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Setting Up Your Account
Before you are able to trade options you’ll need to have a brokerage account and get approved for options trading.
With most brokers you can buy options with very little in your account.
Step 1: Choose a brokerage
If you already have a brokerage account you should be able to apply for options trading there. If not we recommend opening an account at a discount broker to avoid paying high fees.
Step 2: Get Permissions
You will have to answer a few questions about your trading experience and fill out some forms. We recommend applying for the highest level of options trading. Levels vary from brokerage to brokerage but are typically level 2 to 4. If you receive the lowest level don’t worry as you gain experience you can reapply for a higher level.
Step 3: Fund your account
You will need to put some money in your account.
What are Options?
An option is a contract that represents the right to buy or sell a stock at a set price by a set date. The set price is known as the Strike Price. The set date is known as the Expiration Date. You are able to buy and sell options.
Options are quoted on per share basis; however, each options contract represents 100 shares of stock; so to determine the value of an option we will need to multiply the options price by 100.
Money-ness, Expiration & Pricing
“Money-ness” is used to describe the relationship between an option’s strike price and the current stock price. An options strike price can either be – in the money, out of the money or at the money. For an option to be in the money it simply means the option has intrinsic value. Intrinsic Value refers to the amount by which the option is in the money. For example, a put option with a $55 strike price while the stock is currently trading at $50 would have $5 dollars of intrinsic value.
Another example, a call option with a $100 strike price while the stock currently trades at $120 would have $20 of intrinsic value.
When an option has no intrinsic value it is considered out of the money. For example, a
$25 strike price call option while the stock currently trades at $20 would have no intrinsic value and be considered out of the money. If a put options strike price is less than the current stock price, it is out of the money.
Lastly, the at the money option refers to the strike price equal to or nearest to the current stock price.
Options Pricing
An options price, also known as premium, is made up of two components; intrinsic value which we covered earlier and time value.
Time value refers to the portion of an options premium that is not intrinsic value. An option’s time value is equal to its premium minus the intrinsic value.
As a general rule, the more time that remains until expiration, the greater the time value of the option. An options time value is always decaying, and at expiration will have no time value left.
Expiration
Terms
These are some terms you will see throughout this guide. A full list of options terms can be found at the end.
Assignment: The receipt of an exercise notice by an option seller that obligates them to sell (call) or purchase (put) the underlying security at the strike price.
Cover: To buy back as a closing transaction an option that was initially written.
Covered: A written options is covered if the seller also has an opposing market positions. A short call is covered by being long the underlying security. A short put is covered by being short the underlying security.
Credit: Money is received in an account. Net sale proceeds are larger than net buy proceeds.
Debit: An expense or money paid out from an account
Delta: The amount an option price is expected to move based on a $1 increase in the underlying stock.
Exercise: To implement the right under which the holder of an option is entitled to buy or sell the underlying security.
Expiration Date: The day on which an option contract becomes void.
Premium: The price of an option contract which the buyer of the option pays to the option writer for the rights set forth in the contract. This price changes with the market.
Strike Price: The stated price per share at which the underlying security may be purchased (call) or sold (put).
Time Decay: Value of an option reduces with the passage of time.
Looking at an Options Chain
This is what an options chain will look like in ThinkOrSwim, however almost every platform will look very similar. I’ve highlighted some key information. It is important to get familiar with an options chain.
The purple highlighted areas represent strike prices that are in the money.
Open Interest, Volume and Delta: There are tons of different data points you can put on your options chain, however these 3 are what I find to be the most important.
Open Interest indicates the total number of options contracts that are out there for that strike price and expiration date
Volume represents the total number of contracts that have traded today
Delta is the amount an option price is expected to move based on a $1 increase in the stock price, or a rough estimate of what the chance is that that option will be in the money at expiration. (ex. Delta 70 would assume the option has a 70% chance of being in the money)
Put Options
Buying vs Selling Puts
Sold Put Important Information: Breakeven Price: Strike Price minus Options premium Max Profit: Options premium collected for selling the put Max Loss: The same as owning shares below your breakeven point
Purchased Put Important Information:
Breakeven Price: Strike Price minus Options premium Max Profit: Strike Price down to $0 Max Loss: The total amount paid for the option
Making a Trade
Example – PTON June, 2020 Sold Put
On 6/12/2020 PTON was trading around $46. I sold to open the $45 strike price puts that expired in 7 days (6/19/2020) for $1.37 in premium.
