The "Daily Call" From Option Alpha

Latest Episodes:

#181 - The Reliability Of Stock Analyst Recommendations Mar 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 the reliability of stock analyst recommendations. I know this might actually ruffle some feathers out there. I will tell you though that before I get into maybe not bashing people, but bashing the industry as a whole, I do think that there are very, very good, smart people in this industry. I don't think that it's full of people who are completely ignorant or dumb. I think the entire industry is full of people who are very smart, very well-educated, but I just have one major rub with the whole thing and that is basically conflict, the conflict of the people who write the recommendations, who basically sell the research, sell side analysts and then any conflict that an institution or bank might have with people who buy it. That's what I've talked about in Show 164. If you go back to the daily podcast right here, in Show 164, I talk about my short stint as a research analyst. I was on this side of the Chinese wall, the proverbial Chinese wall and I basically talked about what I learned there, so you can go back and listen to that podcast again.

I think the problem with stock analyst recommendations is that it can be anything they want. They do a good job. The way that I was trained and the way that I was taught, if you will, is that we try to do our best guess. There's nobody who can accurately predict the future. We all know that. That's not something that we're trying to do, but we're trying to do our best guess. And so, we talk to the CEO, we talk to the CFO, we talk to the company. We look at the industry as a whole. What did other similar companies do? How did they grow? There's a lot of research that goes into these reports. I'm not downplaying this by any stretch. I'm actually trying to help you guys understand what goes into it. It's not just somebody's expectation. There's models that are driven and built out and very, very fine data points that we have to look at to say, "Okay. How much do we expect this industry to grow in this environment or if inflation picks up or if GDP drops?" There's a lot of data points that go into some of these models.

The problem with a lot of them is that we can basically set the price to anything that we wanted to be. Not that we're going to do that right off the bat or initially or that anybody was going to do that just for the sake of selling more research, but you can basically set the price on any of these stocks to whatever you want to be just by changing a couple of growth levers and cost levers and expectations. Maybe you think revenue grows at 1.2% versus 1%. Well, that's not a huge difference, but over time, that could change how the outcome of the stock is priced today and if it's a buy or a sell recommendation. It's very, very hard to get accurate representations of where these companies are going to be 10 or 20 years out into the future. One little tweak that you do now to growth today has a compound effect into the future.

I think that to me is the hardest part, is like we have no clue where these companies are going to be. And even more so nowadays with how fast technology is changing, we have like… We did a podcast called the Netflix effect and basically that any company could be upended tomorrow. That's the reality of this world that we're in. Look at the entire taxicab industry. Upended by Uber. Netflix blew out blockbuster, came out of nowhere, basically. Any of that can happen in a five or 10 year span and maybe even faster now that technology and AI automation is coming up so, so fast in the marketplace that that has to be priced in and we just can't price that it. We can't realistically say, "Okay. We think that this company is going to make revenue for the next 10, 15 years with no expectation that they're going to be just completely get annihilated and blown away by some competitor that hasn't even started yet." That I think is a really hard thing to get over for most research analyst right now and what I see is a big drawback to that.

The other thing is that what we do in trading is just not that needed. We don't need to reference a research analyst or a stock recommendation or a research report to do anything we need to do in trading. Everything that the market knows, everything that's public information and all expectations of the stock's move is priced into the security right now. Now, it could be overpriced. The market could be overpricing expectations, underpricing expectations. But whatever it is, it's priced in. When you trade on a short duration or a short timeline like we do, we have the ability to quickly adjust all the time. Rather than what I think people doing in stock trading, is get into a stock position and hope and hold for the next five or 10 years that it works out, I want to be able to get into a position and then readjust in the next 30 days and the next 30 days and the next 30 days going forward, so that I'm always adjusting to whatever the new market price is. In fact, I don't care where the market price goes for an underlying security. It could go up, it could go down, it could go sideways. I'll be there constantly selling options and constantly adjusting.

Hopefully this concept has been helpful. Like I said, I think my biggest disputes with stock analyst recommendations are obviously conflict. I think if you look at some of these places that have a conflict where you're selling research and you have clients that are buying that research, totally a conflict there and I think that the expectation conflict or the expectation problem with just how these models are built and how small changes can really, really tweak the underlying price of a security I think is a huge disadvantage in this market. Hopefully this helps out. Again, I don't want to totally bash. I'm not bashing individuals. I think it's just a really weird old industry that probably needs to be reformed at some point. But people like reading research and I get that and that's why it's still around. Hopefully this helps out. Until next time, happy trading!

