- Market outlook – How do you feel about the stock market during the lifetime of your trade?
- Fundamentals – Do you feel comfortable with the sector, industry and company? Why did you pick this particular company, sector?
- News – Any news is coming out during your trade?
- Charts – Did you consult your charts in different timeframes?
- Volatility – Did you check the volatility chart? Is volatility favorable to your trade?
- Liquidity – Do you feel comfortable with the trading volume? Is it easy to get in and get out of the position?
- Target – What is your price target?
- Probability - Use the probability calculator to see if your price target is realistic.
- Trading strategy – Do you feel comfortable with this trading strategy? Is this strategy going to work under the above mentioned conditions?
- Position size – Do you feel comfortable with the size of this position relative to your account?
- Buy signal – What is your buy signal? You only enter the trade if certain conditions are met even if you have to wait.
- Sell signal – What is your sell signal? How much profit do you expect and how much loss are you willing to take?
It is important to at least mentally go thru important steps before entering a trade. It’s even better to write it down and make a sort of checklist. It will be your “pre-flight” checklist. Just like you wouldn’t jump into an airplane and take off you don’t enter a trading position without preparations. Here are some basic steps you want to consider:
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When we purchase a put option and we make some money because the underlying stock moves down we often think that we only have too choices. Either liquidate, sell the position or hold it and do nothing. There are other alternative besides the two mentioned before and they might be better depending on the situation. We can do the followings:
The table below summarizes which solution is the best depending on how the stock moves: Just like regular puts, debit put spreads can be in the money (ITM), at the money (ATM) and out of the money (OTM) depending on the strike prices relative to the security’s current price.
Here we are going to examine four different debit put spreads for SPY with August expiration date. SPY is currently trading at 161.28. The 167/164 and 165/162 spreads are in the money since both the long and short options have strike prices above the current price. The 163/160 spread is at the money since the long option’s strike price is above the current price and the short option’s strike price is below the current price. The 161/158 put spread is out of the money since both strike prices are below the current price. All spreads are 3 point wide. What I am interested is to find out how the strike prices affect the maximum profit, the breakeven point and the maximum loss. I also want to know the probabilities associated with the maximum profit, breakeven point and maximum loss. The table below shows the data I calculated and used and the chart summarizes the results. The table and the chart clearly shows that in the money debit spreads have much higher probability and even if the stock moves against you, you can still make money. You don’t have to be bearish to use this strategy. In the money debit spreads work well in neutral market conditions. MSFT was already overbought in April and showed some weakness since then. A divergence was forming between the RSI indicator and the price chart. Prices were moving higher but RSI was moving lower. The price chart shows that MSFT clearly lost momentum and some kind of top was forming. Continue reading below the chart. One way to take advantage of a correction like this is to buy a Debit Put Spread. A Debit Put Spread consist of a long Put with a higher strike price and a short Put with a lower strike price. What we pay is the difference, a Net Debit.
