The "Daily Call" From Option Alpha

Latest Episodes:

#400 - The Power Of Social Influence On Investing Habits Oct 27, 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 power of social influence on investing habits and in particular, I'm going to tell you why I'm super, super upset and frustrated with this entire industry and it all starts with a conversation that I had with a family member this weekend because we were going down and we were sitting down at dinner and we were going over kind of their investing stuff that they had and they wanted me to take a look at it. And so, I was looking at some of the things that they had in their 403B account and one thing I noticed right off the bat was that a lot of the mutual funds that this person, this family member have been placed into had really high expense ratios and not only that, they were also placed into basically an account that was managed by a seemingly fiduciary person who was also charging a 1% AUM fee. I'm not opposed to financial advisors charging that, but if that's the fee that you're charging for 1% of assets under management, but you're also placing people in this huge bucket of mutual funds with huge fees and in some cases, these fees on the expense ratios were 2%, 2.5%, it just like really put a sour taste in my mouth once again for this entire industry because this person who's a good family member of mine like has no idea that this is going on. I mean, they think 1% for financial advice and everything that they're getting is good, but they're not seeing all these hidden fees that are in there, these expense ratios and then also the mutual funds were these target date funds, so they readjust multiple times every year, every couple of years and then that causes transaction fees and load fees and it's just absolutely ridiculous what this entire industry has gotten to.

But the problem is not necessarily the industry. I'm sure there's problems with the industry, obviously, but the problem is that most of society still is in this mentality that all of the things that we're doing are the social norm. And so, I'm so upset with this industry because what we see not only in fees and mutual funds, but we also see just a lack of variety in investment products, this idea that there's only a couple of places that you should put your money and that things like options or REITs or any of these other things should not be considered. There's a pigeonhole of knowledge and data. It's all consolidated into a couple of sources and you got to almost pay for access and pay for information which I hate, but it's a social influence of decades of relentless marketing that have forced a lot of us and forced a lot of people to be scared to step outside of the investing norm and they fear being outcast, this idea that you're an options trader, so I need to put my hands up and make a cross like, "You're some sort of weirdo. You're doing that crazy thing called options trading or you're doing that crazy thing called swing trading or technical analysis." You basically replace whatever you want to replace options trading. But this idea that we're somehow different or outcast by everyone else is totally bogus and I think most people are just not even aware that this is going on, that this social influence of decades of marketing and decades of seemingly thoughtful smart associations to trading and investing are in many cases, frankly wrong. We see this time and time again and we've pointed this out numerous times. I'm just like here ranting about it again because I'm so passionate about this, but we've seen time and time again that even a small covered call position on the S&P outperforms the market. We've seen that stop loss orders which are meant to stop you from losing more money (stop the loss, that's the whole idea) end up being detrimental to your portfolio and damaging to returns. We've seen that closing trades early and letting probabilities work themselves out ends up being the better solution and focusing on just a few ETFs versus trading the entire universe of things.

I mean, all of these things really kind of summarize what is now the new industry standard for investing, but people have not caught onto it and it's because we're all in this environment that we influence each other through our actions. We're afraid to talk about what we're doing besides just the regular – "Oh, just investing in the market." Like we're afraid to actually say, "I'm doing this, this and this and this is the reason why." But these conversations need to be had and I don't know what other way to start this conversation other than suggesting and basically like pleading with you to start talking about this openly with your friends, your family, your spouse, your coworkers, your family members. Start talking about these changes that we need to have in the industry. Help each other out. Look at each other's statements or figure out what ticker symbols people are in and just search and figure out what the expense ratios are. Figure out what you're paying your advisor, what you're not paying your advisor. Figure these things out, so you have a better understanding of where you're going to be in the future because a lot of these fees and a lot of these seemingly safe products are absolutely terrible investments for us to be making long-term. And even just investing a small portion of our account in say something like options trading and leaving the rest in cash dramatically outperforms everything else, so why do we still go down the path of thinking that things like index investing and mutual funds and all of these things that seemingly are good for us end up not being so good for us at the end?

