To take profit or not? | Mike Follett | 9-5-19 | Leveraging Capital With Futures
You. Good. Day and welcome class. My, name is Mike Follette it's certainly, great, to have you aboard today our. Topic or, our class title I should say is leveraging, capital with futures and by. The way you can follow me on Twitter that's, at M Follet. Underscore, TD a and also, if you want to make life easier in terms of following these sessions you, can like and subscribe, to trader Talks where you can like this video and subscribe to the trader talks channel on YouTube and it just makes it a lot easier to I gain, access to either these archived videos or any. New upcoming videos, on the channel also, we, do have another channel, out there when. You're listening to classes, for me often. Times you're gonna see that broadcast, through the trader talk channel but just to give you a heads up we do have another, channel and it's, called investor, insights, you. Can catch a lot of those classes, live a little bit later in the day but. Those classes, primarily. Focus, on fundamental. Analysis, and long term investing, and so, a slightly different point of view but nonetheless just. As valuable, so, if you get a chance you might want to check those out on, investor, insights, as well and I know many of you already are doing that by. The way it's, good to see you out there Arturo. Kind, of a familiar name good to see you there and also Orlando, good morning to you or afternoon, depending upon what part of the world you're in and let's, get our class started so, as we, get started remember, that futures, and futures options trading is speculative, it's, not suitable for all investors so. Make sure that the, suitability matches, up as. With futures, and Forex while all investing, does involve risk including the risk of loss paper. Money trading is a software, application for, educational. Purposes only also. Options. Not suitable, for all investors as. There are special, risks inherent to trading options that may expose investors, to, potentially. Rapid, and substantial. Losses so, carefully, read the previously, provided. Copy, of the characteristics, and risk to standardized, options, spread. Straddles, and other multi leg up ssin strategies, can obtain. Entail. Substantial. Transaction. Costs, and just, just, remember, that's going to impact returns, and when you've got trades that have minimum. Profit benefit. You know some of those high probability, trades those. Can be significantly, impacted, by those transaction, costs, probability. Analysis, such as the probability, of an option being in the money on expiration. That is, for illustrative. Purposes its theoretical, and it's not guaranteed. Also. Back-testing, does not guarantee what's, going to happen in the future, no. Soliciting no recording, and no taking pictures no part of this presentation should be rebroadcast, without. The written consent of TD Ameritrade, there's, a quick, snap, look, at your Greeks Delta. Gamma Vega and theta, and remember, those are measurements we. Use those in the world of options they, measure a price an option, price sensitivity, to price to, changes, in price time, and implied volatility, if I can get those words out just.
A Quick look little. Agenda we've, got going on today we. Want to take a look at some of the news that's happening, out there and in particular. Kind. Of see what's happening, in, oil markets energy markets based on the. Latest AI, a weekly. Inventory, report, also, we. Did play some paper money example, trades in this class last week and, based. On you know the performance of those I want to have a little bit of a conversation about taking, profits, or not you know how do you how, do you kind of analyze whether, or not it's worth it to keep a position in your account to take those profits or leave it in there or. Or, an excuse me one more thing on that agenda what. We want to do as well is take a look at some, pairs examples, that's something that we haven't really focused on in this class in, probably. A couple of months so. Let's step back and take a look at the. Pair's trader and analyzing. Some, pairs relationships. That. Traders, might use in the futures market so hope you enjoy the session and that's. How we will proceed so, let's jump over to my. Paper. Money, account, and oops, don't want to go there quite, yet the. Paper money account is actually that's showing us the pair's trader will, wind up going there event. But let's start here on oil. Let's, go with /c. L so. We'll type that into our screen, and we'll. Go ahead and zoom in on, oil and if you if, y'all recall, this. Is something that we did talk about yesterday in, our, session, looking. At the chart on. Oil. We. Do have something, evolving. Here that might look into that this is going to be the third, week in a row I believe, where, we've got to draw on oil, inventories. And when you're talking about and, this is published by the EIA. These. Inventory. Weekly, reports. You, know sometimes, traders, will put you know more or less faith in those because it's just one week's worth of data and based, on storms. Based on you know you know whatever data. Data. Irregularities. Or whatever sometimes traders, will discount, the weekly report a little bit but, when you get multiple. Weeks kind, of building, up here, three. Weeks or. So in terms of drawers and today's draw was a draw, of about four point seven million barrels, if I'm remembering that correctly but we got another draw and you put those in sequence, with these drawers. It could, be indicating. That some of the, extended. Supply that we've had in oil markets is getting I worked, it's you know it's getting worked through and so. Quite. Possibly that, could be because of lower productions. Or, lower, production, there, are even some thoughts that just there's been heavy refining. Demand that's, kind, of cut into some of those inventories. But. Nevertheless, when. You do see you, know those continued, inventory, draws as long, as the demand stays the same you, generally do see these price, improvements. In oil but, one of the things that you. Know sometimes individuals, will track, with these oil relationships. It's just is. Their demand based on economic, growth that's. Coming in to oil markets, and if. We do see oil sort. Of confirm, breakout. And maybe work its way higher quite. Possibly. Resistance. Could. Be next seen at about $60. That, could mean that there's a pretty good pocket of air, in there for, oil to move higher and. If, oil does move higher that could be kind, of a positive signal for economic, growth, some, traders might look at that as confirmation to. The. Term risk on environments. But it's interesting to see here oil is strong it's not at the highs of the day but we've, got supply. You. Know is is lower and the. Market right now seems to be in a mode of happiness, in terms of, economic. Conditions well as happy as they can be because at least there is some growth going on and who. Knows quite possibly we could see oil drift, up toward that 60 level now, if someone, were going, to, play. That you know if they thought well this is a breakout. And they wanted to play that move to the upside there. Are a number of ways that that could be done, someone. Is using the world of spread, trading one, of the ways they could do that is with something. Like a bull. Put spread let, me just jump over here to all products, for a second, and we'll, take a look at the, CL, forage, slash CL. That's, going to be the crude.
