Start With Papertrading

I am a newer subscriber. I paper traded  DIA using the exact recommended prices.  I was filled right away on the 1st and 3rd leg. The 2nd leg is at $1.71. Using a limit order of $1.79, I haven’t been filled.  Can you suggest what I should do in cases like this?

My short answer:

I would have entered the trade as one, instead of three options separately.
Sounds like you will have to adjust your price to get filled. my software is showing a price of 1.76 right now. Try that, and if not, reduce it penny by penny until you get it.
 
It’s a good thing you are papertrading. It is exactly problems like there we want to overcome before we use real money.

This situation is exactly why I advise all members to start with papertrading. Look, the market is not going anywhere. I know that you are anxious and eager to start making money but patience is very important. My trades are waiting trades. I mean that you put them on and then wait for time decay to do its thing. You need patience to trade these.

But when you start there are many things that can trip you up. Not knowing how to place an order correctly or misunderstanding your broker’s platform can cause a winning trade to turn into a big loser. I have seen it happen to members many times.

I am in the process of coming up with a papertrading manual that will give exercises on entering and exiting trades plus help you see how options work on a more advanced scale than what is normally discussed. This manual is in the works and will be posted on the members section of the site.

But to anyone who is starting out in options or selling options, or trading in general: Papertrade first, for as long as it takes for you to get comfortable with your broker platform, until you understand what all the order types are, until you understand which trades are debit trades and which are credit trades, until you can execute a trade like a condor (4 legged) in less than 1 minute.

Once you have these basics down, then and only then should real money be brought into the picture, because if you have real money on the line, and you need to move quickly to exit a trade, if you are not experienced you will screw up and cost yourself more money.

Iron Condors and Volatility

Question:

In your lesson you said that volatility is not good for options trading since you trade within  a statistical mean. If you do condor trades don’t you need volatility?  Won’t you make more money or will out of the money be the same at any price?

My answer:

The higher the volatility, the higher the option prices.
But in a condor, volatility is not as important as price action.
If volatility drops, we can exit the condor trade faster. But if it rises it just means we have to be in the trade longer. Volatility is more important in trades like calendars where it can destroy the trade if it drops too much.

Difference Between Stock Options and Futures Options

Obviously, there is a difference between stock options and futures options, and the primary differences are in flexibility as well as overall risk.

Let’s first review what futures contracts are as opposed to stock options. Futures contracts are standardized contracts that guarantee to buy or sell a specific commodity of standard quality, at a particular date in the future. This sum will be at market price. Contracts are traded on what are called future exchanges. So right away we can tell that futures contracts are not direct like stocks or bonds. They are still considered securities, but with a different type of contract.

Price for futures contracts is determined by what is referred to as instantaneous equilibrium, that takes into account basic supply and demand as well as competitive buy and sell orders on the market. The asset here may not necessarily be commodities; it can be anything from securities to intangible assets or even stock indexes. The future date is referred to as the delivery date. The settlement price refers to the official price of the contract at the end of a trading day.

1. One significant difference between futures contracts and stock options is that futures give buyers an obligation to fulfill delivery according to the contract’s terms, and the obligation for the seller to deliver the asset as agreed. The only escape here is if the holder’s position is closed before the expiration date. Whereas stock options are flexible by their nature, futures contracts require obligation. Futures are known as exchange-traded derivatives, as the exchange company’s clearinghouse plays the part of counterparty on all of the futures contracts.

2. Another major difference in these two contracts is the way in which gains are received. In options trading, a gain can be realized by exercising when the option is deep ITM, or by going to the market and taking an opposing position, or by waiting until the expiration and then collecting the difference in prices (in this case asset price and strike price). However, when it’s time to collect gains on futures positions, you will notice that these gains are “marked to market”, which means the change in the value of positions will be automatically handled at the end of every trading day.

3. Volatility is also traded differently. With equity options volatility makes the price of the option go up, in the futures it is the opposite.

4. Futures options also have many more strike prices than normal equity options.

5. Volume can also vary from option to option just generally many more equity options are traded than futures options.

How Wide Should Your Strikes Be In A Credit Spread?

