credit spread checklist to include_ bull puts - Pro Edge Trading Group

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					                             CREDIT SPREADS
                                   by
                                John Kelly




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                     Disclaimer (The Legal Stuff)

  Pro Edge Trading Group is a community of traders seeking to educate and inform other
  traders about strategies, tactics, risks and possible opportunities in options trading. All
  topics discussed are the opinions of the presenters given for educational purposes. We
  are not financial advisors or registered brokers and nothing in these presentations should
  be taken as advice to buy or sell securities of any type.

  Options trading can be complex and financially risky. It is advisable to practice any
  concepts discussed in these presentations using a paper trading account. Please consult
  with a registered broker or financial advisor before placing any trades with real money.

  Past performance, whether actual or indicated by historical tests of strategies, is no
  guarantee of future performance or success.




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                     FUNDAMENTAL CONCEPT


    The overriding goal of trading is to use money to
      make more money as efficiently and safely as
    possible. When in doubt about whether a trade is
   working out, always act to preserve capital. It is the
  only decision that will provide the money for the next
   trade. No capital, no further trades. Trade with the
    expectation of losing. Never trade a strategy until
   you know everything that can go wrong and how to
                          repair it.


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       TRADING IS SKILL & PREPARATION

 FROM PILOT TRAINING AND BEING AN INSTRUCTOR
    PILOT IN THE AIR FORCE TO FLYING AS A PILOT FOR
    AMERICAN AIRLINES, MY BASIC APPROACH TO LIFE IS
    THAT SKILL AND PREPARATION IS BETTER THAN
    RELYING ON LUCK TO BE SUCCESSFUL AT ANYTHING
    WORTH DOING.
   SUCCESSFUL TRADING IS SKILL & PREPARATION
    MEETING OPPORTUNITY.
   IF YOU DO NOT RECOGNIZE A POTENTIALLY
    SUCCESSFUL CREDIT SPREAD, YOU WILL NEVER TRADE
    ONE.
   TRAINING ALLOWS YOU TO RECOGNIZE A POTENTIALLY
    SUCCESSFUL TRADE WHEN YOU SEE IT.
   LET’S BEGIN.


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                PROBABILITY & VOLATILITY

 If you are going to be successful at trading options, you
    will have to understand probability & volatility
    backwards and forwards.
   You will have to conceptually understand why buying a
    call in an uptrend may not always result in a profit due to
    falling volatility.
   Or why credit spreads go against you if volatility is rising,
    but the danger is not from the rise in volatility but in the
    price movement.
   Remember, repetition is your friend. Go over and over
    this until it sticks.
   Know what to anticipate from market moves, up or
    down.

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                       Buying & Selling Options

 When an option contract is opened there is a buyer
  and a seller for the entire life of the contract.
 The Buyer of the option does so with the conviction
  that it will increase in value faster than it decays
  which can then be closed for a profit.
 The Seller of the option does so with the conviction
  that it will decrease in value faster than it increases
  and can be closed for a profit, or will expire
  worthless as the trader collects the entire premium
  and avoids paying an exit commission.

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                HIGH PROBABILITY TRADES

 Credit Spreads generally involve risking a lot of
  money to make a little with a high probability of
  winning.
 We are looking for trading opportunities at the
  outside edge of either side of the “bell curve” at a 2 or
  3 standard deviation or a 90% to 95% chance of
  success (5-10 delta).
 Over time, properly placed trades should experience
  90 to 95 winners out of every 100 trades, but those 5
  to 10 losers can wipe out the winners if not properly
  “managed”.

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    Properly “Managed” Return Expectations

 A properly managed portfolio of “monthly” credit
  spreads should realize a 3% to 6% return per month
  or 36% to 72% per year net after “losses” and
  commissions.
 A properly managed portfolio of “weekly” credit
  spreads should realize a 4% to 8% per month or 48%
  to 96% per year net after “losses” and commissions.
 I would recommend a “mixed” portfolio of monthlies
  and weeklies as the methods and timing of trading
  each is slightly but significantly different.