Hopefully this again, just changes the dynamic. I want to push this conversation a little bit, but it starts with you guys, so if you're listening to this right now, just have an open conversation with somebody, the next person you talk to. I don't care who it is, a stranger on the street. Figure out how we can start this dialogue and start the snowball rolling in the investing space because what we're getting right now is not the best out of this industry. This industry is very smart. There's a lot of money, there's a lot of data behind this industry, but we're getting basically the garbage, the top level scraps and we need to be getting more information, we need to be getting this education and this knowledge out there. As always, happy investing.

#399 - "Selling" Short Options Position? What Does It Mean? Oct 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 selling short options positions and really, what does that mean. There's a big misconception out there with regard to the understanding of the difference between long and short option contracts. And so, what I want to try to do in this podcast is just quickly explain the short side of option contracts, basically what it means, what you're doing and what the eventual outcome should be or how you get out of the position. Selling short option contracts basically means that you are selling contracts that you do not own yet with the obligation that you will either repurchase those contracts at expiration or that they will expire out of the money and worthless. That's the assumption for most option selling strategies. It's very similar to insurance. Insurance is a contract that you would sell. If you're an insurance company, you sell somebody insurance on their house, collect in a premium and then at some point, you're hoping that that contract expires worthless, meaning that the house never burns down to the ground or the car never crashes or you'd have to buy back that contract from the person or pay them a settlement if there is damage or fire to the house.

You have to round out the trade and that's what I usually generally call it, is completing the trading loop. If you sell something that you do not own, you have the obligation to buy it back at some point because the brokers are allowing you to sell this contract in the market, you collect a credit from the option buyer, but you're still on the hook to buy back the contract or hopefully see the contract expire worthless at expiration and that's the way that you are able to complete the loop. Now, some people get confused because you wonder how can you sell something that you technically don't own and it's again, very much like insurance or like a homebuilder who is selling a contract to buy a house and they have this agreement and obligation to actually build the house for the person who's buying the house from the homebuilder. It's just this idea that the tradeoff is the premium that you collect and brokers hold margin, so that they know that you're able to cover that position or have the money in your account to cover that position if necessary, but it's actually a very simple process. Selling option contracts and selling short stock in many cases is actually a very simple process. You just have to complete the trading loop. Most people look at it in the traditional sense that you have to buy something first before you sell it, but it's just not the case in the market. Hopefully this helps out and as always, if you guys have any questions, let me know and until next time, happy trading.

#398 - Is Lack Of Preparation The Leading Cause Of Bankrupt Investors? Oct 25, 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 answering the question, "Is lack of preparation the leading cause of bankrupt investors?" Now, I would argue yes that it is. In fact, I would even argue that definitely, the leading cause of people who lose money is just absolutely a lack of understanding and preparation and just flying blind basically into this entire market and business. And so, I'll use a quote and regardless of whether you agree on his political views or not, this is a great quote and one that my coach back in college has often referred to, although it's not exactly the same as the way that he put it, but the quarterback Colin Caepernick before he was I guess done playing in the NFL said that pressure comes from a lack of preparation. And the whole idea is that when you get into a game situation and I'll use football as the analogy here. But when you get into a game situation, as a quarterback, you should understand everything that the defense can throw at you. You should understand in any scenario where your risk is coming from, who might blitz on one side or where they might shift the line. And so, if you understand what possible outcomes are, that there's only so many guys that can come after you at one given time and you go through in your head and you play through all these different scenarios time and time again, "If this person does this thing, then I do this thing. If this person does this thing, then I do this thing." You play through those scenarios time and time again in your head and you prepare for all of these different environments that might happen to you during a game and so, therefore when something happens, it's not seen as pressure because you have somewhat expected it. You thought that it was going to happen or maybe in a similar fashion was going to happen and you knew what to do moving forward. And so, our coach when I was playing in college would always talk about this. We would take mental reps all the time and I referred to this back on the podcast a million times before, but it's just this idea of playing through different scenarios in your head all the time and I don't think that investors do this. I think investors generally cross their fingers behind their back and hope and pray to whoever they hope and pray to that the markets continue to go up and everything looks good and then when things go bad, they look for a scapegoat instead of looking at themselves and asking themselves the hard questions about why they weren't prepared.