Got the following question this week:

First, thank you for providing a great service. I have been trading options for about a year and have learned a lot from your tips and alerts.

Now, I have a question about position sizing.  I am trading $100k of my funds using your alerts. When you send out an alert I multiply the number of contracts by 10 when putting on the trade. My question is: instead of just multiplying the contracts, can I use a combination of increasing the contracts and/or increasing the width of the strikes?

 

For example, if the alert was to sell 2 SPX 1200/1210 Calls, instead of selling 20 10 point spreads, could I sell 10 20 point spreads? What would be the pros/cons of doing something like this?

It seems to me, if I widen the strikes, then when I need to make an adjustment, I could sell the near strike and buy the next strike as opposed to rolling the whole spread. Is there any advantage to this other than lower commissions and (possibly) better fills? More risk? I feel like I am missing something or not really thinking the strategy all the way through.

Thanks,
Adam

My reply:

How Does Option Time Decay Work?

What is option time decay and how does it work in the context of stock options?  Option time decay is denoted by using the Greek word theta. Theta continues to be one of six indicators in option trading known as the Greeks. 

Options are a decaying asset. Option time decay is a feature of all options that basically means that an option will lose value as time goes on and it gets closer to expiration. So when you are looking to buy an option, the more time until expiration means the more the option will cost versus an option that has less time to expiration in which the underlying can move.

Theta specifically measures the sensitivity of an option’s value according to the passing of time.  Another way of saying this is that theta is the ratio of change in an option price according to the fleetingness of time before the expiration.  An easy way to remember this principle is to think of options as living assets that are wasting away as they age.  The value of an option naturally declines as time goes on.  If an option is fast-approaching the expiration date and is not ITM (In-The-Money) then its value will quickly decline, since it’s highly unlikely it will turn out to be profitable. 

Option time decay really starts to pick up speed in the last 30 days before expiration, assuming that the option isn’t already OTM or Out-of-The-Money).  How about options that are deep In-The-Money?  Ironically, in this case time value actually decays even more rapidly.  Why?  Probably because the market thinks these options are too expensive to hold especially when compared to other strike prices.  Therefore, holders of deep ITM options are wise to discount the time value (for a contract quickly approaching expiry) in order to attract new buyers.  The best way to remember this principle is this: the more certainty about an option’s expiry value you have, then the lower the time value is.  Likewise, the more uncertainty as to the option’s expiry value, then the greater the time value you get. 

This is an important part of choosing when and where to buy selling options.  Theta or option time decay is not precisely the same thing as Time Value, though they are related in thought.  The meaning to take home is basically that the time to expiration will have a major impact on the price of the option.  As the option comes closer to expiry then its chances of becoming more profitable are actually decreasing, and counting against it. 

Besides, predicting a stock price eventually becomes easier as every day passes and seems to resemble the last.  Therefore, it’s the time value that is decreasing as maturity approaches (and particularly so once past the 30 day mark). As the option ages, it loses what is called extrinsic value.

For an OTM contract, the option is made up of extrinsic value anyway, so understanding this time principle is paramount.

When trading options, the amount of time left for an option is what can make or break you. Look at a chart of a stock moving in an uptrend and you can tell it is going higher, but you cannot tell how high it will go and by when. If buying options, buy yourself enough time to be right on your bet.

When selling options, selling close to expiration limits your risk. The farther away from expiration you sell, the more premium you get but you do not get the quick decay benefits of option time decay until there are less than 40 days to expiration.

This is why I like to refer to selling options as “Selling Time”. As time passes, the options you have sold lose value. Making money while sitting around. Not a bad job if you can get it. And you can, if you sign up for my service.

Option Trading Books Reading List

What are Some Good Books on Option Selling?

What should you do if you are interesting in learning more about option selling?

The best way to get started is to read a few good books on the subject.

When I first got started I went to an expensive seminar. After two days I knew enough about options to be dangerous – to my myself. After trying to trade options based on what I had learned at the seminar I realized, after losing a lot of money, that there was more to it.

So I started researching books on options, videos online, websites, etc. Here are some of the best books I found on options and trading in general.

