Recently in Blogs Category

Preface

For those of you who don't know, Adam Warner writes the excellent and influential blog Daily Options Report. I began reading his writing when he co-wrote the options column on Street Insight (part of the TheStreet.com family) from spring 2003 to spring 2005. He is currently Options Editor at Minyanville.com. You can read his profile at his About on his blog.

Readers should know that I correspond occasionally with Adam Warner and that I respect him. I have learned a tremendous amount from his articles and from his answers to my questions. Moreover, I admired his warning readers that they might wish to exercise caution when following Lenny Dykstra's options articles on The Street.com. His warnings were long before Dystra's problems became fodder for the mass media, including CNBC. Adam is a friend and thus some might consider my book review biased.

Overall Summary

I use options in my trading and investing. However, I am not a sophisticated options trader who rebalances his delta hedge on an hourly or daily basis. Instead, I tend to use options to profit from the view I have of the markets or a stock.

As part of my on-going learning, I do read about options on websites, newspapers, and blogs. I read about options traders taking advantage of gamma, and, although I had a sense of what they were doing, I was never clear. After reading Adam Warner's book Options Volatility Trading: Strategies for Profiting from Market Swings, I have a solid understanding.

I thoroughly enjoyed this book because it was like having a conversation with Adam, where he gave me a tutorial on how he thinks about options and how he trades them. He could easily have used complex mathematics, charts and diagrams, overly complex strategies to confuse most readers. Instead, he chose a conversational tone with sufficient material that most options readers would readily understand.

If you are brand new to options, this book might not be the proper entry point. Instead, you might wish to view the learning tutorials covered by Options News Network, an online site dedicated to, surprise, options.

If, however, you have a reasonable understanding of options, then you will find this book invaluable. By reasonable understanding of options, you know what a put and a call are and can describe them. Moreover, you have a rough idea of the Greeks, though Warner does provide a quick snapshot of the Greeks in his book. You don't require a strong or thorough understanding, just a reasonable understanding, to benefit from reading this book.

As fair warning, I did read some sections slowly and more than once. However, when I learn new material, I often read sections slowly and more than once. I learn better using this technique.

After reading Warner's book, I am much more comfortable in reading options articles. For example, when authors talk about the VIX, I am knowledgeable about the VIX, how it works, how to interpret it, and its shortcomings. I have a better appreciation of which options strategies to employ when.

Now that I have read this book, do I plan to become an aggressive options trader? I do not think so. Will I use strategies discussed in this book to enhance my returns? Yes, absolutely.

Is this book a worthwhile investment? Yes, most definitely. Even if the only benefit you derive is being able to understand options articles better than you did before, the book is a worthwhile investment. My knowledge is much stronger than it was before. And, I know that will profit from the knowledge and strategies discussed in the book.

I highly recommend Options Volatility Trading: Strategies for Profiting from Market Swings—Five Stars.

Introduction

Adam Warner sets out the tone of the book where he explains that he will focus on volatility and the VIX. You will learn how to measure volatility or how to manage an active account or an investment portfolio with an ever-changing set of backdrop conditions.

Chapter 1: Who Am I? Why Am I Here?

From August 1988 until the 2000 timeframe, Warner worked as a Market Maker on the floor of the Amex Options Exchange. He describes his experiences and how the Amex changed during his tenure. My most important take-away is that Warner had to think quickly on his feet. Thus, through his experiences, he not only understood the technical aspects, but also gained an intuitive feel. I like that the author has achieved a wealth of knowledge and confidence.

Chapter 2: Know Your Greeks

Warner provides a quick high-level tutorial on the options Greeks. If you are looking for a thorough, rigorous text discussing the intricacies of the Greeks, then you'll need to consult other texts. His purpose in this chapter is to ensure that you have sufficient knowledge to understand the rest of the text.

As part of his quick overview, he teaches you how to think about your position sizing by using delta. That is, convert your option exposure through delta into a stock position. Given your portfolio, is your option size reasonable? While options can employ leverage to positive effect, they can, if you are not careful or have a string of poor luck, destroy your portfolio. He cautions readers to ensure that their positions are not outsized for their portfolios.

