Tag: options

Option Trading – Calendar Spreads & Time Decay

Posted on by The INO.com Team

From David Riveria from Delta Neutral Trading comes a lesson on Option Trading...Calender Spreads and Time Decay. Learn more about David and his site Delta Neutral Trading.

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When traders speak of putting on calendar spreads, they normally refer to buying the further month options and selling the closer month option. While I can not argue with this, it is not best for all options.

I am going to be general in this article because prices change and I don’t want to cause confusion.

For out of the money options, you might want to consider doing the opposite. Buy the close month and sell the further month. This is because the theta is advantageous to you if you are buying the front month. The further the months are from each other, the more you have an advantage. Also, figure out the price per day of the option. Which option costs more and which is cheaper per day. You can find options that are equal distance away in strike from the futures but one option is 3 times cheaper per day than the other.

For the at the money options, the regular calendar spreads are the way to go. For strike prices that are far out of the money, the reverse calendar spread is better. One reason is the theta advantage. Another is the price per day.

So keep your eyes open for out of the money options and check their price per day and theta and compare them to different months. If you are looking at different months, make sure that the month you are thinking of selling, is the same amount of strike prices away or more from the underlying, as the one you sell. Meaning, if you buy an option that is 5 strikes away from the underlying, the one you sell, should be at least 5 strike prices away from the underlying. This is so if there is a big move, both options will be in the money at roughly the same time.

David Rivera has traded commodities and options for one of the largest cash trading firms in the world. He has written a course on futures options techniques.

You can find out more about this concept at: Delta Neutral Trading

Navigating the Q's

Posted on by The INO.com Team

Today I'd like to welcome Allan Harris from AllAllan.com. Over the past few months Allan's blog has become a daily reader for myself, along with many others in the office. His analysis and ability to read the markets is uncanny. Allan decided to do an experiment, on his own, following the Q's...I think you'll find the results VERY interesting. But be sure and visit Allan's website for more details.

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There is no greater feeling as a trader then the feeling you get having successfully navigated an options trade in the QQQQ. This is how I do it, using Market Club Triangles.

I consider Market Club triangles as serving to alert me to breakouts in the underlying tradable, a 3-day breakout for daily charts, a 3-week breakout on the weekly charts. I only use weekly charts because there are less whipsaws and signals generated on weekly charts also serve to confirm an intermediate term trend is in place. Market Club does a great job of monitoring my portfolio as well as market indexes, etf’s and individual stocks for these 3-week breakouts.

Here is a Market Club chart for the QQQQ with the weekly Triangles going back about one year. Notice that there are whipsaws, but more importantly, note how many tradable trends are caught using the automated triangles:

Below is my Excel worktable analyzing these signals. I stated with the Buy generated in September 2007 and finished with the Sell generated on September 2, 2008.

Note that there were a total of eight signals for this 12-month period, about one signal every six weeks. There were 5 net winners and 3 net losing signals.

A Buy & Hold strategy generated a loss of about 12 QQQQ points, or about 24%. A Sell & Hold strategy gained those 12 points, or 24%.

Using the Triangles returned about double the Sell & Hold strategy.

Using the Options made this whole exercise worthwhile, generating over 500% for those eight trades.

Winning 5 out of 8 trades is only a sampling error away from four out of eight wins, or a 50% win ratio. How does something so close to a 50% win/loss generate 500%?

This is an observation that a lot of wannabe traders miss: The magic here isn’t so much pinpoint market timing, it’s that age old trading rule of letting profits run and cutting losses combined with a decent market timing model.

In the case of the Q signals and returns, I’ve used a 50% stop loss rule, meaning all trades that fall 50% based on the underlying options are closed out. All trades that do not fall 50% are held until the next signal. That is why all of the losers are 50% (worst case basis) in the table of trades.

As for the winning trades, the returns above are based on a conservative assumption of losing one month of time premium for each trade and a beta of 60% for just-out-of-the-money calls and puts. Actual real money returns may be a little better or a little worse, but these assumptions capture a fair value for the strategy over the course of the past 12 months.

Finally, considering all of the angst in the market the past few months, look at how beautifully this strategy has bypassed all the fundamental and technical analysis out there and simply went short on September 2 and held short for the entire decline since then.

Consider the ease of trading like this, following the weekly triangles in and out of the Q’s and ask yourself, what other methodology would have navigated this market with as much success and as little sweat equity as the weekly Triangles?

Trading doesn’t have to be complicated, losing proposition. As I have shown, it can be both simple and rewarding.

Allan Harris

AllAllen.com