Short Verticals | Ken Rose MBA, CMT | 1-27-21 | Trading Option Spread Width - Key Metrics

hello investors so interesting looking at the market you know we started to move to the downside we started a recovery but right now the market is crashing to the downside creating even lower lows as a vertical spread investor does the width of your spread have an impact in these types of market conditions so good investors do you want to welcome here to our session here today boy again a very very unusual market a lot of volatility going on here today we'll see how that plays out in relationship to our short vertical trading strategy here as we're going along just a reminder you can follow me on twitter my twitter handle is at k roic underscore tda where i post things related to this area as well as other areas of investing i also just want to welcome everybody here today welcome radio wayne and michael and frank and timothy and lewis and frank and sandeep and henry and joe and james and lisa and trey and alonzo and terence guiles and everybody else got a nice little group here we currently got 43 attending and climbing i also want to thank michael fairborne for joining us in the chat window to address questions do feel free to send in your chat so michael he's very knowledgeable in this area i also encourage you to follow him on twitter and wave disclosures here today just a reminder that in order to demonstrate the functionality of the platform we need to use actual symbols however td ameritrade does not make recommendations or determine the suitability of any security or strategy for individual investors any investment decision you make in your self-directed account is solely responsibility we do use a paper money software application here this is for educational purposes only we want to keep in mind that successful virtual trading during one time period does not guarantee successful investing of actual funds during later time period as market conditions do change continuously here's a picture myself been here for about 16 years going on 17 years i specialize in blending both fundamental analysis with technical analysis that's one of the things i love about my work is i love to learn new things and there's always new technologies and new strategies to apply those to i love to learn i love to teach and also love to train in this area i'm a contributor on the td ameritrade network i'm also a charter market technician and i work with think scripting building indicators triggers and strategies so with regards to our agenda here today we'll take an overview of the market looking at the spx kind of get an idea what's going on we'll review our existing positions and also our past performance what i like to really focus on here today though is considerations with regards to the width of the spread when you're putting on a when you're putting on a short vertical trade particularly in these market conditions where the width of the spread can can come in and play a material can come in and and have a material impact let me just ask you when you think about it have you ever thought of a potential advantages with regards to the width of a spread have you ever asked yourself is it advantageous to have a wider spread between the two strike prices or is it advantageous to have a narrower spread between the two strike prices also in relationship to that have you ever asked yourself when you're thinking about the width and you're thinking about the greeks does delta play a part in here with regards to the width of the spread with regards to why you're in the trade and when you're potentially exiting the trade that's what we want to do here today is is we want to examine these different areas we want to examine them from a transaction cost standpoint we want to look at where breakeven points are we want to look at return on risk we also want to look at in the event that trade gets into trouble what kind of an impact does the width of the spread have what does this spread have if you choose to do a change of polarity okay and given time we'll also look to add an additional additional paper trade here an additional paper trade into our portfolio basically everybody my goal here today is that everyone will have an understanding of some of the key metrics to look at when you're trying to decide how wide you want your spread to be whether or not you want it to be 50 cents wide a dollar wide two dollars wide three dollars white four dollar four dollars wide or whatever one of the reasons we're looking this area today because i have received quite a few questions and quite a few comments with regards to you know can you explain a little bit more about delta and the impact that plays with regards to short verticals and also how do you make up your mind with regards to how wide you want your spread you know do you want a bigger credit you want a smaller credit what about transaction costs like we want to and we want to look at these areas so that you all feel more comfortable in looking at these metrics and also running calculations on your own so let's start off here then with a little overview of the market as i was as it was beginning our session today it wasn't looking too good and it's right now still not looking very good here we are right here this is where we open today that's actually a gap down from from the previous trading day what's happened during the course today well right now we're trading at the lows i was actually looking at this about an hour ago and we were actually recovering nicely so within the last hour or an hour and a half potentially some news is broken or some other things have occurred but now we're all the way back down at our lows and we have been inching a little bit lower now as short as as if you're looking at the overall market you can see that overall we've been in a nice uptrend so in