Lawrence McMillan discusses Snowman's day trading
This All-Star Commentary post features several Trade Notes (long put entry 1, long put exit 1, long put entry 2, long put exit 2, long put 2 re-entry, long put 2 re-entry 2 ) from Snowman.
"O.K. I can not stay angry at myself for ever. I wanted the SFB QN and had my finger on the button for 13.10 and it kept bumping $13.15 I was not going to push it I still felt we may rally. So then the bottom fell out. The selling became furious and I knew at this point the option guys are going to have to cover and we are going to see a continued Melt down. So all is not lost. I had my finger on the button earlier for 16 puts SFB PI for April and we were going up, so I held off. Then we started down I pressed the button and it did not clear right away and I lost out. The adventures of a day trader. You can just call me the Drama Queen." - Snowman long put entry 1
"Looking to buy back in the SPY 132-133 range. Good luck trading." - Snowman long put exit 1
"At this point it looks like a 133 close. You never know though. Still fairly low volume. Yet some resistance on GE and XOM."- Snowman long put entry 2
............................................................................................................................................................
"I was going to sell these first thing and waited. It was a very impressive close. No clue what is up for tomorrow? T-Bills at .01 for six month last night freed up a lot of money. That is one way to get the market up BEN drive them out. You would think that it would just correct down tomorrow after a two day run. That was what had me worried. That is the logical play. I try to stay away from that, because big money almost always goes against that. They seemed pretty committed today and I see no reason for a downturn. I was going to buy C puts at 3:00 then unload these just could not bring myself to do it. If we go up again tomorrow I will do it then. Still in the game, but instead of almost doubling my money I am up a little over 15%. Good luck trading." - Snowman long put exit 2
"Was going to buy these at 10.40 earlier and felt there was just as much upside risk as downside. Then at the close everything was down, yet the SPY remained up? I understand that there were some sectors holding it up anyway the index is 135.30 at 4:00 which is what most people look at. I was going to buy 5 earlier so I bought two." - Snowman long put 2 re-entry
"Thought we would take a big dive early, took longer than I thought." - Snowman long put 2 re-entry, increasing position
Snowman,
From the looks of it, not only are you a very active participant in the Community, you are even more active of a Trader. Thanks for giving us your play-by-play for so many of your trades! To begin, let's go to the Rookie's Corner.
ROOKIE'S CORNER
SPY = 132.08 as of 3/20/08
3/19 3:31 pm Trade 1: Bought to open 10 SPY May 143 puts @ 12.90
SPY = 130.32 as of 3/19 close
3/20 9:47 am Trade 2: Sold to close 10 SPY May 143 puts @ 13.70
SPY = 132.08 as of 3/20 close
3/20 2:50 Trade 3: Bought to open 10 SPY May 145 puts @ 13.30
............................................................................................................................................................
3/24 3:21 pm Trade 4: Sold to close 10 SPY May 145 puts@ 10.80
SPY = 134.72 as of 3/24 close
3/25 4:07 Trade 5: Bought to open 2 SPY May 145 puts @ 10.80
SPY = 134.85 as of 3/25 close
3/26 9:37 Trade 6: Bought to open 2 SPY May 145 puts @ 11.50
SPY = 133.20 as of 3/26 close
Long Put - Play #2 (Education > The Options Playbook > The Plays > Play #2)
A long put gives you the right to sell the underlying stock at Strike Price A (145). If there were no such thing as puts, the only way to benefit from a downward movement in the market would be to sell stock short. The problem with shorting stock is you're exposed to theoretically unlimited risk if the stock price rises. Puts may be used as an alternative to shorting stock, because they limit your risk to the cost of the options. If the stock goes up - the worst-case scenario - you don't have to deliver shares to the investor from whom you borrowed them, as with short stock. You simply allow your puts to expire or sell them to close your position (that is, if they're still worth something).
BREAK-EVEN AT EXPIRATION
Strike A minus the cost of the put.
THE SWEET SPOT
The stock goes right in the tank.
MAXIMUM POTENTIAL PROFIT
There's a substantial profit potential. If the stock goes to zero you make the entire strike price minus the cost of the put contract. However, stocks usually don't go to zero.
MAXIMUM POTENTIAL LOSS
Risk is limited to the premium paid for the put.
MARGIN REQUIREMENT
After the trade is paid for, no additional margin is required.
AS TIME GOES BY
For this play, time decay is the enemy. It will negatively affect the value of the option you bought.
IMPLIED VOLATILITY
After the play is established, increasing implied volatility is your friend. It will increase the value of the option you bought. It also reflects an increased possibility of a price swing (without regard for direction).
Click here for a larger image. Charts may be found under Quotes+Research > Charts.
TRADE DISCUSSION
I'm not sure a specific question is being asked here, but I'll throw in some general comments regarding short-term trading. You were trying to buy puts on March 19th. That was the day after the monster 45-point rally in $SPX and after it had tacked on another 10 points early on March 19th. That, as it turns out was a good time to buy puts. You were trying to buy puts late in the day, although you had been bidding for a higher strike earlier in the day. When the market broke down, around 3:30pm, you bought the May 143 puts, presumably with SPY around 131.30 or so.
