Weekly Options | 6-19-19 – Mike Follett


Hey, good morning, all. This is Mike Follett speaking. Welcome to the Weekly’s class. We do this every week. As you can see on
screen, the topic is straddle/strangle swaps. Now, straddle/strangle swaps,
for those of you who attended the workshop this last week, and
I mentioned that I wanted to do some examples on double
diagonals in the class today with Weekly’s. That’s another way to think
a straddle/strangle swaps. Straddle/strangle swaps are
a form of a double diagonal. And there are some
variations that an investor could apply with this strategy. So we’ll talk about that
and a few more things as well in our weekly
options session. Hope you enjoy it. And thank you for attending. Appreciate you taking some
time out of your morning. Today is June 19, 2019. And if I didn’t get it
on the record already, my name is Mike Follett. All right, what would a session
be without the disclosure? So let’s go ahead and
hit some of those. Remember, options are not
suitable for all investors. There are risks,
inherent to trading in options that could expose
an investor to potentially rapid and substantial losses. So be aware of those risks. When you’re talking
about spreads, straddles, other multi-leg strategies,
they can entail risks as well, including transaction
costs can go up when you’ve got those
multiple legs happening. When you’re dealing with
these weakly options, they are short-lived
investments, which means they may require
some close monitoring and adjusting. And those trades that involve
minimum profit potential, that can be more heavily impacted
by those commissions. Futures and futures options– there’s risks there as well. Make sure that you’re
aware of those risks and that you have an
understanding of the risk disclosures. And make sure you’ve
got approval before you trade any of these things. Any investment decision you make
in your self-directed account is solely your responsibility. Over there on the
right, at the bottom, you’ve got a quick look at
how commission structure might appear in your account. Past performance does not
guarantee future results. Also, probabilities,
such as the probability of an option being in the
money on expiration– just be aware that’s taking a
look at theoretical models. Also, back testing is
looking at history. And history doesn’t
always repeat itself. All investing involves risk,
including the risk of loss. No soliciting, no recording,
and no taking pictures. Also, when you take a
look at these Greeks from Delta, Gamma,
Vega, Theta, just remember those are
measurements of sensitivity to changes in price,
time, and volatility. Also, this class is for
educational purposes only. All right, just let you
know how this class is going to work going
forward, we’re going to spend a little bit
of time on understanding straddle/strangle swaps,
which are a variation– well, they are double diagonals. But in addition to that,
I want to follow up on last week’s trades, as well. You remember last week? We talked about one of
those strategies that could be an income generator. And it includes buying stock
and selling a put and a call– one of those long shot
stock with short straddles. Or short strangles is the
way we’ve structured that. So I want to go back in
and follow up on that, as well as take a look at
calendar spread adjustments. Because if you
recall, last week, I promised we’d take a look at
one of our pre-earnings trades on square. And evaluate that performance. And there are some
possible adjustments that could be made there. So we do have a lot of things
that are going to take place. But we’ll start
with the formal part here on straddle/strangle swaps. And I’ll hit a
couple of PowerPoint slides just to explain
the logic of that trade. And then we’ll go from there. OK, so what we’ll talk
about is constructing those straddle/strangle
swaps, i.e. double diagonals, and identify risk and reward
parameters of the trade. Because that can be
confusing when you’re dealing with a trade like this. It can be a complex type
of example here, right? So it takes a
little bit of study to understand what
the risks actually are in a trade like that. But here’s the good news. The analyze tab
does an awesome job of helping us
understand those risks, evaluate, as well, how
implied volatility can impact to trade like this. And then we’ll practice
placing a double diagonal and show you how to get an
order created in paper money. And when you’re dealing with the
straddle/strangles swaps, first of all, just to help you
with the terminology, this is going to
be a trade that’s a long trade, technically. You’re going to buy it. However, when you buy
it, sometimes that results in a credit. How big of a mind
bender is that, right? That it’s a trade that you buy. But it can result in a credit. And it just depends
on the structure of how options get priced. Option pricing does have a
pretty significant impact on the price of this
trade, obviously. But in terms of just
the core components, what are the building
blocks of this trade? Well, it’s going to
be two primary things. You’re going to sell some
options in the near-term. If someone’s doing a straddle
straddle/strangle swap on the money like that,
sell a near-term straddle, and then buy a
longer-term strangle. Now, if someone’s
doing a double-diagonal that maybe some of you
have already learned about, it’s actually selling
a near-term strangle and buying a farther-term
strangle, right? A lot of this is just
semantics, right? Understand what this all means. Basically, it’s a result of just
understanding how options work, right? Sometimes the different names
can actually confuse here. But we’re going to sell
options in the near-term, buy options farther away on both
sides of the market, but puts and calls. That’s the primary
thing to know. Now, understand when traders
use a strategy like this, there’s a couple of
environments that they might decide to choose. Number one, because
they’re selling options in the near-term, they might
look for implied volatility to be inflated in those
near-term options. And what are some
of the things that can inflate that volatility
in the near-term options? Well, earnings announcements,
events, situations, maybe even Fed announcements,
things like that. But that’s one of
the reasons people will apply a trade like
this is because options in the shorter-term
are inflated. Think of options
as water balloons. Well, how do they
like water balloons? Well, near-term
options or volatility is kind of like putting
water inside of that balloon. And the more water
goes into that balloon, the bigger it’s going to expand. If there’s high amounts of
implied volatility in a given expiration, what that’s saying
is that relatively speaking, there could be a
lot of water, right? Or a very expanded
balloon there. So that’s one of the reasons
why people might choose a trade like this is those
near-term options, the ones that they’re selling– sell near-term straddle– those