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                    PUTS & BULL PUTS-part 1

 “Buying” a put is a bearish strategy. You expect the
  underlying to go down in price, thereby increasing the
  value of the put
 If you “Sell” a put, you do not expect the underlying to go
  down in price, thereby allowing the put to decay in value
  over time and create a profit for you. This is considered a
  “naked” put. But, if the price of the underlying goes
  below your put, the underlying can be “put” to you,
  sometimes for a huge loss.
 To prevent this from happening, we bring the two
  strategies together to create the “Bull Put” strategy, and
  limit the potential loss.

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                    PUTS & BULL PUTS-part 2

 To create a Bull Put, we, simultaneously, “sell” an “out of
  the money” (OTM) put and (usually) “buy” the next put
  further out (away from the underlying price) for
  protection. The nearer “sold” put is greater in value than
  the further “bought” put and the difference is the “credit”
  that we receive. It is this “credit” that we hope to collect
  for a profit over time.
 The difference in the strikes minus the credit is the
  amount that the broker is going to “freeze” or “margin” in
  your account to protect himself against a loss.
 Let’s look at an example.

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                       BULL PUT EXAMPLE - AAPL




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                              AAPL BULL PUT

 From the chart example on the previous slide, we would:
               Sell the June12 Put– 495 f0r a $1.32 credit
               Buy the June12 Put – 490 for a $1.09 debit
                                              _____
                Or a “net” of …………………… $ .22 credit

The difference between 495 & 490 strikes is $5…or a $5
credit spread. The broker is going to “freeze” $500 minus
the credit ($22) for the life of the trade. You have $478 at
risk. Depending on how you manage this trade, you have a
3% or 4% potential profit, or a 96% to 97% potential loss.

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                              AAPL BULL PUT - 2

 You will also note the “prob ITM” & the “delta” in the
    prior slide.
   The “probITM” is the probability of finishing In The
    Money (ITM). In this example, it is a 7.22% of losing or a
    92.78% chance of winning.
   The strikes between a 5% & 10% probITM is where I find
    my trades in monthly credit spreads.
   In this example, the “delta” is .07.
   The strikes between a .05 & a .10 delta is where I operate
    in monthly credit spreads.

 A Bull Put is a bullish strategy.


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                              CALLS & BEAR CALLS

 “Buying” a call is a bullish strategy. You expect the
  underlying to go up in price and create a higher value
  in your call.
 If you ”Sell” a call, you expect the underlying to go
  down in value, creating a profit in your “naked” call.
  If, instead, the underlying goes up in price, you have
  a potential unlimited loss. Most brokers will not let
  you do this strategy.
 However, if you combine the two strategies, you have
  created a bear call with a limited liability.

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                              BEAR CALLS

 As with the bull put spread, for a bear call we,
  simultaneously, “sell” an OTM call and collect a
  credit premium, and “buy” a call one strike further
  out for a debit & protection. The net trade will create
  a “credit”.
 The difference in the strikes will be the amount that
  the broker will “freeze” or “margin” in your account
  to protect against a total loss minus the credit
  received.
 Let’s look at an example.

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               BEAR CALL EXAMPLE - AAPL




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                              AAPL – BEAR CALL

 From the example on the previous slide, we would:
        Sell the June12 615 Call for a $1.25 credit
        Buy the June12 620 Call for a $ .98 debit
                                        ____
        Or a “net” of…………………….… $ .27 credit
The difference between the 620 & 615 strikes is $5…or
a $5 credit spread. The broker will “freeze” $473 in
your account for the life of the trade. You have a
potential profit of 4% or 5%, or a 95% or 96% potential
loss.

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                        AAPL – BEAR CALL - 2

 Again, you can see in the previous slide, that the
   “probITM” of 5.54% and that the “delta” of .06 is in
   my “sweet spot”.

 This a bearish strategy.


 With the huge potential losses, managing credit
   spreads is absolutely critical.



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                              IRON CONDORS

 If we combine Bull Puts & Bear Calls in the same
  underlying and in the same time period (monthly or
  weekly), it is called an Iron Condor.
 So, from the previous two examples of AAPL, the
  495/490 bull put and the 615/620 bear call in the
  June 2012 monthly, constitutes an iron condor.
 The price of AAPL at the time of this trade was
  $560.99, creating an “unbalanced” Iron Condor.