In the world of options trading, we do this every single week as the bare minimum in our weekly strategy call with elite members where we try to go through different scenarios in our portfolio. "What happens if the market goes down? How would we adjust? What happens if the market goes up? How would we adjust? What happens if this position that we're looking at right now that's dragging the rest of the portfolio, what if we take that position out? How would that rebalance the rest of the positions that we have?" And it's taking a lot of these mental reps and really preparing for the week in advance because what most people do is they just go into the week and walk through the doors of Monday and they say, "Okay, week. Give me your best shot, basically." And they take whatever the market gives them that week. Instead, what I like to do is I like to prepare for all of these different scenarios. Even during the recent selloff that we had which was great and we talked about it in a video update on YouTube, the big huge down day that the markets had a little while ago where the market was down 3%, 4% in one single day was a great day for us. We were well prepared for that event. In fact, we were semi-expecting that event. We were looking ahead prior to that week and we were thinking to ourselves, "Look. If the market does take a big nosedive, what do we have that can help save our portfolio? What do we have that can actually make money during those scenarios?" And I think a lot of people got caught "off guard" because they didn't know what was going on and it's just purely because they had a lack of preparation. Hopefully this helps out. Again, it's just an encouragement again today to take those mental reps with your account and your portfolio. Go through the hard questions and go through the different scenarios of all the things that could happen and don't think to yourself, "Oh, that would never happen." because generally, it does. We have this huge misconception that history doesn't necessarily repeat itself, but it does rhyme and so, we do see the same type of moves happen time and time again and especially in different markets. As always, hopefully this helps out and until next time, happy trading.

#397 - Go For A Run Even When You Are Sick Oct 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 be talking about why you should go for a run even when you are sick. Now, please don't misunderstand what I'm talking about here. I'm using this as an analogy and as a framework for understanding this discussion that we're going to have about subconscious trust signals. But the idea here is that if you are sick, you should still potentially go for a run and there's a reason behind this. Now, I'm not saying that if you're absolutely dead sick and you can't get off the couch… Obviously, stay at home, rest up, right? But if you're just a little bit sick, you have a little bit of a cough, maybe you just don't feel so good today, you ate too much last night, you should still probably go for a run and there's a reason behind this. Now, you can interchange run and sick here for whatever you want, but the idea is that we have what are called subconscious trust signals that build in our brain. And I know I'm going to get really deep on you guys here today, but this is really, really important stuff. And I've pre-warned you before in other podcast that I'm a student of understanding psychology and how the brain works and how we become more effective humans in general, but what you have to understand is that there are these subconscious trust signals that start to build up in our brain. And so, what happens is that whether you're aware of it or not, when we promise to ourselves, for example that we'll get up an hour early every day and meditate or read the newspaper or read a book and we are subconsciously sending ourselves signals that we should be doing this, but if we don't get up in the morning an hour early even though we told ourselves we're going to, what we do is we give our brain trust signals that we are not to be trusted and worse, we're then reinforcing the habit or the idea that we can't even achieve some sort of transformation.

Now, this is all on the very, very deep subconscious level of the brain. You don't even know that this is happening. In fact, you're not even aware that this is potentially happening, but it happens all the time. You tell yourself that you're going to go outside and mow the lawn and then you don't and what you're telling yourself is "That person can't be trusted." You. You can't be trusted. You said you were going to do it and you didn't do it and you sent your brain these subconscious trust signals that you are not to be trusted and then it reinforced this habit or this idea. Even as small and stupid as just even mowing the lawn might be, it reinforced this idea that you cannot achieve some sort of transformation or you can't achieve some sort of goal that you're going after because next time when something else comes up, your brain is going to naturally default to "This person can't be trusted" or "I can't be trusted." And again, you don't even know that this is happening, but your brain is doing it automatically in the background. It's basically telling you in many different ways through synapse firing and all of these neurons that are in there moving around and all the different chemicals in your brain are telling you, "You can't do this. You don't have the ability to do or remember that you couldn't even go outside and mow the lawn?" What happens is that when we do this, we really get into a terrible habit of not doing what we say we're going to do. This is why this whole idea of going for a run when you're sick comes out of. Actually, I have a book that I read. It was either a Navy seal instructor or a Marine instructor, a drill sergeant, but he basically said, "I'm going to get up every day and I'm going to go run a mile no matter what happens." And a couple of days, he got up sick and even though he was sick, he still went for a run. And the idea is that even though something was deterring him from going for a run, he still did it because he wanted to reinforce in his mind subconsciously that he could do something even when faced with adversity, even when faced with maybe a little bit of a pushback.