Oil Futures symbol, and depending. Upon their, time frame how long they thought it might take oil to evolve or make the move that they were anticipating, could, affect their choice in terms of how they were going to trade this but, let's say they thought. You. Know that move could be. Something. That could happen in the next 15, days or so it looks like the active, underlying. Crude contract, here expires. In 15 days of course there is another contract, out here at the price level of 47. Sort. Of interesting, as well it looks like oil. Markets. Here they're, in a little bit of a backwardation. Situation. Here as well out in the future it looks like prices, are a little bit lower than where they are at. The spot price but, anyhow someone might want to give. It a trade like this a little bit more time to play out and if they did want to do that they, might consider dealing, with a contract, maybe 42. Days from expiration. And so. We'll open up those 42 day to. Expiration, contracts. And if. We take a look at. These, days to expiration here, being 42, days on the options, themselves, just. Remember, that and this can be a little bit confusing, for people so I always like to point this out but, they would actually be trading. The. Underlying. Future. That, expires, in 47. Days not, the one that expires in 15 days, so they'll be looking at a slightly, lower, price, of. That underlying, crude, oil contract on you, know relative, to the options, that they're trading out here does that make sense that's, just one of the, nuances. Of futures. That you want to be aware of you've got the underlying, future, and then you've got the options, and we've talked about this over and over again but, just a reminder about, the way that works and if someone were thinking a they want to give this a little bit more time to work out just in case maybe it pulls back here in the near term we have had a pretty big move, to the upside and crew Reese crude oil, recently, they, might go with the contract, out here and if they do that they're, gonna be trading an underlying, that's. At, a slightly, lower. Price going, to be at 56. 92. Is the, underlying there but outside. Of just being aware of those details if, someone, did trade these options, and let's say they wanted to exercise, or there, was an assignment that took place.
You. Know just just be aware that these, options, would settle into this contract. Right here the CL, x19. Okay. But that being said depending. Upon the. Bullishness, that, the trader actually. Had they. Could do you know an option spread ranging. From something that's high probability. And maybe selling, and out, of the money put spread, all the way up to something that's low probability. And higher payout, and quite, possibly buying, a call. Spread where. They might buy the fifty, six and a half call, and maybe sell the fifty seven and a half call assuming. That if crude worked its way up to 80 or excuse. Me not 80 of course 80 would work too but if it worked its way up to 60, shoot, well that would easily go, through that spread, and force that spread into maximum. Gain but, just kind of to compare, and contrast, these. Two different types. Of spreads right the thought process, between these two different types of spreads I, will, queue those up and put, them sort of side by side on the analyze tab and. So. The first one here will, go ahead and right click on. An out of the money put the, way I'm selecting, that out of the money put is by, looking at a delta. Of about, 30, Delta. Being used as a probability. Indicator. A low Delta, means higher probability. Of those options expiring. Worthless. Or, being out of the money on expiration. So, if somebody is going for the higher probability approach. And they, chose a delta, of 30 then maybe looking, at about a, 70%. Chance you, know just kind of back in the envelope doing the the Delta thing there but, about a 70% chance of getting their maximum, gain so better than 50/50, a high probability, trade so, it's really not a surprise if, we right-click on, this and choose, sell and then, go with vertical, here if. We sell a vertical and we'll. Just keep that actually, we'll make it a dollar wide, just. Throw. A little bit more meat on there but, if they did that trade and they took this over to the analyze, tab for, example.
Let. Me go ahead and minimize that and we'll look at a risk profile, if, they set their slices, to the break-even, point on the analyze tab this. Trade is going to have some room where. The market can move against, it and, it could still be profitable, in fact the breakeven on this trade is fifty three seventy three the, breakeven is down here, and we're, talking about a price, level of the underlying, up. Here. At about fifty e6 almost 57, 56, 90 some other so, there's some cushion, right where the price. Of oil could actually drop, and this, trade could still have some degree, of profitability, on expiration. And the. Maximum gain point is right here and so they're still cushioned for maximum gain all the, way down to the short strike price here of 54. So. And you, know one thing I thought I just had here just. In case you can't see, my screen, very. Well. And. What, is going on with my, annotation. Okay. We'll get rid of it that way all, right but just in case you can't see my screen very well, I'm. Gonna increase, the font size on this, so, I'm going to take this too well, it's already on very large maybe. We'll try extra, large and hit apply settings, maybe you can see that just a little bit better but, fair warning is I make those fonts a little bit bigger I have, to do a little bit more adjusting. Too, to. My screens to me to make everything kind of fit in the same box but, anyhow back. To this high, probability. Variant, of a spread the, maximum, gain on this would. Be. 27. Cents. Okay. But that 27. Cents could be kept as long, as crude stays above 54, or is above 54, on the expiration, date, but. The risk on this trade is, the difference between 27. Cents and one, dollar so. Really, it's got. 73. Cents worth, of worth. Of risk compared to the reward of 27. But that's logical. Because, it's a higher probability, of winning trade. Okay but that's the high probability sort, of approach if somebody wanted to choose that now, if somebody were more bullish, and they, just had greater conviction, of a, strong move up now, or a continuation, of a strong move higher at this, point well, what they could do is actually create a slightly, different type of trade here and they. Might decide to do maybe, an at the money call, spread, and we'll just kind of put this up side-by-side with. That put spread and so we'll go ahead and buy a vertical. And. That. Should be queued up here at the bottom of the page. And. If they wanted to make that $1.00 wide vertical they might move that short strike price up to the fifty seven and a half and, now, note this right, this is this is a debit trade, the. Debit would be fifty, four cents. But. That debit, would be the risk of the trade and that, risk would be less. Then the risk on the credit, spread which is out of the money the risk on the credit spread is, 27. Cent the difference between a dollar and 27, cents the 73, cents and the. Risk, on the call spread would be whatever, that debit is which is 54, cents but the. One thing about that call. Spread, is. That. It has a higher break-even, point let's, go ahead and set our slices, again to. 1018 you'll see a break-even, point here 5704. And. So. We actually need the market to go up a little bit on. That expiration. Anyway, in order for.