PTON Chart on 6/12/2020
Key Statistics:
Breakeven price: $43.63. ($45 - $1.37) Max Profit: $1.37 or $137 for every put sold if PTON > $45 Cushion: 5% before breakeven price is at risk
Potential Scenarios:
PTON shares rally and I keep the options premium I sold the option for
PTON shares go sideways and I keep some of the options premium I sold the option for due to time decay
PTON shares decline and I purchase 100 shares of stock for every put option I sold at an average cost of $43.63
What Happened Next?
PTON shares rose a few days later to around $50 on 6/15/2020. I was able to buy to close the option for $0.35 leaving me a profit of $1.02 or $102 for every put option I sold. The trade was good for 74% of my maximum profit potential.
PTON chart on 6/15/2020
What Could Have Happened?
What if I had held the put options until expiration day?
In this case PTON traded around $51 dollars on 6/19/2020 and the puts would have expired worthless because the stock price was greater than my chosen strike price and maximum profit would have been achieved. This is a personal decision that must be made to lock in a good profit or try and hold for a bigger profit. I typically will take profits of 50%-70% of my maximum profit potential.
What if the price had dropped below $45?
If shares of PTON had traded lower than $45 I would have been stuck with a decision to make, hold the option until the expiration date and purchase shares of PTON at $45 with a breakeven price of $43.63 ($45-$1.37) or buy to close the option at the current market value before expiration. Depending on the share price you could still show a profit on this trade if PTON was trading above your breakeven point of $43.63. Your outlook on the stock would guide you on which route to take.
Tips for Selling Puts
1. Only sell puts on stocks you would be happy to own. 2. Sell “out of the money” puts, the strike price is lower than the current stock price. 3. Don’t sell more puts than you should, remember you must be willing and able to purchase 100 shares of stock at the strike price for every 1 put you sell.
Making a Trade
Example – BNTX December, 2021 Purchased Put
On 12/20/2021 BNTX was trading around $280. I bought to open the $290 strike price puts that expired on 01/21/2022 for $30.00 in premium.
BNTX chart on 12/20/2021
Key Statistics: Breakeven price: $260 ($290 - $30.00) Max Profit: $290 per share ($290-$0) Max Loss: $30.00 per share Potential Scenarios: What Happened Next? BNTX shares rally or go sideways and I will face a loss BNTX shares decline and I the value of my put option increases
What Happened Next?
BNTX shares declined the next couple days until it found support at its 200 day moving average on 12/27/2021. I was able to sell to close the option for $41.75. Good for a profit of $11.75 or $1,175 for every put option I bought. The trade was good for a 39% return.
BNTX chart on 12/27/2021
What Could Have Happened: What if I had held the put options until expiration day? In this case BNTX continued to fall and traded all the way to around $150 on 1/21/2022. This would have resulted in a monster trade with a huge gain, however there is no trading in hindsight, so I was very happy with a 39% gain.
What if the price had rose above $290? If shares of BNTX had traded higher than $290 I would have been stuck with a decision to make, hold the option longer if I still thought the stock would go down and I had time left until the expiration date or sell to close the option at the current market value before expiration.
Buying vs Selling Calls
Call Options
Sold Call Important Information: Breakeven Price: Strike Price plus the Options premium Max Profit: Options premium collected for selling the call Max Loss: Infinite, unless selling covered calls. Then Same as owning shares below the breakeven point. Purchased Call Important Information: Breakeven Price: Strike Price plus the Options premium Max Profit: Infinite Max Loss: The amount you paid to purchase the call
Covered vs Naked Calls:
A covered call is when you sell a call option on a stock that you own at least 100 shares of already. You can sell 1 call option for every 100 shares you own to be covered. Selling a naked call refers to selling a call option without owning shares of the underlying stock.
Making a Trade
Example – SHOP Sept, 2017 Covered Call
On 8/14/2017 SHOP was trading around $94. Knowing I wanted to sell covered calls on the stock, I bought 100 shares of stock at $94.06 and sold to open the $100 strike price call that expired in 4 days (8/18/2017) for $3.34 in premium.