have a lot of water in them, relative to the
longer-term options. Now, as I’m saying this,
though, you got to be aware, no matter how much implied
volatility has gone into short-term options,
compared to the longer-term options, short-term options
are never going to be priced for more– at the same strike,
I should say. They’re never going
to have a greater value than those
longer-term options, or else there’s a weird arb
that’s happening in the market. But that inflated
vol can certainly make the difference
between those expirations a lot smaller. So sort of an interesting
thing to look at. Now, another reason why
people might put this trade on is because they
just generally think implied volatility
is low in the market. And so they’re buying
those longer-term options to maybe hang onto
those for a while, because volatility is low. And then, selling
near-term options with less consideration for
how much volatility is there, but selling those near-term
options to generate income, while they’re holding those
longer-term options that they hope will benefit eventually
from a volatility increase. OK, there’s a couple of things. Volatility is inflated
a lot in the near-term, or just volatility
is low in general. And they’re looking
for that volatility to raise in that
longer-term over time. So those are some of the reasons
people will do this trade. Now, let’s talk about the
idea, where volatility might be really high in the near-term. And I mentioned this before. Oftentimes, you’ll see
that around events. Markets will create what they
call a positive volatility skew. And so if that is taking place,
here’s what it looks like. You’ll see those average
implied volatilities. Remember, implied
volatility is just kind of a measurement
to tell investors how much water is currently
priced into that water balloon, so to speak, or how inflated
those water balloons might be. And it’s a relative analysis. You’ve got to
compare it to itself. But if you notice,
in this example, options in the near-term
have much higher volatility. 10 day volatility here is a
lot higher than the volatility out here weeks and months out. So that’s what they call a
positive volatility skew. What that means is near-term
options at relatively inflated, compared to those
longer-term options. All right, so if traders
are looking at that, they might consider selling
at the money options. And this is what creates
the straddle/strangle swap– at the money out options
in that near-term frame. If they sell at
the money options, that means they’ll sell a call
and a put at the same strike. And so what that means is that
they just sold a straddle. OK, but then on the other hand,
they’ll buy options farther away at farther out-of-the-money
strikes for protection. Because if you just sell
the straddle by itself, it’s going to be naked. There’s not coverage on that. So traders will buy some of
those longer-term options in relatively low volatility
to provide some protection, provide a wall, so to speak. If you’ve got a
fence in your yard, it’s kind of like buying a
fence in the yard, just in case the dogs start running wild. And so the dogs are going to
be those near-term options. So if the market
moves too far against those near-term options,
that fence out there is there for containment. Now, when you’re doing this,
there’s some general structures that traders might use. And they might sell
those near-term options, maybe one to three weeks
away from expiration. And they might buy options
anywhere from one week farther away than the option
that they sold out to maybe many, many months. But since we’re
using weeklies, we’ll focus on a few weeks
beyond, anywhere from one to maybe five weeks beyond the
options that we’re selling. All right, everybody
confused yet? I know there is some
complexity in this trade, but you can do this. Just remember fences that
keep the dogs in there. The dogs are those
near-term options. If they’re selling a straddle,
those near-term options are going to be the same strike– generally at the money. And if they’re doing
a double-diagonal or a straddle/swap– or excuse me– a
strangle/swap, that means those near-term options
wouldn’t share the same strike. They’d both be slightly
out of the money, and then buying options
even further out of the money from there. All right, but remember to
consider the risk reward and whether or not this
trade is reasonable. Here’s just a quick example
of possible strike selection. If someone’s doing a straight
straddle/strangle swap, if they’re looking at the
market price of a stock– for example, trading at 149– they might look at
these 149 options. You can see here, there’s
puts, and there’s calls at 149. And then, buy options– in this case, it’s
actually three weeks out. It doesn’t have to
be three weeks out. It could be the next
week or some other frame. But just remember, the time
frame is going to be different. But they’ll buy options out
of the money from there. In this case, selling the 149s
and maybe buying the 143s, selling the 149s and
buying the 155s, all right? So the puts will be out of
the money on the lower strike. And the calls will be out of
the money on a higher strike. And if you notice,
this example has one of those positive
volatility skews, where the near-term options are
trading on average at about 42% of all longer term options
trading at about 33% to 34% vol. All right, everybody confused? Nah, you got this. Here’s an example
of a risk profile. This is kind of like
what a risk profile might look like on a trade like this. And note, when you bring up–
this is technically a straddle straddle/strangle swap– this trade would be. But when you bring it up on
the Thinkorswim platform, it’s going to appear
as a double-diagonal– double diagonal. And it’s logical that
it’s a double diagonal because we’re selling those
near-term options and buying those longer term options
at different strikes– and so if you remember if you’ve
been to one of the workshops that I’ve taught, right? It’s kind of like drawing
one of those diagonal lines across strike prices
in time, right? You’re just doing it on
both sides of the market. Buying farther away and from
expiration and strike prices that are out of the money– selling closer to expiration,
closer to the money. And so what that creates
are two diagonal kind of surfaces in the trade. And so just be aware that’s
what you’re going to see. In this example, it would
go for $0.41 credit. And it’s really interesting
because this type of a trade, depending upon
pricing structure, it can result in a credit. And that credit isn’t
necessarily the maximum gain. And like I said, this is
one of the confusing parts. Because in theory if the market,
for example, were trading right at the strike
selected on the short side– so a 149 here. Those 149’s in theory
could expire worthless, which means potentially a trader
could keep all that credit. But also they’ve got
options further out of the money expiring and maybe
a few weeks, which could still have value remaining. So put it in for a credit