#180 - Quick Guide To Trading Volatility With Options Mar 21, 2018

Show notes

Hey everyone, Kirk here again at optionalpha.com and welcome back to the daily call. Today, we're going to do hopefully a fairly quick guide on trading volatility with options. I say quick guide because I don't think that there's a lot that we have to go over to get the broad strokes. There's obviously a lot more detail and a lot more deep diving that you can do on volatility trading. But I want to try to get through the broad strokes here. If you're new to options trading or if you're even a sophisticated trader that's been around for a while, there's probably a couple of key concepts that we need to cover.

The first thing with trading volatility in general is that with options and specifically just calls or puts, however you want to think about it, we have the ability to trade volatility as an underlying asset class. Now, there's two ways we can do this. We can trade volatility in and of itself through volatility products like VIX, VXX, UVXY, etcetera and we can trade the volatility of underlying securities like regular stocks and ETFs. What we prefer to do most of the time, although we trade VXX and VIX a lot, we prefer most of the time though to trade the underlying volatility of regular equities and ETFs. What I mean by this is that we trade the discrepancy between the implied volatility of those options and the historical volatility or actual volatility that they see going forward. It's no different than what insurance companies do where they overestimate how often you might die or how often your house might burn down to the ground or what casinos do when they play their edge in gaming. They just play it over a long period of time. We're playing the same thing. We're trading volatility in the sense of selling high overpriced implied volatility early in the expiration cycle with the understanding that over time, most of our positions once we get to expiration, once we're patient enough to wait to 30 or 45 days to expiration, that our options will end up decaying in value more so than the underlying stock's move that was priced in and therefore, we take that difference or that edge as potential profit. That's the main way that we do it.

Again, you can also play volatility with actual physical underlyings like VIX and VXX where you're making directional bets on volatility on a broad-based scale. Most of those products are based off of the VIX or VIX futures which is then based off of the S&P 500. You're playing broad market volatility which is a good way to go as long as you understand those products. We have a couple of podcast on our weekly show. We also have some video tutorials that you can check out when you search VIX or VXX on our website. That'll give you a better understanding of those instruments and how to trade them. In the case of the ETNs like VXX, UVXY, they are negatively driven, they have negative drag. You just have to be aware of how those products are traded and what the pricing looks like moving forward just so you understand it before you start trading it. Hopefully this is just again, like I said, a quick guide to how we trade volatility with options and how we use and think about conceptually trading volatility around the market.

#179 - The Sometimes Hidden Benefits Of Trading Options From Home Mar 20, 2018

Show notes

Hey everyone, Kirk here again and welcome back to the daily call. Today, we are going to be talking about the sometimes hidden benefits of trading options from home. For me, when I started trading options from home, it was I guess you have this preconceived notion of what trading from home ends up being. But for me, it's very different than what I see portrayed online or what I see portrayed on the internet. The big thing for me was obviously, time with my wife and now, time with my kids. And so, those are kind of my nonfinancial things that I think are really invaluable to me moving forward in life. In fact, my oldest daughter, Molly just the other day, just had this really weird conversation with her about… I decided to go to like a coffee shop because I needed to do some recordings for podcasts and I needed to record some videos for the team and she was totally floored by this. I don't often go to a coffee shop. I just spend most of my time in my office at home and with them and when they're napping, I'll do stuff for Option Alpha, etcetera. And I just had a really weird conversation with her because she was totally floored by the concept of me going someplace else to work. She never actually seen me do that, right? Like never really thought about that. And so, we had this whole conversation about why some people have to go to work and why some people can stay at home and work. That was a really cool experience to go through with her and I'm very thankful for what options trading allows me to do which is just truly flexibility in my time in life and time with family and friends.

