The "Daily Call" From Option Alpha

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#410 - Does Using Multiple Technical Analysis Indicators Help Or Hurt? Nov 06, 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, "Does using multiple technical analysis indicators help or hurt?" Now, this is a question that we get often here at Option Alpha, especially since we did the long, long research, about 20 years of data on multiple technical analysis indicators, settings, parameters. You can find that all in our research report called Signals. But my assumption here is that it has to work in both cases and what I mean by both cases for technical indicators is that technical indicators should work like wheels on a bike or like wheels on a car. If you have a car that has four wheels, each of those wheels has to be strong enough to hold the car. You can't have a tire that's flat or else, the car really doesn't move down the road as well as it should or as effectively as it should. But when you have let's say four wheels on this car and each of those wheels worked independently and then are put on the car and worked together as a team, you can get the whole car down the road. When I think about technical analysis indicators, I think about them in two dimensions. One, they have to work by themselves. If somebody tells me, "I want to use this indicator." there's going to be research and data and back-testing case studies that prove that that indicator is actually effective. Now, not even looking at the other indicators, not confirming signals, not other moving averages or RSIs or MACDs, if you're going to use one indicator and even use that indicator in conjunction with some other indicators, it's got to work independently by itself first just like a wheel on a car. That wheel on the car has to be able to get down the road. If that wheel is flat, I don't care what car you put it on, it's still not going to work.

It's got to work independently by itself. Then once we have a series of technical indicators that work independently, now, we can start to figure out what kind of cross indications can we get by using multiple indicators at the same time. Now, I'm a fan of limiting this to like three or four. Probably four at the most is what you might have to use on some of your charting. You start getting over four indicators on one chart and it becomes chart overload and technical overload, analysis paralysis, whatever term you want to use. It's just less and less effective the more indicators you are looking at. In our research, what we found is that there's probably about three… In most cases, depending on if you're going long or short different stocks, there's probably about three indicators that end up working out pretty well independently by themselves, but then together, they give us a better picture of what might be happening. Now, the way that I use technicals is that in my case, all three of my technical indicators have to line up for me to make a strong judgment call on a direction. If I don't get all three of these indicators to lineup at the same time or very, very close to one another, then I'm probably not going to make a strong judgment call. I'll probably just make a neutral trade. But we have used this before over the last couple of years since we did the Signals research, especially when we get assigned stock. We've been really kind of leaning on these indicators as a means for helping us determine if we should hold the stock long or short, depending on how we're assigned the contracts. I think multiple indicators can help as long as you use them the right way. They've got to work independently by themselves and I think you should limit them to three to four and they can definitely hurt if you use too many of them or just flat out using the wrong technicals. For example, like simple moving average. Not a great technical indicator based on our research, so using that in any form or shape would not really be productive to your trading. Hopefully this helps out. As always, if you guys want to learn more information about the technical analysis that we did, head on over to optionalpha.com/signals. Again, that's optionalpha.com/signals.

#409 - How To Protect Long Call Option Profits? Nov 05, 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, "How to protect long call option profits?" There's three ways to technically do this. I'll go through them here on today's podcast. Again, we generally don't suggest that you trade long call options. It's not really a trade that generates high expected overall returns. But if you find yourself in a position where you did for some reason feel a little bit lucky and you wanted to trade a long call option, you have some profits in place, how do you basically protect those positions?

The first thing you could do is sell the position. This is pretty simple, actually and probably my most suggested option to do is just get rid of the position and take your money off the table. If the market gives you a favorable move and it happened in a short amount of time to where time decay is not ripping the value out of these long call options, then your best choice might be to just simply sell back the call option to close and remove the position. The second thing that you can do is you can then buy a put option. You could buy a put option. This would effectively turn the position into a straddle. And buying the put option would be a little bit more costly because you have to outlay capital for the put which would increase your breakeven points overall, but again, it could protect you in case you think that the stock is going to make a huge move in the opposite direction. Now, the problem with this strategy is that you basically, like we had said, turned this thing into a straddle or to a strangle which means that now, you are no longer directionally long the security. You're looking for the security to make a huge move in either direction. Yes, it does help protect against potentially the stock going down, but at what cost? At what cost do you have to widen the breakeven points, outlay capital to buy insurance?