potentially and then be able to sell this back
out for a credit as well, and that feels
like you’re living in a bowl of sweet chicken. It doesn’t always
work out that way, but that’s where
this type of trade you’ll see how it can actually
potentially on this risk profile show greater profits
than just that credit, and that’s the reason why. There’s the credit plus an
amount that could be there if the value of the longs are
sold for additional credit when the trade is unwound. OK? So exit considerations. If people are
trading this strategy and they understand the general
complexion of this trade– well then exit considerations
can be kind of like a follow through of the reason why
they put that trade on which could be something like this. If that volatility skew
that was existing– if that starts to come back
out because maybe there was earnings, the
earnings gets released, volatility comes crashing out
of the near-term options, that could be a reason to
just take an early exit. Theoretically that should
be profitable on the trade. But you can actually test
that on the Analyze tab as to whether it
would be profitable. And I’ll show you
how to do that. Now if the stock is right at
or near the short strikes, right close to expiration– as
you get close to the expiration date, that should be very
helpful for this trade as well. And so might be worth getting
out and taking those profits before the expiration
actually takes place. Now if the stock is not
near the short strikes– if the stock has made a move
where the dogs are getting close to the fence
or beyond the fence, that could be a good reason when
the extrinsic value in the near term options– those
options that you sold– when that time value
is basically gone and those dogs are
running wild, well that might be a reason to just
get out of the trade and cut losses, right? And sometimes there might even
be a little bit of profit. But if the stock is
not cooperating at all with your strike selection– the dogs are getting outside
of the fence, so to speak. Extrinsic value isn’t
there so the short strikes aren’t necessarily
helping the trade anymore, that could be a reason
to get out of the trade. And getting out of the trade
means you either straight exit that trade or a possibility
would be buyback the near term options. And if there’s time in between
the longs and the shorts a roll could be placed. However, just a
reminder, ultimately you want the stock to be at the
short strikes on expiration– if you’re thinking that there’s
no chance the stock’s going to be at the short strikes,
that could be a good reason to not roll and just exit
the trade altogether. And remember reward risk
analysis and transaction costs in this trade. OK, so I’m going to switch
over now to paperMoney now that we’ve got kind of theory
of that thing all laid out. And it looks like the markets
are up and running here. S&P is down about
three points here– 3.25. And it looks like most markets
are just sort of flat here. Looks like the biggest percent
mover out of these futures that I’m watching– looks like wheat
is the biggest percent mover to the downside– its forward slash ZW. And oil is down
about 1% as well. But rest of the markets
are pretty much flat today. No surprise, got a pretty
big Fed announcement today. I think the general,
maybe just barely, but general consensus is the
Fed isn’t going to do anything. However, there’s
a tone out there as well of many people
anticipating that some cuts are going to be coming this year. Whether or not it’s
going to happen this particular announcement
is another thing. But there are definitely
going to be some eyes watching that Fed today. All right so that
being said though, let’s do an example of a
straddle strangle swap. And then we’ll move on and
we’ll talk about our follow up from last week’s trades. All right, remember last
week we had some long stock and short strangled trades. I want to talk about
the progression of those and some adjustment
possibilities, and also some adjustments
to time spreads. So we’ll follow through
with those things after we go through a
straddle/strangle slop example. Now if people are looking
for double diagonals or straddle/strangle swaps– and especially if
they’re looking at that opportunity
of selling a lot of that near-term
volatility, maybe seeing one of those
positive volatility skew. That’s a new one. Sweet chicken. I used to say sweet
chicken all the time. Yeah, it’s not as forthcoming
from my mouth as usual, or as it used to be. But yeah, living in a
bowl of sweet chicken. That’s what it’s all about. All right, but let’s
keep moving on here. Some traders if they’re looking
for that near-term volatility to sell they’re looking
for event situations. One of those event
situations could be an earnings announcement. Now here’s the thing, we are
not in earnings season at all. However, there are
some stocks even though you’re out
of earnings season that might have earnings. And just as a
reminder, if you’re looking for earnings candidates
for a strategy like this, there’s a pretty
gnarly tool here– a helpful tool I should say– it’s the calendar. And on the calendar– so I’m just going to go
to Market Watch and then the sub tab Calendar. The calendar allows you
to view many things. Looks like the last thing I
was looking at on the calendar was futures liquidation. But if you wanted to
you could see what economic events are coming up. What I’m looking for
though today is earnings. So I’m just going to click the
box that says Earnings here. And now if someone
wants to focus on things that have
weeklies options, maybe those options are
going to be a little bit more liquid than others as well. Generally if something
has weeklies options it’s in demand in
terms of trading. So possibly you could have
better liquidity in that name. So if somebody wanted
to go for weeklies, they might as they’re clicking
this box for earnings, they might go up here to the
top of the column over here on the left hand side. And where it says
Show Actions there, they can select a watch
list– a public watch list– it’s going to be
in R through W– weeklies. So basically what
you’re doing is you’re scrubbing the earnings
calendar against stocks that have weeklies options. It’s a pretty helpful tool. And here you can actually
kind of go through the list and see what’s coming up. And if you notice just in
the next couple of days we’ve got not a whole
lot of candidates, but we’ve got a few. There is CGC– so, you
know, weed basically. Also Kroger grocery store,
you know, that type market. And and also we’ve got Red
Hat it looks like coming out. Now it looks like
the one that’s going to be happening the soonest
is going to be Kroger here. That’ll be before the
market on the 20th. So let’s take a look at Kroger. All right so I’m going to
jump over to the Trade page. And we’ll just type
in ticker symbol KR. And just based on what I showed
you on that previous slide, right? Do you see anything in there
