The Limb I Went Out On Is Cracking Already

Amazing market we're in at this time. There is dip buying, then there is dip buying.

Options Spuikers Under The Spotlight

Choice Magazine which is a consumer magazine down in Australia has done a bit of a spiel on options trading seminars, featuring "The Big O" and a local spruiker. Read the article here.

They took quite an even handed approach, but there are some interesting quotes:

One company, Optionetics, says if you don’t make 300% on your tuition fee in six months you’ll get your money back. Another, Traders Circle, recently said at a free seminar that if you start with just $4000, its options “mentoring program”, “recipe for success” and trading recommendations will teach you how to earn $1000 per month for the rest of your life.

I suppose enough has been said around the traps about Optionetics refund policy, but Traders Circle claiming 25% per month? For life? Hmmmmmm. Excuse me a second while burst out laughing.

We attended free seminars and spoke to other experts to find out if options are really the best way to profit from volatile market conditions. We found options to be highly speculative, with a very real chance you’ll lose everything you invest. We also uncovered some dubious get-rich-quick claims that downplay these risks.

The bit in blue might not be necessarily true, but Choice probably couldn't help arriving at that conclusion from what was presented. Re the green bit - Indeed.

We contacted Traders Circle to confirm what we’d heard at their free seminars. They clarified that profits are before costs described in the company's financial services guide including trading fees (up to $82.50 per trade), education fees ($7000-$13,000) and monthly subscriptions ($349), and before losses from unsuccessful trades.

Holy Shit!!

While the risks of options trading are described and the company (Optionetics) proposes to teach people how to set predetermined entry and exit points for trades as a way to cut their losses when markets move the wrong way, there’s far less focus on the losses that customers must also be experiencing.

We’re not the only ones sceptical about the potential profit claims. “While it may be possible for such returns to be achieved, it would only result from adopting risky strategies,” says the SDIA’s Doug Clark. “The risk of loss from trading in options can be substantial. In all investments, high returns usually mean high risk. A good options adviser is invaluable to help you understand the market and give suitable advice.”

Rod Peters of ABN AMRO Morgans uses options for private clients, but mainly for capital preservation and to earn an additional income, rather than to speculate on big profits. He says 1.5% profit per month, or even double digit figures in a year, would be “a phenomenal return” from options, even for someone prepared to accept some investment risk. “I don’t believe the higher returns being quoted by these options education companies are sustainable,” he says. “Any astute investor would realise that to achieve those returns you need to get lucky, take extreme risks, or both.”

Good comments.

My biggest eye rolling moments come from the "it only takes 20 minutes a day" assertions. Here's what one client had to say:

"I attended an options seminar in 2002 and, while I thoroughly enjoyed the program and felt I learnt a lot, I believe that the instructors give a false impression in relation to both the amount of time and effort required to trade properly. It was stated during the seminar that, provided we put alerts and stops on our buys, we would need to spend no more than 20 minutes per day to trade successfully. However, I do not believe this to be true and feel, particularly if you are working in a full time position, that it is simply not possible to monitor your trades effectively enough to be successful." Fran

Lastly, something anyone that's been around options longer than 5 minutes knows about these seminars:

"The biggest problem I've found with a lot of these training companies that offer 'free' seminars is that the courses they spruik are expensive (probably to cover the HUGE of marketing that they must incur) and the content of the free seminar is purely a marketing vehicle to build hype for the product." - Paul

It not a bad article and a good read. It bags out these companies with reasonably accurate information, but unfortunately perpetuates a few of the pernicious myths about options trading if someone was seriously considering going about it the right way. Lots of good quotes to pull out of it too.

Read.

Stocks Good, Options Bad

How many times have you heard someone pontificate on the subject of "stocks are good, options (or futures) are bad with the contention that:

1. Options (futures) are a zero sum game, for you to win, someone has to lose. They do not create any net wealth.
2. Stocks are a positive sum game. When you buy shares you are assisting the company to raise capital to build infrastructure, employ people and create value and wealth.

Anyone who's been around markets longer than 3 days will have heard this, or some variation of it It's a very persuasive argument used by many civic minded folk to avoid derivatives as they must be the spawn of Satan, stocks are virtuous. There is only one problem with this argument.