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           IRON CONDORS - UNBALANCED

 The 495/490 bull put, with $27 worth of credit, is
  close to $65 away from the price of AAPL (560.99).
 The 615/620 bear call, with $22 worth of credit, is
  close to $55 away from the price of AAPL (560.99).
 There is more money further away in the bull put
  than the bear call. At the time of this trade, the
  market was in a bearish correction. This a bearish
  volatility skew, or in simple terms, the market
  makers computer models are indicating a more likely
  move down than up.

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       IRON CONDORS – UNBALANCED - 2

 From my experience to date, you are more likely to
  have trouble with the bull put in this iron condor
  than the bear call.
 The best trading results come from “balanced” iron
  condors. Be aware of this when you consider iron
  condors.
 Whenever you consider opening a new credit spread
  on just one side, always look at the full iron condor
  to see if there is a “skew” and how severe it is. It can
  save you from a lot of problems later in the trade.

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                  IRON CONDORS - HEDGED

 The best potentially defensible and most potentially
  profitable credit spreads are iron condors, whether a
  monthly or a weekly.
 If you have opened just a bull put or just a bear call
  with my guidelines, you are looking at a 3% profit for
  risking a lot of capital. If the trade goes against you,
  you have limited repair strategies.
 However, once you open a bull put or a bear call, if
  you, either simultaneously or subsequently, open the
  opposite credit spread, you have an iron condor.

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                  IRON CONDORS - HEDGED

 A broker will “freeze” or “marginalize” enough
  capital to cover any potential loss from you one-sided
  credit spread.
 When you open the opposite side credit spread, the
  broker will NOT freeze any additional capital. You
  cannot lose on both sides simultaneously.
 You have just doubled the potential profit, doubled
  the trading power of your portfolio, and hedged
  against potential losses.


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           AAPL “HEDGED” IRON CONDOR

 In our previous example, we had opened an AAPL
    June 2012 495/490 bull put for a potential profit of
    $22, and a AAPL June 2012 615/620 bear call for
    $27.
   This is an iron condor, same month, same $5 spread.
   The broker will freeze $478.
   Rather than a 3% profit, you now have the potential
    for a 6%+ profit, if AAPL finishes between 495 & 615
    and you collect both premiums.
   And, if you manage this trade according to my
    guidelines, you should never lose capital.

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          AAPL HEDGED IRON CONDOR - 2

 However, should the price of AAPL go against one
  side of this trade or the other, then you face a
  decision…do I stay in the trade or do I exit it…and if
  so when.
 You are “hedged” on the either side to $.49 ($.22
  plus $.27).
 If the losing side credit spread climbs to a value of
  $.49, you must make a decision to close that side
  down or choose another repair strategy that I will
  discuss later.
 Let’s say, in this case, you close the losing side.

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          AAPL HEDGED IRON CONDOR - 3

 While the other side of the AAPL iron condor may
  not yet be at full profitability, it will be very close.
  Once it is and you close it down, you will be at
  breakeven and will only suffer a loss of commissions
  on the trade.
 Your capital has been preserved for the next trade.
 Hence, the Iron Condor, if properly managed, is your
  best potential profitable and best potential hedged
  position against loss of capital.
 But how do we “find” these trades? Let’s look at that
  next.

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         FINDING THE TRADE - EARNINGS

 I use a checklist to find my trades or reject them as
  not meeting the standards necessary for a high
  probability trade.
 First, I check the earnings date of the underlying. If
  it is an ETF or an index, there are no earnings and I
  move on to the next item on my checklist. If it is a
  stock, I look for the next earnings date.
 If the earnings date is within the next 20 trading
  days and within the expiration cycle, I pass on any
  potential trade.
 Let’s look at two examples.

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FINDING THE TRADE - EARNINGS DATE




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FINDING THE TRADE – EARNINGS DATE




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    FINDING THE TRADE – EARNINGS - 3

 The problem with opening credit spreads just prior
  to earnings is that many stocks increase in implied
  volatility and the premium increases.
 Doing a credit spread at that time is like trying to
  swim up the Niagara Falls. You are going to drown
  and so is your trade.
 The preparation date for this presentation was June
  the 2nd. In the first example, the ULTA earnings date
  is the 6th of June, 2012. You would not open a June
  or later option credit spread until AFTER the
  earnings were known.

