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AnonymousLet assume we have bought XX/YY Call spread .in case the stock is trading at or above the YY price.please help me to understand when to come out of this trade to avoid any related risk and when to lock in max profit?
Buying a call spread is a great way to not only define risk but to also reduce the overall cost of the trade.
Let’s assume I bought a 120/130 call spread and I paid 3.00 for the spread. My Max Risk in the trade is what I paid for it or $300. My Max Reward in the trade is the difference between strikes minus what I paid for the spread or $700 ($1000-$300).
Here’s what Risk Profile of a long call spread with 33 days until expiration looks like:
As we can see, the Max Reward is only achieved at expiration when there’s no extrinsic value (time premium) left in the trade.
As far as risk goes, there’s a very small chance that a short 130 call may be assigned. If this was to happen before expiration, the long 120 call would cover the short position after the assignment.
The chance of early assignment is very small because a call owner would be giving up all of the time premium left in the option. Another reason this would be unlikely with high priced stocks is that the call owner would have to come up with a significant amount of capital to take delivery of the shares. Think about someone exercising their right to own 100 shares of GOOGL (Google trading at 1516) and having to come up with $151,600 just to take delivery. It is more advantageous for them to just sell the call unless they specifically want to own the stock. The only reason someone would exercise their right early and take delivery of the stock is if there was a dividend that they wanted to capture and needed to be the owner of the record before the ex-dividend date.
RUT at 1489
I’m going to add a balanced butterfly, centered at 1460 with 60 point wings. This will re-balance NET delta to slightly negative and boost theta.
Order Ticket Type Asset Duration Strike C/P BTO RUT 31AUG 1520 PUT STO X2 RUT 31AUG 1460 PUT BTO RUT 31AUG 1400 PUT Total Debit: 8.65
AnonymousWhile option prices are based off stock prices, option and stock trading are two vastly different things. A buy and hold long-term investor does not have to worry about volatility. Option traders, on the other hand, need to be mindful of expiration dates, making volatility key. Option prices consist not only of intrinsic value, but also of time value. The time value varies from stock to stock, but it determines the implied volatility. The stock move must overcome this time value for the option to make a profit, and the move must occur before the expiration date.
Established large-cap companies typically have cheap options, while smaller, more speculative companies generally have expensive options. The example below clarifies that point. There is more certainty in the fundamental performance of Coca-Cola (KO) than Live Nation Entertainment (LYV), so KO will have cheaper options. These two stocks, as of mid-day yesterday, were essentially the same price, right around the $46 mark. The table below compares the 45-strike call option that expires on 7/17/2020 for each stock. The implied volatility on the LYV call option is two and a half times the implied volatility on the KO call option. Thus, for the KO call option to break even, the stock only needs to increase by about 2% before the expiration date. For LYV, however, the required stock move is more than three times that amount, at 6.4%.
Why would anyone choose a LYV call option over a KO call option? For one, the higher implied volatility means LYV is expected to trade in a much wider range than KO. In other words, there is a higher probability of a big stock move in LYV.
That is the trade-off option players make. They can buy a low-priced option that profits handsomely on a relatively small move by the stock, or they can buy a high-priced option on a stock that needs to make a sizable move, but the potential for that sizable move is greater. In the analysis below, I show the challenges that high implied volatility present option traders to see if one of those trade-offs has worked out better over the past year.
The table below perfectly sums up the difference between option trading and stock trading. It also shows the massive effect of option prices on option returns. Since we are 16 trading days from the regular July monthly expiration date (7/17/2020), I looked at stock and option return for 16-day periods before other expiration dates. In the June expiration cycle, the S&P 500 Index (SPX) gained 2.2% in the 16 days before expiration. This was like the market return in the 16 trading days before the December expiration, in which the S&P 500 gained 2.4%. The trading environment, however, was completely different. In December 2019, markets were relatively calm and had been steadily climbing for a few months. More recently, the S&P 500 is coming off one of its worst, then best short-term performances ever. Option prices, therefore, have been much more expensive.
Finally, we can take a look at these numbers. I am comparing the returns of at-the-money call options of S&P 500 stocks in the 16 days before expiration. The options were a lot cheaper in December of 2019, with the stocks having an average implied volatility of 22%. In June, the implied volatilities nearly doubled, averaging 43%. Holding the stocks, a trader would have gained about 2.08% in December and 2.44% in June. For stock traders, there wasn’t much of a difference between these time frames. Now, look at the average return on the call options. The average call option would have gained 21% on that 2% gain in December of 2019. This demonstrates the leverage you can gain using options. Then in June, with a similar stock return, the call options lost an average of 21%.