that kind of represents or that indicates what
we talked about before? If you notice, I’m
seeing something here. If you notice the
implied volatilities over here on the right
hand side– and sorry I don’t have my annotation tool
up and running, shame on me. But over here on
the right hand side, here we’ve got these
different weeks– different weeks. And also these different
implied volatility levels. Notice here how we’ve
got longer term options. Those volatility levels
are lower, right? Near term options– those
volatility levels are higher. Now why in the world
would that happen? Think of volatility– this
implied volatility average over here on the
right as the markets representation of how volatile
they might think the stock could be in that time frame. So in the frame of
these two days, 118%. Traders are saying
relative to the others, they’re expecting
the stock to really be volatile in the
next couple of days. Or at least options are
priced is if the stock could be volatile– 118%. But as we go out in time, that
volatility subsides, right? Might see an event
take place, but then after that kind of
chilling out, so to speak– or getting back to normal. And so this is where
somebody could possibly apply one of those trades. But now remember, if they’re
going to sell these near-term options– let’s just say we open
these two day contracts– a trader might look at selling
right at the money contracts. And it looks like the at the
moneys is right now are going to be the 23 and a 1/2’s. Let me just show you
the structure of that. I’m going to go ahead and click
the bid price on a 23 and 1/2 call and on a 23 and 1/2 put. I’m going to hold my Control
key down on the keyboard as I’m doing this. But that’s going to be
selling a near term straddle, and that’s selling all
that near-term volatility. By the way, if
someone wanted to do a traditional double
diagonal rather than doing a straddle kind
of right at the money, they might do
something like this. Sell a– and I’m going to
switch this over to custom real quick– but sell options,
maybe the puts out of the money just a little bit. Which means the 23 strike
price selling those. And the calls out of
the money just a little bit, maybe selling the 24
strikes on those calls. But if somebody did that that’s
actually selling a strangle, and that would create
a double diagonal once this trade is completed. You know, kind of
the traditional idea of a double diagonal. So kind of is up to you as the
way you want to structure this. Maybe just as a little
bit of a curve ball here– I know I’ve been teaching the
idea of the straddle strangle swap– selling right at the money. But let’s do the strangle here. I’m going to sell one strike
out of the money here. So we’ll sell the 23
puts and the 24 calls. So just a little tiny bit
away from that center strikes. And maybe we can switch
this back and forth and just take a look at the
difference between the two as well. But I’m going to sell the
strangle here to get started. Now as a follow up to
this though, those are selling the dogs, so to speak. If we’re going to be
a buyer of a fence– now just in case
these things get way too volatile
and out of control, that means we need to go to
a longer duration and buy something that’ll wrap
around this thing. So let’s go out to– we’ll
go a couple of weeks out. Let’s go to July 5th. And just the reason
I’m going with July 5th is that notice how volatility
really takes a step down by the time you get 16 days out. Some traders might do
this just nine days out. You just kind of have to
experiment and see which one kind of looks best for you. But now let’s buy
a strangle though. Now in terms of that strangle,
how far out of the money are we going to buy it? One guideline that traders
could use, especially in an earnings situation like
this, is the market maker move. And that’s found right above
the bid and the ask price here. Maybe you’ve heard that called
the expected move before. But the expected move– this
Market Maker Move 3M plus minus right up here, that happens– that shows up on
your screen when there’s one of those
positive volatility skews. When that volatility is
priced heavy in the near-term and lighter in the
longer term, that’s what triggers that
market maker move. And that basically
indicates, just based on current option
prices, how much that stock is expected to move
in a one day scenario. Now, it says $1.95. Now that should be the idea
of a standard deviation. Based on the way
extrinsic value gets priced into options,
that should be kind of a standard deviation’s
worth of probability there. Now all that being
said, if a trader wanted to use that, they
could say, well, let’s go ahead and buy a
fence or buy options– then that market maker move out
of the money from the options that they’re selling. So if they’re selling
a 24 strike price call, they might decide to buy a
22 strike price call, right? Just take that
market maker move, add it to and subtract it from– actually I just said that
completely backward, didn’t I? If they’re going to sell
a 23 strike price put, they might take that
market maker move and subtract that from 23. So that means buy at
21 strike price put. And on the calls if
they’re selling a 24 strike price, maybe by $2 the
market maker move above 24. So in that case it
would take it to 26. All right, with the Control
key down on the keyboard let me just go ahead and
fill in the blanks here. So I’m going to click the
ask price on these options that we are buying out
here at the 21 strike. And again, the Control key
is down on the keyboard. And that was the put– I think I keep saying
calls, rookie mistake. Anyhow, on the calls now
we’re going to go to the 26’s. So again, $2 above, $2
below the short strikes. And there’s a credit
coming in of $0.91. Basically what that means is
that these near-term options are enough to pay for the cost
of those longer term options. And if you take a look at
the Analyze tab on this, this is kind of the
structure that what you have. It kind of looks like, well,
Mount St. Helens I guess– some sort of volcano. Hopefully it doesn’t explode
and blow the whole thing out, which that definitely
could happen. But you’ve got basically
this little cone of theoretically
maximum gain here. That cone up there with
the slight profit peaks, those are at 24 and 23. And coincidentally those profit
peaks happen to be where? Well those are
the short strikes. OK? 24 and 23. With a range of profitability
there in the middle. Now this does lose
or make less money if the market gets away
from those center strikes. So that’s what I mean by
the trade running too far away from the midpoint. But it does have a couple
of break evens here. If the market goes up
too far it could lose. If the market goes down
it could lose too far. If we set our slices to the
break even point on 6.22, this would show
theoretically where those break even points are. Now there’s a reason I stressed
theoretically where those break evens are, because
volatility can definitely impact the location of