You. Know even to get to our break-even point, and in. Order to get our maximum gain we, need to go up above 57, and a half but, if that maximum, gain occurs, right if we are above 57 and a half on expiration, the, spread could go to a full dollar and it. Could make a total, of, 46. Cents, the difference between $1, and 54, pennies so which, one do you choose right, it kind of depends on the individual, and, sort. Of the way they want to take their risk balanced. Against their probabilities. Of winning just, in case you wanted to know the, probabilities. Of winning on a debit spread like that are gonna basically be about 5050, the reason they're right around 5050. Is because. The break-even point is going to be pretty darn close to the current price of the underlying, okay. But there's a couple of ways that a trader if they wanted to get bullish, they, could actually do those things, you. Know in in different ways based on their probability. And their payout needs, that, they have and really if they were willing to risk more, money, you. Know kind of a an, additional, way that a trader might position, themselves especially, if, they wanted to have the, stronger, outcome, right the the, bullishness or the larger payout for, a larger, move of oil does go higher but. Still the ability to make something, even, if oil, goes lower they. Could put together maybe a combination of these two things so for example, they, might decide to sell. A put spread or, maybe even sell, a couple, of puts bread's but as I do this you got to be careful because your risk is gonna go up but, for example if we, had three put spread salt right. And one. Call spread, purchased. The. Total, credit, from the three put spreads would. Be greater than the debit, of the call spread which. Means that if we set our slices to the break-even, point. We. Still have kind, of that high probability. Of winning idea, right, the market could go against, us as long as it stays above.
Fifty, Four dollars there's at least something, some kind of profit there but, if it does rally above, fifty seven and a half well. Then all the puts expire, worthless and, the calls could go in the money and so, they could have the benefit, of the winning calls and they could have the, benefit of the winning puts, but. That's one way to have a higher payout. And. Still get the probabilities. Of the out of the money put spreads and that's kind of like a a risk reversal, type. Of trade but as I do that I mean it's it's kind of fun to talk about this, oh hey, here's here's something that's cool right if, you sold three. Of these put spreads and use those proceeds to, buy one of those call spreads and did that in one chunk well, that's kind of the best of both worlds you get the high probability, and the higher payout, of that additional call spread up there but, the one problem with that is if, you're just going willy-nilly. Increasing. The size of those put spreads you are, increasing. The risk on the trade and just, as a reminder especially. If you're brand new to trading futures maybe, you've never done this before and futures, options the. Actual, way, you look, at the risk on these is different than, the way you might. Be used to looking at the risk if you've been trading, options. On stocks and that is because these typically, have different, multipliers, not, in all cases right, but if we, look at for. Example, just. These put, spreads, and I'm gonna bump this down to one just to make it a little bit easier to understand, yeah. We got a credit coming in of 27, cents you might think oh well that's 27, dollars that's, a dollar wide spread, so that's a hundred dollars, but, really it's not, you have to multiply, all these, things by. 1,000, because, the multiplier, on crude. Oil options, is not, 100, like you see in stocks typically, it's 1,000. Because each of these contracts, is going. To be a, thousand. Barrels of oil right, and that's that, goes into actually how. They determine, the, characteristics, of the underlying, crude, oil future, contract, as well but just watch that right because you. Got to take the, 27. Cents, and multiply that by a thousand, so that's 270, credit. And, you got to take the difference between those strikes and you, got to multiply that by a thousand, so that's actually a thousand, dollar spread, in there for each of these so, if you're not paying attention and, if you just go ahead and sell three of these and buy, one of those call spreads you, might accidentally, be biting off a little bit more than you can chew right that would be twenty, one.
