The "Daily Call" From Option Alpha

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#221 - Some Of The Biggest "Up Days" Happen In "Down Markets" May 01, 2018

Show notes

Hey everyone. This is Kirk here again at optionalpha.com and welcome back to the daily call. Today, we are going to be hopefully shedding some light on a new topic that maybe you haven't heard before. Some of you might before. But this idea that some of the biggest up days actually happen in down markets. This is fascinating stuff and I've known this for a while now, but it's recently come back to the surface because we had now the third largest up day that the DOW has had point wise in basically like the last 15, 20 years or so and it just happened back in March of this year. This again resurfaced to me because I got a lot of emails that people said, "Oh, my God, the markets. This is the bottom." This is it back in March of this year because the DOW had the biggest up days and I calmly described, "Hey, listen. When the markets are really volatile, the DOW and every other market can have some of its biggest up days not in the top of a market, but not even at the bottom of a market. We're still in the middle of a range in a downward trending market."

So, to add some picture or light to this, I guess some color to this, let's go through literally the top three largest point gain days for the DOW in the last basically 20 years. And so, the first two came in October 13th and October 28th of 2008, gains on the DOW of 936 and 888 points respectively, almost 10% changes on those two days back in 2008. It's actually crazy when you think back to 2008 for any of you guys who were trading through that time period as we were. That is a wild, wild… Like that was a wild time. I mean, literally, when you blink your eye, the market was either 10% higher or 10% lower. But if you go back to the charts, October 13th and October 28th, the DOW still had not made a bottom at that point. In fact, it was still 25% off of the bottom. It still had to fall another 20% to 25% before it actually reached a bottom at that point. Just to show you, the largest up days in that time period actually corresponded not to the bottom of a market, but actually maybe a significant fall that the market might have.

Now, we recently just went through the third largest up day that the DOW has had point wise and the DOW was up back on March 26th of 2018. It was up 669 points. So, a huge day, about 3% gain, so not as big as when the market was obviously lower, but the DOW is much higher now to 24,000 versus it was back around 10,000 or so in 2008. And so, again, it just goes to show you that the largest point gains that we've had, even the largest percentage gains that we've had do not necessarily correspond with a market top, but might actually correspond with a bear market or a downward market. We actually had in 2018 another large update, number five that ranks on the point list back in February, February 6th of 2018. Again, just a couple of ranks below the number three day was another day in 2018. We're starting to get all these flashing signs that maybe the market that we're in right now is actually going to be a very cyclical bear market given that some of the largest up days actually happen in down markets or as stocks are starting to fall apart.

Again, it's no surprise really to me that this happens. We see this all the time where stocks are all obviously very calm and regular trending bull markets, they go up by a quarter of a percent, a tenth of a percent per day. But then, when things get more volatile, we can have volatile gyrations on both sides. That's why I always encourage people actually not to even really do a lot of adjustments during periods like this because a stock that may be 6% down today might be 7% up tomorrow. It can snap back so quickly in these periods. That's why having cash and just being more patient is usually the best course of action. Hopefully this helps out. If this was something new that you didn't know, let me know or share it online. Help us spread the word about what we're trying to do here at Option Alpha and until next time, happy trading.

#220 - When To Take Profits Vs. Letting Winners Run Apr 30, 2018

Show notes

Hey everyone. This is Kirk here again at optionalpha.com and welcome back to the daily call. Today, we are going to be talking about when to take profits versus letting winners run. This topic basically came from a question that somebody submitted. I want to read the question here for you guys, so you guys understand the basis behind it. They said, "Kirk, given the research that you've done, I know there's been a change in when to close a position for a profit. The old guidance used to suggest taking straddles and iron butterflies off at 25% of a gain and strangles and iron condors at 50%. Now, I understand that the research shows leaving on particular straddles and iron butterflies a bit longer sometimes in the right direction and I, perhaps and others are interested in learning how you decide to take these positions off at 25% or 50% versus letting them ride a little bit longer and why the research suggest that we hold positions versus take them off. Again, learning through your thought process in these situations would be very helpful." First of all, thank you for submitting the question and as always, if you guys have questions, I want to hear them. We want to read them if you're okay with that or play it in an audio podcast on the weekly podcast if you want to submit them at optionalpha.com/ask. In any case, I'm trying to answer as many of these questions as humanly possible, so please get your questions in and don't be shy about it.

