Options Trading Blog
Options Trading Tips and Strategies
Cam at the Close 2.1.12
The market was very strong intraday, but then sold off at the end of the close. In the last hour of trading the DOW sold off 50 points. I am starting to see some signs of exhaustion in the banking sector. Take Goldman Sachs (GS) for example. Stock has been very strong since breaking from its descending trend line on January 10^{th}. Once it cleared its 100dma it looked like a straight shot to the 200dma at 116. This is exactly what happened today, except it failed to close above the 200dma. This failure clearly shows that there is intense selling pressure in the $115.50$116 area. The Directional Movement Index is also near extremes as you can see below. I also still strongly believe Sears Holding Corporation is a great short here. It failed to get above resistance at $43.50 after breaking through this area yesterday. The problem with SHLD is that finding shares to short is extremely difficult. I believe the majority of traders who were heavily short this stock have covered when the stock went from $30$50 in seven trading days. SHLD could very well make new lows. Technically some would argue that SHLD is developing into a bull flag, but I feel the fundamental issues of SHLD outweigh technical in this specific case.
The gap between the (DI + and DI –) has not been this high since March 10, 2010 When the Reading was DI + (41) and DI – (9) which = a spread of 32. At this time Goldman was trading in the $170$180 range. In the two months after this extreme reading was read Goldman fell 40 points and ended up in the $130$140 range. Currently the spread of (DI + and DI ) is 30. The failure of the 200dma could be the first sign that Goldman is about to switch directions and head to the downside.
Trade of the Week (SONC) 2.1.2012
Reason I like this Trade: There are unusual options activity orders then there was this order in SONC. A customer bought 4100 March 7.5 Calls for $.25 and that was 75 times usual volume, yes 75 times usual volume. I like to give my trades more time, so I bought the June 7.5 Calls for $.45. This is a great risk vs reward and it seems as if the stock is breaking out and can trade up to the $8 level again. I will look to piece out of these Calls if the stock trades higher, but I am very confident with this trade. Please feel free to email me with any questions at andrew@keeneonthemarket.com.
UPDATE 2.2.2012 I took 20% of my position off for a 33% profit, but I am holding the rest for more upside. This was a great trade and I still think it will work out. These Calls are currently worth $.65
UPDATE 2.7.2012 With stock ripping higher and hitting my first target of $8.20, these Calls are now worth $1.20. I took another piece off and a have half of my position left. This was the “Trade of the Week” and is working out as planned.
trade of the week, only the biggest highest probable trades. These Calls are still worth $.95 and good for a HUGE winner.
2.We are really close to key resistance levels being breached to the upside (trendlines & cloud)
3.Strong above average Buying Volume today, Also we are moving strongly away from a high volume point of control level at 6.75. Next significant Volume at price level is 9.00.
4. DMI Buy Signal, Money Flow Bullish
Earnings Trade of the Day (CMG) 2.1.2012
Reason I like this Trade: Chipotle has been a beast lately and I can not fade this movement, but I can fade the movement of the ATM straddle. CMG is implying a $20 move and it has only moved 5.5% once over the last 4 quarters. In this strategy I will make money as long as CMG does not move more than $23. I think this is a great way to play this stock and we have seen lack of movement in SBUX and MCD which gives me more hope that this trade will work out. If you have any questions please email me at andrew@keeneonthemarket.com.
Harmonic Patterns
Harmonic Trading is a methodology that utilizes the recognition of specific price patterns and the alignment of exact Fibonacci ratios to determine highly probable reversal points in financial price cha
What Are Harmonic Patterns? Harmonic Trading is a methodology that utilizes the recognition of specific price patterns and the alignment of exact Fibonacci ratios to determine highly probable reversal points in financial price charts. This methodology assumes that trading patterns or cycles adhere to natural harmonic mathematical ratios and repeat themselves, sometimes in a fractal nature. Once these patterns are identified, they can be used to enter or exit trading positions with very high degrees of accuracy. Although, harmonic patterns are not 100% accurate and sometimes fail, they have been historically affirmed as some of the most highly precise patterns to trade. The most comprehensive references to Harmonic Trading are outlined in the following books:
Below is a Visual Reference Guide to Identifying Specific Harmonic Patterns 1. Starting at point X: 2. Then identify a swing level high/low A. 3. Identify & Measure B Retracement. Using the Visual References note that the grey dashed lines that connect two points represent the level of retracement in % terms. Example for Bullish Gartley: B point is 61.8% retracement downward from the previous move of X to A. Point C is then either 38.2% or 88.6% retracement of prior down move of A to B. Then D would then be projected 113.0% or 161.8% downward from point C, using the length of B to C for the base length to be projected. 4. The last projected move D is the final and key point that we are trying to project for the potential reversal zone. *It is also key to note that a distinct AB=CD patterns do form in variations of these patterns. The simple Harmonic AB=CD and ALT AB=CD 4 point patterns do appear independently from 5 point patterns as well. Additionally, the Three Drives pattern is a obscure harmonic pattern that exists as well. For all these harmonic patterns, the point is to wait for the entire pattern to complete before taking any short or long trades. *When I trade these patterns I do not see D as an area to blindly just place buy or sell orders, but I look for key reversal bars/candlesticks as well as other technical indicators to provide further catalyst for trade execution. And I always use a stop loss order. 