Ninety. In terms of total risk and. The. Maximum. Payout here, and. This is what's kind of nice about this. Analyze, tab just so you know wherever. You float your pointer around on this screen if, you float it into this maximum, loss spot well. The negative number here. Matching. The expiration, of your options, would, be twenty, seven thirty so, that would be the total loss and, the. Total, gain would be twelve seventy. If the, market were you. Know above, our short strike by the time expiration, rolled around so, you got to get comfortable, knowing that if you're going to do something like that you can risk about three thousand, dollars on that trade, but. You know maybe for illustrative. Purposes we. Do that right, this is an account you, know when people ask me all the time hey you know Mike how. Much risk should, I think about taking on a trade well we, don't make recommendations. For how much risk you should absolutely take. However. Makes, sense that any trade, that you do use is is. Small, right. One thought is to, maybe take you, know just for an. Example, here maybe, one, to two percent of an account and. Maybe. Risk that, on any given trade and that might be a lot some traders actually, might go with maybe. One percent or half a person half of a percent and have, that be their risk on from. Their account and determine, their position size, from that now, this account happens to be worth almost, well, it's seven hundred and eighty seven thousand, dollars right. So even if we took three, thousand, dollars worth of risk that's going to be a very small, position. Compared, to the net liquidation, of the overall account but, double check that anytime you're, you. Know considering, getting into a future straight no the, risk but. Let's go ahead and put, this in for illustrative, purposes I'm, just gonna hit confirm and send on these. And. That'll. Be something that we can kind of track going. Forward, now. That's. A little bit on oil and I mentioned, that we, wanted to talk a little. Bit about oil just to get started some, of those inventory. Reports, and maybe, just, talk a little bit about different, ways that traders could trade that and that's, using a bullish bias the. Bullish bias could be absolutely wrong here you know some traders might look at this and say no this is just a fake-out oils, gonna drop from here in that case that would be the wrong type of position, at least you. Know to a certain point. We. Did have a break-even point, down there at about 53. Ish which, would put our breakeven, down pretty, close to some of these lows right, but if if this trade goes down right that's gonna be the wrong trade for it so maybe practice, taking, a look at different types of spread variants, and paper, trade that according. To your liking but. I wanted want to talk about some of the news and some of the inventory reports, that are going on with oil let's. Transition, here though and talk about some trades that we put on last week for illustrative, purposes and, discuss. The idea of taking, profits, right another question that I get from traders, a lot, when I'm out there especially on the road you know talking to people in person face to face because. You know when when, do we take profits, you know when do or take a loss if the loss has to be taken, you. Know when when, does a trader actually, pull the trigger and get out well. Let's take a look at maybe some of the examples, that we put last week and kind. Of go through a thought experiment. Analyzing. Those trades to determine, whether or not it might be reasonable, to exit and ultimately, it makes sense that traders, have some guidelines or some rules that they use to, determine, when to take profits, so, I want to talk about some of the structure, that a trader might use to make that you, know create, possibly, a rule or a guideline, on how they might decide to exit a trade but. First of all know the trade that you're in right what type of trade do you have and how's, that trade, actually going to work now. Opening. Up gold if you recall last week we. Actually looked, at. Paper. Trade here, shorting. Gold. Gold. Was you, know and it has had this big run higher a, little, bit of a contrarian point of view we, used the option, market to sell some out of the money call spreads, and if. You notice there's, the two call spreads sitting, on our screen that's, what they look like when they're sitting in an account the. First of the two call spreads well. That was filled that was traded, at a dollar, 10 let me just highlight that for the trade price I found that this is very useful, if you're, managing existing, trades. To, have this trade, price on your screen and remember, you can edit in, the, trade price if you wanted to just. By using that gear, icon in the upper left hand corner there, that.
Would Allow you to edit that just in case you don't have it on the screen but, the first call, spread here was sold for a dollar 10 if. You notice we have a second, call spread here and that, one was sold for a dollar 20. So, that was just an example of, layering, in writer scaling, in had, a goal here that, we wanted a couple of call spreads, and thought, that there might be some volatility, in gold so, we chose to sell one, of the call spreads at, a dollar 10 then, put in an order to sell the other one for, a dollar 20, and it looks like both of those got filled but these are actually the same, spreads. Just. On different lines because, they were filled at different times and sometimes that can be a little bit confusing right. Now if you wanted to know you. Know the current value, of the, spreads. What. You could do is take a look at the mark price, okay, and so you can see the mark values, here we, got respectively, 80 cents, on both of those of course because they're the exact same spread, so, just thinking this through, these. Are credit spreads, when, they were sold they brought in a dollar twenty and a dollar ten in. Order to make money on those the trader wants the value of those to drop if they've, gone to 70, cents, these, are actually making money they're profitable, okay. So far, they. Still have though 20, days remaining, who, knows within, the next 20 days gold. Might actually go, back. Up huge again, and that would be bad for these, trades of course gold could go down and that would be good for these trades but, right now if you're wondering about profitability, they've, made around 40, cents, right. About 40 cents, on one and what 50. Cents on the other so. Question, right, what do you do with them so. What do you do with these positions now. Right. Yeah it's kind of nice we're basking, in the glory of all of our paper profits, here and that's, exciting, but. When you've got a, winner how, do you approach that to take profits, or to not take, profits. Well. One. Way to look at it especially. When you've got a defined, reward, and a, defined risk spread, like this is. How. How. Much profitability. Remains. Right. How much more could you make on this trade, relative. To, how much risk. There is in the trade and I found that going through just a reward risk, analysis, can be a very useful way to think about this to determine. Whether or not to take profits and it could be a way to drive some. Sort of a rule or a guideline, so to speak on when, somebody might decide to take profits so there's still 20 days left so we still got some time right. And in the next twenty days here, right. That time remaining, well. These could make seventy, more cents a piece, right, they've already made you. Know fifty and forty cents but they could still make seventy, more sense if. The market, continues, to cooperate we, need the market to be below. 1570. And right. Now we're at, 1517. So we got a nice cushion, right. 20, days and, still. A lot, more that could be made than what we have already made, does that make sense the. One way to think about this there's 70, cents worth of a remaining reward, in this trade now, a thought though is if, you're comparing, that to the risk the. Risk on these is five, dollars a piece so. It's kind of like having a position if when I say five dollars a piece that's the maximum value the spreads could have so. The. Risk is kind of different the difference between the, current price 70. And 80 cents or. 70, or 80 cents at five dollars so it's kind of like well risking. 4 dollars and 30 cents right now to. Make 70. More cents, now here's, the question is that, worth it oK, we've only made 50. Or so cents. Right, we could make 70, more right. But right now we're risking for 30 to make that, additional 70 more sense now. What a trader could do is maybe set up some guidelines, that. Determine, determine. Where hey, if there's still time remaining. And these. Trades have made a certain amount to where the reward versus. The remaining, risk is no longer worth it they, may decide to get out early, because. Of a reward risk analysis, and I don't know you. Know sometimes. We forget about reward, risk when we're trading but I'll bet you don't forget about it when you're driving down the road you're putting your seat belt on you, know you probably lock the door in your, house when you leave your home maybe you don't I don't know but, you know we kind, of constantly, take these. Micro. Assessments. Doing, these reward, risk analysis. Ideas. In daily, life but. We oftentimes, don't think about that when it comes down to our monetary, situation. Or our current trade example, here so, this is where somebody might say okay if the, remaining, reward, just becomes, too small, that. Means the, remaining, risk is too high I'm, going, to cut that so that trade can't come back to haunt me because it still has time remaining, does that make any sense in the world and that's, where some traders, will choose, a percentage, of return so like for example if, they've.
