It’s easy to come up with a solid list of reasons to learn to trade options. High-probability trades, liquid marketplaces, leveraged products - these are good reasons, but not the only reasons for at least taking the time to understand options trading. One of the biggest differences between equity trading and options trading is the amount of cash required to place a trade with similar characteristics to a stock trade.
For example, buying 100 shares of MSFT right now would cost you nearly $3,000. Taking a position that replicates the performance of 100 shares of MSFT could be as cheap as $100 - the cost of two at-the-money, 1-point-wide call spreads. These positions, at least in the short-term, are expected to perform very similarly - both will rise in price by around $100 if the price of MSFT moves up or down $1. The big difference is that one costs 30 times less than the other!
Recognize that options trading has its risks, many of which are tied to the use of leveraged products and the decaying nature of expiring products. But also recognize that for the trader looking for control of shares without most of the cost of purchasing them, options provide a real opportunity for success.
Most experienced traders recognize that the performance of their account will often mirror the performance of the major market indices. Those indices track the most popular stocks in the US markets, and are among the most widely watched economic indicators in the world. For the trader who wants to trade changes in the overall market, or who wants to hedge existing positions, major ETFs present one viable path to do so.
Major market ETFs like SPY (S&P 500 ETF), QQQ (NASDAQ ETF), IWM (Russell 2000 ETF) and DIA (Dow Jones Industrial Average ETF) present traders with products that nearly perfectly track the indices upon which they’re based. These ETFs are extremely liquid, trade through the normal and after-market hours, and have incredible options volume, making them prime targets for any options trader, and great tools for hedging a long stock account.
Bottom Line: Familiarize yourself with the products that are available to you – stocks, ETFs, options, even futures and forex. The more you understand about the market, the better equipped you are to manage your portfolio in any market condition.
If you’re a TickerTank Premier Member, you receive our trade ideas. Sometimes we post complex options trades like spreads and iron condors (see today’s trade!), and sometimes we keep things more simple and put out mixed stock and option trades, like covered calls.
The covered call strategy is the most widely used in the options market. It involves buying stock and selling a call option against that stock, in order to reduce the total debit paid when the stock is purchased.
Why do we want you to know about them? Because selling a covered call against stock you already own creates a credit in your account, reduces the cost basis of your stock, and increases the probability that your stock trade will be a successful one in the long term.
Bottom Line: If you own long stock, covered call trading is a great way to increase your income and your probability of success.
Arbitrage is a term that every trader has heard in a headline, and every finance major has calculated on a test. It has a kind of mystique about it - the concept of “free money” in the markets, taking advantage of inefficiencies in pricing across multiple products or locations. It’s an interesting concept for a trader to consider, because the market is driven by fair pricing.
True arbitrage occurs when a trader can open a position and open an exactly opposite position at the same time, for a difference in price. An example would be the trader who can buy a share of AAPL at 590 and sell short a share at 590.50, in simultaneous orders (or at separate exchanges at exactly the same time). The trade has an instant profit of .50 per share - the definition of free money in the market.
It turns out that most options strategies are built by this concept. This is a tough thing to visualize without real training in advanced options strategies, but contracts are priced in relation to the underlying stock, and to each other, across strikes and across months, and even across products in some cases. This giant web of relative pricing keeps things in line for the retail investor, and helps to guarantee fair pricing on any product with significant volume.
While true arbitrage is almost impossible to find for the retail investor, it’s not an impossibility for the large players in the market. As you read this, servers across the world are ticking across hundreds of thousands of trades to capture fractions of a free penny. This transaction volume means there is substantial liquidity for those of us who trade in comparatively smaller lots, and we get better, faster fills on our orders because of it.
Bottom Line: Free money isn’t something you should search for, but understanding how options strategies replicate stock and other options positions will help you be a better, more mindful trader.
FSLR is up almost 10% today on news that it reached an agreement with a Californian county to continue construction of large-scale solar panels. Taking a look at the FSLR daily chart, it could be coming out of a nice basing pattern, and has recovered to cross it’s 50-day moving average for the first time since a late-February gap down.
This is worth paying attention to for the next few days. FSLR July options still have an almost 90% implied volatility even after the news of the agreement. This could be a great candidate for vertical spreads, or even a naked put, given the low cost basis of the stock and high implied volatility (roughly 5x the current level of the VIX, 18).
It’s been a summer of interesting volatility movement this year, as is evidenced by a 10-point range in the VIX since the start of May. It could be Europe fears, or Fed nonsense, but it’s presenting some interesting opportunities in the options markets. The VIX is up almost 3 points today on a >1% drop in the S&P 500, and this is about the 10th time in June that we’ve had such a large range.
Keep your eyes open for buying and selling opportunities that tend to crop up during periods of VIX fluctuation. Even if day-trading isn’t your speed, a spread seller can find good fare while the market is deciding what a fair volatility level is. You can bet we’re paying attention, and you’ll find proof in our trade alerts as the summer moves along.
