Thursday, February 26, 2009

Formidable Resistance

Once again the S&P 500 failed to pierce the 775-780 resistance area (see 30 min. chart above). This will be a key level to watch going forward. With today's downdraft the 30 min. chart has change from an uptrend to more of a trading range between about 780 and 743 ish. A valid break of either level could trigger the next move in the market. Unil then, we may just get more chop, which is fine and dandy for day traders & those with positive theta trades, but perhaps a bit frustrating for swing traders.

Just a heads up, tomorrow we've got the GDP report come out pre-market at 8:30 AM EST. This is usually a market moving number, so it may be the catalyst to push us out of this 30 min. trading range.
One other quick chart for you to mull over. GLD has formed a bullish retracement over the last week, dropping back down to its breakout level. One of the common axioms of technical analysis is that prior resistance typically becomes new support. It will be interesting to see if we hold this level and give it another go at $100.


Wednesday, February 25, 2009

Options Are Building Blocks

In many options manuals or books, when discussing option spreads or complex strategies, the vernacular used in describing them is that of building or constructing an options trade. These terms help convey the notion that options are building blocks. If I wanted to be successful in building a structure with blocks, I must first be familiar with the characteristics of each individual block, such as a triangle, circle, or square. Upon reaching a solid understanding of the basic blocks, I can then begin to map out the best way to combine the blocks to construct a more complex structure, such as a house or castle. In the same vein, there are core building blocks one must master with options trading, prior to jumping into trading advanced spreads such as condors and butterflies. All too often new traders want to jump into spread trades, without first achieving a sufficient knowledge of call and put options. That’s the equivalent of wanting to construct a castle, without first knowing the difference between a triangle and a square. You can try, but don’t be surprised if your castle looks more like a shack.

Within the options market, call and put options are the two basic blocks used to construct more advanced trades. Moreover, there are two actions we can take with these two blocks, bringing us to a total of four core blocks we can utilize.

Bullish: Long Calls, Short Puts
Bearish: Long Puts, Short Calls

Now, if we add in the actions we can take in the equities market, namely, buy and short stock, that brings us to a total of six building blocks or actions we can utilize to build a trade:

Bullish: Long Calls, Short Puts, Long Stock
Bearish: Long Puts, Short Calls, Short Stock

Every equities or options trade you see will be a combination of one of these six blocks. There are literally hundreds of varying strategies constructed with these blocks. Whether you’re just venturing into the options arena, or are a seasoned veteran, memorizing the characteristics of these six blocks will no doubt make you a better trader. Once that’s accomplished, spread trades should be much easier to grasp. One way to simplify a spread is to picture it as the sum of its parts.

To illustrate the concept let’s analyze a spread trade which involves two building blocks. Suppose stock XYZ is trading at $50 and we enter a bull put spread by simultaneously buying a 45 put and selling a 50 put. Now, even if we had no idea what a bull put spread was, we could simply break down the spread into its respective building blocks to determine the risk-reward characteristics of the trade. The two building blocks are a long put and a short put. The short 50 put obligates us to buy stock at $50 and the long 45 put gives us the right to sell the stock at $45. Reviewing these rights and obligations inherent with the two blocks enables us to determine our maximum risk is $5.

Perhaps the greatest benefit to understanding options as building blocks is aiding in reading risk graphs. Each of the six core building blocks has their own respective risk graphs. Therefore, spread trades are simply a combination of the risk graphs of the individual blocks. For example, a bull put spread is constructed by selling a higher strike put and simultaneously buying a lower strike put. Thus, its risk graph is the combination of the individual risk graphs of a long and short put.

In addition to the bull put spread there are many other multi-leg option trades that combine two, three, and sometimes four of the building blocks. Shown in this light, options spreads should be much easier to understand.


Higher Low?

Good Morning everyone. So yesterday's breakout came to fruition. After the S&P broke 758, it preceded to rally up to the prior day's high at 774.
Despite puking up most of yesterday's gain this morning, the 30 min. chart has put in a higher pivot low implying that we still have an intraday uptrend intact. Consequently, we could still see a continuation of a bounce up to resistance on the daily chart. Breaking 752ish would break the uptrend- so keep an eye on it.

Tuesday, February 24, 2009

Minor Strength

Today's early strength has been quite underwhelming to say the least. I'd love for this to be the start of a multi-day bounce back up towards resistance, but the market needs to at least break above some intraday resistance levels to get the ball rolling. The 15 min. chart has formed a few higher pivot lows showing some signs of increasing demand (buyers on the dips). What we really need is a break of 758 level, so I'll be watching that for the remainder of the day.