Made 80, percent. Of their, maximum, gain okay. If their maximum, gain on the trade they've, made 80 percent, of that, that. Is a reward, risk assessment. So. Close it out there's not much that can be made but, there's a whole lot of risk that actually, remains now, determine, to determine, the 80 percent, you, kind of have to go back to what the original trade, price was right, so if we traded this for a dollar 10 you'd, have to figure out the price to buy this back for 20 percent of what you sold it for and that would be 80 percent of, maximum, gain but, that means that would be buying this back for basically. 22. Cents, right so if someone were going with 80 percent of their maximum gain, they'd. Be buying back that spread for basically, 22. Cents. Right that's just 20 percent of a dollar 10 80 percent, return, okay, so if. Someone's we're subscribing, to that philosophy, they could just keep their eye on this okay I'm not gonna do anything with this unless, that spread gets down to 22, cents that's my 80 percent threshold that's, where my reward, no longer justifies, the remaining risk of the trade now, not everybody, follows that approach, some. Traders might go with 50 percent of their maximum gain, if they're want to be a little bit more proactive, in terms of their exits, and what, would be 50, percent of this right, basically, half of a dollar 10 it's, going to be 55, cents, right so if that could be bought back for 55, cents, boom, a trader might do that to take their maximum gain but either way and hopefully I'm not over belaboring this point just, trying to be very clear on what this all means, but. Either way right now that spreads going for 80 cents it's got time remaining, it hasn't, made 18 or 50 percent so there's still some profitability, left, now. If. You're interested in maybe opening, your mind beyond, just that percentage, idea, this. Is a technique, that I learned, from, a. Gentleman, I knew that were traded, on the floor of, one. Of the option, exchange is actually the SPX, pit and, he. Actually shared this idea with me one time which actually was kind of nice, and. It actually allows the, investor. To not have to worry about their original, entry price all the time so, in other words rather than going back and researching, now what did I sell that for I got I've know what I sold it for in order to determine my percentage.
Of Maximum. Gain, one. Time a gentleman, told me you. Know it's hard to keep track of the cost basis, on all these things especially. If you're layering in trades and maybe you overlap, strike, prices so. The trade you have now is not actually, the trade that you put in originally, because you, may be over, overlapped. Your strikes right so now you've got instead. Of two five, dollar wide spreads maybe you've got now one $10, wide spread and that can be a little bit confusing, so I'm going to share something with you here, some. Traders might look at this and say okay we've got a $5, wide spread. Well. Is it worth it to ever have a $5. Spread, in there that. Could be bought back for 50 cents, so. Maybe and you and you can even adjust that, but, maybe five or 10% of, the width, of the spread and let's just say we went with 5%. Of the width of the spread okay. We've got to spread with here that's five points. Okay, what's. 5%. Of five dollars well. 10% of, five dollars is $0.50, cut. That in half okay. 25, cents, you know trader might decide to say okay just because of that width the risk that's in that spread if the, price of the spread is very, small, compared, to that width right. It's not worth having it anymore and they could use that without even knowing what they originally traded. That vertical, for I don't know if that helps anybody but. If you're looking for maybe a way to just judge. That and more of a pure reward, risk sense you, know someone could get out if just because the spread width you, know the value of the spread is less than a certain percentage of the width of the spread and so let's let's do that let's say on one of these we, decide to create a closing, order to, buy back a vertical, here and. Let's. Say we get out of one of these four. 25 cents so we even if we didn't know what that spread was originally, sold for, 25. Cents okay well that's just 5% of the spread width, boom, and we could make that GTC. Go tell cancel hit confirm and cent and that, could be a working order right they could just exit, that thing along. The way now, how about on this second spread let's, create a closing, order here let's. Buy back that one, let's, say we buy back that one for 10% of the width of the spread which, would be 50 cents so, we scaled in, may. As well look at the idea of scaling, out right so having these closing, orders now to get out of these verticals. You. Know and just make them good tell cancel and that way we don't have to watch these every single day if, the price of the spread actually trades at that price and the order can be filled it'll, just fill for us and we'll just go ahead and hit confirm, and send on that now, I don't know if that helps anybody right but that's just going through a reward.