SHOP Chart 8/14/2017
Key Statistics: Breakeven price: $90.72 ($94.06 - $3.34) Max Profit: $9.28 or $928 per every covered call sold. ($100-$90.72) Max Loss: Same as owning shares below $90.72
Potential Scenarios: What Happened Next?
SHOP shares rally over $100 and I sell the shares I bought at $100
SHOP shares go sideways and I keep the options premium I sold the option for due to time decay
SHOP shares decline and my sold call option expires worthless and I still own shares from my lower cost basis of $90.72
What Happened Next?
SHOP shares went basically sideways and on 8/18/2017 expiration day were still trading at $94.58. I was able to let the option expire worthless and keep the full premium I was paid for selling the option. The trade was good for a 3.5% return while the stock only went higher .5%. At this point I then sold the $100 strike price for the September expiration for $2.84 in premium, essentially lowering my breakeven point to $87.88. Shop rallied above $100 by the September expiration and I chose to let my shares go at $100 while keeping the additional premium.
SHOP Chart 8/18/2017
SHOP Chart 9/15/2017
What Could Have Happened:
What if shares had rallied over $100?
If shares of SHOP had rallied quickly and traded over $100. I would have a choice to make between letting the shares be sold at the $100 and keeping the options premium or rolling out the option to a further date. Rolling consists of buying back the sold option at the market price and at the same time selling a new option at a farther out expiration date. This only makes sense to do if you can receive more options premium for selling the farther out option than buying back the current option you own.
Tips for Selling Covered Calls
1. Only sell covered calls on stocks you would be happy to sell at your strike price.
2. You can sell “Out of the money” calls to take advantage of rising share prices.
3. Make sure you are selling 1 call for every 100 shares you wish to cover.
Making a Trade
Example – AMD November, 2020 Purchased Call
On 11/12/2020 AMD was trading around $81. I bought to open the $80 strike price calls that expired on 01/15/2021 for $7.45 in premium.
AMD Chart 11/12/2020
Key Statistics:
Breakeven price: $87.45 ($80 + $7.45) Max Profit: Infinite Max Loss: $7.45 per share Potential Scenarios:
AMD shares rally and I profit
AMD shares decline or go sideways and I have a loss
What Happened Next?
AMD shares started rise over the next few weeks. As the share price rose so did the value of my call option and I was able to sell to close the option for $17.48. Good for a profit of $10.03 or $1,003 for every call option I bought. The trade was good for a 134% return.
What Could Have Happened: What if I had held the call options until expiration day? In this case AMD met resistance around the $100 level and started to fall trading all the way to around $90 on 1/15/2021. While this still would have been profitable, it was a better decision to sell into strength and lock in larger profits.
What if the price had dropped below $80?
If shares of AMD had traded lower than $80 I would have been stuck with a decision to make, hold the option longer if I still thought the stock would rise and I had time left until the expiration date or sell to close the option at the current market value before expiration.
Tips for Buying Calls
When buying calls, it’s better to go out farther in time than it is to go shorter. You want to limit time decay.
Purchase in the money or at the money calls, out of the money calls can provide great looking % returns but require huge stock moves to workout.
Don’t purchase more than you are willing to lose, remember when purchasing an option, you can lose the total investment
Credit Spreads
A credit spread is an options position in which you both sell and buy options of the same type, usually with the same expiration date on the same stock. The premium received from selling the option is larger than the premium you pay to buy the option giving you a net credit when setting up the trade.
Setting up a credit spread
There are two main types of credit spreads we use, a Put Vertical and a Call Vertical.
Put Vertical
Sell to open higher strike put (premium received)
Buy to open lower strike put (premium paid)
Call Vertical
Sell to open lower strike call (premium received)
Buy to open higher strike put (premium paid)
A credit spread is known as a multi-leg order, which is a trade that involves executing two or more options transactions in a single order. Each transaction of the order is known as a leg. Most brokers will allow a trade to have up to 4 legs.
Credit Spread Important Information
Breakeven Price: Put Vertical = Sold Put Strike minus Credit received. Call Vertical = Sold Call Strike plus Credit received.