Monday, February 23, 2009


We can consider the Greeks as the language of options. They are commonly defined as variables used to quantify risk. Another word for “quantify” is “measure”, thus they are variables that allow us to measure risk. Simply put, the Greeks answer the question, “How Much?”. For example, if we buy call options we will lose money as the stock drops. The question is, “how much will we lose?” There is a significant difference between a long call position that loses $50 of value for every $1 the stock drops, versus a long call position that loses $5000 of value. For this very reason, it’s not enough to say I have a long call position and I know it will lose value if the stock drops. You must know how much value it will lose. We can look at the Delta of our position for this information.

Another example is that of time decay. Most option traders know that options lose value as time passes. Once again, it is insufficient to say that I own a call or put option, therefore I lose money as time passes. You need to know how much you lose. There’s a big difference between losing $1 a day and losing $200 a day. You can bet the way I manage a trade will differ depending upon how much money I’m losing due to time decay. We could also look at other examples on changes in volatility, but the above examples sufficiently illustrate the importance of assessing the Greeks. As option traders it is vitally important that we understand our risks for all our open positions, and really the only way to do that is via the Greeks. Stay tuned for an overview of Delta....


Tech Analysis of S&P 500

Today's video recaps last weeks market movements:

Saturday, February 21, 2009

Options Terminology

Options are instruments that can be utilized as a speculation or hedging tool. As a precursor to using options it is imperative that you understand basic options terminology. Throughout the next couple weeks, I’m going to do some educational posts highlighting specific aspects of options. My plan is to post links to each of these posts on the left hand side of my blog so you can easily access them.

One of the difficulties in making a transition from stock trading to option trading is dealing with all of the additional variables that affect your trades. For example, when I trade stock, all I really pay attention to is the stock chart. When long the stock, if the price moves up I make money and if it moves down I lose money. Put another way, the price of the stock is the only variable that directly affects the profit or loss of a stock trade. Options, however, have multiple variables that affect your trade. In addition to stock price, time and volatility are two other components that will affect an options price. If you want to be consistent and successful option traders, you must learn how to track your option’s sensitivity to not only the stock price, but time and volatility as well. This can be accomplished using the Greeks. Namely, Delta, Theta, Gamma, and Vega. Stay tuned for an overview of these Greeks....

Friday, February 20, 2009

Bear Call Recap

I wanted to highlight a recent bear call spread I played with on the $RUT. Vertical credit spreads are often my weapon of choice when looking to exploit market moves. First off, I like milking the higher rate of time decay offered by short term options. - I typically put these on around 6 weeks out. Furthermore, the wider range of profit (e.g. high probability of profit), offered by OTM spreads appeals to my nature. So let's evaluate the numbers-


Feb 4th - $RUT @ 455
Sell to Open March 530 @ $2.60
Buy to Open March 540 @ $1.45
Net Credit = $1.15
Max Reward = $1.15
Max Risk = $8.85
Delta of March 530 = .12
Probability of Profit = 88%
Potential ROI = 115 / 885 = 13%

I typically look to buyback any credit spread I enter at around $.25 or less. The rationale behind exiting early is simple, I lock in the gain, remove risk, and free up my money to go elsewhere.

Feb 18th (14 day trade)
Exit the spread at $.25, netting a $.90 profit
Net ROI = $90 / $885 = 10%

Although I entered using 6 week options, I was able to exit after a mere 2 weeks. I’ll take a 10% return in 2 weeks all day long. Now if I could only get my entire portfolio to net 10% every couple weeks… lol.
I'll do a market recap a bit later.


Tuesday, February 17, 2009

Ominous Break

Hey folks. Well, today turned out to be a stellar days for the bears. Down 37 points or 4.5% on the S&P 500. After gapping down this morning, the bulls were unable to muster up ANY sort of intraday rally. (I'd post a SPY 5 min. chart, but am on the road with my laptop, which unfortunately lacks SNAG-It). We've been monitoring the symmetrical triangle of the market for a few weeks now, and after Thursday's head fake, it seems as if today we finally got the decisive break. Moreover, we also broke below the pivotal 800 level on the S&P 500.

With today's price action, it's tough to get excited about going bullish (with a few exceptions of course... eg. gold, some technology, etc..). Until we see a break above resistance, I still like the idea of using market rallies to reload on bearish positions. To those of you that had bearish positions, congrats on some well earned profits! Just a reminder, this Friday is options expiration for February contracts, so make sure you adjust any short Feb option positions accordingly (e.g. buy to cover or roll forward to March).


