Which Option Strike Price Should I Trade?

Option Trading Question

Can you blog about the strategies that you use to pick the option strike price and expiration month once you have identified a possible stock? Also are there any tools out there one can use to identify possible profit and loss and probability of success for option trading?

Option Trading Answer

Throughout my blog you will find that your option strategy is a function of your opinion. You have to nail down the direction, duration and magnitude of the move. Then you need to assess your confidence in; the market, your analysis and your recent performance. All of these factors will lead you to the optimal strategy and trade size.

If I have a long term grinding move in a stable stock and the market is neutral, I would probably opt for an ITM call that has a few months of life. I will be buying intrinsic value and the option will move point for point with the underlying. This gives me the latitude to take profits along the way. This is almost like a surrogate stock position.

If I am looking for an explosive move in a short period of time, I will buy a front month OTM option. That will give me the biggest bang for my buck and I can buy more contracts.

If I am fairly confident in the stock’s strength, but the market is volatile (like now), I might consider selling an OTM put credit spread. This strategy will give me more cushion. If the market moves against me, the stock should hold up well and the puts will expire. If the market falls apart I should have time to buy back my put spread before things get ugly.

I trade relative strength and weakness within the market - that is my edge.

As for software, OptionVue has very good scenario analysis software. It will calculate your P&L based on many different outcomes. For most traders, this software is overkill. I like to keep things simple.

Know your stop before you place the trade. If your forecast was wrong, get out. When a trade is profitable, start getting out when the move stalls. Predetermined targets will often leave too much money on the table and you need to let your winners run as long as they are behaving.

Adsense for Domain

The Inside Adsense Blog has just announced that Adsense for Domains is now available to all publishers who owns several domains which are not really live sites. Whereas previously the only way that domain owners can earn from their registered dormant sites was to let third-party publishers to run their ads on those and then earn a miniscule of earnings. But with the Adsense for Domains open to all publishers, everyone can now run Adsense on their dormant domains regardless of whether they own only one or two domains.

By being available to “all publishers”, Google meant only those who are located in the U.S. Google Adsense is yet to roll this out to “all publishers” worldwide.

Although this would not make domain owners ultra-rich with revenues, it is however a better deal than letting other advertisers not connected with Adsense run their ads on those domains. This is for the simple reason that Adsense assumingly pays better.

If you opt to join Adsense for Domains, which you can do so by visiting your Adsense account, Google will run ads, links and search results on the dormant domains and will add more useful information in the near future.

This is a good way of making use of domains we bought but we haven’t really had the time to develop. Instead of paying them for nothing and hoping someday that somebody would buy it a high price, might as well run Adsense for Domain there.

Celebrity adsense

I have never been much satisfied with Adsense for celebrity sites anyways. Since last 5-6 months Google Adsense has been paying a cent or two for every click i get on my celebrity sites network. Believe me, i have lot of traffic on those sites and i really do get lot of clicks there. An average 100 clicks give me $2.00 only. I mean, this really is insane. Isn’t it? Is that what the advertisers at adwords are really paying for celebrity sites? I feel totally looted here!

Anyways, recently i was browsing my Adsense account and there in those green highlighted pointers it was written that verifying your website via Google Webmaster Tools will help us serve you better. Well, i thought this is it. Much targeted ads, much more money and much better revenue for the celebrity sites. So i readily added and verified all my celebrity websites. So what do you think? Problem solved? Am i earning more now?

Lol Not really. It’s even worse! Now an average 100 clicks give me $0.50 to $0.75. There you are Google Adsense. You really are brilliant with getting much more targeted ads.

My Dear God. Who in the world pays less than 1 cent per click to any advertiser program in the whole wide world?

I checked the ads running on my sites. Just reading the url and opening them in new windows. Each and every site is Made for Adsense (MFA). And they look worse. With absolutely no content. For God sake even blogspot blogs are being advertised by Adsense! Where is the Google TOS of “good landing page” being applied? I just want to ask, why is Google so dumb with their advertisers? And yet they come out brave and merciless when it comes to paid advertising on other sites which we have, by deindexing and banning and PR ripping things. What is it with you Google? Why don’t you get a life? Why can’t you live your own life and let live others their own?

Fact is, Google won’t let you sell advertising on your sites and blah blah blah, because they want people to use Adsense instead. But hey, they will not let you earn with Adsense either. Because they can’t filter MFA’s from their advertiser program.

So there you have it. Google Adsense vs. Celebrity Sites. You clearly know who the winner is! Don’t ruin your life. Get some better publisher advertisement programs on your celebrity sites.

Option Trading Books

ere are many option trading books worth reading. Before you consider one, you should have a basic understanding of technical and fundamental analysis. I believe you need to be a good stock trader before you can become a good option trader.