It's bullshit!

If one buys stock on the open market, not one dram, not one iota, not a jot of that capital goes to the company in question at all. While it's true that stock and bond markets are mechanisms for companies to raise capital, the vast majority of investors probably never contribute to this process at all. Or if so, it is a pittance.

Why? Companies only raise money through the issuance of NEW shares or bonds. Unless participating in an IPO or bond offering, the company will never see a cent of your money.

These are a miniscule proportion of transactions, with the overwhelming majority of transaction being the exchange of existing shares between specialists, marketmakers, institutions, traders and investors. The actual company whose shares we are trading is outside this loop, apart from you actually removing capital from the company if they pay you a dividend.

That means that for the most part, share trading is also a zero sum game (actually negative sum because of tranaction costs), capital profits come as opportunity cost for the seller.

The wealth creation bit is performed by the company itself, not the owner of shares purchased second hand on an exchange.

Ergo, the trading of options (or futures) or shares are equal in virtue, none have any moral advantage over the other.

Credit Spread Myths

So a few posts back I started on a bit of a rant on the BS being passed off as information on credit spreads and gave up about half way through. As the fashion for option bloggers is to do the odd video these days, I decided to finish the job in a video.

I've picked on the same article, because it encaspulates most of the nonsense out there in just two or three paragraphs and a few bullet points. I don't have anything to sell, so no need to be wary about any marketing at the end.

Covered Calls - Naked Puts Redux

About a month ago, I was opining opining that though covered calls and naked puts are synthetic equivalents, there may be valid structural or psychological reasons why a trader might use one over the other.

It might not surprise many that I am impressed by my own profundity in that discussion ;). *Some* other arguments on the merits of one over the other leave me underwhelmed however, most particularly when those arguments are chockers full of non-sequiturs, half truths and plain old BS. These of course are all over the place in Option Land, but I'll pick on a recent article published by an option book vendor.

In the article, the author recognised the synthetic equivalency of covered calls and naked puts (rare), but argues the superiority of CCs based on a load of old cobblers, to wit:

Here are the reasons I prefer covered call writing to naked put selling:

1- Many brokerages want the assurance to know that you have the ability to purchase the shares you are obligated to buy when selling the put. Therefore, they will require you to have an adequate amount of cash in your account to cover such an event. You will then have sold a cash-secured put and set aside the same amount of cash as the CC seller.

I don't see this as a disadvantage at all if the goal is conservative premium collection. As the author acknowledges, capital usage is the same. Therefore, there is no valid reason on this point to prefer covered calls.

2- The seller of a covered call captures all dividends distributed by the underlying corporation, the put seller does not. We’re not talking about a huge windfall here, but the cash is better in our pockets than someone else’s.

Just plain incorrect. Option pricing takes into account any pending dividend and option pricing cum-dividend and ex-dividend account for them. If you have a covered call position, the call premium will be cheaper to the tune of the dividend amount. You get the dividend via the stock, but you lose it via less call premium. I have an article on the effects of dividends for further information.

3- Selling covered calls allows the investor more flexibility. The most profit a naked put seller can generate is the premium on the option sale. A covered call writer can profit from the option premium PLUS additional share appreciation if an out-of-the-money strike is sold. That choice is available to the covered call writer but not to the naked put seller.

There is still no difference in payoff. If an OTM call is written, the *corresponding* ITM naked put can also be written, again with the same payoff diagram as the OTM covered call. Synthetic equivalence is maintained no matter what the strike price.

4- Early assignment is not an issue for CC writers because the option premium is not affected and possible additional upside appreciation is incorporated into your profits if an O-T-M strike was sold. For naked put sellers, early assignment could be a disaster. Imagine a stock gapping down, and the stock “put” to us at the $30 strike. The stock is plummeting and heading for the teens! The put seller wants to sell the stock before it loses more ground but perhaps the shares haven’t even hit his account yet. He may have to wait until the next day to sell the shares. One way of getting around this issue is to sell the shares short (selling before actually owning them). The problem with this solution is that average... investors will have a difficult time getting “shorting privileges” from their brokerage firm and may lack the sophistication necessary to manage such situations. Besides, who needs the headaches?