I think there are financial gains that could be taken from trading at home that people don't think about. I think people most often think about people driving Lamborghinis and these huge houses. I very much live a completely different lifestyle than that. I have a very nice small house in Pennsylvania and we have a nice investment property portfolio that we've built because we live in a small house. I drive a minivan because I have kids. It is nothing like what people portray online. But I will tell you that when you trade at home and when you have everything in one place, you're much more likely to actually save money I think in most cases if you're willing to make the investment in choosing a location, choosing a house, deciding on cars, things like that. When we originally lived outside of DC, it was terribly expensive. And so, when we moved after my first daughter was born to Pennsylvania, that was a huge windfall for us as far as finances because we were living basically for a fifth of the cost of what we were living in DC and none of our regular expenses change. We didn't magically go out and just spend that money on something else. We kept everything low, so we could continue to save more and invest more. That's the whole idea. And then also because we live in a town now and we decided to live in town where we live versus outside of town and we now have the ability to basically be a one car family. We have a backup car basically if we need something for the kids or both of us are running around. But 99% of the time, we're doing things with the family, so we're basically a one car family. We walk a lot to places, we walk to the park, to the pool, we walk to the grocery store. We do a lot that doesn't require a lot of commitment and time and travel and income.

I think about this stuff often because I think people underestimate some of these hidden benefits. That's why I call it hidden benefits of trading because there's so many other things besides just the monetary gains you could have from trading. Now, I don't think you have to trade from home to be successful trading at options. I think the whole goal of Option Alpha and more importantly, what we're releasing very soon as far as auto-trading software helps people get to that point while still keeping their regular job or their day job or whatever they're doing at their profession that they like doing. But for me, I think there are some benefits that you can't really describe I guess from trading at home or just working at home in general and being in that environment. Anyways, I wanted to talk about that real quick because I think it might just maybe stir some things and food for thought. If you guys have any questions or have any comments, I'd love to know. Until next time, happy trading!

#178 - Why Long Option Strategies Fail To Profit After A Stock's Earnings Are Released? Mar 19, 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 the question, "Why do long option strategies fail to profit after a stock's earnings are released?" A common misconception, totally common misconception in the marketplace is that when a stock announces earnings, you get this huge move in the underlying stock and therefore, you can profit potentially from that huge move. But the problem is that as you're approaching that unexpected event, that earnings event, the market prices in the expectation of a huge move. It naturally happens. And so, what we see is we see actually heading into those events, sometimes a week or two weeks or a month out, implied volatility will start to rise heading into that earnings event because we don't know if the stock is going to announce great earnings, if they're going to announce bad earnings, if their revenue fell or grew, whatever the case is, right? And so, traders are expecting a big move to begin with. They just don't know which direction the big move is going to happen. And so, implied volatility increases and all option prices get bid up on both sides.

The misconception here is that people can go into these events and buy options right before earnings or shortly before earnings, maybe a week or two out and profit from this huge move in the underlying stock. What people often do is they actually trade what are called long straddles. They'll trade a long straddle or a long strangle and say, "Well, I don't care which way it moves. I'm going to profit no matter where the stock goes as long as it has a big move." I get the concept and it's very easy to explain. The problem is that in reality, it's just does not work this way. We've done a lot of back-testing on this and we actually released a podcast, Show 113 on our main podcast or weekly podcast which you can check out as well. And the highlights from that are we basically tested three of the biggest names in this. We did Apple, Facebook and Chipotle. And what we found in that test is that all of those had expected moves that were much, much higher than the actual move of a stock, meaning the market expected for example, Apple to move say 10% up or down, but it only moved 5% up or down. And so, what happened was that these long straddles and long strangle ended up winning a very, very small percentage of the time. In fact, in Chipotle's case, if you did a long straddle where you are just hoping for a huge move in the underlying stock, you ended up winning 35% of the time. You drastically underperformed something else like a short straddle or a short strangle.

The key here is obviously, we know that these expected moves are going to happen. We know that we're going to get big moves in the stock, but it's already priced in. And over the long haul, not over every single period, over the long haul, we do see that selling options around earnings events end up being the more profitable strategy versus long option strategies. As always, hopefully this helps out. Again, you can check out Show 113 on the main podcast by heading over to optionalpha.com/show113. Until next time, happy trading!