Conversely, each time that we do fulfill our promises to ourselves… And remember, these can be as little as "I'm going to take out the trash. I'm going to mow the lawn. I'm going to get up an hour early. I'm going to go to bed an hour early." Every time that we fulfill a promise to ourselves, we are reminding our brain subconsciously that we are capable of doing something that we put our mind to, that we can say something and then put our mind to it and actually do it. What I would encourage you to do today and what I definitely have been trying to do for the last couple of weeks since I started reading more about this, is I would encourage you to try to set very small baby step type goals of things that you will be doing, that you're going to do no matter what and then actually do them no matter how small they are. If you think that you're going to wake up in the morning and read for just five minutes, just wake up and read for five minutes. If you're going to turn the phone off at dinner time with the kids, turn the phone off at dinner time with the kids. Anything you want to do in your life, it doesn't matter, but send your brain subconscious trust signals that build your confidence when you're not even aware of it and let yourself know that you can achieve something, that you can reach some sort of transformation that you didn't think was possible before. Hopefully this one really helps out. If it did, please let me know. Share it with me. I'd love to know. As always, happy trading.

#396 - Does Moving The Unchallenged Leg Of An Option Trade Make The Break-Even Points Wider Or More Narrow? Oct 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, "Does moving the unchallenged leg of an option trade make the breakeven points wider or more narrow?" This is a common question that I get and it's always a point of confusion for many traders, is "How do we adjust or hedge a trade when the stock is moving against us?" Now, one of the techniques that we try to teach here at Option Alpha and you see this all over the web also, is that moving the unchallenged leg of an option trade or the untested side of an option trade closer to where the stock is trading ends up being a good technique to make the adjustment. For example, if we have a strangle and the stock starts moving lower, we would roll the call side of the position down and move that call strike to a closer strike. That is the unchallenged, untested, the side that the stock is moving away from. We move that side closer.

Now, the question here today is, "Well, what happens when we do that? Does that make our breakeven points wider or more narrow?" And the answer here is really both. It basically shifts the breakeven lower on the whole payoff diagram. What you end up doing is that when you move the unchallenged leg of an option trade, you end up shifting the breakeven point down by the amount of the credit on the challenged side. Again, using our strangle example, if the stock is moving lower towards our put strike and our put breakeven side, if we move the call strike down and take in a credit of say $1 on that roll down of the call strike, that would then move the breakeven point on the lower side of our strangle, the put side of our strangle lower by $1. Now, we didn't get this for free, obviously. We had to give up something and that's what people always forget, is that the market is a give and a take. There is risk and reward. You can't get a free lunch of $1, an additional potential breakeven point without giving up something else. And so, what you give up is you start to compress or you start to narrow the unchallenged breakeven point. Now, the stock market is moving down against your put strike. You move down your calls. Yes, you get some additional wider breakeven points on the put side, but you also move down your breakeven points on the call side in exchange for that. You basically shifted or picked up the payoff diagram and moved it over a little bit lower or to the left depending on how you're looking at it on a chart.

What people don't understand though is that in my opinion and this is just my opinion of how this would work in the markets based on our testing and our research in this space, is that when you do this, it is more than good to make this tradeoff of making your challenged side strike and breakeven wider in exchange for narrowing the unchallenged breakeven because what would happen is that if the stock were to rebound, it would have to rebound through your potential profit window, leaving you an opportunity to hopefully take some money off the table. I'm a fan of moving down the unchallenged leg, of moving the untested side of a trade closer to where the stock is trading in exchange for moving out and widening that breakeven point, so that the stock has more potential room to come into a profit zone or if the stock is already outside the profit zone, has the opportunity to rebound or come back into our range and potentially give us an opportunity to make some money before it gets to the other side of the position. And so, that's why I favor this type of adjustment. It reduces risk. It does give us potentially a higher probability of making money on the trade overall and/or reducing risk on the trade overall, but you have to understand that it does do a little bit of both. It actually does both. It widens your breakevens on one side and it narrows it on the other. Hopefully this helps out. As always, if you guys have any questions, let me know and until next time, happy trading.

