BetterTrades

Consider Calendar Spreads in Unpredictable Markets

When I'm out teaching my trading methods, one of the most common complaints I hear is about market unpredictability. A lot of times when you

think the market is going to go up, you'll play it in an upward fashion and it goes down. Likewise, a lot of times when you think the market is going to go down, you'll play it in a downward fashion and it goes up.  The bottom line is the market is very unpredictable and it's difficult to predict what the market is going to do on a day-to-day basis. It can be very difficult to know what to expect out of the market in the future. That's one reason that credit spreads have rapidly gained popularity among traders. The best way I've learned to sidestep the unpredictability is to trade credit spreads. Why do I teach this method?

Credit spreads give you the potential to make my money up front. You  get paid a credit or a premium when you  get into the trade. Many  people like this better than waiting until the end of the trade to collect the money.

You can look at the trade and determine whether the trade is worth the risk. This gives you the opportunity to nail down the odds of profitability and determine how likely it will be to make a profit on a particular trade.

Probably the biggest reason is it simply allows a lot of room for error. You have a lot of room to be wrong, a lot of room to make mistakes, a lot of room for the trade to go against you and still make a profit.

You can also share the maintenance costs. You can get into one trade and get paid to get into that one trade, and then enter other trades for free.

Credit spreads are the basis for many other trading strategies and styles. With proper training you can learn to use credit spreads to gain extraordinary returns. I believe you'll find credit spreads may be the sort of low-risk, low-maintenance strategy you need that can still provide profitable returns.

Keep Feelings Out of Trading

Take a second to look at the 'choices' you have presented to you in the buttons below. Pay particularly close attention to the 'feelings' reading each button label engenders.

Buy Quickly!  How does that make you feel?  Did you recognize an urge to 'get in on the ground floor ... before the opportunity is gone?

Sell Immediately!  Are you moved to quickly avoid some pending 'disaster'?

Think About It ...  Do you notice a perceptible calming, almost reassuring feeling that everything will be 'okay'?

If you felt any of these feelings, you felt  emotions which were generated by stimuli which had their origins in things having absolutely NO significance to anything real or genuine in your life right now.  Rather, the stimulus evoking these feeling were attached to prior experiences.  Unrelated to present situations, your past experiences 'colored' your perceptions of the present.  Under the right circumstances, that can be a good thing.  It's important to be able to recognize when opportunity or danger is present so you can react accordingly. However, it is critical in our trading to be able to control these emotions and recognize to what degree they can adversely affect our trading decisions.  If you've ever been in a trade which you have later looked back and asked "WHY did I do that...?" then you've probably experienced what I'm talking about.  Emotions and trading simply don't mix profitably!

I see the effects which emotions can have on trading frequently  New traders are particularly susceptible to this phenomenon and often have to be constantly  brought back to 'reality'.  To avoid even getting into these situations, I use a daily trading plan.

This plan is a complete outline of "how, when and if" to enter the trade, what we'll do while IN the trade and how and when to exit the trade.

Give yourself a set of guidelines for what do "If ....", helping you to avoid those situations which can generate a lot of emotion!

Revisiting Calls and Puts

The basis for learning to trade options in the stock market is the understanding of how to buy and sell calls and puts. The average investor, many who are only involved strictly with stock transactions, may have never even heard of the teams. But calls and puts are the basis of options trading and traders need a thorough grasp of how they work before they can be effectively used in the market.

An option gives an individual the right, but not the obligation, to buy or sell a stock at a specific price on (or before) a specific date.

If a trader believes the stock or index being traded will increase in value, they will buy a call option. If the stock price rises, the value of the call option will rise, too. If the stock price falls, the value of the call option will fall with it.

If a trader believes the stock or index being traded will decrease in value, they will buy a put option. If the stock price falls, the value of the put option will increase. If they are wrong and the stock price rises, the value of the put option will decrease in value.

Don't be confused. Consider this simple to remember a call from a put. When you make a phone CALL, you pick UP the phone. Then you PUT the phone DOWN to end the call.

Buying and selling calls and puts gives a trader more investment options than are available from only trading stocks. There are options strategies that work when the market goes up and down, as well as on the occasion when the market is stuck in place. Knowing how it works is the key to potential success.

There are several differences between trading stock and trading options that must be understood before a person can decide to get involved.

Stocks may be traded in any number of shares, while options are only sold in contracts, a unit that controls 100 shares of stock. A person who owns five contracts controls 500 shares of the company's stock.

Stocks may be traded at any price point, depending on the perceived value of the company to the buyer and seller. Options are only traded at predetermined price points, known as the strike price. This is the agree-upon purchase or sale price for the underlying equity for which an option is bought.

The biggest difference is the fact that options have a limited shelf life. A share of stock is good for as long as it is owned, providing the company is still in business. But an option has a date at which it becomes worthless, a predetermined time known as expiration day. If a trader doesn't buy or sell the option prior to this date, the option expires worthless. This time element is important to remember when learning to trade calls and puts.

Setting a Stop using Average True Range

One of the most important aspects of successful trading is not the strategy itself. That will either work or it won’t (all things being equal).  We have a 50 / 50 chance either way.  While perhaps not mathematically accurate, that pretty well captures the spirit of my point; we exercise precious little control (as in NONE) over how our stocks move.  We ALL have losses from time to time.  It’s a fact of trading life!

That being a given,  one of the most critical aspects of successful trading is to control any LOSSES we might be facing.  Obviously, it is in our best interest to minimize those losses as much as we can. Minimizing losses is important to be sure, but to complete the picture of successful trading, we cannot ignore the other eventuality; the profits.  While minimizing our losses, we need to maximize these profits.  The system used by most new traders for managing their positions is the ‘watch and see’ method.  That is, they put a trade into place and ‘watch and see’ what it does.  While it sounds like the right thing to do, it has one factor involved which works against it … US! Being emotional by nature, we are all prone to the challenges and ‘misfires’ which often occur in manually managed trades.  You know … you BUY when you should SELL and SELL when you should BUY.  We all come equipped with that ability!

The European Style of options

A European option is different from an American-style option in that it can only be exercised at the end of the trade. It may not be sold before the expiration date, which could lead to better trades. The European option does not hold an advantage or disadvantage over other styles of options, but are simply an alternative form of trading.

This subject will be covered in depth when BetterTrades trading education coach John White teaches his "Flying With Condors" class on Thursday, Dec. 10, at 8 p.m.

If you own a European style option and want to remove it from your portfolio, the option must be sold.

The drawback is the inability to exit the trade if the highest profit comes prior to expiration date.  This is quite different than at American option, which can be sold at any time to capture the most profit. But the European style option is certainly simpler to understand, especially for the newcomer to better trades.

European options are all cash settled. Depending on the strategies you use, it’s typically more convenient when options settle in cash.

American options settle at the closing price on the third Friday of the month. The European options are determined by the price of each component of the index when it opens for trading on the morning of the third Friday. Since you never know where the market will open, options that seemed ready to expire worthless can suddenly become worth hundreds or thousands of dollars. Because of the risk involved, many observers believe it’s better to cover any short positions before the market closes on Thursday before expiration.

European options are generally traded over the counter, although some trade on exchanges. To make better trades using European options, a trader will need to establish a margin account through a broker.