an uptrending market like this we're most likely to be in short put verticals and if we're in short put verticals the market starts taking a dive like this that's going to put some pressure on those short put verticals and this is where this is where we may want to make an adjustment okay when we've talked before basically our session last week was all about what types of things to do if your trade gets into difficulty so i might encourage you to possibly review that session from last week because we're going to be focusing a little bit more on on the width of a spread here but if you want to get more of a general idea you might want to check out our archived recording from last week but just to when the market's moving down like this that can put some pressure on your short put verticals and this will this will actually lend nicely to our discussion here today with regards to taking into consideration determination with regards to the width of the credit spread when you first enter it and what kind of impact that can have in the event you're looking at exiting it under duress okay now before i get started here again looking over there i see a lot of familiar names i want to welcome you to everybody that's here it it is assumed in this session that you do have a basic understanding of options in other words you know what a call option is you know what a put option is you know the difference is between buying and selling options if you don't have that understanding then then you may then you may feel a little bit lost in here okay i i do try to craft the word so that these sessions are beneficial to everyone but there's the potential that you may feel a little bit lost because we do make that assumption that you do have that basic understanding of options if you don't have that basic understanding of options let me just point you to a couple of resources that are available to you i'm going to come over here so i'm going to come over here on the td ameritrade website let's just see if we can log in here quickly and then we're logged in so it's just a standard td ameritrade website i want to point you to this tab right here education now you also have the education tab on the thinkorswim platform i just like the way that it shows up a little bit better here over on the td ameritrade website when you roll over the education tab right here you have some choices one of the choices over here under education center is options we come down here and we click on options you'll see in here that we have a course it's an online course that helps you to get started with options here it is right here there's a video there's a video right there options for volatility let's see what else here we have for options that one's a three hour course and here's one i sure call vertical spreads and it looks like this is the course that we have for options i'm also going to look at another area because i believe this is called options for volatility but i believe there's also a course in here that's like getting started with options let me just come up here and click on stocks here for a second see if it's hiding under there it's not hiding under there click on overview here for just a second see we got here not seeing anything there either i'm thinking that perhaps that course that we have here on options options for volatility i'm thinking this is probably going to be beneficial to you as a beginning option traders if not come in here and you can check out some of these videos investing basics for options five minute video there basic options three minute video there maybe come in and check out some of these option videos for beginners then also under the education tab if you come up here and come over here to webcast and click on webcast right here this will bring up a our webcast page and looking at our webcast page here i just want to point you to a webcast that we have that is called getting started with options and when this page comes up i'd suggest you just come over here to the webcast calendar and click on the webcast calendar and then if you come down over here notice that on fridays right here on fridays we have getting started with options okay this is taught by barb armstrong and that's 11am these sessions are also archives if you can't make it live do keep in mind that you can catch it as an archive while we're over here i'll also mention to you again i specialize in blending with fundamental analysis with technical analysis so you'll find that as an option trader i i use a fair amount of technical analysis and with regards technical analysis we have a nice getting started with technical analysis session that is right here okay so just a a couple of resources you have available to you let's shift gears here then and we've taken a look at the market right we kind of get i got an idea what's currently going on here we're currently moving here to the downside let's just take a moment here then because we wanted to take a look at we want to take a look at existing positions and also our performance so to do that i'm just going to bring up a spreadsheet we don't want to spend a whole lot of time here but i do want to just review how we've been doing overall basically we have completed 37 trades okay the most recent the most recent complete completions was twitter and on twitter we took a maximum loss okay and we also had two verticals on ibm which was an earnings trade maybe some of you saw what ibm did actually though uh by on our exit on there we actually came out better than a maximum gain on ibm and i'll explain that a little bit later on in our session here with our twitter loss here that means we now have two losses out of our 37 trades we took a loss on vlo we have a maximum loss here on twitter next session i'm going to i'm going to plan on going in and and kind of tearing the loss up here on