. Again, it's really different. If you're going to trade Delta neutral, it really only works if you're trading in one particular product. Like you could trade Delta neutral in SPY as long as you have nothing else because there's no need to Beta weight SPY to itself, but as soon as you introduce just one other ticker symbol, you had better switch over to a Beta weighted or Beta Delta waiting type of approach for your portfolio, so you have a better understanding of how things are going to react and what the correlations are between those different products.

Hopefully this helps out. I know this is a little bit more high level, but it's super, super important you know the difference between these. If you have any questions, let me know and until next time, happy trading.

#455 - Best Way To Use Protective Put Options Dec 21, 2018

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 the best way to use protective put options. And the best way to use protective put options is actually not to use them at all. How about that? That's actually a little bit of a reversal from the title. But look. The reality is that when we go back through and back-test put buying strategies and specifically like single long put buying strategies, there is no put buying strategy that actually is better than just not using a put buying strategy. Yes, there's probably certain time periods during a market crash where using protective put options works for a very small zoomed in time of reference, but the problem with that is that we never actually go through a market situation where you know exactly when you need to use that put protection buying strategy and when not to use it. The one microscopic time that a put buying strategy would actually work and help the portfolio is almost impossible to pinpoint and to time as an actual trader going through real market scenarios.

When we actually went back and said okay, like back-testing wise, let's assume that we knew when the top was going to be in the US equity markets in 2007, 2008. We knew that that exact top was going to be there. Great. At that time, start executing different put buying strategies. And we put this all on the weekly podcast, so you can search for it and go back and listen to the research, but the end result is that even though we knew or told the system we knew when the top was in and to start buying puts right before the market crash, we actually still were left with a strategy that was less productive, less efficient, made less money than actually just holding through the market crash and not buying protective puts. Again, what we see here is that buying options on a continuous basis is not a good strategy for success and in fact, it actually leads to lower performance and returns than doing nothing at all.

Here is one alternative to doing it. I promise I won't leave you hanging and just say don't do anything at all. The alternative here is to use a collar. And so, a collar strategy is where you would sell a call option to finance most, if not, all of the put option that you purchased. Now, this is a good strategy to use because if you can do this for no cost or even a little credit, it does not create a draw or a drawdown on your portfolio and cash balance. And so, it doesn't offer as much protection as a flat-out regular long put option, but you can slowly start to chisel away or hedge your portfolio on the way down by using collars and it could be costless in many cases. Hopefully this helps out. As always, if you have any questions, let me know and until next time, happy trading.

#454 - Earn Money Fast With Options Trading? Not Likely Dec 20, 2018

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 earn money fast with options trading?" And the short answer to it is not likely. Is it possible to earn money fast with options trading? 100% it's possible to do. But is it likely to happen? Probably not. And in fact, if you do earn money fast with options, maybe you bought some option contracts and the stock moved or the ETF moved in the direction you thought it was going to move very quickly, yes, you can very quickly make some money. You can double, triple, quadruple your investment very quickly.

But again, what I'm planning and I am more than happy to play the long-term game here is the overall expected payout of trades like that versus trades that I'm making. As a net option seller, I know that the expected outcome of my strategy is a profitable position and a profitable outcome for my portfolio, but as an option buyer, I would highly, highly suggest that you reevaluate the expected outcome of option buying strategies because we have not found many, if any, that produce total net gains that are higher than option selling premium.

Again, can you earn money fast with options? Of course you can. You can earn money fast doing anything. But the real question is how sustainable is it, how likely are you to scale, how many times do you have to be lucky before eventually, the numbers come back to bite you at the end because you can't fight the numbers, you can't fight the math in this business. You can get lucky here and there, you can have a good run of trades, you can pick a couple of winners, but that is not a long-term sustainable model or system for building wealth. Hopefully this helps out. As always, if you have any questions, let me know and until next time, happy trading.