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    FINDING THE TRADE – EARNINGS - 4

 The earnings date for AAPL is July 17th, well after the
  June options expiration date. Credit spreads in AAPL
  with June expirations are safe from an earnings
  standpoint.
 But there are other restrictions to follow before
  opening a credit spread.
 The next one is: volatility.




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       FINDING THE TRADE - VOLATILITY

 Volatility is a key component of finding a good credit
  spread trade, along with Probability, which I cover in
  depth later.
 Volatility deals with the VIX, Realized volatility,
  Implied volatility, & Historical volatility.
 Generally speaking, the lower the realized volatility
  the better chance of a successful trade. Realized
  volatility is found by dividing the Average True
  Range (ATR) by the stock price. I like to use a 10 day
  ATR (10 trading days).
 We will use good old AAPL as an example.

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  FINDING THE TRADE – VOLATILITY - 2




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  FINDING THE TRADE – VOLATILITY - AAPL

 By the close on June 2nd, 2012, AAPL was trading at
  560.99. The 10 day ATR was 16.83.
 If you divide the ATR by the price you get 3%
  realized volatility.
 I have found a higher number of credit spread
  failures at realized volatilities above 5%. Generally,
  the lower the better, as long as all the other
  requirements are met.



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AAPL – IMPLIED & HISTORICAL VOLATILITY




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AAPL – IMPLIED & HISTORIC VOLATILITY - 2

 In the previous slide, you can see the implied
  volatility of AAPL was 36.9% & historical was around
  32%.
 As long as the implied is greater than the historical
  and there is no major news event (earnings or
  product announcement), then credit spreads are
  worth looking into.
 Remember, we make our money from time decay
  (theta – more about this later) and the collapse of
  implied volatility.

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                              THE VIX

 The VIX is the “fear factor”.
 It is volatility and you will learn to monitor it constantly
    and you will know it better than your own family.
   It’s movement and your profit/loss are directly
    correlated.
   If the VIX is going up, premiums are gaining in value and
    if it is going down, premiums (and credit spreads) are
    getting cheaper.
   The VIX spends most of it’s life between 15 & 30.
   Your ability to trade credit spreads profitably varies
    greatly in that range.


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                              THE VIX - 2

 When the VIX is below 20, it generally means that
  there is no fear in the market. The market is in an
  uptrend and options are relatively cheap. It is very
  difficult to do anything but bull puts.
 When the VIX is above 20 and rising, the market is
  in a correction or downtrend, and bear calls are the
  easier trade.




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                    RESISTANCE & SUPPORT

 The next checklist item we want to find is resistance &
    support.
   The general rule is to be above resistance with bear calls
    and below support with bull puts.
   The next question is …”which resistance or support???”.
   Basically, it comes down to how long are you going to be
    in the trade…
   If you are going to be in for 22 trading days, it makes
    sense to “look back” 22 trading days…
   For example, let’s look at our favorite – AAPL.

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          AAPL – RESISTANCE & SUPPORT




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       AAPL – RESISTANCE & SUPPORT - 2




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         AAPL RESISTANCE & SUPPORT - 3

 As of Monday the 4th of June, 2012, there will be two
    weeks left in the June option month.
   I would start by looking back 10 trading days to find
    the high and low prices of AAPL.
   We have a high of around 580 and a low or around
    530.
   The 50 day moving average is in blue at 586.95.
   The 200 day moving average is in purple at 466.90.
   The bottom of the regression channel is in red at
    490.60.

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       AAPL – RESISTANCE & SUPPORT - 4

From the chart below, we can easily get above
resistance with the 615/620 bear call and meet the
restriction of 5% to 10% probITM and the .05 to .10
delta.




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       AAPL – RESISTANCE & SUPPORT - 5

 In addition, the chart below shows a recommended
   entry for the AAPL bull put of 495/490, which is well
   below support.




