Basic Option Trading: Verticals

Thomas we're back my friend all right taste good bites let's do it I'm by the way ESPYs are down five bucks and drinking 1626 yeah the Dow is really weak this morning um funny because the the Russell's only down two bucks on the Dow is down 50 mm-hmm I I can't believe how much that trade widened out that's right um but anyway listen it is what it is and and we move on um let's do this tasty bite segment it's really well put together today but the reason we take breaks cuz somebody asked me why wouldn't even need to take breaks because you know I've watched your commercials they're funny but you know we and and we have to for our archives so we need to we need to we have so many different cameras everything here is remote all of the place that this way we make sure that all archives are accurate we can so you can watch it you don't have to go through the whole show when you go through the archives you can just stop at each one yeah and then Tony and I sometimes we have to yell each other for about 30 seconds then we're fine then we give one of these I'm good and sometimes banette it just has to you know vent a little herself yeah she gives it to me and Tony and then were because it just gives it to you yeah usually me and um so that's it but there we keep it short anyway trading verticals you ready mmm tasty bites this is for accounts that are we like to say under the PDT pattern day trading which is $25,000 so anything less than $25,000 this is kind of what we're geared towards where you have these which I think are rules that need to be changed as well which pattered day trading rules because really the concept of day trading doesn't exist anymore but let's talk let's focus on verticals for a second and and we did something a little bit different trading verticals in a smaller size in smaller sized accounts we often recommend avoiding higher risk trades such as selling naked puts naked puts selling naked uh puts and calls now in to be completely fair we actually we don't want you to avoid it we want you to avoid it as the sole source of revenue in other words we think it's important that you're both um strategically diversified and you are underlying diversified okay so your product diversified and product could mean anything could be an underlying can mean it really literally a different product but we don't want you to get what happens sometimes is you fall in love you know as soon as you taste the soon as you taste chocolate you want chocolate okay - forbidden fruit as soon as you taste something that's really good you all that's all you want and you don't want to eat anything else you don't want to have anything else in what you have to do to be to be successful you've got to um not necessarily avoid all high-risk trades but you have to avoid being all in one bucket we also encourage you to keep a variety of strip we also encourage keeping the variety of strategies to a minimum and that's understandable so you to find that happy place between the number of strategies the products you're using and to mix it up so we decided today we'll talk verticals let's go next slide today we're going to look at defined risk strategy that is an effective way to make a directional plan in the market because the risk is defined is essentially beneficial in smaller accounts because it's like a stock replacement Tony if I can show you a way instead of having to put up a thousand dollars which you could put up a hundred dollars or instead of having to put up two thousand dollars you can put up you know one hundred and thirty dollars then all of a sudden if you can create a stock replacement mentality you can learn how to tweak that to become more effective with less money it is that what it's all about yes I mean even if you have a large account I know this was for a small cap beam you have a large can that's what it's all about sure you look I mean let's let's just say you're interested in implied volatility and let's say you want to buy 100 shares of VX X 100 shares of VX X's is 2,000 bucks and if you have a small account assuming that it's even a margin account you put up either 2,000 dollars or you fully margin it at a hundred at 1000 dollars and you know that's available to every listener but even a thousand dollars is a lot of capital put up to do 100 shares of stock the alternative is you can buy some kind of delt equivalent let's call it 3/4 you know call spreads whatever it is that are one dollar wide five call spreads you may pay $50 each so you may put up $250 which is 1/4 of the amount of money to have the same kind of Delta effect and without any additional premium now there are negatives to the to the debit spreads the negative being that you don't profit on it on a tick for tick basis but the positive side to it is you also have a limited risk of course so there's all there's always trade-offs in this business let's go to there's no free ride there's always trade-offs vertical spreads consist of the purchase of one option and sale of another option both options are the same type either both puts or both calls and they both expire at the same time they only differ in strike price next slide regardless of whether vertical spread contains puts or calls whenever a trader buys a lower exercise price and sells the higher price the position is bullish the position becomes bearish if the