There's two things we have to talk about. One is what does the research now suggest. The old way of doing it… I don't say old way like it was a bad way. It's just we didn't have all the data that we have now on strategies. We were kind of handcuffed to a certain degree many years ago because we didn't have the ability to buy data, to build out a back-testing framework, software, technology around that. Now that we have that, we have to be realistic in that our expectations or what we're doing have now shifted a little bit. The good stuff that came out of a lot of the back-testing that we did and when we released our huge back-testing report called the profit matrix which you can get to at optionalpha.com/profit is that a lot of the key concepts that we have been preaching about from basically 10 years remains true and evident, basically that option selling works, it's the most effective strategy, taking profits early works, extending duration works, a lot of these key concepts. Now, what we have as part of that research since we subdivided each of the strategies and all the test into different buckets around implied volatility and when the trade was entered and when it was exited, where IV was, how far out it was, the frequency of the trading, whether you're doing trading weekly or daily or sequentially, now we have a lot more data around where particular profit targets need to be for situations in different markets. Although it's a good benchmark to say 25% gain or 50% gain on general strategies, we now know that in many cases, there is a more optimal exit in some market situations versus others.

Now, this doesn't mean that we now throw that completely out the window. That's still a good general benchmark. If you don't want to go through the process of buying and reading our research, no problem. You can use those benchmarks and they probably do well. But there's probably a lot better performance that you could get for many of your option strategies by using more optimized framework and data around it. That's in fact why we built the trade optimizer, to use all of this data in conjunction with current market dynamics, so that you can go in and basically say, "Okay. If the market's 40 days out till expiration and IV is here, what are the best strategies that I should be trading?" In all of that research, what we did find as an underlying thread is that generally, when you hold trades a little bit longer towards expiration, not to say you have to hold them all the way to expiration in every case, but when you hold trades a little bit longer, you get compensated by having higher returns than if you were to take them off early. Now, look. We do have to play this dance between win rate, drawdowns and total returns, but if your sole focus on trading is to generate as much money as humanly possible, then in many cases, you might need to hold past our traditional 25% and 50% levels. Now, that's going to come at a sacrifice. You can't get everything for free. You're going to give up your win rate. Your win rate is going to be a little bit lower. You're going to give up on your drawdowns. You might see a little bit higher drawdown on average. But if you're willing to withstand those fluctuations with the end in mind, you might generate some higher expected returns.

Just to shed some light on this before we get into the second part of that question which was, "How do you know when to hold it or not?" In this case, when we look at a short strangle using out heat maps that we have in the profit matrix, what we see is that in one particular series of trades that we did where you were basically testing the difference between letting a trade go all the way to expiration versus taking the trade off at 50% or 75% profit target even, we saw on average that the sharp ratio of these trades were significantly higher when you let the trade go all the way to expiration. We're looking at about an 11 sharp ratio, .11 on some trades that went all the way to expiration, so you really had no profit target in some cases. When you had a 75% profit target, you had a .7 sharp ratio and when you had a 50% profit target, you had a .05 sharp ratio. As you actually took money off the table at earlier and earlier increments, 50% versus 75% versus letting it go to expiration, you actually crippled yourself a little bit in this scenario for the ability to generate outside returns and outside gains. Now, in this case, as you took money earlier, you did have higher win rates. When you took money at 50%, you won at 69% of the time. When you took money at 75%, you won 63% of the time. It went down a little bit. When you let trades go all the way to expiration, you won 62% of the time. You can see, you are sacrificing a little bit of your win rate on the path to generating higher returns. Look. This seems very normal. The way that I read this is not some like huge revelation. Maybe you do, but I don't. It's that when you take on more risk, you should be compensated for the risk that you're taking on. When you hold trades a little bit longer towards expiration, you should be compensated for the risk that you're taking on. In my case, when I decide to get back to the second part of this question, when do we decide to let trades on maybe a little bit longer than usual, most of my decision-making is now out of my hands because I use the trade optimizer. A lot of the "decisions" that I have to make are now out of my hands. Because I optimized all of our trades, I can see exactly where I should be taking trades off at any given point before I even get into the trade. I already have those levels pre-populated in my system.

If we get to the situation where trades are now starting to hit those profit targets, then another thing that you can look at is portfolio balance or position balance. Oftentimes, if we have a trade that say at our 50% or 75% profit target early and the trade is literally in the middle of our expected range, the stock is trading at $100 and we want it to trade between $95 and $105, if the stock is trading right in the middle of our range or very close to the middle of our range, I'm probably more likely to hold the trade a little bit longer because I really don't have much to gain or lose versus if the stock is trading at one end of the extreme or not. It does come down a lot to balance too. I think that that's the second layer that you have to understand, is what does my portfolio need right now or are all my positions generally balanced. "I'm well-balanced. I don't really care where the market goes." Okay, maybe we can afford to hold another day or two or a couple of days and try to get a little bit more out of it. In most cases, we will not take trades all the way to expiration. I think taking it all the way to expiration might be an over-exaggeration because if at five or 10 days out from expiration, let's say your short strangle is worth $5, there's no reason to carry it all the way to expiration for $5. You got to be a little bit rational with your thinking around this, but hopefully this generally helped. I think that there is a lot to be learned from digging into a lot of this research. It's not going to be easy. It's not a one page report by any stretch. But it is worth its weight in gold just to understand the different nuances between different time periods and IV levels, etcetera. Again, if you guys want to learn more about that, just search profit matrix on the website and until next time, happy trading.