The third way that you could do it is you could turn it into a spread. You could sell a call option above where your long call option is or above where the stock is trading at this time, collect some premium by doing that and basically turn this position into a bull call spread. Now, this doesn't do much though because you basically still have all of the downside risk of the call option going down in value, but by selling the call option above where the stock is trading or above where your strike price is, you might capture a little bit of premium to pad some of that downside movement. Again, the real limitation to this one is that if the call option goes up in value from say $100 to $1,000, selling a call option is not going to reduce the risk that that call option then goes right back down in value from $1,000 to $100. Hopefully this helps out. Again, just kind of helping you guys out with different strategies as we always try to do here at Option Alpha. If you have any questions, let me know and next time, happy trading.

#408 - The "Wheel" Options Trading Strategy For Beginners Nov 04, 2018

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 the wheel options trading strategy for beginners. Now, the wheel strategy is a really unique option strategy that you can use if you're just getting started in options trading and you're not quite comfortable trading a lot of risk defined spreads or iron butterflies, iron condors, etcetera and you just want to kind of stick to some basic premise strategy that you can use. Now, the wheel strategy is something that we've talked about in-depth on one of our weekly podcast where we actually interviewed one of our long time members and fellow trader, MACDDaddy on show number 107, so if you want to jump over to the weekly show, you can hit up show number 107 and hear my interview with him. He's been trading the wheel strategy for a really long time and put together some great resources for you that you can use.

The basic premise of a wheel strategy is the following and it's made to sound like a wheel because you could do it in a complete cycle over and over again as many times as you want. But you start off with a short put option and I would typically start off with a short put option. I guess you could start with short put or long stock. It doesn't really matter. But I would say you start with a short put option. You sell a put option on a stock that you are willing to own at some point in the future, so you like Tesla, you like IBM, you like something else. You sell a short put option, collect premium. You keep selling short put options until the point at which some time in the future, you're going to be assigned stock. At some point, the stock is going to drop and it's going to go below your strike price and you'll be assigned stock. At that point, you take delivery of the stock and you are now long stock in that contract or that stock or ETF that you wanted to be long in. The next thing that you would do then to continue moving around the wheel is you would sell covered calls against that stock position. You take delivery of the stock. Let's call it Netflix or Tesla. Now, you start selling covered calls against Netflix or Tesla and try to reduce the cost basis as much as possible. Now, at some point, the stock is going to rally and it's going to go beyond your short call option strike price at which point that you just let the stock be taken away by the short option contract. And so, now, you're left with no calls and no long stock, so what do you do? You now go back all the way back around and you start selling put options again. This is what kind of completes that little wheel or circle if you want to think about it that way, is you just continuously sell put options until you're assigned stock. Once you're assigned stock, you sell covered calls until you get assigned on those covered calls and have to give away your stock and then you go back to selling put options again and you just continuously move in this cycle and this kind of ebb and flow around the market.

Again, it's a really unique strategy, a really interesting strategy. A lot of people like it because it's very simplistic in nature. It's very easy to follow and understand. I think there's a lot of things that you can improve on it and obviously, it uses stock positions which are very capital intensive. But again, as a beginner, it might be a really good strategy at least to start out with just a very small ETF position and start using the wheel strategy around it. Again, as a reminder, we did do a long interview with MACDDaddy, one of our great and long time members here at Option Alpha on show number 107, so if you want to dig deeper into the wheel strategy, check out show number 107 on the weekly podcast. Until next time, happy trading.

#407 - Are There Advantages To Letting Options Expire In The Money? Nov 03, 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, "Are there any advantages to letting options expire in the money?" And yes, we are talking about options that are in the money. This means you could have long options that you want to expire in the money or short option contracts that you're choosing to let expire in the money. And to me, really, the only advantage is stock ownership in one form or another. That would be the only advantage to me in letting contracts expire in the money. First, let's take the assumption that we are a long call option buyer or a long put option buyer and we want the stock to expire in the money. The only reason that we would want that to happen would be to convert our option position into short or long stock. Again, there's no real pricing advantage to it because at the end of expiration, the option contracts are going to trade basically in parity with the stock if there's any value left in them. You do have the disadvantage of having to go through the commission process and in many cases and with most broker platforms, the commissions to exercise or get assigned contracts are pretty high. But again, if you have the assumption that you wanted to get delivery of or wanted to be long or short the stock, then you could let it expire in the money.