In other words, doubling of the implied volatilities was extremely damaging for the option returns. Nearly half of the call options would have been profitable in December of 2019, but only around 30% were profitable this past June. Similarly, over a quarter of the call options would have gained 100% or more in the low-volatility environment of last December, but only 13% would have doubled in June with more expensive options.
AnonymousFibonacci Retracement Levels
What Are Fibonacci Retracement Levels?
Fibonacci retracement levels are horizontal lines that indicate where support and resistance are likely to occur. They are based on Fibonacci numbers. Each level is associated with a percentage. The percentage is how much of a prior move the price has retraced. The Fibonacci retracement levels are 23.6%, 38.2%, 61.8%, and 78.6%. While not officially a Fibonacci ratio, 50% is also used.The indicator is useful because it can be drawn between any two significant price points, such as a high and a low. The indicator will then create the levels between those two points.
Suppose the price of a stock rises $10 and then drops $2.36. In that case, it has retraced 23.6%, which is a Fibonacci number. Fibonacci numbers are found throughout nature. Therefore, many traders believe that these numbers also have relevance in financial markets.
KEY TAKEAWAYS
Fibonacci retracement levels connect any two points that the trader views as relevant, typically a high point and a low point.
The percentage levels provided are areas where the price could stall or reverse.
The most commonly used ratios include 23.6%, 38.2%, 50%, 61.8%, and 78.6%.
These levels should not be relied on exclusively, so it is dangerous to assume the price will reverse after hitting a specific Fibonacci level.
The Formula for a Fibonacci Retracement Level
Fibonacci retracement levels do not have formulas. When these indicators are applied to a chart, the user chooses two points. Once those two points are chosen, the lines are drawn at percentages of that move.Suppose the price rises from $10 to $15, and these two price levels are the points used to draw the retracement indicator. Then, the 23.6% level will be at $13.82 ($15 – ($5 x 0.236) = $13.82). The 50% level will be at $12.50 ($15 – ($5 x 0.5) = $12.50).
How to Calculate Fibonacci Retracement Levels?
As discussed above, there is nothing to calculate when it comes to Fibonacci retracement levels. They are simply percentages of whatever price range is chosen.However, the origin of the Fibonacci numbers is fascinating. They are based on something called the Golden Ratio. Start a sequence of numbers with zero and one. Then, keep adding the prior two numbers to get a number string like this:
0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987… with the string continuing indefinitely.
The Fibonacci retracement levels are all derived from this number string. After the sequence gets going, dividing one number by the next number yields 0.618, or 61.8%. Divide a number by the second number to its right, and the result is 0.382 or 38.2%. All the ratios, except for 50% (since it is not an official Fibonacci number), are based on some mathematical calculation involving this number string.Interestingly, the Golden Ratio of 0.618 or 1.618 is found in sunflowers, galaxy formations, shells, historical artifacts, and architecture.
What are Fibonacci Extensions?
Fibonacci extensions are a tool that traders can use to establish profit targets or estimate how far a price may travel after a retracement/pullback is finished. Extension levels are also possible areas where the price may reverse.Extensions are drawn on a chart, marking price levels of possible importance. These levels are based on Fibonacci ratios (as percentages) and the size of the price move the indicator is being applied to.
Fibonacci Retracements Thinkorswim
Fibonacci Extensions Thinkorswim
KEY TAKEAWAYS
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Common Fibonacci extension levels are 61.8%, 100%, 161.8%, 200%, and 261.8%.
The Fibonacci extensions show how far the next price wave could move following a pullback.
Fibonacci ratios are common in everyday life, seen in galaxy formations, architecture, as well as how some plants grow. Therefore, some traders believe these common ratios may also have significance in the financial markets.
Extension levels signal possible areas of importance, but should not be relied on exclusively.
The Formula For Fibonacci Extensions
Fibonacci extensions don’t have a formula. When the indicator is applied to a chart the trader chooses three points. Once the three points are chosen, the lines are drawn at percentages of that move. The first point chosen is the start of a move, the second point is the end of a move, and the third point is the end of the retracement against that move. The extensions then help project where the price could go next.How to Calculate Fibonacci Retracement Levels
Multiply the difference between points one and two by any of the ratios desired, such as 1.618 or 0.618. This gives you a dollar amount.