#219 - What Are The Advantages Of Trading Strangles Vs. Iron Condors? Apr 29, 2018

Show notes

Hey everyone. This is Kirk here again at optionalpha.com and welcome back to the daily call. Today, we are going to answer an email that I got from a user which is basically, "What are the advantages of trading strangles versus iron condors?" The email from one of our members said, "My Thinkorswim platform doesn't allow me to write straddles and strangles because of the unlimited loss risk." They get a message that says it's illegal to write these shares. They have an illegal negative one shares. However, I can do an iron condor because the risk is limited. When I see the iron condor diagram, it is the same as a strangle except for the defined risk. Again, they basically are asking what are the advantages of using a straddle or a strangle over an iron condor.

The clear advantage of using straddles and strangles versus iron condors is a couple of different things. I don't think it's not just one thing. There's a couple of clear advantages to using them. The first is that in most cases, you end up generating more total dollar profits. When we go back and back-test lots and lots of strategies, we're talking hundreds of thousands of strategies, strangles and straddles end up generating more dollar profits overall. When you look at a $100,000 account, which account grew by the most total dollars, had the biggest total return? It's probably the accounts that have straddles and strangles. Now, that said, the downside to that basic advantage is that you probably have more fluctuations in your account. We saw more gyrations, maybe a little bit more volatility in the P&L curve, so bigger rises and falls. But if you're willing to hold through that, you generally get higher expected returns.

Now, the other advantage to trading strangles versus iron condors is that they generally hit their profit targets much faster which also means that you're holding the trades for much shorter time period. When you're trading just pure naked options or option selling, you'll see that those options tend to decay very quickly in value and they hit their profit targets much faster which means you don't have to hold them as long. Now, compare this to trading iron condors. With an iron condor, you are able to control risk a little bit better, so you don't have the gyrations in your P&L profit statement as much as you do with a straddle or a strangle. But with iron condors, since you are buying options and using spreads on either side of your short strikes, you generally see those trades decay at a much slower pace. You don't hit your profit targets as quickly. Not to say you don't them at all because you probably will, but it just might take more time. It might take an extra week or an extra two weeks which generally means you're holding trades a little bit longer than we would ideally like to do.

I think those are really the clear distinctions between those two strategies. In either case, I think generally, one's good for one particular type of trader, one's good for another type of trader, so I wouldn't throw my hands up and say I would only do one versus the other. I think there's a lot of factors that have to go into it. We use iron condors and iron butterflies a lot here at Option Alpha mainly because during low implied volatility markets, those out of the money options that we can buy to create defined risk are really cheap. If we're selling a straddle and we can collect $300 of premium and then convert that into an iron butterfly and basically give up $5 of the $300, so if it only cost us $5 to buy those far outside wings, but we create defined risk, we give ourselves protection, then it's worth it. We're still collecting $295 of premium. What's another $5 that we can pay for risk protection and management on the further ends of the extreme?

Hopefully this helps out. As always, if you guys have any questions like the one that we just went over today, please let me know. We're always looking for new content here for the daily call and for our website, so the more, the merrier. I love getting questions. We just basically add these to the list here and we'll just continue to create this huge working list of questions that you guys have around options trading. Until next time, happy trading!

#218 - Employee Trading Restrictions & Trading Compliance Apr 28, 2018

Show notes

Hey everyone. This is Kirk here again at optionalpha.com and welcome back to the daily call. Today, we're going to be talking about employee trading restrictions and trading compliance. I actually get a lot of questions about this. I get a lot of questions about how people want to try to get around these restrictions or compliance in their firm that they work for, company that they work for. The end result here is that you should not be trying to escape the system and get around some of these restrictions and trading compliance. If your firm or if the company that you work for has defined restrictions around trading or how you should notify people of your trading activities, you really want to follow those and not try to walk a very, very thin line. There is no room in this industry for people to be trying to manipulate the system.

Now, in most cases, most companies… And you'll have to check with your own company or your own firm for their particular regulations and laws. But most companies have restrictions around trading in companies or in products that have a clear sense of conflict of interest. If your company is let's say a broker dealer or you're an investment bank, you probably have trading restrictions around trading any of the companies that you cover, any of the industries that you cover, any particular sectors that you cover or even trading your own firm's stock or underlying options without predefined approval. And in many cases, there are also restrictions on how quickly you can buy or sell underlying securities. You have either 30 or 60 or in some cases, 90-day windows that you have to maintain the position before you get out of it and this is really to discourage this idea of quickly buying or selling on some sort of insider potential information or some sort of hunch that you might have about what a company or whatever company you're at might be doing in the future.