Max Profit: The total premium credit collected for selling the spread.
Max Loss: The difference between the selected strike prices minus the credit received.
Making a Trade
Example – SE Oct, 2020 Put Vertical
On 10/05/20 SE was trading at $157. I opened a put vertical credit spread by selling to open the $160 strike put for $8.75 and buying to open the $150 strike put for
$4.20 expiring 10/16/20 using a single order. Resulting in a net credit of $4.55.
SE Chart 10/05/2020
Key Statistics: Breakeven price: $155.45 ($160 - $4.55) Max Profit: $4.55 or $455 for every credit spread sold. Max Loss: $5.45 or $545 for every credit spread sold. (($160-$150)-$4.55)
Potential Scenarios:
SE shares rally over $160 and I keep the credit received for selling the spread
SE shares go sideways and I keep some of the options premium I sold the option for due to time decay
SE shares decline and I take a loss on the trade or potentially breakeven depending on the share price.
What Happened Next?
SE traded higher a few days later to above the $160 strike price put I sold. I bought back the credit spread to close the trade on 10/08/20 at the market price of $1.30 by buying back the $160 put for $2.00 and selling the $150 put for $0.30. This resulted in making 71% of my maximum profit potential and $3.25 or $325 for every credit spread I sold.
SE Chart 10/08/2020
What Could Have Happened:
What if I had held the credit spread until expiration day?
In this case SE traded around $165 dollars on the 10/16/2020 expiration date and both sold and purchased puts would have expired worthless because the stock price was greater than my sold put strike price and maximum profit would have been achieved. This is a personal decision that must be made to lock in a good profit or try and hold for a bigger profit. I typically will take profits of 50%-70% of my maximum profit potential.
What if the price had dropped below $150?
If shares of SE had traded lower than $150 I would have been facing a loss. However, because you don’t need to hold options until the expiration date you could have gotten out for the going market price at any point the trade started going against you and most likely would not have faced your maximum loss. If you held on until expiration and the share price had dropped below $150 then you would face your maximum loss, which you knew beforehand.
Making a Trade
Example – ZS December, 2021 Call Vertical
On 12/28/21 ZS was trading at $330. I opened a call vertical credit spread by selling to open the $330 strike call for $11.50 and buying to open the $340 strike call for $7.00 that expiring 01/21/22 using a single order. This resulted in a net credit of $4.50.
ZS Chart 12/28/2021
Key Statistics: Breakeven price: $334.50 ($330 + $4.50) Max Profit: $4.50 or $450 for every credit spread sold. Max Loss: $5.50 or $550 for every credit spread sold. (($340-$330)-$4.50)
Potential Scenarios:
ZS shares fall staying below $330 and I keep the credit received for selling the spread
ZS shares go sideways and I keep some of the options premium I sold the option for due to time decay
ZS shares advance and I take a loss on the trade or potentially breakeven depending on the share price.
What happened next?
ZS traded sideways for a few days before breaking lower on 1/3/22. The stock price fell well below my $330 call I was able to to buy back the credit spread to close the trade at the market price of $1.35. This resulted in making 71% of my maximum profit potential and $3.25 or $325 for every credit spread I sold.
ZS Chart 01/03/2022
What could have happened:
What if I had held the credit spread until expiration day?
In this case ZS traded much lower on the 01/21/2022 expiration date and both sold and purchased calls would have expired worthless because the stock price was lower than both and maximum profit would have been achieved. This is a personal decision that must be made to lock in a good profit or try and hold for a bigger profit. I typically will take profits of 50%-70% of my maximum profit potential.
What if the price had advanced above $330?
If shares of ZD had traded higher than $330 I would have been facing a loss. However, because you don’t need to hold options until the expiration date you could have gotten out for the going market price at any point the trade started going against you and most likely would not have faced your maximum loss. If you held on until expiration and the share price had been above $330 then you would face your maximum loss, which you knew beforehand.
Iron Condor
The Iron Condor is the combination of a Put Vertical and a Call Vertical. An Iron Condor is a great strategy to use on a range bound stock. You are making a bet on where the stock won’t go.
