Trading P.I.T. Session 6

The final online session of the Trading P.I.T. with Bill Keevan began with a review of the previous Options strategies we've learned. Although I thought the material was presented in an easy-to-grasp manner, there were a number of questions from the students on each of the strategies. Most of the questions were worthwhile and demonstrated understanding from the student that asked it. It seems natural to be a little confused on the finer points, and Bill did a nice job of answering each question as it arose. Because the review covered the specific entry and exit criteria, I can't simply spell it all out, but I'll include the list of strategies learned along with a brief description of their general applicability:

• Bull Call Spread & Bear Put Spread (Trading P.I.T. Sessions 1 & 2):
  Buy ATM & Sell equal number of OTM
  This is a debit trade used when expecting a strong directional move. This spread trade reduces our downside risk and limits our upside potential.
  
• Bull Put Spread & Bear Call Spread (Trading P.I.T. Sessions 1 & 2):
  Buy OTM & Sell equal number of ITM
  This is the credit trade equivalent of the Bull Call Spread (Bear Put Spread) but it has some advantages. It's ideal to hold to expiration and it tends works on less movement (which doesn't necessarily match our market outlook for a bullish move). For these reasons Bill Keevan doesn't like this trade.
  
• Straddle/Strangle ( Trading P.I.T. Session 3):
  Buy ATM/OTM Bulls & Puts
  This is a debit trade where we stand to make money if the stock moves in either direction, especially on increased volatility.
• Call/Put Ratio Backspread ( Trading P.I.T. Session 4):
  Buy more OTM options than the number of ITM Options sold (2:1,3:1,3:2,etc...)
  This is a credit trade where we make money as long as the stock moves. You have unlimited upside potential if the underlying moves in your direction or the possibility to keep the credit if it moves against you.
• Calendar Spreads (Trading P.I.T. Session 5):
  Buy long-term option and sell short term at the same strike price (unless it's desirable to diagonalize the trade).
  Calendar spreads are a way to take advantage of stagnation in an underlying security. If the stock trades within a certain range, you can be profitable. The strategy is similar to a covered call, except that it is pure options without owning the underlying.

After reviewing the above Option strategies, Bill Keevan talked briefly about Covered Calls which lead him to the Collar Trade. A Collar trade is a very low risk (<1% possibly) trade where we own the underlying security, sell a long-term Call (similar to a covered call, but with a longer time frame) and use the proceeds to purchase an OTM put for the same time frame. This trade has a limited gain and ties up much more capital than other options strategies, but the stock can be purchased on margin since we're protected by the Put we own. This is a very low-maintenance trade that can make 20%-50% annual. The Collar trade works in a Bullish market and can be an excellent, safe way to get a nice ROI. This resembles more of an investment strategy than a trading strategy.

There is considerably more to know about the above trades that the definition of what they are. Teach Me To Trade's entry and exit guidelines are pretty easy to follow, but do require considerable analysis of the options to put the odds in your favor and limit your downside risk. In most trades you make decisions based on the cost of the option and the delta, but if you want to know the specifics you'll need to take the class for yourself ;-). Seriously, mention my name... I don't gain anything from you doing so, but shouldn't you give credit where credit is due?

Following the review of the options strategies and the introduction of the Collar trade, Bill looked through some of our suggested trades and put them into OPUS. Bill took my suggestion which happened to be the last one of the night. I had suggested a Call Calendar Spread on COF (Capitol One Financial). The initial parameters of my trade made sense according to the entry guidelines but when we used OPUS to analyze the risk graphs of other combinations of options for a Calendar Spread, a Put Calendar Spread may make more sense. Bill suggested that it may be good to reevaluate this trade in a couple weeks and use the September expiration on the sale of the short term option to see if it works for me then. It was much easier to "see" the trade (risk graphs) using OPUS. I will be reevaluating what makes sense for this trade nearer to the August expiration.

I do plan to get OPUS or an equivalent option analysis software package to really unlock the potential of options in all market conditions. I'll be keeping all of these trades in mind and have already put in a Put Ratio Backspread and am watching it develop. The world of Options & Spread trading is very exciting and I see a ton of potential that I'll tap into soon. Stay tuned!

Trading P.I.T. Session 5

In tonight's Trading P.I.T. class, Bill Keevan presented Call and Put Calendar Spreads. Calendar Spreads are a powerful way to profit from stagnation in a stock. If you're familiar with Covered Calls, you've got a head start on understanding the basic strategy.