Risk Assessment, and that could. Be one way right, to just step, back and think. Like you normally do in life when you make other decisions and, just ask you a question is it worth it right is it worth it for me to go get. A. Gallon. Of milk right now knowing, that I have other things to do in life of, gotta do, the laundry you know whatever right. You. Know you do these constant, reward risk assessments, why not apply, that and try to create some guidelines, in terms, of exiting. Especially, these defined, risk, vertical, spreads, and. I would say it's a little bit easier to think in a binary way, when, you're using vertical spreads, because these vertical spreads have a maxed. Or a Max gain and a Max loss and, so it becomes a lot easier to think in terms of percentages, now, traders, are not using, you, know defined risk vertical, spreads let's, say they were just trading the underlying future, itself. You, know when they were planning on the future to go down and they. Wanted to get out if they've collected a certain measure of profitability just. From a Down move remember these were bearish trades they, might decide to set targets, and, those targets, could be made to match, levels, of support you know just areas where in the past you've. Seen the underlying go down before but it hasn't wanted to go down much beyond. That level right and so you, can see here on gold right, around this five or, 1500. Level and even. In a closer sense, about. 1525. There's. Some a few support levels in there so, if someone were trading, just the underlying, in a bearish way and they were trying to know when to get out at least for profitability, they. Could set targets, based on these support. Levels that might be appearing in here right, now, they could also understand. Where to take a loss if, quite. Possibly, gold breaks through maybe. 1%. Above. The most recent, high that, could be an exit for a loss and then targeting, support, for. A profit. Taking exit, if if the, underlying actually, dropped here on a bearish trade right, so it kind of depends on the type of position that you have but, what we've been focusing, on in this class at least lately primarily. Are, those defined, risk trades, and so we can step back and just think in terms of a binary nature. Percentage. Of either, spread with the percentage, of Max gain and kind, of operate, accordingly, now. There, is, kind. Of some interesting exceptions. To all this that you can run into. That's. That's, just using. Sorry. Let me open this up down here but, that's just using the. Aspect, of a credit spread how. Do you handle these debit spreads to, remember, on. Oil. We. Just did that trade example, where we for. Illustrative, purposes we sold three put spreads right, credit spreads and we, bought one call spread right. So, that kind of that three to but. This call, spread that was purchased down here and that's the one that's highlighted you. Got to think a little bit differently, on spreads, like that when you're thinking in terms of reward versus risk because.
The, Exit, on this trade for profitability, is not. Buying it back for less than what you sold it for it's. For selling it for more than what you bought it for does that make sense so, if somebody were looking for profitability. On this tray and getting, out because they've got a winning trade and so do they have enough profits, yet as long as there's time remaining, right, but, they be looking at this the. Value of the spread going higher which, is it's not right now okay, right now, we're. Dealing with a spread, that's currently priced at, 51. Cents we, bought it for 53. So. Now this, is where I you, know some, traders find it incredibly. Useful to. Think in terms of spread width okay. So the width of this spread is one dollar if we, bought it for 53, cents, that means the most it could ever become worth is one dollar that's. Going to be the maximum value it could have those credit spreads zero, dollars that's the minimum value and that's we're going for here right, but if we're going for one dollar here, a trader, might decide to look at this and say well if it becomes worth maybe, ninety, percent of, the, value of that spread, so, rather, than 10, percent of the, spread. Width they might decide to go okay ninety percent of that spread, width which, means if this becomes, worth ninety. Cents create. A closing, order just. Go ahead and sell that vertical, if the, value goes to 90. And, I know it's a weird thing to kind of get your arms around there. But. It's a risk reward assessment. If, the spread has been purchased, the. Minutes, a dollar wide spread the most it could become worth is a dollar that's, your maximum, gain basically, so, if you get ninety percent of, that dollar, width, ninety. Cents, right doesn't mean you've made ninety percent on your trade, necessarily. Right because the max the, profitability. Is the difference between the entry price and a dollar but, this is just one way to think about okay if I be if I get 90, percent of the spread width then, we'll, just take that trade out and take those profits, if, they, happen before expiration and so we'll go ahead and do that we'll hit a GTC, on that we'll hit confirm, and send and now, we've got a closing order on the. Debit. Spread here so that's the difference between trading. Credit, verticals, and debit, verticals those, defined risk trades and you, know this doesn't just apply to futures, this, applies to you know basically anytime you're trading vertical, spreads if you're, interested, in that just, we happen to be looking, at vertical spreads applied to oil, right now okay. So, now. There's one more thought process, here too and again our focus here is talking. About to take or not to take profits, right we're really to even, take losses or not to take losses, even, though we're talking about these profitable, trades on gold, at, some, point somebody's going to have to think about taking losses, when the time actually occurs and so. If, someone is dealing with spreads. You. Know a big part of taking losses, is actually, focusing, on the amount of time you have to expiration. These, have plenty of times still remaining to expiration, so, let's say for example these were losses it. Might not be worth it to remove, them because there's still so much time remaining so the market could come back right, but.