You can sell an Iron Condor without taking on any additional risk compared to just a call or put credit spread. This is because only one of the spreads can be in danger of losing money. If the put side of the Iron Condor suffers its maximum loss, than the call side will have made its maximum profit and vice versa.
Setting up an Iron Condor
Puts are in red, calls are in black
Using this example, both spreads have a maximum gain of $1.00 or $100 per spread and a maximum loss of $4.00 or $400. When we sell them together to form the Iron Condor our new maximum profit is $2.00 or $200 while only risking $3.00 or $300.
Iron Condor Important Information:
Breakeven Price: Put Vertical = Sold Put Strike minus Credit received.
Call Vertical = Sold Call Strike plus Credit received.
Maximum Profit: The total premium credit collected for selling the spread.
Maximum Loss: The difference between the selected strike prices minus the credit received.
An Iron Condor will earn it’s maximum profit as long as the stock trades anywhere between the two sold options at expiration, in this example $40 and $50.
In this example if shares trades above $55 or below $35 at expiration we would suffer our maximum loss of $3.00 or $300. However, because you don’t need to hold options until the expiration date you could have gotten out for the going market price at any point the trade started going against you and most likely would not have faced your maximum loss. Another option would be to roll the side that is in trouble to bring in additional premium. This is done by closing one side of the iron condor while at the same time opening a new spread at new strike prices or a farther out expiration date.
Debit Spreads
A debit spread is an options position in which you both buy and sell options of the same type, usually with the same expiration date on the same stock. The premium you pay to buy the option is larger than the premium you receive to sell the option giving you a net debit when setting up the trade. This trade has a defined maximum risk and gain.
Setting up a debit spread
There are two main types of debit spreads we use, a Put Vertical and a Call Vertical.
Put Vertical
· Buy to open higher strike put (premium paid)
· Sell to open lower strike put (premium received)
Call Vertical
· Buy to open lower strike call (premium paid)
· Sell to open higher strike put (premium received)
A debit spread is a multi-leg order, which is a trade that involves executing two or more options transactions in a single order. Each transaction of the order is known as a leg. Most brokers will allow a trade to have up to 4 legs.
Debit Spread Important Information:
Breakeven Price: Put Vertical = Purchased Put Strike minus the cost of the spread. Call Vertical = Purchased Call Strike plus the cost of the spread.
Max Profit: The difference between the selected strike prices minus the cost of the spread.
Max Loss: The total premium paid for purchasing the spread
Making a Trade
Example – CRWD September, 2020 Call Vertical
On 09/30/20 CRWD was trading at $135. I opened a call vertical debit spread by buying the $135 strike call for $8.00 and selling to open the $150 strike call for $2.25 expiring 10/16/20 at the same time for a net debit of $5.75 or $575 for every spread I bought.
CRWD Chart 09/30/2020
Key Statistics: What Happened Next? Breakeven price: $140.75 ($135 + $5.75) Max Profit: $9.25 or $925 for every debit spread purchased. ($15.00-$5.75) Max Loss: $5.75 or $575 for every debit spread purchased.
Potential Scenarios:
CRWD shares rally over $150 and I make my maximum profit potential
CRWD shares go sideways or down and I will have a loss
What Happened Next? CRWD traded higher a few days later to around $145. I chose to sell the debit spread to close the trade on 10/12/20 at the market price of $10.50. This resulted in making 50% of my maximum profit potential, 82% on my capital at risk and $4.75 or $475 for every debit spread I purchased.
CRWD Chart 10/12/2020
What Could Have Happened:
What if I had held the debit spread until expiration day?
In this case CRWD traded around $145 dollars on the 10/16/2020 expiration date which would have resulted in a profit still. The call option purchased would have had an intrinsic value of $10.34 based on CRWD closing price that day and the call option we sold would have expired worthless, since CRWD’s price was less than the $150 strike price.
What if the price had dropped below $135?
If shares of CRWD had traded lower than $135 I would have been facing a loss. However, because you don’t need to hold options until the expiration date you could have gotten out for the going market price at any point the trade started going against you and most likely would not have faced your maximum loss. If you held on until expiration and the share price had dropped below $135 then you would face your maximum loss, which you knew beforehand.
