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OptionSIZZLE is created to help you better understand and become more familiar with options and what the professional traders are doing everyday in the market and provide effective options trading strategies to allow you to trade better and trade smarter. We have found over the years some of the... More
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  • Putting Context Behind Your Options Strategy

    One my favorite parts of running OptionSizzle is engaging and interacting with all the different types of investors from all over the world. It brings a lot of joy to me to be able to help them in their quest to build wealth.

    However, sometimes I feel when they reach out, they've got so many preconceived notions about how options should be traded…along with a list of Do's and Don'ts, that aren't always logical.

    For example, I get a ton of responses on social media whenever I discuss the topic of selling option premium. For whatever reason, they believe that selling premium is a widow maker. I'm not sure where this belief stems from…but it's pretty silly.

    Let me show you why.

    On October 3, 2014, Tesla Motors closed at $255.21. Let's say you had a bullish bias on the stock over the next 5 weeks and wanted to express that by buying a call spread, the November $265/$275 call spread.

    Using mid-price (average between the bid and ask price), these were the values:

    NOV $265 calls: $12.90
    NOV $275 calls: $9.30

    So if you bought the NOV $265 call and sold the NOV $275 call for $9.30, the spread would cost $3.60.

    (Note: This is not a trade recommendation and in a live market it's unlikely that you'd get filled at the mid price…this is just an example)

    What is your belief with owning this spread?

    Well, to break even on the trade at expiration, we would need Tesla to close at least $3.65 above $265, which is $268.60.

    Since this is spread was purchased, the maximum risk is $3.60 per contract.

    The trade is risking $3.60 to make $6.40. This is derived by taking the max value of the spread, $10, and subtracting the premium spent on the trade.

    Makes sense?

    Good…Moving On

    I know that some savvy option investors already know this…but what if I were to tell you that you could replicate this same position by selling premium…here's how:

    By selling the NOV $275/$265 put spread.

    The mid-price for the NOV $275 put is $29.13
    The mid-price for the Nov $265 put is $22.73

    By selling this ITM put spread, you'd receive a premium of $6.40

    So what is this spread saying?

    In order to break even on the trade at expiration, we would need Tesla to close $6.40 below the $275 calls that were sold, which gives a price of $268.60.

    In this example, $6.40 were collected on a $10 spread…which means the max risk is $3.60.

    Now, if you look at both examples again, you'll notice something very interesting…

    They are both the same trade in respect to break even points, risk and reward. One is done through buying an OTM call spread, while the other is done by selling an ITM put spread.

    This isn't magic…this is how options work. After all, if one was more expensive than the other…you'd simply sell the more expensive spread and buy the cheaper spread for an instant profit.

    In options jargon these are called "synthetics" or replication.

    Here are some more examples:

    A long stock position: Has "undefined" profit potential on the upside and defined risk on the downside (a stock can only go to zero).

    How do we do achieve this with options? Well, a long call option has "undefined" profit potential…but what about the defined risk on the downside? That can be achieved by selling a put.

    Going back to Tesla, if you were long stock at $255…the synthetic equivalent would be long the $255 call and short the $255 put.

    A short stock position: Has defined profit potential towards the downside and "undefined" risk towards the upside. To replicate this with options we would just using a combination of calls and puts that have this same risk profile.

    For example, if you're short Tesla at $255…the synthetic equivalent would be long the $255 put and short the $255 call.

    Long StockLong Call + Short Put
    Short StockLong Put + Short Call

    By using the above table, we can mix and match stock and options to create other replications.

    For example, long stock and a short call is known as a covered call…or synthetic put.

    Long Stock + Short CallLong Call + Short Put(the embedded long call is canceled by the short call)

    I could keep going…but I think you get the picture.

    You see, there is a relationship between stocks and options…longs and shorts…calls and puts…they can all be replicated. This ideology that you've got to stick to only buying premium is silly once you understand these relationships. With that said, being solely a premium seller is also silly.

    Professional traders understand this…for the most part, they don't care if a stock is moving higher or lower…all they want is increased volatility…because that's what creates opportunities in their eyes.

    With that said, your focus should be on the opportunities in front of you. Too many people are focused the premium buying vs. premium selling debate. It's like democrat vs. republican…the reality is it's all the same.

    Unfortunately, we as people sometimes put our attention on the wrong things.

    So What's important then?