twitter going into the details of of of this loss and the reason for that is we you know we can benefit a lot by looking at our gains and by putting our gains into our trading journal but we definitely want to look at our losses in detail whenever we have a loss we we want to capitalize on that meaning that we want to look at it we want to see exactly what happened because that can help benefit us with regards to avoiding that in the future we know we're always going to have losses right when you do have loss you'd want to go in and you want to look under the hood and look and look at in detail we'll do that next session okay we have 37 trades out of those 37 trades we have two losses which gives us a percentile we have 90 we're just we're at 94.5 successful trades that means 94.5 percent of our trades either have a maximum gain or 85 to 95 percent of a maximum gain our average return on our trades is 23.25 percent our average days in the trade is just under 13 days now a lot of the success is attributable to to being in an overall bullish market that that has definitely helped us out i'm not going to sell i'm not going to sell our process short either i think i think our process is something that's also beneficial to us we want to keep in mind with regards to this 94 percentile when we're entering in these in these trades we are typically looking at a theoretical probability of about 73 percent so we are nicely outperforming what the theoretical probabilities would be of course we know that there's there's something called a a reversion to the mean okay so it wouldn't be too surprising if we did get some losses and revert a little bit closer to what these what the statistical inference would suggest well with that then let's go ahead and do this we'll ship gears and let's look at metrics for a spread width and delta let's take a look at that i'm going to bring up the thinkorswim platform right here what i thought i'd do is to is to discuss this while we're discussing it look at it kind of kind of set it up looking at an actual potential trade but that does look like it's continuing to creep down there doesn't it and i i brought up our washless center what i did is i just came down here and i wanted to find the first stock that didn't have an earnings announcement okay because we were in the middle of earnings season didn't have an earnings announcement was priced somewhere in the neighborhood about 50 bucks and i came up on marvel here okay so we use marvel for our example i mean it's not a recommendation or anything what we want to do here is basically want to recommend a process here okay and what we'll do is we'll compare and contrast we'll compare doing marvel with a one dollar widespread and we'll compare that to doing a three dollar widespread we'll just look at the differences i think in doing that we can have a good understanding of some of the key differences when you're deciding to go with either a one dollar wide or when you're deciding to go with a three dollar wide so let's let's go ahead and start this off then i'm going to bring up marvel now some of you may actually be asking yourself and maybe i just throw this out or some of you asking yourself right now does it really make a big difference ken i mean is the width of the spread is it that big of a deal well we'll also be addressing that question you know you know whether you go one dollar wide two dollar wise three dollars worth of five dollars walls is it that big of a deal okay and that's that's that's part of what we'll look at today and and and i'll leave it up to you to determine whether or not it's a big deal whether you determine to go one dollar wide two dollar wide three dollar wides or whatever all right so looking at what we have right here let's do this i actually i think we've maybe changed this around a bit so so here's marvel notice on marvel we broke above this resistance level right here and notice that we're pulling down and we're hitting that resistance level right now so this this would fall in that realm of what's called a falling knife okay and we go into detail on detail on falling knives in some of our other sessions basically a stock that is pulled back and is approaching a old resistance level which is a theoretical support level so we're looking at this we're saying okay that was an old resistance level so we're counting on that to hold up a support we don't know that it will hold up a support which makes this trade a little bit more aggressive by nature but we're looking for it to hold up the support so we're looking to come down here then we're looking to sell down here looking to sell an option that has a delta that is less than 30 preferably somewhere in the neighborhood about 25 or less because we want a probability of success again somewhere in the neighborhood of say 73 to 76 percent probability of success why is that the probability of success that we'd like to have because that's so that's what we previously used okay we're playing the part of the investor that's comfortable with that if you like to have a higher probability of success you're then there's no problem with that if you're okay with a lower probability of success then you're okay with that as well this just we're just playing the part of the investor that's looking at that okay so let's open up our option chain here and typically what we've done here is we've gone out about 23 days and some of the neighborhood about 20 about 20 to 30 days we'll come in here at 23 see if we get something here 23 days i'm going to come in here and let's find our delta right here here's our delta values and we want a delta value that is going to be less than 30 maybe somewhere in the neighborhood about 25 26 it looks like we have a 48 right here we can even maybe look at a 4750 let's let's start out here at a 48 okay so this has a delta of 27.