Making a Trade
Example – ZI December, 2021 Put Vertical
On 12/27/21 ZI was trading around $66. I opened a put vertical debit spread by buying the $70 strike put for $5.30 and selling to open the $60 strike put for $1.15 expiring on 01/21/22 at the same time for in a net debit of $4.15 or $415 for every spread I bought.
ZI Chart 12/27/2021
Key Statistics: What Happened Next? Breakeven price: $65.85 ($70 - $4.15) Max Profit: $5.85 or $585 for every debit spread purchased. ($10.00-$4.15) Max Loss: $4.15 or $415 for every debit spread purchased.
Potential Scenarios:
ZI shares drop I make a profit
ZI shares go sideways or up and I will have a loss or breakeven depending on the share price.
What Happened Next?
ZI traded lower a few days later to under $60. I sold the debit spread to close the trade on 01/04/21 at $8.25. This resulted in making 70% of my max profit potential, 99% on my capital at risk and $4.10 or $410 for every debit spread I purchased.
ZI Chart 01/04/2021
What Could Have Happened:
What if I had held the debit spread until expiration day?
In this case ZI traded all the way down to $45 dollars on the 01/21/2022 expiration date which would have resulted in a maximum profit trade.
What if the price had traded higher than $70?
If shares of ZI had traded higher than $70 I would have been facing a loss. However, because you don’t need to hold options until the expiration date you could have gotten out for the going market price at any point the trade started going against you and most likely would not have faced your maximum loss. If you held on until expiration and the share price had been above $70 then you would face your maximum loss, which you knew beforehand.
The Greeks
Delta – Delta is the amount an option price is expected to move based on a $1 increase in the underlying stock.
Calls have a positive delta Puts have a negative delta Delta ranges from 0 to 1 for calls and 0 to -1 for puts.
Gamma – Gamma is the rate of change in Delta based on a $1 change in the stock price.
Gamma is always positive.
Additional money gained or loss for each additional $1 price move.
Gamma is highest at near the money strike prices Theta - Theta is the amount the price of options will decrease every day as the option approaches expiration, or time decay.
Great for options sellers, bad for options buyers
Theta is always negative because time value is always decaying.
Theta increases as expiration approaches Vega – Vega is the amount an options price will change for every 1% change in implied volatility.
Vega only affects time value.
High implied volatility will give options a higher price. Farther expirations have higher Vega.
Other Strategies
Synthetic Long
A synthetic long is set up to mimic ownership of a stock without having to own shares of the stock. This is a bullish strategy and is recommended to use an expiration date far out so you have plenty of time for your thesis to play out.
Setting up a Synthetic Long Setting up an Iron Butterfly Maximum Profit & Break-even Sell to open the at the money put option Buy to open the at the money call option
Delta
Delta is the amount an options price is expected to move based on a $1 increase in the underlying stock.
When you set up a synthetic long, the combination of the short put and the long call will have a Delta very close to 1; meaning for every $1 dollar the stock moves up your synthetic long will also gain $1.
Iron Butterfly An iron butterfly is a strategy used when you think a stock will trade sideways and you wish to collect as much premium as possible.
Setting up an Iron Butterfly
Sell to open the at the money put option Sell to open the at the money call option
Maximum Profit & Break-even
The maximum profit of an iron butterfly is the options premium originally collected for opening the trade. This happens when both strike prices are at the money at expiration.
There are two break-even points when selling an iron butterfly.
When To Place A Trade
Before placing a trade, you need to ask yourself if you are bullish (think the stock will go up) or bearish (think the stock will go down) on the stock. A simple way to tell whether a stock is in a bullish or bearish trend is to simply look at the chart and see if the price is moving from the bottom left-hand side to the top right (bullish) or from the top left to the bottom right (bearish).
Example – Bullish Charts
Price goes from lower left to upper right
Price goes from lower left to upper right
Example – Bearish Charts
Price goes from upper left to lower right
Price goes from upper left to lower right
However, just because a stock is in an uptrend or downtrend doesn't mean that it's the right time to place a trade. We want to take our analysis a step further, by looking at key moving averages and a contraction of volatility. We’ll start with the moving averages.