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         LINEAR REGRESSION CHANNELS

 When you look at a chart, it should talk to you, and
    give you your first indication of where this stock has
    been and where it is likely to go.
   Linear Regression Channels are wonderful first
    impressions and lasting impressions.
   Linear Regression Channels show you the “bell
    curve” turned on it’s side and how that underlying
    trades in regard to 2 & 3 standard deviation moves.
   This is how we trade.
   Let’s look at a few examples.
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 AAPL – LINEAR REGRESSION CHANNEL




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AAPL LINEAR REGRESSION CHANNEL - 2

 The slope of the AAPL Linear Regression Channel
  tells you that this is a bullish chart.
 The 200 day moving average is riding below the
  bottom of the bottom channel…very bullish.
 It has “honored” the bottom and the top of the
  channel for the last 52 weeks.
 If you can find credit spreads outside of this channel,
  you would have been “right” 12 months out of 12
  months…that is a 100% return…it does not get any
  better…and yes, there have been trades outside the
  top and bottom for 12 months.

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AAPL LINEAR REGRESSION CHANNEL - 3

 Linear Regression Channels are not set in concrete,
  but are like rubber…the angle of the slope will
  change over time after repeated attempts to bump up
  against the top and down against the bottom.
 The top and the bottom make excellent resistance
  and support areas to place credit spreads outside of
  those points with confidence.




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                              NFLX




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                              NFLX - 2

 What does the chart of NFLX say to you?
 How would you trade it?




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                              AZO




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                              AZO - 2

 What does the chart of AZO say to you?
 How would you trade it?




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                        THE ATR MULTIPLIER

 One of the less scientific guidelines that I have come
  to use is the ATR multiplier, but it is another
  indicator to use to verify the probability of the trade
  being successful.
 I generally look for a 2.5 multiplier as a minimum.
  Anything above a 3 is good and a 4 or better is very
  good. The higher, the better.




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                              AAPL - MULTIPLIER

 AAPL currently has an ATR of 16.83.
 42.07 is it’s 2.5 multiplier minimum.
 The current price of 560.99 and the recommended
  bull put at 495/490 and bear call at 615/620 fit well
  within the minimum recommendation.
 The 495/490 bull put is 66 points away from the
  price of AAPL and that is a 3.9 multiplier.
 The 615/620 bear call is 54 points away and that is a
  3.2 multiplier.


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     FINDING THE TRADE - PROBABILITY

 The final requirements are probability & premium.
 I find my trades between a 5% and 10% probITM or
  probability of ending In The Money, which also runs
  closely with the .05 & .10 delta.
 My premium requirement is a minimum 3% return
  with commissions and exit fee taken out.
 On a $5 spread, every $.05 of premium is a 1%
  return. So, on a $5 spread I am looking for a
  minimum of $.15 plus commission in and out plus
  the normal cost to exit early (this exit fee varies from
  broker to broker).

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         FINDING THE TRADE - PREMIUM

 For a $10 spread double the amount and for a $2.50
  spread cut it in half. I generally do not do $1 spread as
  the commissions just about kill any chance of a profit.
 As you go thru an option month, cut all values
  accordingly..
 A monthly 3% return on my portfolio size pays my bills
  and adds a little capital to my portfolio.
 You will have to do the math and find out where your
  breakeven portfolio amount is and what it takes to trade
  credit spreads with a reasonable probability that will pay
  your bills and increase your capital.

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  TIMING THE TRADE – POST EARNINGS

 Now that you have run your checklist and you have a
  candidate for a trade, when do you open it up?
 There is a “timing” consideration.
 Opening a credit spread right after earnings is an
  excellent strategy. You know whether it was a “beat”
  or a “miss”, and you know the market reaction. If you
  are quick enough you can capture the collapse of any
  implied volatility buildup prior to earnings.
 You can realize as much as a 50% return on a credit
  spread by the end of the post-earnings trading day.

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  TIMING THE TRADE – MARKET DIRECTION

 As with the post-earnings trade, the direction of the stock
  market and the stock at the time of the trade is
  important.
 If the stock market or the stock is going up, then a bull
  put is usually a good trade, unless you are coming up on
  an area of resistance (like a double top or the 50 or 200
  day moving average), and the same for a bear call if the
  market is going down ( like a double bottom or the 50 or
  200 moving average).
 The day of the trading week is also important. Options
  decay every day of the week, including Saturday and
  Sunday. Market makers also know this, and will take
  premium out between Thursday’s close and Friday’s
  open.

