Option Trading - Developing a Solid Mechanical Trading Strategy.

[Music] tell us your back my friend tasty bites how we are what I mean listen I mean I mean I know we're at a different point in tasty trades longevity than we were a couple of years ago but do you have to have a team come in and primp you in between breaks I mean Boyle was here washing your table down for you fixing your hair we had somebody else put a little something-something on your nose you didn't oh yeah we did it's going on over there nobody over your head is smiling I just feel like I was gonna use my I believe it's gonna use my sleeve you can be used for anything you know that right I mean we've been doing that since 2:00 or 3:00 all right I'm before I get into market stuff I want to touch on do this tasty bite segment then we'll talk more about the markets at mechanical trading yeah it's really important and and people email us all the time and they say I wish you guys spend more time talking about the markets and I kind of want to spend less time talking about the markets and more time talking about more time more time talking about how to be independent with respect to the markets because the markets tell the market to tell a nonstop story mm-hmm the thing with it is is it's it's not how you make money what you make money from is an appreciation is a deep understanding and an appreciation of where everybody else spends their time right so that you don't have to right so the UK the benefit from it or avoid it altogether you can be one of the heard and nobody's really ever been able to explain the heard the hurt the hurt is not necessarily doing the same thing that everybody else does to me the crazy thing is I never even cared if everybody does what everybody else does to me the heard is trying to figure out everything like everybody else does right like the whole world tries to figure out the markets you know there was the funniest thing was there was this I got this email from TV because I'm a customer just like anybody else and have this day like an investor day-to-day yeah which means they have a education day or something and they have Jeremy seagulls actually speaking you're kidding me I swear I couldn't believe it I realize I'm like there are the biggest bunch of losers speaking and I'm like and I love this firm but I'm just looking at this thing going oh my god like they fell the trap is set mm-hmm okay like because they're trying to do the right thing which I understand but it's like trying to figure out like you know listening to the juries Jeremy seagulls of the world what what's gonna happen with what you should do with your money it's just like you're part of the herd debt right what you should be figuring out is why you're different so that so that when everybody else is trying to figure out what he can't figure out and is trying to tell you that he'd never been around to figure and nobody has ever been able to figure it out okay what you should be the on the other side trying to say how do I take advantage of everybody else is trying to take you know of everybody else trying to figure out how do I take advantage of that that's where that's what differentiates me mm-hmm that's the cool piece all right let's go to and then every firm is is you know every firms guilty of that and because that's all they know huh what's gonna happen as years and years as we go down the road for the next couple of years and years and years is that there'll be a few people whether that's a hundred thousand people or two hundred thousand people or 50,000 people who knows that that that understand that just five ten minutes and something like tasty bites is worth four four hundred hours of trying to break down a room like that sure trying to break it down agreed yeah there's um yeah they have it economy I mean the whole whole deal is like oh my god I've heard all these people speak they say the same damn thing there's absolutely nothing it's like anything useful for the retail you know figure out a better way to waste ten hours you know can you figure it but that's anywhere like like can you you can watch CNBC or Bloomberg all day can you figure out a better way to waste ten hours I want my hour back that I read Barron's last weekend like after all these years I'm still like you know I I still make the mistake everyone I want that hour back mm-hmm creature of habit right I want that frickin hour back because that was a waste of life and you have a back I know I know sometimes I like I yes say yes I want the time back we and we spent playing golf and I want the time back I spent reading Barron's I want time back I listen to economists I want the time back you know I mean unfortunately we never get it back but I'd rather waste it on you know reruns of Family Guy right useful mechanical trading throw it up this is for a lot of new listeners we're gonna take one step backwards before we take two steps forward starting next week on tasty bites I'm we're gonna take a slightly different approach and starting next week there will be a there will be a specific takeaway a majorly takeaway every single week and the takeaway will be something different than you've ever heard before putting together right now so it's a change of direction but to set that up I wanted to go through kind of the mechanics of kind of the small account mentality the mechanics of the small account of the small account process developing a solid mechanical trade strategy is critical for success in any tried size trading account the problem with smaller accounts which is the tasty bite account is that you don't have room again I'll use a horrible baseball analogy if you're a rookie or if you're a first or second year player and you're a low draft pick and you make it up to the big leagues and you don't succeed right away they cannot take the risk to keep you around right you don't have the cushion same thing here on a small account if you're a high draft pick and you're making a ton of money and/or you're a veteran making a ton of money you have to be kept around because they can't afford to eat your salary it's it's business it was a whole too-big-to-fail type thing that's exactly what it is in in the world of in the world of trading it's the same thing if you have a decent size account you can skate by on a few mechanical mistakes it's not good but you can get by if you