Options Books

One of the most advertised books is The Complete Guide to Options Selling: How Selling Options Can Lead to Stellar Returns in Bull and Bear Markets by James Cordier and Michael Gross. It goes into detail about option writing strategies that can improve your profit. It reviews all of the basic mechanics of selling options and profiting as well as strategies that are insider-quality, easy to follow, and that have a high-probability approach. The book is written to appeal to the new investor, not a mathematician. In this book you can look forward to learning why selling options is more profitable than buying, and specific strategies for selecting various types of markets. Keep in mind that this book is about futures options, not equity options.

One of the first books I got was Options As A Strategic Investment by Lawrence Mcmillan. I would say this is the “bible” of options books. Why? Because it is huge and covers all the basics of option trading and then some.

Most option books cover the basic strategies but they leave out when you should use these strategies and what to do when the trade goes bad. Very few books talk about adjusting trades. The best one I found that does is The Option Trader’s Handbook – Strategies and Trade Adjustments by George Jabbour and Philip Budwick.

My favorite book on Option Selling is Generate Thousands In Cash On Your Stocks Before Buying or Selling Them, by Samir Elias. I myself have only used a couple chapters of this book but it was a very interesting with good ideas.

Wall Street Money Machine by Wade Cook is also a good read. But read this book for motivation only. Most of the examples and numbers in this book were over exaggerated but still, I liked it and enjoyed it when I was starting out so you might too. Most of the book was on covered calls.

A couple other “should” read book on option volatility are Option Volatility and Pricing by Sheldon Natenberg, and The Volatility Edge in Options Trading by Jeff Augen. Both are technical and for advanced options traders.

Books On Trading

How To Trade In Stocks by Jesse Livermore is a must read. Livermore was the best stock trader of all time and his strategies are now copied by just about every firm on Wall Street.

Trade Your Way To Financial Freedom by Van Tharp is good to give you some basic guidelines on trading.

Trading For A Living by Alexander Elder is also very good. I have all of Elder’s books even though they focus a lot on technical investing, he does show how traders with different styles can all make money if they get the basics right.

Option Symbols Are Changing

The symbols used to trade options are changing soon. Here is how Fidelity explains the changes:

Options Symbology Initiative (OSI)

Background

Due to the significant growth of the option market, the Options Clearing Corporation (OCC) has enacted an industry-wide initiative known as the Options Symbology Initiative (OSI). Fidelity will be implementing changes during the weekend of January 23, 2010. The new options symbology will expand the current option series key, commonly referred to as the OPRA symbol, from a 5 character convention to a new key that accommodates up to 22 characters.

Benefits of the symbol change

• It will be easier to identify a contract’s underlying security, original expiration date, call or put, and strike price without the use of code-translation tables. It provides more flexibility than the OPRA symbols. The new convention allows for the addition of unique identifiers for new issuers, for the indication of expiration days other than the standard monthly expiration, and for adjusted contracts. It will also indicate more precise and varied strike prices.

How this change affects you

• The main impact to you as a Fidelity customer will be learning the new symbology. Below is a guide that explains this new symbology and the important dates that you need to know.
• Existing functionality in Fidelity.com and Active Trader Pro will not change. You will still get quotes, place trades and do your analysis in the same way you did before this change. The only difference is you will now use the new OSI symbol in place of the 5 character OPRA code. If you choose not to input the new OSI symbol you can use the option chain to bring up quotes, click to trade, or use the drop down menus for quick and easy point-and-click access.

For more in-depth information concerning the Option Symbology Initiative you can go to the following industry website: http://www.theocc.com/initiatives/symbology/default.jsp.

Proposed Timeline

To allow for a more orderly transition from old symbology to new symbology, the OCC will use a two-phased approach. Phase One, Conversion, will roll out elements of the new symbology. Phase Two, Consolidation, will introduce all aspects of the new convention and will complete the process.

Phase One weekend of January 23, 2010

Phase One involves converting the old OPRA-based symbology to the new OSI symbology and its 4 key fields: Option Root Symbol, Expiration Date, Call/Put Indicator and Strike Price.