    Idea Generation: This can be driven by fundamental, technical, unusual options activity, event-driven and from views on volatility to name a few. If you're having difficulty generating ideas, I suggest you check out my free report on unusual options activity.

    Options Landscape: Are the bid/ask spreads competitive? Are options relatively cheap or expensive? After addressing these questions, then you can start thinking about an options strategy.

    Identify The Type of Trade: Is this a binary event? A technical play? A long term or near term play? An earnings play? By answering this question you'll get a better feel for what you should be risking, time needed and how you should be sizing the position.

    Risk & Position Management: Now, if you've sized the position correctly, a lot of the hard work is out of the way in regards to handling losses. For many option investors, handling winning trades is a lot harder. I have different approaches, depending on whether I sold or bought premium.

    As I've mentioned before, options are just a vehicle and an options strategy is an expression of a trade idea. As you gain more experience, you'll learn what works best for you and what doesn't. You'll want to focus on your A+ setups as much as possible…and have the discipline to not overtrade or put on trades out of boredom. There are periods where trading options can be full of excitement…others where there isn't much going on and you'll need to be patient.

    Remember, cash is also a position and a luxury when you manage money for yourself.

    Choosing when to be more active or less active comes with understanding opportunities when they do or do not arise.

    It's a myth that you have to be fully invested at all times and something financial professionals have told you for many years because they only get paid if your money is invested.

    With that said, you've got to put everything into context. Although I'm an advocate about selling premium, certain conditions apply. The same can be said about being long premium. They both can work if the right conditions are met.

    For example, when I'm selling premium…I'm look for options that are relatively rich, the stock options need to offer good liquidity so I'm not chopped up in the entry and exit.

    Also, I take into account the price of the underlying stock and the type of risk I'm willing to expose myself in. Sometimes short strangles can be justified…other times I'll use a structure a trade to define my overall risk.

    In fact, The SPX Method is a detailed course that teaches you a step by step blueprint on how to make the market beat you. By following specific parameters you'll be provided with the best chances to create profits on a weekly basis.

    However, certain conditions need to be met. For example, if the VIX is above 15…we'll look to entering one of our trades on Wednesday morning…but it's near 17.50…we'll put it on Wednesday afternoon…if it's near 20, we'll wait a day and put in on Thursday.

    Bottom line, the opportunities must fit the parameters.

    In conclusion, the premium buying vs. premium selling debate is futile context. My belief and my approach is to utilize both. Money can be made and lost in both fashions. What's important is your process and execution.

    Too many times investors get caught up in "strategies" and options marketing jargon…most strategies are just way to define risk. A strategy will only work if the right conditions are met…that's what OptionSIZZLE tries to teach you.

    I believe that selling premium provides the best probabilities of success. However, I understand that buying options offer that potential for a home run trade, and that you should have some of these type of plays on as well.

    Focus on what's in front of you and you'll never look back.

    What are your thoughts on this great debate? I'd love to hear from you in the comments section below.

    Oct 09 1:16 PM | Link | Comment!
  • How To Start Trading Options Successfully

    (click to enlarge)

    In How Can The Average Guy Succeed Trading Options?, I wrote about how there is no minor leagues for investors…that we are all trading the same markets. Of course, this is intimidating when you think about it.

    After all, you are competing against sophisticated algorithms, well-financed hedge funds, traders glued to the screen, itching to move on the latest news that hits their Bloomberg terminal.

    While I think there is a speed edge for them, that shouldn't affect the success you can create in the markets.

    Namely because these groups have different approaches and objectives when trying to generate alpha.

    So, how can you possibly compete as someone new, just starting out?

    Most likely, you'll end up losing money. I know I did on my first options trade…but I chalked it up as a lesson learned and knew there was a lot more I needed to learn.

    You see, there's a lot to learn before you can become a successful options investor. Not only do you need to know the mechanics behind options…but generating ideas and executing them, given the current market conditions.

    After all, options are just a vehicle and an option strategy is just an expression of your opinion. Without placing a live trade, you won't know exactly what fits your time constraints and level of comfort.

    Many successful investors will tell you that they have no clue on whether a stock will be up or down any given day…however, over a longer term horizon they feel they'll be right.

    Whereas, a day trader can tell you where they think a stock will be headed over the next 5 minutes but have no clue on what it will do tomorrow or next week.

    First things first, it's important to set reasonable expectations for yourself.

    You've probably heard from a loved one before that you're special…and you are…but don't think that's going to translate to instant success, when it comes to investing and trading the markets.