#177 - Liquidity Concerns When Selling Options - 3 Things To Check Mar 18, 2018

Show notes

Hey everyone, Kirk here again in optionalpha.com. Welcome back to the daily call. Today, we are going to be talking about liquidity concerns when you're selling options and three things that you can check really quickly as you're starting to build out your trades. The first thing you have to understand is that as we build out our auto-trading software, we are going to be building in some liquidity screens or protections that are going to be in there, so that you don't ever end up trading or the auto-trading software ever ends up trading something that isn't at least more liquid than something else. We want to build that into our software. That's something that we're going to be doing as part of that roll out.

When you are looking for trades manually and you want to check liquidity, there's a couple of things you can check. One, just check volume and open interest. This is pretty easy. But you'll see either good volume that are open interest or not. You don't have to say that it has to be above 1,000 contracts a day or 100,000 contracts or 10,000 contracts. There's no benchmark to say anything has to be anything. But what you do want to be is be cautious that you are not a big fish in a small pool. We still want to be small fish in a very big pool of liquidity. And so, that's going to be relative to different things that you're trading because different things have different prices and different contracts have different spreads that are open, like strikes that are open, so half strikes versus full strike, etcetera. But you generally want to look for good volume and good liquidity across the board. That's important.

The second thing you want to look for is a very tight bid ask spread. If there's volume and liquidity, the bid ask spread should take care of itself. But sometimes it doesn't and sometimes there's lightly traded or light open interest because new strikes have just been opened up. Maybe there's a recent move in the underlying, so the market is now opening up new strike prices at a higher or lower price, so there might not be a lot of volume, but the bid ask spread is pretty tight because people are now trading it. If you start to see a very tight bid ask spread, always a good sign of liquidity. Wide spreads which are super wide, not a good sign of liquidity.

The third thing that you can check for really quick is just neighboring strikes. I look at this as like "What does the entire trading block look like?" And so, it's very similar to maybe like in this case, real estate. Are all the houses nice in the neighborhood or is there one really nice house and everything else is falling down? If you see that on an option pricing table or an option chain that only two or three strikes have all the volume and liquidity, yeah, it might be great to trade those two or three strikes, but do you really want to get yourself in a position where you're selling options and then have to adjust and nobody's there to adjust with you, nobody's there to make adjustments to a different strike other than the ones you initially sell? For us, what we like to see is we like to see neighboring strikes, basically, the entire trading block to have lots of liquidity, great volume, great open interest. Again, just look at SPY versus pretty much anything else. That'll give you a good frame of reference for what great liquidity looks like. Until next time, happy trading!

#176 - How Many Option Trades Do We Have To Place To See Profits? Mar 17, 2018

Show notes

Hey everyone, Kirk here again and welcome back to the daily call. Today, we are going to be answering the question, "How many option trades do we have to place to see profits?" This is a huge topic that we get a lot of questions on and a hot topic for me because I think that people totally misunderstand what they are doing when they get into this business. I say business. I actually just said it without even thinking about saying business. But most people actually get into options trading like they're getting into business, but they treat it like a hobby. They treat it like a hobby because they don't have the right expectations heading into it. I've often related options trading in the sense of opening up a restaurant. If you're going to open up a restaurant business, you expect that you're going to be in business for a couple of years. You wouldn't go through the hassle and the process and the capital investment to open up a restaurant just to close it down after two months. But yet, magically, people still do this in options trading. They get into it, they think they want to do this, but they don't actually have the right expectations heading into it, they don't have the longevity that's needed to see success.

Here's what happens in options trading. We have what's called the law of large numbers which is just a very simple law that basically just says that the more times that you execute an occurrence or a trade basically, that it will start to gravitate more and more towards the expected outcome, meaning that if you're targeting 70% chance of success trades, the more and more and more you trade, the higher the chance that you're going to see that 70% become present. Now, the downside to this is that you have the most amount of variance in the first 100 trades or so. When you first start trading options, you could have… I tell people this all the time, but they still don't believe me. If you start trading options… I say, "Okay. Target 70% chance of success winners." Well, your first 10 trades could be total losers. It doesn't mean that the probabilities are wrong. It doesn't mean that your trades were bad. It doesn't mean you had bad entries or anything actually happened bad. It just means that the occurrences that just happened happen to be losing trades. Again, it still means if you keep trading, you should see 70% chance of success. Now, you could also have your first 10 trades be winners. Now, you think you've reached the Holy Grail, you've uncovered something that nobody else has seen before in their entire life and so, now, you have this false-positive or false-negative (however you define it) expectation of the future. But the reality is that your first 10 trades or your first even 100 trades, you're not making enough trades to really see the probabilities solidify and firm. It's like curing of metal or curing of stone. It takes a long time for them to really solidify. If you are flipping a coin, you could flip a coin 10 times on heads. It doesn't mean the coin is broken. It just means you got to flip the coin a lot to see 50/50 heads and tails.