have a small account you cannot get by with mechanical mistakes all right so the most important for the most important first step is to develop a well-thought-out logic chain nobody else would ever suggest that to you as the first step with investing there's hate understand understand you know why this market does try to do your homework figure all this stuff out that's not what you need at all what you need is a logic chain and the logic chain has nothing to do with what is ultimately gonna happen with this underlying its make sure that the pieces that all the pieces line up and you can connect all the dots with respect to whatever your assumption is and whatever strategy you're gonna apply it let's go next slide so we create a watch list of 30 to 50 stocks and even for small accounts okay one of the problems I have with what case does is I don't like her watch list she has that very she has a small watch list and she's not really utilizing her watch list so she's focusing on a couple of different underlines she needs to be she needs to she needs to really broaden understand her watch list so there's 30 or 50 different underlines and she's familiar with that rather than watch your P&L watch your watch list make sure that everything on your watch list is liquid so you can rely on pricing efficiency we talked about this yesterday pricing efficiency is a huge drag remember average three contracts three contracts per spread times that buy some Commission amount it's thousands of dollars a year that's right even for a small account it could be thousands of dollars a year so be very careful here because liquidity on a small account has a greater percentage effect than it does even on a larger account and by limiting the number you can become comfortable and familiar with them to aid in your trade assumptions liquidity is way more important than almost anything else you as long as you kind of understand the different logic steps you have to have the liquidity the marketplace first mechanical thing I always look for it even before IV it's even before anything else you give it to understand liquidity you've got at least have a watch to see you can compare apples to apples and you can compare all the other line so you need a watch list first then you need these ridiculously liquid stocks because again if you make 200 I mean just think about this cases by the end of your she's gonna and made you know 500 different trades okay 500 probably all total or at least 500 trays we're talking about 500 trades all right you're gonna end up with if you give up a dollar on each one even if you're only trading two Lots that's a thousand dollars sure when you're talking about 2500 our account that's 40% of your revenue say you numbers are you mungus let's go to the next slide on your watch list keep an eye on your watch this you can keep an eye on implied volatility and implied volatility percentile to add in your decisions the two questions are and again this is what's so important here remember you're talking about a retail public of a few hundred million people ultimately or a few hundred million investors you're talking probably 50 million retail investors you're probably talking about less than fifty thousand that have any idea what implied volatilities and you're talking about less than a few thousand that or less than a few tens of thousands that really understand what implied volatility percentile is so just be very clear of where the volatility that you're buying or selling or trading is relative to its range so you can have reasonable expectations about expected move and and direction okay price efficiency whatever you want to call it let's go next slide look at the price to see if there is any mean reversion assumptions that can be made I wrote something last night Tony in the cherry bomb and I think I may have confused some people because I got some emails on it this morning but this is very interesting go back to the cherry bond for a second and what I wrote in the first line was although volatility took a beating yesterday when reversion to the mean dictates that premium fails premium falls Trading is always better what that means is that even though volatility was down yesterday when reversion to the mean dictates that premium falls Trading is better because we like to sell premium above historical means or historical averages okay and so what happens is when volatility Falls and your starting point is above the number that you expected to get down to it's good so one of the things that we like to focus on is at least understand which is a reasonable level for expectations if you're selling volatility or whatever you're doing if you're expecting a certain type of move you're not likely to get that move if you're facing complacency or or capitulation because a volatile extreme and you're not likely to get the price advantage if you are situated at a volatility level that you're not going to get paid on correct okay and so it's very important to understand that those are just reversion assumptions so when the market moves in a direct that might not be your own as long as volatility the direction you want to go on as long as volatility is contracting you can still make money that's exactly right you know remember you can be shorted below the mean or you could be shorted above the mean you'll take above the me correct shorting it below that mean just put you in it's much more challenging shorting above the me makes your position a lot more reliable on a direction that's right so so that's all I wrote in there today was that's a positive thing are there binary events such as earnings announcements that may come they may change the strategy we employ you know as much as we think we're all over everything we're not and we sometimes make we made a mistake yesterday we correct thought we made an earnings play that was coming out today it's tomorrow so it's not that easy but it's not that easy to stay active it's not that easy to do all the stuff that's required you know to kind of always stay in the game so so you by just looking at implied volatility you can tell if there's a binary event yep let's go the next slide okay next we look to create our trading assumption are we bullish are we bearish are we neutral are we looking for price reversion I mean I don't know the answer except that when things are extremely what we