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    TIMING THE TRADE – DAY OF THE WEEK

 So, opening a credit spread on Thursday is the perfect
  timing to gain weekend decay…especially if it is a 3-day
  weekend.
 Monthly options expire the 3rd Friday of every month. A
  lot of traders will carry a fully profitable trade thru
  expiration week, just to avoid the exit commission and let
  it expire worthless.
 Again, market makers are not in it to make you money.
  They will shave the “fat” off of the new “front” month
  options between expiration Friday and new front month
  Monday. You lose premium by waiting for the next
  month credit spreads.

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TIMING THE TRADE – BULL PUT/BEAR CALL

 Which comes first? The bull put or the bear call or
  both simultaneously?...answer…Yes…Yes…Yes.
 This will make perfect sense to you once you think
  about it.
 If the underlying is coming off an earnings
  announcement, it is easy to pick direction and open
  in the post-earnings direction.
 If the underlying has just bounced off a double
  bottom or double top, 50 or 200 day moving average,
  bottom or top of a regression channel, the market is
  handing you the trade, up or down.

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    TIMING THE TRADE – IRON CONDOR

 If the underlying has been going sideways at the
  mean regression in a sideways market, it is very
  likely that you can open both sides of the iron condor
  at the same time.
 Or, if you can get outside of the regression channel to
  the top and bottom at the same time, open the full
  iron condor.




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           CME & THE MEAN REGRESSION




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               TIMING THE TRADE - THETA

 Another consideration is Theta.
 The decay of an option is, primarily, how we make our
    money.
   The decay rate of Theta is not constant. It accelerates
    during the last 30 calendar days.
   And it really accelerates in the last 20 calendar days.
    The last 20 calendar days is where we make our money
    the quickest. But, we must have our trades on before we
    hit that time period.
   But, it is these trades that are placed before the last 20
    calendar trades that are the most vulnerable to big
    market and/or underlying price moves.


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           TIMING THE TRADE – THETA - 2

 This is a two-edged sword. You want to be in the
  trade, but you are leaving yourself vulnerable until
  the last 20 calendar days kicks in.
 Because, once the last 20 calendar days acceleratin
  kicks in, it is very hard to find trades that satisfy all
  the requirements for new entries.




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                  MONTHLIES VS WEEKLIES

 But, once inside that last 20 calendar days, there is a
  new set of trades available…Weeklies.
 Weeklies open on Thursday at 9:30 am and expire on
  the next Friday.
 The Theta and Gamma of these trades are very rapid.
 You can make your money very quickly or just as
  quickly, get into trouble, so I trade these differently
  than monthlies.



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              MONTHLIES VS WEEKLIES - 2

 I look at fewer candidates for weekly credit spreads.
 These candidates are very liquid with a lot of options
  to choose from.
 I am looking for trades at the probITM of 5% or less
  and a .05 delta or less.
 The premium requirements will net me a 1% return
  after entry & exit commissions are taken out along
  with any exit premium. On a $5 spread, I need $.10
  or greater for this trade.
 1% per week is 48% annualized.

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                  MONTHLIES VS WEEKLIES

 I am also looking to open both sides of the iron condor
  simultaneoulsy, so I am looking for a 1% on both sides
  and a 2% per week profit or 8% per month or 96%
  annualized.
 I am looking to close these trades by the following
  Tuesday or sooner, and rarely carry these trades to
  expiration.
 Then on that next Thursday, I open new trades with the
  new weeklies.
 These trades are more dynamic than monthlies and
  require more attention and a quicker response to trades
  that are going against you.

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                  MONTHLIES VS WEEKLIES

 There are over 150 tradable weeklies…here is the list
    I look at, and offer the best probabilities of success,
    thus far (as of June 2012):
   AAPL
   AMZN
   BIDU
   CF
   CMG
   CRM

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                  MONTHLIES VS WEEKLIES

 GOOG
 IBM
 ISRG
 LNKD
 MA
 NFLX
 PCLN
 RUT
 SPX

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                  MONTHLIES VS WEEKLIES

 I, also, have to add, that I do not get the percentage
  of “fills” that I get with monthlies.
 I will carry 30-50 monthly trades (iron condors) at
  the same time.
 I usually only carry 6-8 weeklies at the same time.