Monday, February 16, 2009

Trade Management Techniques

In today's video, I review 4 different techniques for managing naked puts that run amiss.


Saturday, February 14, 2009

All That Glitters is GLD

GLD has continued it's bullish run and received a strategy recommendation on last night's Options Action. Concerned with the run that the GLD has already had, as well as it being potentially overcrowded, the recommendation for those buying stock was to provide some protection by selling some upside calls and buying some downside puts. In other words, a collar trade. I gotta admit, I'm not a big collar trader and think there are usually better alternatives in the options world.

Let's take a look at an example:

Buy 100 shares GLD @ $92.50
Sell March 98 call for $2.30
Buy March 88 put for $2.00
Net Debit = $92.20
Max Risk = $4.20 (if stock below $88)
Max Reward = $5.80 (if stock above $98)
ROI= $4.20 / $92.20 = 4.5% return
The Risk-Reward ratio is over 1:1. I'm risking $420 to make $580, which sounds pretty good. However, because we're buying stock the net debit is $92.20. So I'm tying up a ton of capital on a trade which in the end is merely risking $420 to make $580. This begs the question, is there a cheaper way to build a position that risks $420 to make $580? The anwer is yes.

Collars are synthetic bull spreads. In other words, the risk-reward characteristics of collars can be the exact same as a bull call or bull put spread. The main difference is the bull spreads are a heck of a lot cheaper. My last post on GLD highlighted a bull call spread- if you haven't seen it, take a look here.
Here's an alternative bull call spread:
Buy March 88 call for $6.65
Sell March 98 call for $2.30
Net Debit = $4.35
Max Risk = $4.35 (if stock is below $88)
Max Reward= $5.65 (if stock is above $98)
ROI= $5.65 / $4.35 = 129% return

Are you able to differentiate between the two risk graphs? No? That's because there really isn't one! I'd much rather tie up $435 than $9220. Now, I assume if you already own stock and want to protect, then collars may be the way to go. However, if I'm constructing a new bullish trade I'd take the bull call spread over the collar any day of the week.

Friday, February 13, 2009


So I started to do a post yesterday at around 3:00 PM EST that went something like this: "Well, looks as if Mr. Market wants to head lower, with today's downdraft the symmetrical triangle was finally broken to the downside. We'll see if this starts the next leg down in the market." Err.... scratch that... that was before the ridiculous 27 point rally in the last hour on the S&P 500 that put us right back into the range.

Today serves as a great example of whipsaw and a failed breakout. Anyone that had bearish day trades on got it handed to them the last hour of the day. Unfortunately there's not much you can do to predict a countrend rally of that magnitude. I think this also illustrates the benefit of scaling out of a position when you've accumulated a nice profit, that way if the market does put in a hard reversal, you don't give everything back.
In short, scaling out means closing part of your position to lock in some of the gains. For example, if I was short 500 shares of the SPY and I participated in the intraday drop from $83 to $81. I may have closed 250 shares and let the rest ride. Generally when you're sitting on a profitable position you begin to get antsy
to lock in your profits (fear), yet you also want to make as much money as possible (greed). Rather than giving in to one or the other, you can compromise! Sell a portion thereby satisfying your "fear", and keep a portion thereby satisfying your "greed". In my experience I've found scaling out a much easier decision to make from a psychological standpoint than closing all or none.

Tyler -

Wednesday, February 11, 2009

Bullish Charts

After yesterday's precipitous drop, today was kind of a snoozer. The S&P 500 finished with an inside day, closing up about 6 points. We're still within the midst of the symmetrical triangle previously mentioned. In the short term keep an eye on the low of yesterday & today (823 ish), as well as about 837 on the SPX. We really need to pierce below 800 for the bears to get the party started.
In addition to the relative strength exhibited in technology recently (AAPL, AMZN, GOOG, etc..), two other stocks that may be worth keeping an eye on are POT and MOS.

POT is in the midst of a short term uptrend above it's 20 and 50 day moving averages and recently formed a higher pivot high. Assuming the market doesn't fall apart, POT will be an interesting stock to watch and see whether or not it develops a clean retracement and bounce off support.