those break even points, OK? But that’s kind of the basic
structure of this trade. Now note though, it might look
like this trade doesn’t have any risk because there’s
a credit coming in– ah, there’s no risk on this trade. Be aware, there is risk. If the market goes up and beyond
the long strikes or down below the long strikes
on the puts, there could be risk of the difference
between the strikes, which is going to be $2. We’re $2 above 24,
were $2 below 23– distance between shorten longs. You’ve got the risk
in between those two numbers minus that credit. So the risk here is going
to be about $110 per trade– or per side here I should say. If you put your pointer
way out here to the edges, there you go– negative $109
in the lower left hand corner. And go all the way down here,
negative $109 down there in the corner. And that’s where we’re
coming from this. It’s the difference between
the strikes minus that credit. That’s kind of the maximum
loss scenario here. Now assignments could take
place in the near term as well. Which that can throw
a fly in the ointment. So just be aware that assignment
could be a mental challenge, especially if someone
has to take possession of the underlying stock. But now, I mentioned
you can evaluate how volatility changes could
impact a strategy like this. Here you can price in some
of that volatility just to see how this trade
might be impacted. Some of the more advanced
features of the Analyze tab– if we go to the bottom
of our risk profile here there’s a gear icon. On the gear icon
you could actually account for changes
in volatility. And in particular,
knowing that we’ve got these two different
expirations somebody can even be selective with volatility
in the different expirations– and actually see what might
happen if volatility drops in both of these expirations. Now just real quick
before we do this, I’m kind of curious
about something. I’m going to go to
a chart on Kroger. And we’ll just take a look
at implied volatility– the averages here. The average implied
volatility right now, including all
expirations, is elevated. If volatility dropped after
this earnings announcement we might see volatility–
and the average right now is about 45%. if volatility drops down close
to some of these previous lows, it might drop down to around
30-ish percent on average. So from 45% to about
30-ish percent on average. Now that likely is going to
happen for all the expirations here. It may not work out
perfectly to that, but that’s probably
going to happen– something similar in
all these expirations. Which means our
options that we’re selling that have
more than 100% vol, they might go down
in the neighborhood of around 30-ish
percent volatility. The options that we’re buying
around 50-ish percent vol, they might drop to somewhere in
the neighborhood of around 30% vol. If that happened–
and I know that this is adding some complexity here,
but just do the best you can. If volatility dropped from– and so one thing if see
where my pointer is– down here in the
double diagonal, we’ve got volatility indicated
right where my pointer is. Those are the individual vols
for all of these options. Notice how these
near-term options are above 110 for
their volatilities. Let’s say that drop
down to 30, right? So 110– so let’s say
volatility dropped– we’ll just say 70% in
those near-term options, you can account for that. And then let’s say
volatility dropped from right around 50-ish
in these long term options down to about 30. So let’s say it dropped 20%, you
can account for that as well. You can do more parameters
and just focus on the options expiring in these
different expirations. So let’s say these
near-term options– these June options–
and some might argue the percentage drop
could be greater than that. But let’s say those
lost 70% volatility. OK? Notice that this trade
would immediately become fairly profitable from
that decline and volatility in the near term. Now if you have these
options that are owned though in the slightly longer
term those are probably going to drop as well. Let’s account for a drop
of maybe 20% in those. We’ll put negative 20% there. And that’s going to draw
back from the profitability of the trade a little bit. But here, this is where somebody
could account for profitability scenarios if volatility drops. Now this is a strong
assumption here, right? Because if volatility
does flatten though we don’t
know for sure where those numbers are going to go. Let’s say that near-term
volatility drops 70% and that longer term
volatility drops 20%– both go down. And you can see here
that this trade would have a nice little profit to it
just from that volatility drop. OK, so this is
where you can really stress test and factor in how
volatility scenarios might the trade. OK, so now the
difference between this and a straddle strange swap– this is a double diagonal
straddle strangle swap just so that you know
slightly different complexion. This is where
somebody would just sell the exact same strike price
on their near term options. So if they went
with the 24 and 1/2 on the short strikes
on both sides, boom, they’ll gets a slightly larger
credit out of this trade. That’s going to throw this
off just a little bit too– I might need to adjust
my strike prices. However, kind of the same
kind of logic scenario here. But it will have a profit peak. Nice profit peak will
happen if someone chooses the straddle
strangle swap as opposed to the double diagonal. Let’s go back, we’ll do the– we have the puts at 23
and the calls at 24. And I think I chose the
wrong strikes on that trade. But let’s go ahead and put
a paper trade on that– this little double
diagonal here. If someone has
created the trade– and we’ve already talked
about creating the trade on the Analyze tab– one step will allow you to place
this trade for an actual trade on paperMoney here. Just from the Analyze page if we
right click on that simulation, we can hit Confirm and Send
and that will actually create a read back screen for us. We’ll see some of the terms in
terms of buying power effect. Also the price of commissions. Commissions are going to be
heavy on a strategy like this by the way. Because you’ve got so many
different moving parts in there. So just remember commissions
are going to impact this trade. But you can kind of see
the general breakdown. Now one thing I wanted
to focus on here is the buying power
effect being $307. That’s a pretty
important number here. If someone wanted to
size their position– if they used that
buying power effect, that would help prevent
them from losing too much if the market
goes against them. If they decided, hey, my buying
power effect– it’s $307. Let’s just say I wanted
to invest maybe $1,000, I’m comfortable losing a grand. Take that $1,000 and
divide it by $307, and that would be your
maximum position size. And so basically
three of these– one, two, three– if
we did three of those and hit Confirm and Send on
that, that would be a buying power effect of basically $924. And believe it or not that’s