    Every now and then, I'll get emails from aspiring traders, they'll tell me how committed they are, how quickly they can learn and that they're analytical…all great things of course.

    However, they then end the email by asking me if I think it's realistic for them to achieve 10-15% monthly returns if they do all the right things.

    Unless you're some kind of prodigy, your first 6-12 months is a learning experience. The goal should not be making a lot of money…but simply not losing a lot of money.

    Even Kobe Bryant had to wait till his 3rd NBA season before becoming a full-time starter for the Los Angeles Lakers.

    So how do you get started?

    The answer is simple, like the Nike slogan says…JUST DO IT. What I mean is opening an account with a brokerage firm and start trading small. But Josh, can't I get started with a demo account and paper trade?

    You could, but I personally think it's a waste of time. Most likely, you won't take it seriously enough…and if you are not doing the stuff you'd be doing with real money then the entire exercise is a time waster.

    By starting off small you accomplish a number of things:

    • You'll have skin in the game
    • You'll learn about execution
    • You'll learn how you manage emotions
    • You'll also be able to see how your idea plays out because you're not risking a lot
    • You'll learn the foundations of money management

    You see, one of the biggest issues new and sometimes experienced traders have is poor position sizing. By starting off small, you'll have the ability to evaluate whether your ideas are profitable or not.

    Two things could happen.

    The first, your confidence grows, allowing you to eventually add more size to your trades.

    The second, your ideas don't make money and you have to go back to the drawing board.

    In business they call this proof of concept.

    Again, by starting off small, you'll gain valuable "screen time" and experience. If you haven't noticed, there is a lot of noise in the stock market. If you're over-leveraged, you'll most likely react to the noise, forcing you out of a position at an unfortunate time.

    In addition, by starting off small you'll learn the foundations of money management. Not every trade is the same. Some trades you'll get in might be binary events, earnings, for technical reasons, fundamentally driven or even based on a view on volatility.

    For me, a good chunk of my ideas are generated from unusual options activity using my SIZZLE Method.

    Of course, I like to mix it up by shorting volatility in stocks or indices that I believe are over-valued. In fact, learning how to make the market beat you is probably easier to manage than buying options, which I've found that a lot of individuals struggle with.

    In any event, you'll need to record and backtest yourself on each trade to see what works for you. For example, let's say you bought calls after following unusual options activity in a stock.

    Some notes that you should record:

    • What was the order, the quantity and price that motivated me to get in this?
    • What is the implied volatility and how does it relate to where it's been this year?
    • Did you pay up and chase these calls or are you getting in at nearly the same level they are?
    • If these are near term options, do you think the order flow was driven by technicals or something else like an earnings, conference, rumors or some other news catalyst?
    • If these are long term options, will you stay in the position until it possibly works? could your capital be better used elsewhere? Will you get bored and close out if nothing happens in a month or two?
    • Is there any other activity in the sector or is this isolated in just this one stock?

    The beauty behind unusual options activity is that you're given some sort of guideline on where the smart money thinks a stock will go and by when.

    Of course, they are not always right…but there is some comfort in knowing that they're putting their money where their mouth is…and not some random talking head on TV sharing their opinion with likely no skin in the game.

    Once you're in a position:

    • Take note on how the options react intraday, daily and weekly. Of course, some stock options are more volatile than others. It's important to identify how you react to these up and down swings. By trading small, you won't be spooked out by the random noise.
    • Pay attention to how the value of other options in the stock reacted. Could you be doing better if you bought another strike or another month? What if you sold put options instead?
    • Take a note of anything that surprises you. For example, are you seeing other call options being bought in other strikes or months? Are volatility levels increasing or decreasing? Have the bid/ask spreads gotten more competitive or worse?

    Most importantly, evaluate yourself as if you had more positions on.

    • Would you be getting out if you reached a certain level of losses? If so, would that be the right decision or would you have gotten shaken out?
    • Would you piecing out and taking profits as it moved in your favor?
    • What if what you were playing for actually happens, will you take profits or get greedy?
    • If you're wrong, will you be able to accept that and move on or will you take it personally and be stubborn and take in bigger losses. Being wrong is part of this game, losing money on trades is part of this game…if you can't accept that, then this isn't for you.
    • Is your strategy scalable?

    Again, these early stages are all about discovery.

    Discovering who you are (and will be) as an options investor… and how you'll react and perform given different types of market conditions.

