Category: Stock Trading

Question about Monthly Income Trading

QUESTION: I have read the special report and if I’m interpreting it correctly we have been in a low volatility environment for the past few months, but appear to be entering a period of increased volatility. So put debit spreads seem to be in order along with vertical call spreads for credit at areas of resistance.

ANSWER: Right! You got that right away… very impressive.

I never said adjusting your credits will give you the same profit potential as the original trade… but it does save the trade and sets up potentially more profit by adding to your inventory.

If I went further than that in the videos I’m afraid I would have lost most of my viewers because there is so much more to successful income trades than just making robotic adjustments at break even points.

If you can grasp what I’m about to tell you I think you could graduate to a higher level of income trading:

Most traders think 2 dimensional, when you need to think 3 dimensional. Credit spreads and condors and calendars, etc are only names we give to help us profit from theta decay but the reality is all you are doing is adding to your ‘inventory’ of short positions and adjusting your deltas and vega according to market conditions and volatility.

It’s a completely different mind-shift when you begin to think in these terms. Suddenly you are like a real business… you add inventory at opportune times and then simply manage it being aware of your risks: delta and vega – the 2 most important risks of the income trader.

Question about buying calls – synthetic stock

QUESTION: I was playing around with SDS and noticed something interesting.

If I buy a call (and not sell a put) I am limiting my loss to the premium paid yet am able to participate in unlimited gain. This way I don’t have to mess with buying the actual stock to set a stop.

I guess I am wondering why establish the downside leg, except to receive a small credit?

ANSWER: It depends on what call and what strike you want to buy.

Here’s why call buying alone is not a good choice IMO:

#1: You buy the call – so your entire investment is at risk.
When the position moves against you and you sell your call then you have no position so you lose on the position and the commissions paid. Or you let the call expire worthless and you lode 100%. Or the stock moves in your favor but since the at-the-money call has a .50 Delta it does not move as much as you expect and your profits are limited.
(SYNTH: when you buy synth stock you place the order to sell the stock at a pre-determined price giving you a snythetic STOP loss so you determine the loss – but it also keeps you in the position! When the position starts to move in your favor again you simply exit your stock position. If the position looks like it will never recover then you can simply exit the entire position at any time without further loss.)

#2: You buy the call with less than a 1.00 Delta which means you lose money every day even if the stock moves in your favor or it just does nothing.
(SYNTH: when you buy a synth stock position the short put in SDS will offset the long call loss due to theta decay.)

Questions about Inside Days

QUESTION: If a trade still may be worth placing on Day 3 and your rule states that it should be closed out at the end of that day (or the open of day 4), is there a certain time of the day on Day 3 after which you wouldn’t make the trade because there’s not enough time for the stock to move much before you’ll be ending the trade. In other words, if a breakout finally occurs late in the afternoon on Day 3, isn’t it useless to make the trade at that point?

ANSWER: As long as the stock has not broken out yet it’s never too late.

QUESTION: If you have detected more inside days (that meet all of the criteria) than you have money to invest, how do you rank them and decide which ones to trade? Do you just go with the lower priced stocks because you would have to put out less money in order to have the same profit potential?

ANSWER: I would go with those stocks that have been in the narrowest range for the prior time period (1 week, 1 month etc.) which means that they arealso likely to have lower volatility. At some point they will experience higher volatility and the inside day could be the trigger to a big trade setup.

QUESTION: Do you recommend sticking with only certain exchanges, or is it not necessary to limit yourself in that way?

ANSWER: I use only the NASDAQ and NYSE. Also I only use stocks that trade 1 million shares or more, on average, per day.

QUESTION: If Stock A is trading at $20 per share and Stock B is trading at $60 per share, ignoring the possibility of a major event with either of the stocks (like an earnings report being released), is the likelihood of a $1 move in Stock A equivalent to the likelihood of a $3 move in Stock B (since both would be 5% increases), or would there be no difference in the likelihood of a $1 move between the two. In other words, is the amount that a stock moves dependent on where the stock is currently trading?

ANSWER: The amount the stock moves has more to do with its Beta and volatility than it’s price.

QUESTION: New question: I don’t understand what kind of judgment might be needed at the time of the trade. Isn’t the entry as mechanical, just in the reverse direction, as it was when you would’ve entered the market on the original breakout?
ANSWER: It’s mechanical in it’s execution, you’re right, but in a reversal situation you may want to increase your bet size now that the odds favor you -which requires you to make a new decision.

Bottom fishing or Covered stock?

Q: I am a member of the DMA and had some questions regarding SRS. I want to enter this trade but do not know if I should be bottom fishing it or buying a covered stock, due to the following:

– Bottom Fishing: negative skew / am considering selling the Oct 9 Put / buying Jan 8 Put
– Covered Stock: high IV – for each 100 shares bought I am risking around $140, which seems “expensive”

Any thoughts you can share with them. Is there another alternative I could be considering?

A: It depends on whether you are bearish or bullish on srs.

The ‘bottom fishing’ trade you mentioned is bearish. You will only make a profit is srs falls to 9 (max profit). You max loss is the debit you pay for the spread and you will have a max loss if srs rises by the October expiration.

If you’re bullish I would recommend the covered stock rather than the diagonal position.

The reason why the covered stock is seemingly expensive is because srs has a high beta (high volatlity) so the premiums are generally high but you can adjust the risk by going deeper into the money on the put side.

You didn’t say what strikes you were going to use for your covered position… but I would look for a put with an .80 delta if you want to reduce your downside risk – you’ll pay a little more for the protection but if srs declines you will have good protection.
You’ll also get unlimited upside potential if srs continues to rise.