what exactly does that delta mean you know sometimes we look at a delta and we're saying okay what does it mean okay well notice the sign on the put side is a minus sign so that means the direction of benefit on that option on that option all by itself is to the downside if we have a delta of 27 right here what that means is if the price of marvel here if it goes down by one point or in other words by one dollar the value of our option contract will increase by 27 cents per share or in other words by 27 now delta cuts both ways if the price were to go up by one dollar then the value or option contract would decrease by 27 so that is that's that is one of the key factors to keep in mind with regards to delta okay a secondary way that you can use delta is delta is giving you a percentage probability that this option in other words this 48 dollar put option it's giving you a percentage probability that that option will be in the money in the money on the expiration day so the expiration day is out here 23 days this delta is at 27. so what is that saying it's saying that theoretically there's a 27 there's a 27 percent probability that the stock will be at okay it'll be let's just say equal to or less than 48 dollars on the expiration day now if there's a 27 probability that the stock will be equal to or less than 48 on the expiration date what does that mean it means the inverse of that which is 73 percent there's a 73 probability that that that the that the price okay that the price of marble right here the price of marble will be greater than 48 on the expiration day so this is where we get our our probability of success of 73 is because we're usually looking at the option that we're selling have a delta that is less than 30 and usually somewhere in the neighborhood of about of about 25 to 27 so this one kind of fits the bill with that delta there at 27. now if you want if you want to go lower with your delta obviously your probability of success is going to be greater that's that's that's going to be fine too right now though we'll play the part of the investor that's looking at doing a 48 let's start off with a 48 a 48 47 so we're going to start off looking at a one dollar wide we're going to look at a one dollar white and we're going to look at a three dollar white and we're going to compare them looking at three things we're going to look at transaction cost we're going to look at breakeven points i should say four things transaction cost breakeven points return on risk and the delta that will be in play if you choose to do a change of polarity the change of polarity is something that you may choose to do if the trade is in trouble with the market moving down like this we could have some trades that could be in trouble if the you know we just we actually just had a trade last week ibm on the earnings announcement we had a trade that went into trouble because it went right through our strike prices okay and we'll take a look at that change of clarity and how the delta can play a part in that so let's start off then by just looking at transaction cost okay so i'm going to come in here and i'm just going to create a one dollar wide one here so i'm going to do cell and these come in 50 cent increments so i'm going to do deep and wide two price is vertical and there it is right there 47-48 and i'm looking at a 32-cent credit so let's just say hypothetically i'm going to bring up a calculator here let's say hypothetically that we have two thousand dollars that we're okay risking what is our max loss on this trade if we get a 32 cent credit what's going to be our max loss on the trade i'm just going to i'm going to write down here credit is 32 because i want to these things are going to be changing as the market is changing but i'm just going to lock them in place here credit is 32 for our one dollar wide okay this again is going to change from 32 to 31 or whatever we'll just we'll go ahead and we'll use 31. i do want to note here that there's a significant difference here between the mid and the natural which means we we may get filled at 32 or 31 but we may actually have to come down here a waste of 30. so i did want to note that but for both the one dollar wide and the three dollar wide we'll assume that we're able to get filled at the at the mid price so how many contracts how how many of these spreads would we be doing if our max loss in this case is going to be what's our max loss in that case is that going to be 69 right well actually we're going to use 32 right let me just pop this up here at 32. okay so what's our max loss then it's the distance between the strike prices which is one dollar minus our credit of 32 puts our max loss at 68 right whoops well i've just lost my calculator let's bring that back okay so one dollar we're gonna use two thousand dollars of risk right so we got one dollar minus point three to sixty eight bucks so if we're willing to risk two thousand 000 and our max loss on the trade is 68 bucks we can do 29 29 spreads okay 29 spreads 32 dollar credit what would be our transaction cost then well each one of these spreads involve two option contracts okay let's let's see let's see what each one let's see what the let's see what the commission cost is on each one of these in our paper trading account your accounts may be different in our paper trading account what is the cost for each one of these spreads we'll come up here and do a confirm and send looks like the cost for each spread is a dollar 30. so we'll come back over here then

we're doing 29 of these each one of these is a dollar 30 but we may have to pay these we may have to pay these transaction costs going in and coming out so it's going to be 260. 260 for each for each one of our 29 here so i'm going to take 29 i'm going to times it by 2 dollars and 60 cents and we've got transaction costs here then of let's see transaction cost is going to be 75 40. okay i've got a little sheet here just kind of a little a little thing we can fill out here to keep track of stuff so here's our transaction costs we're actually going to come down here and do a 48 we're looking at a 4847 right and we're looking at a credit on that of 32 okay and this and then we have our the number of spreads we're looking at doing here and i'm just going to come over here and adjust this up for what we're looking at which was 75 75 and 40 cents okay what if we go three dollars wide so looking at 48 45 how many spreads can we do well first of all we need to we need to assess our credit i think it's probably going to be close to 8 but i'm not sure let's check that out so come over here i'm going to come down here and choose edit let's widen this out so we're three dollars white so it's a 48 45 let's open this up now we're looking at a 93 credit a 93 credit and we're three dollars wide so what is our max loss then well if we take three dollars and we subtract from that this thing's bouncing around isn't let's lock it in here it looks like it's settled down a little bit let's lock it in here at 69. okay all right so we are three dollars wide we're going to subtract from that 0.69 so our max loss is going to be 231 dollars a contract so if we're okay risking 2 000 i'm going to divide that by 200 and whoops let's try that again shall we 2 000 is what we want to allocate for risk we're going to divide that by 231 contracts there's our there's our eight contracts okay so let's come back over here then and take a peek to see how we're doing here okay so this one then is going to be eight contracts and a contracts i've got times a dollar thirty here times two to get over here but let's see let me just do the math here well actually it's going to be same eight contracts it's a dollar 30 per spread then i times that by two let's make sure the math is right on there 20 80.