    You'll discover which type of ideas work best and which ones don't. That means keeping a journal and recording the details of your trades. This topic has been discussed in greater length here …if you'd like to learn more about it.

    There is a ton of noise in the market…trading small allows you to play out your ideas and strategies without getting spooked out of a position. The more experienced you become…the easier it will be to identify from what is real and what is noise.

    Look, you can read all the articles and watch all the videos you want…heck, you could even shadow a great trader…but unless you jump in and start doing it yourself…you won't fully grasp what's going on.

    A proud father can tell me everything I need to know about parenthood…but unless I experience it for myself, it won't hit home like it would if I was in his shoes.

    The combination of a good options education and real-life experience is going to help you become better and potentially successful at this.

    Sorry, but there are no guarantees here.

    With nearly 10 years of industry experience, I can confidently tell you that I can help you in reducing mistakes. As well as, showing you how to spot opportunities that have a strong likelihood of success.

    I understand that most trader educators have a bad reputation…and I agree some of them are snake oil salesmen. But that doesn't mean we should all be thrown in the same mix.

    Elite athletes rely on several different types of coaches and trainers to help them get to the next level.

    However, when it comes to option trading and investing, the general public believes they can pick up a book on Amazon or watch a free video on YouTube and they'll be ready to compete against the best, brightest (and sometimes crooked) traders and institutions on Wall Street.

    It's not that easy folks, but hard work and doing the right things will help you succeed.

    You know, I am a big believer in keeping things simple. I understand that some of the advice mentioned in this article may sound too simple…but believe me it works.

    If you're looking for a good starting point to build a foundation, without a steep investment, check out Fearless Leverage for Income, a book I wrote that covers the basics on option investing

    I am also working on a course for those who are just starting out, something that I wish I had when I first started learning about options…probably would have prevented me from losing $2k on my first trade.

    In the meantime, our SPX Method is a very detailed and easy to follow along course, aimed at helping those who do not have a lot of time to focus on finding quality opportunities. It will help you trade smart and prevent you from chasing the next hot stock in play.

    If you decided to start off small, Congratulations!

    I'd love to hear how you're doing. It's always good to bounce off ideas and thoughts with someone else who has (or is) going through the same obstacles as yourself.

    I'll be hanging out in the comments section below.

    Oct 03 9:47 AM | Link | Comment!
  • Why Market Insiders Are Not Always Smart Money

    If you followed every unusual options activity order during the trading session…you might end up running out of capital before lunch time.

    What I'm trying to say is that there are literally hundreds of large option block trades a day.

    After you watch the case study video below, you'll be able to understand that spotting an unusual options order is just the first step of the process.

    Too many times option investors don't take the time to analyze the order…they simply copy and paste the same exact trade the institution made.

    By following that approach you'll sometimes have to endure several losses before potentially reaping the rewards. Some option investors are not capable of enduring that kind of psychological pain and frustration.

    This doesn't mean that following unusual options activity is a waste a time. It's actually the best tool for generating investment ideas. However, you've got to be able to analyze the orders before you can select the proper strategy.

    This is why I created The SIZZLE Method Report after receiving a emails from people asking me about my approach and hearing the frustrations from people losing money chasing trying to chase every trade and learning the hard way.

    You see, all we know is that a large player in the market is expressing their ideas with options. We don't know how much capital they're working with…whether the options are used as a hedge or for speculation.

    Sometimes they are wrong and they lose a lot of money…or what seems like a lot to you and I.

    Let's put things into perspective.

    Let's say an institution has $1 billion dollars under management and they go out and buy $200,000 worth of upside calls in a stock. Sure, it's a big bet to you and I…but if they're dead wrong on the investment idea…they aren't going to be closing down their business off that one trade.

    Furthermore, we can still take their ideas…but instead of copying their trade verbatim, we try to structure trades that skew the risk/reward more towards our favor and manage our risk.

    Like you will learn in the video as I explain my thought process when I spotted an unusual options order, that was likely and insider.

    The insider was right, but still lost money…

    In the video, you'll learn the kind of questions you should be asking once you spot an interesting idea… and how to scan through an options chain to gather valuable information.

    Also, how to generate alternative trade ideas that have a higher probability of success and using unusual options activity to generate investment ideas.

    After you watch the video I'd like to hear your thoughts. Are any of the concepts in the video new to you or are they incorporated in what you're currently doing?

    Learn More About The SIZZLE Method Report

    Oct 01 11:54 AM | Link | Comment!
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