I think all this stuff is really actually good. I think look, people should not be allowed to trade based on insider information. Whether it's hearsay or not, they shouldn't be allowed to do something where there's a clear conflict of interest and I think that's actually good stuff for the industry. It makes everyone a little bit more regulated. It's one of the things though that I think does hold people back and I get that it holds you back. My suggestion is that if you do work for a company that has a very strict policy on what you trade and how you trade, is to talk to either the compliance officer or the HR manager and find out how you can streamline that process of approval. If you want to make trades, if you want to actively trade options, figure out who you need to talk to, make sure you talk to that person, be totally open and clear about what you want to do and get a framework in place. Maybe they will grant you approval to trade in certain products versus other products without having to go through a bunch of hoops and legal process and paperwork before you make those trades and those transactions. I think it's actually worth it just to really sit down with somebody maybe 10 or 15 minutes. I'm sure that they would want to do this. They probably appreciate people coming to them first before asking for forgiveness later and trying to make trades.

It's also noted that many employee trading restrictions and trading compliance agreements have in place restrictions on other people who are part of your family or stand to gain financial interest for many of the knowledge that you have. This would also include any of your spouses, significant others, people who are living at your house that may not even be related family members. I know that people try to do that. They try to skirt the system and say, "Well, that's my friend who's living here and he's not really a family member." But if he's around you and stands to gain financially from what you're doing in any way, shape or form, whether it's through monetary means or otherwise, then it's probably restricted. You're probably better off just knowing what you've gotten yourself into. If anything, making sure that you walk a very, very straight and narrow line with regard to compliance. Hopefully this helps out. If you guys have any questions, let me know and until next time, happy trading!

#217 - Active Traders Can Now Take A Passive Approach Apr 27, 2018

Show notes

Hey everyone. This is Kirk here again at optionalpha.com and welcome back to the daily call. Today, we're going to be talking about how active traders can now take a passive approach to investing and particularly with options trading, take a passive approach. Right now, the big buzz in the industry and has been like this for many years now is this passive indexing style of trading and investing. Basically, this idea that you continue to buy the indexes regardless of the value or how high they are and everyone buys the indexes because that's what everyone should do and everyone should buy the indexes, so everyone does, etcetera, etcetera. Well, I definitely subscribed to the idea that long-term active traders are more profitable with less volatility in their account than passive index trading. I think one of the biggest flaws to index trading right now is that everyone is blindly buying the indexes regardless of the value of the underlying stocks. Because everyone's buying indexes, more people buy in. It's just this self-fulfilling prophecy that they just continue to go higher until they reach bubble territory which maybe we've already gotten through now in February time period of 2018. But what we're trying to do with Option Alpha and with our new auto-trading platform is actually create a series of indexable option strategies. Now, they won't work in the traditional sense that you can buy in the next and hold it, but it can work in the auto-trading sense that we will have indexable strategies that both include stocks and some that don't include stocks where you can basically setup and clone the strategy and then go through all the approval processes to have it auto-traded in your account.

One of the research reports that we did many months back, even probably a couple of years back now on our regular weekly show was this idea that a simple covered call on the S&P 500 actually beats the market performance. It actually beats the S&P 500 just adding in one simple covered call every single month. Well, now, with our auto-trading system, we're going to able to create an index covered call strategy where you can just plug in whatever stock you want and it will automatically not only buy the stock, but it will also manage and trade a simple covered call, so that you can sit back and replicate a more active approach to options trading and investing without having to go through the physical activity of clicking and selling options every single month. The system would in this case, sell a covered call at whatever predefined Delta you want. It would manage that covered call, it would roll it. If it was assigned stock, it would repurchase stock and then sell another covered call. It's truly a robotic trading system that does what active traders wanted to do with a more passive approach. You don't have to do anything. It's all done by computers and algorithms and robots. It's a very cool way to trade. It's one thing that I think we're super excited about, is creating a bunch of these different indexable option strategies, some around iron butterflies, some around short strangles and straddles, credit spreads, volatility trading, earnings trading. There's going to be a lot of these that we're going to create. They're all going to be in this new marketplace that we have or template place that we have that we're creating on the website where you can just go in, use some quick filters and create some of these literally in a couple of clicks of your mouse and then just sit back and monitor these things as they go. Hopefully this helps out. As always, if you guys have any questions or want to learn more, just let us know and until next time, happy trading!