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 MANAGING THE TRADE – THE BEST ENTRY

 Congratulations, you went thru the checklist and you
  have a trade that is ready for the auction block, but
  first how do you get the “best” entry.
 As you know there is a “bid” and an “ask”. They want
  to fill you at the “ask” and close you at the “bid”.
 Always the worst for you and the best for them.
 Many times I have put my contracts out and been
  “filled” immediately and thought…I went too
  cheap…I probably could have received more credit.


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                 MANAGING THE TRADE – 2

 Always ask for the maximum credit.
 If you are doing multiple contracts, start with one at
  the maximum, and reduce it a penny at a time until
  you are filled and then put the rest of your order out
  for a fill. That will guarantee you the “best” price.
 It is a small point, but the devil is in the details.




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                  MANAGING THE TRADE - 3

 Ok, so now you are in the trade for, what, 30
    calendar days.
   How do keep track of it? When do you close it? How
    do you know if you are in trouble? And what do you
    do if you are in trouble?
   The potential loss is horrendous if it is allowed to go
    totally against you.
    You cannot ignore it, and hope it expires worthless.
   Basically, I recommend you do what I do, record the
    closing value of the credit spread every evening on
    the same piece of paper or computer chart.

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                  MANAGING THE TRADE - 4

 If you opened the trade for $.25, then see what it would
  be to open the same trade one day later…then two days..,
  and so on until it is ready to be closed for a profit.
 If one day after opening the trade, the underlying gaps in
  your favor (away from your credit spread) and you are in
  a sudden profit, what do you do?
 Simple rule, if there is not enough money left that would
  entice you to open the trade, you received a gift. Take the
  gift. Close the trade, and move on to the next trade.
 Make your money work hard for you, you do not work
  hard for your money.

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        MANAGING THE TRADE - REPAIRS

 That was easy.
 But, what if your trade does not decrease in
  credit…i.e…$.25…$.20…$15…$.10…and so on.
 What if your trade is going against you?
 Well, first you have to know that it is going against
  you. That is recording-keeping 101.




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   MANAGING THE TRADE – REPAIRS - 2

 Let’s say that the market has a very unusual day.
 You open a bull put in the morning at a .10 delta with
  a $.30 credit. The underlying price is at $100. Your
  bull put is at the 75/70, at the bottom of the
  regression channel.
 The market has some really bad news. The VIX goes
  from 20 to 25 in one day. The DOW is down over
  $200.
 Your premium to open the trade after the close has
  climbed to $.60. You are in a $.30 loss. 100%. What
  now?

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                  MANAGING THE TRADE - 3

 Your underlying price has only gone down to $99.
 Are you in trouble and what will you do?
 This is not how John Kelly said it would be. This not
  watching paint dry. Where is the defibulator? Pepto
  Bismol? Jim Beam? Shoot, where is my gun and
  where is John Kelly? I am going to fix this!!!
 Relax, the problem will fix itself it the price remains
  steady. Over time (think theta and decay), if the price
  holds, then the spike in the premium will fade away
  and you will eventually collect on your trade.

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   MANAGING THE TRADE – REPAIRS - 4

 Now, let’s say that both the price of the underlying
  and the premium goes against you…from the open of
  $.30 and a .10 delta to $.35…$.40…and finally, $.45
  and a .15 delta over a short period of time.
 This requires a response on your part. If you are not
  in the iron condor, do it now. Open the opposite side
  for around $.30. Now you are hedged.
 If the underlying goes sideways, congratulations, you
  will collect on both sides.


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   MANAGING THE TRADE – REPAIRS - 5

 But, if the trade on the bad side continues against
  you…$.50…$.55…$.60 and a .20 delta, it is Decision
  Time.
 As I have said before, the simplest action is to close
  the losing side and eventually close the opposite side
  for a full profit.
 You will breakeven at on the iron condor and will be
  out commissions.
 You have preserved capital. Move on to the next
  trade.

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                NEUTRALIZING THE DELTA

 There is always more than one way to skin a cat or
  repair a credit spread going against you.
 If you are faced with a credit spread 100% against
  you (open for a $.30 premium and it goes to $.60)
  and the delta has reached .20 and you have taken a
  good look at the chart and have decided that, say the
  bull put, is close to a solid bottom and that this trade
  may come back. If only there was a way to stay in the
  trade a while longer while not into a deeper loss.
 There is: neutralizing the delta is one alternative.