Here are a few of my favorite option trading books in order of complexity.

Options: Essential Concepts, Third Edition by The Options Institute. The Options Institute was formed by the various option trading exchanges to educate retail and institutional clients. This option trading book gives an overview on the history, pricing, strategies, floor operations and Market Making. It is easy to read and it provides an excellent foundation.

Options for the Stock Investor, by James Bittman. This option trading book goes through many of the basic option trading concepts and the terminology. James is an instructor at The Options Institute and he has decades of experience. He is one of the most knowledgeable authors in the industry.

Options As a Strategic Investment, by Lawrence McMillan. In short, this book is known by many as the "option trading Bible". I have read it cover-to-cover many times. It is detailed and comprehensive. It explains every option trading strategy and every option pricing concept. If you read it and understand half of it, you will know more than 90% of the people engaged in option trading.

McMillan on Options, Second Edition by Lawrence McMillan. Larry is one of the foremost authorities on option trading. In this option trading book he rolls up his sleeves and dives into some of his favorite option trading strategies. He uses examples to illustrate his approach.

Option Volatility and Pricing: Advance Trading Strategies and Techniques, by Sheldon Natenberg. This option trading book gets into serious option trading strategies and you need to have a good understanding of the basics.

As I mentioned before, to be a good option trader, you need to be a good stock trader first. Start with basic books on technical and fundamental stock analysis and then work your way up.

Index Trading vs Individual Stocks

Option Trading Question

Today Lloyd R. asks "I understand why someone would want to be long options, but why not use indexes for credit spreads? Stocks are so unpredictable and a news event (takeover, earnings pre-announcement, law suit...) can come at any time. The penalties are extreme"

Option Trading Answer

Great question. Stocks do carry a surprise component and obviously, when you are long premium you want that to a degree. You don’t want random surprises where you are continually blindsided. Indexes are diversified and consequently they do not have “unsystemic risk”. They only have “market risk”. There is a statistical advantage to selling out of the money put spreads, on indexes and I do like that trade under the right circumstances. With the market near a seven month low and the implied volatilities (IV’s) spiking - that trade is setting up.

As you know from my prior blogs, I do not advocate Iron Condors or neutral trading strategies. There is too much slippage and one big market move can strip away half a year’s profits. These are very popular “seminar” strategies and they are typically index based. At $3000 per seminar, they’re the ones making the money.

On the topic of index call credit spreads, I do not feel I’m properly being compensated for the risk. As the market rallies, the IVs collapse and you have to get too close to the money to get any premium. Look at the OEX July 600 calls and the 530 puts. Both are 35 points out-of-the-money (OTM) and one trades for $.70 and the other trades for $4.40. The risk reward ratio is not there on the call side.

Indexes have so many eyes focused on them that I don’t feel I have an edge. Every large institution is analyzing the SPY, OEX, SPX and they are executing baskets of stocks and futures against their option positions. I won’t pretend that I know more than Goldman Sachs and its 50 Floor Traders. There is no edge for me. I could tell you stories about the sophisticated trading tactics I witnessed in the OEX pit 15 years ago. If ever there was “fair value” it’s the exact price of that product at any moment. In the end, when I trade indexes I’m forced to predict what the market is/isn’t going to do.

My edge lies in my ability to find relative strength and weakness within the market and I have a proprietary program that helps me find that. There are opportunities that large institutions are not interested in. They can’t get the size done to justify trading it. There is a large advantage to trading a balanced long/short portfolio of stocks with relative strength/weakness. Choose well and the strong stocks gain more than the weak stocks lose when the market goes up and vice versa. This strategy helps me reduce my market risk. I also feel that I can identify supply/demand imbalances in a stock and I know when someone is trying to move “size”. That comes from my chart reading skills and I like to shadow them. In a crowded arena like an index, that trail is masked by “noise”.

I have found that careful research and selection can help me navigate news events. For instance, I don’t do credit spreads on biotech stocks. The chance of a material, unscheduled news event is too high. When all of my research has been conducted only a quarter of my trades translate into option trades for liquidity reasons.

Getting back to selling options, when the stock or the market are uncertain, the IVs are high and I’m rewarded for selling premium. The credit helps me distance myself from the trade and I can keep my objectivity. The key is to watch for upcoming news events and to get intimate with the stock. Know what’s driving it. Just as I would go long or short a stock, the credit spreads are no more than a directional trade with a built-in buffer. Another way to throttle risk is to size the position accordingly.

Never start your search by looking for stocks with high IVs. That is suicide. Those big premiums are there for a reason. There’s a very high likelihood that a lightly publicized event is forthcoming.