#395 - What Is The REAL Reason Why Someone Would Trades Stocks And Options? Oct 22, 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 try to answer the question, "What is the real reason why someone would trade stocks and options?" And what I want to get to is I want to get to the real motivation, not just to become rich or not just to talk about financial terminology and numbers all day. People like numbers or you might like money and terminology, but it's not the real reason why people would want to trade stocks and options. Now, I think and I would assume that many people who are listening to this right now, you didn't get here because you're on some magical ride and you want to just find out what the option market is about or learn a little bit about it. No. There's something that's driving you here. There were some catalyst or some trigger or some event that pushed you into the options market and specifically, maybe have pushed you to look online, on social media or on Google or wherever to learn about options trading or learn a different methodology of trying to generate income or stabilize your portfolio. There was something that happened to you, some triggering event, some catalyst that pushed you here.

And so, what I'm trying to figure out (and I've always asked this question on myself too) is what's the real reason why I do this. Now, for me, (and I can only answer this for me and I'm assuming that for many of you, it's very much same thing) it comes down on one thing and that one thing is control. If I were to basically summarize all of the reasons why I trade stocks and options, why I choose to do it, why I don't hand this off to somebody else, why I don't just blindly invest in indexes, it's because of control. I want to have control over what my financial future is and that's not some far-fetched thing. That's not some mystical thing that we should be cautious about, that we shouldn't tell other people about. I feel like people don't tell people that they trade options because they're afraid of what somebody else is going to say. But the reality is that we simply want to control our financial future. And for me, control then leads to freedom. If I have control over my finances and no market can knock me out, no world event, no political leader being elected or not elected, all of these things that people use as crutches for why they aren't successful, if I have control over that, then I have complete freedom. I'm free to do whatever I want or not. It's up to me. It's under my control. I can lead myself down the path to financial freedom or not, but I'm still in control. I'm in the driver seat. And once I have freedom then, it just frankly leads to happiness and I think that's really the logical approach for me, is like if I have control over my finances, my investments, then that leads to freedom. I'm free to choose what I want to do or who I want to spend my time with, how I want to behave with my wife and my kids and my family and my community and once I have that freedom, then that leads to happiness.

I think that's really why people start trading stocks and options. And again, I would encourage you to get back to the root potentially today of why did you come into this business, what was it for you. Like go back and review and think about what was the catalyst, the triggering event that pushed you into the options market and what are you really looking to get out of it because if you can figure out that it's about control or it's about income or whatever that thing is for you, then you can tailor your journey to making sure that you work towards that target, towards that destination or that goal. And so, that's my goal for you today, is make sure you understand again, really, why are you here and what are you looking to get out of this and then try to figure out what the best path is to take, so that you can ultimately accomplish your goal. As always, hopefully this helps and until next time, happy trading.

#394 - What's The Point Of Trading High Implied Volatility When The Stock Is Making Even Larger Moves? Oct 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 answer the question, "What's the point of trading high implied volatility when the stock is making even larger moves?" This question came from another one of our members and the underlying theme here is really just this idea of – Why do we trade options when high implied volatility is present in the market? Doesn't high implied volatility then reflect that the stock is going to make this large move or this massive move? Why are we stepping in front of a freight train (for lack of a better term) and trying to trade options and sell premium hoping that the stock is going to stay contained when everyone is betting on these big moves? And the reason that we do that is because what we've consistently seen not only through our research, but you can also check other sources and other data providers, but when we see high implied volatility situations, situations where a stock is expected to make a very, very large move and we're talking the upper echelon of implied volatility ranges, the 70% to 100% IV rank or IV percentile ranges, when a stock is expected to have these wild, wild moves, option premiums go through the roof. And so, what we see is we see that traders are expecting a big move and therefore they bid up all option premiums on both sides, both calls and puts looking for this big move, but the catch is that it generally doesn't happen as big as the market expected. Now, this doesn't mean that the stock won't move. In most cases, it probably will make a pretty big move, but even that big move is going to be more than compensated by the option premium that you might have been able to sell by selling strategies around where the stock is trading.