Same thing would be applied in reverse for option sellers. If I'm an option seller and I sell a call or sell a put, the only "advantage" would be to let the option expire in the money if we wanted to get assigned short or long stock. Again, if we were shorting puts and we knew that we would be okay and willing to buy stock at the strike price, then maybe we let the option contract expire in the money and we are forced then to buy the stock at the strike price that we sold on the put side. Again, the disadvantage to all of this is the capital that's required to hold the underlying stock. It's much easier to use a stock synthetic using options which we've talked about in previous podcast and have video training on the website and in my opinion, we also remove the risk of commissions which in many cases, can be very high, sometimes $15, $20, $25 per contract to go through the assignment or expiration process. Although there are maybe some slight advantages if you even want to call them advantages, I am still a fan of closing positions before expiration even if they're in the money. If you want to buy stock, then go out and buy stock at the new market price. Just remove the option contract. You'll pay a cheaper commission and it'll ultimately be a more simple process for you. As always, if you guys have any questions, let me know and until next time, happy trading.

#406 - How Do I Close Out Of A Bull Call Spread? Nov 02, 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, "How do I close out of a bull call spread?" Closing out of a bull call spread also commonly referred to as a bull debit spread which is an option buying strategy is actually just as simple as reversing the trade. To understand how we reverse the trade, we first need to understand what the core position is of this bull call spread. This spread trade is created by buying one in the money option contract and selling one out of the money option contract both on the call side of the option pricing table. For example, if a stock is trading at $100, you might buy a 99 strike call option and sell a 101 strike call option. This creates a debit and that's why it's an option buying strategy. Again, this is not necessarily the exact way you have to set them up. This is just how we would set them up if we were trading them here at Option Alpha. If you are long a 99 strike call and short a 101 strike call option, then the process of removing the position and closing it out is as simple as just reversing the trade. What we would do is we would end up selling back our 99 strike call and buying back our 101 short strike call option and closing the position. This would hopefully result in a net credit that is higher than the net debit that you paid to enter the position, therefore, leaving you with a profit on the trade. As always, if you guys have any questions, let me know and until next time, happy trading.

#405 - Do I Need A Margin Account To Trade A Covered Call? Nov 01, 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, "Do I need a margin account to trade a covered call?" The short answer to this is no, you do not need a margin account to trade a covered call. The beauty of trading covered calls is that they are covered by existing stock positions in your account and that's why most brokerages will allow you to trade covered calls because you're selling options, but it's completely covered and therefore, no additional margin is necessary by the underlying stock that's in your account. Now, I would highly suggest, however that if you are serious about trading options and continuing to use options trading as a source of income either now or in retirement that you start to apply for margin accounts or start to open margin accounts that allow you to trade more complex strategies and tickers. In particular, what we found is that trading covered calls while could be profitable for many different market scenarios is usually a big drag on your equity and capital because you actually have to buy the underlying stock. There's more effective alternatives or synthetic covered calls including short puts and the poor man's covered call which is also tying in a leap option contract that's at a further out date that you can use and those are mostly required to be traded in margin accounts. Again, yes, you can trade covered calls even if you don't have a margin account, but it's highly advisable that you get a margin account, so that you can trade some more strategies that ultimately I think will improve the performance of your portfolio more so than trading just covered calls. As always, if you guys have any questions, let me know and until next time, happy trading.