If projecting a price move higher, add the dollar amount above to the price at point three. If projecting a price move lower, subtract the dollar amount from step one from the price at point three.
For example, if the price moves from $10 to $20, back to $15, $10 could be point one, $20 point two, and $15 point three. The Fibonacci levels will then be projected out above $15, providing levels to the upside of where the price could go next. If instead, the price drops, the indicator would need to be redrawn to accommodate the lower price at point three.If the price rises from $10 to $20, and these two price levels are points one and two used on the indicator, then the 61.8% level will be $6.18 (0.618 x $10) above the price chosen for point three. In this case, point three is $15, so the 61.8% extension level is $21.18 ($15 + $6.18). The 100% level is $10 above point three for an extension level of $25 ((1.0 x $10) + 15).
The ratios themselves are based on something called the Golden Ratio.
To learn about this ratio, start a sequence of numbers with zero and one, and then add the prior two numbers to end up with a number string like this:
0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987…
The Fibonacci extension levels are derived from this number string. Excluding the first few numbers, as the sequence gets going, if you divide one number by the prior number, you get a ratio approaching 1.618, such as dividing 233 by 144. Divide a number by two places to the left and the ratio approaches 2.618. Divide a number by three to the left and the ratio is 4.236.
The 100% and 200% levels are not official Fibonacci numbers, but they are useful since they project a similar move (or a multiple of it) to what just happened on the price chart.
What Do Fibonacci Extensions Tell You?
Fibonacci extensions are a way to establish price targets or find projected areas of support or resistance when the price is moving into an area where other methods of finding support or resistance are not applicable or evident.If the price moves through one extension level, it may continue moving toward the next. That said, Fibonacci extensions are areas of possible interest. The price may not stop and/or reverse right at the level, but the area around it may be important. For example, the price may move just past the 1.618 level, or pull up just shy of it, before changing directions.
If a trader is long on a stock and a new high occurs, the trader can use the Fibonacci extension levels for an idea of where the stock may go. The same is true for a trader who is short. Fibonacci extension levels can be calculated to give the trader ideas on profit target placement. The trader then has the option to decide whether to cover the position at that level.
Fibonacci extensions can be used for any time frame or in any market. Typically, clusters of Fibonacci levels indicate a price area that will be significant for the stock, and also for traders in their decision making. Since extension levels can be drawn on different price waves over time, when multiple levels from these different waves converge at one price, that could be a very important area.
The Difference Between Fibonacci Extensions and Fibonacci Retracements
While extensions show where the price will go following a retracement, Fibonacci retracement levels indicate how deep a retracement could be. In other words, Fibonacci retracements measure the pullbacks within a trend, while Fibonacci extensions measure the impulse waves in the direction of the trend.Limitations of Using Fibonacci Extensions
Fibonacci extensions are not meant to be the sole determinant of whether to buy or sell a stock. It is advisable for investors to use extensions along with other indicators or patterns when looking to determine one or multiple price targets. Candlestick patterns and price action are especially informative when trying to determine whether a stock is likely to reverse at the target price.There is no assurance price will reach and/or reverse at a given extension level. Even if it does, it is not evident before a trade is taken which Fibonacci extension level will be important. The price could move through many of the levels with ease, or not reach any of them.
SPX at 3238
I’m going to close this trade at close to 50% of max profit in 21 days.
Order Ticket Type Asset Duration Strike C/P Sell To Close SPX 31AUG 3475 Call Buy To Close SPX 31AUG 3450 Call Buy To Close SPX 31AUG 2800 Put Sell To Close SPX 31AUG 2775 Put Total Debit: 2.80 RUT at 1482
I’m going to scale in an Income Butterfly with 52 days until expiration.
I’m going to start with a 70X60 put butterfly centered at 1460.
I will add Tier 2 when RUT trades above 1500-1510 and will center T2 butterfly 20 points above Tier 1.