First, I like this approach - buying in-the-money puts to eliminate the vagaries of implied volatility and time value premium. These in-the-money options have very small Vegas and thetas, and very large deltas. So, if you're correct on your opinion of the underlying, the option acts as a proxy for (shorting, in this case) the underlying. I might think, though, that buying April puts instead of May puts would accomplish the same thing and be in a slightly more liquid contract.
Then you exited the next morning, early, when the market was off slightly before a big rally took place. You stated you were looking for SPY to rally back towards 132-133 before re-establishing the put position. You were correct in that assessment as SPY rallied strongly on the 20th, and you re-entered a position in the May 145 puts in late afternoon on Thursday, March 20th. That was the last trading day of the week, and I see that you took them long into the weekend.
We don't know (at this point) what happened next, but $SPX opened strongly on the Monday - the next trading day - and carried above what had been resistance at $SPX 1340 (134 on SPY). I would suppose that once the 134 area was exceeded, a short-term trader of this type would exit.
This type of speculative trading is certainly not for everyone - especially using the deep in-the-money options, as in these examples. We don't know what trading system you are using to enter these trades (hopefully, it's not just seat of the pants trading). But whatever it is, it's active and aggressive.
This is fine for those with the nerves to handle that sort of trading and your approach appears to be "right on" for you. Others, though, might want to speculate, but in a somewhat less aggressive manner. In any case, the speculator needs to buy an option that fits his or her trading system.
There is a very simple rule for which option a speculator should buy: the shorter-term the time horizon of your trading system, the larger the delta of the purchased option should be.
Click here for a larger image. Chains may be found under Research+Quotes > Option Chains.
In other words, we all have a time horizon for our trades. Yours is very short term. Others may be position traders - holding for days or even weeks or months. You know the time horizon of whatever trading system you're using (if you're not using a system, but are merely trading "by feel," you should do some research and find a system; "feel" trading or "seat of the pants" trading breaks down badly when emotions run high, whereas a system always gives you some rules to fall back upon).
In any case, if you are a very short-term trader, then the rule states that you should buy an option with the highest delta. So, that would either be a very deeply in-the-money option, as you are using or the underlying itself (SPY or S&P e-mini futures, in this case). It should also be the nearest-term option, expiring in less than a month.
However, if you're a position trader and expect to be in the position for a week or two, then you should buy something with a high delta (perhaps 0.85 or so), but still expiring in the first available expiration month (if there's just a couple of days left in the front month, then you should buy the next month out, but nothing farther than that). That would be an in-the-money option, and supposedly you would have some sort of stop price in mind as well, preferably based on where the underlying is trading.
For intermediate-term traders - which I classify as holders for 3 months or so - then an at-the-money option could be utilized, expiring in three months or so.
And, finally, if you're truly long-term, you might consider buying a LEAPS option (9 months or more to expiration) slightly out of the money.
The point is that short-term traders are presumably good at predicting 2, or 3, or 4-point moves in the stock. You want to own an option that is going to appreciate quickly when the stock moves. Therefore, you need to own an option with a high delta in order to do that. As I noted earlier, such an option also has small exposure to volatility (vega). For example, this past week, when SPY rallied strongly, implied volatility ($VIX) dropped sharply. That hurt at- and out-of-the money call holders, so their calls didn't appreciate as much during that rally as they might have expected, whereas in-the-money call holders were barely affected by the drop in implied volatility and participated more fully in the rally.
On the other hand, if you're going to be in the position for months, then you need limit risk, buying at- or maybe even slightly out-of-the-money. Presumably, if your system works, over that amount of the time, the underlying could move significantly and you'd still profit handsomely even with options that are not in-the-money to begin with.
Many successful stock traders have trouble translating that skill into successful option trading. It's usually because they buy an option that is (too far) out of the money and/or one with not enough time remaining. Following the above rule will cure that problem.
This comment and any market data included here were prepared on 3/24/08.
President
For a list of previous All-Star Trades, please click here.
Options involve risk and are not suitable for all investors.
Please read Characteristics and Risks of Standardized Options.
While implied volatility represents the consensus of the marketplace as to the future level of stock price volatility or probability of reaching a specific price point there is no guarantee that this forecast will be correct.
The Greeks (Delta, Gamma, Theta, Vega, and Rho) represent the consensus of the marketplace as to the how the option will react to changes in certain variables associated with the pricing of an option contract. There is no guarantee that these forecasts will be correct.
Any strategies discussed and examples using actual securities and price data are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. In reading content in the Community, you may gain ideas about when, where, and how to invest your money. Although you may discover new ideas or rationale that may be compelling, you must ultimately decide whether or not to put your own money at risk. Consider the following when making an investment decision: your financial and tax situation, your risk profile, and transaction costs.
Lawrence G. McMillan has a professional business relationship with TradeKing.