#216 - Everything You Need To Know About Margin Calls Apr 26, 2018

Show notes

Hey everyone. This is Kirk here again from optionalpha.com and welcome back to the daily call. Today, we are going to hopefully describe everything you need to know about margin calls and particularly, margin calls for options trading. Without going into too much nitty-gritty terminology because I think people get lost sometimes in the mud, like worrying about the specific price ranges and the specific percentages that are affected, I want to help you understand basically what happens with margin calls when you're trading options. The first thing that we have to understand is that margin calls do not mean that you're actually borrowing on margin. That usually happens when you invest in stocks. Somebody could borrow on margin, you could invest $50,000 into a stock and then borrow another $50,000, basically secured by that stock and that investment that you have and you can borrow on margin. Now, that cost money and there's margin interest that has to be charged by the brokers. That's not what we're talking about necessarily with options trading. With options trading, margin usually refers to putting up some capital in your account as collateral for a short option strategy that you might be entering into. Now, it doesn't mean that you're borrowing that money. It just means that you're basically setting that money aside and the broker is saying, "Hey. You can't trade with this side money here because that money is to cover the short option contract or short spread that you're trading to make sure that you're good and we can perform the contract on all parties sides if things go bad and your trade doesn't work out the way that you think it's going to work out." In the options trading side, that margin is not necessarily put aside. You're not borrowing that. It's not interest-bearing. It's just money that you can't trade as part of your account. They call it basically margin or collateral. Brokers use different terms.

The other thing that we have to understand is that margin does not apply to any option strategies in which you pay a net debit or let's say most option strategies in which you pay a net debit. If you're paying to get into an option strategy, either you're buying a call option, buying a put option, buying a debit spread, buying a butterfly, anything where you're paying money and that ends up being your maximum possible risk, well, you've already put up the money that you could potentially lose, so you don't have the ability to lose more than that unless you change the structure of the trade later on, but in that case, you are putting up the money and that's the amount of money that you're at risk, so you really wouldn't have a margin call per se because there's nothing you're putting up in margin. Now, what happens is that let's say you're doing a short strangle or a short straddle trade. You take in a couple of hundred dollars of premium, but you have to put up aside in the account a couple of thousand dollars in margin to cover the position in case it goes bad. That would be a general setup that we're talking about here. And now, let's say that Murphy's Law takes hold and when things that could go bad do go bad and they happen to you, then the stock goes dramatically down or dramatically higher, causing you to lose a lot of money on paper. Now, at that point, the stock has made a huge move, so the brokers are going to basically recalculate the risk of the trade making these huge moves after the current move. And so, now, that means that your margin that's required to hold that position or to maintain that position might go up. Maybe implied volatility has spiked, maybe there are some news event that's causing the stock to go dramatically higher or dramatically lower. Whatever the case, even if the stock doesn't move, but implied volatility goes up, your margin that's required to hold that position might go up dramatically. In some cases, we've seen in huge black swan type events margin go up by 2X, 3X, 5X what the initial margin is. If your initial margin on a position was $1,000, it could go up to as high as $5,000 on that position just during these really weird one-off black swan events. But in that case, you would run into a margin call if you don't have enough capital in your account to now cover that position. That's when your broker would come to you or they'd alert you through a message or email or text or phone or maybe multitude of ways to let you know, "Hey. You don't have enough cash in your account to cover the risk that is maybe inherent in this position."

Now, I stop here and I pause and I say – Because you don't have enough cash in your account to maybe cover this position, you have one of two major ways to get your position or your account back underneath of that margin call situation. The first way is to transfer money over to your account. Now, what I always tell people is that if you have money in other accounts, you better have a good idea of how quickly that money needs to get there or how quickly it can get there. I've seen people who say, "Well, I've got money in stocks or I've got money in this and that means that I can liquidate the stocks and then transfer it over." Well, liquidating the stocks and then clearing that liquidation to be able to then transfer money over might take two days or might take 24 hours. In most cases, when you get a margin call, you have to satisfy that call very, very quickly. If you can transfer money over, just make sure that wherever that money is, it can be sent to your brokerage account literally the same day if needed or at the very latest, 24 hours later. Some brokers do have requirements that has to be there that day. Some brokers are 24 hours. You want to check with your broker and make sure you know what the requirements are. Again, the first way that you can basically get your account back under the margin call is to transfer over money. The second way that you can get back under the margin call is to simply close the position or close a number of positions that would reduce the risk in your account. Even though the particular position that we're talking about earlier might have $5,000 of "potential loss" if the stock continues to move lower or higher, it might only be losing $200 right now from your initial credit to where the stock is trading. You close the thing, you take a $200 loss, but you reduce or basically eliminate this $5,000 margin risk that you have or basically, holding risk in your account. That's the second way that you can cover these margin call positions or get your account back under the margin call threshold. Either one is appropriate. I generally prefer to usually trade with about 50% of my account in cash anyway at the bare minimum. I usually have plenty of money to withstand these margin fluctuations.