MOS has moved pretty much in lockstep with POT, recently forming a higher pivot high and starting to pullback to a potential support level. Assuming MOS continues it's current pullback it may provide a low risk/reward entry for a bullish play


Tuesday, February 10, 2009

Market Recap

Tim Geithner's overview (or lack thereof...) of the government's plan to save the financial industry was met with waves of selling in the market today. The S&P 500 ended the day down almost 5%. Today seems somewhat reminiscent of the sell off that we saw in reaction to when the first bank bailout plan was passed by congress months ago. Both instances serve as prime examples of selling the news.

Today's selloff brings the S&P 500 within the brink of breaking below the lower trendline of it's symmetrical triangle. Now, in the short term the market is bit oversold, so I wouldn't be surprised to see at least an intraday bounce some time tomorrow to alleviate some of the oversold pressure. After that, could be game on to the downside.... we shall see. Watch the 800 level on the S&P over the coming days. As mentioned in previous posts, entering OTM bear call spreads or other bearish trades on rallies looks as if it's going to continue to work.

The cliche that states, "if it ain't broke, don't fix it" is applicable in this scenario. In other words, if you have a trading strategy that is working (like selling the rallies), don't second guess yourself, simply do it until it doesn't work anymore. It's often easy to second guess yourself or think that "this time is different", when in reality it isn't!

Now that the retracement has begun, it will be interesting to see whether or not the $NDX and big cap tech stocks, which have been market leaders, establish higher pivot lows or whether they reverse into downtrends. Assuming they reverse into downtrends, I'm going to start to wonder if the market will be able to put in any sort of sustainable upturn.

Tyler -

Monday, February 9, 2009

Do-ji, Don't-ji

Pretty lackluster trading today to say the least. The S&P 500 traded in a dismal 12 pt. range and ended the day forming a doji candle. A doji is a potential reversal candle which conveys indecision and a stand-off between buyers and sellers. The S&P has reached a resistance level at 870 formed by its prior pivot high, furthermore we are reaching somewhat overbought levels (click on pictures to enlarge). The question to consider going forward is whether or not today represents a ‘pause that refreshes’ or the start of a reversal into a down swing.

As mentioned in last Tuesday’s post the relative strength in the technology sector has continued. Take a look at the comparison chart and price charts. Many of the big tech names (AAPL, GOOG, RIMM, AMZN) have formed higher pivot highs and may be candidates for bullish entries on the next retracement.

USO Undercut!

Interesting trading day in USO on Friday- That is to say interesting in terms of price and volume. First off, volume topped off the day at a whopping 67,685,773. Highest volume day (that I can find) since USO started trading back in April 10, 2006. Now, volume in and of itself isn't the end all be all. You need to assess volume in correlation with the price action to get a better perspective. On Friday the USO had a small 'undercut' of it's support level around $28.00.

Typically when a stock takes out support, it triggers existing sell stop orders that have been strategically placed beneath support, as well as short sellers jumping in to exploit an expected breakdown in price. It is therefore significant that the USO was able to rally back above it's 'broken support'.

Now, the candle formation wasn't perfect. Rather than closing at the high of the day and forming a bullish engulfing candle pattern (which would have been a VERY bullish scenario), the USO did give back some of it's intraday gains.

If the USO is able to break above Friday's high, that may signal a short term upswing in the price.


Saturday, February 7, 2009


Today's video reviews a bullish breakout price pattern I used for a day trade on the SSO.


Disappearing Jobs...

Surprising strength today after the release of a horrible jobs number. Today’s trading helps validate one important trading principle: Trade the reaction to the news, not the news.

As traders, we can’t be too quick to pass judgment on whether or not a certain news release will cause the market to rise or fall. Rather than trying to guess, simply play the charts. A great phrase to remember is, “trade what you see, not what you think.” The rationale typically cited for the market (or individual stock) being able to rally on bad news is that the market has already discounted the bad news into the price. In other words, it’s already baked into the cake. Remember the market is forward looking and tries to price in what’s going to happen 6-8 months into the future. Jobs reports are a lagging indicator, thus unless their WAY different than what was expected, the market may still rally off the bad news. Keep this in mind next time we have a potential market moving news release.


Friday, February 6, 2009

Quirks of Levered ETF's

I saw this video posted on another blog I frequent. For those of you that play the levered ETF's that aren't already aware of some of their quirks over the long term, you'll be interested to hear what's in the video. Levered ETF's (SDS, SSO, QID, QLD, SKF, etc...) have been a godsend for day traders. Most of them have good liquidity and 2x or 3x the daily returns of whatever index/sector they track, making them superb trading vehicles. However, when you look longer term the returns don't match up the way you would expect.