consider to be oversold two things happen either we get an oversold condition with implied volatility it's a hundred percentile are we in an oversold condition with implied volatility yet they you know at the bottom end or we get adverse we get overbought too either way like yesterday afternoon I wanted to put a position on a Groupon mm-hm and I haven't read Groupon in a while I thought you know what I'm gonna sell the eight I just looked at Groupon stock was trading a little over eight bucks and I sit and say you know what this is a good price I'm gonna sell the eight straddle mm-hmm each straddle so here got a Groupon facility show this one up so I go to Groupon yesterday I'm just looking for trays because you know I've been watching it it finally got over eight bucks I'm thinking this eight straddles kind of rich I opened up July options I looked at the eight straddle and I look at the calls are 53 cents the puts are 36 cents I'm thinking wow you know I thought I'm I'm thinking I get this thing off for 90 cents it's a pretty rich straddle eight bucks sure 90 cent straddle for 23 days so I'm thinking myself okay this looks good so but before I enter it I go you know I'm just gonna check to see what the volatility percentile is because you know I saw improvement here and where does it say 8:8 now I know Groupon came from much lower numbers whatever the company was in turmoil but then I just pulled in the rains right okay because I said you know what as as much as I like this straddle here and it's got exact I want about it you have to make a directional a trade if you're going that's right you can't sell premium here you're gonna look I never entered the or a debit spread never getting short Groupon that's a perfect example for a tasty bite saying I was I had my finger on the button and I said to myself you know what how come we're not practicing what I preach so I went back looked at the 8% I said you know what take it off the board and this is being again I'm not selling I'm not selling it in the 8th because it certainly has liquidity yeah I just I pulled it right off the board so that's a perfect example I was neutral on that trade sometimes I'm bullish sometimes I'm bearish sometimes I expect price reversion but you know what price aversion is much more of like a pears type or commodity trader than this really there really is for we don't Tony I don't think of price reversion to the mean very much when it comes to trading stocks irie reversion to the mean absolutely but you know the problem for me is that IV reversion to mean means do I sell them when they're high cuz I don't buy them when they're cheap right so I'm not gonna buy this Groupon straddle so so if it was high I would sell it if it's low I'm just walking away okay good and finally a possible isn't a possible pairs candidate I mean that's something we're gonna look for today we've got an open pairs trade on right now where we're having SPS first Nasdaq on a 5 to 3 ratio it was close to about unchanged yesterday but we'll look at some different stuff I thought about a bonds pairs to trade last night unfortunately you know it would have been it would've been okay nothing so have a point so would've been good pairs trade I was gonna buy actually wanted to buy bonds and sell less in peace and but hey you know whatever we're gonna cover some of that bond SNP pair stuff today at the nine o'clock hour you're gonna hear a little discussion about it buttons just a bigger product when they both move 1% then you gotta make more money with the bucks I didn't talk I talked about buying the bonds if they got down to the 133 and changed level which they did last night early but they've never traded their cents on the sell side of bonds at 135 they're one 3509 right now at the one 3602 I wrote it two days ago somewhere around 1:30 602 1-1 3528 to 130 602 that's a big area for them at 136 here and 136 and a half as well so those are areas I'm not necesary gonna get short bonds but I may sell some premium up there understood if you're not getting the cherry bomb for some reason just email support at tastytrade.com and they'll set that all up for you let's go next slide is there one more Linda perfect pick a strategy based on overall IV of the security and the market we only have a couple seconds here so I gotta move quickly and I'm going to see something sure okay yeah I know two more after this sorry so I was behind the overall pick a strategy based on the overall implied volatility of the security and the market itself I mean sometimes you know if the implied volatility the market is trading Forex and the security and and then let's say it's a hundred and the securities trading at 70 or 80 then you know what you're gonna do the ETF right look for defined risk trades and and you don't define restraints this is a starting point we're fine without defined risk trades believe me we are but with really small accounts you just want to be careful that you have enough capital left over for strategic diversification and then make sure you're capturing the right amount of premium let's go the next one execution and strategy we like to choose a price point for entry and exits and avoid chasing straights which means we're looking for some price event and we also may be looking as I wrote the last thing we're employing a profit or a date based exit strategy so profit meaning hey I've gotten to this percent relative to the date or the date being hey it's this date it's late enough in the cycle and of course we always match winners we try to defend individual unlimited risk losers but for the most part rather than defending losers we manage winners and the key take away from here is employing a profit or date-based exit strategy there's like there's like this ratio which we're gonna talk about of profit to number of days left let's go lest last slide when trading a smaller-sized account there many hurdles to face a well-defined and mechanical strategy is important step to successfully facing these challenges which just kind of a wrap-up slide will archive all this stuff there's a lot of great material in here we're good health we got the opening bell coming next you'll still get tasty on tastytrade Network [Music]

Channel: tastytrade

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Id: 015oGP9l_yU

Length: 18min 12sec (1092 seconds)

Published: Wed Jun 26 2013