High Expectancy Trading

IWM closed at 73.70 today.

Heres the low-down on my current spreads.  All June 21st expiration:

Short 64, Long 59 - Currently trading at .10, opened for .25 on 5/2, so I have a .15 gain so far.
Short 64, Long 61 - Currently trading at .08, opened for .17 on 5/12, so I have a .09 gain so far.
Short 66, Long 63 - Currently trading at .14, opened for .17 on 5/16, so I have a .03 gain so far.

I plan to close the short options at .04.  Based on my previous trades I expect to do this the first week of June.

I am considering some diversification for the July expiration month.  I am looking at other ETFs for high volatility in Puts and good option volume.  It would be best to not trade all my risk capital in IWM.  I am looking at foreign exchanges and commodities.

Van Tharp is a successful trader and trading educator.  His book on the left side of this blog is excellent.  It is thought to be one the of the best all-around trading books ever.  His description of expectancy in this book excellent.

Here’s a link another friend passed along from the Tharp site.  Tharp is known for teaching trading psychology.  If you are interested in this subject, this trader test is right up your alley.

http://www.tharptradertest.com/default.aspx

A friend of mine sent me this link.  It gives a good description of credit spreads.

http://www.graymetalbox.com/tutorial/credit_spread_tutorial.htm

Credit spreads in IWM are still hot because despite the recent break to the upside, volatility in Puts is still high.

After the open today I filled a 66/63 spread.  This was the most profitable. (considering ROC and positive expectancy)

I sold the June 21st expiring 66 Puts for .31 and bought the 63’s for .14 for a net credit of .17.

I bought back my June 30th 60 naked Puts yesterday for .11, netting a .21 profit to free margin for my new spread today.

I now have all of my risk capital in play.  Here are my positions.

All June 21st expiration:

Short 64, Long 59 - Currently trading at .15, opened for .25 on 5/2, so I have a .10 gain so far.
Short 64, Long 61 - Currently trading at .12, opened for .17 on 5/12, so I have a .05 gain so far.
Short 66, Long 63 - Currently trading at .17, opened for .17 on 5/16

I plan to close each position when the short option is trading at .04.  Based on my past trades I expect to close these the first week in June for full profit.

IWM closed the day at 73.4. 

My 64/61 spread ended the day at .12 so I gained 2 cents from Monday’s close.  Again, I’m looking to close this spread at .04 for a full profit of .13.  (I opened the spread for .17)  To calculate the $ profit, multiply .13 by 100 (shares per contract) then by the # of contracts. 

The number of contracts you can trade is limited by the cash you have in your account that will be held as margin.  To calculate the number of contracts you can trade, divide your risk capital by 300.  (Take the difference between the strike prices (3) and multiply by the number of shaes per contract (100) = 300)

Right now there is a 98.21% chance of collecting all the planned .13 of profit.  The current ROC annualized is 87% assuming this trade closes on 6/1, 20 days ahead of expiration.  Wow.

This is an excellent trade so far.

OK, my naked 60 puts closed at .12 today. (.20 profit so far)  The problem with this trade now is that so much value came out of it already, relative to the length of time to expiration.  There is only a 12% ROC annualized on this trade.  With the IWM pull-back late today, it feels like IWM may close lower tomorrow.  If it does, I will likely close this naked Put for it’s profit and use the margin to open another spread that is currenly showing an 88% ROC.  That sure makes sense to me!

I opened a new spread today with my freed margin.   I sold 64-strike Puts and bought 61-strike Puts, each with June 21 expiration.  This happened to be fortunate because IWM moved up nicely today.  I was not able to trade right at the open and IWM zoomed about .80 before I could submit my order.

I sold 64-strike Puts for .31.  I bought the 61-strike Puts for .14 for a total of .17 net credit. 

To calculate how many contracts you could trade, divide your risk capital by 300.  (Take the difference between the strike prices (3) and multiply by the number of shaes per contract (100) = 300)

The spread closed the day at .14, so I gained 3 cents just today.

This position has a 68% annualized ROC and an expectancy of 44%.  Wow.  I expect to close the trade on or about 6/1/08 based on my own history of closing positions ~20 days ahead of expiration at .04.

My other position is short the 60-strike Puts with expiration of June 30.  It closed at .13 today.  I sold these at .32 on 4/29.  This positon is eroding nicely.  The current ROC is 12.85% annualized.  I may close this soon in favor of using the margin for another spread trade.  If I can get 60% or more annualized, I might as well.