Order Ticket Type Asset Duration Strike C/P BTO RUT 18SEP 1520 PUT STO X2 RUT 18SEP 1460 PUT BTO RUT 18SEP 1390 PUT Total Debit: 5.50
AnonymousCan you explain the mechanics of butterflies at expiration if they are ITM? I know that OTM butterflies you can let expire worthless, but what happens if you have a butterfly ITM at expiration day and you’re trying to get a good price for it; is it possible for the short strikes to get assigned? How would that work in practice, since my understanding was that the long strikes “covered” your shorts? Same question for when your butterfly ends up deep ITM at expiration: is it possible to get the short strikes assigned, and if so, how do you deal with that?
AnonymousContaining fear and greed are key to making money
TABLE OF CONTENTS
• Making Snap Decisions
• Understanding Fear
• Overcoming Greed
• Setting Rules
• Conducting Research and Review
Many skills are required for trading successfully in the financial markets. They include the abilities to evaluate a company’s fundamentals and to determine the direction of a stock’s trend. But neither of these technical skills is as important as the trader’s mindset.
Containing emotion, thinking quickly, and exercising discipline are components of what we might call trading psychology.
There are two main emotions to understand and keep under control: fear and greed.
Snap Decisions
Traders often have to think fast and make quick decisions, darting in and out of stocks on short notice. To accomplish this, they need a certain presence of mind. They also need the discipline to stick with their own trading plans and know when to book profits and losses. Emotions simply cannot get in the way.KEY TAKEAWAYS
• Overall investor sentiment frequently drives market performance in directions that are at odds with the fundamentals.
• The successful investor controls fear and greed, the two human emotions that drive that sentiment.
• Understanding this can give you the discipline and objectivity needed to take advantage of others’ emotions.
Understanding Fear
When traders get bad news about a certain stock or about the economy in general, they naturally get scared. They may overreact and feel compelled to liquidate their holdings and sit on the cash, refraining from taking any more risks. If they do, they may avoid certain losses but may also miss out on some gains.
Traders need to understand what fear is: a natural reaction to a perceived threat. In this case, it’s a threat to their profit potential.
Quantifying the fear might help. Traders should consider just what they are afraid of, and why they are afraid of it. But that thinking should occur before the bad news, not in the middle of it.Fear and greed are the two visceral emotions to keep in control.
By thinking it through ahead of time, traders will know how they perceive events instinctively and react to them, and can move past the emotional response. Of course, this is not easy, but it’s necessary to the health of an investor’s portfolio, not to mention the investor.Overcoming Greed
There’s an old saying on Wall Street that “pigs get slaughtered.” This refers to the habit greedy investors have of hanging on to a winning position too long to get “every last” tick upward in price. Sooner or later, the trend reverses and the greedy get caught.
Greed is not easy to overcome. It’s often based on the instinct to do better, to get just a little more. A trader should learn to recognize this instinct and develop a trading plan based on rational thinking, not whims or instincts.
Setting Rules
A trader needs to create rules and follow them when the psychological crunch comes. Set out guidelines based on your risk-reward tolerance for when to enter a trade and when to exit it. Set a profit target and put a stop loss in place to take emotion out of the process.
In addition, you might decide which specific events, such as a positive or negative earnings release, should trigger a decision to buy or sell a stock.
It is wise to set limits on the maximum amount you are willing to win or lose in a day. If you hit the profit target, take the money, and run. If your losses hit a predetermined number, fold up your tent and go home.
Either way, you will live to trade another day.Conducting Research and Review
Traders need to become experts in the stocks and industries that interest them. Keep on top of the news, educate yourself and, if possible, go to trading seminars and attend conferences.
Devote as much time as possible to the research process. That means studying charts, speaking with management, reading trade journals, and doing other background work such as macroeconomic analysis or industry analysis.
Knowledge can also help overcome fear.Stay Flexible
It’s important for traders to remain flexible and consider experimenting from time to time. For example, you might consider using options to mitigate risk. One of the best ways a trader can learn is by experimenting (within reason). The experience may also help reduce emotional influences.
Finally, traders should periodically assess their own performances. In addition to reviewing their returns and individual positions, traders should reflect on how they prepared for a trading session, how up to date they are on the markets, and how they’re progressing in terms of ongoing education. This periodic assessment can help a trader correct mistakes, change bad habits, and enhance overall returns.
AnonymousThe Stop-Loss Order — Make Sure You Use It
With so many facets to look at and brood over when weighing a stock buy, it’s easy to forget about the little things. The stop-loss order is one of those little things, but it can also make a world of difference. Just about everybody can benefit from this tool in some way. Read on to find out why.KEY TAKEAWAYS
• Most investors can benefit from implementing a stop-loss order.