Here's a mental model that helped me:

• Delta - Useful for sizing and judging risk exposure.
• Theta - The slope on a hill while driving or biking. Either it is a positive force driving forward or it is a negative force that you need to overcome through trading.
• Gamma - Represents the energy or power. If I have lots of gamma at my disposal, I can more readily overcome theta.

Chapter 3: Understanding the VIX

Warner provides a high level overview of the VIX. As part of his overview, he instructs you on how you should view and make sense of iVolatility.com historical and implied volatilities. He also provides some historical contexts and provides some quirks with the VIX.

Chapter 4: Nuts and Bolts VIX

This chapter picks up from the last and provides more detail. Warner teaches you how to interpret the VIX in that it provides an expectation, not a guarantee of future price movement. Moreover, market volatility expectations are formed from the volatility of individual stocks and their correlation.

Chapter 5: Volatility Timing

Not all days are created and not all months are created equal. Warner uses historical analysis to help guide you when it is usually better to buy and sell options.

Chapter 6: How Do Traders Trade Volatility

In general, net selling options at a higher volatility and net buying options at a lower volatility than they ultimately realize is profitable. However, active trading is often required. Warner discusses how often you should rebalance your delta hedge among other considerations.

Because of my style of trading options is so much different from Warner's volatility style, I found this chapter particularly rewarding and helpful.

Chapter 7: Options and the Quarterly Earnings Report

Often you hear analysts say, "Stock ABCD is expected to move X%, either up or down, after the bell when it releases its earnings."

This chapter teaches you how you can determine for yourself how much the stock is expected to move. This knowledge is helpful whether you are an option or stock trader. If your expectations are different from that of the market, you can play accordingly. But, as Warner mentions, you have to be prepared to defend your position and take your medicine when the markets surprise you.

Chapter 8: Like the Weather--The Trader VIX and Why It Doesn't Do What You Think It Does

For those that don't understand them well, VIX, VIX futures, VIX Options on Futures, and VIX ETNs are complex and confusing. After reading this chapter, I have a clear understanding of how these instruments work. Consequently, I will take Warner's advice not to use them. Instead, as he suggests, I will keep it simple by using a different set of common indexes and ETFs.

With all the discussion in the media about VIX and fear index and how people might want to protect themselves against volatility, investors and traders should understand VIX. I suspect a surprising number do not.

Chapter 9: Ratio, Ratio

Put call ratios should be interpreted and used with caution, especially for individual stocks. By themselves, they could indicate any number of scenarios, and for you the trader, it is often difficult, if not impossible, to understand which scenario is at play.

Chapter 10: We're (Pin) Jammin'

Warner discusses the circumstances that make pins more likely. A pin is where a stock expires at a strike price. If you knew in advance where a stock would be pinned, then you could profit from this knowledge.

Chapter 11: Myth-Busting and Other Assorted Options- and Expiration-Related Stats

There are several urban legends related options and options expiry. Warner examines a few of them and provides you with his analysis. For example, we often hear that expiration week is more volatile? Is that true, and if so, how can you profit from it?

Chapter 12: Buy-Write--You Bet

I found this chapter surprising because the results were exactly counter to my expectations. A buy-write is when an investor or trader buys a stock and sells a call. The call provides extra income while limiting potential capital gains. Under what circumstance is it advantageous to engage in buy-writes?

Chapter 13: Strategy Room

This is a great chapter because Warner provides his thoughts and analysis on some common strategies such as:

• Naked Put;
• Bull Call Spread;
• Bear Put Spread;
• Backspreads;
• Calendar Call Spread;
• Backspread and Calendar Spread Combined;
• Butterfly Spread;
• Iron Butterfly;
• Condor;
• Iron Condor;
• Synthetics; and
• Dividend Plays.

Armed with this knowledge, you are better equipped to think about which strategies you want to employ under various circumstances.

Chapter 14: Ultra and Inverse ETFs

I found this chapter surprising, because even though I am well versed in how double and triple exchange traded funds (ETFs) work, I didn't realize the size and scope of some of these ETFs. If you don't understand how ultra and inverse ETFs grind your results down over time, you definitely need read and understand this chapter. And perhaps you'll be surprised too at how important these ultra and inverse ETFs have become to the markets.