To use two examples of this and you can check them out from just like recent charting here, GDX is a great example of this, same thing with EWZ which we're going through right now actually at the time I'm recording this. GDX back in early August had a massive decline in price and as a result, implied volatility went from basically the 20th percentile up to around the 88th percentile. Now, at that time, we sold a lot of option contracts in GDX because volatility shot up through the roof and had this huge movement. Option premiums were blowing up in the gold market, and so, we sold a lot of options. Now, fast-forward nearly two months and GDX has no joke (right now as I'm looking at this on my chart) has moved dead sideways at the end of two months. Now, there's been some fluctuations back and forth, but the price that GDX was at when implied volatility was at 88 and the price that GDX is at now is the same price. And there's been a little bit of fluctuation between there, but basically, what's happened is that GDX has really not moved anywhere over the last two months, although traders expected GDX to have a $3 or $4 move, but it's moved nowhere. And so, that's the over-expectation that we see all the time in pricing. Now, granted this happens a lot with GDX and SMH and all these other ones. It doesn't happen all the time. I'm not here to say that it happens every single time. But the vast majority of the time, you have a much better probability of success. The odds are heavily tilted in your favor to be selling premium during these time periods.

The other example here is EWZ. EWZ had recently gone through an election and right before that election, option premiums were about $5 to trade a straddle. Even though the stock was trading at around 36, you could collect about a $5 premium for trading the at the money straddle. And so, that basically would've put your breakeven point around 41 ish depending on where you traded it. Well, fast-forward and we got the election news out of Brazil and whatever the results were and I honestly don't even know what the results were, but it caused the market to move and the market had a big move. It was up almost $3.5. Now, most people were freaking out because this is a big move in EWZ. It gapped higher. It had a lot of volume, a lot of liquidity coming into the market, but it still wasn't enough to cover the difference in the option premium, so traders were expecting an even bigger move in EWZ. And although we got a big move, for sure, it was a big move for a small ETF stock like this, it was definitely not the big move that we expected. Again, the reason that we trade implied volatility when it's high even though we're expecting large moves is because the option premium should more than cover the expected move long-term. And so, if you stay small, stay consistent with these strategies, you're going to be on the winning end as an option seller and try to let everyone else try to expect and over-anticipate where things are going to go in the future. As always, hopefully this helps out. If you guys have any questions, let me know and until next time, happy trading.

#393 - The Basic Business Model Behind Options Trading As A Professional Oct 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 be talking about the basic business model behind options trading as a professional. Here's the thing. Every business has a definable profit or edge that they are going after and all it comes down to is effectively spread. You can think about every single business, every single possible business out there and what they're all going after is some conceivable spread between cost and revenue, so somewhere where they can make money as a profit. In case of trading, specifically as options traders and option sellers, what we are going after, our primary advantage is implied volatility and the edge that is derived between the expectation and the actual volatility of underlying prices. We have no discernible edge in market direction, so that's something that people oftentimes don't understand, is that we're not trying to go after a directional edge in the market, we're trying to go after an implied volatility edge in option pricing. Now, fundamental stock investors are trying to go after an edge that is different between market price and the fundamental value of the company. It's no different. They're just going after it potentially a different way and they're not necessarily going after it all in a directional fashion of like only the stock could go up. Sometimes they might sell stock that is overpriced compared to its fundamental value which could be much lower. That's where most trading happens, is within this edge.