• A stop-loss is designed to limit an investor’s loss on a security position that makes an unfavorable move.
• One key advantage of using a stop-loss order is you don’t need to monitor your holdings daily.
• A disadvantage is that a short-term price fluctuation could activate the stop and trigger an unnecessary sale.What Is a Stop-Loss Order?
A stop-loss order is an order placed with a broker to buy or sell once the stock reaches a certain price. A stop-loss is designed to limit an investor’s loss on a security position. Setting a stop-loss order for 10% below the price at which you bought the stock will limit your loss to 10%. For example, let’s say you just purchased Microsoft (Nasdaq: MSFT) at $20 per share. Right after buying the stock you enter a stop-loss order for $18. If the stock falls below $18, your shares will then be sold at the prevailing market price.
Stop-limit orders are similar to stop-loss orders, but as their name states, there is a limit on the price at which they will execute. There are then two prices specified in a stop-limit order: the stop price, which will convert the order to a sell order, and the limit price. Instead of the order becoming a market order to sell, the sell order becomes a limit order that will only execute at the limit price or better.Advantages of the Stop-Loss Order
First of all, the beauty of the stop-loss order is that it costs nothing to implement. Your regular commission is charged only once the stop-loss price has been reached and the stock must be sold. You can think of it as a free insurance policy.
Most importantly, a stop-loss allows decision making to be free from any emotional influences. People tend to fall in love with stocks, believing that if they give a stock another chance, it will come around. This causes procrastination and delay, when giving the stock yet another chance may only cause losses to mount.
No matter what type of investor you are, you should know why you own a stock. A value investor’s criteria will be different from that of a growth investor, which will be different still from an active trader. Any one strategy may work, but only if you stick to the strategy. This also means that if you are a hardcore buy-and-hold investor, your stop-loss orders are next to useless.
The point here is to be confident in your strategy and carry through with your plan. Stop-loss orders can help you stay on track without clouding your judgment with emotion.
Finally, it’s important to realize that stop-loss orders do not guarantee you’ll make money in the stock market; you still have to make intelligent investment decisions. If you don’t, you’ll lose just as much money as you would without a stop-loss, only at a much slower rate.Not Just for Preventing Losses
Stop-loss orders are traditionally thought of as a way to prevent losses, thus its namesake. Another use of this tool, though, is to lock in profits, in which case it is sometimes referred to as a “trailing stop.” Here, the stop-loss order is set at a percentage level below the current market price, not the price at which you bought it. The price of the stop-loss adjusts as the stock price fluctuates. Remember, if a stock goes up, what you have is an unrealized gain, which means you don’t have the cash in hand until you sell. Using a trailing stop allows you to let profits run while at the same time guaranteeing at least some realized capital gain.
Continuing with our Microsoft example from above, say you set a trailing stop order for 10% below the current price, and the stock skyrockets to $30 within a month. Your trailing-stop order would then lock in at $27 per share ($30 – (10% x $30) = $27). Because this is the worst price you would receive, even if the stock takes an unexpected dip, you won’t be in the red. Of course, keep in mind the stop-loss order is still a market order—it simply stays dormant and is activated only when the trigger price is reached—so the price your sale actually trades at may be slightly different than the specified trigger price.Drawbacks of Stop-Losses
The advantage of a stop-loss order is you don’t have to monitor how a stock is performing daily. This convenience is especially handy when you are on vacation or in a situation that prevents you from watching your stocks for an extended period.
The main disadvantage is that a short-term fluctuation in a stock’s price could activate the stop price. The key is picking a stop-loss percentage that allows a stock to fluctuate day to day while preventing as much downside risk as possible. Setting a 5% stop loss on a stock that has a history of fluctuating 10% or more in a week is not the best strategy. You’ll most likely just lose money on the commission generated from the execution of your stop-loss order.
There are no hard-and-fast rules for the level at which stops should be placed. This totally depends on your individual investing style: An active trader might use 5% while a long-term investor might choose 15% or more.
Another thing to keep in mind is that, once you reach your stop price, your stop order becomes a market order and the price at which you sell may be much different from the stop price. This fact is especially true in a fast-moving market where stock prices can change rapidly. Another restriction with the stop-loss order is that many brokers do not allow you to place a stop order on certain securities like OTC Bulletin Board stocks or penny stocks.