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Option Risk Profiles
Risk Graphs, also known as a risk/reward diagrams, payoff diagrams or profit/loss diagrams, are charts that represent the profit or loss of an option across a spectrum of prices. Risk Profiles allow option traders to evaluate the risk/reward characteristics of an option trading strategy. Risk Profiles display at a glance where are the areas of the highest gains and losses occur. This enables option traders to make more educated decisions without complex calculations. Risk profiles also allow option traders to identify option trading strategies with similar risk/reward profiles, making synthetic positions easier to create and manage. Risk Profiles are simple diagrams made up of 2 axis and a line representing option price at various prices of the underlying security. The horizontal axis or XAxis represents stock price and the vertical axis or YAxis represents option profit or loss.
Is Risk/Reward Limited Or Unlimited
To find out if the risk/reward of an option trading strategy is limited or unlimited through a Risk Profile Graph, a Trader would look at the top end and bottom end of the graph line. If the top end of the graph line is pointing upwards, it is an option trading strategy with unlimited profit potential. If the top end of the graph line is pointing horizontally, it means that it is an option trading strategy with limited profit potential and will rise in price no further when a certain stock price has been reached.
In Addition, if the bottom end of the profile risk graph line is pointing downwards, it is an option trading strategy with unlimited loss potential. If the bottom end of the profile risk graph line is pointing sideways, horizontally, it means that it is an option trading strategy with limited loss potential and will lose no more money beyond a certain stock price has been reached.
Direction of Profit
An option trading strategy turns a profit when the Risk Profile Graph line crosses above the XAxis (horizontal axis). Remember, the center of a risk graph is the prevailing stock price when the chart is built and that stock price increases to the right and decreases to the left. If the Risk Profile Graph line crosses above the XAxis to the right, it means that the stock price needs to increase in order to turn a profit. If the profile risk graph line crosses above the XAxis to the left, it means that the stock price needs to decrease in order to turn a profit.
Where is Breakeven on an Option Trade
The Breakeven Point of an option trade is presented on the Risk Profile Graph as the point where the graph line touches the XAxis (horizontal axis). This is the point where the option position neither gains nor losses money. In more complex strategies, there could be more than one breakeven point. Where the breakeven points are in relation to the center of the profile risk graph, it tells you which direction the stock price must go in order for the position to breakeven.
Option Strategy Risk Profiles
The following charts illustrate the profit and loss profiles for many popular option strategies.The profit and loss profiles simply show what your option trade profit or loss will be for various stock prices at expiration. It is important to understand that all profit and loss diagrams shown in this reference guide are drawn at expiration of the options. Please note that prior to expiration the diagrams can look very different. Just because a diagram shows a profit at a particular stock price at expiration does not mean that same strategy will be profitable at that same point prior to expiration. Still, the charts are important to understand because they help you get a feel for each strategy and what it is trying to accomplish. This post is sponsored by our partners.
Listed for each strategy:
Outlook: Tells whether the strategy is bullish, bearish or neutral. Bullish strategies make money when the underlying stock rises while bearish strategies make money when it falls and neutral strategies make money when the stock does not move.
Directional Risk: Describes what the risks are for each individual strategy. For example, if a strategy has unlimited risk if the underlying stock rises, this field will say “unlimited upside.” On many positions you may see “unlimited downside risk” meaning there is potential for unlimited losses if the stock falls. To be exact, this is not unlimited risk since a stock cannot fall below zero. However, since it is extremely rare to see a stock down to a price of zero, this risk is still considered to be unlimited.
Max gain: Shows the maximum amount of profit that could be made.
Max loss: Shows the maximum amount of loss that could be occur.
Breakeven: Shows the stock price (or prices) where the strategy breaks even; that is the point where the trader neither makes nor loses money.
Long Stock 

