Stops?

Sounds like for what you are doing, 10% allocation to each position is fine. You might have noticed that 10% loss of that 10% happens in a hurry when the support or resistance is broken.

Do you use any particular type of reversal strategy or just simply cut your losses and find another. I ask because that is influential in determining where I place the sell stop. If you are always long single contracts you should probably place a fairly tight stop, because there is no way to really reverse the position effectively. Some people might argue with that, and they have a right to. In the past, more often than not if I tried to reverse that kind of position, the timing was off and I lost more than I gained. I try to evaluate where to place the stop by looking at the charts for the individual stock. Day traders are very religious about where they place their stops. Swing traders can be a little bit more artistic, and determine that point on an case by case basis. When you decide where to put it, stick to it!

In regards to trailing stops, you must take into account the volatility of the underlying and the delta. Sometimes a $0.10 TrailStop is great. Other times that kind of TS will get hit immediately. It might also help if you determine how much of your profits you are willing to give up and set the Trailstop there. Then if it turns against you, you're ok with it, and if it keeps running you'll eek out some extra profits.

If you like using Trailstops I don't know that I would "scale out profitability". My opinion is that if you have hit a point where you would consider pulling part of the position, leave the entire thing and place a fairly tight Trailstop. The only reason to scale out is if you are fairly confident that it might keep running. The Trailstop allows for all of your money to keep running if you are right and allows for the same loss protection. Except in the case that the underlying gaps against you. In other words, be careful with companies like biotech that have violent price swings on unexpected events.

About commissions, it sounds as if you do some investing with other non-leveraged instruments. Options commissions, even at 0.75/contract are still huge compared to say common stock purchases. I use TOS (they allow you to adopt the fee schedule of the other brokers like IB) and I'm paying my fair share of commissions. Worth it.....yes. Desirable.....not hardly!

 

By the way Neoxx, I forgot a couple things. If you use your system for picking stocks, absolutely don't get into straddles/strangles! You will lose money faster than you can think. Not saying that they aren't good strategies, just that they require completely different setups.

I agree with the comment on calendar spreads. Make sure you figure in the IV and theta. Calendar spread can make money pretty consistently, but they do take longer than certain other spreads.

In regards to spreads reducing profits. That depends on how you look at it. I used to love the thrill of those huge gains obtained by long directional plays, but the losses suck too. On a long directional play, no matter how good the evaluation, there are so many things that can go wrong that probability of profit is pretty close to coin flip. And the probability of huge profit (>200%) is even less. The question is, would you rather have <30% chance at a HUGE profit, or >70% chance at a LARGE profit. The only thing that matters in the end is Net Gain for the year. My account value has told me that certain strategies that supposedly "limit" gains, produce a higher Net Gain at year end. But my opinion is only worth what you are paying for it.

 

No reversal strategy. Welcoming the small loss and looking for the next opportunity.

As for stops, I take a long hard look at the chart, but generally, I'm placing them 20 or so cents below support.

Given that I'm starting with 80 deltas, by the time there's been a move, it's near enough a stock position. Have you got a rule of thumb for how you calculate the trailing stop based on underlying volatility?

Because of that 1% rule, I'm mostly just trading single contracts so not really noticing the comissions yet.

Will probably upgrade to a more professional platform once the account is over 20k or so. Not sure which though. OptionsXpress? TOS? PowerEtrade Pro?

Then again, the IB interface is growing on me...

Neoxx

 

Thanks for all the advice Cache.

I take it you're talking about debit spreads. Max profit is the difference in the strikes minus the initial debit, right? I'm curious, how do you structure your spreads, and what does P/L look like prior to expiration?

Do you need to hold them til expiration to realise max profits?

What I particularly like about long calls is the ability to ride a trend for a few days, cash out, and look for the next (hopefully ;-) free ride.

Yeah, I'm saving straddles and strangles for when I know what I'm doing

 

Aha! A chance to learn something the non bloody nose way! Why would you not recommend straddles/strangles for a stock picking system?

Thanks,

- The New Guy

 

Actually, I was talking about credit spreads. That is why I made a statement before that risk is all in how you look at it. If you are using software to get probability for profit then it likely will not give you a truly accurate number. The number it gives you will likely be the probability that the price of the underlying will be above or below a certain point at a given time. This is based on the volatility and price movement during a recent specified amount of time. That said, it should be obvious that this number isn't perfect. It needs to take into account a few other things that iT can't possibly account for, such as support and resistance.

Anyway, on these forums, as soon as someone starts promoting a certain strategy there are a bunch of people waiting to attack that strategy because it isn't their personal favorite. With that understood I will give a general example of a trade that might work out. To anyone who reads this....understand that I am going to use a couple ESTIMATIONS and give a SIMPLE analysis. I'm not trying to account for every possibility, nor perform a really thorough analysis. I would give you an example of a successful trade from the past, but I don't believe in that. As every disclaimer states, "past performance is in no way an indicator of future results."

Take SHLD right now. As we speak it's trading at about $118. If you look at the chart, it has been stuck in a range for some time now ($114 - $126). Anybody want to guess what will happen when it breaks out? Let's say that YOU think the support at $114 will hold. You could wait for the stock price to drop down toward $115 and get into a Feb. bull put spread.

Sell a 115put & buy a 110put. You'll likely get about a $2.35 credit depending on how close to $115 you let it get. Your risk is the diference between the strikes, minus the credit ($265), but that isn't the probable risk. If the underlying runs against you about $10, the spread will have increased from $2.35 to about $3.55, so if you buy it back then you'll have lost $120. Using that as a stop point your P/L would be almost 2/1. But are you really gonna let it run $10 against you? No, because you defined the support at $114. At $114 the spread will have increased to maybe $2.70, so if you buy it back then you'd have lost $35 (P/L=6.7/1).