just go eight times it's going to be 260 right is 20 80. so if we're only concerned if our only concern is transaction cost then which which which way is going to be the preferable way to go is it going to be to go with dollar wide spreads we're paying we're paying almost three times as much in transaction costs if we go with the dollar wide or is it going to be better to go with three dollars wide where we pay a third as much transaction costs if all we're looking at is total transaction cost then the investor's going to want to go with the wider spread right here okay however let's look at something else before we get before we walk away from this okay if we do if we do 32 spreads let's see was that 32 let me just double check that i think we're at 27 on that other one let's come back over here i'm going to make this a dollar wide let's go back here so we're dollar wide there we are right there let's change this early earlier was 32 so let's let's stay with 32 okay just uh you know let's bounce up now it's up to 30 but let's go with the 32 and let's just calculate the number of spreads again we got 2 000 2 000 divided by our max loss is 68 bucks right looking at 29 spreads let's come back over here and enter that in our template 29 spreads okay it's looking at 29 squares now i we basically took our took our 29 number and got this right let's double check just to make sure okay we'll take 29 times two dollars and sixty cents and that's our 75 40 so we're good with that let's take a look at something else though okay if we do 29 spreads and we get 32 bucks for each spread we've got 29 times this is the max gain right 32 we're looking at 900 and 28 dollars is the maximum accumulated gain okay i'm going to subtract from that 928 our commission costs our transaction cost here which is 75 and 40 cents that leaves us with a communicate a cumulative gain of 852 60. on the other hand if we do eight spreads and what we what were we looking at on our eight squares are looking at our let's just let's just double check on our rate spreads i want to i want to keep this as accurate as possible if we come out here and we go three dollars wide we do eight spreads let's go ahead and we'll go ahead and go with 71 here okay if we do eight spreads grab our cheat over here too we're gonna do eight spreads and eight spreads we're looking at 71 bucks on each one of those spreads so here eight times 71 only puts us at 568.

and if we subtract our transaction costs from that puts us down here at subtract 20 80. it puts us at 547. so before we get too carried away thinking that you know i don't want to pay these extra transaction costs we may want to take this into consideration as well this is just theoretical if we're successful on all these trades then we're looking at 852 if we're successful on all these trades we're looking at 547 so if you find the difference between those two it it it it is significant okay so if we're only looking at total transaction costs the three dollars why is good if we're looking for total potential profitability in relationship to those transaction costs and that then that paints a different story and i think we'll see that here again when we look at return on risk secondly how about how about breakeven points looking at our breakeven points here because we're going to be selling we're looking at selling the 48 right and you know did i write that down i think we're looking at uh 32 right so on our on our one dollar wide spread we're looking at a credit a little bit earlier 32 bucks and on our three dollar widespread we're looking at a credit of 71 i believe is what we're looking at right let's double check over here is that still yeah that's that's sitting there at about 69.71 we'll go ahead and use 71. that's i think i think that's good enough so where would our breakeven points be on these now the break-even point if you think about it create a short put vertical you know the stock's gone up like this kind of like this and we've sold our strike price right here in our example right here we've sold the 48 right so how far below that 48 can the price of stock go and for us to break even well it's going to be 48 minus the credit that we receive okay and said one we'll go ahead and do the actual math here but 48 minus 71 is going to be is going to our break-even point is going to be lower on the three dollar widespread than it is on the one dollar widespread because our credit is higher on the three dollar widespread than is a one dollar widespread you know how much lower or how much wider is it let's just check it out here we'll grab a calculator and here so i've got 48 here minus 0.71 puts us at 47 47.29

let's change that to 47.29 and then whoops i lost my calculator here for a second and then the other one is going to be 48 minus 32 so 48 minus 0.32 you get 47.68 47 68 what is the difference between these two well what do we got 29 39 49 59 60 it's about 39 cent difference right uh now i may be off a penny or so but i think i think that's about it okay so the break even point is favorable on the three dollar wide spread so if we're only looking at break even points we have a more favorable break-even point when when we're when we're at three dollars wide in this case it's 39 cents now to kind of put this in put this into context let's look at the chart for for marvel here for just a second come over here and bring up the chart boy my mouse is doing some i hope it survives please survive mouse please survive there's a chart for marvin kind of look at here and think okay is the is the 39 cents is it is it that great of a difference well it could be okay i just but when you're looking at the difference in the