There are a couple of points here:

a) It's true that the naked put might be assigned early if there is zero extrinsic value, however the short put will have a delta of +1, or very close to it, and will be trading like the stock anyway. This will put the trader in a position of a substantial open loss for sure, but the author neglects to inform the reader that the covered call will be in the identical position of a large open loss. Once again, the positions will be the same.

b) The suggested response of shorting stock is incorrect for the stated goal of exiting the position, as you don't know if and/or when you will be assigned. You may just be flipping your deltas and have an open synthetic short call. That's not what the author intended. There is no law that says you have to hold the put till expiry or assignment. The best response if you want to exit the trade before possibly being assigned is just buy back the written put.

5- Those interested in option investing in tax sheltered accounts, will have an easier time establishing such accounts using covered call writing than any other form of options trading.

This isn't my field, but I am led to believe that cash covered naked puts are permissable in such tax sheltered accounts.

If people really want to trade covered calls over naked puts, fine, there may be valid reasons as I stated in my earlier article. No skin off my nose, but let's not justify it with misinformation and bullshit.

Options and the Unconscious Competent

In other technical fields, I often heard of experts speak of the phases of skill progression from novice to expert, invariably stated as having four phases as below:

1. Unconscious Incompetent
2. Conscious Incompetent
3. Conscious Competent
4. Unconscious Competent

It's a fancy way of saying that you progress from an idiot, to knowing what you're doing without thinking. The unconscious competent is that individual that acts and reacts from second nature without having to think first. A kung fu master has hundreds of complicated techniques as his disposal that are second nature, due to thousands upon thousands of hours of practice. A master tradesman can be thinking about the hot looking woman that just walked past while he works; he is creating his work without thinking about it.

(N.B. I use the male gender generically and of course include females in this discussion)

Options trading is of course no different and it is the aim of any non-delusional individual to progress to the Unconscious Competent stage; just knowing what to do at any point, quickly, without an over reliance on software, calculators and suchlike.

The unconscious competent can have been in such a state for so long, that he no longer realizes what knowledge he is actually using.

An illustration of this point came up on a discussion forum recently. The question was asked, can you be successful without regard to the Greeks? Various points of view were put forth, but the one that interested me was from an ex-institutional trader with decades of high level experience. He thought that Greeks were not necessary for simple directional strategies.

I questioned whether he in fact had a mental map of option pricing that was so ingrained, that perhaps had a "picture" of the Greeks that he used without thinking about it, even with simple strategies. At first he didn't think so, but later reversed that opinion and agreed.

That man is an unconscious competent. Options trading is just second nature, to the point that he doesn't even have to think about it. This is the state all will aspire to and achieve given the correct knowledge/education. This is actually easier said than done as there is soooo much erroneous information and truly worthless (and very bloomin' expensive) options education programs out there.

Getting to the Conscious Competent stage for a retail trader is harder than many imagine, that is, getting the correct grounding in options theory and pricing. So many crash and burn from being taught BS.

Every options education program, whether in book form or CD/Internet course needs to be marketed in order to attract clients; and the trainers will require remuneration for their efforts.

But how does the options neophyte sort the good from the bad and the truly ugly?

Even good programs will indulge in a certain level of hype. This is the reality of marketing, "warts and all" reality just won't sell well. But on the other hand, what seems to good to be true, probably is. This is the sort of thing I have bagging out recently, the total BS claims and totally erroneous and inaccurate, even mischievously outrageous claims.

I guess it boils down to avoiding the worst of the hype and being somewhat skeptical, perhaps even cynical when evaluating a potential information vendor.

Be careful out there. Marketers are master psychologists (unconscious competents) and work on your base emotions rather than your intellect. Some of the worst programs are the most absolutely taleted marketers, because they appeal to those most powerful of financial market emotions, fear and greed.

American vs Euro Double Take

As I trawl around the options universe I see many statements from the erroneous to the downright dishonest. Occasionally there are statements from ersatz options "experts" that even make me do a double take, so stunning are they in their cretinous ignorance.