So, to get back to our question about how many trades do you need to make to see profits, you could see profits very early, but I think that at least at 100 trades, you should now start to breakeven or be more than breakeven for sure at that point with a 70% target. If you're targeting 70% chance of success trades, after 100 trades, you honestly still could be in the ballpark of 50% winners or 90% winners. It's that wide of a disparity and variance. And so, what that means is that some of you might come to me after 100 trades and making 90% winners and you're like, "This thing is the greatest thing since sliced bread. You're amazing." Other people come to me after making 100 trades and they're still 50/50 or maybe just above 50/50 and they're like, "Kirk. You're a scam artist. You're totally scamming people out of this. This doesn't work." But you just haven't made enough trades yet. You just actually haven't let the probabilities solidify. After say 200 to 300 trades, now your variance is cut down dramatically, you might be within about a 10% variance of where you need to be. Now, after a couple of hundred trades which at this point, should take you at least a year, so you should be at least a year in now to start really starting to see this thing solidify or at least starting to really grow some income legs for you, now you're starting to see trades, all of your trades between 60% and 80% winners. And after let's say 500 or 600, even up to like 1000 trades, now you're starting to really narrow down on this probability and win rate and you're starting to see something very, very close within like 2% or 3% of what you should expect as far as probability.

The key here for today's show is just realizing that it is a long-term game to play this business and to be in this business and you have to have the right mindset coming into it. It is 100% true that every single day that you stay alive in this business that you continue to trade, you just end up becoming more and more successful, just like solidifies itself day after day after day. You start working towards this target of probability of success and win rates and etcetera and it just becomes more and more solid every single day that you stay alive. Now, the question becomes, "How do you stay alive?" Well, you keep your position size down. You keep your allocations down, so that if you do have a run of bad trades, it doesn't blow you up. That's what happened to a lot of people in February this year. A lot of people out there… We got a lot of influx in February when the market had this mini-crash because people that had been used to take in lots and lots of profits finally saw the other side of the coin, finally saw a huge string of losers and they were way over-allocated. They didn't have enough capital left over. They had position sizes that were too big that actually ended up blowing up people's accounts against the better judgment of what I've been saying and the better advice of what I've been saying for years. That's what I think is really important here, is just realizing that you have to stay involved in the game. You have to want to be in this game for a long time because if you are in this business, it will just continue to solidify itself over time.

To finalize it and wrap it up, how many trades do you need to make? I think after at least a year of trading, you should now start to be at least like over the 50% for sure threshold. You could definitely be higher than that. But over 50/50 winners, I'm just saying what the expectations are. And then at least two years in, you should be really, really solidifying and honing in your skills and your profits I think should be really, really solid at that point. Hopefully this helps out. As always, if you have any questions or comments, let me know. Until next time, happy trading!

#175 - Managing Individual Option Trades Or Combined Positions In A Ticker? Mar 16, 2018

Show notes

Hey everyone, Kirk here again and welcome back to the daily call. Today, we are going to be answering the question, "Should you manage individual option trades or combine positions in a particular ticker?" Let me just back up and tell you the basis of where this question comes from. If you are getting into laddered entries like we talked about just a couple of days ago in one of the shows here on the daily call, if you're getting into laddered entries and you're starting to enter multiple positions in the same ticker, the question is, "Do you manage each of those individual positions one by one or do you manage them together as a combined community?" Let's say you got into position in SPY. Your first position, you took in potential credit of $100. The second position, you took in $120. Now, do you add those two things together and say, "Okay. Now, the combined credit is $220 and I want to take 50% of that." Or do you take 50% of the first position and 50% of the last.