opposite is done ok these are interesting strategies for smaller accounts because even with a large market move the delta of a position will not invert a bullish play remains bullish and a bearish play remains bearish and again that's the takeaway of having that is the one of the key takeaways of having kind of this vertical spread mentality let's leave it on the slide for one second the users of vertical spreads which is Tony myself and everybody out there it takes a long time to get comfortable beat wheat on basically how to use vertical spreads and when to use vertical spreads I didn't get comfortable for a long time in my trading career and a long time when I became a retail trader with vertical spreads because the first thing I thought is this is stupid ok I'm wasting a lot of transaction cost it's hard for me to make you know 20 25 cents bla bla bla I went through all this stuff in my head and I'm like it doesn't make any sense as a retail I couldn't get to a big enough size where it made enough sense for me because between the transaction cost between everything else it just wasn't making I wasn't clear so you do things like you widen out the strikes you pick him up yesterday a phone on a phone call you you wide out the strikes you pick and choose when you ultimately want to get involved because sometimes you have positive theta decay and sometimes you have negative theta K once I started to recognize that every time I put on a vertical spread I essentially want to have positive decay working for me so I'm buying them at parity under parity and when I started to look at it as a stock replacement why not the strikes sometimes ratio it's sometimes not I started to think you know what I really enjoy doing vertical spreads because the duration that they enabled me to have and the combination of duration measured risk and high probability success if I can if I can control and the capital reduction started to get me very excited about actively trading again because the tractors so so it's also a decent lowball strategy so you know what to say after all these years you know it's we would say that vertical spreads to this day debit or credit spreads some form of a vertical still makes up the largest percentage of option trades that we do make sense okay because those are spontaneous yes when we trade verticals were generally sellers of premium we look to taking a credit that reflects at least one-third the width of the spread now I'm going to be fair about this it depends on market conditions if implied volatility is very rich we look to do credit spreads if in fact if in plied volatility we believe is cheap or we feel like we are in directionally inclined we will lead on the debit spread a credit spread higher probability of success a debit spread a lower probability of success still wrapped around 5050 but a higher payout and so depending on whether we're directionally inclined and we're the recapitalize chap whether we're we're capital challenged so one of the things about tasty bites is vertical spreads you have a lot of limitations and when you're going to pick and choose what options you want to be naked short in a tasty bite size account if you're even able to sell like puts and calls whatever it is you have to be very careful to pick your spots low price stocks high volatility low basis stocks they're in play tons of liquidity and tons of efficiency if you decide you want to step outside that box you don't want to use your capital in a small account to trade a vertical spread I'm sorry you don't want to use your capital small account to trade a naked option when you can use a vertical spread there's no way you've enough capital and small account to trade anything naked or directional in for example Apple Amazon Google whatever it is but a vertical spreads to say whether it's a 500 our stock or a $20 stock Pierce exactly let's go to the next levels out the playing field between all stocks it allows you to be able to trade like you were just saying a stock that's four or five eight hundred dollars the same way you can trade a stock that's five six or ten dollars so we decided to go very very basic almost beginner like for this tasty bites today because again a lot of new listeners and just people that let's get let's get this concept down so for example if we're looking to put on a bullish one point wide put spread we'd look to collect at a minimum thirty three cents now you'll see we don't do a lot of trades we're collecting thirty three cents we'll do a lot more trades we're collecting sixty-seven cents or we'll do a lot more trades we're collecting a dollar seventy five that's will use the one-third the width of the strikes but will widen out the strikes so that we have an opportunity to trade things that that where it's transactionally makes sense what's the last trade we put on in IBM no today we took it off yesterday bucks seventy something bucks seventy four to get all four but that's a great trade that's a vertical spread okay that that's what that is I mean we $5 Wi-Fi driver and spread but you'll see us all the time we traded vertical spread saw you know a couple times last week it's just a big part of our trading methodology it doesn't have to be 33 cents on a dollar wide it could be 167 to 175 on a $5 why correct same proportion and they move yes all right let's go next slide vertical spreads are just