For example:

The old symbol (OPRA) of -VMFAY for a Microsoft January 22, 2011 27.50 Call will be -VMF110122C27.5 as a new symbol (after Conversion).

Phase Two March 12, 2010 through May 14, 2010

Phase Two involves simplifying the root symbols. The multiple-option root symbols currently used to identify options will be replaced by the symbol of the underlying stock.

For example:

The new symbol (after Conversion) of – VMF110122C27.5 for a Microsoft January 22, 2011 27.50 Call will be -MSFT110122C27.5 as a final symbol (after Consolidation).

Below is a detailed look at the upcoming changes. Please carefully review the following symbol formats and timelines.

Phase 1: What is Conversion? weekend of January 23, 2010

It is the date that the OLD SYMBOLOGY becomes “inactive” and the NEW OSI SYMBOLOGY becomes “active” for all processes. At Fidelity we plan on switching to the new OSI format during the weekend of January 23, 2010. The first trading day you will see and use the new symbol format will be January 25, 2010. The industry mandated cutover date is February 12, 2010.

What does this mean for you?

Until the weekend of January 23, 2010 you will continue to get quotes and place orders under the current symbology. On January 25, 2010 you will get quotes, analyze options, and place orders using the new symbology.

Phase 2: What is Consolidation? March 12, 2010 through May 14, 2010

The second stage, Consolidation, will start March 12, 2010. Consolidation is the process of consolidating option symbols that share the same underlying symbol. In nearly all cases, the resulting symbol will be the same symbol as the underlying symbol being delivered. For example, all LEAPS, wraps, short dated symbols with an underlying of MSFT and their respective series will be converted to MSFT. Furthermore, the standard MSQ series will be converted to MSFT.

There are a few known exceptions to the consolidation strategy above. One is for previously adjusted options with non-standard terms of delivery. The strategy for consolidating these nonstandard options is to convert the symbol to the primary underlying appended by a single integer. The initial integer being appended will be the number “1”, and incremented for subsequent non-standard options. For example, MSZ is the result of a prior adjustment and has multiple deliverables with the primary deliverable being MSFT. When Microsoft options are consolidated, MSZ options would become MSFT1. The planned date for consolidation of non-standard or adjusted options is: March 12, 2010.

The goal of this approach is to have all classes consolidated prior to June 2010. Here is the schedule for consolidation. The dates below are the days the options will be trading under the consolidated and FINAL symbol.

Option Symbology Key

It is important to note that Fidelity.com, ActiveTrader Pro and OptionTrader Pro will continue to offer existing functionality in the same manner as you are currently accustomed. The only change will be the symbol used. Below is a detailed explanation of the current option symbology and the new option series key for both conversion and consolidation.

Current options series key:

The current option series key is comprised of 3 individual data elements (Underlying, Expiration Date, and Strike Price) that collectively can be used to fully qualify a unique option. The Expiration Month and Strike Price Indicator elements are currently derived from translation tables. You will continue to use the old symbology until the cutover during the weekend of January 23, 2010.

Here is an overview of the current OPRA code symbology:

For a Microsoft January 22, 2011 27.50 Call, the current symbol is -VMFAY, where the first one to three characters represent Contract Symbol (in this case VMF translates to MSFT), the next character represents Expiration Month, and the final character represents Strike Price Indicator.

New Option Symbol Format — after Phase 1 Conversion (weekend of January 23, 2009)

The new OSI symbol format contains 4 key fields: Underlying, Date, Call/Put Indicator and Strike Price. IMPORTANT! — These 4 fields are strung together with no spaces in between to create the new OSI symbol format. During conversion the “underlying” contract symbol will be the unique root symbol used to identify the underlying in the old symbology.

For example, Microsoft, under current symbology, has several different root codes to identify the underlying. Those identifiers or root codes (-MQF, -MSQ, -WMF and -VMF) will continue to be used to identify those specific options. After consolidation, all of the unique identifiers will be converted to MSFT and adjusted options will be identified with an appended integer.