Moving Averages of Importance:
8 day exponential moving average (8ema) – light blue
21 day exponential moving average (21ema) - orange
50 day simple moving average (50sma) -red
200 day simple moving average (200sma) – black
10 week simple moving average (10wk) – dark blue
The order of these moving averages will help confirm the trend of the stock. For a bullish stock you are looking for the 8 ema to be on top of the 21 ema, which is on top of the 50 sma which is on top of the 200 sma. This is known as having the moving averages stacked. The 10-week line and the 50 day are very similar, and I will treat them as one in the same. For a bearish trend, you would look for the opposite stack.
Example – Stacked Moving Averages Bullish
Price goes from lower left to upper right, with stacked moving averages
Example – Stacked Moving Averages Bearish
Price goes from upper left to lower right, with downward stacked moving averages
The last piece we want to look for when making a trade is a contraction of volatility. We can see this with an indicator known as the TTM Squeeze. This is available for free on Think or Swim and TradingView. I will also link below chart templates already set up with the proper moving averages as well as the TTM squeeze. A squeeze occurs when a stocks Bollinger bands contract to inside the Keltner channels. The indicator displays as a histogram with colored dots along it’s horizontal axis indicating whether a squeeze is happening. If the dots are green there is no squeeze, if the dots are red, black or orange it indicates there is a squeeze and the Bollinger bands are inside the Keltner channels, this is when you want to start thinking about placing a trade. The second part of the squeeze is the histogram bars, light blue indicates momentum is trending up, dark blue means momentum is up but slowing, red means momentum is trending down, yellow means momentum is starting to turn from down to up. Ideally, we will place a trade with yellow or light blue momentum bars.
The last part before we place a trade is the stock price. The sweet spot for placing a trade is when the price of the stock is somewhere between its 8ema and 21ema. So to sum up when to place a trade, we are looking for a stock that is trending upward if bullish with a squeeze (red, black, orange dots), with momentum either blue or yellow, and the stock price in between the 8 and 21 emas.
Example – Squeezes
Trade Size
How many contracts should you trade for each position?
The answer is simple; it depends on your risk tolerance and goals.
Before you can determine how much you should risk and how many contracts to trade you need to think about a few things.
First, you don’t want to risk so much on any single trade that it can erase all the profits from previous trades. It is inevitable that eventually, you will have a losing trade (even though we try our best not to), you don’t want this to undue a good month or even year.
Secondly, you don’t want the daily swings in our account to be so much that we start to get emotional. Trading decisions need to be based on logic, not emotion. If the amount at risk or the daily fluctuations are making you lose sleep or pull your hair out, you’ve traded too many contracts.
Risk Per Trade Sizing a trade? Example:
Everyone has a different risk tolerance. Here is a chart that will show the different risk amounts by account size.
The risk per trade is based on the maximum loss on a trade for defined risk trades and the margin requirement for undefined risk trades.
Sizing a trade? In order to determine how many contracts you will trade, you need to determine your risk tolerance based on your account size (chart above).
Once you know your risk tolerance you will need to determine the maximum risk per spread or the margin requirement needed to open the trade.
Once you have both of those, you will divide the maximum risk tolerance by the maximum risk per spread.
Example:
$100,000 trading account with a 4% risk tolerance.
Sell to open a $50/$45 put vertical on stock XYZ for a credit of $1.00 or $100. Risk per spread:($50-$45)-$1.00=$4.00/$400 # of contracts = $4,000/ $400 = 10 spreads
How much money do you need to trade for a living?
To determine how much money you will need in order to trade for a living and support yourself or your family off of the profits you make trading in the market we will need to know a few things.
First, what is your annual cost of living? This will vary person to person based on where they live and the lifestyle they chose to have.
Second, you will have to take into account taxes.
Lastly, you will need to know what your average annual return is.
Example:
Cost of living: $50,000
Taxes: 25% (25% of whatever we make will be taken for taxes, so to reach $50,000 we need to calculate how much we need to make before taxes) (Taxes will be different from person to person)
Pre-Tax requirement: $66,667
Average Annual Return: 10%
Required account size: $667,000
Using this example you can see that in order to reach a profit of $66,667 with a 10% return we would need an account of $667,000.
Let’s take a look at how different annual returns affect the required account size to reach our goal of $66,667.