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                NEUTRALIZING THE DELTA

 If the “short” strike of your credit spread has reached
  a .20 delta, then the “long” position is trailing
  behind, usually at around a .10 or greater delta.
 It is this delta “difference” that is causing the
  increasing loss.
 If it is a .10 delta difference, count the number of
  open contracts that you have and multiply those two
  numbers. In the example, there is a .10 delta
  difference and 5 contracts. You have 50 deltas going
  against you.

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             NEUTRALIZING THE DELTA - 2

 Now, go to the next month’s options and find a .50
  delta stike and buy it.
 For every dollar that the trade continues to go
  against your credit spread, the new trade in the next
  month gains an equal amount.
 You have neutralized the loss. You may even have a
  slight advantage with the slower theta decay in the
  next month than in the “front” month credit spread.
 Let’s look at an example.


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                              RIO




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                              RIO




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                              RIO




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             NEUTRALIZING THE DELTA - 3

 In this example, the RIO 40/35 July 2012 bull put
  has gone against us. But I have “neutralized” any
  further loss with a RIO 47.5 October 2012 Put.
 If RIO continues to go down in price, eventually the
  July bull put will become “intrinsic” and you will
  have a max loss scenario, but your October put will
  continue to increase in value.
 It is possible to realize a bigger profit in the October
  put than you every
 hoped to make in the July bull put.

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             NEUTRALIZING THE DELTA - 4

 On the other hand, RIO price movement could
  reverse and go up. You have to be very careful, as the
  “protection” in October, could end up losing you
  more money than the July bull put.
 You have now turned “watching paint dry” into “day”
  trading.
 This repair strategy can result in “whip-sawing” back
  and forth. No fun.



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                              REPAIRS - ROLLING

 Finally, rather than closing the trade or neutralizing
  the delta, you can choose to “roll” the trade.
 If you reach a .20 delta or 100% premium loss, you
  have to make a decision.
 If there is room and premium, you can roll the credit
  spread further away from the approaching
  underlying price for a small loss. The danger here is
  that you may have to roll away a number of times.
 Or, you may end up rolling back to your original
  position, to re-capture your potential losses.

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                          REPAIRS & ROLLING

 Again, rolling can result in “whip-sawing” and
  turning this into “day” trading.
 Also, realize that you can “roll’ the opposite side of
  you trade for more profit, as you are rolling the
  losing side further away.
 Let’s, use RIO as an example.




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                              RIO

 A the time of this presentation, the RIO trade was in
  trading day 19, nearly 30 calendar days.
 The original trade was opened with RIO at a price of
  $50.
 The July 2012 bull put was opened at 40/37.5 for
  $.25.
 The July 2012 bear call was opened at 62.5/65 for
  $.20.



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                              RIO

 The July 40/37.5 bull put was expanded to a 40/35
  bull put for an additional $.40 for a total premium
  now of $.65.
 The July 62.5/65 bear call has been expanded 3
  times to a 55/65 bear call for an additional $.50 for a
  total premium of $.70
 Currently, there is $1.15 in the 40/35 bull put or a
  $.50 loss
 The bear call is currently at $.15 or a $.55 profit.


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                              RIO

 The October 2012 47.5 Put was opened for $6.00
  and is currently worth $8.00. From the initial 4 puts
  I opened, I have added 2 additional puts as the delta
  difference has expanded.
 My options are to shrink the bull put back to the
  original 40/37.5 which will cost me $.70 in premium.
 I can, also, expand the 55/65 bear call to 52.5 /65
  and add an additional $.10.
 Stayed tuned.


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                              SUMMARY

 Credit spreads are a slow way of making money in the
    market.
   A strategy for an up, down, or sideways market.
   You risk a lot of money for a very small return.
   But the return has a very high probability of success.
   You can now trade weeklies as well as monthlies for a
    “blended” return.
   The average capital requirement to trade my monthly
    portfolio is $20,000.
   The average capital requirement to trade my weekly
    portfolio is $7,000.

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