Nature of the symbol change (OSI Symbol — Up to 22 characters) — the new options symbol format will include:

For a Microsoft January 22, 2011 27.50 Call, the Conversion Phase symbol is -VMF110122C27.5, where the first one to six characters with no trailing spaces represent Underlying (in this case VMF translates to MSFT), the next six characters represent Expiration (YYMMDD), the next character represents Call/Put Indicator, and the final characters represent Strike Price.

During Conversion, the root symbol of the contract will be the underlying identifier under old/current symbology. Date is a full numeric representation of the contract’s original expiration date (YYMMDD); for example, November 21, 2009 becomes 091121 and January 16, 2010 becomes 100116. For the Call/Put Indicator, “C” is used for Call; “P” is used for Put. Strike Price is a full numeric representation, including the decimal point with fraction up to three spaces (with no trailing zeroes); for example, 100.00 becomes 100, 27.50 becomes 27.5, 37.125 remains 37.125, and 52.50 becomes 52.5.

New Option Symbol Format — after Phase 2 Consolidation (begins March 12, 2010)

For a Microsoft January 22, 2011 27.50 Call, the Consolidated (final) symbol is -MSFT110122C27.5, where the first one to six characters with no trailing spaces represent Underlying and the remainder of the symbol is unchanged from Conversion Phase.

After Consolidation, the underlying identifier will convert to the stock symbol for the underlying; for example, MQF becomes MSFT, MSQ becomes MSFT, VMF becomes MSFT, and WMF becomes MSFT.

Adjusted options will be followed by an integer to indicate that the option is non-standard.

Adjusted Options

Adjusted options will be followed by an integer to indicate that the option is non-standard. This means it represents something other than the typical 100 share deliverable when an option is issued. The first adjustment will be designated by a number “1” after the underlying symbol. The second adjustment for the same option will be designated by a number “2” and so on, if applicable. See below for detailed information on the change.

Example: Microsoft goes through a 3/2 stock split:

• Old Symbology (Microsoft Jan. 22, 2011 25 Call — represents 150 shares): -MSZAE
• After Conversion (Microsoft Jan. 22, 2011 25 Call — represents 150 shares): -MSZ110122C25
• After Consolidation (Microsoft Jan. 22, 2011 25 Call — represents 150 shares): -MSFT1110122C25

Notice that after Consolidation the number “1” now follows MSFT. This additional designation indicates that this option has undergone an adjustment and is a non-standard option.

Note: A leading hyphen is used by Fidelity to identify the instrument as an option.

Examples and company trading symbols mentioned herein are provided for illustrative purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for the security.

What is a LEAPS Option?

LEAPS refers to Long Term Equity AnticiPation Security.  These are options that consist of longer terms than average, as in the date of expiration.  LEAPS are not as common as other options but are still available on roughly 2,500 equities and 20 indexes.  However, like short-term options, LEAPS are also available for calls or puts. 

Options for LEAPS are traditionally created with expiration cycles of three months, six months or nine months, with no option term exceeding a year’s worth of time.  While there might be some exceptions now, traditional LEAPS are still the majority.  LEAPS are relatively new to the market and may extend as long as 2-3 years out.  As is the general rule, the farther away the expiration date, the more expensive the option is.  LEAPS are also available for indices now, as opposed to merely equities.

LEAPS are popular tools of investors who hope to reduce their risks.  The LEAPS strategy makes it possible for investors to manage risk and protect pricing by buying out put protection.  Obviously, using LEAPS does not guarantee success, as nothing in the market is ever 100% sure.  However, having more time on your contract for the position to work is a positive.

There are also other advantages to using LEAPS.  LEAPS lets you take an alternative route to stock ownership.  It allows you to benefit from price rises, while also risking less capital, as opposed to ordinary share-purchasing.  If the stock price increases to a level that is higher than the exercise price stated by the LEAPS contract, then the buyer has the right to purchase shares below the market price.  Then the investor can turn around and sell back the LEAPS calls for a much higher profit.

The buyer is also able to use these calls to diversify his or her portfolio.  Historically speaking, the market tends to reward investors in the long-term.  Most investors do not purchase shares in every single company they follow.  They carefully select according to market performance and research.  What’s nice about a LEAPS call is that once bought you have the right to purchase shares of stock at a specified period of time—or even up to three years into the future. 