Without going into much detail about a Covered Call strategy, the basic idea is that you own the underlying security and sell the Out of The Money (OTM) Call for a market premium. Doing so limits your downside risk by the amout of the market premium, and if the stock doesn't move at all, you make a nice profit on the sale of the Call Option. If the stock goes down, you've offset your losses by the premium you took in with the sale. If the stock moves above the strike price, the option will be exercised; you'll make a nice profit, while limiting your risk, but will be out of the stock and unable benefit from further increases in the stock's value. You can make a nice percentage return using Covered Calls, but owning the stock ties up a considerable amount of your money and although you gain some downside risk protection, it's only offset by the amount you were paid for writing (selling) the call.

In a Call Calendar Spread we will buy a long-term Call Option (say 6 months out); this is akin to owning the stock like in the covered call strategy described above. We then sell another, short-term Call Option and take in the premium. By doing so, we don't have to tie up as much of our capital; this is the way we use the leverage that Options provide to make considerably more reward on risk. We can typically expect 4-8 times the reward on risk using a Call Calendar Spread instead of a Covered Call. In either the Covered Call or the Call Calendar Spread, we achieve maximum profits if the underlying security rises to, but does not exceed the Strike Price of the Call Option we sold. If the stock does rise above the strike price on the option we sold, we will be exercised and need to either buy back the short-term option or perform a same day substitution cover the Option we sold.

To me, this is the most complex strategy to describe profitability, especially without having a risk graph. Basically, when you combine the options in a risk graph, you'll see a range of profitability at expiration with fairly steep slopes around a peak that is centered above the strike price of the option we sold.

There are many ways to structure a Calendar Spread. Unlike a Covered Call, you can take advantage of a stagnant-to-bearish outlook by using a Put Calender Spread. The flexibility of this trade adds to the complexity. You can choose to structure the spread At The Money (ATM), Out of The Money (OTM) or even diagonalize the spread by buying and selling different strike prices. By comparing the difference in premiums between the options, you can choose which spread will match your outlook.

In order to make the most informed decision between the variations on this trade, it is a tremendous help and time savings to compare the risk graphs by using OPUS or another Options Analysis program. Of course the tools of the trade (yes, pun intended) cost you money, but consider this: If you're building a house, but are not willing to buy a nail gun, it will probably cost you more in labor than you saved on the tool.

Trading P.I.T. Session 4

Tonight's Trading PIT class with Bill Keevan was about Ratio Backspreads. We covered both the Call Ratio Backspread and the Put Ratio Backspread. This is a credit trade where we are expecting a strong directional move in the stock. However, if the stock moves against you, you still come out ahead. Let me give you a moment to think about that. If you are dead-wrong on the direction the stock is going, you can still make money. Isn't that a nice trick? There is a downside: if the stock just consolidates and doesn't move either direction before the options expire, you stand to lose money.

This strategy involves simultaneously Selling an In-The-Money (ITM) Call (or Put) Option and using the credit to Buy 2 or more Out-of-The-Money (OTM) Calls (or Puts). There is a lot you need to know about the Options in question in order to make this trade work for you. Again, this is one of those times I can't really tell you a lot about how to structure the order, you'll need to take the class so that I don't reveal the proprietary entry & exit criteria.

I have created an Excel template for a evaluating a Ratio Backspread. It allows you to quickly evaluate the entry criteria, by comparing 3 ITM contracts to 3 OTM contracts and allows you to change the number of contracts to Buy and Sell. Unless you have taken the class, you may not understand how to use it, even if you have taken the class, you may not know how to use it. I just created it to help me evaluate Ratio Backspreads for myself. If you're interested it can be downloaded by clicking here.

Trading P.I.T. Session 3

Tonight's Trading P.I.T. class with Bill Keevan covered the Straddle/Strangle option strategy. This is a neutral debit strategy where you make money if the stock moves either up or down. Without covering the specific guidelines TMTT teaches for entry and exit, the basic idea is that you buy a Put and a Call before expected volatility in a security. Of course if you think really hard about stock behavior, you may be able to predict increased volatility around specific, predictable events. I'll let you think about which events repeatedly produce such an increase in volatility so you feel like you've earned the answer.