Now, I just want to give you some other examples, so that you understand that it's all the same thing. It's all just trying to go after the spread or this edge in many businesses. Now, a service-based business like a painter or homebuilder is trying to go after an edge between the cost of labor and tools and supplies and how much somebody would pay to have their house built or their house painted. It's all the same thing. They're just trying to go after that spread. In e-commerce, if you're selling towels or chairs or jeans or something online, you're trying to capture a spread between how much you have to manufacture or buy or build a product and how much you can sell it for in the market. In restaurants, the food and the service and the experience allows you to charge a premium or a spread above and beyond the actual cost or raw ingredients of the food and the actual entertainment or whatever is associated with the restaurant, like the napkins and the silverware. Restaurants are just trying to charge a premium compared to what it actually cost to prepare the meal. In insurance, we see the same thing with policy pricing. Insurance companies will price an insurance policy at a likelihood that you're going to get in a car accident or your house is going to burn down and you're going to die sooner than it might actually end up happening. That edge in pricing comes from the expectation that you have an event happen sooner than what they know might actually happen in the long run. Casinos do the same thing where they have an odds edge in the game. They have some sort of mechanism in all of the games that gives the casino a slight edge in pricing or a slight edge in the win rate or the payout, something that allows them to create a spread between you and them and allows them to generate a profit long-term.

Now, what you can see in all of these things if you really look at all of these disciplines, every type of business out there, is that no business is based on one transaction, no business is based on one particular person making a transaction and then causing a huge profit. It's all based on repetition, selling a lot of homes, selling a lot of chairs or towels if you're in e-commerce, feeding a lot of people if you're in the restaurant business, writing a lot of insurance policies if you're in insurance, getting a lot of people to play games if you're in the casino business. It's all based on probabilities and numbers, the expected outcome of what you're trying to go after. And so, please don't think that options trading is any different. It's the same basic business fundamentals and the same basic business model applied to just a different area and all we're trying to do is go after again, the implied volatility spread and the option pricing differential. Hopefully this helps out in kind of understanding it. Maybe you might even try to explain it to somebody else, maybe a colleague or a family member. It always is a good idea to try to explain some of these topics to them and hopefully reinforce the learning in your own mind. As always, if you guys have any questions, let me know and until next time, happy trading.

#392 - When Is It NOT Worth Adjusting An Option Trade? Oct 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 answer the question, "When is it not worth adjusting an option trade?" I do get this question all the time and I wanted to publish this daily call to talk about it specifically because I'll go through in this call, three cases or three scenarios in which you would not be worth you making an adjustment to an option trade. Now, what I do find just as a precursor to all of this is that a lot of times, traders are trying to put lipstick on a pig and what I mean by this is that traders get into a bad trade or a bad setup initially and they think they can adjust their way out of the position. But again, most of your success is going to come from the ability to execute and enter trades correctly and what I mean is position sizing correctly, adding a trade that gives your portfolio balance and diversification, using the right strategy. Those things will give you a far greater impact on your performance and income than anything that we could do on the adjusting side. Again, don't try to put lipstick on a pig. If you have a bad position and it's not working out, just close that position, try to get into a better position and then work through the adjusting techniques that we talk about in our training.

Now, when it comes to not adjusting a trade, I think there's again, three scenarios in which I would not make an adjustment to a trade. Number one is paying money to adjust the trade. Whenever we are in a position and we try to make an adjustment, particularly since we are option sellers, we try to make adjustments that add or pad our increased credit in the position. We try to get paid for making an adjustment. We either by rolling down strikes or by rolling contracts out to the next expiration period. If you have to pay money to make an adjustment net overall, it is not worth doing. We would never roll an option spread from one period to the next. If we had to pay money on an overall basis, so pay money net to roll that contract out to the next month, we would never make that type of adjustment. Number two is when you're increasing risk. With regard to increasing risk, what we're talking about is making an adjustment that dramatically changes the payoff diagram of the position that you're in. A lot of times, people will try to make adjustments where they make one side of a spread dramatically wider which will help them facilitate the adjustment, but in fact, what they're doing is they're giving themselves an opportunity to lose maybe 3x or 4x what their initial loss was on the position. And we all know that what can go wrong sometimes does go wrong, so those positions that end up having huge amounts of risk and you're trying really hard to cover the risk in that position might end up costing you a lot more than you initially thought. If we ever get into a situation where an adjustment maybe reduces one leg or cuts one leg off and we are left with this huge amount of risk that we didn't necessarily think we could handle on the initial trade, we won't make the adjustment. We'd rather just take the loss and move on.

