PurelyTechnical

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Welcome!

Welcome to the webinar on Volatility-based Options Strategies, brought to you by TheMarketMessenger.com. We thank you for being with us today and look forward to your participation.

Your comments and questions are encouraged. You can leave comments or questions via the form on the bottom of the page for all to see or, alternatively, you may send us a personal message via Email.

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Topics Covered in this Webinar

This webinar is being conducted in order to provide you with a brief insight into why a particular volatility options trading strategy might be used when a stock is showing a given technical profile.

You will get a taste of some of the methods that will be utilized in the Options Trading Coaching classes that we will be making available to you, starting in September. What you will see today will only be the tip of the iceberg compared to what will be available in the Coaching classes.

Coming back to today's webinar...

With a goal towards creating a 'real-world' feel, we'll be providing you with a handful of live options trading picks. (Please note that, as usual, these trading picks are provided for educational and informational purposes only. Standard disclaimers apply.)

 

Let's begin...

 

Good Morning, welcome to the webinar!

 

We were going to start with a live options trading pick on AMZN, this morning. However, we're going to have change the plan a little bit because... would you believe that while the stock opened exactly at the level (80.00) at which we'd have wanted to enter the position, it has already rallied to the target (of 85.00) and beyond...

 

Well, nice little surprise there. Nevertheless, we'll use the example for illustrative purposes, because it provides a really simple to follow trade. Give us a few minutes to update the material, given today's surprise move, and we'll be back with a synopsis of what would have been the first featured trading pick. In the meantime, take a look at the chart (below), as of Friday's close and try and think up a couple of potential options strategies on it, given the technical picture at the time.

 

 

 

10:20 AM...

 

Above, you see a snapshot of AMZN as of the close on Friday.

 

The fact that the stock had apparently broken out of a rectangle would have been immediately apparent to you. As you know, the rectangle is a neutral pattern and typically leads to a move (in the direction of the eventual breakout) that is equivalent to the height of the pattern. Accordingly, the fact that the pattern broke to the upside meant that a move to 85 was on the cards...

 

With that information in mind, can you think of any potential options strategies that you could have used to play the anticipated move?

 

Now, the simplest answer might be "Long Calls" - the basic of all options strategies. You'd have ended up doing quite well with such a strategy, but think of it this way... If the stock fell back below 80, there was a good chance that prices would drop to the bottom of the rectangle (75). The Long Calls strategy would have failed miserably in such a scenario.

 

Think of another strategy that would have given you a good payoff regardless of whether the pattern was successful and the stock hit 85 or failed and the stock fell to 75.

 

We'll be back in a couple of minutes with a look at the strategy we'd have used...

 

10:30 AM...

 

Here's a look at the chart as of a few minutes ago...

 

 

You'll notice that we had chosen the AUG 80.00 Straddle. A profit/loss payoff diagram of the strategy has been provided below.

 

 

Why did we choose the Long AUG 80.00 Straddle?

 

As mentioned earlier, it was believed that there was nearly an equal chance for the stock to move to 85, as there was for it to move 75. Given that the stock was at trading at 80.00 this morning, the most appropriate strategy was a no-brainer.

 

That was because the 80.00-strike was perfectly at-the-money, at that point. It doesn't get much better than that for a Long Straddle on the 80.00-strike...

 

When a straddle is at-the-money and you are looking for a move of "x" points in one direction or the other, you are in luck because the stock is sitting perfectly in the "sweet spot" of the Straddle. A straddle is usually at its cheapest when it is trading precisely at-the-money.

 

10:40 AM...

 

Just a quick admin note... The webinar was originally scheduled to last 1 hour. We'll try and finish as much as we can by 11, but for those of you who're interested in sticking around, we'll continue past 11 and finish at least three illustrations. (You can also come back later to view the entire transcript).

 

By the way, please feel free to leave a comment or ask a question, using the form at the bottom of the page (or Email us, if you'd prefer).

 

Getting back to the example...

 

The AUG 80.00 Straddle was trading at a Net Debit of 4.16 or so, just after the open, when the stock was trading just above 80.00. The AUG 80.00 Calls were trading @ ~2.22 and the AUG 80.00 Puts @ ~1.94. The total cost - the net debit - of an AUG 80.00 Straddle, therefore, was ~4.16.

 

What information can you garner from the fact that the 80.00 Straddle was trading at 4.16?

 

Think about the answer to that question for a moment...

 

10:55 AM...

 

The first thing that comes to mind, of course, is the breakeven points. You'd obviously be wondering, "What price does the underlying stock have to reach before expiration, so that I can start to make a profit?"

 

You can arrive at the answer to that question by using simple arithmetic (or your favourite options analysis software). The breakeven point for a Straddle is the Strike Price plus/minus the Net Debit...