actually very conservative because that’s taking
the risk from both sides. And the difference
between the strikes minus the credit
on both sides, it’s actually including both sides. So it’s a very conservative
way to size position. But I’m going to go ahead
and hit Send on that. And there we go. We’ve got three double
diagonals in there. And that’s based on
that volatility skew. And there are other ways to
do double diagonals as well. But what I would encourage you
to do is maybe practice that. Just take a look
around the market. If you’re looking for those
positive volatility skews, a good place to look is
around those earnings events or some sort of an
event situation. See if you can recognize
that volatility skew. And then on the
Analyze page, maybe practice creating those trades
and evaluating the reward to the risk. And then just do a thought
experiment as to whether or not that’s a reasonable trade. And then maybe place a
paper trade on one or two of these things so you can get
comfortable with the outcomes– how they work from here. Now speaking of outcomes– if a trader is focused on
this strategy as a volatility kind of collapse trade– after
the earnings volatility comes out and it flattens kind
of across the board, someone might decide to get
out of this trade really quick. In other words,
within half a day after the earnings announcement
be done with this trade. If the market is right in
between your short strikes and there’s more profitability
that could be had, maybe they let this work
a little bit longer. Or maybe they take profits
on part of this position. But generally speaking,
it’s one of those that traders will look for that
mean reversion on volatility and then a pretty quick
exit if it’s working. If it’s not working, especially
if a trader is looking at and the market’s up to 30
and down at 20 or something like this– it’s made a big
move outside of the range, they might want to get out
of this thing pretty quick. That way they can avoid,
maybe, an early exercise that could happen on the trade. Especially if they thought
the market’s not going to come back toward the middle. So just a couple of
things to factor in there. And we’ll visit the outcome
of this trade next week. So next week if you want to
see how that thing results feel free to join me and
we’ll circle back around and take a look at that. So that’s Kroger. And just so you know,
here’s what the Greeks look like on that trade. It’s going to be Vega positive– Positive Vega. Whole lot of positive
Theta in there. And a little tiny bit of
negative delta in this case. But it’s going to be basically
a Delta neutral trade with a lot of time decay. And it will show positive Vega,
but really it wants volatility to flatten– go flat across those
different expirations. OK, so let’s shift
gears here shall we? That’s the ins and outs of
these straddle/strangle swaps or double diagonals. And again I would encourage
you to practice those. Just note as well,
Ken Rose on Thursday– he’s got some classes
in there where he’s gone through some double
diagonals in the advanced options class. You might want to
take a look at those if you want more work just on
diagonal strategies in general or see some examples
that he’s done in the past on double
diagonals as well. So there’s other resources
you can use especially if the way I present
doesn’t necessarily work in your understanding. Because I get it, my style
isn’t necessarily for everybody. But there is an
example for you and use some of those other resources. By the way, Ken Rose as well– for those of you
who are thinking, yeah, there’s more to life
than only trading options. You know, maybe some of you
have a big stock portfolio and you’re wondering about
ways to generate income from your stock portfolio. Just be aware Ken Rose
has a class on generating income with dividends– dividend paying stocks. And that takes place
Monday evenings at 7:00 PM eastern time. So check out Ken. I guess there’s a
couple of web cash you might want to check out. One that could help
you better understand what I’m talking about
in this one, that’s going to be the advanced
options on Thursday. And then also Monday
evening, 7:00 PM, Ken takes a look at kind of the
stock investor approach using dividends and dividend
reinvestment possibilities as examples of generating income
kind of in a stock portfolio. OK, Rick is giving
me a hard time for not checking those chats. Yeah, Rick, I’d like to see
you present this and keep your eye on the chats. But what did I miss by the way? Let’s see here. Oh, is there one in there
for volatility when earnings are a couple of weeks away? Yeah, I mean it can. But the one thing about
using this volatility skew trade the way I structured it– it’s kind of nice if a trader
is expecting volatility to drop immediately. So that makes a case for
putting this trade on right before the earnings
announcement. You know, one could
make a case as well for maybe buying
into this strategy a couple of weeks
before to see volatility could lift and increase the
value of that double diagonal, but it might not work. And the reason is
because if those shorter term options that– the ones that were selling– those are really sensitive
to changes in volatility, especially around
those earnings. And I shouldn’t say they’re
sensitive to changes in volatility, it’s
just volatility is much more volatile in the
shorter term expirations. I want to say I’ve looked
at statistics in the past where volatility
moves 200% faster in those near-term options
around those earnings events than it does in those
longer term options. So if those are the
ones that we sell and we want that value to be sold
high and then go away, it kind of makes a case
against doing this two weeks or so before the earnings–
selling those shorter term options. Because they might
they might increase in value which kind of
defeats the purpose of selling those premiums. So anyhow, there’s
a thought for you. OK, you ready to move on? Since we’re running
out of time anyway. Hopefully this has been
worth your time though, taking a look at
these strategies. Now let’s do just a couple of
more items in our checklist. Let’s follow up from our
long stock short strangles last week. And then we’ll talk about an
adjustment to some time spreads here. I hope to get through at
least a couple of examples of adjustments on
those time spreads. Now last week if you recall, we
did a couple of paper examples. We had one on Uber
and one on Stitch Fix. Stock’s been cooperative
on both of those examples. Just for simplicity’s
sake, I think I’m going to go with
the Uber follow up. The concepts that we talk about
though, they could be applied for any long stock
short straddle or short strangle example that
a trader could have. I might not have time
to cover everything that we’ve done
previously, but just think of this as a
learning experience and then take the
time to apply it yourself to
different candidates. All right, so we’ll