Maybe As a basic, guideline if we're. Within 10 days to expiration so, time is growing short there's, just not a lot of time left, if, these trades are working against, us and especially if, you jump back and take a look at the chart and obviously. You feel like you're wrong based, on the chart, you. Know that's oil but, we should probably shift this back to gold G see if, you feel like you know gold is just not bearish, and that there's not a chance and time is almost gone, that. Could be a reason to get out of that trade, early. Right, somewhere, inside the 10 day window right, then here's what's, kind of interesting about, that is you're, with that 10 day wait and you can adjust this I'm just throwing this out as a guideline for this class right. But if someone is in, just inside 10 days but, it expiration. Is not here, even. When these trades are losing, because, there's still a little bit of time left they, tend, to not. Be at maximum, loss okay, so if someone wanted to not, take a max loss if they could avoid it but, still take, as much time on that as possible, because, you. Know it's a probability, based idea, held till expiration. They, might use that 10 day window if, they've got losers and they're not comfortable with it they might decide to take those. Focusing. On about 10 days to expiration but we're there now and, 20. Days on and so hopefully this is helping going, through that now also we've, got a couple of vertical spreads on natural, gas. That. We put in last week let. Me just open those up and how do you even know what. Types of spreads these are these debit or these credit, spreads you know how do you even know well. One of the things you can look at to just determine whether they're debit or credit spreads, is just, create an order and see, what it would take to buy, them back right just so just click on the actual, trade. That's, on the screen and then, choose create a closing, order and you'll. See okay I got to buy this back that means I must have sold it in the first place so, my maximum gain is going to happen if this, is worth zero, right, right now it's before it's worth point zero zero six that's, a weird one if you're not familiar with that but, that point zero zero six needs to be multiplied, by ten thousand. To get the actual remaining, value on this and so, there's $60. Worth. Of remaining. Profit. In that trade although when we look at this it says remaining. Loss, now that spread, width is worth, five, dollars so. If somebody could buy this back for 50. Cents so like point zero zero five or. Point, zero, zero two five, something, like this that, would be closer to following, those guidelines of. Maybe, five to ten percent of the spread width but this still has a little bit more profitability. That could be made and by. The way they're. Still let. Me go back to the actual monitor page there's still twenty days to expiration so. We'll just go ahead and let these continue, to work as well okay so again kind, of if we're talking about the width of the spread the notional width of the spread in there and it's, weird right because it's probably not what you're used to but these spreads are worth five hundred dollars between the difference between those two strikes, so if they can be bought back for maybe fifty cents or. Twenty-five. Cents, or excuse, me point, zero zero five, or, point, zero zero two five, that, would be either. Five or ten percent of that spread width but. Anyhow they're not quite there yet I will show you how to create a closing, order we'll go ahead and buy one of the for point zero zero five, and just, make that a good. Tail cancel order hit, confirm and send and then, on the other one that's in there we got two of these will. Create a closing, order. To. Buy back that other vertical, four point, zero zero will just go point zero zero two on that so a little bit cheaper oops. You may make sure I hit confirm and send on that or. Excuse me GTC, before, I hit confirm and send and now would buy that back for twenty cents okay. Twenty, dollars notional. Boom. There you go so, now. That. Is just a little example of taking, profits, or not to take profits okay, so now let's, get, into our last concept, here which, is using the pears trader and you know what next week we'll spend a little bit more time on pears, trader because.
I Spent a little bit of an extra time on not or to, take profits and not to take profits but. Let's focus on this pears trader for a minute here and then, and, then again we'll continue our conversation on, this next week so, pears, trader is kind of an interesting tool, that's available, and. You'll see oftentimes well, you don't have to just trade futures, with this but, oftentimes especially, when, you're dealing with you. Know commodities, types of futures. Been, for eggs and just for illustrative purposes today, let's, take a look at the relationship between, let's. Go gold GC. And silver. Pat, milolii had, an interesting tweet, yesterday. Toward. /gc. Enter. And. /si. Enter, well first to back off of this just to explain what we're talking about here on this pears trader when. You're in the pears trader it's, kind of an interesting tool, because what it allows you to do is. It allows you to take the difference, between the, price of two different underlyings. And the, underlyings, that i'm gonna use right now are gold and silver. And over. To pat milolii. Pamela. Lee sent out an interesting tweet follow him, you. Know if you're interested, in in checking out some fascinating, tweets. You. Can follow him at P milolii, mu, ll a ly underscore. T da, on, Twitter but, he tweeted I believe it was last night where he talked about the gold silver relationship, and actually. How what, we've seen let. Me go ahead and just remove this study for open interest I think, I hit edit on accident. But we'll remove that study right there just to clean up that screen a little bit but. What he's talked about is how in the, recent, run-up in these precious metals silver. Has, actually, even, though silver, and gold have both gone up, silver. Has gone up faster than, gold. Has right on a percentage, basis, when you're talking about the price differential, between these two things silver. Has gone up faster than gold, just kind of something for your gee whiz collection, if, you're trying to keep track of those relationships. On maybe two different underlyings, like this a good, way to view that is in the pears trader because, for example on the left side if we have gold, /g. C and on the right side we have, /si. Silver. What. This does this chart down here at the bottom of the page is it, takes the price differential, between the two of these underlines, takes. Gold -. Silver, and you, can see that price differentials. Kind. Of on a trend line right here and see how. Recently. We've seen this massive. Run-up, in this. Right. That's not just indicating. That, you. Know precious metals have been higher but it's indicating, that the difference, between the, price of gold and silver has. Narrowed, right again take gold -. The price of silver these futures, and if.