 

In other words, the breakeven prices are 80.00 +/- 4.16, which converts to an upper breakeven of 84.16 and a lower breakeven of 75.84.

 

That's great, because it means that your bullish target of 85.00 is above the upper breakeven price and your bearish target is below the lower breakeven price. If AMZN were to hit one target or the other at or before expiration, you'd have a guaranteed profit. The sooner one of the targets is hit, the better of course (because the more time value that will be present in the options).

 

Take a look at the options payoff diagram provided above for a moment. Does everything fall into place? Do you see how there are profits to be had, if the underlying stock (AMZN) rallies to 85 or falls to 75, before expiration?

 

Notice that we have provided you with three p/l lines in the profit/loss payoff diagram...

 

The lowermost line represents the p/l as of expiration. The uppermost represents the theoretical p/l based on current prices and implied volatility (as of the time of opening the trade). The line between the two represents the theoretical p/l as of an interim date - a date inbetween the opening of the trade and expiration of the options; we've chosen Wednesday, which is perfectly between trade open and expiration, in this case.

 

11:00 AM...

 

Well, we live in a world of instant gratification, so why not go ahead and give you the result of the trade, which (not completely by our doing, mind you) has already reached and surpassed its target...

 

The Straddle is currently trading at approximately 7.66. That converts to a profit of $3.50 (84.13%) in less than 90 mins! The AUG 80.00 Calls are trading at 7.35 and the AUG 80.00 Puts are trading at 0.31, for a net debit of 7.66.

 

Of course, the stock is trading at a level that is higher than our target and it is arguable that given that the stock was moving so strongly today, it might not have been a bad idea to abort the target for a while just to see if you could squeeze a little more out of the trade. However, just to keep the record straight, let's make the point that even if you had closed off the trade when the stock was trading at the target of 85.00, a little earlier, a profit of $2.06 (50%) was available, with the Straddle trading at approx. 6.22, at that point.

 

11:15 AM...

 

Let's move on the next pick...

 

Below is a chart of NOV.

 

You'll notice that there are several bearish signs on the chart. Your first instinct might be to open a Long Puts play on the stock and you'll do really well if the stock does not reverse course.

 

Let's take a quick look at the technicals...

 

There's a bear rectangle on price; the pattern calls for a move to 62.50. The bollinger bands are falling, MACD is in negative territory and pointing downwards and RSI is showing a potential descending triangle. All signs point to a continuation of the bearish move.

 

Traders who don't mind losing money in the event of an unexpected gap upwards may think about shorting the stock or simply buying Long Puts. We'd like to have some protection, however, because if the stock manages to pull back above 72.50, a move towards 82.50 could easily take place.

 

Think about a potential options strategy that could work out if the stock turns around and would work just as well if the stock were to actually reach the most obvious target of 62.50.

 

11:30 AM...

 

What strategy did you come up with?

 

There were a myriad from which we could have chosen, including Strangles, Straddles, Strips and Straps (not to mention others such as Butterflies and Condors), but we settled on a Straddle on the AUG 70.00 strike, which is just above current prices (~68.00).

 

Now, we don't want to give our too many of our proprietary secrets away - that will be reserved for the upcoming Options Coaching classes - but to give you a brief insight into why a Straddle that is not perfectly at-the-money might work in this case, it has to do with the bearish bias that exists, based on the technical picture mentioned above.

 

Here's a look at the stock chart, depicting the strike and current prices of the AUG 70.00 Straddle (and its components). A p/l diagram will follow...

 

 

11:45 AM...

 

Here's a look at the options p/l diagram...

 

 

So, does the strategy look worthwhile? Let's see...

 

What was our primary target and what was the alternate target?

 

The primary target was 62.50. That target is easily attainable before AUG expiration (5 days left, including today). The strategy p/l diagram shows us that if that target is reached before expiration, there should be a profit of at least $3.35 (80%). In fact, we only need to see the stock fall below 65.85 (70.00-4.15), in order to attain profitability.

 

On the other hand, a move to 82.50, which is a possibility if the stock moves back above support at 72.50 would bring about a profit of around 200%. However, to be perfectly honest, it could be challenging for the alternate target of 82.50 to be reached by Friday. A move to, say, the 20-day Moving Average at 76.30, might be more realistic.

 

Where does the upper breakeven lie?

 

We can find out that number by adding the net debit (4.15) to the level of the strike price (70.00), to arrive at 74.15, which is below the more probably alternate target at 76.30. A look at the p/l diagram tells us that there would be a profit of around 2.30 (50%) or slightly more, if the stock gets to that level.

 

11:55 AM...