Short Stock 

Long Call 

Short Call 

Long Put 

Short Put 

Long Straddle 

Short Straddle 

Long Strip 

Short Strip 

Long Strap 

Short Strap 

Long Strangle 

Short Strangle 

Covered Call (BuyWrite) 

Covered Put (SellWrite) 

Bull Spread


Bear Spread 

Long Butterfly Spread 

Short Butterfly Spread 

Long Condor Spread 

Short Condor Spread 

Long Albatross Spread 

Short Alabatross Spread 

Call Backspread (Long Call Ratio Spread) 

Short Call Ratio Spread 

Put Backspread (Long Put Ratio Spread) 

Short Put Ratio Spread 

Long Call Christmas Tree 

Short Call Christmas Tree 

Long Put Christmas Tree 

Short Put Christmas Tree


Long Semifuture 

Short Semifuture 

Long Wrangle 

Short Wrangle 

Long Cartwheel 

Short Cartwheel 

Long Calendar Spread Position: (Can be initiated with either either calls or puts). Long a far month contract and short a shorterterm contract with equal strike prices. Outlook: Neutral Directional Risk: Limited upside and downside. Max gain: Limited – assuming the positions are closed together at expiration of short strike. Occurs if stock closes at strike price of nearterm contract at expiration. Difficult to say exactly what the max gain will be as the position is an attempt to exploit time decay and other factors will move as well. Max loss: Limited to the net debit. Occurs if: (1) Stock closes below strike through both option expirations or (2) If stock makes a large move up or down prior to expiration of nearterm strike. Another scenario may happen: If the trader initiates the position and the stock makes a large move upward prior to January expiration, then both options will converge on intrinsic values and lose nearly all of their time premiums. The same is true if the stock collapses. In either case, the trader may lose the entire net debit. Of course, if the stock collapses during the shortterm contract and the position is nearly worthless, one choice for the trader is to close out the short and hold onto the long hoping for a rebound. The trader does not have this choice if the stock makes a large move upward since the short position will exercise and the trader will usually cover with the long position. Breakeven:Strike price net debit. 