#453 - Uncertainty Is The Only Cause Of Market Volatility Dec 19, 2018

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 uncertainty is the only cause of market volatility. This is really important because I think a lot of people get this wrong. But the only reason why stocks, options, bonds, real estate, anything is volatile is because of one thing and one thing only and that is uncertainty of the future. When the future is more uncertain than not, things will become very volatile and in many cases, will just go down. When the future is certain or close to being as certain as possible, then we see that many, many times, markets or securities or industries and sectors actually rally. Even though the news could be bad, even though it could be detrimental, it's still certain news. We know it's going to happen. The markets know how to adjust and know how to react. And I find this very fascinating because if you actually go back and you watch many times where a news announcement has come out and more recently with the Brexit vote that was then delayed in the UK, this was a bad announcement for the markets and the reason it was bad is not necessarily because Brexit itself is good or bad for the markets. It's just that the vote was delayed. Now, that causes more uncertainty in the market which is what is the cause of market volatility. Had the vote been set for a certain date or had the vote actually happened on the day that it was supposed to happen and then the Brexit vote was either good or bad, the markets could've rallied off of that information because it was said, it was known, it was certain.

We also saw this very briefly if you actually look at the intraday futures, the night that Donald Trump was elected as the president. We saw the market selloff hard when he was finally determined, I guess by the news stations to be the President-elect and the markets sold off really hard because what the market was anticipating was anticipating that Hillary Clinton was going to win the election. And so, when the news came in immediately that Donald Trump had actually won the election, market sold off hard on all this uncertainty because now, what they thought was going to be a sure thing is now not and so, the market sold off hard. But then very quickly, it took literally probably about 15 to 20 minutes for this to happen, the markets turned around because then, they started to realize and investors, people, us humans started to realize – Hey. Maybe this means that we're going to get a cut in taxes, more stimulus, etcetera. Again, not to say that any one of the candidates is better than the other, I don't really care, but that's what actually happened. If you look at the intraday futures the night of the election, that's the logic of what happened during those time periods and again, the only reason that the markets became more or less volatile is because of uncertainties. When you look at any new story, anything that's coming out, again, ask yourself. "Is this going to make the market more or less certain about the future?" And if the answer is less, then it's probably going to be bad for the markets. If the answer is more certain about the future, whether the news is good or not, it probably is going to be good for the markets moving forward. Hopefully this helps out. As always, if you have any questions, let me know and until next time, happy trading.

#452 - 20% Volatility In Stock Prices Should Be Expected Dec 18, 2018

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 20% volatility in stock prices should be expected by all investors. In fact, you could even substitute stock prices for portfolios, options trading strategy, basically any investment strategy at all. It pretty much is the standard that most investment strategies on a long enough time horizon are going to go through some sort of drawdown or drawdown period and probably a minimum, we're going to see a 20% drawdown at some point. In fact, most of the strategies that we back-test through our back-testing software and in the profit matrix research where we put together, went through a period of 20% drawdowns at some point in the cycle. It may have been 25%, may have been 18%, but somewhere around 20% drawdowns.

And so, for most stocks in general, 20% volatility is kind of the normal. I feel like people actually worry about a 20% move in a stock, but the reality is that if a stock moves 20% down or up, that's the normal expectation. If a stock moves down by 50%, okay, that's probably abnormal. But a 20% move in stocks is to be expected, so I don't know why people get so worried about it and frightened and it's because I know why they do it because they're just fearful and they don't understand the markets, but a 20% move is priced in. I mean, like most stocks have that type of implied volatility and that expectation that's priced into their security. That's why you can make so much money investing in stocks because there is such a high volatility and high risk associated with it that if you get it right, you should be able to capture a lot of that premium. Same thing with an options trading strategy. Because you're using a leveraged product, you should be able to capture above average returns when you're doing it right and using proper position sizing, etcetera. But don't be fooled into believing that you're never going to have a drawdown or that you're never going to have even just a small drawdown. We could go through a 20% drawdown at any point and that doesn't mean that anything's broken or bad or wrong. It's just how the numbers shake out. It's how the expected returns and the portfolio graph starts to move.