break-even point it's always a good idea to pull up a chart and look at it visually from a you know from from as far as how many cents we're talking about with regards to a difference there now some somebody we're just looking at marvel here this is one slot i'd encourage all of you to go through the same exercise just to solidify what we're talking about here just just go through these same exercises then it'll be somewhat second nature when you're looking at stock you can say okay i can take a look at some things sometimes a break-even point the difference in break-even points can be more meaningful than what we're looking at here on marvel okay so where do we want to go next then okay so if we're looking at total transaction cost and that's all we're looking at three dollars wide would be preferable however if we're looking at total reward okay in relationship to those transaction costs and that then that then that produces a potentially different result break even points while we're looking at breakeven points three dollar wide is better than one dollar wide well taking consideration that why would someone do a one wall a one dollar wide spread well let's take a look at two areas let's just say on these two here we'll give this to the wider spread okay this one's a little bit of a question mark here i i tried to show you that okay if we're looking at a one dollar wide spread are these two going to favor one dollar widespread let's let's let's take a look at it okay so we'll come up here and go back over here to the trade page and looking at let's look first of all take a look at our return on risk for three dollar wide spread now if you think about it when we were looking at total potential profitability also including transaction costs the one dollar widespread was favorable to the three dollar widespread that should play itself out when we're looking at return on risk in other words we should see a favorable a more favorable return on risk on the one dollar widespread than on the three dollar widespread but let's see okay so we're looking right here at at a at a at a 71 on three dollars wide so let's see what our let's see what our return on risk is then we're here so we're at three dollars and i'm going to subtract from that .71 which is our max gain remember our credit is our max gain so that's 229 so we're going to take 71 divided by 229 to get our return on risk so 71 divided by 229 again it's just max gain divided by max loss our credit right here our credit is our max gain our max loss is the distance between our two strike prices minus our credit and our return that gives us our return on risk when we divide our max gain buyer max loss it gives us our return on risk so our return on risk is 31 percent let's put that on our little notepad here return on risk for three dollars wide was thirty one percent thirty one percent how about one dollar wide come here to one dollar wide let's decrease this let's make this a 48 47 take our padlock off there looking at a 38 now again there's a significant difference here so we may not we may not get filled we may have to come off but we're just going to use the mid the mid for all these numbers okay and we'll lock this one in at 36 cents so what is our return on risk here then it's going to be the difference between our strike prices which is one dollar minus our credit which is 36 cents what's that going to be that the dollar minus 36 isn't that going to be like 64 i think well let's just double check just to make sure we're right on the right on the right on the target here okay so we're one dollar wide minus 0.36 is 64. so to gauge our return on risk

we're going to take our maximum gain of 36 divided by our maximum loss of 64. so we take 36 divided by 64 is a 56 percent return we'll come over here and let's pull up our little notepad here and so we got 31 on there and we have 56 right here we expected this we expected this because we're looking at total potential gain in here so those two are related so if we're looking for a dollar wide it looks like dollar white has return on risk here um is fee is favorable if we're one dollar wide this one right here though we we saved the we saved this one for last and this is price this is probably the most important one as it relates to if your trade gets into difficulty okay this is all about if your trade gets into difficulty and you choose to do a change of polarity what's going to be beneficial being one dollar wide or being three dollars wide just to review a change of polarity we've discussed this in other sessions but the change of polarity is again remember that we've got something like this and here's support and we've sold our short strike price here and we purchased our long strike price here so here's our short and here's our long these are both put options okay they're both put options but because we're selling something that has more value than what we're buying that results in a credit and we're looking for these options to just expire worthless what if the stock comes down like this though and breaches our short vertical well the way it is right now okay we're going to be losing this this is going to be a losing trade our the amount of our loss is capped okay because we have a vertical here it's it's basically capped on this transaction if we're a dollar wide it's capped on one it's capped to one dollar i should say it's theoretically kept one dollar if we're three dollars wide then it then then it's going to be capped to three dollars that's just this transaction though to get the net maximum loss you you would subtract the credit that you received when you first entered the trade but if we're breaking through