What I do see people doing all the time is they trade very, very close to their threshold of their account limit particularly with option strategies that are undefined risk and they don't have enough of capital to hold those strategies and then the market has some crazy gyrations. Maybe your stocks that you're trading don't even move, but implied volatility moves on those stocks which causes margin to go up. Your broker at the end of the day, if you don't satisfy your margin requirement by transferring money or closing the positions, your broker is going to close those positions for you and remove the risk of your account. They're not dummies. They're not going to stand by and just let you blow up your account and have too much risk than you can handle or that you can cover with cash. They will go into your account at the end of the day if you haven't done anything. Assuming that you're maybe off the planet, off grid, can't get a hold of you, etcetera, they will close out those positions for you at probably worse possible pricing. When usually we have these huge black swan events, what kills people in these events is not the actual move of the underlying security, not how the options are then priced. It's the margin to hold the position because if you have the margin to hold through some of these gyrations, you usually end up very, very well off. And so, that's really the key lesson for today, is keep a lot of cash, keep your margin available, huge cushion because you don't know at any point, it can really blow up and there's margin calls that go up all over the place. You don't want to be caught in that situation and frankly, you don't need to invest all of your account to generate above average, above market expected returns. You can do it in many cases with 30%, 35% of your account and most of your account sitting in cash. Hopefully this helps out. As always, if you guys have any questions, let me know and until next time, happy trading!

#215 - Test Option Strategies With Automated Paper Trading Apr 25, 2018

Show notes

Hey everyone. This is Kirk here again and welcome back to the daily call. Today, we are going to be talking about how you can test option strategies with automated paper trading. As we get closer to rolling out our new automated trading platform, one of the very cool features that we'll have as part of this is the ability to paper trade with anybody who signs up for an account. And so, this is good because it allows you to not only test the framework of our automated trading and our bots, but also to test and forward walk some option strategies in the future. Now, inherently, there are some regular flaws that are present in any back-testing framework and although we strongly believe in back-testing strategies and as do many other professional traders, it's a very cool feature to have the ability to forward walk some of these testing option strategies with an automated paper account.

What I will be doing just to give you a frame of reference is I'm going to be putting together a lot of automated strategies and then using them in the paper trading account that I'll have and then I'll publicly share all these once they get started and everyone can watch and monitor them as they go. But I'll be testing out different hypotheses and different ideas around trading and we'll create a lot of these automated bots and strategies in the paper trading account and then basically, let them loose for a couple of months and come back and see how they performed, which ones did well, which ones didn't do as well or which ones performed and we never even thought that they would perform that well. And of course, it's all just going to be a lot of testing and data that's going to go into it. We know that when you forward test option strategies with an automated paper trading account, we have to make some assumptions about fills and liquidity and strike price selection, etcetera. That will all be included in some of the bots that we create and within the paper trading account, you can make adjustments for commissions and make assumptions for commissions that make it very easy to have the account trade like it was realistically trading in the market.

But we also know that once we start doing a lot of this automated paper trading, we're going to have to collect a lot of data in the future and we'll need to see a lot of trades get executed before we'll probably get comfortable trading some of these strategies. Now, again, what we're going to try to do is try to test out some new strategies, new ideas that we might have or new ideas that come from the community and start creating automated paper trading around that, so it's kind of like live or real-time back-testing of strategies to see what works. It's a very cool feature and we're really, really excited to release it to you guys. As always, if you guys have any questions or comments, let us know and until next time, happy trading!

#214 - Should You Dollar Cost Average When Trading Options? Apr 24, 2018

Show notes

Hey everyone. This is Kirk here again at optionalpha.com and welcome back to the daily call. Today, we are going to answer another member question which is, "Should you dollar cost average when trading options?" I think there's two key concepts that we have to describe, first of all. One is this concept of dollar cost averaging which is the idea that when you buy stock and if the stock goes down and you like the investment or presumably, you think there's value in the investment that you continue to buy in small increments all the way down. If a stock is trading at $100, you buy say 10 shares. Now, the stock is trading at $98, you buy another 10 shares. Your average blended investment is now $99 per share. You're averaging down as the stock continues to move lower.

Now, the concept is not easily applied in its I guess, regular form to options trading. This would assume that if we wanted to dollar cost average in options trading that if a particular strategy that we're trading goes down in value that we would then trade more of that strategy or add more of that strategy. Now, I'm not a fan of just generally doing this. I don't think that that's the right way to look at it. The other way that we can look at dollar cost averaging is actually just spreading your trade entry out over time and averaging strike prices. This is a way I really consider this concept being applied to options trading, is with this laddering technique that we talk about where if a stock is trading and we have a strangle at the 15 Delta, let's say instead of doing 10 contracts at one time, we want to do just maybe two or three contracts. Then if the stock moves, we move our entire next entry of a strangle, the next say three or two contracts, we move that maybe a couple of strikes higher or a couple of strikes lower wherever the stock ends up going.