The other side of this is – Don't believe either that just sitting in cash or in bonds is the safe alternative to this. When you sit in cash, you get eaten away by inflation and inflation has been fairly tame over the last couple of years, but there's no expectation necessarily that it's going to be the same moving forward. Even sitting in something like cash, you're going to go through a drawdown. You just don't feel it. It doesn't look in your bank account like you went through a drawdown because you don't lose money in your bank account, but you lose purchasing power. Hopefully this helps out, again, just to kind of reset the bar for expectations. I see too many people that are just like absolutely freaking out about moves in the market and I'm sure there's probably reasons why you can freak out about fundamentals and macro type stuff, but when a stock moves down 10% or 20%, I mean, frankly that's the expected. We're expecting stocks to do that on a general basis. Hopefully this helps out. As always, if you have any questions, let me know and until next time, happy trading.

#451 - Great Depression Stock Market Recovery Timeline Dec 17, 2018

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 the great depression stock market recovery timeline and more importantly, I think this is an interesting topic because as I've been reading a lot more about dead cycles, the great depression, the Weimar German Republic and hyperinflation, I think it's interesting because of the timeline that we're on right now where we could be entering into the next phase of this market which could potentially be recession/depression/some sort of consolidation and sideways movement. And so, I think it's important that we understand a little bit more about history and how long things might take to recover because the fact remains is that many of us have not gone through basically decades or even multi-decades of no growth or zero growth or low growth in the markets.

When you look back at the great depression stock market recovery timeline and the timeline that it took the market to get back up to its original peak right before the 1929 crash, on a nominal basis, it took about 25 years. Now, really think about that. Almost a quarter of your life is how long the market took to recover. Naturally, when I hear stories about how people were hoarding cash, hoarding gold and just like people's mentality coming out of the great depression, it's very easy for me to understand why they have such a saving mentality or kind of… I don't know if I'll call it hoarding, but just like a very conservative fearful mentality of the markets because on a nominal basis, it took 25 years for the market to recover. Now, many people would say, "Kirk. Well, that's not really true because that's just from a price. If we adjust for inflation because we actually went through a deflationary period during the great depression, then we readjust for inflation, it actually only took four and a half years." Okay, fine. Yes, if you adjust for inflation, it took four and a half years which is still a long period of time, but that is just the price wise, like most people actually never recovered from those events. And what I know for sure is that when you have somebody that goes through a 60%, 70%, 80% drawdown, there's almost no hope that you actually recovered. Now, yes, there's probably some people who held through that. Maybe. I don't know how many people actually held through the entire great depression and got back up to those levels that quickly, but I would dare to say that it's almost nonexistent.

The fact this is that although it took four and a half year on an adjusted basis, that doesn't really do us any favors because if inflation is running rampant and prices of everything are going up, then what does it matter for our stock portfolio. It's just basically catching up. We're losing here and gaining there. I think it was just an interesting period. I think the end result here is that if we go through potentially another period like that which is not off of the table by any stretch and anybody who thinks it is, is totally fooling themselves, then it could be a really long time before the markets recover. And so, that's why I think like… I'm telling you guys. I truly believe that options trading is going to go through this massive, massive growth during the next downturn in the market. With the number of people who are going to be interested in it, the number of people who are going to start trading, we're going to start to see a major shift in market dynamics from more equity style trading to more derivative style trading over the next 10 years than I think we've ever seen in the entire history of derivative markets and it's because we could potentially be in basically a lost decade or lost multiple decades potentially (who knows?) of the markets not really going anywhere, inflation going up, deflationary pressures coming back down (if that happens) and that could really be the catalyst to kind of propel the options market.

So, learn about some of this stuff. Read up on the great depression. Read up on some of these other market declines and dead cycles. Have an understanding of what happened during these events before it happens to us even if we're in potentially that time right now. I think it's really important. Hopefully this helps out. Hopefully it gives you some food for thought as always and until next time, happy trading.

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