It is important to note that the higher the return the more aggressive and unrealistic the chance of repeating it year after year. You will also face more loss potential with larger draw downs. With a lower return you are able to use much more conservative strategies and have a higher chance or repeating it year after year.
Things to Consider
Not all months will be profitable. You want to have money set aside to cover a couple of months’ worth of living expenses. It is inevitable that you will have a month with a loss.
Be realistic with your average return estimate. With lower returns you will need a larger account size.
Trading Plan
Bullish Environment
Stock in an uptrend – 8ema (exponential moving average), on top of the 21 ema, which is on top of 50sma (simple moving average) with stock price above 21 ema.
If bullish uptrend criteria is met, look to sell a put credit spread or buy a call debit spread that expires 9 to 14 days out.
Bearish Environment
Stock in an downtrend – 8ema (exponential moving average), below the 21 ema, which is below 50sma (simple moving average) with stock price below 21 ema.
If bearish downtrend criteria is met, look to sell a call credit spread or buy a put debit spread that expires 9 to 14 days out.
Which spreads to buy or sell
Credit Spreads Sell delta 60-70 put, buy delta 30-40
Debit Spreads Buy delta 60-70, sell delta 30-40
Targets
Credit Spreads – 70% of max profit Example - $4.55 credit 70% of $4.55 = $3.19, $4.55 - $3.19= $1.36 target
Debit Spreads- 70% of width of spread Example - $15.00 wide spread 70% of $15.00 = $10.50 Target = $10.50
Stops
Credit Spreads– 50% of max loss Example - $10 wide spread, $4.55 credit, max loss $5.45 ($10-$4.55) $5.45 * .50 = $2.73 Stop = $4.55 (credit) + $2.73(50% of max loss) Stop = $7.28
Debit Spreads– 50% of max loss Example - $7.00 debit paid $7.00 / 2 = $3.50 Stop = $3.50
Time Stop If no profit target or stop loss has been hit by Tuesday of expiration week close the spread at the current market price.
The Plan in Action
Example Trades from June 2020 – Every trade has the correct bullish moving average stack. Not every trade worked out perfectly, but more winners than losers were had and profit was generated.
Terms
Ask Price: The price at which a seller is offering to sell an option or stock.
Assignment: The receipt of an exercise notice by an option seller that obligates them to sell (call) or purchase (put) the underlying security at the strike price.
At the Money: An option is at the money if the strike price of the option is equal to the market price of the underlying security.
Bid Price: The price at which a buyer is willing to buy an option or stock.
Call: An option contract that gives the holder the right to buy the underlying security at a specific price by a specific date.
Cover: To buy back as a closing transaction an option that was initially written.
Covered: A written option is covered if the seller also has an opposing market position. A short call is covered by being long the underlying security. A short put is covered by being short the underlying security.
Covered Call: An option strategy in which a call option is written against a long position.
Credit: Money is received in an account. Net sale proceeds are larger than net buy proceeds.
Debit: An expense or money paid out from an account
Exercise: To implement the right under which the holder of an option is entitled to buy or sell the underlying security.
Expiration Date: The day on which an option contract becomes void.
Good until Canceled: An order type meaning the order remains in effect until it is either filled or cancelled.
Implied Volatility: A measure of the volatility of the underlying stock.
In the Money: A term meaning an option has intrinsic value. A call option is in the money if the underlying security is higher than the strike price. A put option is in the money if the underlying security is lower than the strike price.
Intrinsic Value: The amount by which an option is in the money.
Limit order: An order to buy or sell securities at a specific price.
Market order: An order to buy or sell securities at the current market price.
Out of the money: A call option is out of the money if the underlying security is below the strike price. A put option is out of the money if the underlying security is above the strike price.
Premium: The price of an option contract which the buyer of the option pays to the option writer for the rights set forth in the contract. This price changes with the market.
Put: An option contract that gives the holder the right to sell the underlying security at a specific price by a specific date.
Strike Price: The stated price per share at which the underlying security may be purchased (call) or sold (put).
Time Decay: Value of an option reduces with the passage of time.
Time Value: The portion of the premium that is attributed to the amount of time remaining until expiration. Out of the money options are all-time value. Time value is whatever value the option has in addition to intrinsic value if in the money.
**Not Financial Advice. For Entertainment Purposes ONLY**