 

So now we've spoken about the potential entry into the trade. It's time to plan for potential exit strategies or repair strategies (if needed). We didn't speak about such strategies in the case of the first example (AMZN) because the stock had already shot to the target and there was to have been no trade, of course.

 

Exit Strategy

 

We've already touched the periphery of how/when this trade may be closed, when we spoke about the potential targets of 62.50 and 76.30, earlier. However, we didn't specify whether the entire Straddle needs to be closed if one target or the other is reached, or if only the "winning leg" is to be closed.

 

In order to not confuse those of you who are relatively new to the topic, we won't go in-depth into closing the winning-leg only exit strategies in this webinar, instead we'll leave them for our Options Coaching classes series. Advanced traders often use this kind of exit strategy, because it can provide a bonanza of profits over and above the original profits and has an element of "playing with the house's money" to it. So look out for such content in our Coaching classes, which will start in September.

 

As far as this trading pick goes, we'd suggest that just closing off the entire Straddle if/when the target is reached, would be obvious.

 

What if the target is not reached by, say, Wednesday or Thursday - a day or two before expiration? ...In such an event, we'd have to consider exiting the trade immediately and booking profits or cutting losses, depending on where the stock is trading. Alternatively, a repair strategy might be considered...

 

12:05 PM...

 

Repair Strategy (if needed)

 

If one of the targets has not been reached within a day or two of expiration, a repair strategy might need to be implemented. There are a myriad of repair strategies that can be performed. Depending upon interim price action, those strategies can increase the capital-at-risk but will drastically improve breakeven points or might inherently allow for a limitation of losses. There are too many potentialities to discuss all of them; we'll stick to one of the most likely.

 

Let's say that the stock moves back to the broken support level at 72.50 on, say, Wednesday. The trade is likely to be showing a loss of around 10-20% at that point and a decision will then need to be made to exit at a loss or to hold on in the hopes of a quick move towards one of the targets. Another potentiality will be to "repair" the trade.

 

Ignore the next two paragraphs if you are quite new to options. You can learn about this stuff later in our Options Coaching series...

 

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With the stock back at 72.50, the trader might believe that this is just a return move and that the stock will quickly start to fall again. S/he could hold on to the position in the hopes that the stock will drop at least to 65.85 or s/he could try and beef up the position by adding another AUG 70.00 Put to the mix. The Puts will be trading at a much lower price - probably around 0.60 at that point in time - and adding one Put to each Straddle would increase the total outlay from 4.15 to 4.75.

 

Such an adjustment - which would convert the Straddle into a "Strip" option combination - would mean that there is the potential for a larger loss, but think about what it would do to the breakeven points. Yes, it would raise the upper breakeven from 74.15 to 74.75 (because the net cost is now 4.75 and there is only one Call in the Strip), but it would also raise the lower breakeven to 67.62 (from 65.85). That calculation is arrived at as follows... The net cost is $4.75. Dividing that by 2 (because there are two Puts in the new position), means an average cost of 2.375 per Puts (assume that the Calls will be worthless). Subtracting 2.375 from 70.00 brings a price of 67.625, as the new lower breakeven.

 

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12:30 PM...

 

We've far exceeded the time we'd first allocated to the webinar, partly due the curve ball that AMZN threw us and partly due to the fact that this is the first such presentation that we're providing you with but, most of all, because we'd like to do as thorough a job, as possible, of putting the material across to you.

 

We'll provide updates to the NOV pick and other picks that are covered today on each trading day until expiration on Friday. Intraday updates may also be provided, if necessary. Our goal is to showcase these potential trades from start-to-finish.

 

Think of it as an attempt on our part to demystify volatility-based options strategies and the trading thereof.

 

12:35 PM...

 

Just received an Email from OptionDog72, who had this to say regarding the NOV pick, "what if the stock got stuck at current levels?". That's an excellent question. The simplest solution is to bail out, cut your losses and run. However, there are potential repair strategies, such as doing the opposite of the repair strategy mentioned above - buying one more Call, which would help lower the upper breakeven - or just drop the Puts leg and hold the Calls.

 

Like we said, there are several potentialities, but they are better left explored once we actually know what the situation is at that point. Good question though. Keep the Emails coming or feel free to leave a comment at the bottom of the page.

 

12:45 PM...

 

The next setup that we going to look at is on the chart of OXY...

 

 

There's a symmetrical triangle - a completely neutral pattern that is seen as bullish or bearish only once there is a breakout - on price that calls for a 7.50-10.0-pt move upon breaking out. However, we've refined the targets to 67.50 or 84.50 based upon other technical factors such as old support/resistance levels.