Chapter 15: Chartin' Them Derivatives

Many investors have profited by using technical analysis. In this chapter, Warner cautions traders not to employ the same methodology to derivatives. Under certain circumstances, it might provide some additional guidance around the edges.

Chapter 16: Plus Ticks and Other Rules

The key theme in this chapter is that you must trade the market you're given, not the market you would like it to be. Whether you agree with the plus tick rule for shorting stocks is irrelevant. Trade the market with rules as they exist.

Disclosure: As part of the Amazon Associate program, I receive remuneration for each book sold by clicking on the Amazon.com links in my article.

On Thursday, 4 June 2009, I photographed Ana Avramovic at Heritage Park in Calgary Alberta. If you click on my Flickr profile link, you will be taken to Flickr where you can see more of my pictures.

Building on my prior article on Adam Warner's book, Options Volatility Trading: Strategies for Profiting from Market Swings, I will comment on the next four chapters.

Chapter 3: Understanding the VIX. This is a critical chapter because it serves as the backbone for the book. You learn what volatility is and how it is represented through VIX. VIX is how many investors and traders express fear and complacency. However, VIX is not perfect and this chapter explains why.

Chapter 4: Nuts and Bolts VIX. You learn that VIX represents the expected volatility of the SPX, the S&P 500. Notice that it is an expected volatility. For example, a VIX of 32 implies a roughly 2 percent range in the SPX on any given day. You also learn that volatility has two key components: volatility of individual S&P 500 component stocks and correlation among those stocks. That is, if stocks are extremely volatile but uncorrelated, then the VIX will be lower than when the stocks are undergoing the same volatility but are tanking in unison.

Chapter 5: Volatility Timing. With regard to buying and selling options, you learn that not every day is created equal. There are better days within the expiration cycle to either buy or sell options. And, there is seasonality to options as well.

Chapter 6: How Do Trader Trade Volatility. This chapter is where the real fun starts. Now, you are beginning to use your knowledge from the previous chapters to think about how you want trade. If you buy or sell options, what are your considerations with regard to volatility, delta, and gamma? Can a buyer and seller of the same options both make money, and if so, how? Do you prefer a high or low volatility environment, and why? What does volatility mean to options traders?

In a few days, I will provide another update.

On Sunday, 18 July 2009, I photographed Fish Creek in Fish Creek Provincial Park, which is located within Calgary. In a larger version of this photograph, you can easily see one of the many bridges in Fish Creek Park. And, if you click on my Flickr profile link, you will be taken to Flickr where you can see more of my pictures.

Disclosure: As part of the Amazon Associate program, I receive remuneration for each book sold by clicking on the Amazon.com links in my article.

I have begun reading Adam Warner's new book Options Volatility Trading: Strategies for Profiting from Market Swings. For those of you who don't know, Adam writes the excellent and influential blog Daily Options Report. I started reading Adam's writing when he co-wrote the options column on Street Insight (part of the TheStreet.com family) from spring 2003 to spring 2005. He is currently Options Editor at Minyanville.com. You can read his profile at his About on his blog.

Readers should know that I correspond occasionally with Adam and have tremendous respect for him. I have learned a tremendous amount from his articles and from his answers to my questions. Moreover, I admired his warning readers that they might wish to exercise caution when following Lenny Dykstra's options articles on The Street.com. His warnings were long before Dystra's problems became fodder for the mass media, including CNBC. Adam is a friend and thus I will likely be biased in my review of his book.

So far, I have just covered the Introduction, Chapter 1: Who Am I? Why Am I Here?, and Chapter 2: Know Your Greeks. The introduction is great because Adam sets out that the book will not be a cookbook with easy to follow recipes for success nor will it be steeped in heavy mathematics or formulas. Instead, the book will be focused on how to use information and data to manage an active account or portfolio with an ever changing set of circumstances. Adam provides his personal background in Chapter 1. I found knowing his background interesting for a couple reasons. First, I was amazed at how primitive the options markets were only a few years ago. And second, because of Adam's experience as a floor trader at the Amex Option Exchange, I know that Adam has a well honed intuitive feel for the markets and is able to think rapidly on his feet. In Chapter 2, Adam provides the reader with a high level overview of the major Greeks in options trading. As stated earlier, Adam skips over the mathematical treatments and provides the reader with the essential information.

