How do we choose our trading strategy?

strategy selection this is important now because now I'm going to take the art contextualizing positive drift and put it into strategy selection yesterday we addressed the key statistics and conditions for selecting an underline today we're going to turn our attention to strategy selection and what to do once you've chosen that underline and again this is a generalization don't don't look at this and say hey you know what there is this is I live by it breathe by this is just everything we do here is just to get you on the right kind of footing then you have to adjust I kind of compare it to somebody that goes skiing and um you get to the mountain you really don't know what to expect snow wise correct it may snow the night before you have this nice soft powder you don't know might may know that before and it's really icy it may rain it may be icy may be packed it may get slushy later you just don't know and so you're going skiing just like you're going trading but you just don't know what all the conditions are so you have some general say hey that the objective here is to get down the mountain have some fun doing it but I just have to see what the conditions are yesterday we we we just did this go to the next slide when implied volatility is a major component of our underlying it is also the primary factor in our strategy selection process first we'll look at where Ivy sits in its range and then we'll compare it to the overall market because what we're doing here is we're trying to build a basis okay we're trying to say hey you know what and again I'll make another I'll make another skiing analogy the conditions are beautiful okay but you have to make a decision at the top of the mountain how hard do you want to push yourself do you want to push yourself down the mountain down something that's really hard and test yourself or are your legs hurting I just wanna have a fun run okay you have to make these decisions in every aspect of your life but we don't necessarily do what we think every single time we make a trade we're going to hit it out of the ballpark correct exactly the same that's correct let's go the next slide so for example if the market implied volatilities trading ninety-five percent and we select a stock that's trading at a higher volatility let's say forty percent we will choose a strategy that looks to take advantage of the volatility / premium okay volatility we can translate volatility into expected move we can translate it volatility into kind of time premium just a big it's it's a big catch-all for for whatever we're looking at yes like it is catch-all to catch-all for expected movements a catch-all for a time premium let's go next slide the reason we look for more volatility stocks as compared to an index or a market is the non diversified and binary nature of individual stocks as such we would always rather be short an individual stock opposed to an index one of the reasons that we like really rich implied volatility is because it lets us migrate and transition to an underlying that doesn't have nearly as much risk to us we feel much less comfortable with bigger positions in stocks like Tesla or CMG than we do in stocks like the spiders sure so if we consider the kind of liquid ETF like that if we can sell 30% implied volatility in the spiders with a huge strike selection lots of marketplace efficiency we don't even look another stock correct but right now we don't need the equities at all right now we don't have that opportunity so we have exactly the opposite that's right we have an extraordinary amount of risk with respect to reversion of the mean in diversified products so we look to other things that have lots of kind of cushion but um it again one last skiing analogy one last key analogy are you planning on a ski vacation no here something maybe but no right now Laskey analogy you go to the top you go to any mountain and especially in like Colorado or Utah wherever it is and you get to the top of the mountain and you see these guys or gals walking up a higher than the top lifts goes - sure so above the basin above everything else there's like a catwalk or there's some kind of way some trail where you can take your skis off and you can walk up because there's you can have 16 seconds of glory coming down some shoot that you either kill yourself or you get you know or you have that fun of your lifetime sure you know you're a thrill seeker and for me okay I'm not going to walk up to carry my stuff up to that shoot okay so I'm going to opt for the more liquid underlying but there are different times in the in for certain skiers and there's different times for certain traders when you know what you just want like walking out the top of that chute is like taking your shot in Tripoli last night yeah to a certain extent and what happens is you have a thinly traded stock you have this very rich implied volatility and you say you know I'm just go up the top of that damn mountain and I am going to walk up there and I'm gonna have sixteen seconds of fun it's gonna take me three hours to walk up there really that's what it does I know and in the end you go that was the greatest 16 seconds of my life that's like it's like let's just take the helicopter hey it's for people that do skydiving for the first deccan thing that go took me eight hours to take the class you know learn how to use everything and I had whatever it is eleven minutes of fun right and it was worth every dime of it sure now I'm not gonna do that normally here so let's look at some strategy selection here for a second so we picked we picked some dates 718 we basically just went back in time and we looked at different symbols the spiders Apple Lulu whatever we looked at price we looked at in plot volatility and we looked at implied volatility percentile so just Tony let's say let's just take a walk through this the spiders with implied volatility of 14% and the implied volatility percentile 19% first Apple on the same days at 20s currently that's yes turn today yeah right place but just kind of go back in time and look at the different relationships between these 10 30 108 which was kind of right now heat of that meltdown the implied volatility was 50 almost 60 percent Cisco was 67% the volatility percentile 71 and 90 and and there's no question okay which one were trading correct I mean you would rather go into the SP why of course 2008 of course and if you go back and you look at the even even with respect to Lulu there's no question which one were trading right but right now we're trading Apple correct okay because because we're just using implied volatility as almost a stepping stone into strategy selection as it compares two different broad-based index let's go next slide and again we archive all this so you can see it all when volatility is high strategies to consider because you guys asked for this kind of a market measure segment so that you can grasp everything when volatility is high strategies are to consider selling strangles selling iron condors selling credit spreads those are selv articles doing covered calls doing naked puts okay these are all strategies that have a relationship with high volatility and again just just become just to become consistent strangles more money wider strikes iron condors not not more money but wild strikes