look at Uber here. Uber– remember last week
we bought stock, right? So first, reminder– if
someone does a trade like this they’re bullish. They’re willing to
own stock shares. In this case 100
shares of stock. And then as a follow
up to that, they’re willing to sell
their bullish stock. They’re willing to sell
their stock if it goes up in value at a certain point. And so they’re selling a
covered call basically. And that’s what
we’ve got here is a short call at the 44 strike. And also, they’re willing to
buy into additional shares if the stock goes down. So subtract from their
stock if it goes up a lot. Add to their stock if
the stock goes down. But either way, they’re
selling calls and puts and therefore bringing in income
from both sides of the market. It’s one way to buy
and sell shares. Sell higher buy lower and
generate income along the way, or at least that’s the
goal of the strategy. Remember last week that
strategy had a Delta of 100. Right now the strategy’s
got a Delta of 54. And the reason the delta
has dropped on this is because the stock’s gone up. And we talked about
this last week. Stock goes up a lot
especially if it gets beyond your short strike. The delta on this will flatten– it’ll go to zero. The reason it’ll go to zero is
because the puts get worthless. The calls become
a near guarantee, or closer to a
guarantee that we’re going to sell the stock at 44. And so that’s when the
odds become greater that we’re going to sell the
stock at the short strike on these calls,
then the position will take on an assumption that
that’s going to happen early. And so the Delta will
go close to zero. There’s still 54
positive Deltas here, but, it’s a pretty good example
of how those Deltas can change. OK, but on the
management end of this, this still has nine days
on these short options before expiration. But what I want to talk about
today is an active exit. You know, some traders might
not do anything with this. They might just let this go. And that’s completely fine. And if the stock’s
above 44 on expiration, just sell their stock,
puts expire worthless, and they’re back to flat
and they’ve got profits. OK however, somebody who wants
to be a little more active and keep this
position in play, they might watch the values of
those short term options. And notice here, there’s
one thing that I’m noticing. See these puts? Just focusing on
the put side here– I don’t know how to
highlight the put only so I’m putting my pointer
kind of close to those. But the puts were
sold for about $0.12– or excuse me, what were
the puts sold for? $0.90. And right where my
pointer is, $0.90. And right now
they’re worth $0.12. So the point is the puts
are almost worth zero. They’re not worth much. And so a trader is
looking at this, especially if time
decay is a goal, they might look at those
puts and say there’s just no more benefit from those. There’s no more decay
coming out of those puts. So that could be a
reason to create a roll. If they wanted to keep
the time decay rolling when one side or the
other gets to the point where it’s nearly worth
zero, some traders might wait until the short term
options are for $0.05 or less. But that could be a reason
to buy them back and then sell something
else if they wanted to keep the trade in play. Now the question is, do they
only role the winning side? Or do they roll both sides? It might make sense
actually to roll both sides at the same time–
just reposition the whole thing and see if they can get
additional credit for doing that. And then reset where
this time decay could be. So let me show you what
it would look like if we rolled both sides here. Now in order to do
this what we can do is left click
on these options and that’ll highlight both. Then right click,
and in the menu choose Create a Rolling Order. Now here’s what’s interesting– in the first item in the menu
says Sell a Double Diagonal. Wait, we talked about
double diagonals right? I’m going to click Sell a
Double Diagonal though and just show you the structure here. By selling this double
diagonal, the reason it’s called that
is because we’re buying options and
selling options in different expirations
and different strikes. So if you remember the
graph that I showed in those workshops– if you’ve seen that
and I’ve done it in this class. If you can visualize those
options at different strikes and time frames–
there’s diagonal lines connecting those strikes. That’s what we’ve got here. But in particular, this has this
buying back the June contracts at 44– and the calls. Buying the puts at 40 and a
1/2– so getting out of those, and reselling those
options at the same strikes in the next week out. And that would generate
a credit of $0.40. But a trader might be looking
at this and saying, yeah, but you know the calls
are in the money? And maybe I don’t want
to sell those stocks. And maybe I wouldn’t
mind getting a little bit more premium out of the puts
because the stock has actually gone up here. This is where a trader
might make an adjustment to the strikes. And so maybe killing two
birds with one stone here. This is adjusting a time spread. If you visualize this, this
is kind of a time spread. Buying back near options,
selling options further away. If somebody is
making an assumption that the stock is now going
to be at a higher value, they could adjust
their short strikes to a higher set of strikes. Let me show you one
way to create this. If you remember the logic of why
we selected the trades that we did last time. We sold options that had a
Delta of right around 30. If we sold new options
in the next expiration– July 5th here at a
Delta of around 30, that means the puts would be
positioned at about 42 and 1/2. And the calls would be
positioned somewhere around 46-ish– OK, around 46. Now let’s see what would
happen if we take the puts and bump those up to 42 and 1/2. So I’m going to
take my put strike. And this is on the new cell. And we’ll go 42
and 1/2 on those. And the calls, let’s say, we
do the calls at about 46 there. So buyback the near terms, sell
the longer term options, OK? And that would be rolling
basically the whole bracket of options higher. Now note the cost of this
is going to be $0.05. There would be a
cost to doing this. Now why would
somebody do this then if they’re going to
have to pay a debit? The reason– and I’m going
to lock that in on zero. The reason they would do
that is because they’re giving themselves more room for
the stock to go up now, right? If the stock goes
up beyond 46, they can now make the difference
between the current price of the stock and 46. So this is not an
illogical adjustment, OK? But that’s kind of the scenario. They might have
to go even money, or actually even pay a little
bit of money to do this. Now just as a heads
up, if somebody wanted to maybe
effort for a credit on this, rather than selling
those calls at the 30 Delta, they could make an
adjustment and sell maybe slightly lower strike
price on those calls. So they’re only giving