Behold the latest example, from someone selling information, producing videos etc:

American vs. European style options:

American style options such as OEX or SPY can be traded anytime. European style options can not be closed until their expiration date. I prefer to trade American style options since I can buy and sell them out when I want.

LMAO

Of course European style options can be traded into and out of, anytime, just as American style options can. Jesus! We ALL know that one don't we? (For the newbies reading this, American or European style refers to when options can be exercised, not whether they can be closed out or not.)

Further down the page, we are served up this little beauty, in big bold type:

Turn $1000 into $124,000 in One Year!!!

Where do I sign?

Credit Spread Nonsense

In keeping with my current fetish for trying to bust a few nonsensical myths and mistruths with premium collection strategies, I guess I've turned my attention to credit spreads.

Look! Credit spreads are a good strategy, one good strategy, one of any number of good strategies. I use them when I think they are the right strategy to use. What makes me lose the will to live is the bullshit that emanates from ersatz experts and course spruikers.

N.B. I have nothing against education courses at all. There are a few good ones I'll never criticize, but they are outnumbered by some truly odious and dangerous programs inflicted on innocent neophyte option traders... usually at vast expense.

To subject (sent via email so unable to attribute) of my ire today, which resulted in a distinctly forehead shaped dent in my desk, behold:

The beauty of option trading is that it opens up a lot of alternative ways building wealth from the stock market. Recent events have shown that the "buy-and-hold" approach to stock trading carries substantial risk. With a volatile market, a safe "in-and-out" approach is much more desirable. Of all the option trading strategies available, trading credit spreads is by far the safest and simplest method. It has a risk profile significantly lower than stock trading, and it offers much better profit than any type of stock trading strategy around.

Selling credit spreads takes advantage of the fact that the value of any option declines as the expiry date of the option approaches. It does this particularly fast during the last 30 days of the life of the option. It has been said that 90% of option buyers lose their money. This means that those who sold the options to those unfortunate buyers win 90% of the time!

What are the advantages of credit spread trading?

• It is short term - trades are typically less than 30 days in duration, and take advantage of short term trends in the market;
• It is low risk - trades have a better than 90% of success - always! You know exactly what the risk, return and profit will be before you enter a trade - there is no guess work.
• Profit is up front - a trader gets his profit immediately, and only needs to protect that profit for a short period;
• Market fluctuations are mostly irrelevant. The market can continue its trend, stagnate, or even turn against you to a certain extent, and your profit is completely safe and untouchable.
• Simple technical analysis - other options trading strategies (and stock trading) require intense fundamental and technical analysis, significant understanding of the market, and the ability to "beat the news". Selling Credit spreads needs a very simple trend analysis procedure, which should not take longer than 10 minutes a day, and the ability to plan for upcoming events such as earnings reports.
• Time spent in monitoring the trade is very low;
• Profits range between 5% and 20% per month, depending on how actively the spreads are traded. Compounded, this leads to significant growth in a profile. Starting with $1,000 and gaining a steady but sure 15% per month, you can get your first million dollars in four years, without deductions for ulcer treatment.

What do you need in order to start building wealth by selling credit spreads?
you need an account with an options trading broker such as Thinkorswim or OptionsXpress.
you need a minimum balance of $1,000, in order to cover margin requirements for selling credit spreads.
you need to be able to identify a trend in the market and in your chosen stock.
you need to be able to look ahead for predictable events such as earning reports and dividend payments.
you need about 15 minutes per week.
...and that's it!
You do not need nuclear physics degree in fundamental and technical analysis; you do not need to spend hours pouring over graphs and indicators; you do not need to go bald, get an ulcer or a heart condition; and you definitely do not need to pander to your obsessive compulsion to constantly monitor your trade, making fiddly adjustments on the way!

Selling credit spreads is an excellent method for those who are committed to a safe, steady approach to building wealth.

I sell credit spreads every month, and even when a very few trades have gone against me, I still build an average 15-20% growth on my portfolio each month.

Hallelujah! The Holy Grail found! Gold, Frankincense and Myrrh for all! If your still with me, indulge me in a point by point fisking:

The beauty of option trading is that it opens up a lot of alternative ways building wealth from the stock market.