Stop-limit orders have further potential risks. These orders can guarantee a price limit, but the trade may not be executed. This can harm investors during fast market if the stop order triggers but the limit order does not get filled before the market price blasts through the limit price. If bad news comes out about a company and the limit price is only $1 or $2 below the stop-loss price, then the investor must hold onto the stock for an indeterminate period before the share price rises again. Both types of orders can be entered as either day or good-until-canceled (GTC) orders.The Bottom Line
A stop-loss order is a simple tool, yet many investors fail to use it effectively. Whether to prevent excessive losses or to lock in profits, nearly all investing styles can benefit from this trade. Think of a stop-loss as an insurance policy: You hope you never have to use it, but it’s good to know you have the protection should you need it.
AnonymousHow the Trailing Stop/Stop-Loss Combo Can Lead to Winning Trades
Online brokers are constantly on the lookout for ways to limit investor losses. One of the most common downside protection mechanisms is an exit strategy known as a stop-loss order, where if a share price dips to a certain level the position will be automatically sold at the current market price to stem further losses.KEY TAKEAWAYS
• With a stop-loss order, if a share price dips to a certain set level, the position will be automatically sold at the current market price, to stem further losses.
• Traders may enhance the efficacy of a stop-loss by pairing it with a trailing stop, a trade order where the stop-loss price isn’t fixed at a single, absolute dollar amount, but is rather set at a certain percentage or a dollar amount below the market price.Trailing Stops
Traders can enhance the efficacy of a stop-loss by pairing it with a trailing stop, which is a trade order where the stop-loss price isn’t fixed at a single, absolute dollar amount, but is rather set at a certain percentage or dollar amount below the market price.
Here ‘s how it works. When the price increases, it drags the trailing stop along with it. Then when the price finally stops rising, the new stop-loss price remains at the level it was dragged to, thus automatically protecting an investor’s downside, while locking in profits as the price reaches new highs. Trailing stops may be used with stock, options, and futures exchanges that support traditional stop-loss orders.Workings of a Trailing Stop
To better understand how trailing stops work, consider a stock with the following data:
• Purchase price = $10
• Last price at the time of setting trailing stop = $10.05
• Trailing amount = 20 cents
• Immediate effective stop-loss value = $9.85If the market price climbs to $10.97, your trailing stop value will rise to $10.77. If the last price now drops to $10.90, your stop value will remain intact at $10.77. If the price continues to drop, this time to $10.76, it will penetrate your stop-level, immediately triggering a market order.
Your order would be submitted based on the last price of $10.76. Assuming that the bid price was $10.75 at the time, the position would be closed at this point and price. The net gain would be $0.75 per share, less commissions, of course.
During momentary price dips, it’s crucial to resist the impulse to reset your trailing stop, or else your effective stop-loss may end up lower than expected. By the same token, reining in a trailing stop-loss is advisable when you see momentum peaking in the charts, especially when the stock is hitting a new high.
Revisiting the aforementioned example, when the last price hits $10.80, a trader can tighten the trailing stop from $0.20 cents to $0.11, allowing for some flexibility in the stock’s price movement, while ensuring that the stop is triggered before a substantial pullback can occur. Shrewd traders maintain the option of closing a position at any time by submitting a sell order at the market.The Best of Both Worlds
When combining traditional stop-losses with trailing stops, it’s important to calculate your maximum risk tolerance. For example, you could set a stop-loss at 2% below the current stock price and the trailing stop at 2.5% below the current stock price. As share price increases, the trailing stop will surpass the fixed stop-loss, rendering it redundant or obsolete.
Any further price increases will mean further minimizing potential losses with each upward price tick. The added protection is that the trailing stop will only move up, where, during market hours, the trailing feature will consistently recalculate the stop’s trigger point.
Using the Trailing Stop/Stop-Loss Combo on Active Trades
Trailing stops are more difficult to employ with active trades, due to price fluctuations and the volatility of certain stocks, especially during the first hour of the trading day. Then again, such fast-moving stocks typically attract traders, because of their potential to generate substantial amounts of money in a short time. Consider the following stock example:
• Purchase price = $90.13
• Number of shares = 600
• Stop-loss = $89.70
• First trailing stop = $0.49
• Second trailing stop = $0.40
• Third trailing stop = $0.25Figure 1: A trailing stop-loss order
In Figure 1, we see a stock in a steady uptrend, as determined by strong lines in the moving averages. Keep in mind that all stocks seem to experience resistance at a price ending in “.00m” and also at “.50,” although not as strongly. It’s as if traders are reluctant to take it to the next dollar level.