and looking to get out of the trade and we're looking at a max loss situation it's probably going to cost us a dollar to get out possibly a little bit more but theoretically a dollar on a one dollar widespread and three dollars wide and three dollars to get out on the three dollar wide spread so what can we do in this situation well we can go ahead and take our max loss there's nothing wrong with that when we position size we position size based on that but another possibility is to buy back our short leg here buy it back and leave our long leg in place and look for this thing to continue to move down and have this long leg make back okay make back the loss that was incurred on this short leg we're going to look at this okay we're going to we're going to look at this now we may go just a little bit over today but i i think it's important enough that i i'm i'm okay going a little bit over here today i'm not talking about 20 minutes over but we may be a few minutes over so let's take a look at this then okay we're going to come back over here to think or swim collapse this so let's just say that if we enter a trade and that trade gets into difficulty these options that we sold out here with the delta of 30 they're not going to be out there anymore they're going to be down in here okay they're going to be down in this area why because the price has moved down so now that they're now these options are either at the money or in the money so this is where they're going to be it's also not going to be with 23 days left we're also going to be looking usually well into the trade we're usually not going to be looking at doing anything we're probably going to be looking for time to plan until we get until we get within about the last week let's come over here to nine days left till expiration and let's open this up and let's say okay houston we have a problem all right okay you you houston we have a problem what's happened well our spread our spread is now in the money okay let's first of all look at it from a from a one dollar wide perspective if we're a one dollar wide perspective then we and let's just say looking at this let's just say that what we've done is we sold the 5250 and we bought the 5150 they are both in the money because the price has gone through our spread to come in and buy back that 5250 we're going to use theoretical pricer for both of these rather than try to you know kind of estimate between we're just going to use theoretical price which is the price halfway between the bid and the ask if we came in here then to change the change of clarity we'd have to pay four dollars and 10 cents to buy this back at the time we paid four dollars and 10 cents to buy this back this option would be trading at 353. how much how much how much would this option have to increase in value to get us back to max gain keep in mind if we pay 410 to buy this back and we sell this one for 410 these two transactions are going to cancel each other out and what do we have we have our original credit which is our maximum gain i just got a little beep over here on something so i want to make sure our technology is doing okay because some sometimes i'll get these beats because we have a technological problem but i've not seen a technological problem so i think we're okay okay so how much is this going to have to go up here right here well let's first file look at the difference between the two so we're buying this one back at 410.

i'm going to subtract from that the 353 and so the value of this option and i in in the interest of time because we're a little bit short on time i'm just using a calculator i have in hand the value of this option right here is going to have to increase by 57 cents or in other words 57 how far does the stock have to move in our direction for this option to increase in value by 57 in other words in order for us to get back to a max gain point here's our delta right here our delta is 51. remember delta is giving us the change in value of the option for a one dollar change in the price of stock we can assess how far that has to move by taking our 57 the 57 cents that we need okay and dividing it by our delta of 51. okay so if i take 57 and i divide it by 51 the stock's gonna have to move one dollar and 11 cents in order for me to get back to in order for me to get back to max gain if i wanted to calculate how much to get back to breakeven i take that i take that dollar 11 and i would subtract well what i would do is i'd take the difference of 57 i'd subtract from that our credit and run the calculation again we'll just do from the standpoint that we that would like to get back to max gain if possible so in this situation if we do a change of polarity in one dollar wide we need a one dollar and eleven cent movement to get back to max gain it is not uncommon for that to occur in a matter of minutes particularly in a volatile stock with the interest of time we'll we'll take a look at ibm in more detail next time but in ibm this is precisely what happened to us last last week we had an earnings announcement ibm gaps strongly to the downside so both of those puts were deep in the money so i opted to right at the open i opted to go in and i bought back the short and i left along in place it was less than a minute in fact ibm was moving so quickly to the downside but by the time i bought back the short and went in to buy back the long it had it it had hit it had passed the point of max game so we actually did better than max gain on on the ibm trade and and next week we'll we'll go into a little bit more detail on that we we're not going to have time we're not going to have time to do that today but we'll look at that a little bit more detail next time okay we want to also look at so keep in mind at dollar 11 here i just want you to keep in mind that what if we were three dollars wide then what would happen let's come in here let's come in here look at three dollars white so here we are fifty one fifty if we're three dollars wide then you know i i don't have let's see 51.50 that would mean um boy 53 there's one two i'm not i'm not able to get three dollars wide so let's do this let's go with let's go with 54. let's say we're at 54