#404 - Is Using A Protective Put As Hedge For ETFs Worth The Cost? Oct 31, 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, "Is using a protective put as a hedge for ETFs worth the cost?" Now, there's a lot to unpack here, so we're going to try to do it in a couple of minutes. But the key points that we have to realize about using a protective put to hedge an existing ETF position is that using any sort of long option strategy requires an outlay of cash from our account. And so, the rub that I always have and the data confirms this across the board as well, is that when you outlay cash as means of buying insurance, that insurance is a net cost on the portfolio. This means that sometimes the insurance might kick in and it might help. Consistently buying a protective put as a hedge for an ETF position or a stock position that you have might work in some cases, meaning the market might go down at just the right time that you bought the protective put. But keeping and maintaining that constant insurance or that constant protective put as a hedge is going to be very costly to the portfolio in the long run. And so, the end result is I don't think that it's generally worth buying puts as a means to protect the portfolio. In fact, if you just wanted to protect it for one major systematic event that you are just really concerned about, okay, fine, maybe do it for that one time. But the problem is that even at that one time, what we're trying to do is we're trying to pick and choose when the market is going to peak and trough and that's very, very hard to do. In fact, we've seen this multiple times before in history, most recently like a couple of years ago with the Trump election. Everyone thought that the Trump election was going to be bad for the markets. It ended up being good for the markets. Everyone who bought put protection against the markets ended up getting totally wiped out with that cost. Now, of course, the cost could be embedded into your strategy, so you could choose to figure out a different way, an alternative way using maybe a synthetic collar or some other strategy to pay for or reduce the cost of the put insurance. But as long as you're outlaying money from your account, it's going to be a drag on your returns over the long run. Hopefully that helps answer the question. As always, if you guys have any other questions, please let me know. Head on over to optionalpha.com/ask and leave me a voicemail with your question. We'll get it queued up here for the daily call and until next time, happy trading.

#403 - How To Calculate Options Profit Or Loss As Percentage? Oct 30, 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 how to calculate options profit and loss as a percentage. And the reason I want to talk about this is because I'm seeing a lot of people who are confused on how to calculate the amount of money that they're making on a trade as a percentage of the trade itself. Now, I'm not talking about calculating this as a percentage of the overall account. That should be actually pretty intuitive and pretty easy to calculate. Just figure out how much you make and divide that by the account balance that you have and you figure out how much you're gaining on the whole account. But the end result here is that I do see a lot of people and also companies misrepresent what they're making because they're calculating everything based off of the option profit for the individual strategy or contracts that they're trading, not necessarily the whole account.

There's only two ways that you can calculate… Two basic I guess broad ways that you can calculate the profit or loss of a position as a percentage of the trade itself. The first is based on max risk and the second is based on margin that's required to hold the position. The first way is pretty easy because all you have to do is figure out what the maximum risk is for any particular trade that you get into. Now, this is going to be a little bit different depending on what strategy you choose. If you choose an option buying strategy versus a spread versus a multi-leg spread, the max risk is going to be a little bit different to calculate. But in any case, you should be able to figure out for any spread trading that you're doing where you have defined risk, the maximum amount of risk that's in that position or how much you could lose if the position goes sideways. That's going to be the basic number that we're going to use as our kind of core position size or how much we're allocating towards that position because we could potentially lose it, so that's money at risk. And so, on top of that, what you would figure out is how much you made on the option strategy. If you are long options, how much you gain in option premium. If you're short options, how much you collected an option premium back at the end of the day and figure out how much you made on that contract and divide that number by the amount of max risk that you had in the position. So, to use a very simple analogy or a very simple example here, let's say that we did a $1 wide spread and we sold let's say a 101 call, we bought a 102 call and we collected $.30 of premium and as an option seller, we have $.70 of potential risk in this trade. If the trade goes sideways and becomes a full loser, we'll lose $.70. If we have the trade become a full winner, we win $.30 in our premium that we collected. And so, what we would do is simply take 30, divide it by 70 and that gives us a 42% return on our money if the position wins. Now, again, that's a really high return. That's the whole point of trading options, is that we're going to use a highly leveraged product like options and use it on a smaller portion of our account, keeping a lot of our account still in cash as a reserve and kind of rainy day fund. In this case, we could generate a 42% return on this position if it went all the way to expiration.