If you are just starting out with Options, this book is not your best starting point. You should have a basic understanding of calls and puts. If you don't have that understanding, the free educational videos at Options New Network ONN.TV are a good resource. You don't require an in-depth understanding of options to read Adam's book. However, you should know what calls and puts are and understand their basic payoff diagrams.

So far, I am thoroughly enjoying Adam's book. After a few more chapters, I will provide another update.

On Sunday, 18 July 2009, I photographed the Weaselhead area in North Glenmore Park in Calgary. I know that Adam enjoys riding his bike, so I thought this photography from one of my bike rides was an appropriate photograph to include with my review. And, if you click on my Flickr profile link, you will be taken to Flickr where you can see more of my pictures.

Disclosure: I am long TheStreet.com stock. And as part of the Amazon Associate program, I receive remuneration for each book sold by clicking on the Amazon.com links in my article.

We have enjoyed two strong days in the stock market. On a pullback, one strategy you might wish to consider is to short puts on a stock that you like and do not own. This is called a naked put or uncovered put position.

Why short puts?

I am occasionally shorting out of the money puts on stocks that I do not think will go significantly higher from current levels and—this part is important—would be comfortable owning at the strike price. Because current volatility is high, options are relatively expensive. And, all options decay with time. That is, if the stock price were to remain at a stationary price, the out of the money put options would become cheaper as the expiration date approaches. And, if the put expires out of the money, I keep the entire put purchase price.

If the stock price moves upwards, the put options decrease in price. You can either buy back the put options to lock-in a gain. Or, you can continue to wait, hoping that the options expire worthless. What I decide to do is largely a function of how much the stocks have moved upwards and how much time remains before the options expire. For example, if recently I initiated a short put position with one month to expiration and we enjoyed a strong two day rally of over ten percent, I would close out my short put position to lock-in the gains.

If the stock price plummets such that the out of the money puts are now in the money puts, you have two options. One, you can buy the put options back for a reduced profit or loss. Depending on how far in the money the puts are, you might be in a loss position, but not necessarily. It depends on how deeply the puts are in the money. Or two, you can wait for expiration and be assigned the put. In theory, you could be assigned the put at any time the puts are in the money; however, with the current high volatility and low interest rate, the put holder is better to sell rather than exercise the puts.

Remember at the very outset, I determined that I would be comfortable owning the stock at the strike price. In reality, you would own the stock at the strike price less the initial short put price (plus commissions). For example, if you sold puts (naked puts) on stock ZZZZ for $5.00 with a strike price of $100.00, your effective purchase price is $95.00. One important thing to keep in mind is that your comfortable price today may change once the stock has defiantly punctured that floor price. In other words, you might be happy initially owning ZZZZ at $100.00. But on a sudden meltdown where ZZZZ plummets to $80.00, you will wonder how could you have ever been comfortable with owning ZZZZ at $100.00. The key point is that you must continue to monitor your position because your comfortable floor price might change with market or stock conditions.

Let us look at an example using Apple Inc. (AAPL). Assume that we believe that Apple's stock price will remain turbulent for the next several months. We do not believe that Apple will snap back to well over a $100 and stay there. So we want to sell out of the money put options to capture the premium. Please note, this is purely a hypothetical example. I am in not recommending this trade or investment. In other words, you must arrive at your own decisions.

Today, Apple closed at $92.95, up $10.37. Below is a one year chart of Apple. If you click through, you can view a larger image.

Assume that you are comfortable owning the stock at $75 under any conditions. Looking at Yahoo Finance Apple Option Quotes, we note that the December $75 options are bid $2.02 and ask $2.08, down approximately $2.95. Because we just experienced a strong two day rally, you decide not to enter the trade at these prices. Instead, you wait for a pullback.

Let us further assume that tomorrow morning the markets go down heavily. Apple reverses today's gain of $10.37, goes back to $82.58 and the put options prices go up $3.00 to $5.10. Now you execute the trade. Under this scenario, you gain $5.10 as long as Apple remains above $75 per share. If the stock is going to expire below $75.00, you will either be required to purchase the put option back prior to or upon expiration or be assigned the put option, meaning you will be forced to purchase the stock.