Yesterday we posted an opening trade alert on SPY, and talked about a possible pullback to the $134 neckline of the recent inverted head and shoulders. Our blog post yesterday morning mentioned the possibility in detail, and it looks like the market was listening.
There were two hard spikes towards 134 during the day - once at lunchtime (the highest volume bar in the day, which is rare) and once in the last hour. Both drops were followed by rallies back to the daily VWAP (volume-weighted average price) near 135.40.
This just strengthens our feelings about the chances for a bullish market in the short term. If you put in that opening trade today, you should have been filled (we were, check the update) and you should have your eyes open for a possible exit next week, depending on market circumstances.
If you’ve used our trades, or read through our ideas, you’ll see that we include a very specific probability of success for each trade we propose. Obviously this is an estimation, as it’s predicting success in the future, but it turns out that the numbers are very accurate over time, with a large enough sample size of trades. It’s an accurate enough measure that tickertank.com founder Nick Fenton won’t place a trade without first considering probability of success - and in fact he manages his portfolio to maintain a specific probability average.
Take the time to consider your odds of success when you trade - it’s an important measurement that can offset the human tendency to “reach” for bad trades and be over-aggressive. Look for the trade that makes sense for you, and if it isn’t there, step back and find another than fits your criteria. If you can do this, the probability is that you’ll find more success!
If you’re a veteran trader, or you’ve been with us for a while, you know all about penny increment options - those options whose bids and asks move .01 at a time (or can, at least), vs. all other options, who move at .05 or .10 per tick. Penny increment options are great, because they allow for tighter spreads, more liquidity and allow you to be very specific in placing your orders.
You can find a list of all stocks and ETFs whose options are listed in penny increments inside the thinkorswim platform, which Nick will be demonstrating today on thinkorswim’s Wednesday Chat at 4:30 EST. Pay close attention - there are a few stocks that fall outside the list (notably Google, symbol GOOG), but for the most part this is a great starting point for making your personal watchlist.
Learn more about liquidity here:
Nick Fenton, founder of tickertank.com, will be speaking on thinkorswim’s Wednesday Chat tomorrow at 4:30 EST. Among other things, Nick will explain how to use specific criteria to find trades using different strategies.
One of the tools on the thinkorswim platform, the Spread Hacker, has turned the art of evaluating strategies into a science. You can use the tool to sort through specific filters, like probability of success, time to expiration, and underlying price. You can even assign the Spread Hacker to look only in your custom watch list of stocks and ETFs you trade.
Whether or not you use the spread hacker tool to find your trades, remember our advice - have parameters for each strategy you use. This will help you reduce the time it takes to find a trade idea, and help you hone your skills as a trader.
A recent article quoted various industry sources in claiming that new miniature options contracts could be released soon on high-priced, liquid stocks such as AAPL and GOOG. These options would use a contract multiplier of 10x instead of 100x - meaning that the trader who buys or sells a contract is only involving 10 shares of stock, rather than 100.
This could be a great opportunity for retail investors who own a few shares of large companies as a part of their portfolio. Instead of having to own $60k (100 shares * $600) in AAPL to write a single call against the stock, those investors who own 10 shares, or roughly $6k of stock, can participate in the additional returns and hedging opportunities that the options market presents.
Be warned, though - this type of product, when first released, will likely have less volume than “normal” 100x options, so prices may fluctuate wildly until the market gets a firm grip on pricing.
Bottom Line: New products are released regularly that, in theory, help the retail investor. Be sure to think carefully about the products you trade and the cost and leverage provided.
Tomorrow tickertank.com founder Nick Fenton will host a 3:00 PM CST chat session on TD Ameritrade’s trading platform, thinkorswim. Nick will cover trade selection regarding a few options strategies - Iron Condors, Butterflies, and Short Strangles. Be sure to catch the chat, as we’re sure you’ll learn a lot from Nick - he’s a seasoned pro!
One of the things Nick is sure to mention during his chat is liquidity. Liquidity, to most people, means the ability to sell something (like a house, car, or baseball card collection) for a fair price without a large delay in “execution”. In the market, liquidity includes this definition, but also involves the amount you lose when you enter a trade.
It’s common to see new traders, and even experienced traders, hear a tip on a new company, or catch an article online that sparks a trade idea. This isn’t a bad thing, but less-known (and less-traded) stocks have wider bid-ask spreads, which means you’re paying a higher price to buy, and receiving a lower price when you sell, than the real value of the shares. This is especially true in the options market, where low volume and wide spreads can lead to differences of $100’s of dollars per trade.
How much do you lose to low liquidity? Well, if the bid/ask spread on an option contract is $1.30/$1.70, and you purchase the option, you’re paying $170 per contract for an option with a real value of $150 (the average of the bid/ask spread). This is $20 per contract you’re losing - a simple 5-contract trade pushes the “loss” to $100!
This isn’t money you want to leave on the table! Catch Nick’s chat tomorrow, and be sure to listen carefully for his full explanation on how paying attention to liquidity can save your trading life!
Meet Nick here: http://www.tickertank.com/General-Information/meet-nick-fenton