 

Stock traders often wait for a break out of the pattern, before entering a trade based upon a symmetrical triangle. That's well and good, but the problem is that often you'll get a gap out of the pattern and the stock will have moved too far to consider entry. As an options trader you can look to pre-empt a breakout, enter early, and rather than fear a gap, even encourage one to occur. That's if you use an appropriate volatility strategy, of course.

 

Think about a potential strategy on this setup for a couple of minutes and we'll come back with one that we think might be useful...

 

1:00 PM...

 

We were hoping to mix it up a bit and provide you with a Strangle or a Strip or a Strap (those are some of the basic volatility strategies; others include Condors, Butterflies, Calendar spreads, but we'll save those for the Coaching classes), however, the examples so far have dictated Straddles and OXY is no exception (although you may find that some other volatility strategy is more to your liking).

 

Here's a look at the stock chart with our choice of strategy - Long AUG 75.00 Straddle..

 

 

The fact that the stock is trading nearly perfectly on the 75.00-strike makes the Straddle a no-brainer. Now, if you have a strong bearish bias, you could have considered a Strip option combination; if you have a strong bullish bias, you could consider a Strap. The potential exit and repair strategies would differ, depending upon your choice.

 

We're absolutely neutral and have an equal expectation for a 5-8 -pt jump as we do for a similarly-sized drop. (We'd probably say that there is a 33% chance of each of those outcomes and a 33% chance of a move of less than 5 pts in one direction or the other; the latter would not be our preference, of course).

 

The p/l diagram is provided below...

 

 

As you can see, profitability will be attained as long as the price of the stock is below 71.75 or above 78.25.

 

Exit Strategy

 

A move to the bearish target of 67.50 would bring about a profit of over 100% and we'd just look to book profits on the trade. On the other hand, if the stock rallies to the upper end of the pattern, we'd need to see it easily break through the upper line. If resistance is found, the upper target will most likely not be reached before expiration and we'd need to consider closing off the position early, if such a scenario occurs.

 

Repair Strategy

 

We'll expore potential repair strategies on Wednesday, if needed.

 

One more setup before we close this webinar...

 

1:35 PM

 

Check out this setup on STP...

 

What strategy would you place on this setup? Scroll past the chart to see which strategy we would use..

 

 

We would NOT place a long volatility strategy on this trade. We might consider a "short volatility" strategy or not play the trade altogether.

 

Why?

 

Two reasons:

 

a) Implied volatility is a crazy 120% (correction) 90% on the options on this underlying, which means that the stock would literally have to move by a massive amount just to allow for a small profit.

 

b) The strikes are too far apart on the underlying. For example, the nearest strikes are at 35.00 and 30.00, which means that the stock has to move nearly 2.50pts (around 8%) just for one of the nearest strikes to be at-the-money.

 

For each of the reasons above, this setup does NOT represent a great opportunity for a volatility trade. We'll go more in-depth into implied volatility, appropriate strike choices and many, many other related topics in the Options Coaching classes that will begin in September.

 

Final Comments

 

In this webinar, we've barely scratched the surface of what's available to the options trader. As we've said time and again there are a myriad of strategies that can be implemented by the options trader to counter virtually each and every setup that is presented on the charts. You'll be able to learn about all of these strategies in our Options Coaching classes. Therein we'll provide you with a hands-on approach to learning about options theory and strategies; you'll have access to one-on-one coaching or an online classroom environment, if you prefer.

 

When it comes to options trading, you not only need to know how and when to place an options trade, but also when NOT to place an options trade. The example of STP, above, perfectly illustrates this point. Many a beginner options trader makes basic mistakes such as not checking the implied volatility  picture on the underlying and purchasing inappropriate strikes. In our Options Coaching classes, we'll take you step-by-step through many of these topics and show you how to avoid pitfalls that can doom a trade virtually as soon as it has been opened.

 

We thank you for your patience through this webinar, which has taken a little longer than anticipated, but we hope that you enjoyed the content and are considering expanding your options by signing up for our Options Coaching classes, which by the way will be provided in a completely state-of-the-art format and that will not be limited to some of the timing constraints that have had to be dealt with in providing today's content in a text-only format.

 

We look forward to your feedback and hope that you have enjoyed this webinar.

 

Enjoy the rest of your trading day and please remember to come back to check out the updates to the trading picks provided in this presentation.

 

Regards,

 

Asher Pinto

 

TheMarketMessenger.com

 

Correction: Please note the following correction with respect to the comments on STP. It was mentioned that implied volatility was nearly 120% on the options on that underlying. That was an error (it was the IV levels of only a couple of strikes, not the average). The average IV on front-month strikes was actually around 90%, which is still quite high, generally speaking. Note that the error does not detract from the point that we were trying to make,