further verticals not more money wider strikes should they be wider strikes of course wide it strikes me the same same with the strikes further away sorry sorry further away um covered calls lower-cost basis because high implied volatility means means lower prices so covered calls lower cost basis higher premium on the calls naked puts same thing lower strikes further away out of the money higher premium you collect much better return on capital the thing with strangles is when volatility is high your return on capital relative to the amount of money you're going to use is a huge improvement in fact because that doesn't change right the usually though ours it goes lower so remember when you sell strangles when volatility is high the market is cheaper so what happens is you're selling strangles on cheaper stocks you're putting up less money and your return on capital is greater so again all of these except for iron condors and verticals offer a higher return on capital using less capital so you use less money and you get a higher return on money significantly higher that's why that's why they're interesting the iron condors are the verticals you just go further away from the optimized strike let's go to the next slide as premium sellers strategy selection in a low implied volatility environment is way more challenging however it's important to stay in the game and stay engaged do this by widening our strikes and focusing on underlyings that maintain a rich implied volatility and that's the challenge that is the binary event challenge that we faced last night with Google that's the binary event challenge we faced with CMG or any other stock shares Microsoft and you know what sometimes it's all luck of course and don't think it's anything but and don't don't get make more luck with higher volatility than you can with lower volatility you can make more luck by just having general market awareness listen it's it's is it lucky that we pick CMG to be perfect is it lucky that Google stayed with inside the range of course is it lucky that we didn't pick Microsoft at all is it lucky that we but it wasn't luck as and random luck I don't think it was random luck at all was it lucky that we didn't pick is our G at all I mean the we did things because we have a set of mechanics that we stick to thank you is our G was way too inefficient price-wise so we stayed away and it proved to be the right move Google and Chipotle were much more efficient the most efficient of them all was Microsoft but we couldn't find any hm-hmm so we stayed away from the most efficient and the least efficient because the least efficient we didn't think we just didn't have any feel for it because it just didn't give us what we felt was accurate readings and it wasn't the most efficient just gave us a situation we didn't like the risk/reward correct so we went for the other two that's all part of market awareness that's all really important stuff to take take away from here let's go next slide one key factor in selling premium during low implied volatile environments is to protect against a sudden rise in implied volatility so if implied volatility is is low look to places that won't be negatively affected by a sudden volatility volatility expansion of the market strategies such as diagonals or pairs trades are good choices having a position like we did yesterday in the VIX that was part of the reason we essentially I don't say we bought volatility but it's pretty damn close correct closest thing we do we get to it let me a call spread the VIX yes diagonals are interesting because they like higher volatility just like calendars and then finally pairs trades are good because they allow you to extend your duration while reducing your risk they just don't give you a statistical chance any statistical edge nextslide strategies to consider when volatility is low bearish directional trades because listen I'm short Citigroup right now I don't know what citigroup's doing today it's down 17 cents I'm sure at Citigroup say because implied volatility percentile is zero so that's why I have a bearish directional trade a put debit spread in the money one strike in one strike out a pairs trade again or potentially a diagonal to take advantage of a directional diagonal lower prices higher implied volatility and the pair's trade you can skew it a little bit to give yourself some directionally it's somebody called in yesterday afternoon they said what about Nasdaq versus SPS and we've joked 30 to 1 we're pretty good would have been pretty good as right let's go next one works out just fine other factors to consider regarding strategy are pop and rock pop probability of profit Rock return on capital both for individual traders as well as the portfolio's as a whole I'm not going to sell a put if my return on capital is one and a half percent I'm not going to do something where my probability of profit does not fit my overall portfolio so let's keep hammering this stuff home both for individual trades as well as propose as a whole the general rule would place high probability trade I'm sorry probably profit rates while attempting to maximize ROC on a weighted average we looked for a portfolio to have a probability of profit somewhere 60s low 70s 65 75 I had to pick one sure in this current market 60 to 70 and if the volatility gets richer a little bit higher very good less like last slide sorry I went a little bit over Dave I apologize in summary after we've identified potential underlyings to trade we look for strategy to take advantage of the implied volatility premium while looking to maximize our pop and rock very good sir it's a lot of information I'm sorry that was 20 22 minutes of but that's good a lot of people looking for what strategies to look in what volatility environment you just gave them to him pretty much the other day when we had Glassman on the show they they make the case both written through radio through through different articles they write and everything else that trading is bad because buy and hold is the most effective strategy in that there can be the reality of it we tried to show you today is that buy and hold actually especially to go back to the last decade and a half has underperformed anything there's nothing you could have done by hole wise it would have worked and that would have outperformed your feast I always talk about preferring mediocrity there's now of course if you bought the bottom it's all the top that's different if you do try to time everything you can do a little bit better by selling at least 25% away from highs twenty-five percent away from lows I do not think that's your goal right 25 percent okay called it selling into strength and buying into weakness over a 10 or 15 year period would improve your returns exponentially but again let's get out let's get out of our head that we don't have to lower cost basis that we don't have to focus on some of the nuances me imagine making a bet on a football game even you know whatever just ABS I'll take anybody sure you know who does that it's 907 we've Dave Johnson on hold and sorry Dave for hay leaving out to dry there we'll be back in two minutes with him and we'll have a little chat

Channel: tastytrade

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Id: MOxQqT_s-Eg

Length: 14min 25sec (865 seconds)

Published: Fri Jul 19 2013