Now, the other way to calculate a profit and loss as a percentage is to use it based off of margin that's required. Now, this is only for positions that are naked or undefined risk. These would be straddles, strangles, short calls and short puts. Now, in this case, because when you're selling options, you don't have any way to define the maximum risk since the position can fluctuate, so what we would basically do is try to figure out some sort of initial margin or margin that's required on the position and base our percentage win or loss off of that initial margin. Now, again, this is going to fluctuate because the second you get into the position, the margin could change, it could expand, it could contract. There's no perfect way to do this, but again, we're just using kind of this as a guideline and as a guidepost. But let's say that we were to sell a strangle around the market at some ticker symbol and we were to potentially enter the position for $100 in credit. Well, if the strategy requires a $2,500 margin required for that position, we're looking at basically just a 4% return on our money for that trade. Now, not as great clearly as the spread trade, but the idea is that there is a trade-off here that generally, undefined risk positions like straddles and strangles, short calls, short puts make money faster. You're holding them for shorter periods of time. You can end up rolling them and adjusting them. They're more flexible. Don't look at it as a one-to-one. You also have to consider and weigh the options of the profile of the strategy in doing a risk defined versus an undefined risk trade. Now, I'm using a really extreme example. It's not always that extreme that selling strangles and selling straddles is a 4% return, but again, I'm just using that as an example to help you guys get a basis for how you can calculate these. As always, if you guys have any questions, let us know, but hopefully this helps out and until next time, happy trading.

#402 - Why Do Option Contracts Offer Multiple Strike Prices And Expiration Dates? Oct 29, 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 do option contracts offer multiple strike prices and expiration dates?" And the simple answer here is variety. I could've said options, but that would be too simple because we're talking about options contracts, but the answer here is just variety. And I often relate this to either grocery stores or cars, but in our world, we see that there's hundreds, if not, thousands of different kinds and models and trim packages of cars out there, so if you want to get a car, there's no one standard car you could buy. You could buy this brand or that brand. You could get a truck, an SUV, a sports car, a convertible, a not convertible, whatever. And so, this variety allows people to choose based on their preference of what they want. They can choose to pay a higher amount of money to get a car that moves faster. They can choose to pay more money to get a car that's more reliable. It comes down to variety and preference.

And the same thing happens in the options market. When you have multiple strike prices either in the same contract month or in different expiration dates because you can also have multiple expiration dates, it allows traders to pinpoint their exact preference and use the variety of the options market to get them into the contract that they specifically want to be in for that time period at that price level. And potentially, no true traders are going to be exactly the same all the time. You might think, for example, if you're going to go out and buy a put option to try to hedge one of your stock positions, well, trader A might think that the stock is going to go down 10%, trader B might think that the stock is also going to go down 10%, but might think that that 10% move might happen in a year versus trader A thinks that move is going to happen in two weeks. And so, you have two different traders with two different preferences on what they want to trade. Maybe at the same strike price, maybe at different strike prices, but maybe at different expiration dates than somebody else might be trading. It all comes down to variety. It just allows the options market to be more robust, to be larger, to be more efficient because it allows people to get into the exact contracts that they want at the exact timeframe that they're looking to trade.

This is one of the things that I actually love about the options market in general, is that unlike stocks which just have one price and then you can choose from a lot of securities, but the stock price is the stock price. With options, you have the ability to choose where you're going to trade and on what timeline. And so, you have a lot more flexibility I think in creating and crafting and building strategies that ultimately end up paying out based on the market dynamics that you think are going to play out in the future. As always, hopefully this helps out. If you have any questions, let us know and until next time, happy trading.

#401 - Selling To Close vs Writing An Option Contract Oct 28, 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 differences between selling to close and writing an option contract. Now, there's a very subtle distinction between these two terms or phrases that you have to understand and it just comes down to understanding who's on what side and what action is being performed. With regard to selling to close, this would imply that you are first closing a position. If you sell to close something, that means that you might have had something to begin with and therefore, you're removing the position or closing it. When you see sell to close, that means that the trader had a buy to open as the original position. They were long option contracts. If you're long option contracts and you performed a buy to open, that means that to reverse that trade, you would have to perform a sell to close order which is just a really fancy way of just saying you removed and closed the position.

Now, when it comes to writing an option contract, we often refer to or you might hear the terminology, writing which is synonymous with selling an option contract and in particular, selling to open an option contract. When you're an option seller, you would sell to open a contract to begin with or you would write an option contract, collect a premium which then obligates you at some point in the future if your option contract stays in the money at expiration to buy to close that contract back. You're just simply completing the trading loop and buying to close the contract back. Now, of course, as an option seller, you can choose to let the option contract expire and become worthless as long as it's out of the money by expiration. Again, a lot of these terminologies and phrases are thrown around and we just want to again, do another podcast here to help you understand the differences between these. If you have any questions at all...

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