Thursday, February 5, 2009

Bear Calls

In today's video I review the posture of the S&P 500 and review a bear call spread trade.


Tuesday, February 3, 2009


The S&P 500 continued yesterday’s intra-day reversal ending the day up 13 points or 1.58%. Of the major sectors I follow, the Homebuilders (XHB) performed like a champ, finishing up almost 8% for the day. However, all it takes is one look at the homebuilders chart to know that it’s gonna take a lot more than one 8% up day to get me bullish on homebuilders. Technology, which has outperformed the S&P 500 over the last month, continued to exhibit relative strength (see comparison chart below).

The Financials were the only major sector that finished lower on the day (what’s new?). It will no doubt be tough to have a broad based sustainable market up turn without any participation from the financial sector.

After having formed a lower pivot high last Wednesday and more recently (yesterday) forming a higher pivot low, the S&P 500 is still in the midst of a 3 month long symmetrical triangle. A symmetrical triangle is a continuation pattern that is comprised of lower pivot highs and higher pivot lows. Upon reaching the apex of the triangle, the stock normally breaks out one way or the other. Given that the S&P is in the midst of a downtrend, we would assume that the triangle breaks to the downside.

The 800 level (8000 for the Dow) has recently served as a significant source of support. A break below that level could serve as a confirmation of the breakdown and a potential sign of more downside to come. I wouldn’t be surprised to see this rally lose steam as it approaches the upper trend line of the triangle (if it even gets that far). When/if that occurs I’ll be mighty tempted to start entering OTM bear call spreads or other bearish trades.


Sunday, February 1, 2009

Options Action

I got a chance to tune in to CNBC’s new options show, Options Action, this past Friday night - It airs every Friday at 11:30 PM EST. Below is a summary found on the CNBC website:

CNBC's "Options Action," hosted by CNBC's Melissa Lee, is a fast-paced, weekly half-hour roundtable discussion featuring four prominent options traders who will demonstrate how to profit from the news of the week using options. Fresh from the trading desks, the "Options Action" traders will not only offer the latest fundamental analysis of individual stocks, but also tell the viewer how to increase returns and limit losses by employing the right option strategies on those stocks. The playbook will include basic call and put buying, selling puts and covered calls, and some of the more advanced techniques, such as buying put and call spreads.

Being an avid options trader, I was rather interested in how useful the show would be for individual retail traders. Having now sat through two episodes I’m pleased to report they haven’t done too shabby. Below are a few of my observations.

1. I like the fact that they advocate using spreads vs. buying options outright. Hopefully this helps the majority of call & put buying retail traders see the benefit of using spreads as a way to drastically lower cost and risk. If the pros (with huge amounts of money at their disposal) are saying things like, “I’m cheap so I’m going to enter a spread…” or I’m going to sell a higher strike call to help finance the purchase of a lower strike call…”, it stands to reason that an individual trader (with much smaller accounts) would be interested in implementing spreads. All too often, I see new traders gaga eyed over the potential returns of call & put options, when in reality their overlooking the fact that most of the time these two strategies have low probabilities of success. One of the spread strategies they threw out was buying put spreads on the SPY (Jun 80-75 put spread) as a way to hedge a long portfolio vs. that of simply buying straight puts.

2. As the show continues, one change I’d like to see is spending a bit more time on education. Like explaining implied volatility and its effects on option prices. In addition, rather than simply stating that the market is pricing a 15% chance of stock XYZ going down to a certain price (as they sometimes do), it would be nice to teach individual investors how to use delta to calculate these probabilities themselves.

One of the trades they mentioned that I want to highlight was a bull call spread on GLD. Currently GLD is trading @ $91.31. The person that mentioned this (can’t remember the name) was bullish on GLD and wanted to use an April 100-105 call spread to take advantage of a further increase in its price.

Buy Apr 100 call for $4.10
Sell Apr 105 call for $3.10
Net Debit/Max Risk $1.00
Max Reward = $4.00 (if stock is above $105)
Breakeven (at expiration) = $101

Here's the risk graph:

It’s tough to deny the relative strength GLD has seen over the past 3 months. Although it is a bit overbought in the short term (see stochastic in chart).
Whether the uptrend continues or not though, time will tell. I do like the choice of using an out-of-the-money bull call spread. It’s a cheap low risk way to establish a bullish position- plus you’ve got until April for GLD to reach the $105 level.
As always, feel free to post your thoughts/questions in the comments board.