If the stock closes between $69.90 and $75.00, you win. You win because you effectively paid $69.90 ( = $75.00 - $5.10 ) for a stock that is worth $69.90 or greater.

If the stock expires below $69.90, you lose. For example, if the stock expired at $60.00, then you lost $9.90. Your initial premise, however, was that you were willing to own Apple at $75.00 under any conditions. If Apple were to expire at $60.00 in December, that would certainly test how honest you were with yourself.

By having a naked short out of the money put position, you are paid to provide insurance until expiration. If the stock remains above our strike price, you keep the entire put purchase price. If the stock is going to expire below the strike price, you will be forced to cover prior to or upon expiration or to purchase the stock.

What are some of the risks with this strategy?

One obvious risk is that Apple takes off over $100 and never looks back. While you keep the put purchase price of $5.10, that is a small consolation prize. If you had purchased Apple stock outright, your gains would be much, much larger. Again, our initial thoughts were that Apple would remain range bound for the next several months.

Another risk is that Apple expires at a low price, say $60.00 or lower. While you were initially content with purchasing Apple at $75, you now have buyers' remorse at having paid an effective price of $69.90.

Yet another risk is that you sold naked too many put options. You initially thought to yourself, how could Apple ever possibly go below $75.00 and sold a ton of naked put options? Much to your extreme surprise and disappointment, the unthinkable happened—the stock market crashed quickly taking Apple along with it. Now, you have too much expensive Apple stock sitting in your portfolio.

The three mentioned risks are the obvious ones.

Some people incorrectly believe that selling naked put options is extremely dangerous. The reality is that naked put options are very similar to a long stock and short call position. That is, if the stock rises dramatically, your gains are limited. If the stock just sits there and does nothing, you capture the price for the puts (or calls). If the stock tanks, you suffer the consequences. Where naked puts are dangerous is where you get over your head and short too many put contracts. This is the third risk that I mentioned above. Then, you have the potential to do major harm to your portfolio. Thus, before employing this strategy, you need to ask yourself, am I comfortable with owning the stock at the strike price (or more precisely at the effective price which is the strike price less the put price plus commissions)?

With volatility being high, I like this strategy for certain stocks. Please note, again, the Apple example is a hypothetical example only. You must decide which stocks, if any, are appropriate for you and at which strike prices you are comfortable. And, you should likely wait for a pullback before employing this strategy.

If option strategies interest you, I highly encourage you to read my friend Adam Warner's blog Daily Options Report. Adam provides much more detail and much more insight than I do in my high level discussion in this article.

Disclosure: I have no positions in Apple.

My photograph of Calgary at Night is hosted at Flickr. If you click on the picture, you will be taken to my Flickr account where you can see more pictures.

James DiGiorgio recently highlighted a new and interesting blog StudioMarcotte.com by Bob Marcotte, a photographer in Fresno, California. With his latest article When Your Best Is Not Good Enough (Part 1), Bob has turned me into a loyal reader. Go and read his article, and I am sure you will become a loyal reader too.

Regardless of our methods and techniques, we’re all striving to create a soul in our images. So it would seem to be an easy task to shoot a town filled with souls. It would seem…

California is filled with millions of souls and personalities. Most of the world only hears about the fruits, flakes and nuts that make up the Granola State. I would like all of you to know that there are heroes who live here, too. They don’t get headlines. In fact, I couldn’t get these pictures or this story published by the one major newspaper or the two local magazines in Fresno. Anti-heroes get press, the story of these volunteers wasn’t considered news.

The souls I refer to are the pilots, doctors, nurses, translators and volunteers of an organization called the Flying Doctors of Mercy. I was fortunate to fly with the Fresno chapter. The short version of their story is that the first weekend of almost every month, private pilots fly their own planes filled with volunteers and supplies to impoverished towns in Mexico. Planes fly from San Diego, Los Angeles, Fresno and other cities to adopted towns deep inside Mexico … far from prosperity and medical expertise.

Just wait to you see his picture that accompany the beginning of his article. They drip with soul. I especially love the photograph of the husband and father with his child and wife.

My photograph of Jasper National Park is hosted at Flickr. If you click on the picture, you will be taken to my Flickr account where you can see more pictures.