This strategy is one where you can make money, typically 100% of what is at risk in the trade. However, if the stock does not move, you stand to lose money. It's important to make a distinction between how much is risked versus the total cost of the trade. We won't be risking the total cost because we'll only be holding the Call & Put for approximately 1/4 of their expiration time. Hence, if the stock's volatility decreases and it just consolidates or trades sideways, we will primarily be risking the decrease in value of the Options due to lower volatility. Option value is derived from volatility, so if there is a decrease in volatility the value of the options that we've purchased will also decrease. Theta decay (time decay) will also account for some of the money at risk.

I know this sounds fantastic, right? Make money no matter which direction the stock goes!?! It is a very cool trade, but let me tell you that there are a number of aspects that you need to pay attention to in order for this trade to work, and if you don't know the guidelines you can easily spend too much on the trade relative to the reward. You can also set yourself on a biased position instead of a neutral position. If you wanted to put yourself in a biased position, there are better trades to capture a directional move. As you would expect about pretty much any Option Strategy, you need to pay attention to the Option Deltas. This is a volatility trade and you must also take Implied Volatility into account. Also, like most trades, you need to take a look back into the history of an underlying security to help forecast the future to ensure your success. TMTT gives very clear guidelines for what the Net Delta should be for an ubiased position, as well as entry criteria based on Implied Volatility.

Tonight's class helped point us to some resources for identifying potential stocks to trade using a Straddle or Strangle Option Strategy. This isn't the easiest concept to grasp, but it shows just how powerful and flexible Options can be. I look forward to trading a Straddle/Strangle soon, but it seems this class was just a little late for taking advantage of this trade this quarter, however I will be looking for a current setup for this trade and hope to find one that will work for a paper trade. Stay tuned, it's starting to get interesting, isn't it?

Trading P.I.T. Session 2

Session 2 of the Trading P.I.T. with Bill Keevan was all about vertical spreads. We primarily focused on the Bull Call Spread because a vertical spread is a vertical spread, whether it's a Bull Call, Bull Put, Bear Put or Bear Call. Along with a recap of delta and how it affects option pricing Bill introduced us to Gamma also.

Gamma is often referred to as the second Greek. Second, of course, to Delta. Where Delta is a value that represents the change in option premium relative to the price of the underlying security, Gamma is a value that represents the rate at which the Delta will change. This can be described as the rate of change of the Delta. Delta captures the rate of change of the premium and Gamma captures the pace of the change.

Bill didn't spend a whole lot of time focusing on Gamma, instead we looked through practical applications and some spread setups against live market data. We already covered the basics of the Bull Call (Vertical) Spread and in Trading P.I.T. Session 1.

Trading P.I.T. Session 1

Tonight was Session 1 of Wealth Intelligence Academy's Trading P.I.T. Advanced Training Course. My presenter is Bill Keevan and I'm very excited to be in his class. Why? Firstly, I dig his personality -- he's funny. Probably more importantly, he has a nationally syndicated radio show; check out his profile on www.stockdr.com. He's also the co-ordinator for all the online training classes, and I've seen him pop in during some Master Trader sessions. He's instilled a new mantra in me in only one night. I'll be chanting this in my sleep (that keeps getting interrupted by my cat): win often and never lose big.

Bill did give us homework. We need to write a review for 2 out of 4 possible brokerage firms; possible firms: www.OptionsXpress.com, www.InteractiveBrokers.com, www.ThinkOrSwim.com, and www.PTISecurities.com. I've already set up an account with Options Xpress and am about 85% complete with an Interactive Brokers account. I'll write up my Interactive Brokers adventure soon, it should be quit entertaining, you won't want to miss it! Since I've already taken the tours of each of these and have set up the account, they'll probably be the ones I write about, however I will look at the other two as well. I'll also post my review here for your reading pleasure.

Tonight was an overview of Options as well as an introduction to the Bull Call Spread. What's that classic definition? Oh yes: An option is a contract between a Buyer and Seller, that give the buyer the right, but not the obligation to buy or to sell a specific stock at a specific price on or before a specific date in exchange for a market premium. By the way, that was from memory because I have not yet received the materials for this course (and I'm not a very good note-taker). The "specific price" in that definition is referred to as the strike price and the "specific date" is known as the expiration date. Options expire on the 3rd Saturday of each month, but for all practical purposes we only have up to the last trading day before the expiration to exercise the option. However, as Bill Keevan explained, we should never exercise, and especially we should never exercise an option. Instead of exercising the option, we should close our position by buying or selling the option.

There are two types of options that we can Buy and Sell: a Call Option and a Put Option.