Our sample stock is Stock Z, which was purchased at $90.13 with a stop-loss at $89.70 and an initial trailing stop of $0.49 cents. When the last price reached $90.21, the stop-loss was canceled, as the trailing stop took over. As the last price reached $90.54, the trailing stop was tightened to $0.40, with the intent of securing a break even trade in a worst-case scenario.
As the price pushed steadily toward $92, it was time to tighten the stop. When the last price reached $91.97, the trailing stop was tightened to $0,25 cents from $0.40. The price dipped to $91.48 on small profit-taking, and all shares were sold at an average price of $91.70. The net profit after commissions was $942, or 1.74%.
For this strategy to work on active trades, you must set a trailing stop value that will accommodate normal price fluctuations for the particular stock and catch only the true pullback in price. This can be achieved by thoroughly studying a stock for several days before actively trading it.
Next, you must be able to time your trade by looking at an analog clock and noting the angle of the long arm when it is pointing between 1 p.m. and 2 p.m., which you’ll want to use as your guide. Now, when your favorite moving average is holding steady at this angle, stay with your initial trailing stop loss. As the moving average changes direction, dropping below 2 p.m., it’s time to tighten your trailing stop spread (see Figure 1).
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• The trailing stop/stop-loss combo eliminates the emotional component from trading, letting you rationally make measured decisions based on statistical information.Trader Risk
Traders face certain risks in using stop-losses. For starters, market makers are keenly aware of any stop-losses you place with your broker and can force a whipsaw in the price, thereby bumping you out of your position, then running the price right back up again.
Also, in the case of a trailing stop, there looms the possibility of setting it too tight during the early stages of the stock garnering its support. In this case, the result will be the same, where the stop will be triggered by a temporary price pullback, leaving traders to fret over a perceived loss. This can be a tough psychological pill to swallow.The Bottom Line
Although there are significant risks involved with using trailing stops, combining them with traditional stop-losses can go a long way toward minimizing losses and protecting profits.
A butterfly that is OTM at expiration will expire worthless and the most it can possibly lose is the debit paid to put the trade on.
If the price overshoots all of the strikes and puts a butterfly ITM at expiration, that is where things get a bit confusing. A butterfly is a combination of a debit spread and a credit spread. If both spreads are ITM then the debit spread is worth the max value, which is the difference between the long and the short option and the credit spread is at a max loss, which is the difference between the short and the long option. Technically, they offset each other and the premium paid to enter the trade is worth 0.
If a trader decided to hold through expiration and all options are exercised then the NET position should be flat. The only cost there might be is the assignment fees on the short options. IMO, it is best to close the trade instead of holding through expiration to avoid dealing with assignments.
The question about early assignment on short strikes comes up all the time and the answer is that there’s a very small chance of this happening and long options have this situation covered. There’s nothing to worry about.
RUT at 1511
I’m going to add Tier 2 butterfly. I am setting up a butterfly 20 points above Tier 1 with 70 X 60 wings. Next level where I need to add is 1530
Order Ticket Type Asset Duration Strike C/P BTO RUT 18SEP 1540 PUT STO X2 RUT 18SEP 1480 PUT BTO RUT 18SEP 1410 PUT Total Debit: 5.80 RUT at 1533
I’m going to add Tier 3 butterfly according to the plan. This butterfly is 20 points above Tier 2 and I am using the same structure as previous Tiers (70/60 wings)
Order Ticket Type Asset Duration Strike C/P BTO RUT 18SEP 1560 PUT STO X2 RUT 18SEP 1500 PUT BTO RUT 18SEP 1430 PUT Total Debit: 6.50 – 6.60 RUT at 1539
With 26DTE I am looking to eliminate upside risk and keep my NET delta relatively flat.
I am going to roll 1520 put down 20 points, taking in a credit (which will remove upside risk) and this move will increase BPR by about 1,350 per 1 contract
Order Ticket Type Asset Duration Strike C/P Sell To Close RUT 31AUG 1520 PUT Buy To Open RUT 31AUG 1500 PUT Total Credit: 6.60