Now, this is different than dollar cost averaging because when you dollar cost average, you're moving down always with the stock or moving up always with the stock if you're shorting the stock. In the case of options trading, we're just maintaining the same range or the same perimeter around the stock as it moves. If the stock continues to move higher, each additional laddered or sequential trade that we make in that particular stock or ETF is at higher and higher strike prices. Say we're targeting the 15 Delta on either side. We'll continue trading the 15 Delta on either side even if the stock makes a $5 move. We'll just stair-step and ladder our trade up or ladder our trade down. That's why we call it laddering because on the pricing table, it looks like all of our positions are spread out in an equal distance or generally equal distance as the stock continues to move.

Now, I think this concept really works well with options trading to ladder trades because we basically move with the market. Whenever the stock moves higher, our new positions are now centered a little bit higher. If the stock moves lower, our new positions are now centered a little bit lower. In fact, just this past month in April, we had an EWY position that we had entered three laddered iron butterflies into and we got out of all three of those with profits at different times. They weren't all exited at the same time. We just were very opportunistic about taking profits whenever the stock came into the range of those particular strikes. I do agree conceptually with the idea of dollar cost averaging, but I think we just have to apply it a little bit different to options trading. As always, hopefully this helps out. If you guys enjoy these, let us know or shoot me a message over on optionalpha.com/ask and leave me a voicemail with your guys' questions for upcoming episodes. Until next time, happy trading!

#213 - What Are Contrarian Investors? Apr 23, 2018

Show notes

Hey everyone. This is Kirk here again at optionalpha.com and in today's daily call, we're going to answer the question, "What are contrarian investors?" I don't know who officially labeled the term contrarian investors, but it's basically the concept that people are taking the other side of a position. If everyone is bullish, you might be bearish. If everyone is bearish, you might be bullish. You could even say in most cases that some of the greatest investors of all time have been really good contrarian investors. Not that they weren't long-term bullish on say the broad US economy and the markets, but they were bullish during the right times and they were bearish during the right times and it's usually some combination of looking at either charts or forward PEs or crowd or herd mentality to see where most people are and then taking the opposite view. The idea is really that most investors and most traders I guess are really dumb money and that smart money usually takes the opposite side which I think has been proven many, many times before. I do consider myself to be a little bit of a contrarian investor. I usually tend to see the bearish side in things. I usually believe that stock charts always look overbought and always look like they're going to come down. I think that bearishness has subsided the last couple of years and we've talked about it in a podcast on the daily call awhile back about why I'll probably be more tilted bullish after the next drop. Not that I don't think it's coming because I do. I think that a huge market reversal is always in store for us. It's just when and resets the parameters for everything. But when that happens, I think I'll be a little bit more bullish than maybe I was before.

I do though see most investors not being contrarian in the sense of options trading when you get huge moves up or down in particular stocks in a very short period of time. One thing I have 100% learned and I'm trying to display not only through a podcast like this, but blog post, video tutorials, my trades that I post all the time on YouTube or on Facebook. I'm trying to show you guys that the market is cyclical and does not move in one direction forever. And so, when we do see a stock that has a huge run-up, I usually tend to be more of a contrarian to think that that move might reverse or turn around and same thing in the down move. When a stock has a huge down move, I tend to think that I'm a contrarian in the sense that the stock might have a huge reversal and at least retrace some of that movement and move back up. This has proven to be pretty right. When you look at most stock charts, you don't see that stocks act in a directional vacuum, meaning that they only move in one direction, never any gyrations or zigzags, whatever you want to call them. I think it tends to be right that over time, the markets are pretty cyclical, they're pretty random, it's much harder to predict where the markets are going than just basically assuming that we don't know where they're going to go and then build a strategy around a particular range. I think you'd probably do yourself some service if you're not already, to be more of a contrarian when you see a stock making a huge move higher or a huge move lower. Yes, there might be fundamentals in place, but that doesn't mean that that necessarily, that initial move is going to be the one and only and it's going to continue at that pace. Usually, when we see things go parabolic, it ends very quickly and very abruptly. Hopefully this helps out. As always, if you guys have any questions, let me know and until next time, happy trading!

#212 -Stock Snap Backs & Fibonacci Retracement Apr 22, 2018

Show notes

Hey everyone. This is Kirk here again at optionalpha.com and welcome back to the daily call. Today, we are going to be talking about stock snapbacks and Fibonacci retracement. Both of these things commonly occur and we'll talk about the differences between them or if there's any similarities and differences between them in today's quick little session. What typically happens is that stocks obviously don't move in one direction at one time all the time. There's no stock that goes vertically higher or significantly lower without having gyrations in between the stock move. Now, gyrations can happen and basically, just active trading in an efficient market can happen at any timeframe. It can happen on an intraday basis, on a one-minute, a five-minute, a 20-minute chart. It can happen on a daily, a weekly, an annualized chart, etcetera. These gyrations, people always try to find some sort of meaning that can be derived out of them. Now, I'm not saying today that there is or isn't meaning to them. I'm just trying to help explain the sequence or thought process behind them.