Short Calendar Spread Position: (Can be initiated with either calls or both puts). Buy a shortterm contract and sell a longerterm contract with equal strike prices. Outlook: Very bullish or bearish Directional Risk: None Max gain: Limited to net credit (usually slightly less). Occurs if stock closes well above or well below the strike at expiration of the nearterm contract. Max loss: Difficult to say exactly what the max loss will be as the position is an attempt to exploit time decay and other factors will move as well. Once the long position expires (shortterm contract), the volatility (and skew) will dictate the price of the short position, which determines the potential loss. Another scenario may happen: The stock may close at exactly the strike and January expiration. In this case, the long call is worthless and the trader must buy back the short call to close out the position. However, there is no way to determine what the market will be asking for this contract and thus no sure way to determine what the loss, if any, will be. Breakeven:For the reason stated in the paragraph above, it is impossible to say where the breakeven points will be. 
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Option Greeks
What Are The Option Greeks?
The Mathematical characteristics of the BlackScholes Model are named after the greek letters used to represent them in the equations. The 5 Option Greeks measure the sensitivity of the price of stock options in relation to 4 different factors; Changes in the underlying stock price, interest rate, volatility and time decay.
Delta
The movement of the option position relative to the movement of the underlying stock position. Measures the speed at which the option position is moving relative to the underlying stock position. Therefore, a Delta of 1 means the option position is moving 1 point for every point the stock moves. A Delta of –1 means the option position ismoving –1 point for every point the underlying stock moves. Delta is another way of expressing the probability of an option expiringinthemoney.
Formula for calculating option Delta:
Formula Components
C = Value of the Call Option
S(t) = Current value of the underlying asset
N(d1) = Rate of change of the option price with respect to the price of the underlying asset
T = Option life as a percentage of the year
ln = Natural log
Rf = Risk free rate of return
Gamma
Gamma is mathematically the second derivative of Delta and can be viewed in two ways: the acceleration of the option position relative to the underlying stock price, or the odds of a change in the probability of the position expiring ITM (in other words, the odds of a change in Delta). Gamma is effectively an early warning to the fact that Delta could be about to change.Both calls and puts have positive Gammas. Typically, deep OTM and deep ITM options have near zero Gamma because the odds of a change in Delta are very low. Logically, Gamma tends to peak around the strike price. Gamma is important because it shows us how fast our position delta changes in relation to the market price of the underlying asset.
Formula for calculation option Gamma:
Forumla Components
d1 = Refer to Delta Calculation
S = Current value of underlying asset
T = Option life as a percentage of a year
Theta
Theta stands for the option position’s sensitivity to time decay. Long options have negative Theta, meaning that everyday you own that option, time decay is eroding the Time Value portion of the option’s value. In other words, time decay is hurting the position of a Long option position. When you short options, Theta is positive, indicating that time decay is helping the option writer’s position. The closer to the expiration date, the higher the theta and the father away the expiration date, the lower the theta.
The below graphs show the effect of Theta on options during the last 30 days to expiration. ITM and ATM options decay fastest during the last 30 days to expiration. OTM options decay the least during the final 30 days.
Formula for Calculating Theta
d1 = Refer to Delta Calculation
T = Option life as a percentage of year
C = Value of Call Option
St = Current price of underlying asset
X = Strike Price
Rf = Risk free rate of return
N(d2) = Probability of option being in the money
Vega
Vega stands for the option position’s sensitivity to volatility. Options tend toincrease in value when the underlying stock’s volatility increases. So, volatility helps the owner of an option and hurts the writer of an option. Vega is positivefor long option positions and negative for short option positions.
Formula for Calculating Vega:
Forumula Components
d1 = Refer to Delta Caculation above
S = Current Value of underlying asset
T = Option life as percentage of year
C = Value of Call Option
Rho
Rho stands for the option position’s sensitivity to interest rates. A positive Rho means that higher interest rates are helping the position, and a negative Rho means that higher interest rates are hurting the position. Rho is the least important of all the Greeks as far as stock options are concerned.
Rho Charateristics – Options Rho come in positive or negative polarity. Long call options produces positive options Rho and Long put options produces negative options rho. This means that call options rise in value and put options drop in value with a rise in interest rates. Options Rho increases as time to expiration becomes longer. Options Rho is almost equal for all ITM and decreases for OTM options.
d1 = Refer to Delta calculation
T = Option life as a percentage of year
C = Value of Call Option
X = Strike Price
N(d2) = Probabilty of option being in the money