A good start for the writer here, this is exactly the reason we option traders trade options rather than the underlying stocks. Unfortunately, it's all downhill from here.

Recent events have shown that the "buy-and-hold" approach to stock trading carries substantial risk.

Well, yes, but wait for the rest.

With a volatile market, a safe "in-and-out" approach is much more desirable.

Why is it more desirable? It might be for the author and it might be for me, but it might be the antithesis of what is desirable for somebody else, depending on innumerable factors.

Of all the option trading strategies available, trading credit spreads is by far the safest and simplest method.

How so? Simplest? So a two legged strategy is simpler than a simple bought option? Safest? How does he/she quantify safe? Considering that one can put their entire capital at risk in one trade, with some probabilty of a maximum loss, I violently disagree. Most strategies are safe if used safely, i.e. with proper position sizing. All strategies, including credit spreads, are unsafe if used with too much size/leverage.

It has a risk profile significantly lower than stock trading, and it offers much better profit than any type of stock trading strategy around.

This is about the point where my forehead first hit my desk with some velocity. Without going into mathematics and payoff diagrams, this is a truly pukeworthy statement. Much better profit? Credit spreads offer a "different" risk/reward/probability profile which may be better in certain circumstances but not others. Stock going sideways? Sure, give me a credit spread or related strategy. Stock about to go to the moon? I'll take the stock, or perhaps some call options thanks.

Selling credit spreads takes advantage of the fact that the value of any option declines as the expiry date of the option approaches. It does this particularly fast during the last 30 days of the life of the option.

This person has obviously never heard of delta/gamma. True, extrinsic value, in simplistic terms, declines, but what about intrinsic value? I want to ask this person if he/she thinks the value of the put option he/she just sold is going to be worth less if $10 in the money at expiry.

It has been said that 90% of option buyers lose their money. This means that those who sold the options to those unfortunate buyers win 90% of the time!

Just disingenuous bullshit. Even the standard myth only says 80%. The truth is somewhat different and more complex. For another post maybe.

It is short term - trades are typically less than 30 days in duration, and take advantage of short term trends in the market;

Yes short term, but the preceding statement says this person is trading OTM credit spreads. If I want to trade short term trends, I'll pick an entirely different strategy. OTM Credit spreads are best for non-trends or slow trends. If you're trying to trade a trend and still want a vertical spread, go an ATM debit spread.

It is low risk - trades have a better than 90% of success - always! You know exactly what the risk, return and profit will be before you enter a trade - there is no guess work.

Well I don't know about low risk, there is a higher probability, but also a very low reward compared to the outright risk. Again that's OK, if it suits your view. But a credit spread constructed with 90% theoretical probability is going to be extremely skinny on the nett credit. As far as "always", a truly risible statement.

Profit is up front - a trader gets his profit immediately, and only needs to protect that profit for a short period;

Oh brother!! The old credit is better than a debit fallacy. I wonder if this person ever tried to spend that up front profit? I wonder if he/she ever looked at their margin statement. I think these are best constructed as credit spread, but for completely different reasons than the up front credit. The credit is *irrelevent*. It is the positive theta one is trying to trade here while hoping not to get crunched by the other greeks. Positive theta, AKA premium collection, can still be acheived with an initial debit.

Market fluctuations are mostly irrelevant. The market can continue its trend, stagnate, or even turn against you to a certain extent, and your profit is completely safe and untouchable.

This one is kind of half true. Provided that the underlying doesn't close ITM on the sold option, you keep the credit. In the intervening period however, you can be deep in a hole if the stock is moving against you. The profit is most certainly not safe as you are then in a position of hope. An exit or adjustment is going to cost.

Simple technical analysis - other options trading strategies (and stock trading) require intense fundamental and technical analysis, significant understanding of the market, and the ability to "beat the news". Selling Credit spreads needs a very simple trend analysis procedure, which should not take longer than 10 minutes a day, and the ability to plan for upcoming events such as earnings reports.

What can I say.... this is just nonsense. A simple approach may work, indeed it does. But a simple laissez faire TA approach is not going to give you 90% probability spreads.