Typically with stock snapbacks, what I see happen all the time is definitely on charts where you see a stock having a huge run-up or even a huge rundown, is we get some sort of hard or aggressive snapback in that stock. Let's say a stock is at $10 and it falls quickly to $5. Well, it might rebound very quickly to $7 and that might be the snapback that the stock has. I do see this all over the place, so I would definitely say that this happens a lot and I just call it, I don't know, market cyclicality, you can call it randomness, you can call it white noise. Whatever you want to call it or label it, the reality is that things don't move in one direction too long without having some sort of gyration or pullback or retracement, whatever you want to call it. We see this a lot in the broad equity markets and a lot of ETFs where I'll talk about on a video update or on a podcast update how a stock is moving and it seems to go parabolic. That's when I think that those snapbacks or retracements happen more often because that move is just not sustainable. In fact, it's what we saw back in the early part of 2017 where the equity markets were just going literally parabolic in some cases for the S&P and for the NASDAQ and we just knew that that type of move was not sustainable without some sort of either consolidation and/or pullback.

Now, one of the favorite ways that traders like to label this and like to see if they can find hidden gems of information in the stock charts is to use what are called Fibonacci retracements. This is just the very simple calculation of a series of retracement levels that a stock might go through from a peak to trough and kind of rebounding from those levels. If a stock is making a move, you can simply use a Fibonacci retracement tool and most brokers have it or you could probably find some free Fibonacci retracement levels someplace online. But it goes from the low end of a market move, so theoretically, the bottom of a move up to the top of a current move or a current trend and when you draw these lines or put these lines on, the software will automatically create what are called these retracement levels, so these likely levels that we're going to see maybe the stock retrace back to. In most cases, it's around the 23.6% of the full move that the stock had or the 38.2% or 50% or 61.8% or 78.6% or then, 100%. Those are the most common Fibonacci retracements, kind of those four that I mentioned in the middle. Now, I don't know. I've read a lot online and I've seen a lot of studies on this. I don't think there's anything that says that one is more effective than the other. It's commonly referred to that the 50% retracement is a likely area in which a stock will have this huge rally and then come back down and pull back down to the 50% level or the 61.8% levels also seem to be a pretty fairly popular level for a retracement.

I actually did some little bit of digging here and actually recently looked at some Fibonaccis that I drew on the S&P for the last about year and a half, two years or so just from peak to trough on the recent move up that the equity markets had. Now, again, this is the downside to these Fibonaccis in my opinion. Not to say they do or don't work. The downside to them is that they're totally subjective. In the case of what I'm drawing right now in the charts which you guys can't see, but I'll explain, I drew the Fibonaccis to start from basically November of 2016 all the way to the market top that we just had in 2018. Now, the market top is easy to spot. We just had a pretty clear defined market top on the S&P, but where I draw the beginning of this is really up to subjectivity. I could've easily done it back in June of 2016, but I decided to do it in November of 2016. That was the last really rundown that we had in equities before it continued to move higher. But in any case, in the case of the S&P, when I drew this Fibonacci retracement line, ironically enough, the market has stalled both in early February and then here in April, it has stalled at the 38.2% level. Now, it hasn't stalled exactly at that level, but pretty dang close and in multiple cases, it's tested this level before. Again, totally subjective, it could've been totally different if I would've picked a different starting point, but it is something to be aware of, I guess if you want to use them. I'm not totally crazy on using them, obviously. I really don't use any stock charting, any patterns.

I think it's an interesting tool when people point it out to me and they send me email updates on Fibonaccis. I definitely take a look at them. I'll look at the charts if somebody sends me their chart. I think it's interesting to note. I don't think it helps make any investing decisions on my end because we're such short duration and we're so much more focused on staying neutral and playing the volatility edge. But right now, I think that those are interesting picks for sure. Fibonaccis are something I actually used to use a long time ago and then just really phased them out many years ago because I found more value just coming out of just not watching things, not trying to chart things, not trying to assume I know where the market is going. Again, the reason I want to talk about them today is just because I do think maybe they serve a little bit of a purpose when you are trying to figure out, "Okay. Hey, if we're in a market top here and things are starting to fall, maybe where might some of those support levels be, broadly speaking?" I don't think it works necessarily for every obviously scenario and I do not use them practically at all, but again, it's an interesting tool to put in your toolbox, if you will. Hopefully this helps out. If you guys have any questions, let me know. Until next time, happy trading!

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