Let's say you aren't excited about that loss. The underlying will likely break toward the downside after it passes through support at $114. So instead of closing the whole position you just buy back the short leg. You now have long put worth about $5.50. To break even you need to make up 0.35, so you put a stop in just in case it reverses on you again and wait for the more likely event that momentum carries it down to either break even, or a profit. At that point you could either sell to close or place a trailstop and try to ride the new trend down.

Anyway, because of the support, the probability of profit is actually much higher than it might appear, and the risk is much lower. If you factor in the reversal strategy then that is even more true. Obviously there is a little bit more to account for, like theta if you were forced to stay in the trade for a month without the underlying moving at all, but you get the idea. I'm not saying I would trade it like that because I would actually wait for it to break out before trading it, but the concept is the same.

For MAX profits you do have to hold them till expiration, but you can get very close to max profits much sooner if you are correct about the direction of the stock movement. In which case you wait until the short leg gets close to 0.05 and buy it back. The long leg is still open but essentially worthless at this point. Unless by chance the stock reversed big right after you bought the short leg back. I call that luck, but it happens. While you are in the position you can decide if you are just chasing pennies, and it would be better to free up the money in your account for another trade.

As far as ROE...you would be tying up $265 to make a maximum $235 if held to expiration. 88% in a month and a half. Not bad. Whoa...long response. Sorry

 

The question is, why would someone play straddles/strangles? The answer is because you can count on something more predictable than directional movement, VOLATILITY. Volatility is generally more predictable and you are merely chasing the change in delta. No matter which way the stock goes, you can make unlimited profit.

Anytime someone says the word unlimited all the newbies perk up. I don't like the word unlimited because it is misleading. Yes there is no limit to the possible profit, but those profits are improbable. Most stocks have to make a considerable run before one could even come close to 100% gain in a straddle. Those runs are usually event related which means that IV is going to crash. So it severely limits your choices on which equities you can play. You have to rely on the IV staying the same or higher, and you're fighting against double theta, and you're tying up double equity.

I based my recommendation not to play those strategies on his comments about his trading style and preferences. Straddles/strangles can make money when traded actively (assuming all the profits aren't eaten up by double commissions). But they shouldn't be used just because someone doesn't want to have to pick a direction. In a swing trade situation, the odds are stacked against you. Based on his style of evaluating plays, he would likely just sit and watch as theta and IV destroyed his account.

 

Good thing I decided to steer clear then!

 

So you mostly trade credit spreads… I hadn’t actually given them much consideration. To start with I tried a few debit call spreads, with very unexciting results, and resolved to leave spreads for a littler later in the game.

Your analysis is interesting and portrays them in a whole new light.

So while potentially more of your equity is at risk in any one situation, because of high probability setups (e.g. breakouts) and clearly defined S/R levels your actual risk is much smaller.

And another factor that deterred me from using spreads was the seemingly poor risk/reward ratio. But, you paint them in a far more appealing colour. So because of the initially defined stop, which is by necessity close to the entry point for breakout plays, the small risk inflates the risk/reward ratio, giving you enviable figures like 1:7.

That compares very favourably to my long ITM calls, and you’re also insulated from downside gaps.

Take my ITM calls on a 7K account. I can risk $70, meaning I can afford about 0.75 between entry and stop, taking slippage into account. If I’m hoping the stock moves about $2 in my direction, then that’s only gives a risk/reward of 1:3. I’d have to expect a move of $5 to realize similar ratios to your spreads.

And I hadn’t realized you can realize most profits well in advance of expiry if the underlying moves your way. So you don’t actually have to hold your spread for a whole month.

I’d envisioned my long call strategy as a solitary ethereal surfer, hovering amidst an ocean of swells, flitting effortlessly from wave to wave. Riding momentum.

But it seems you can also maintain your mobility with spreads.

Also, it seems like you’re benefiting in 2/3 scenarios, substantial losses coming only by way of a sluggish underlying, which again, is unlikely at a breakout point. The stock will either burst through the S/R level or falter and fall back through the other way. Right? And if you’re wrong about the initial direction, because you’re using a credit spread you can easily adjust your position in the opposite direction.

It does make a lot of sense, and seems perfectly synergistic with a breakout strategy. So, in essence, while the right-hand side of your P/L diagram is a vertical spread, the left-hand side resembles a shallow version of the left-hand side of a straddle P/L. Is that correct?

Taking a real life application…

I bout HXL 17.5 puts on 27th December. My rationale was: channeling, rising on faltering volume, a hammer at support then a long red candle with good volume. In retrospect, perhaps I should have been a little wary, given that resistance didn’t hold on the last occasion and the aerospace industry has been in a steady uptrend since 2003.

Thank you, Osama.

Yesterday, a long green candle broke through resistance, after two days of strong accumulation.

So, I could adjust my position by selling a 22.5 put and metamorphosing into a bull put spread. My absolute max loss (5.0 – (credit – initial debit)) would be about 4% of my equity, and max profit would be 3%.

If the breakout failed, I could simply buy back the 22.5 put and ride my long put down.

Is that right?

Or (assuming the move continues) should I dissolve my position, incur my 0.8% loss and participate in the upside move with a long call?

 

Elected to take my 0.8% hit.

Would have liked to buy the long call but P/L wasn't all that attractive so just dismissed all thoughts of revenge on Hexcel and moved on.