Short Term Trading method using Options

Introduction

I was introduced to the options trading instrument by Conrad in his Pattern Trader Tutorial. He and his team have convince me the stability of using this instrument as a mean to trade. The main reason to use options is mainly as follows,

  • Options is regulated. Authority has eyes looking over it.
  • Options has high liquidity in SPY. High liquidity means less probe to manipulation.
  • Options is not expensive. It is a leverage instrument.

The word leverage is a very scary word. Everything I heard about leverage is always about big losses that cannot be handled. This was also why I was quite negative about trading. I can understand why most people has the perception of trading and the word leverage as a very dangerous stuffs. I don’t blame them because I was too.

Conrad tutorial has shifted my mind back into the fundamental of being a trader. I wasn’t expecting his form trading teaching. I was really wondering why am I in his class. Even though he and his team has convinced me on using Options as an instrument to trade, I dare not even touch options on my paper account. It was that terrifying. We were taught using a trading platform ThinkOrSwim (TOS). The platform was overwhelming. I took me very long time to learn the basic of this platform alone, about 6 months after I graduated from his 8 weeks class.

Reading books and books about Options didn’t really help me to overcome that fear. I choose to join Chen Pang classes (Conrad’s trainer) to learn options from him. His trading method is much less aggressive and is very different from Conrad. It totally remove my fear about Options. My confident is there, but I am still not familiar with TOS platform. Shortly after the Options class end, I put in extra effort to study the platform in more details. Just as I am pretty comfortable with the platform, Chen Pang invited us to start placing an Options position to learn trading. I placed my very 1st trade on SPY using my live account. Ok, the trade that I was going to take has a pretty high probability but this is my 1st trade, I cut my order from 10 to 5 contracts, which gave me about USD 300 max profit and loss. This is about S$500, which is already quite a big trade compare to my past trade using CFD. I learn much more from this real trade, the mechanics of trading Options, learning how to click to place my Options order, and learn to monitor. After familiarizing, I learn how safe Options can be.

Options can be like driving a car or riding a bike. Some may see it as a dangerous and risky activity. This is why we need to learn driving/riding, take a test before we can drive/ride on public roads. Once we learn and be familiar with how to drive or ride safety on the road, practise it often, we become better with it and there will be lesser fear in us. If you don’t know, don’t understand it, it will be scary and difficult to understand. If you know it, it become easy to understand and less scary. It takes a lot of effort to push myself through this scary journey. Now I don’t feel that scary because the trainers have shown me where all the most dangerous pit holes are. We just need to pay attention them, and not get ourselves into trouble.

Through Options is known to be a leverage instrument, if you use it properly there is really no leverage at all. It is meanly an instrument which allows you to trade a good and safe stock at a price which you can afford it. Penny stock in US market cost around $10 and below. The amount of money that we can buy blue chip stock in Singapore, can only buy us a penny stock in US market. Penny stock is not stable as blue chip stock. A good stock in US market can easily cost more than USD50 per share. This turns out to be about S$70-150 per share, or $7000-$15,000 per lot of 100 shares. That’s means we need to fork out that much money in order to make a smaller amount of gain.

The 1st trade that I took was a vertical spread (selling a vertical call spread). It has a limited gain and limited loss. This means that I am in control of the maximum amount of profit I can make and know the maximum amount of money I can lose. The trade is quite plain sailing. As long as the price do not move against me, I will be in the positive side. The gain/loss movement is slow. Each trade easily last for 1-2 months period. Slow and steady, there is no excitement no quick bucks. Very different from what Conrad teaches. Every trader has their own style of trading. I feel much safer with this.

From Conrad gathering yesterday night (16 Sep 2016), he also reminded us that each trading strategy is very much on its own, with its own sets of rules to follow. Selling vertical spread is only a method of trading. There is a limited trades we can do using only this.

Defending the Delta (DTD)

I wanted to start my trading using the Almanac for a start. Stock Trader’s Almanac is a book which provide us the statistical probability of the stock market base on its historical performance, which helps put a better odd to our trade. It is a guide for beginner to start with. There are many short trades opportunities from this book, but using vertical spread, I can only use it for longer term strategy. Conrad’s defending-the-delta that he taught in class is meant for short term. I couldn’t understand back then even after attending his re-sit class. Now that I have gone through the Options class, I understand better about Options. Unlike selling a vertical spread call/put, defending-the-delta is meant for a short term trading period.

Defending the delta is a method to ensure that we can safely purchase a cheap call/put Options, giving us enough time (2-5 days) for the stock price to move to a favorable position that we have on our short term trading plan. Buying Options has the disadvantage of losing the premium value from the time decay and from the reduced in volatility. The idea is to have a quick check on the Options the amount of days available to us for the stock to move in favour to our direction in our trading plan. A short term trade strategy, go in quick and get out quick.

It can be seen as scalping. Scalping is not advisable unless you have a bigger account. For smaller account holder, we are only allowed to have 3 day trades. We have to wait for 5-7 days before this entitlement is returned for us to do another day trade. This is a preventive measure from the broker to prevent scalpers to do day trades bigger than their account can afford. The strategy is to buy today, then sell tomorrow. (don’t buy and sell on the same day)

Procedures

  1. Fundamental Analysis: Picking up a possible trade base on statistic.
  2. Checking out the Economic Situation ahead.
  3. Pick up a call/put Options (DTD check)
  4. Prepare for entry base on MRE, UVOL/DVOL.
  5. Take 50% profit the next day.
  6. Let the rest run.

Fundamental Analysis

  • Stock Trader’s Almanac
  • Seasonal Cycle Analysis (probability chart for the week)

A Stock Trader’s Almanac can only provide us with the statistical advantage. We should NOT use it as a tool to predict the future. What is more important is the current economical situation.

Open up the Stock Trader’s Almanac, and check out the coming week for a possible short term trade (2 to 5 days). The Almanac is mainly a statistic for the index.

  • S&P 500 (SPX)
  • DJI, Dow Jones Industrial Average
  • NASDAQ, NASDAQ Composite

The book will analysis the daily probability of the stock market going bull or bear.

To trade these index, we use ETF. The respective ETF tickers are,

  • S&P 500 -> SPY
  • Dow Jones -> DIA
  • NASDAQ -> QQQ

Economic Situation

  • Forex Factory
  • Earning Season check (starting about third week of each quarter, for the next 6 weeks)

Check out if there is any coming economic events or earning seasons. Remove position before important event. Avoid trading during these period.

Pick Up an Options to Buy (DTD)

Proceed to ThinkOrSwim (TOS), open up the SPY Options chain.

Looking for an Options at a Delta of about 0.25. It usually cost about $1.00. If too expensive, don’t buy, and look for one in other expiration month. Usually it is available in the coming expiration month.

Check the DTD of the Options to see if it can last you through the short trading period that you have planned.

DTD = Gamma + Vega – Theta – (ask-bid).

A positive value allows you at least a day of trade. Dividing theta gives you an idea of the number of days available. Have to check this figure daily as the Options greeks will change everyday.

The idea is to buy cheap, yet enough extrinsic value (time decay) for you to do a short trade (2 to 5 days).

Don’t leave position open over the weekend. Reason being, the time decay over the weekend still continue and anything can happen over the week end(news, natural disaster, etc…).

Prepare for Entry

Use Minimum Risk Entry (MRE) and check the Market Internals for the day to increase the odds of entry.