themselves an additional dollar of upside on the stock, OK? But now they’re getting a
credit out of this trade. Also another way to possibly
bring in a credit on this trade and let’s say they wanted to
keep the short strike up there at 46. They could
potentially take those puts and put them closer
to the money so sell maybe the 43 or the 44 strike
depending upon their goal here, right? But selling higher
strike put could also be a way to generate credit. But that’s going to be
a more bullish variation of that trade, OK? But let’s say we did maybe
a mixture of the two. Let’s say we sold the puts
at 43 and 1/2 and the calls maybe at– how about 45 and 1/2? Rather than 46, we’ll go
to 45 and 1/2 on the calls. And on the puts rather
than doing the 43, let’s do the 43 and 1/2. So kind of finding
a middle ground. There, we’d actually get
new credit coming in, right? Kind of reset on the
time decay there. And eliminating that obligation
to sell the stock at 44 and building in a new
obligation selling the stock at 45 and 1/2. So that’s a way to kind
of move everything higher. And if a trader wanted
maybe fewer commissions that they’re dealing with, they
could always roll this out. Maybe rather than going
to the next week out, they could go to
maybe two weeks. So if I switch this from July
5th to July 12th, so two weeks, that’s going to make it so my
commission burden goes down. I’m not rolling these as much. And I’ll get some pretty
decent credit all in one trade. The credit would be $1.05. And in fact, that’s
what I’m going to do. We’ll roll out two weeks
here and move everything up. All right, so $1 right
now is the credit and actually I’ll go
with $0.95 on that. We’ll hit Confirm and Send. And boom, that’s an adjustment. And if you wanted
to see the trade now it basically just repositions
everything to the upside. And it gets us back some
of those positive Deltas. And it sort of puts
us in a position where we’ve got more time decay
that we could experience over the next couple of weeks. So that’s an adjustment to
the straddle/strangle swap. Just moving everything
higher if that’s something the trader wants to do to
generate those credits, reset the time decay, and maybe
get some of those deltas back. All right, now there’s
another trade in here. It was a pre-earnings
trade on SQ. We did this about three
weeks ago as I recall. This is an example
of a calendar, just a straight
calendar it’s 60 strike. And that means we want
the stock to be at 60. Let me jump to the Analyze
page actually on SQ. And see if maybe just
looking at the Analyze page can help everybody understand
this trade a little bit better. So this trade would be
better if the stock actually dropped back down to 60. Now honestly, everything’s
working out nicely in SQ because we own 300
shares of stock as well. So a trader might decide to
just leave this the way it is. But just so you know,
there’s a profit peak on the calendar itself at 60. And the stock is all
the way up at 72. Now if someone
doesn’t have stock– so this is OK because
we’ve got stock. The stock’s gone higher
making us more money. But the calendar spread
is actually losing, OK? So if somebody has
got a calendar spread and they need the stock
to be at the strike. And they’re convinced,
though, that stock is going to stay higher. They could make an adjustment
to that calendar spread to make it more bullish, OK? May or may not be useful in this
situation with the long stock, but nevertheless I want to show
you how somebody could actually make a roll on the calendar
to make it more bullish. And I’ll just add a
simulated trade here. And it probably makes
sense to get something like this done
anyway because we’ve got options that are getting so
close to expiration– holy crap I’m running out of time. I have to go pretty
quick here but hopefully we can squeeze it in. I’m going to need
more strikes because I can’t see where my options are. OK, so notice we’ve got
these short strikes down here at 60 on these puts. By the way, if you can buyback
a single short option– I’m just going to click
the ask price on those– buyback these three puts here. If you buy those back for
less than $0.05 cents, you do that on thinkorswim and
not pay a commission for that. So rather than
putting in a roll, I’m just going to buy back
those single puts at first, OK? So buy those back. Now next step here,
if somebody wanted to make this position a
little bit more bullish they could resell some
options potentially at a higher set of strikes. Now the question is,
is the juice really worth the squeeze on this? I’m going to go ahead though. We’ll go out 16 days, so
a couple of weeks here. I’ll sell the 65 strike here– 2, 3. And let’s see how
that would– yeah, the risk profile isn’t
going to work here because it’s got a roll on it. And when you swap
out expirations it kind of screws
up the risk profile. But what you need to understand
if someone sold a higher strike now, they move
that short strike to 65. On these calendars–
the short strike is where ultimately you’d
like to see the market be on expiration for the trade. So if you move that
short strike higher you’re making the trade
more bullish, right? Moving it closer to
the price of the stock. But make sure the new premium
you’re getting from this is worth it. In this case, the
new premium is $0.35 and we’re going to
add $5 worth of risk. And I’m not sure
that’s worth it. So quite possibly a
trader might decide to just exit this trade because
the market has gone too far away from it. I know I’m going
kind of fast on this. But the market’s gone very far
away from the short strikes here. Rolling that short
strike to a higher strike isn’t given us a lot
of additional premium. But it’s widening out
our risk to difference between those strikes–
although would make the trade more bullish. That leaves me
with the reasoning here that I think I’m just
going to close this trade. Because we’ve got risk remaining
in these puts that we own. So this would be just a straight
exit– hit Confirm and Send. That would just get
out of that trade. And I know a moved really
fast on that example, but just selling a
higher strike could make the trade more bullish. But make sure there’s
enough premium to make it worth your while. And there really
wasn’t enough premium. So I just decided to
get out altogether. OK guys I’m going to put
a survey in the chat box. Mission accomplished today. Apply what we’ve learned. Just go ahead practice
these strategies, right? Take that survey by the way. It’ll go ahead and allow you
to rate my performance today. Five questions and
you should be good. But hopefully this has been a
learning experience for you. Just remember what we
talked about today is not a recommendation to buy or sell. Coming up a little bit later,
I’ll be in the Splash Options. That’ll be the next
class and that’ll be happening at
11:30 Central time. So hopefully I’ll see you
in the Splash Options. Until then, everybody
have a terrific day. And bye for now.

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