LEAPS contracts also allow investors the opportunity to hedge their current stock holdings.  So if you are thinking about potential price drops on stock that you own, know that LEAPS options let you sell the underlying product at the strike price.  You can also do this at any time, up to the expiration date.

Are there any negatives to using LEAPS options?  Risks are limited, but still existent.  You have to invest the price you paid for the position.  If you are an uncovered seller of LEAPS calls or puts there is actually unlimited risk.  The risk generally varies according to what strategy you take.

It is important for investors to fully understand fully the risk of LEAPS as well as how this financial tool can work in your favor.  If you are willing to stick around for the long-haul, you may find LEAPS very beneficial.

One way to use LEAPS is in a covered call in exchange for stock. You can buy a LEAPS online for expiration in Jan a year or two away and sell current month options against it. The current month option will provide monthly income while the stock may appreciate in value. Thus, the value of the LEAPS will go up, while you make money month after month.

Beware of Option Trading Advisories

Many of my members belong to other option trading advisories. Some of these are similar to mine.  And normally you have to become a member to determine if their claims and trades are reality.

So this post is to just say beware of option trading advisories. Even mine.  never put money into a trade without papertrading the strategies first. Take everything said at face value and make them (and me) prove to you that they are telling the truth and that their trades do make money.

Here is an email from a member who tried another service. The name of the service is blocked out.

By the way, I had to open a XXXXX account just to see what those guys were up to.  Their 100% auto-trade loss last October was pretty scary (the only thing that saved them was that they came up with 100% gain in one day on what I guess was a $10,000 investment, which was not auto-traded and brings up many other concerns).
 
Anyway, I’ll be cancelling that and thought you must might be interested in hearing about your “competition”.  They’ve been legging into positions from the put side, which has worked out well through the summer, I’m not sure why (maybe to complete the condor, maybe being greedy for returns) but they opened 3 call legs 5-6 days before expiration last month.  One of which they sold for $.06 cents and it was threatened with a $.29 buyback the Wed before expiration and they chose to ride it out.  I had heartburn just watching.  Nonetheless, that proved to me they’re more focused on posting returns even when it would be near impossible to follow the trades, or when they’re breaking standard condor rules and that my returns would be a very distant concern of theirs.  So I’m done paying to watch that nonsense.

Scary stuff indeed.

“The Iron Condor is not boring.”

Hi, I just went through the course.  I have a question on the iron condor.  I had subscribed to another site that did those.  They said they picked strike prices far away from the current price so that the odds were better than 90% that they would make money.  Of course the market started to gyrate 100s of points per day and everyone was holding their breath for days. So I learned that these spread trades are not boring at all but can be extremely stressful.  I was glad to see that you weren’t just touting you make money 90% of the time.  I see that all the time but they fail to explain that you can lose 100% of your money up to 10% of the time.  That makes the strategy not conservative at all.  So my question is how much capital would you allocate to iron condors?  Also, in your example, when the price dropped near the lower strike price you closed out the options on that side and then entered into new options just farther down in price.  I can’t figure out why that couldn’t be done all the time so you really could have entered into this trade even when the market was swinging wildly in Oct.  I guess a follow up to that is how did you end up losing 30+% in that one month?  It would be great to learn what can go wrong.  Thanks.

First you have to limit your loss. 100% loss is not acceptable. I am out of a trade when I am down around 20%. The month I lost was a very large, sharp, quick, move. That is the worst enemy of the condor.
 
Most months you have no problems, like this month. i though it would be wild, but even with earnings I have not had to adjust my condors at all. Both are doing nicely.
 
If the price moves towards my strikes, at a certain point I will roll the options away from the money. That is a simple adjustment and one of the ways that help me to stay in the trade and profit even when the market does move. But last September, it was just too much too fast and i just got out of the market instead of try to play with it. I took my loss and exited. Which saved me because Oct was another horrible month for the condor. Through experience I felt that the market was not acting correctly and stayed out of the market.