When you buy a Call Option, you have the right, but not the obligation to Call the stock away (to buy the stock) at the Option's Strike Price. This is a debit trade, because you pay a market premium for the right to purchase the stock. Typically, you would buy a Call Option if you expect the stock to go up. For example, if the stock is currently trading at $35 today, you could buy the October 40 Call (a Call option with the strike price of $40 that expires the 3rd Saturday of October), anticipating that the stock would increase in value between now and October. Let's say it cost you $2 per share for the Option (the market premium). You'd end up spending $200 for the right to buy (to Call away) the stock for $40. If the stock does not increase in value, you lose that market premium. If the stock increases to anything above $40, say $45, you have the right to purchase the stock for $40, ensuring that you will make $5, minus the cost of the option ($2) meaning you stand to profit $3 for simply exercising the option.

When you sell a Call Option, you are obligated to sell the stock (have the stock Called away from you) at the strike price. This is known as a credit trade because you receive the money up-front. It also means you place yourself in an unlimited risk position as you are obligated to deliver the stock at the strike price. Bill made it very clear that he will NEVER recommend selling more options than you buy for this exact reason.

Buying a Put Option gives you the right, but not the obligation to sell the underlying security (to Put the stock to someone else) for the Strike price. You typically purchase a Put Option when you anticipate the value of the stock will decrease in value. You pay a market premium to have the right to sell the stock (to Put the stock) to someone else. If the value of the underlying stock is less than the Strike price, you stand to make a profit.

Selling a Put Option means you sell the right for someone to sell the stock to you (to put the stock to you) for the striking price. This one seems to be the oddest one of the bunch doesn't it? After all, you're selling the right to have the stock sold to you. This, like selling a Call Option, is a credit trade and puts you in an unlimited risk position. You are obligated to purchase the stock for the strike price because you were paid the market premium. You could profit from this trade if the stock's value increased while the option was still good. However, your profit is limited to the credit (the market premium) you receive when you sell the option.

The At-The-Money (ATM) Option is the option with a strike price that is nearest the current stock value. An In-The-Money (ITM) Call Option means the value of the stock is greater than the option Strike price. An Out-of-The-Money (OTM) Call Options means the value of the underlying security is less than the Strike Price. The opposite is true of a Put Option, it is ITM when the value of the stock is less than the Strike Price and OTM when the stock is greater than the Strike Price.

A bit more on terminology: If you Buy an Option you are described as Long the Option or the Option Holder. If you are Selling an Option you are Short the Option or the Option Writer. Why is all this terminology important? It's the language traders speak. If you don't know what it means to be an Option Writer, you don't know what the person is attempting to convey to you. And, of course, you need to know the difference between Calls and Puts and what it means to buy or sell either of those options. It is also important to know the Intrinsic Value versus the Extrinsic Value of an option. The Intrinsic value is simple enough. If the Option is In-The-Money (ITM) the option has intrinsic value, specifically the difference between the strike price and the current value of the stock. For more information about Options take a look at Wikipedia's entry on Options.

The introduction of the Bull Call Spread necessitated an explanation of Delta and Net Delta. Delta describes the value change per $1 move, so the Delta of a stock is 1-to-1. For every dollar the stock moves the value of holding the stock moves one dollar. Options are far more interesting because the Delta changes relative to the underlying stock. An Option's delta is at 0.5 when the stock value equals strike price, and approaches 1 when the option is deep enough In-The-Money (ITM). Likewise the further Out-of-The-Money (OTM) the option becomes the lower the Delta.

The Bull Call Spread involves taking advantage of simultaneously buying the At-The-Money (ATM) Call Option and selling an OTM Call Option. I'd share with you TMTT's specific rules for entry into this kind of a trade, but I'll let you pay for classes if you'd like to know. However, I will let you know that understanding Delta is important, and that you calculate the Net Delta by subtracting the OTM Option Delta from the ITM Option Delta.

If all this has your eyes glazed and your head spinning, not to worry. Bill will be reviewing all of the above information on the first half of Session 2 of the Trading P.I.T. If you've been reading this blog, you'd know that I gave myself a head-start by going through the OnDemand classes nearly a month ago. It's been my plan all along to go through the materials more than once to really solidify what I'm learning. I have a feeling most of these Trading P.I.T. Sessions are going to be on the technical side, and honestly I don't think I'll be able to share the specifics so as to no violate TMTT's copyrights and such. I'll do my best to give you a decent, general idea of what the class is about. Thanks for reading all this, I know it isn't easy!