Profits range between 5% and 20% per month, depending on how actively the spreads are traded. Compounded, this leads to significant growth in a profile. Starting with $1,000 and gaining a steady but sure 15% per month, you can get your first million dollars in four years, without deductions for ulcer treatment.

[sigh] The BS just doesn't stop! I'm weary, I've had enough of this. Maybe I'll continue this once I've recovered from concussion

WTF are "Normal Conditions" Uncle Ben?

Well I got a timely kick up the arse for not keeping up this blog, so an update from my cognitively biased point of view. (... and you think you're not? LOL)

Of course, in the intervening time I've had a fiddle with my blog template, as I do. And also of course, I've fucked everything up, as I do. LOL! So now I have to rebuild my blogroll and all the other shit I had in my sidebars. Anyway, I digress.

Interesting article at CNBCs site today... actually it wasn't interesting at all, more speculation of interest rate cuts and all is going to be OK nonsense. Read it here. The statement that caught my eye was this:

Bernanke and his central bank colleagues "expected a return to more normal market conditions," but they recognized that might not be the case, according to minutes of the closed-door meeting released on Tuesday.

I thought to myself: What the fuck are "more normal market conditions" then? Resumption of the bubble economy, the Goldilocks fairytale, the ridiculous discounting of risk?

Apart from the credit market problems as highlighted by the Cramer buffoon a couple of weeks ago, a 10% correction in the stock market every now and then is pretty much..... ummm, normal. What is abnormal is how easy it is, still, to get credit. at least in this country and the UK. It's abnormal that asset values are so fucking stretched (and don't give me the "stocks are cheap" bullshit; they aren't), particularly real estate.

I still don't think there will be a "crash". The goverments' (plural) willingness to intervene is all too apparent and obvious, that is unless something big-time happens. However I would be surprised to see a new high for a while.

Meanwile the stock market has provided a few nice short swing setups. That always make a bear happy.

A Change

Hi Folk, (This is not a typo, there is only one person tenacious enough to check this blog for new posts. That's my wife... and only cause I just told her.)

As intimated in an earlier post, I've been moving in the direction of commodity trading. I've been dabbling in commodities for some time while predominantly trading stock options, but over the last year things have changed. I've become predominantly a commodities trader who dabbles in a few stocks and their options.

There are a few reasons for this which I won't bore you with right now, but mainly I am attracted by the non-correlated returns offered by non-related commodities and financial futures.

You will have also noticed that I've changed the name of the blog. Obviously I wanted to reflect my change of direction, but also to out myself as a bear. (Those that know me know this already) "Trading the Apocalypse" seemed to reflect all the bullshit happening in the world right now. Wars, global warming, terrorism, mortgage fiascos, perpetual bubbles waiting to pop, all point to some "exciting times in the near future. Perhaps an apocalypse? Perhaps not. LOL

So what I want to do here is comment on whats happening in the various markets; of course throw up some charts on the action as well, nothing new there. But maybe I'll have a bit of a vent every now and again, bitch about house prices, make enemies on the other side of the political spectrum (wherever that lies), give out fuckwit awards, stuff like that.

Maybe even a stock of the day once in a while.

Anyway, this is purely for my enjoyment and as an outlet for my frustrations. If you feel like joining in (that is, if anyone apart from my Mrs reads this) please do so.

Margin Hysteria Rules

Many folks are all a-flutter over the new Margin rules that set to be introduced this April. Most of the hype seems to centred around the leverage available under new rules.

Hitherto unavailable leverage IS available on a some strategies, most notably, buy/writes. But the most amusing thing is ersatz experts waxing lyrical about this amaaaaaaazing leverage now available on such things as married puts and collars.

This really ignores simple synthetic relationships between strategies. Possibly intentionally.

For instance, I read one post on a bulletin board from an allegedly ex-market maker, extolling the virtues of the new leverage married puts will have. Well excuse me, but a married put is just a blinkin' synthetic call! The leverage has been available all along!

It has gotten the stage where folks are predicting either 1/ a leveraged, LCTM style perfect storm, taking out the whole market, or 2/ an incredible bullish flourish as all and sundry massively add to their portfolios, courtesy of this "new" leverage.

I'm predicting business as usual with some small scale stupidty around the edges, just like normal LOL