The third scenario in which adjusting doesn't work is when it unbalances other positions. Now, this to me I think is a much more advanced and higher level concept, but the idea behind options trading is always that we have this grouping or series of positions in our portfolio that should all work together in perfect harmony to create this balanced, unified portfolio. We might have bearish positions, we might have bullish positions, but ultimately, all of those positions on a reoccurring basis should be fairly neutral when we Beta weight them to something like the S&P 500 index. Whenever we make an adjustment that puts the rest of the portfolio in jeopardy, we would never make that adjustment. If we were to look at a possible adjustment to a trade that might fix the individual trade itself, the individual person or element of the trade, but it puts the rest of the portfolio in an unbalanced or jeopardized position, we would never do that. And it's truly this idea of doing what's best for the whole portfolio, not necessarily for an individual position. As a final thought, what I've often found is that sometimes people end up focusing on the trades that are losing and losing context of the rest of the portfolio. Many times, we have chosen not to make an adjustment to a position simply because making that adjustment to the position would remove a big portion of what is allowing our portfolio to be balanced at that time. Let's say we have a very large bullish position and the market's going down. Well, the rest of the portfolio might be doing great even with our large bullish position that is losing, but if we were to remove or adjust that bullish position, it would cause the rest of the portfolio not to be as balanced or as positive as it is around the market. And so, again, we would never make an adjustment that would unbalance other positions.

Hopefully this helps out. This is a very interesting question, great topic to talk about. Hopefully you can review this one a couple of times. I think it's one that should be refreshed and repeated many times if you're listening to this right now. As always, hopefully you guys enjoy these and until next time, happy trading.

#391 - Does Implied Volatility (IV) Matter For Option Spreads? Oct 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 answer the question, "Does implied volatility matter for option spreads?" Again, this is a user member submitted question. If you have a question you want to get answered on the podcast here on the daily call, please let me know. Shoot me an email, send me a Tweet. Go over to optionalpha.com/ask, do whatever you need to do to get that question in. The question that somebody asked is, "If you are only doing calls or puts and not spreads, it looks like implied volatility is a good idea and you should base trades off of that. But in a spread, since we're buying and selling an option, one cancels the other out. And what I meant is that if implied volatility or IV rank is high and options are expensive, well, you're buying an expensive option and you're selling an expensive option. Why does it matter?" And this is a great question, I think a question that most of the time comes up when people really start to feel the gears and their mind start to move and click and they're starting to understand the whole process around options trading as a business and particularly, option selling as a business for income.

I would say that when you have very tight spreads, say $1 or $2 wide, then yes, implied volatility probably matters much less because it cancels out from one to the other. But it's still important in the overall scheme of selling high implied volatility setups because generally what we see is that when we have high implied volatility setups, we see that you are able to then sell options further from the market. Even though it's a very tight spread, you can still potentially sell it further away from where the stock is and those stocks tend to underperform that high expectation. While the implied volatility may not matter as much for the individual strike prices if you're doing a very tight spread, again, a $1 or $2 wide spread, what you don't see in this high implied volatility environment or maybe what you're missing in this high implied volatility environment is the ability to sell that tight spread, say $10 away from where the stock is as opposed to $5 away from where the stock is. That to me is really where the difference is. Now, again, this difference is then magnified if you are selling really wide spreads. If you're doing something where you're doing an iron butterfly or an iron condor and your wings or your spreads on either side are say $5 or $10 or $15 wide, then yeah, implied volatility has a much greater impact because you're selling an option closer and buying one much further out, so the difference between those two contracts is going to be much greater when it comes to its impact from Vega or volatility.

Hopefully this helps out. Again, it's not that it doesn't matter because it does. Implied volatility does matter with regard to how far you can sell those options and how the underlying is going to perform compared to the expectation. But again, if you have a really tight spread, then it's going to be cancelling each other out. You just have the ability then to sell options further from the money. Hopefully this helps out. Great question. As always, if you guys have any other questions, let me know and until next time, happy trading.

Our TOPPODCAST Picks

Follow Us

Stay Connected

The “Daily Call” From Option Alpha

Related Podcasts

Links

Stay Connected