Good times….

I closed my 59-strike June Puts today by purchasing them back at .19.  This is short of full profit.  Why did I do this?  Because, the ROC for this position was 14% annualized.  This isn’t bad, but, I could use these margin dollars to enter a credit spread position for a whopping 91% annualized gain based on the option prices at the end of the day Friday.  The expectancy for both trades is positive.  I actually attempted to enter the spread trade Friday but it did not fill.  I will try again Monday. 

I am trying to sell the June 64 Puts and purchase the June 62 Puts.  The downside risk is defined as the difference in the strike prices (2) multiplied by the # of contracts, multiplied by 100 shares (per contract).  This is the same as the margin calculation, by the way.

I can trade 3-4 times the contracts in this spread than in my previous naked positons.  This allows for the increased $ gain potential. 

I have one naked Put position open, the June 60-strike.  It’s at .21 yesterday (Friday). I opened it for .32 on 4/29, so I have a .11 gain.  The margin required for this position is $921 per contract.  The current ROC is 23% annualized and the expectancy is 77% of the remaining position value.  This is pretty good, which is why I did not close this position in favor of a credit spread yet.

I will update on my positions soon.  I am contemplating closing my naked positions now, before full profit, to free capital to open spread positions.

The sidebar to the left is not working properly.  I apologize.  The book links should work but the “My Favorite Posts” and the Calendar are not working.  I have a help ticket in to the admin and they are working on it.

I am researching credit spreads now for my next trades.

A spread is generally defined as selling and buying options to create a position with characteristics favorable for improved profitability.  A credit spread is when options are bought and sold for a net credit.  (selling options for more value than you buy) On the Put side I am looking at simply selling Puts at the same level I sold the naked Puts, then purchasing the same number of Puts 2-3 strikes further out of the money. 

I do not have capital available right now, but I expect I will sometime next week.  If I could open a position now I would sell the 64-strike IWM Puts with 6/21 expiration and purchase the same number of contracts in the 61-strike IWM Puts.

Get this…right now, selling the 64-strike Puts naked would result in a generous 41.66% ROC with a 94.8% chance of collecting full profit.  This is great.

But, the credit spread I mentioned above would result in a whopping 58.24% ROC with the same 94.8% chance of collecting full profit.  This is wild.  Why is this position more profitable than selling Puts naked?  It is because the options purchased greatly reduce the overall position margin requirements.  So, for the same amount of margin, I can sell about three times the number of contracts as the naked position.  This results in better profitability per dollar of margin. 

As if this weren’t enough, there is another advantage.  Naked Puts have a theoretical unlimited loss potential.  I say “theoretical” because I have a trigger point where I must take action to defend the trade, so I would very likely never lose more than my system allows.  At some point I will write another “Trading System” post to cover position defense.  But…there is that very small chance that a cataclysmic event may occur causing a drastic drop in the market overnight.  This is very unlikely but possible.  The 9/11 tragedy caused a 1-day 10% drop in the market.  Typically, it would take a 15% drop to put my short Puts in the money.  So, it would take quite an event, but it could happen.   This credit spread has limited loss potential.  The loss potential is defined as the difference in the spread strike prices, times the # of contracts traded, times 100 shares.  So, this could be large, but it is limited.

I need to be open to new positions that allow better profitability.  It’s all about maximizing profits, not being locked into a particular trading method.  I will gladly switch to credit spreads now if the profitability is better.  I look forward to cashing in on my current positions so I can open credit spreads!

Please comment if you trade credit spreads.

Today IWM continued its uptrend by closing at 72.86. 

> My short 59-strike Puts, with 6/30 expiration, last traded at .15. 
> I opened this position by selling these Puts for .33 on 4/25.
> The probability of obtaining full profit is 99.2%

> My short 60-strike Puts, also with 6/30 expiration, last traded at .18. 
> I opened this position by selling these Puts for .32 on 4/29.
> The probability of obtaining full profit is 98.7%

I like my odds.

I expect I will close these positions at .04 in 2-3 weeks.   It will be sooner if IWM continues to rise.

IWM made a decisive move up today to the highest close of this rally so far.  If IWM can convincingly close above 73 then we will likely see this rally continue.