154 and 51. that's that that's going to be three dollars white we're not quite in the money here but we're pretty close we could go down here to 55.53 let's see 55 54 53 52. let's go ahead and do that we'll go way in the money all the way down here to 55 okay let's say we we blitz this thing out we're all the way we we did a 55 52 which would be a three dollar wide this thing is gap down these things are in the money now how much is it going to cost me to buy this thing back it's going to cost me six dollars nine cents okay that's the 55. how much is the 52 trading for it's trading for three dollars and 62 cents okay what is the difference between those two i'm going to take my calculator here i'm going to take 609 minus 3.62 equals let's try that again 6.09 minus

3.62 equals 2.47 is going to be the difference okay dollars and 47 cents what is the delta the delta is 53 i need to make up 2 and 47 cents how far does the stock need to go in order for me to get back to max gain well i can take i can take i can calculate that by taking 247 divided by my delta of 53 and the stock needs to go four dollars and 66 cents okay so on the one we were talking about a dollar eleven on the other one we're talking about 4.66 so this is where the one dollar wide can be can be beneficial now if you're a trader that isn't interested in doing a change of polarity you just want to stay with you want to stay with the trade and and there's nothing wrong with this you just want to stay with the trade you don't want to make an adjustment like this you want to play the probabilities out you pro you could very well you could very well be better off with the with the lower breakeven point okay you could very well be better off that but if you would like if you would like to consider possibly a change of polarity then perhaps and then it looks like from a change of polarity and with regards to an adjustment the one dollar wide is a more favorable situation right there all right folks well let's go and wrap it up we took a little bit longer than i anticipated okay but i did want to go through this because i have received several questions related to this particular area okay let's just wrap that up so we've talked about so what then are there are what are some cares to look at look at transaction costs but look at them in relationship to return on risk take into consideration break even points okay they they are definitely a consideration taken to take into consideration especially if you're really not interested in making any kind of an adjustment if you are looking at taking if you are looking at an adjustment then the delta and you know when you when you're looking at those things we use the delta you can see the part that not only the delta place but the spread width place in making these determinations as far as how wide to have your spread hopefully you know it's it's my hope that everybody today has benefited from this little discussion you know following our discussion here today sometime maybe between uh this session next week i'll go ahead and see what i can do as far as putting a trade on in marvel here but we've run out of time here for today all right everybody so with that then so we talked about we didn't we didn't quite have time to fit this one in our potential paper tray but i'll see what i can do between now and next time as far as possibly putting that marble trade in there as a potential paper trade i do believe we covered everything else so just a reminder that in order to demonstrate the functionality of the platform we do need we do need to use actual symbols however td ameritrade does not make recommendations or determine the suitability of any security or strategy for individual traders any investment decision you make in your self-directed account is solely your responsibility everybody thanks again for joining us here for short verticals i hope i hope that i was successful in clearing up some of these questions that that you had here today hopefully you also have kind of a better feeling and a better understanding of some of the major considerations when you're when you're looking at setting the distance between your strike prices when you when you are doing these verticals hopefully that's been beneficial to you also just a little bit of a heads up be careful be cautious you know my i i i got a phone call from from my father-in-law uh last night he actually is scheduled to have his coveted shot he's he's he's over 80 years old so it's good to know he's got his which means i don't know if it's a good thing or not but it doesn't mean that i'm not that too far behind and i think all of you are probably not not that too far behind as well so let's be careful and careful get on the other side of the whole covert thing as happy and healthy investors thanks everybody again hope to see you next time thanks to michael fairborn for being over the chat window i just glanced over there seeing a lot of chats roles so i know you kept him busy so thanks michael for that as well and hope to see you next time bye everybody we'll see you thanks again you

2021-02-03 15:18

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