Well, ultimately, it's your decision, but here's how I would do it. I would still manage each individual position by itself. That's how we built all of our back-testing software. All of our research is based on individual position, not any combined positions. It's just a very simple way to go about it. Each independent occurrence should act like an independent occurrence for the next ones. And it's also how we built out our auto-trading software because we believe that when you start trying to co-mingle things together, it actually creates the opportunity to start mingling things together that maybe shouldn't be together. If you start making adjustments to one position, does that count for the second position or does that count for the whole thing? If you start rolling contracts, do you include those on the whole roll or just because you rolled half of them, it includes half of the roll? It starts really getting it super, super complicated beyond what it needs to be and you can do just as well and be just as effective if you just manage the individual trades when exiting.

Now, does that mean that we don't look at the overall combined position? Of course. When we are looking at our analyze tab and we're looking at the position, I'm not clicking through and saying, "Okay. This is one iron butterfly and this is another iron butterfly. This is one condor, this is another condor." I'm looking at the overall payoff diagram for that ticker, but when it comes time to exiting, I might exit one of the positions today and we might actually find that we exit the next position five days later or not at all. We have to adjust that side of it. That's why I think that you have to manage them individually. It does give you an opportunity I think to smooth out your returns. And back-testing wise, the way that we did a lot of research, is we did it on the individual basis because it's a lot simpler to manage and basically to build automation around that versus trying to combine positions. Hopefully that helps out. As always, if you guys have any questions, please let us know. Until next time, happy trading!

#174 - How Do Corporate Earnings & Dividends Impact Options Trading Decisions? Mar 15, 2018

Show notes

Hey everyone, Kirk here at Option Alpha and welcome back to the daily call. Today, we are going to answer a question from one of our members which is basically, "How do corporate earnings and dividends impact our options trading decisions?" The real question here was that somebody sent in… Again, thanks for submitting questions because it helps out on this podcast in topics and things that we cover. But the question that was submitted was, "Can you talk more about how these corporate actions like corporate earnings and dividends affect trading decisions? For instance, if you're trading in a security that has a dividend being announced before a contract expiration or is going through an earnings event, do you wait until after that announcement or that dividend to pull the trigger?" I think this is a really good topic. It's one that we've covered before, but it's worth covering again. When we start looking at trades, we do look into the future for any trades that we're doing in individual stocks and we want to have a frame of reference for where dividends and earnings come up. Now, in most brokerage platforms, you can actually see into the future a little bit by just adjusting your chart settings and actually showing dividends and corporate earnings. On the Option Alpha website, what we have with our watch list and our software is we have little tags that show you if earnings or dividends are coming up in the future, so that helps out with the watch list. But you just want to be aware that those things are in the future because they could impact your trading decision.

For example: I think earnings are probably the biggest one that impacts our trading decision to either get into a trade or not. We generally know that heading into earnings, though it doesn't happen all the time. But generally, heading into earnings, we start to see implied volatility start to slowly tick up. The stock might be a little bit more volatile than usual because it's coming into this earnings event. It could have great earnings. It could have bad earnings. There could be something missing in there, great revenue, bad revenue, the whole deal. And so, the stock is likely to make a big move after earnings, so we start to see implied volatility start to tick up as we head into that event. How that would impact us was that we would not then start trading a short premium trade heading into that earnings event because if we're going to start selling options, we want implied volatility to either stay low or go lower and that's the total opposite of what would typically happen in that environment. We would rather just wait for the actual earnings announcement itself and trade that one time IV crush that happens or IV collapse that happens around earnings versus trying to get it right heading into the earnings event and taking a lot of risk in the meantime. That's really how it impacts us for trades. That's why you typically see if you're a pro or elite member that we do a lot of trading and a lot of auto-trading on some of the ETFs and some of the larger indexes because they don't have that corporate action coming up every 30 or 60 or 90 days, depending on what industry you're in.