Buying a Put and Selling another Put lowers the cost but there are other benefits too. The time decay and volatility is sort of neutralized since the long and short position cancels out each other. Even if the price doesn’t change time decay won’t take a bite out of your position. Another advantage whit debit spreads is that you will know ahead of time the Maximum Profit and the Break-Even Point at expiration. For as long as your position is open these parameters won’t change. Depending on how you choose the strike prices the Break-Even Point could be very close to the current price. This way even if the stock only slightly moves you can still make money. In the current example I used my Virtual Trading account to open this position. I bought 20 MSFT Sep 13 33/36 Put Spread for 1.33 Net Debit each. The total cost was 1.33x100x20 = $2660. The Maximum Profit = (36-33)-1.33x100x20 = $3340 which is 125%. The Break-Even Point is 36-1.33 = $34.67. I entered this position on 6/12/2013 when MSFT closed at $35.00. In this case as you can see if the price moves down more than 1% until September we are going make money. Today, when MSFT closed at $33.26 the value of this position is 1.83 for the total of $3660. It already made $1000 or 37% in 9 days. If this was real money in a real account I would probably exit the trade and take the profit. For now in my Virtual Account I will leave this trade open since I see further weakness during the next few weeks. According to the SEC (Securities & Exchange Commission) any stock trading under $5 is a penny stock. Others consider stocks trading on the Pink Sheets and the Over The Counter Bulletin Boards (OTCBB) to be penny stocks. Micro-cap (market capitalization between 50 and 300 million) and nano-cap (market capitalization under 50 million) stocks can be also considered penny stocks. Trading penny stocks is different than trading blue chip stocks. Just like with any other securities before you trade penny stocks you should learn about the risk they involve. Trading penny stocks has advantages and some disadvantages compared to blue chip stocks. First let’s look at the disadvantages: · Penny stocks considered riskier than stocks traded on the big exchanges. One reason is that to be listed on the Pink Sheets and the OTCBB requires less requirements. These companies are only obligated to disclose limited information. Some of these companies might be under bankruptcy. · Penny stocks are more volatile. · Liquidity can be a problem with penny stocks with low volume. · You can be a victim of a pump and dump scheme if you don’t recognize it. Penny stocks have some advantages too: · Due to volatility penny stocks can be a lot more profitable than blue chip stocks. · Profit is comparable with profit from trading options. · Penny stocks don’t expire unlike options. · Penny stocks don’t have time decay unlike options. · Penny stocks have little correlation to the major markets. · If you are a good stock picker you can find many good penny stocks on the Pink Sheets and OTCBB and some even on the Nasdaq and NYSE. If you decide to trade penny stocks don’t put all your eggs in one basket. You will always have winning trades but you will have losers too. When you buy penny stocks always use limit orders and use limit orders when you sell them. This way you don’t have to sit in front of your computer while the trade is on. Sometimes it's tempting to quickly buy a cheap call or put option for extra profit. But it's easy to make a mistake and lose money if we don't consider the followings:
There are several reasons many investors don’t like to get into option trading. One of them is the expiration. Unlike stocks options expire at a certain expiration date. It could be this month, next month, 6 month from now or even next year depending on the expiration date. Another reason is that you have to have some knowledge of the Greeks, the Delta, Theta, Gamma and Vega. The future price of the option not only depends on price of the underlying stock but also depends on these Greeks. Another reason is the fact that options a leveraged trading instrument and their price movements are much more volatile than that of the underlying stocks. One way to keep option trading simple is to buy LEAPS or Long-Term Equity Anticipation Securities. These are options with expiration dates longer than a year. You can buy LEAPS today that will expire in 2014 or even 2015. Buying LEAPS are much cheaper than buying stocks. With Theta being nearly zero you don’t have to worry about time decay. If Delta is close to one in other words the LEAPS is deep in-the-money the option price will change just like the stock price. Sometimes you can even find LEAPS where the option price is not much higher than the price for an option with shorter term expiration. Buying LEAPS is much safer than buying options with shorter expiration dates. The profit might be a little less but LEAPS are still leveraged instruments. For example you can buy LEAPS 60% cheaper than the stock and if the stock moves 10% you can make 30% profit. Open interest for different strike prices are calculated at the end of the trading day. Open interest or OI is telling us how many contracts for a certain strike price are not closed. Open interest is calculated for puts and calls fro all strike prices. Open interest configuration shows the different open interests for different strike prices. On the open interest configuration charts the strike prices are on the horizontal axis and the open interest are on the vertical axis. We can use this chart in our analysis which describes the relative levels of investor optimism and pessimism. When we look at the chart for the front moths spikes represent short term support and resistance levels where traders have to be cautious. Below you can see the open interest configuration chart for SPY.
As I mentioned earlier I started trading with individual stocks. I was mostly attracted to stocks the News mentioned or I could read about. Later I found out that by the time everyone new about it it was too late. With exerience I found out that instead of individual stocks trading a basket of stocks is much safer it doesn't depend on individual company related events. I picked the SPDR S&P 500 ETF (SPY). There are several reasons I did that:
These are just a few things from the top of my head. |
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