one of the many option strategies available with defined risk with with the defined risk characteristic there's an essential basic strategy useful in small accounts and again we decided to do this very basic today just go back to kind at the beginning because people forget um is that last one that's last one okay people forget that how important vertical spreads are as a stock replacement strategy and again and nobody talks about this throughout like people will say you should be invested this one things I've never understood about this business you should be invested you should be invested in Apple goldman sachs said the other day you should buy Apple going into the W WWDC conference so you should buy calls an Apple like that's dumb advice that's not even advice actually that's just like saying the way that goes up down or sideways yes it's dumb advice it's just dumb advice on every level because of the premium erosion because of the low probability of success everything else but what they didn't say is hey you know what buying out the money vertical spread at Apple you don't put up very much money in fact right now you can buy at the money vertical spread wherever Apple is for two dollars and fifty cents here the way option pricing is this is what we call fish and market theory and the way option pricing is done no matter where Apple is one strike in the money and one strike out of the money no matter where the stock is is between two dollars and forty cents and two dollars and sixty cents period correct and that's in any stock if any stock it's fifty percent of the width of the strikes you go one strike in the money go one strike out of the money you pay fifty percent you're controlling okay a smaller amount of stock you have defined risk and you're participating does somebody really need to buy 10 shares of Appleton does somebody really need to buy two shares of Apple hey I read here that this is would you rather do buy two shares of Apple or do something like this that's right so let's let's for the first time let's treat people with the Intel let's treat people with the intelligence that they have hmm okay we don't weaken for some reason explain a menu with the most complicated spices and food items how can ever how come everybody can figure out like what a pork belly is and what faux Gras is and everything else but for some reason we can't explain I still can't figure out what sweet brains are but okay sweet Reds yeah but but we still can't for whatever reason describe a vertical spread in the financial markets hey I mean you look you go to restaurant with somebody that you don't really know and they'll say I'll take this Savin your long from you know from blah blah blah we're in this particular so you're telling me you can remember a specific region and a specific year to order a sobbing Yong block but you can't figure out what a vertical spread is the financial markets which may actually pay for this Avignon blog sometime in the future that's okay just a we rely on we would never walk in and say you know I shouldn't say never but for the most part you do not walk into a restaurant since you've never been before and as you sit down so you don't just bring you every one but we hand our money over to somebody just do whatever you want say said just bring me whatever you think is good okay and just do whatever you want my money how crazy is that it is crazy I don't even know how I would do that I can't even like I don't how people do that how do you walk in somewhere and you hand somebody your money and you say do whatever you want just make me some money and usually those returns are but how hard is it just to sit down for a few minutes and say hey you know what if I buy this one strike and I sell this other strike and then you know what I'm actually long Apple and then if Apple goes higher I can learn so much from that and if Apple goes lower I'm still gonna learn so much from her she don't have to learn I bought a four hundred and fifty dollar stock stock went down I lost 125 bucks I can live with that mm-hmm ya can live with that and I actually had a small cushion a lot of cases where was actually the spread I was buying gave me a cost basis that was lower than the stock is trading it was a bullish strategy meaning I wanted this duck to go which is more fun you go to Vegas okay and you sit down and you play blackjack for three seconds and lose a thousand dollars in other words you bet 333 303 303 the whole process together because you're playing against a dealer takes about 40 seconds you get three hands and 40 very quickly they deal very quickly so in 40 seconds you lose $1,000 is that fun no what if you take the thousand dollars and you play all night long you sit down at six o'clock at 6:00 in the morning you're still there and you have and you have nine hundred dollars left okay is that fun yes okay I agree emoji better much better that's what this is except except we don't even want lose $100 of course not employ some form of a vertical mentality into your trading methodology regardless of account size if you have smaller accounts you will employ it on a greater level it's 827 we're back in 90 seconds with opening bell you listen to get tasted on the tastytrade Network you

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Id: HaoM4nqxYhU

Length: 15min 24sec (924 seconds)

Published: Wed Jun 05 2013