The other thing that we look at is dividends. Dividends for us are not a huge decision-maker. We recognize that dividends are on the horizon for something. That doesn't mean that we won't do the right strategy at that time because by the time we get to the dividend announcement, it does not mean necessarily that we'll always be assigned by the dividend or we'll have any assignment risk. If we get to that dividend event and we are in a position where we could be assigned, then we can adjust or close or roll the position. I've never really found it to be this detrimental thing to trading. Again, I'm aware of the dividends, I know when they're coming up. They're scheduled out and I can see them in the future and as they come closer, we get announcements for them and updates for them, but it doesn't really impact my trading decision because the trade I make today if dividends are 45 days out, I might be out of in 30 days, so it might have no impact at all. I think for me, it's more of the corporate earnings that impact things versus dividends. But hopefully this helps out. As always, if you guys have any questions or want to hear different topics, please submit a question like this person did. You can submit it on email or at optionalpha.com/ask and leave me a private voicemail. You can also just send us a tweet or a message on Facebook, Twitter, YouTube, Instagram, any of the social networks out there. We'll definitely respond to it and get it queued up for the daily call. Until next time, happy trading!

#173 - Laddering Option Trades - Frequency & Pricing Guidelines Mar 14, 2018

Show notes

Hey everyone, Kirk here again at Option Alpha and welcome back to the daily call. Today, we are going to be talking about laddering option trades and specifically, frequency and pricing guidelines that you might be able to use. First, let's talk about what our laddered option trades, what's the concept that we often refer to. Basically what it means is that we're not going to enter one big stinky position around a strike price and plant our flag in the sand and say, "This is our position for the next month." Instead, what we'll do is if we're going to enter say 10 contracts, we'll try to split that up into a couple of different entries, maybe three different sets of trades, 334, something like that where we start averaging around the security, start averaging down or up as the security starts moving. For example: If a stock is trading at $100 and we want to do some straddles, we might sell three straddles at 100 then wait for the stock to move. If it does move up to say 103, we'll sell another three straddles at 103. If it moves up to 106, we'll sell another three straddles at 106 and start moving up with the position. We found that this works really, really well in back-testing and research wise because we spread our entry out over time, we increase our trade frequency, increase our duration in trades and also spread out our strike prices which means that we have overall, wider breakeven points on the overall position. Really, it actually works out well.

As far as frequency goes, I do not have a set frequency that I stick to. I don't say every week, I'll get into a new position or every three days, I will get into a new position. For me, it comes down to movement. If the underlying security is not moving, I will not add another laddered position. To get back to our example: If we have a stock that's trading at $100 and we sell the first set of three straddles at $100, if the stock just stays at $100, maybe goes up to 101, goes back down to 99 and then back up to 100, I'm not going to add to that. The stock is doing exactly what I thought was going to happen. Now, we don't have a big position on, so we can't capitalize on those as much as we hope, but in this case, the stock is doing what we want, so we're not going to add a position to it. But let's say two days later, the stock jumps up to 103 or 104. Okay, then I'll add another laddered position. And maybe one day later, the stock jumps to 106 and now, it's had a huge move in just a couple of days. Okay, maybe then I add another laddered position. For me, it's about strike price spreading, like I want to spread out my strike prices across different movements in the stock. If that happens very quick in a couple of days, great. If it happens a little bit later on in the cycle and I have to wait a week or two before I get into another laddered entry, I'm fine with that too. I'm not holding to any one particular timeline or frequency for getting into laddered trades.

As far as pricing goes, I base pricing and the number of contracts that I do generally off of implied volatility. If we see low volatility, I'll do a couple of contracts maybe two or three to start and keep doing two or three unless implied volatility goes higher. If we start to see implied volatility go higher, then we'll start to see more premium in those contracts and we'll start to scale up. If we start with three contracts, but the next move, we also saw implied volatility jump, then that means that we might do four or five contracts the next time around. I think starting small is always the better opportunity. We know that we're never going to be perfect in picking direction. We know we want to trade consistently neutral, so why not use an option technique like laddering to help facilitate that kind of concept of non-directional trading, not needing to pick the market, just trade where the market goes. If the market goes higher, continue to add new trades at higher strikes. If the market goes lower, continue to add new trades at lower strikes and then scale based on volatility. If it's low volatility, scale back your position sizing. If it's high volatility, scale up your position sizing. As always, hopefully this helps out. Until next time, happy trading!