That Price is going up that means silver, is actually. Narrowing. The the price gap differential. Between those two things so the spread price the. The price differential, between those two things is actually narrowing, right, now also. It on this page you, know very useful tool here you can also see, the correlation. Difference. Between these, so. In other words take a look at this, bottom. Of the page. Okay. So. We know that Silver's, been running up faster, than gold but are these things kind of going up at the same time are they going up together when, we've got a correlation. Component. At the bottom of the page as well and, it actually tells you whether these are currently behaving, in some sort of a correlated. Fashion, and when. And. This has a scale it goes from 1 all, the way down to a negative. 1 actually, but, it goes from 1 to negative 1 all you're seeing here is 0 is basically 0 on the lower part of that scale but. If they're 1 that. Means they're both highly. Correlated they're kind of going the same direction if, they're. Negative 1 that means they're just doing the opposite, thing from, one another right but right now silver. And gold are actually quite correlated. Right they're moving kind of together. But. On. To the idea of pairs trading it's. Not always that way sometimes these. Aren't. Moving quite. Together right, but the price differential. Might. Actually be narrowing anyway anyhow talking. About these correlations. And these spread. Differences, between these two prices, some. Traders might decide to do trades based, on this right, so let's say for example, you. Know they're with this big run-up and silver right, so silver has relatively. Gotten. A lot, stronger. Or. They it's narrowed, the gap so to speak in terms, of the. Difference, between gold, and silver prices and someone, thought that were due to maybe change, that. The. The spreads narrowed, they're expecting, it to maybe open up a little bit what. A trader could actually do especially if these things are correlated with one another is they, could put these trades, on and, it. You know trade that relationship. The widen and so for example the left side here, to. The right side somebody, could make, a decision to, buy. That. Pair, and, I don't know what am I doing wrong here because I might have missed clicked a button or. Something because it's, not giving me the ability to buy or sell that pair. Anyhow. You can check this out on your own screens. If you need to maybe I've accidentally. Missed clicked something here. Yeah, I don't know what I've done there but for some reason I can't buy or sell this pair but you can practice this at home and we'll, circle back around and do this again next week I. Must, have missed clicked something and I'm not even sure what i misclicked but anyhow if you, buy this pair, right. So let's say you bought. Well. Buy pair what, you're actually going to be doing is you're, going to be buying, gold. And you'll actually be selling silver. Right, so effectively, what you're doing is you're putting on a trade where they're, these two things are correlated, with. One another so, if one goes up, the, other one you know so let's say gold and goes. Up well silver is probably going to go up - does that make sense because, these are heavily correlated, with one another but. The assumption, would be if somebody did this trade is that, gold is going to start going up faster, than silver, would now, both of these go down right, there have they're quite correlated, right now that, means silver. Would be making money goal to be losing money so there's kind of an offsetting effect, there but, with this trade it could still potentially profit. If silver. Winds, up going down faster. Than gold does so in other words the spread differential. Between, those, two it's kind of a fascinating, way to trade where, somebody could take sort of the directional, element, out of this so to speak right especially with two correlated, underlyings. They kind of offset, one another on the directional, standpoint, and, what the trade becomes, is just. The differential. In the price of those two underlyings. Here does that make sense so, now, this could go absolutely, wrong if silver. Continues, to increase at a faster rate on a percentage basis, than gold does this, could be a losing, trade right, or if gold goes down and silver goes up based, on correlation. Usually. Doesn't happen but. If that did occur this, could be a double whammy type, of loser but, if you've got a strong correlation and, a widespread, relative. To where, things have been someone. Might decide to short one and buy the other and expect that spread to actually narrow and in this particular example if, they were expecting, us, silver.
To Weaken, because it's been so strong in, it's pricey appreciation. Relative, to the gold, appreciation. This, could actually profit, from that but I can't actually show you trade here because for some reason that's turned off and I probably clicked something I'm not sure what it is though we'll. Explore, this more when, we get together next. Week because it is kind of a fascinating, thing to circle back around and take a look at some of these pairs relationships. You, know we talked throughout. The session about spread trading right, this is sort of a spread trade but where you're lining up a spread between. The price of two underlying, futures. Pairing. That against, one another right, rather than pairing options, on the same future. Together you know one is bullish, one is bearish here you're taking two like, components. Right, they're quite, correlated, you're, buying one and selling the other and just looking, to, benefit, for, from the price differential, between those two things again, well I'll figure out what I'm doing wrong here with the buy or sell pair here. Situation. And I'll circle back around and, we'll. Talk about this again next week but, hopefully that gives you at least a start I would. Encourage you to take a look at some of these tools on the pair's, trader tab and explore some of these differentials. And these and. These pair correlation, numbers that are on your screen could, be very useful for you by the way if you want to learn more about different, technical, analysis, techniques, stick. Around because we've got technically, speaking coming, up following, my session, and that's. Gonna be a powerful, session, you can bet on it and it's. It's, gonna be taught. The. Topic, today is actually, trend, trading and that'll be with the one and only James Boyd unless he's not in the office then he'll have a substitute, but, hopefully you were able to learn some things here wanted, to talk about taking, profits are not taking profits, and introduce, you to this Parrish trader and again. We'll circle back around and look at that pairs trader again next week but I got to run. Thanks, again everybody for sticking, around, there's final look at our agenda and there's a final look at our slides. Remember. There. Is risk, in the markets don't forget that risk and everybody. Have a terrific day and stick around again for technical. Analysis, and technically, speaking thanks everybody have, a terrific day don't.
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2019-09-09 10:45
