What Exactly is Option Trading?

A Fascinating Friday ! That’s how I can think about Market’s action on Friday. Option trading is not only about attending a seminar, do some paper trades, get some winning trades and the stage is set. It is also about constantly evolving your own trading style and continue to sharpen your saw. With this post I hope you pick up one or two important nuggets that might add value to your trading style, so pls just relax and continue to read.

First a simple one VIX– I mentioned on April 15, that I was not convinced of rally when markets are overbought for 6 continuous weeks; and shared my bias for bearish stand via $VIX bullish spreads.  Those OPN Members who followed it generated about +28.5% returns for 2 days holding. It could have been done with straight calls, but I wanted to minimize risk exposure without compromising delta.

The King of Earnings- Google (GOOG)
It was once in 6 months (if not 3) type event i.e. earning announcement just before Option Expiration. Those who have been with OPNewsletter for past 3 years, or at least have been reading OptionPundit blog, know how much I love trading Google.

To begin with, I shared 4 different types of trades that could have been done on Google. Nothing much has changed Feb’07. However, this time, for OPNewsletter members I used one of my high yield/low risk/technical/intuition based strategy, Double Butterfly. We opened Google 540/550/560 Put Butterfly and 600/610/620 Call butterfly; for roughly $1.40 to $1.70 price combined.

Google opened at $568 thus panicking some members, as it means 100% “potential loss” on this speculative trade. Based on “what if” scenarios I shared before markets opened, few members could still get out of the trade in “style” for break even or minor gains/loss even though Google was still out of our profit zone.

But guess what, Google was pinned at $550, those who held till close, yielding almost +588% gains!!!

But that’s not the end of the story, I traded Google almost live (though not recommended to members). I kept on switching between Calls and puts, resulting into +46% gains (bearish), then +21% (Bullish), then +95% (bearish), then +54.6%, (Bullish) then -12% loss (Bullish). Those who were following the thread live and could trade speculative (though not intended), could have still converted $1 into $10 by the end of the day!

Google again, 95% gains; again out, i need to see if it can hold $560, if not, next may be $557…i am sharing almost real time to share how quickly i am changing my opinions….pls note, at one time, i have only one direction either bearish or bullish..i am not mixing two..(i have already close the 550 puts (i further broke the Bull put spread into individual options leg and purchased the short 550 puts, and still kept the 540 puts)

added later, by the time i finished my msg, google was already below $556 and those puts were already quadrupled.

Here is the screenshot of key trades I mentioned above-

We didn’t even touch on Google Stock pinning as otherwise it would have just too much of trading to handle for a single trading day. Here are some excellent reads for OPNewsletter members on how to successfully play stock pinning, especially on Google. I also run a separate experiment (income trading strategy) with Google for following set of conditions – 1) Expiration week, 2) Earnings in that week but before expiration day; the gains were +18% within a few days even though google moved significantly against the “market neutral” strategy, before the earning day. I shall share this in another post.

Here is another example of ISRG–

Another stock I am looking at is ISRG, I had expected it to move about $20-$25, but it hasn’t…I don’t know if it will if drops below $372…I didn’t share it yesterday (i mentioned my bias on twitter though– http://twitter.com/OptionPundit/status/12171040022 ) as the options are not very liquid.

ISRG closed at $360.39!! I am not mentioning Goldman Sachs (GS).

Now the key points, why am I sharing all this? Recall back in early 2008 I shared on key factors that contributed to a record year (till then) for OptionPundit. Here are some additional thoughts.

The Formula for Long Term Success
Speculative trades should only be done with what you can feel comfortable losing, I must add, losing 100%. This is not income trading which many OPNewsletter members trade with over $100,000 and anything x 0=0

This is a high risk/high yield scenario. The formula of long term success is

Long Term Success = (Profit $$ x Winning Trades) > (Loss $$ x Losing Trades)

Don’t be stubborn with your opinion–
One shouldn’t marry to a single opinion. Markets can humble anyone, anytime and it has demonstrated time and again. No one will always be right else there won’t be a trading market. Keep agility and flexibility as your competitive advantage. Remember, the end goal is not to be right rather it is to make money. I encourage OPNMembers to re-read the whole speculative thread (May 2010) how often I changed my opinion between bullish and bearish, the same day, often in less than 30mins.

Trade with a plan and be nimble
I didn’t send alerts for these Google trades for OPNewsletter Members, only demonstration. I don’t put stop loss on the screen as I don’t want it to be shown to brokers. I keep a mental stop loss and write it down and close it. Why am I sharing this? Because one may say, with “hindsight bias”, that there was no need to trade so much, you would have made a 1000% gains (10times) if you just held those 560 puts till expiration; I was not in for a 1000% gains, I was trading and time value was against me, and I was just following my trading plan.

Option Trading is both Art and Math
The twin butterfly we opened would have been a 100% loss if Google were to close above $560. But breaking the flies into vertical spread, then finally into singles achieved great result for even those who panicked and wanted to get out to collect “whatever” was left. Options are very versatile, so just don’t 100% loss. Create “what if” scenarios for if it goes up, goes down or move sideways. No one is much more in touch with your trades as you are and hence prepare in advance yourself and don’t just panic. Panic never helps, it about keeping the big picture mind and bringing that to trading world. Trading is equally tough like any other business, if not more.

Here are some additional thoughts on how to become a more profitable trader.

More trades to come. There are more companies announcing earnings in next few weeks so stay Tuned,

Profitable trading, OP