#172 - Why I've Traded A Lot More Iron Butterflies During Low IV Markets Mar 13, 2018

Show notes

Hey everyone, Kirk here again and welcome back to the daily call. Today, we are going to be talking about why I've traded a lot more iron butterflies during low IV markets. This is always one for people who are new to Option Alpha. It's a little bit of a confusing concept because we see low implied volatility which we're generally and most of the time, although we had some high volatility spikes here in March and in February which were good and good trading opportunities, but most of the time, we're in low volatility. Why have I started trading a lot more iron butterflies? I think there's a couple of reasons why and I want to go through this in the podcast just to help share what we've been doing.

The first thing is when we go back and we look at research on what works just generally using our profit matrix research which you guys can all get to at optionalpha.com/profit. But when we go back and look at back-tested option strategies, we'd know that in low implied volatility environments, option selling still works. It's just as simple as that. Option selling still generates nice expected returns, profitable trading strategies, but the key is finding premium. I think it's really what it comes down to. One of the better strategies that we found in low volatility was a variation of either a straddle or a wide strangle. Wide strangles, although I love to trade them in low volatility, like really wide iron condors, basically, you just don't get enough premium to do them in low volatility, especially on some of the lower ETF values. If there's an ETF under $50, selling an iron condor during low implied volatility might generate say $30. It's not a lot of money per contract, per spread and it's a lot of commission to do that.

Now, we have to start thinking to ourselves, "Okay. Well, if we know that we still need to be selling options, how do we replicate to some degree, a strangle type payoff diagram where you have wide breakeven points without doing an iron condor that doesn't make any money or basically doesn't collect enough premium to do it?" The way that we that is by doing a very wide straddle and using a synthetic iron butterfly. The inside of an iron butterfly is basically a straddle. You're selling at the money options. During low implied volatility, at the money option contracts still have significant amounts of value. In some cases, a couple of dollars worth of value. Now, we start selling these at the money straddles and then because implied volatility is so low, what we have the ability to do is buy wings on these straddles very far out or in some cases, actually not that far out for very cheap amounts or very cheap premiums.

One example of this just to use a very standard example which helps out is let's say that the stock is trading at $100. We might sell the 100 strike put, 100 strike call, basically the at the money straddle and collect say $6 of premiums. Now, our breakeven points are $6 out on either end. Now, even though we were selling at the money strikes, because of the premium that we collected which was $6, now our real breakeven points are 94 on the bottom side and 106 on the top side. Now, it actually replicates to some degree, a strangle or an iron condor type breakeven points, like those further out breakeven points. And even though we sold the at the money straddle at 100, we now maybe able to buy say the 95 puts and the 110 calls or something around there, something further out on either end for very, very cheap premium. Say we bought these options for say $.8 or $.10, so basically $20 we give up of our entire premium. That's really the case.

In low volatility, it does not cost a lot of money to buy these further out legs. Even though we collected a $6 credit, so $600 of notional value, it might cost us $20 to buy these further out legs for protection and basically to reduce margin, but if we're still taking in say $580, it's worth it to pay the $20 or $30 or $40 in some cases to buy all of the legs on the outside to give ourselves defined risk, so that if volatility does spike, we're not caught basically holding a bag of positions that have undefined risk with a lot of huge spike in volatility, etcetera. That's why we're starting to do a lot of iron butterflies. It mimics a lot of the strangle, iron condor type breakeven points while giving us the ability to collect enough premium to make the trading worth it and we're using those out of the money options as protection against black swan type of events, market spikes of volatility and it's really, really cheap. Because implied volatility is so low, those out of the money options are very, very cheap. You don't have to go that far out of the money to buy those and they end up becoming very, very cheap insurance.

This worked out very, very well during the recent move down that the market had back in February because we were under-allocated, we kept our allocation size small, kept our overall allocations down and we had a lot of iron butterflies on, so we could afford to wait for the market to bounce before we took a lot of these things off because we had that protection in place and it was very, very cheap. In some cases, we paid $4 or $5 for some of these protections and these out of the money options on the long side. And yes, they were far out when we entered them, but then, when the market started to mini-crash, those really gave us a lot of protection for margin and allowed us to then scale into some of the higher probability, higher payoff trades during high implied volatility. I think they work really well during this environment. We're going to be setting up as we release our auto-trading software. We're going to be setting up some of these iron butterfly auto-trading bots that you guys will be able to use and clone over and that'll help honestly me in just setting up this low volatility strategy on a consistent basis. As always, hopefully this helps out. Until next time, happy trading!

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